The investment market in senior secured loans is a specialised one and, so far, much of the activity is focused in the US and Europe, but there are moves to push awareness in other regions such as Asia.

This publication likes to get into the finer details of investing to explore some of the trends and asset classes that don’t always get the attention that some say they merit. A market that has its own characteristics and risks is the senior secured loans market - SSLs - which are privately arranged forms of loan issued to groups of banks and institutional lenders to provide companies with capital. Given the travails of credit markets since the 2008 financial crisis, the workings of such SSLs deserve attention in the major wealth management markets of the world. This publication recently spoke to Invesco, and specifically to managing director and senior client portfolio manager Kevin Petrovcik, based at Invesco Fixed Income. Petrovcik had been on a trip through Asia to talk to private banks about the merits, as he sees it, of this asset class, and to raise awareness about it.

Petrovick has been at the firm’s senior loans business since 1999 to establish its product management initiative and launch its first collateralized loan obligation product. He has, since then, been responsible for providing client solutions for retail and institutional clients globally, with products ranging from retail mutual funds, closed-end funds, exchange-traded funds, commingled institutional products, separate institutional mandates, hedge funds and collateralized debt obligations. Underlying investment products have included senior secured loans, high yield bonds, investment grade bonds, asset backed securities and structured products.

In broad terms, what is the state of the senior loans market like? Is this market underdeveloped, is it expanding, and if so, where? In what currencies?
Senior secured loans (SSLs) are privately arranged loans issued to a consortium of banks and institutional creditors that provide companies with access to debt capital. SSLs traditionally offer a fixed spread over the reference rate, typically LIBOR or EURIBOR, making them “floating-rate” instruments. Borrowers typically have a credit rating below investment grade. Nonetheless, their special credit protection mechanisms (e.g. collateralization, seniority in the company’s capital structure, comprehensive financial covenants) rank SSLs at the top of the company’s capital structure.

Although companies have used SSLs for decades as part of their capital structure, the institutional market for these loans did not develop until the 1980s. Thanks to the progressive development of loan trading, settlement and administration, as well as improved transparency standards, SSLs have now established themselves as an asset class in their own right. 

Who are the main issuers of such senior loans (all sectors, only some, etc)?
Large loan issuers incorporate all major commercial and industrial industry sectors including healthcare, electronics, business equipment and services and utilities. 

What are the typical maturities of such loans? What sort of terms and conditions attach to them?
While loans are often repaid within the first two to three years, they are structured with maturities ranging from six to eight years. Loan agreements have a series of restrictions that dictate, to varying degrees, how borrowers can operate and carry themselves financially. These restrictions are called covenants. For instance, one covenant may require the borrower to maintain its existing fiscal-year end. Another may prohibit it from taking on new debt. Most agreements have financial compliance covenants, stipulating perhaps that a borrower must maintain a prescribed level of equity, which, if not maintained, gives banks the right to terminate the agreement or push the borrower into default. The size of the covenant package increases in proportion to a borrower’s financial risk.

Additionally, leveraged loans usually require a borrower to prepay with proceeds of excess cash flow, asset sales, debt issuance, or equity issuance. Borrowers must pledge all their unencumbered assets as collateral. In the leveraged market, collateral usually includes all the tangible and intangible assets of the borrower and, in some cases, specific assets that back a loan. There are some loans that are backed by capital stock of operating units. In this structure the assets of the issuer tend to be at the operating-company level and are unencumbered by liens, but the holding company pledges the stock of the operating companies to the lenders. This effectively gives lenders control of these units if the company defaults.

What are the attractions of senior loans as an asset class and why is there interest now from private banks?
Senior loans offer the potential to diversify a fixed income portfolio through both their distinct structure and their historically low correlation to other fixed income investments:

-- Senior loans provide an attractive steady income stream. As a below investment grade asset, the income generated on a senior loan typically is above other types of fixed income assets;

-- Senior loans are floating rate. Unlike traditional bonds, senior loans are structured with floating rates, which means their coupons regularly adjust to changes in a base rate.  The more frequently a loan’s coupon adjusts, the less sensitive its price to broader market changes in interest rates;

-- Senior loans are senior and secured. The senior claim means that the loan is given top priority and is repaid first, before all other claims are repaid. Senior loans are typically secured by liquid assets of a company. In the event of default, the senior status and collateral banking of senior loans generally results in a high rate of recovery;

-- Senior loans have low correlation to other types of fixed income investments and may help to mitigate volatility in rising interest rate environments.

Where in the world is there a lot of issuance of such loans at the moment and why?
Roughly 80 per cent of the global senior secured loan market is US-based with the remaining 20 per cent in European senior secured loans.

Where does Invesco invest? What sort of exposure does it have?
Invesco operates in the broadly syndicated loan market and focuses on large, liquid companies. We offer investors investment alternatives that could be US, European or global in nature.

Within HNW portfolios, do senior loans form only a small portion of total portfolios? Is this still a niche asset class?
Senior loans are a significant component of the corporate credit markets and represent roughly 4 per cent of fixed income.

How much awareness is there among investors and bankers of this asset class? Why is it changing?
Globally, investors are looking for yield today and to reduce duration risk in their portfolio. Bank loans provide good current income with little duration risk.  The third chart shows how, on a 3 year historical basis, bank loans have an attractive Sharpe ratio [risk-adjusted return].