For an investor in fixed income there is an obvious fact: the profitability of the German ten-year bond (Bund) is in negative territory, while the ten-year US bond is below 2%. They are not tempting returns for such a long term.
Therefore, and after the cuts in interest rates in the United States, Europe, Brazil and Hong Kong and the announcement that Japan and Switzerland would also be willing to reduce them if necessary, investors seek profitability on other assets within the debt, mainly among those of private fixed income.
In this environment, the attractiveness of private debt increases because the fundamentals of companies with the highest financial rating (investment grade) are strong and the risk of a recession has been reduced. In a market context where sovereign debt pays very little, in order to achieve a more profitable debt market, other options must be sought within corporate fixed income; One of them is that of senior loans.
Senior loans consist of the extension of an existing loan to a company that does not have a credit rating, but that needs to refinance its debt, finance some purchase or support non-organic growth (purchases of other companies).
This kind of loans is secured by the borrower’s assets (the company that is requesting the loan) but with the provision that they are the first line of payment to receive, so they are the safest of the issuer. They are granted by large financial companies, which chop senior loans and distribute them throughout a private market among other entities and investment funds, which would be to convert that senior loan into a syndicated loan.
‘Senior loans’ or ‘senior debt’ differ from subordinated or junior debt in terms of repayment: senior debt is guaranteed and offers less risk than junior debt.
The market for this class of assets has grown considerably in recent years due to the greater supply available and a significant increase in the number of demanding institutions.
On the interest side, it is worth knowing that senior loans do not offer a fixed rate, but a variable or floating rate, since the company that requests them pays a fixed differential plus the evolution of a given index (Euribor or Libor).
Advantages and disadvantages of senior loans
Like any investment product, senior loans have their pros and cons:
Since we are in an environment of low profitability, precisely the main advantage is its greater profitability compared to public debt, very similar to that of high yield debt, to which security is linked in the term, because they depend on the evolution of a benchmark and are not of a fixed type.
They are also interesting because they are the first on the collection list (first-class guarantees) and suffer less volatility, because they adapt to the market through the benchmark index at all times.
However, its disadvantages include the fact of possible defaults (default), the possibility of renegotiating conditions in case of need by the issuing company, lower liquidity to buy and sell in the market and profitability which also adjusts to the market thanks to that benchmark index , so they do not offer unexpected joys either.
How to invest in senior loans
This corporate fixed income instrument is not available to retail investors. As we said, it is listed on a private market that only institutional investors have access to. On the other hand, as we have also pointed out, the shares that are placed in this market are not small enough for a retail investor to achieve sufficient diversification in its debt portfolio.
As a better example of what we say, when the first alternative debt investment fund arrived in the Spanish market in 2016, it had about 30 million dollars under management and announced 21 investments in European liquid quoted loans. Among the broadcasters that it had in its portfolio in its first stages were emissions from Savesafe Security, IPC Salud or ByteNet. And its annual profitability objective was Euribor plus 4-5%, with fortnightly liquidity.