Investors like leveraged loans because they are senior, secured, and provide a safe return on investment.
Loans Are a Safe and Attractive Investment
Loans are floating rate, which minimizes interest rate risk for investors. Additionally, loans are senior in the corporate capital structure. In the event of a default, senior lenders are repaid first, before bondholders and shareholders. Loans are secured by collateral, further increasing the likelihood they will be repaid in the event of default. Loans also provided a 10% return in 2016.
The aforementioned non-bank lenders include CLOs (who are the biggest lender class), mutual funds, pension funds, insurance companies, hedge funds and others. These investments have performed well. CLOs have consistently performed especially well and boast loss rates among the lowest in investible classes. Moreover, not one AAA or AA investor has ever suffered a credit loss. In fact, over the past 20 years, CLOs have suffered credit losses of less than 1%. This is a better performance history than most investment grade corporate bonds and nearly any other asset class.
Part of this is due to how CLOs are structured. The assets within CLOs are real loans to real companies and are not some type of financial engineering. CLOs also have many rules they have to follow. Another reason CLOs perform so well is that they are actively managed by managers who have a vested interest in their performance.
Cumulative 5-Year Loss Rates For Different Asset Classes
Source: Bank of America Merrill Lynch, Moody’s Analytics