Interest rates are making a strong comeback in the market. Three years ago, many anticipated increased interest rates, but it’s only now that the market seems to catch the wind. For the last 10 years, the U.S. 10-year Treasury bond is about to hit 3%. On the other hand, the LIBOR which stands for London Interbank Offered Rate rose past 2%.
For investors with fixed income portfolios, the rise in interest rates means good fortunes. Good fortunes regarding investors who look to maintain exposure to fixed income as floating rate or bank loans.
As a borrower, you can take out a loan from a bank or any other financial institution. Keep in mind, this is a debt financing obligation, one which lies with a company holding legal claim to the assets a borrower owns on top of all other debt-related obligations.
With this structure, the borrower’s loan takes priority or is senior to other claims against the borrower.
Should the bank face bankruptcy, it will have to repay the senior bank loan first. The floating rates aspect make banks an interesting and lucrative investment option. Asset rates fluctuate from time to time. This is along with LIBOR’s observations and other interest rate yardstick.
For instance, take a bank loan’s rate which stands at +5% LIBOR and LIBOR stand at 4%, the total loan outcome is 9 percent. However, loan rates also fluctuate throughout the year. As such, according to nation21loans , interests on the loans will also fluctuate with respect to the rates.
These fluctuating rates offer investors a chance to maximize their earnings since the changing rates apply to their principal amount. This means when the rates sky-rocket, the investors will earn through increased interests. This is different from fixed bonds which don’t change despite increasing interest rates.
On one hand, the fixed rates on bonds protect the investors from the frequent fluctuations and also against inflation. The former lowers the bond prices.
Time to Test Bank Loans
Bank loans continue to prove their worth compared to high-yield bonds with little volatility. Maybe it’s time to give try them.
In 2017, the bank-loan market enjoyed a fantastic season with up to 4.75 percent in returns. When compared to fixed-income asset classes like government and investment-grade government bonds, the latter lost value while the loans appreciated.
The good news is this trend is expected to continue for at least 18 to 24 months from 2018. This is true because, in the first 2 months of 2018, bank loans returned an average of 1.23 percent, thus indicating a promising positive trend.
The Reasons Why the Positive Trend Will Continue
The first reason is tied to the Federal Reserve. In 2018, the Federal Reserve anticipates making at least four rate hikes. For this reason, the high rates will prevail for the rest of 2018 spilling over into 2019 and beyond.
Second, the economic conditions in the global arena continue to grow the firm by the day. Couple this with increased inflation rates and higher deficits and you’ll see the global and domestic interest rates succumb to pressure with only one card left. To increase interest rates.
Third, the U.S. tax reforms continue to increase the economy’s momentum not forgetting the corporate earnings. In addition, the rates will go up as a result of growing corporate and consumer confidence.
For example, the corporate sector has shown tremendous growth and strength in the previous quarters. Their stable to ever-increasing corporate earnings is proof of their growth and this is bound to display one of the strongest earnings and revenues in the last few years. Such stability and future promise allow loan refinancing across banks to extend in 2018 and beyond.
The credit cycle, as a result, has received an extension running into a few years. Furthermore, it continues to sustain a cap on standard rates across the industry. These standard rates are expected to stay well below 2% (which is lower than the 3.5% on long -term average). As such, this particular asset class will continue with its strong performance.
Moreover, it’ll also enjoy amplified demand from institutional and retail investors. In 2017, loan mutual funds climbed to $16 billion and this is just the beginning. They will increase to over $20 billion in 2018 because investors will migrate from the long duration and pure high yield funds.
From 2018 going into 2019 and beyond, interest rates take the top spot and with this in mind, the loan asset class provides a lucrative appeal. The reason, as stated in this article, is the banks have a massive advantage compared to fixed income bonds and this is their ability to adjust their rates as influenced by LIBOR movements. As such, this allows investors to reap massive returns from the short-lived increase on interest rates.
While fixed rates on bonds protect the investors from frequent fluctuations and also against inflation, the resurgence of interest rates as witnessed during the past year offers investors another avenue to make a kill.
This is courtesy of the increased interest rated albeit for a short while. However, the loan asset class is backed by a solid historical performance as well as the prevailing stable elements. This makes banks a preferred investment option when compared others such as fixed income bonds.
Therefore, as an investor, bank loans promise greater returns for investors willing to place their money in this asset class.