Once a hot asset class, high-yield leveraged loan exchange traded funds are cooling down as new regulatory rules put pressure on the leveraged lending industry.
The PowerShares Senior Loan Portfolio (NYSEArca: BKLN) has decline 0.9% over the past three months while the Highland/iBoxx Senior Loan ETF (NYSEArca: SNLN) has dipped 1.2%. Year-to-date, BKLN is up 1.0% and SNLN is 1.2% higher.
Meanwhile, the actively managed SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN) is down 0.7% over the past three months and the active First Trust Senior Loan ETF (NasdaqGM: FTSL) is 1.0% lower.
Leveraged loans are a type of extended loan for companies that already have large debt on their ledgers. Consequently, the leveraged loans have a greater default risk, but the higher risk comes with more attractive yields. For instance, BKLN has a 4.18% 30-day SEC yield, SNLN has a 3.18% 30-day SEC yield, SRLN has a 3.98% 30-day SEC yield and FTSL has a 3.97% 30-day SEC yield.
The leveraged loan market has attracted heavy interest in a low-rate environment. Sales of leveraged loans in the US jumped to $607 billion last year, compared to the previous record of $535 billion in 2007, reports Tracy Alloway for the Financial Times.
Deals “were structured and underwritten for a bull market,” Jeff Cohen, head of loan capital markets at Credit Suisse, said in the article. Some had terms in them that investors found “reprehensible, but they needed the paper.”
Now, U.S. regulators, including the Federal Reserve and the Office of the Comptroller of the Currency, have revealed new guidance to govern banks’ leveraged lending to contain a potentially overheated credit market. The Fed also confirmed that it will incorporate the guidance in its annual stress test for banks, which would diminish a failing bank’s ability to pay dividends to shareholders.