For years, the fixed-income landscape was defined by a desperate hunt for yield in a low interest rate environment. As that cycle has shifted, a once-niche corner of the credit market has moved to centre stage.
Bank loans — often referred to as leveraged loans or floating-rate debt — have evolved into a US$1.5 trillion asset class. It now rivals the high-yield bond market in both size and institutional relevance.
For investment professionals, particularly those managing Canadian portfolios with a mandate for global diversification, the case for bank loans rests on three pillars: income enhancement, duration management and structural seniority. Yet, as recent jitters in the regional banking sector remind us, this is an asset class where fundamental credit work is essential.
To appreciate the strategic value of bank loans, let’s first distinguish them from their more traditional cousins. Both bank loans and bonds represent debt obligations that must be repaid with interest to the holder of the debt within a specified time frame.
Bond issuers or borrowers can be either corporations or government agencies. Bank loan issuers are typically non-investment grade corporations, which means they carry a lower credit rating than investment grade bonds.
Bank loans possess unique structural characteristics that alter their behaviour in a rising or volatile rate environment. Unlike traditional investment-grade bonds that pay a fixed coupon, bank loans are inherently dynamic.
Their coupons consist of a base rate, typically a secured overnight financing rate, and a fixed spread to compensate for credit risk. This coupon resets at regular intervals, usually every one to three months, which creates a floating-rate mechanism that keeps the debt aligned with current market conditions.
Because the interest rate adjusts so frequently, bank loans possess a duration of less than one year, whereas the average duration for investment-grade bonds often hovers between six and seven years. This near-zero duration makes bank loans an effective hedge against interest rate sensitivity, compared to the price erosion of bonds when rates rise.
It’s important to remember that loans sit at the top of the capital stack as senior secured debt, meaning they are backed by specific collateral. Historically, this structural protection has led to significantly higher recovery rates in default scenarios compared to unsecured high-yield bonds, even though the issuers themselves are typically non-investment grade corporations.
For Canadian investors, the domestic market for leveraged loans remains relatively shallow, making the U.S. loan market vital for those seeking what is often called secured yield. In the current environment, the risk-reward profile is compelling: it allows investors to move down the credit spectrum to capture a higher coupon while retaining a margin of safety.
By staying at the top of a borrower’s capital structure through a bank loan rather than a junior bond, the investor gains a yield pick-up and strategic diversification.
That cockroach quote
The loan market isn’t without volatility. Headlines about bad loans or regional bank charges spark memories of the 2008 sub-prime crisis.
JPMorgan Chase CEO Jamie Dimon touched a nerve, saying, “When you see one cockroach, there are probably more.” We saw the result immediately: a frantic sell-off in regional bank ETFs as investors scrambled for the exits.
But there’s a difference between a systemic fire and a few isolated, idiosyncratic credit events.
The bankruptcy of First Brands Group or the earnings hits at Zions Bancorp and Western Alliance are certainly cockroach-like. But they don’t necessarily represent an infestation.
While the market’s reflex is to sell first and ask questions later, the underlying data tell a different story. Look at the heavyweights: Bank of America’s investment banking revenue just climbed 43%. Morgan Stanley is posting double-digit profit jumps.
This doesn’t look like a broad economic slowdown — it looks like a classic credit cycle where the weak get culled and the strong offer a buying opportunity.
Picking up yield
Bank loans have graduated from a niche play to a $1.5 trillion essential for any serious fixed-income portfolio. For Canadian investors, they offer a way to escape the duration-heavy domestic market without sacrificing security.
You get a yield pick-up, you sit at the top of the capital stack and you stop losing sleep over interest rate hikes.
Vigilance is fine, but don’t let the cockroach headlines scare you. If the macro environment holds — and the big bank earnings suggest it will — the floating-rate space remains one of the most compelling ways to win the search for yield in an unpredictable market.