Viewpoints
Separating signal from noise in today's loan market headlines

Timely insights from portfolio managers and industry experts on the issues that matter most to institutional investors.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

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      By Craig P. Russ, Co-Director of Floating-Rate Loans, Eaton Vance Management and Andrew Sveen, Co-Director of Floating-Rate Loans, Eaton Vance Management

      Boston - "Everyone is entitled to his own opinion, but not to his own facts." These are the sage words of the late-U.S. Senator Daniel Patrick Moynihan.

      As leading floating-rate corporate loan investors, Moynihan's sentiment strikes a particularly timely chord with us today. If you've read a newspaper or watched financial news lately, you likely understand why. Their motto seems to be, "don't let the facts get in the way of a good story." Ours is an asset class the public pundits love to hate, including those who should know better.

      Loan fund investors have moved away from our asset class in recent months, despite a sound fundamental picture and a risk/return proposition that has drawn consistent and ongoing institutional buyership. Has the approximate 10% of our market comprised of retail investors identified a fatal flaw that's been overlooked by some of the world's most sophisticated investors, that represent the 90% majority?

      While the answer is almost surely "probably not," one key distinction between the two camps is that the smaller faction indeed tends to get much more of its news from popular press. And the news cycle has been no friend to this market. This is why we don't get our news from newspapers. By contrast, research providers, the asset management community and other centers of expertise are not sounding the alarm in loans that you're seeing in financial media.

      So in no particular order, here's a quick punch list of the opinions we're hearing in retail circles (largely echoing the popular headlines of late) -- and some facts surrounding each:

      1. The Fed is on "pause" and loan returns will be worse from here. Loan coupons float over a combination of 1-month and 3-month LIBOR, and both of these track closely with the Fed's policy rate. A Fed on pause merely suggests that today's loan market base rates are expected to remain stable, not move lower. That means that today's current income levels are likely to prevail for the time being, though it appears they could still rise modestly next year if rate hikes materialize.

      2. The yield curve is flat, which portends a recession and loans should be avoided. Regardless of the shape of the yield curve, the U.S. economy remains strong -- a bright spot on the global stage, in fact. But if investors are truly concerned about a U.S. recession, selling equities and increasing safety exposures is usually the first-order place to start. If you are not so concerned about recession to the point of reducing equities, cutting second- or third-order credit products seems a bit non-sequitur (to us), especially the senior/secured kind like loans, as these have shown over time to be much more recession-proof in comparison.

      3. The loan market is illiquid. Loans represent a large and liquid asset class, with $1.2 trillion in outstandings. Concerns about liquidity and settlement times yet again proved unfounded. The loan market handled more than $20 billion in mutual fund withdrawals without incident during the last six weeks of 2018, including the typically slow holiday period. And this week, the Loan Syndications & Trading Association (LSTA) provided data that shows secondary trading in the loan market hit a new record in Q1 2019 with more than $212 billion in volume.

      4. Loan quality has degraded from its long-run character. By almost all common credit metrics be it leverage, interest coverage, fixed charge coverage, or loan to value, the ratios are within their long-term averages. Default rates just ticked below 1% versus an historical average of 3%. Other measurements of credit stress (such as loans trading below 80 cents on the dollar -- at 2%) are benign. Fundamentals of the underlying issuers are in good shape.

      5. The "trade" is over. Our base case is the loan "coupon" plus a little price appreciation - there has already been some of that, but there is also a little room for upside price movement. The S&P/LSTA Leveraged Loan Index ended April with an average bid price of $97.52 and a year-to-date return of 5.7%. Tactical entry points for loans come and go, along with routine volatility, for investors who seek to add to the coupon yield. But we think loans are best utilized strategically, given their unique characteristics, such as a secured position in the capital structure and near-zero interest-rate duration. Consider, the yield to maturity (YTM) of the S&P/LSTA Leveraged Loan Index is approximately 6.5% as of April 26, closely comparable to what's on offer in the unsecured high-yield bond market. To us, the loan market is signaling strong relative value.

      Bottom line: Floating-rate loans may serve an important role in asset allocation, today and always. They are uniquely different, and difference is by-and-large what makes for portfolio components that blend well together. The loan market has been tested over a number of business and credit cycles, in which it has proved its value as a complement to traditional portfolio fixed-income holdings.

      By Craig P. Russ, Co-Director of Floating-Rate Loans, Eaton Vance Management and Andrew Sveen, Co-Director of Floating-Rate Loans, Eaton Vance Management

      Boston - "Everyone is entitled to his own opinion, but not to his own facts." These are the sage words of the late-U.S. Senator Daniel Patrick Moynihan.

      As leading floating-rate corporate loan investors, Moynihan's sentiment strikes a particularly timely chord with us today. If you've read a newspaper or watched financial news lately, you likely understand why. Their motto seems to be, "don't let the facts get in the way of a good story." Ours is an asset class the public pundits love to hate, including those who should know better.

      Loan fund investors have moved away from our asset class in recent months, despite a sound fundamental picture and a risk/return proposition that has drawn consistent and ongoing institutional buyership. Has the approximate 10% of our market comprised of retail investors identified a fatal flaw that's been overlooked by some of the world's most sophisticated investors, that represent the 90% majority?

      While the answer is almost surely "probably not," one key distinction between the two camps is that the smaller faction indeed tends to get much more of its news from popular press. And the news cycle has been no friend to this market. This is why we don't get our news from newspapers. By contrast, research providers, the asset management community and other centers of expertise are not sounding the alarm in loans that you're seeing in financial media.

      So in no particular order, here's a quick punch list of the opinions we're hearing in retail circles (largely echoing the popular headlines of late) -- and some facts surrounding each:

      1. The Fed is on "pause" and loan returns will be worse from here. Loan coupons float over a combination of 1-month and 3-month LIBOR, and both of these track closely with the Fed's policy rate. A Fed on pause merely suggests that today's loan market base rates are expected to remain stable, not move lower. That means that today's current income levels are likely to prevail for the time being, though it appears they could still rise modestly next year if rate hikes materialize.

      2. The yield curve is flat, which portends a recession and loans should be avoided. Regardless of the shape of the yield curve, the U.S. economy remains strong -- a bright spot on the global stage, in fact. But if investors are truly concerned about a U.S. recession, selling equities and increasing safety exposures is usually the first-order place to start. If you are not so concerned about recession to the point of reducing equities, cutting second- or third-order credit products seems a bit non-sequitur (to us), especially the senior/secured kind like loans, as these have shown over time to be much more recession-proof in comparison.

      3. The loan market is illiquid. Loans represent a large and liquid asset class, with $1.2 trillion in outstandings. Concerns about liquidity and settlement times yet again proved unfounded. The loan market handled more than $20 billion in mutual fund withdrawals without incident during the last six weeks of 2018, including the typically slow holiday period. And this week, the Loan Syndications & Trading Association (LSTA) provided data that shows secondary trading in the loan market hit a new record in Q1 2019 with more than $212 billion in volume.

      4. Loan quality has degraded from its long-run character. By almost all common credit metrics be it leverage, interest coverage, fixed charge coverage, or loan to value, the ratios are within their long-term averages. Default rates just ticked below 1% versus an historical average of 3%. Other measurements of credit stress (such as loans trading below 80 cents on the dollar -- at 2%) are benign. Fundamentals of the underlying issuers are in good shape.

      5. The "trade" is over. Our base case is the loan "coupon" plus a little price appreciation - there has already been some of that, but there is also a little room for upside price movement. The S&P/LSTA Leveraged Loan Index ended April with an average bid price of $97.52 and a year-to-date return of 5.7%. Tactical entry points for loans come and go, along with routine volatility, for investors who seek to add to the coupon yield. But we think loans are best utilized strategically, given their unique characteristics, such as a secured position in the capital structure and near-zero interest-rate duration. Consider, the yield to maturity (YTM) of the S&P/LSTA Leveraged Loan Index is approximately 6.5% as of April 26, closely comparable to what's on offer in the unsecured high-yield bond market. To us, the loan market is signaling strong relative value.

      Bottom line: Floating-rate loans may serve an important role in asset allocation, today and always. They are uniquely different, and difference is by-and-large what makes for portfolio components that blend well together. The loan market has been tested over a number of business and credit cycles, in which it has proved its value as a complement to traditional portfolio fixed-income holdings.