A Bank Loans Pull-Back? Not So Fast.

After nearly two years of inflows, U.S. retail bank loan funds have seen outflows in recent weeks. Is this an early sign of potential hard times? Not in our view.

What has caused the recent reversal in demand for bank loans from U.S. retail investors? We don’t believe that it's tied to underlying fundamentals, which in our opinion remain attractive. U.S. corporate profits have been generally solid, with Thomson Reuters reporting that first quarter earnings growth for the S&P 500 increased a solid 5.5%. In addition, cash flow growth is allowing the vast majority of companies to meet their debt obligations. What's more, the capital markets are open and refinancing activity has pushed out maturity dates, helping to keep defaults generally low. According to JP Morgan, the leveraged loan default rate at the end of May was just 1.35%.

So what's behind the shift in retail investor sentiment? This year's surprising decline in 10-year Treasury yields has retail investors less concerned with near-term increases in interest rates. And given spread compression, loan coupons aren't as attractive as compared to 12–18 months ago. But we expect demand to resume sooner rather than later. Here's why.

  • Fundamentals: Again, they're solid. Even if the economy continues to sputter, we don't anticipate a meaningful uptick in defaults.
  • Incremental Yield: As shown below, yields for loans are comparable to the overall high yield market and superior to those of other fixed income asset classes and Treasuries.
  • Less Duration Risk: Since loan coupons periodically reset, they have less duration risk than most fixed income assets and can actually benefit from a rising rate environment.

Bank Loans Offer Attractive Yield Potential with Limited Duration

Source: Neuberger Berman, Bloomberg, Barclays as of April 30, 2014. Bank Loan: S&P/LSTA Leveraged Loan Index, High Yield Bond: Barclays U.S. High Yield 2% Issuer Cap Index, U.S. IG: Barclays U.S. Corporate Index, U.S. Treasury: Barclays U.S. Treasury Index, U.S. Stocks: S&P 500.

Of course, as with any non-investment grade asset class, there are risks to consider. Volatility triggered by geopolitical events and other non-fundamental driven factors could drag down the market. And more aggressive loan provisions could make certain securities more susceptible to a sell-off. Still, net new issuance (excluding refinancing) remains robust and, in our view, there's no shortage of attractive loans coming to market. So we view the recent soft demand from U.S. retail investors to be a buying opportunity for an asset class that offers attractive relative value. Many sophisticated investors appear to agree, as demand from institutions has more than offset the redemptions from retail investors over the past eight weeks.

This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This material is not intended as a formal research report and should not be relied upon as a basis for making an investment decision. The firm, its employees and advisory clients may hold positions of companies within any sectors discussed. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. This material may include estimates, outlooks, projections and other "forward-looking statements." Due to a variety of factors, actual events may differ significantly from those presented. Investing entails risks, including possible loss of principal. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.

This material has been issued for use by the following entities; in the U.S. and Canada by Neuberger Berman LLC, a U.S. registered investment advisor and broker-dealer and member FINRA/SIPC; in Europe, Latin America and the Middle East by Neuberger Berman Europe Limited, which is authorised and regulated by the UK Financial Conduct Authority and is registered in England and Wales, Lansdowne House, 57 Berkeley Square, London, W1J 6ER, and is also regulated by the Dubai Financial Services Authority as a Representative Office; in Australia by Neuberger Berman Australia Pty Ltd (ACN 146 033 801, AFS Licence No. 391401), which is licensed and regulated by the Australian Securities and Investments Commission to deal in, and to provide financial product advice for, certain financial products to wholesale clients; in Hong Kong by Neuberger Berman Asia Limited, which is licensed and regulated by the Hong Kong Securities and Futures Commission; in Singapore by Neuberger Berman Singapore Pte. Limited (Company No. 200821844K), which currently carries out the regulated activity of fund management under the Securities and Futures Act (Chapter 289) (“SFA”) and operates as an Exempt Financial Adviser under section 23(1)(d) of the Financial Advisers Act (Chapter 110) (“FAA”) of Singapore. Under the FAA, NB Singapore is exempted from Sections 25, 27 and 36 of the FAA, where its financial advisory service is provided to an accredited or expert investor (as defined in Section 4A of the SFA); in Taiwan to specific professional investors or financial institutions for internal use only by Neuberger Berman Taiwan Limited, which is licensed and regulated by the Financial Services Commission (“FSC”) and a separate entity and independently operated business, with FSC operating license no.:(102) FSC SICE no.011, and address at: 10F, No. 1, Songzhi Road, Taipei, Telephone number: (02) 87268280; and in Japan and Korea by Neuberger Berman East Asia Limited, which is authorized and regulated by the Financial Services Agency of Japan and the Financial Services Commission of Republic of Korea, respectively (please visit http://www.nb.com/japan/risk_eng.html for additional disclosure items required under the Financial Instruments and Exchange Act of Japan). Except for the foregoing, this material is not intended for use or distribution within or aimed at the residents of any other country or jurisdiction. This document is not an advertisement and is not intended for public use or additional distribution in the following jurisdictions: Brunei, Thailand, Malaysia and China.

The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.