Hold the Senior Position in Your Portfolio as Banks Tighten Credit Access

COVID-19 has certainly put a strain on a lender’s ability to offer money to borrowers in need of a capital injection. While rates are low, credit is drying faster than a wet towel in the Arizona sun, but if that’s the case, it’s best for loan investors to be in the senior position.

Enter the Invesco Senior Loan ETF (BKLN), which seeks to track the investment results of the S&P/LSTA U.S. Leveraged Loan 100 Index. The Adviser and the fund’s sub-adviser define senior loans to include loans referred to as leveraged loans, bank loans and/or floating rate loans. Banks and other lending institutions generally issue senior loans to corporations, partnerships or other entities (“borrowers”).

Senior loans are typically used for business recapitalizations, acquisitions, leveraged buyouts, and re-financings. BKLN’s loan portfolio will include the purchase of loans from banks or other financial institutions through assignments or participations.

Additionally, BKLN may acquire a direct interest in a senior loan from the agent or another lender via an assignment or an indirect interest in the loan by participating in another lender’s portion of a loan. BKLN sells the loans within the portfolio through an assignment, but it may also sell participation interests in the loans in order to fund redemption requests.

The inherent risks associated with senior loans are similar to the risks of junk bonds, but have seniority in the event of borrower default so if the business is forced to sell its assets in a liquidation scenario, the senior loan will be paid first. In addition, senior loans are secured by assets whereas junk bonds are not, making them a more attractive investment option when constructing a loan portfolio.

BKLN Chart

As the pandemic continues to put stricter underwriting requirements on borrowers, this once again underscores the importance of being in senior loan position. The higher risk of default for a borrower, the more important it is to be in senior position.

“In the third quarter, banks tightened their loan standards to firms of any size and also saw weaker demand than usual, according to the Federal Reserve’s October 2020 Senior Loan Officer Opinion Survey on Bank Lending Practices,” a PYMNTS article noted. “The tightened standards and weaker demands could be seen over all of the major commercial real estate (CRE) categories, construction and land development loans, nonfarm nonresidential loans and multifamily loans, according to the report. In addition, consumer loan categories, including credit cards, auto loans and other items, saw the tightening standards.”

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