Loomis Sayles’ Bank Loan team is often asked: how will rising rates affect the capital structures of the companies to which you are lending? Are interest rate hikes likely to cause a strain? In this edition of Loomis on Loans, the team delves into why they believe the answer is no for most of the credits they follow.

Corporate Capital Structurecorporate capital structure graphic
Source: Loomis, Sayles & Company


Scenarios 1 and 2 look at a generic capital structure the Loomis Sayles Bank Loan team views as adequately capitalized – and the various metrics that prove the point of minimal impact from seven Fed rate hikes.

Key Takeaways:

  • Rates do not rise in a vacuum. In general, rates should be rising when the economy is relatively strong and growing. If that is the case, then company cash flows should be rising with rates, offsetting some, or even all, of the effects of rates on profitability.
  • Is the company’s balance sheet built to withstand what the world is likely to throw at it, including rising rates? In the pandemic, we saw that most balance sheets could take the pain caused by fluctuating demand.
  • Interest coverage drops from 3.38x to 2.84x, but free cash flow remains ample. This balance sheet is built to withstand rising rates.
  • As always, it is the job of managers to separate good credits from bad credits, with "good" defined as those that are robust in the face of the threats they face and "bad" as those that are vulnerable to what is potentially coming down the line.

Resource

Loomis on Loans – Q2 2022

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All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions.

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.

Floating rate loans are often lower-quality debt securities and may involve greater risk of price changes and greater risk of default on interest and principal payments. The market for floating rate loans is largely unregulated and these assets usually do not trade on an organized exchange. As a result, floating rate loans can be relatively illiquid and hard to value.

Credit risk is the risk that the issuer of a fixed income security may fail to make timely payments of interest or principal or to otherwise honor its obligations.

Liquidity risk exists when particular investments are difficult to purchase or sell, possibly preventing the sale of these illiquid securities at an advantageous price or time. A lack of liquidity also may cause the value of investments to decline.

Diversification does not guarantee a profit or protect against a loss.

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