Inflation’s effect on bank loans, defaults at this phase of the credit cycle, and the loan market’s move away from LIBOR are among key topics covered in this interview with Loomis, Sayles & Co. Investment Director for Bank Loans, Cheryl Stober. She summarizes expectations for a constructive 2022 with high demand and low defaults, below.

Leveraged loan supply and demand experienced a banner year in 2021. Syndication of M&A-driven loans and CLO (collateral loan obligation) issuance shattered records.1 In the wake of such a remarkable year, investor focus has turned to the broader issue of inflation. How could that impact demand in the loan market?
Looking at our portfolios, we see a lot of companies that permanently reduced costs during the pandemic and are showing pricing power. That combination should help them bolster results against cost inflation in 2022. However, as inflation has increased across the economy, the Federal Reserve is likely to raise rates in order to control it. This could be a benefit to the loan market. Loan coupons float alongside rate increases, which tends to spur new demand for leveraged loans and keeps their prices near par. On the demand side, we believe that CLOs and retail mutual funds will be strong buyers of loans again this year. 

What is your outlook for defaults in 2022?
The environment for loan credit quality remains very constructive. As always, our credit selection remains focused on long-term risks, not short-term movements. We agree with the market expectation that default rates are likely to be very low over the next year due to both company-specific circumstances (healthy liquidity, cost cutting and revenue retention) and macroeconomic support in the form of fiscal and monetary stimulus. We believe companies in the loan market are well positioned to survive any likely increases in interest rates. With few maturities scheduled in the coming years, defaults are projected to be quite low

S&P/LSTA Leveraged Loan Index Maturities

S&P/LSTA Leveraged Loan Index Maturities from 2022 to 2029
Source: S&P Capital IQ as of December 31, 2021

How is the loan market handling the transition from London Inter-Bank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR)?
The market is several years into the transition away from LIBOR, and has hit the major milestone of no new LIBOR-based issuance after 2021. The loan market has seen limited SOFR-based issuance so far. However, based on the average price of loans trading close to par, it appears the market doesn’t seem nervous about liquidity or the operational aspects of this change. We expect this transition to continue without disrupting the market, especially given the prevalence of interest rate floors, which are generally above the reference rates in use.
1 S&P Capital IQ, as of December 31, 2021.

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Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.

The S&P/LSTA Leveraged Loan Index (LLI) covers loan facilities and reflects the market-value-weighted performance of U.S. dollar-denominated institutional leveraged loans.

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A collateralized loan obligation (CLO) is a single security backed by a pool of debt.

The London Interbank Offered Rate (LIBOR) is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans.

The Secured Overnight Financing Rate (SOFR) is the average rate at which institutions can borrow US dollars overnight while posting US Treasury bonds as collateral.

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