Brian Juliano, managing director and head of the US bank loan team at PGIM Fixed Income, shares his insights on bank loans as the asset class is seen gaining favour among investors.

Brian Juliano 

Juliano joined Prudential Financial in 2000 to help convert the private mutual insurer into a publicly-traded company. He transferred to PGIM Fixed Income’s bank loan team in 2003. Today, he manages the US bank loan team and co-heads its US collateralised loan obligation business, which oversees $30 billion in bank loans.

1. What characteristics distinguish bank loans from high yield bonds?

Bank loans are loans made to below investment-grade corporate issuers. They often back mergers and acquisitions (M&As) or leveraged buyouts but are also used by corporates to finance growth or pay for the construction of new facilities.

Unlike most high-yield bonds, bank loans are senior secured investments with the first claim on a borrower company’s assets. Therefore, they are often rated higher than bonds issued by the same company. If one likens a company’s capital structure to a pyramid, bank loans sit at the very top of it. In case a company defaults, bank loan holders have a first claim on the company’s underlying assets and are the first in line to be repaid. 

2. Aside from being more senior in the capital structure, why else might someone invest in bank loans?

Unlike other fixed-income investments, bank loans are floating-rate assets, meaning that they pay a coupon on top of a benchmark interest rate. In the case of bank loans, the benchmark rate is the three-month Libor, which rises and falls alongside other global interest rates. So, while the value of other fixed-income assets typically declines when rates rise, bank loans are less sensitive to rising Treasury yields. Investors find this asset particularly attractive during times of rising inflation. And PGIM Fixed Income has seen this play out recently, with individual investors pouring over $20 billion into bank loan mutual funds so far in 2021 as they sought out floating-rate assets as a potential hedge against rising interest rates.

However, individual investors are not the main investors of bank loans. Mutual funds account for only a small portion of the market. The largest investors are collateralised loan obligations (CLOs), which invest in pools of bank loans and pay end-investors from the resulting cash flows. Global CLO issuance has been strong so far in 2021 as banks and insurance companies continue to view the spread pickup, particularly those offered by the highest-rated CLO tranches, as attractive.

While CLO managers actively manage the portfolio of loans which these funds own, they are typically long-term holders, with limited ability for frequent withdrawals. This has provided for relatively strong and stable demand for bank loans historically

3. How have bank loans performed recently and historically?

Like other spread sectors, bank loans have performed well over the past year or so. The average price of a loan rose from 76.5 as of March 2020 to 97.7 at the end of July 2021, while average bank loan yields have declined from 12.75% to 4.52%. Through the first seven months of 2021, the US Credit Suisse Leveraged Loan Index posted a total return of approximately 3.5%, just slightly below what US high-yield bonds have generated.

Bank loans are also widely considered to be a more stable asset class. Since 1992, bank loans have generated only two years of negative total returns (2008 and 2015).  The performance is due to their relatively high yields, low duration, and low historical correlation with other fixed income asset classes.

Figure 1: Bank Loans Have Experienced Only Two Years of Negative Total Returns

Source: Bloomberg, Credit Suisse. As of August 17, 2021.
 
4. What is their outlook in the post-pandemic future?
 
Strong demand combined with an improved global growth outlook and a decline in default rates is likely to remain supportive of bank loans going forward. Global CLO creation remains robust, with about $95 billion and €23 billion in US and European net issuance, respectively, so far in 2021. Meanwhile, inflows into bank loan mutual funds could continue as investors remain concerned about inflation and the potential for rising interest rates.
 
5. What are some other considerations for bank loan investors?
 
While PGIM Fixed Income believes bank loans offer a compelling pick-up in yield, strong demand
has led to some deterioration in both the credit quality of issuers and the covenants (or investor protections) that govern individual loans. Therefore, strong credit research and financial modelling capabilities, as well as deep industry experience, are more critical than ever.
 
While richer valuations and tighter spreads exist in many sectors of the fixed income marketplace, the bank loan asset class currently offers some relatively attractive opportunities for active managers.
 
For more information, please contact:
 
Helen Chang, CFA
Managing Director
Head of Asia Pacific ex Japan
Client Advisory Group

PGIM (Hong Kong) Limited
T: + 852 3769 8283  M: + 852 6898 0982
E: [email protected]

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