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CREDIT CHECK-IN: LEVERAGED LOANS UNDER THE MICROSCOPE 

July 29, 2022  |  5 Minute Read


 

This month we place key risks that have contributed to recent weakness in leveraged loans under our investment microscope. All told, we remain constructive on the asset class and continue to dynamically adjust our clients’ portfolios in response to loan market dynamics and the broader investment environment.

 

Deconstructing Recent Performance

The leveraged loan market has outperformed other fixed income sectors year-to-date (see Appendix in download), benefiting from robust investor demand for floating-rate assets in a rising rate environment as we discussed at the turn of the year. The asset class also proved resilient to market volatility induced by the onset of war in Europe; however, loans have recently come under pressure as financial market focus has shifted from high inflation and rising rates to downside growth risks. This has led investors to sideline the floating-rate benefits of loans and instead place greater emphasis on a potential increase in credit risk. The resultant decline in loan prices has lifted the market-implied default rate to a level that is above the historical average and the experience of the global financial crisis. Our default outlook remains benign and far below that reflected in market-pricing, meaning loan valuations appear attractive, in our view. Overall, we think the recent sell off is overdone and in Exhibit 1 we take a closer look at key credit risks to explain why we believe this to be the case.

 

 

Exhibit 1: Placing potential credit risks under our investment microscope

 

Household Net Worth Near All-Time Highs

Source: Goldman Sachs Asset Management. As of July 29, 2022. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this presentation.

 

 

Portfolio Perspectives

As seasoned leveraged loan investors, we continue to combine our assessment of credit fundamentals with astute bottom-up security selection. In particular, our dynamic approach to portfolio management has led us to respond to the three factors outlined above as follows:

 

 

  • Tilting toward higher quality. We are underweight the CCC-rated loans and our overweight exposure to B-rated issuers is tilted towards B+ issuers rather than B- issuers.
  • Liquidity and quality aware. Our loan exposure is centered on loan tranches that are large in size and therefore typically exhibit higher liquidity. Loans from these tranches also tend to skew higher in quality and therefore experience better recovery rates. The average loan tranche size for loans in our portfolios is considerably higher than the leveraged loan benchmark.3
  • Underweight loan-only issuers. We favor loans issued by companies that have both high yield bonds and loans in their capital structure given more favorable recovery rate prospects. An advantage of our expansive research coverage across both high yield bonds and loans is that we can identity relative value opportunities across the two assets for a particular issuer.

 

 

 

Overheard at Goldman Sachs

Each month we feature quotes from our investment team, offering a glimpse into our investment views and what we are monitoring and analyzing.

 

“Given the recent market selloff, we believe that current spreads more than compensate investors for the fundamental risk in leveraged loans”

 

Peter Campo, Global Co-Head of High Yield & Bank Loan Credit

Goldman Sachs Asset Management | July 2022

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Credit Check-In: Leveraged Loans Under the Microscope

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1 Source: J.P.Morgan. As of July 12, 2022. Goldman Sachs Asset Management’s and J.P. Morgan’s products are not related, and J.P Morgan has not endorsed either Goldman Sachs Asset Management or its products.

2 Source: J.P.Morgan. As of July 12, 2022. Goldman Sachs Asset Management’s and J.P. Morgan’s products are not related, and J.P Morgan has not endorsed either Goldman Sachs Asset Management or its products. Reflects the average spread differential between loans issued by loan-only issuers and loans issued by companies that issue both bonds and loans.

3Credit Suisse Leveraged Loan Index.

 

General Disclosures

Data and views expressed are as of July 29, 2022.

Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.

Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice.

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