| Senior Bank Loan 101 |
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| 15/10/2006 | |
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Daniel A. Norman, Senior Vice President and Senior Portfolio Manager at ING Investment Management, answers this week's 101 on Senior Bank Loan 1-What is a Senior Bank Loan ("SBL") and how is the instrument structured? What is the performance of ING's Senior Debt Strategy YTD on a monthly basis? (1) Gross returns for the Composite are the net returns of the fund(s) in the Composite plus the annual expense ratio(s) for such fund(s). Annual expense ratios for the current year are based on the prior year's financial statements. Returns may be adjusted based upon each year's audited annual report. Net returns for the Composite are the Composite gross returns less 0.64% of assumed annual fees and expenses. Senior bank loans (also known as "leveraged loans" because they provide leverage to a company's capital structure) are loans made to non-investment grade businesses to finance acquisitions, refinance existing debt, support business expansion, and similar purposes. Senior bank loans are large, ranging from $50 million to well over $3 billion, and are originated by money center banks and other major financial institutions that syndicate the loans among a large number of banks and institutional investors. Senior bank loans have floating interest rates that reset usually monthly or quarterly. As a result, senior bank loans have an ultra-short interest rate duration, making them a natural hedge against fluctuations in short-term interest rates. Senior bank loans are typically secured by a first lien on all of the assets of the borrower and are therefore "senior" in the borrower's capital structure. Accordingly, in the event of a bankruptcy or other liquidation scenario, senior bank loan obligations would be paid first, before subordinated loans, bonds, preferred stock or equity holders. Historically, senior bank loans have exhibited both lower default rates than high yield bonds and almost double the recoveries once a default occurs. Senior bank loans are privately issued and are not traded on any public exchange. Instead, senior bank loans are traded directly among banks and institutional investors in a private secondary market.  Source: ING IM / Past performance is not indicative of future results and the possibility of loss does exist. 2-What is the impact in the asset allocation in terms of diversification? How can Senior Bank Loans meet the needs of institutional clients? Senior bank loans produce a distinctive pattern of returns including high risk-adjusted returns, low price volatility, lower default rates and higher recoveries than high yield bonds, and very low correlation with other asset categories (See, chart below). This combination of high risk-adjusted returns plus low correlation makes a position in senior bank loans particularly valuable in terms of its potential contribution to the diversification of institutional portfolios. Correlation with other asset category  Source: ING IM Institutional clients who are seeking to lower the volatility in their portfolios while minimizing the impact on their returns can benefit from adding senior bank loans to their portfolios. Over a full credit cycle, the senior bank loan asset class has provided the highest risk-adjusted returns vs. other major US asset categories. (See, chart below) This is due to its ultra-short duration interest exposure, the benefit of high relative recovery values in the event of defaults provided by senior security and by efficient adjustment of credit spreads to credit risk derived from financial and reporting maintenance covenants. Risk-adjusted returns, 1992-2006  Source: ING IM 3-How should Senior Bank Loans be integrated in an institutional portfolio? The most practical way for an institutional investor to gain an exposure to this important asset category is through an established senior bank loan manager. Since the senior bank loan market is private, investors can benefit from the enhanced access to deal flow that an experienced and well-established manager can provide. Also, investing in senior bank loans requires an extensive back-office operation, as purchases and sales of senior bank loans are done on an individual sales contract basis, requiring the review and processing of a significant number of documents to close each trade. Experienced managers can provide a variety of products to the institutional investor, including mutual funds and SICAVs, private accounts and CLOs. These products can also be accessed though mechanisms that will allow for customized levels of leverage. Senior bank loans can be a desirable asset class to leverage because of their relative stability and the floating rate nature of their yields, thereby avoiding interest rate mis-matches. (1) Gross returns for the Composite are the net returns of the fund(s) in the Composite plus the annual expense ratio(s) for such fund(s). Annual expense ratios for the current year are based on the prior year's financial statements. Returns may be adjusted based upon each year's audited annual report. Net returns for the Composite are the Composite gross returns less 0.64% of assumed annual fees and expenses. |
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