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Treasury & Capital Markets
Time to take a walk on the floating side
The secondary loan market is ripe for a major revival, and in Asia, the evidence is there: from the springing into life of the primary market after a few moribund years, to the renewed activity in the secondary loan market, at both ends of the credit curve.
Jonathan Rogers 28 Mar 2017

The secondary loan market is ripe for a major revival, and in Asia, the evidence is there: from the springing into life of the primary market after a few moribund years, to the renewed activity in the secondary loan market, at both ends of the credit curve.

There should be nothing surprising about this. The rate cycle in the United States has turned, and barring accidents, we should see at least two rate rises from the Federal Reserve this year, in addition to the one initiated this month.

Buy fixed income paper on a hold-to-maturity or hedged basis if you wish, but the bigger gains are likely to come from owning floating rate paper.

This could be in standard FRN issuance or from secondary bank paper, issued in syndicated, club or bilateral format.

According to Standard & Poor’s, since 1995, the floating rate product denominated in US dollars has had a low correlation of just 0.57 to equities and 0.38 to 10-year US Treasuries, something to bear keenly in mind if you distrust the Donald Trump-inspired equity surge. And if the long-awaited bear market in US debt after a 30-year odd bull run is coming to an end, the floating asset class is just where you want to be.

The advantage of the product is its relatively high position in the capital structure, although there are caveats to jumping on board. Those caveat emptors would not sit within high-grade, otherwise known as the par loan space. This category tends to trade on a tight bid/offer basis, is well researched and within Asia, firm prices on the bid are available.

On the high-yield/distressed side, it’s something of a different matter. In many cases, paper originating from this space in Asia will contain relatively loose covenants, bids on a negotiated basis and those investors hoping to get the pickings from a debt workout may be disappointed by the willingness of banks to simply kick the can down the road via refinancing rather than pushing for a full-on restructuring.

But assuming that distressed paper is bought without the end aim of an ordered restructuring or the realization of the capital structure in the event of liquidation, there are decent prospects.

As we have seen with the beaten-up coal sector, prices can recover relatively quickly for the underlying commodity, meaning that money can be made, even without eyeing a restructuring or liquidation scenario. The secondary debt price in that sector has recovered rapidly alongside the price of the underlying real asset.

If there is anything like a renaissance in the floating rate sector it may well come from banks seeking to pump up their franchises via loan portfolio purchases.

Mizuho did this over a year ago in the US, via the purchase of a US$38 billion loan portfolio from RBS Americas. It’s a neat way of gaining new relationships on the borrower side, as well as kick-starting a secondary loan trading business. And in a rising rate environment it adds to the real interest rate income on the asset side of the bank’s net interest margin.

So I would suggest to fixed income debt managers that they get an extra string to their bow and start shopping around in the floating rate market. In past rising rate environments FRNs have outperformed fixed rate bonds by a considerable margin. I suspect that time is upon us again.

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