Lee Shaiman is the Executive Director of the Loan Syndications & Trading Association, an organization whose aim is to promote a fair, orderly, efficient, and growing corporate loan market. It is a market that many investors may not be familiar with or how it works. He joins the ETF Think Tank to talk about the syndicated loan market and some of the themes that are impacting it at the moment.
Syndicated loans are typically those that help finance leveraged financial corporations. The total bank loan market is around $1.4 trillion with the majority of them getting syndicated to big institutional investors. In that case, banks act as the middleman – they collect interest payments on the loans and distribute them to holders. It’s important to remember that these are not securities, they are loans. When someone owns one of these loans, they are effectively becoming a lender.
In terms of structure, most of these loans have maturities between 5 and 7 years. There is no real duration risk with them because the rates reset every 30-90 days. Credit spread risk is the biggest risk because these are mostly leveraged companies with low credit quality. The core of the leveraged loan market has a rating of single-B, so this is not insignificant. Right now, there’s minimal amortization of these loans in the first few years, but in falling interest rate environments, many get repaid or prepaid quickly.
The bank loan market is facing some significant challenges. One of the biggest issues is liquidity. There needs to be ample liquidity available in case of a large drawdown, such as the one that occurred during the financial crisis. Currently, this asset class has never missed a redemption, so it has historically worked very well, but the current environment continues to raise concerns about ongoing liquidity issues.
Another is the regulatory environment whose issues may or may not get resolved. The SEC proposed new regulations on mutual fund and ETF settlements, which could present an existential threat to the market. It may become very difficult to hold bank loans within a fund format and meet the daily liquid requirement the SEC is proposing. Shaiman says that it is going to be a very tough road.
Shaiman believes that active management within a bank loan portfolio is the way to go. In general, you need to manage credit risk instead of following an index because plain beta includes too much junk that can be avoided. Issues that are over-levered or positioned poorly can be filtered out. ETF transparency is helpful in this regard, but you also want to understand what the managers are doing and what they’re buying.
Other key takeaways:
- Senior loans come in at the top of the liquidation priority order. They’re usually secured by most/all corporate assets including IP. They do not usually have insurance guarantees because there is too much risk exposure to the insurance companies.
- The ETF wrapper has made some issues less complicated. You have the ability to redeem and issue in the market. Bank loans cannot create or redeem, so ETFs helped allow that. ETFs and mutual funds investing in bank loans have been able to consistently make redemptions.
- Why is there not more energy exposure here? In bank loans, there was a downshift in energy. In 2017, there was a big flush out and the fracking industry got crushed on commodity price moves. Volatility is high and it will take time to rebuild confidence.
- In the event of a default within a bank loan fund or ETF, the fund usually bears the cost.
- As a prior fund manager, what would Shaiman do differently with a new fund? He says he’d be more model-focused in optimizing the portfolio. He would also spend more time helping people understand the products.
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