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David Milward, Head of Loans and member of the Secured Credit Team, explains why he believes secured loans could prove to be attractive in the search for relatively stable income in 2021.
Covid‑19 vaccination programmes in Europe and around the world have brought the prospect of a return to more normal levels of activity in the economy. This has bolstered credit markets as investors look ahead to the world emerging from the grip of Covid‑19, which is likely to drive a general improvement in corporate credit quality. The expectation of better times ahead, fuelled by a strong tailwind from seemingly endless central bank liquidity, has meant yields have continued to depress and the percentage of fixed income assets delivering below 1% yields has continued to grow. Hence, investors looking to generate real returns have had to look lower down the credit spectrum.
For those investors looking for a relatively stable income, we think that secured loans could screen as attractive.
As we started 2021, loan spreads remained wider than their pre‑pandemic levels (the three‑year discount margin for the market stands at 459 basis points (bp) versus 406bp at the end of 2019), in part reflecting the fact that the average market price is 100bp lower, a year on.
Looking back at the last 20 years, loan spreads have been tighter than current levels roughly 50% of the time, and as shown in chart 1, this makes them look attractive relative to other fixed income asset classes).
In a year of so much upheaval, one thing that positively surprised during 2020 was the low level of defaults despite the massive shock to the global economy. Central bank liquidity injections lowered the cost of funding and allowed companies to continue to raise funds. Business owners and governments also provided capital to meet short‑term liquidity needs and protect employment; thus, secured loan default rates remained low (chart 2), confirming that this is a very different crisis from what the market experienced in 2009.
We do not see any change in this dynamic, which should allay fears of default-linked losses – a primary concern for investors when stepping down the credit spectrum. The ability of companies to refinance, which is linked to ongoing central bank and government support measures, should continue to suppress default risk through 2021. Credit Suisse are forecasting a default rate of 1.1% and a loss rate of 0.3% for European loans this year*. Accordingly, we would expect the loans asset class to deliver attractive levels of income through 2021.