Thierry De Vergnes, managing director of acquisition debt funds at Amundi, presented a compelling case at FILS 2023 for why high yield loans are the asset class to be in right now.
Amundi.
Higher for longer is not necessarily bad news – at least not for the leveraged loans market. That was the message from De Vergnes, who pointed out that over the past three years the asset class as posted lower volatility and shown higher total returns than high yield bonds. And given the current economic climate, things are only going to get better. “This is an asset class with a lot of growth ahead of it,” explained De Vergnes, “What we’re going through right now in terms of volatility of rates is just another catalyst to expand the leveraged loans sector. We’re in a very strong position from a credit perspective.”
Some people call these loans bank loans as up until a few years ago, they were sitting quite happily on bank balance sheets – and the banks were happy to keep them. Why? Because these products sit at the very top of the capital structure, secured by assets and or shares and with strict covenants and restrictions surrounding them, including the requirement for borrowers to submit regular financial information and limit additional debt. Notably, leveraged loans have outperformed high yield bonds over the last three years – benefiting from key characteristics including the strong Euribor performance, to which most coupons are linked.
The Euribor three-month forward curve directly benefits the loan market due to its floating rate nature, and is expected to reach 4% by year-end and stay above 3.5% until December 2024, directly impacting coupons. “There is also less volatility than the high yield bond market,” said De Vergnes. “Ninety-nine percent of the asset class is senior secured, compared to around 47% of the high yield bond market, while it is also more remote from credit risk than high-yield bonds.”
There was a slight squeeze on spread in Q1 2021 due to excessive liquidity post-Covid, but spreads for leveraged loans bounced back to 4% by the end of 2021 and continued to widen in 2022 and so far in 2023, driven by the Ukraine war and quantitative tightening. Current spreads on the primary market significantly exceed five and 10-year averages – the Q2 2023 spread was 4.68% compared to 4.06% and 4.03%, respectively. The yield to maturity of recent transactions syndicated also exceeded 8%, as coupons benefit from the afore-mentioned elevated Euribor rates, while new loans are often issued with Original Issue Discounts of 2-5%, making them even more attractive.
One frequently raised concern, admitted De Vergnes, is whether the market is large enough to invest in, but he pointed to the rapid growth of the asset class on both sides of the pond – with volumes of around EUR283bn in Europe and US$1.4trn in the USl while the average size of new transactions is around EUR700mn. “To give you an idea, just six or seven years ago the loan market in Europe represented less than a third of the high yield bond market European bond market. Today it represents 72%,” said De Vergnes. “There is phenomenal growth as more and more investors, especially institutional investors, see its appeal and are looking for access.”
Another crucial point is that these loans are actively traded, with secondary trading estimated at around EUR13bn per quarter. “It’s paradoxical,” said De Vergnes. “It’s a private market but these loans are traded on a regular basis. Why is this important? Because trading in and out of loans is a way to manage risk, but it also gives a clear picture of the value of our fund to the investor, on a near-daily basis, and means that we can welcome new investors coming in at fair price.” In the current economic climate, De Vergnes posited that loans are preferable to bonds. “In periods of maximum stress, loans will outperform bonds,” he stressed. “Recovery rates in leveraged loans have also been more resilient, both past and present.
If you’re going into a recession, where do you want to be – at the top of the capital structure, or the bottom?” And finally, although these loans might have been the preserve of banks and insurance companies, a dollop of regulatory action and some provider ingenuity has meant that now, if carefully constructed, they can be included in some UCITS funds, while new products are now also being developed in Europe as a bridge to enable retail investors to also access the asset class.
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