LSTA raises objections to WSJ article on floating rate funds

The Loan Syndications and Trading Association has today responded by letter to an article in the Wall Street Journal article on Friday which extols the virtues of floating rate bond funds over loan counterparts in an environment of likely rising interest rates. In the letter, the LSTA dismisses the article’s use of what it terms ‘headline grabbing’ quotes from ‘sources far outside the major practitioners of the industry’, but also puts forward several counter-points.

The LSTA refutes the assertion that protection against rising interest rates is the only reason to invest in loans as an asset class – although it allows the floating base rate is a free option in that respect. It points out that the performing end of the market trades at an average price of 92.5 cents on the dollar, creating a total return profile of Libor + 600 bp. Assuming no future increases in Libor, this equates to an approximate annual yield of more than 6%. Expected yields would jump above 7% if the forward rate curve were applied.

The LSTA next argues that the Wall Street Journal wrongly dismisses the value of collateral security and structural seniority given to bank loan investors over bond holders. It notes that principal loan losses reached a historical peak of roughly 2.7% in 2009 versus a default rate of 10.8%. The consensus outlook for defaults through the end of 2011 is at 4% with credit losses in the vicinity of 1.2%. As a contrast, according to recent research from Moody’s, the peak default rate for high-yield bonds came at 14.5% in 2009 and credit losses were in the vicinity of 10%.

While the market's average maturity is around four years, the LSTA says it continues to see a high level of pre-payments and an expected roll-off of three years could push annual yields up by another 60bp.

Finally, the LSTA argues that loan fund volatility in 2008 and 2009 was caused at the market and product level – and not by realised credit losses on bank loan holdings, as implied by the Wall Street Journal.