Financial Professionals

Market Insights

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Outlook Favorable for Bank Loans: Quality is Key

02/10/2014

In 2013, floating rate bank loans demonstrated a healthy resilience to interest rates during a volatile year for fixed income. For 2014, we are looking for “more of the same” from the sector: a coupon return of 4.0%-4.5% and a below-average default rate of 2%.* Our outlook remains positive for bank loans due to a continued benign credit environment, supportive technical backdrop, and attractive relative value.

Fundamentals

  • Macro economy is improving, and modest to moderate growth is constructive for fixed income
  • Loan default rate is 2.11%. Expect a continued low default environment in 2014: CCC-rated credit risk and debt maturities are low while debt service ratios are healthy
  • Macro tail risks remain elevated but are improving

Technicals

  • Record demand for bank loans ($152 billion) in 2013 outstripped record new volume ($129 billion), pushing prices to near par
  • Transactions are becoming more aggressive and worth watching – e.g., looser terms, higher leverage
  • Transaction risks are still manageable – i.e., market leverage, debt service, use of proceeds, and spreads are all better than 2007 pre-financial crisis levels
  • Expect new bank loan issuance to be less than 2013 levels

Pricing

  • Performing loan prices are near $99.00 (S&P/LSTA Leveraged Loan Index**). Yield to maturity as of 12/31/13 was 4.94%
  • New issue spreads are still wide by historical standards, but continue to tighten further
  • Loss avoidance at current levels and issue selection are keys to strong performance
  • Growth in retail investor inflows could enhance price volatility to the downside during “risk off” periods

Credit Selection

  • Important to be highly selective in the current environment; avoid deals with looser terms and higher leverage
  • Emphasis should be on higher quality to mitigate against macro volatility

Data cited as of December 31, 2013.

*Default estimate excludes bank loans issued by former TXU Energy Corp. (renamed Energy Future Holdings).

**The S&P/LSTA Leveraged Loan Index is a daily total return index that uses LSTA/LPC mark-to-market pricing to calculate market value change. On a real-time basis, the Index tracks the current outstanding balance and spread over LIBOR for fully funded term loans. The facilities included in the Index represent a broad cross section of leveraged loans syndicated in the United States, including dollar-denominated loans to overseas issuers. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and is not available for direct investment.

Newfleet Asset Management’s industry trends and observations are the result of research conducted by the portfolio management/research team.  These observations reflect their industry expertise and have been prepared using sources of information generally believed to be reliable; however, their accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.