Beware of these signs on the bank loan market

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08/09/2019 | 04:57 pm
In an interesting analysis, Collin Martin from Charles Schwab singles out three warning signs for the bank loan market:

Because three-month LIBOR are highly correlated with the federal funds rate, and the market expects some more rate cuts, it’s unlikely that LIBOR rates will move higher anytime soon. “That means bank loan coupon payments are likely to fall further,” says M. Martin.

Source: Charles Schwab, with Bloomberg, using weekly data as of 7/31/2019. ICE LIBOR USD 3 Month (US0003M Index).

He also warns that bank loan prices are high and there’s little room for prices to rise much further. “Through the end of the year, income payments, not price appreciation, should be a key driver of total returns”.

Source: Charles Schwab, with Bloomberg, using weekly data as of 7/31/2019. S&P/LSTA U.S. Leveraged Loan 100 Index (SPBDLLB Index). Past performance is no guarantee of future results.

Finally, the analysis highlights the deteriorating quality of bond covenants, which are a set of terms outlining what the issuing firm can or can’t do with regard to its business. “Lately, loans simply haven’t included many covenants that can help protect investors (…) Without strict covenants, firms can engage in riskier business practices”. As a result, “there may be less value in a given company if it were to default, leading to lower recovery rates.” Charles Schwab concludes that this trend in covenant quality could actually lead to sharp price declines. 

These are relevant observations that should be taken in consideration by anyone who is interested in the bank loan market.
Romain Fournier
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