Loan Note: The ups and downs of floating rate loans; Arcmont weighs up direct lending vs liquid markets

Oaktree takes a look at the pros and cons of floating rates. Plus: Arcmont considers the continuing merits of direct lending in the face of a liquid market bounce-back and Arrow makes a senior hire in the Netherlands. Here's today's brief for our valued subscribers only.

With little economic relief on the horizon for Europe, and US inflation data likely to mark a new high for the year and keep the Fed hiking aggressively, we think the risks remain skewed in favour of the greenback”

Jonas Goltermann, a senior markets economist at Capital Economics, quoted in this Reuters article.

First look

Performance on the up: loans buoyed by floating rates (Source: Getty)

Floating rates – good for lenders, not for borrowers
In the latest version of Oaktree Capital Management’s Insights series, Ronnie Kaplan – the firm’s portfolio manager of US senior loans – notes that loan prices fell by 3.2 percent in the first half of 2022, but also that loans “meaningfully outperformed both investment grade and high-yield bonds”.

The basis for the outperformance was the predominantly floating rate nature of loans, which is proving to be attractive in a period of rising interest rates. Kaplan says this outperformance is expected to persist in the near term given the likelihood that the US Federal Reserve will continue to aggressively hike interest rates. The piece points out that, in tandem with the dramatic increase in rates, the projected income from loans exceeds the yield on high-yield bonds.

However, the other side of the coin is the pressure faced by borrowers in the face of rising interest expenses, which may see them facing liquidity challenges if rates stay higher for longer. Kaplan says that while some borrowers were prudent during the pandemic and shored up their balance sheets, others took on high levels of debt based on the assumption that interest costs would remain ultra-low. Borrowers in the technology sector are cited as “especially vulnerable” given their high average leverage.

Liquid markets versus direct lending
A new paper from fund manager Arcmont Asset Management compares the direct lending and liquid markets and encourages investors to look beyond the current boost to liquid market yields delivered by dislocation.

The liquid markets have seen a rising yield environment in recent months, with yields in the European leveraged loan market rising from 3.4 percent to 4.4 percent between December 2021 and April 2022 and the European high-yield market seeing a rise from 3.1 percent to 5.4 percent over the same period.

However, Arcmont points out that liquid market excess yield is driven primarily by the secondary trading prices of securities rather than the fundamental return characteristics of those securities such as margin and base rate. In addition, capturing that excess yield in the liquid markets requires precise entry and exit timing from investors – making it a short-term rather than long-term opportunity.

Looking over a long-term time horizon, Arcmont believes direct lending returns remain at a premium to liquid markets even through periods of market volatility. It also claims direct lending offers lower risk due to more thorough due diligence, a focus on less cyclical industries, better investor protections and longer-term funding structures.


New Dutch head for Arrow
Arrow Global, the European credit and real estate fund manager, has appointed Reza Atighi as chief executive officer of its Dutch arm, Vesting Finance Servicing.

Atighi joins from debt purchase and collection company Intrum where he was, most recently, chief executive officer of the Netherlands and Belgium. Prior to this, he worked for Morgan Stanley, Merrill Lynch, and ABN AMRO.

He has been hired to grow Vesting as a servicing and data specialist in the Dutch markets, as well as an origination platform for Arrow’s Credit Opportunities Fund. He joined the firm on 1 July and is based in Amersfoort, reporting to Mark Gollin, managing director and global head, platforms.

M&G takes Finance Ireland stake
M&G, the savings and investment giant, has acquired a 41 percent stake in Finance Ireland, Ireland’s largest non-bank lender. The investment comes from M&G’s £143 billion ($171 billion; €169 billion) Prudential With Profits Fund and external client funds.

Finance Ireland provides residential mortgages, commercial property, car finance, leasing, SME financing and lending to the agricultural sector. Last year, the firm’s lending total passed €1 billion for the first time, and the €50 million raised in equity by the deal will be used for future lending growth and expansion.

The firm entered the domestic residential mortgage market in 2018 and M&G has purchased around €1 billion of these mortgages over the past three years.

BBI supports Beach Point UK expansion
British Business Bank subsidiary British Business Investments has made a £20 million commitment to funds managed by Beach Point Capital Management. Beach Point has run funds in the US and Ireland and is now expanding into the UK market.

The commitment will enable Beach Point to make investments of between £2 million and £5 million in smaller UK businesses with high growth ambitions.

Beach Point will invest across all regions of the UK, particularly targeting Northern Ireland, where it is intended that a minimum of £10 million will be invested, plus the North of England and Scotland, where Beach Point has a strong adviser network.

Since it was established in 2014, BBI has committed more than £3 billion to providers of finance to UK smaller businesses.

LP watch

Institution: Iowa Public Employees’ Retirement SystemHeadquarters: Des Moines, USAUM: $40.83 billionAllocation to alternatives: 31.71%

IPERS has announced a $150 million commitment to Kayne Anderson Real Estate Debt IV, according to materials from its June investment committee meeting.

IPERS made the commitment in Q2 before the final close in May of the fourth iteration of Kayne Anderson’s flagship debt fund. The vehicle raised nearly $1.9 billion in capital commitments, marking the largest debt fundraise so far for the firm.

Founded in 1984, Kayne Anderson Capital Advisors is an independent alternative investment management firm focused on niche investing in upstream oil and gas companies, energy infrastructure, specialised real estate, mid-market credit and growth private equity.

IPERS has a 4 percent allocation to private debt, comprising $1.65 billion in capital.

IPERS’ recent private debt commitments are focused on North American real estate debt vehicles.

Today’s letter was prepared by Andy Thomson with John Bakie and Robin Blumenthal.