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.
In October, the leveraged loan market experienced heightened volatility as global growth concerns and the end of the Fed’s asset purchasing program weighed on the high-yield market. For the week ended October 22, outflows from bank loan funds reached $1.66 billion, compared to $946 million in outflows for the week before.
However, in a research note, Kevin Horan, Director of Fixed Income Indices at S&P Dow Jones Indices, argued that leveraged loans could remain steady as other fixed-income assets fumble ahead of the Federal Open Committee meeting.
“Market sentiment can change quickly though and if news from the FOMC does undermine the current risk-on environment; leveraged loans could to be the least volatile in price,” Horan said. “Compared to the municipal high yield’s 7.35 year duration and the U.S. Issued High Yield’s duration of 4.86%, the weekly reviewed leverage loan index will be least effected to the change in rates.”
The FOMC meeting begins Tuesday and the committee will announce its decision Wednesday, October 29. [Senior Loan ETFs Still Have Rising Rates Appeal]
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.