Private credit: A case for senior loans

As the fourth quarter comes to a close, Investors are increasingly reassessing the health and positioning of the bank loan asset class amid a backdrop of macroeconomic uncertainty and headline-driven volatility. Despite these challenges, we see three compelling reasons to consider investing in senior secured loans now. (This is an excerpt from our latest whitepaper, The case for senior loans. For a deep-dive into the sector and our outlook, read the complete paper.

1. Potential high level of current income

Current income is comprised of two key components—base interest rates (which are expected to stay higher for longer) and credit spreads (which have continued to remain wide). Coupon income for bank loans has been 7.67%, which remains well above the long-term average.¹ Market expectations are for rates to remain higher for longer, well above pre-2022 levels. Loans have proven to provide consistent, stable income through varying market cycles, including recessionary periods and periods of falling rates. 

2. Resilience to interest rate changes

Bank loans are uniquely positioned in today’s market to deliver high income regardless of the direction of interest rates. As floating-rate instruments, their coupons reset regularly to SOFR helping insulate investors from the price volatility that affects traditional bonds. Whether rates rise or fall, loan prices are not directly linked to interest rate volatility and continue to generate attractive income. Importantly, interest rate movements are notoriously difficult to predict. As a floating rate asset class, when rates rise, coupons increase; when rates fall, loans reset lower but still offer competitive yields relative to other fixed income segments such as high yield bonds. Moreover, declining rates ease interest express burden on borrowers, improving issuer fundamentals and reducing default risk. This flexibility makes loans a reliable source of income in both rising and falling rate environments, making this worth considering in portfolios.

3. Compelling relative value

Loans have consistently provided some of the most attractive yields in the fixed income market, while also offering downside risk mitigation due to their senior position in the capital structure and being secured by a company’s assets. This year, high yield bonds have outperformed loans, largely driven by the longer duration of high yield bonds benefiting from rates falling¹,². However, much of that duration trade is now priced in. High yield bond spreads have compressed to historically tight levels limiting forward return potential. In contrast, loan spreads remain near their long-term averages, and loans continue to trade at a discount, creating an appealing entry point and price-upside potential as spreads normalize. Loans also offer these high yields with potentially lower risk. In a recessionary scenario, loans provide further downside risk mitigation due to their senior secured status, which gives them the highest priority for repayment in the event of default. Historically, this seniority has translated into stronger recovery rates and lower credit losses during economic downturns reinforcing their role as a resilient asset class with historically positive annual returns.

Read the complete whitepaper, The case for senior loans.