Bank loan funds (also known as senior loans or leveraged loans) have seen $5.6B of net inflows this year, with a nice chunk of that coming in the weeks since the election, writes Chris Dieterich at the WSJ.
It's no secret why: First, investors view bank loans as lower risk than junk bonds as they're ahead in the corporate structure in the event of a default. Maybe more importantly given the current environment, these loans are floating rate, making them popular in times of rising interest rates.
One measure of how popular they've become - narrowing discounts to NAV in closed-end funds. The Apollo Senior Floating Rate CEF (NYSE:AFT) could be had for a 15.1% discount to NAV in February, but just 5.1% today. Similar action is seen in others like the BlackRock Floating Rate Income Strategies Fund (NYSE:FRA) and the Nuveen Floating Rate Income Opportunity Fund (NYSE:JRO).
"Our fundamental outlook for leveraged credit remains constructive," says Global CIO Scott Minerd, noting spreads of more than 900 basis points in February are consistent with six-month default rates in the 9-10% range - an overestimation in his view.
Though spreads have narrowed since, Guggenheim is still finding bargains in both high-yield (HYG, JNK) and bank loans, and Minerd reminds bank loan borrowers in particular could benefit from the Fed's caution on rate hikes (bank loans tend to be floating rate).
Guggenheim's Floating Rate Strategies Fund (MUTF:GIFAX) is near the top of bank loan funds, with an average annual return of 2.84% over the last three years.
The average bid of LCD News' flow-name loan composite has surged 82 basis points over the few sessions to 96.49% of par. Of the 15 names in the sample, 13 advanced, none declined, and two were unchanged.
By far the biggest mover was Scientific Games B-2 term loan due in 2021, which was a bid a full five points higher after better-than-expected Q4 results.
$13.1B of money exited bond funds in the week ended Wednesday, according to BAML in a report titled "Bond Carnage," the largest weekly outflow since June of 2013.
Unsurprisingly, bank loan funds and high-yield funds (two sides of the same coin) were stung hardest (based on percentage of AUM). Emerging market debt was right behind, while investment-grade and Treasury funds saw relatively small outflows.
You wouldn't know it by today's busy M&A headlines, but a sizable slump in the prices of recent buyout loans, could threaten the pace of future deals.
Nearly half of the $75B in buyout loans arranged in the U.S. and tracked by Bloomberg are trading below their issue price, and leveraged loans could be headed for their first loss since 2008.
Investors have pulled cash from leveraged loan mutual funds for 12 straight weeks, and just $5.8B of CLOs were created last month, 34% below 2015's monthly average.
The result is underwriters forced to sell debt at the steepest discounts to par in four years and investors pushing for higher interest rates to buffer against possible principle loss. It didn't scare Western Digital away from SanDisk, but Dell could need to raise nearly $50B for its purchase of EMC.
Vanguard Group, Guggenheim Investments, and First Trust are among U.S. ETF providers lining up bank credit lines or expanding existing ones in order to meet a rash of redemptions in some future market panic, writes Ashley Lau and Michael Flaherty.
At issue are ETFs in less liquid corners of the fixed-income world - bank loans (also known as senior or leveraged loans) and high-yield come to mind.
State Street (NYSE:STT) and Invesco's (NYSE:IVZ) PowerShares have credit lines for their respective senior loan ETFs (SRLN, BKLN, VVR), with SRLN having exclusive access to $100M of the $300M total credit facility State Street has in place.
BlackRock (NYSE:BLK) hasn't opened any lines for its bond funds as it doesn't trade in these less liquid areas, but it has opened a line for some its emerging market stock ETFs.
The AdvisorShares Pacific Asset Enhanced Floating Rate Note ETF (Pending:FLRT) will be managed by Pacific Asset Management and seeks to maximize yield while targeting highly liquid loans and debt securities.
While senior bank loans are high-yield assets, they are less risky then the average high-yield bond since in the event of a bankruptcy senior bank loans are the first debt to be repaid.
There's $791B of high-yield debt coming due in the next five years, according to Moody's, raising at least some concern as most expect interest rates to be anywhere from slightly to significantly higher.
The projections are the highest since 2010, when Moody's said companies faced $1.2T in debt coming due. Things worked out all right for that wave as borrowers were able to refinance, usually at far lower interest rates. This time around, the Fed and ZIRP may not be around to help.
After first sweetening terms to try and attract buyers, Apollo Global yesterday pulled a $400M deal meant to help fund its purchase of Presidio Holdings. And Apollo isn't alone. "Anything with a little bit of hair on it is more challenged," says Pimco's Jason Rosiak. "People are being more selective."
Outflows from high-yield funds began about nine months ago, and accelerated last week, with $738M in net redemptions bringing the year's total to $1.7B, according to Lipper.
Into this environment, Dollar Tree is trying to raise money for its $8.81B takeover of Family Dollar, and PetSmart needs $1.9B of bridge financing to close its BC Partners purchase.
"It's going to be a buyer's market," says one fund manager. "We’ll continue to see a bit of a premium.”
Leveraged loan volume in November of just $6.5B, according to numbers compiled by Bloomberg, is set to be the slowest since the financial system suffered cardiac arrest in 2008. This follows volume of $30B in October.
Volume is plunging alongside prices, which fell more than 3% last month, forcing yields up to 6.2%, the highest in over two years. Regulators of late have also been taking a closer look at lending practices. Year-to-date, leveraged loan volume of $473B compares to about $700B for all of 2013.
Leveraged loans have returned 2.4% YTD vs. 4.6% over the same period one year ago, and vs. the 4.1% of junk bonds. Also a change from previous years, investors are quickly pulling money out of leverage loan funds - $15.5B YTD against inflows of $62.9B a year ago.
"Banks must not heighten risk by originating and distributing poorly underwritten and low quality loans," says this year's review of bank lending from the Fed, OCC, and FDIC. "Institutions that participate in this lending activity, without implementing strong risk management processes consistent with the 2013 guidance, will be subject to criticism by the appropriate agency.”
Leveraged lending represented most of the underwriting issues observed by regulators, though the share of criticized leveraged loans fell from 2013 as big banks adjusted to last year's guidance meant to curtail deteriorating standards in the lucrative (for banks) industry.
“Thirty-one percent of leveraged transactions originated within the past year exhibited structures that were cited by examiners as weak, mainly because of a combination of high leverage and the absence of financial covenants,” says the report.
The high-yield market "rebounded spectacularly" between last Wednesday's panicky action and the start of this week, says Martin Fridson. If one were to annualize the 1.32% total return from this period, it would work out to a 160.9% gain.
Some more numbers: The average yield in the BAML high-yield index topped 6.4% last week, and has dropped back to 5.9%, bringing the spread to Treasurys down more than 50 bps to 4.5%.
Barron's Michael Aneiro continues to see value in a number of sizable closed-end funds still trading at around double-digit discounts to NAV, notably the BlakcRock Corporate High Yield Fund (HYT +1.2%), the AllianceBernstein Global High Income Fund (AWF +0.2%), and the Wells Fargo Advantage Income Opportunities Fund (EAD +0.7%).
"Banks have been scolded and they have been warned, and yet you are seeing a lot of signals that the market is heating up,” says a bank regulation consultant as the Fed - its guidelines mostly ignored by banks - is now taking a closer look at the steamy leveraged loan (also called senior loan or bank loan) market. “We have seen this bad movie before," says the consultant. "The issue now is, will the regulators deploy the rest of the arsenal of tools they have?”
Previously, regulators collected loan data in an annual survey, but have shifted in recent weeks, say sources, to monthly oversight.
“Terms and structures of new deals have continued to deteriorate in 2014," said the Fed's Todd Vermilyea in a speech earlier this year. A report last month from Barclays says covenant-light loans are on track to exceed 70% of issuance this year - a record. Another report says total debt levels for large LBOs have risen to 6.26x EBITDA in Q3 from 5.89x in H1. The average at the peak in 2007 was 6.23x.
Losing $403M in funds last week according to Lipper, loan funds (also known as leveraged loans, senior loans, bank loans) saw their 7th consecutive week of outflows - this after a 95-week streak of inflows going back to June 2012. Popular for not just their yields, but the adjustable nature of said yields, a little digging finds the variable nature is tied to Libor - which won't rise until the Fed actually hikes. Further, most loans have Libor floors, which means their rates won't rise until Libor has moved about 75 basis points.