David Hernandez, CFA
This week we look at the historic three year discount margin for bank loans. Bank loans provide a source of financing for public and private corporations as well as private equity firms. They are a floating rate debt obligation generally linked to LIBOR and typically callable with few or no penalties. In comparison to investment grade bonds, bank loans have higher credit and liquidity risk, but lower interest rate risk. In a low rate environment, floating coupons can be attractive to investors.
In 2008 and 2009 liquidity issues caused bank loan prices to drop drastically. This can be seen in the chart, as the price drop drove the three year discount margin to all time highs. Since then, liquidity has improved and the discount margin has come down. In 2012 we saw the discount margin fall from 656 bp to 555 bp. Even with the pronounced decline from 2009, discount margins are still above the long term median of 387 bp. This spread appears to be an enticing option for investors looking to decrease interest rate risk. The discount margin also compares favorably with high yield bonds, and based on early data, institutional investors have begun to swap high yield investments for bank loans.
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