Should you give preference to bank loans over junk bonds?

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Leverage loans and Invesco Senior Loan ETF (NYSEArca: BKLN) are gaining more attention lately, for the simple reason that income is becoming hard to come by.

Due to low yields on other bonds, a growing economy and low default rates, junk bonds are also getting a lot of attention. Traditional high-yield businesses and bank loans, including BKLN’s holdings, are often compared to each other.

The comparison is relevant because most of the bank lending universe has undesirable ratings. For example, 82% of BKLN’s 144 holdings are rated BB, B or CCC, according to Invesco data. Still, investors should note that bank loans are not carbon copies of standard junk bonds.

For example, this form of debt is usually secured by something, which means bondholders are higher on the corporate totem than their traditional counterparts. The flip side is that leveraged loans generally have lower yields because they are considered to be less risky than unsecured debt. BKLN’s 30-day SEC yield of 2.81% is lower than benchmarks for standard high yield corporate bonds.

Bank loans also default at lower rates than junk bonds and the recovery rate for the former is higher. This is another thing for investors to think about.

“It’s not just the default rate that matters for bank loans or high yield bonds, but the amount that bond or loan holders receive after default, known as the payback rate.” note Collin Martin by Charles Schwab. “Over time, loans tend to have significantly higher recovery rates, due to their collateralized nature, than high yield bonds. In the 12 months ending June 2021, the average loan recovery rate was $ 55, compared to just $ 41.1 for traditional bonds. The difference is even greater over the past five years, with loan recovery rates of $ 63.4 compared to just $ 41.6 for bonds. “

Seen differently, bank and BKLN loans are more defensive than traditional junk bond strategies. Additionally, senior loans have the advantage of being more positively correlated with rising interest rates due to their variable rate component, although it may take some time for this to materialize.

“Bank loan floating coupon rates also help limit their sensitivity to interest rates, but keep in mind that coupons float on short-term yields, not long-term yields. Bank loan interest rates are unlikely to rise until the Federal Reserve begins to raise short-term rates, ”adds Martin.

For more news, information and strategies visit the ETF Education channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon and may not come to fruition. The information on this site should not be used or interpreted as an offer to sell, a solicitation of an offer to buy or a recommendation for any product.

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