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Betting On Bank Loans Again

May 17, 2016 8:36 am
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Investors continue hunting for yield, and with the Federal Reserve pausing on hiking interest rates to this point in 2016, some previously beloved high-yield asset classes that came under pressure amid last year's rate hike speculation are again being embraced.

Floating Rate Notes, Senior Loans

That includes senior loans and the PowerShares Senior Loan Portfolio (PowerShares Exchange-Traded Fund Trust II (NYSE: BKLN)). BKLN, which turned five in March, was the first exchange-traded fund to make senior loans, an asset previously reserved exclusively for institutional investors, accessible to the wider audience.

Floating rate notes and senior loans are unique in that their yield is tied to a benchmark such as LIBOR, rather than being fixed. Loans are also higher on the capital structure than other unsecured obligations, and some even carry floors to insure you earn a respectable yield even if rates stay low. Their coupon rate typically resets every 90 days, resulting in a duration shorter than three months, Benzinga reported last year.

Related Link: BlackRock Adds To Smart Beta Lineup With 9 Sector ETFs

In Defense Of BKLN

Part of the reason advisors and investors have recently eschewed BKLN is because the ETF easily qualifies as a high-yield offering. A 30-day SEC of over 6.2 percent confirms as much as does a lineup that devotes 91 percent of its combined weight to bonds rated BB, B or CCC. Fortunately, BKLN's allocation to CCC-rated bonds, one of the worst-performing corners of the junk bond market last year, is just 6 percent.

“Investors in senior bank loans expect to see competitive yields in exchange for investing in debt with lower credit ratings. However, bank loans generally have minimal exposure to the volatile energy sector. Energy accounted for 1.4 percent of the S&P/LSTA U.S. Leveraged Loan 100 Index as of April 30, 2016, and energy sector defaults are expected to climb as high as 20 percent in 2016,” said PowerShares in a note out Monday.

BKLN follows the S&P/LSTA U.S. Leveraged Loan 100 Index. In the event of issuer default, senior loans reside higher on the claims totem pole than traditional corporate bonds or preferred stock, meaning holders of these bonds have higher claims probability if the issuer goes bankrupt.

“Even in the event of a default, however, holders of senior bank loans have first claim on an issuer’s assets, owing to the loans’ ‘senior’ lien status in a company’s capital structure. According to Moody’s Investors Service, senior loan recovery rates have historically hovered around 80 percent — compared with 28 percent for the Barclays U.S. Corporate High Yield Index — which can help investors get more of their investment back in the event of a default. That can have a positive effect on a loan or bond’s total return,” added PowerShares.

Over 95 percent of BKLN's holdings have maturities of one to five years or five to 10 years. The $4.3 billion ETF currently holds 111 senior loans from issuers in the consumer discretionary, technology and utilities sectors, among others.

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