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LPC: US rate hike keeps pressure on pricing as loan funds’ assets grow

By Kristen Haunss

NEW YORK, March 17 (Reuters) - Investors seeking to offset the effects of the Federal Reserve’s interest rate hike on Wednesday are pouring money into US loan funds, which is expected to keep a US$208bn refinancing wave rolling as new leveraged loans remain in short supply.

Cash is flowing into bank loan mutual funds and exchange-traded funds (ETFs), which have seen 18 weeks of inflows as investors buy floating-rate debt to secure higher yields and effectively hedge against further interest rate rises.

With few new buyout loans to invest in, borrowers have been able to use the unsatisfied demand to slash pricing on existing loans, which are being refinanced at a rate not seen since the second quarter of 2013 when refinancing hit a record US$245.65bn.

"Inflows remain very strong, which will keep the pressure on spreads and create opportunities for repricings," said Jonathan Insull, portfolio manager at Crescent Capital Group. “Repricings tend to come in waves, and we have had a couple of tsunamis roll through here. Until we see heavier new issuance or inflows abate, it won't be safe to go near the water."

The Federal Reserve, which raised its target rate by 25bp to 75-100bp on Wednesday in the third rise since December 2015, said it expects two further increases this year and three in 2018.

Loan inflows of US$11.1bn so far this year follow $8.6bn of inflows in 2016, which reversed a combined outflow of more than US$45bn in 2014 and 2015. There was a record annual inflow of US$62.9bn in 2013.

“Institutional interest in the asset class continues to be strong globally, so we continue to see demand,” said John Popp, global head and chief investment officer of the credit investments group at Credit Suisse Asset Management.

The influx of cash is boosting the assets under management of bank loan mutual funds and ETFs. Assets increased 4% to US$146bn in February from January, according to Thomson Reuters LPC data.

Investors seek floating-rate products, such as leveraged loans that pay lenders a coupon over Libor, in a rising interest rate environment as yields increase along with rates, unlike fixed-rate bonds, where returns fall as rates rise.

Inflows into loan funds are a “natural reaction to the expectation of not only seeing dividends move up, but also protecting your capital when invested in fixed income,” said Jeff Bakalar, co-head of Voya Investment Management’s senior loan group.

Bank loan funds are attracting global investors that face low or negative rates in various other regions. Some funds have been increasing existing loan allocations while others have even been reducing their longer duration bond allocations and moving into loans, Bakalar said.

High-yield bond funds have had three consecutive weeks of outflows, including US$5.7bn in the seven days ending March 15, according to Lipper.

“If you look at the history of Fed rate hikes, typically ahead of the move you will see inflows into the loan market and outflows from high-yield bonds, so [the last few weeks] is inline with history,” said Brad Rogoff, head of credit strategy at Barclays.

(Reporting by Kristen Haunss; Editing By Tessa Walsh)