A senior loan is a private loan taken from an underwriting bank or a syndicate of lenders. The loans are secured in that they are backed by the borrowers’ assets, which act as collateral. If the borrower defaults, lenders have a senior claim on the defaulters’ assets. Moreover, senior secured floating-rate loans have, as their name suggests, a floating interest rate component, which fluctuates with market rates.
SEE MORE: Inside Floating Rate ETFs
“Most floating-rate bonds and loans are issued by junk-rated companies. As such they must be considered aggressive or speculative investments. If short-term benchmark rates rise without a commensurate increase in corporate earnings, the result could be increased defaults and not simply higher income streams for investors,” according to a Wealth Strategies & Management note posted by Amey Stone of Barron’s.
Since rates are typically reset once per quarter, senior loans typically have low durations – a measure of a bond fund’s sensitivity to changes in interest rates. The floating-rate component also offer investors an alternative method of earning yields while mitigating interest-rate risk. Consequently, bank loans are seen as an attractive substitute to traditional corporate debt in a rising rate environment.
PowerShares Senior Loan Portfolio (NYSEArca: BKLN)