Senior Loan Market Overview
The fourth quarter of 2009 closed out the most significant calendar year rally in the history of the senior loan market. The S&P/LSTA Leveraged Loan Index gained 3.78% in the fourth quarter, bringing the full year 2009 return to a remarkable 51.60%. This rally was welcomed news to investors after witnessing the -29.10% return the year prior. Average loan prices increased 25 points for the year, from 62 cents on the dollar at the start of the year to 87 cents on the dollar at year-end.
Lower quality loans continued the trend of outperformance in the fourth quarter. For the quarter, CCC rated issuers gained 7.30% and defaulted issuers 10.30% significantly outperforming higher credit quality BB 1.20% and B 3.20% names. For the full year, CCC rated issuers were up 88.60% outperforming the 35.80% return for BB rated names and 61.20% for B rated issuers.
Both improving fundamental conditions and positive technicals provided the boost to returns over the past year. From a fundamental standpoint, U.S. GDP growth steadily improved throughout the year. GDP growth improved from -6.40% in the first quarter of 2009 to 2.20% in the third quarter (with expectations of positive growth again in the fourth quarter GDP, once the numbers are released). The improved macroeconomic conditions translated into an improving default picture as well. While defaults within the senior loan market hit a peak of 10.80% in November (and finishing the year with a default rate of 9.60%), the pace of defaults slowed throughout the year. The annualized default rate, which began the first quarter at 19.50%, ended the fourth quarter at an annualized rate of 7.60%. This improving fundamental picture increased investor confidence and risk taking throughout the year.
From a technical standpoint, the loan market continued to benefit from increasing demand and a lack of new issuance. The opportunity of purchasing senior loans at a discount to par and the prospect of increasing short-term interest rates in the periods ahead helped spark investor interest. The bank loan category of retail mutual funds took in approximately $1.6 billion in net new flows over the course of the year. This increased demand was met with modest new supply in the market. New senior loan issuance for 2009 was $75 billion, down 52% from the 2008 issuance level. The increased demand and light new issuance provided a strong technical backdrop for the market. Additionally, the trend of companies issuing new high yield bonds and using the proceeds to pre-pay bank debt at par continued throughout the year. In the fourth quarter alone, loan prepayments totaled $32 billion. This amount was in excess of the $26 billion in new loan issuance in the period. This combination of higher prepayments, new investor demand and light new issuance created a strong bid for loans in the secondary market.
Invesco Van Kampen Senior Income Trust Performance and Positioning
The fund performed well in the fourth quarter as well as for the full year 2009. The fund’s NAV was up 6.45% for the most recent quarter, and 89.02% for the full year, outperforming the S&P/ LSTA Leveraged Loan Index. The fund’s NAV was up 1.13% since the inception on 6/23/98.
The portfolio continues to be well diversified with over 280 individual issuers held and no loan holding in excess of 2.25% of the portfolio. From an industry standpoint, the fund has been favoring sectors in which we feel offer more stability such as health care, utilities, food, and cable. These industries tend to have more stable cash flows throughout a cycle and strong collateral coverage.
The fund continues to benefit from a very large and experienced investment team of 27 investment professionals. For new investments, the fund has been investing in higher quality credits that we believe have the financial flexibility and stability to perform throughout the cycle. The fund also benefited from the use of leverage in the period, as loan prices generally increased in value. The fund was approximately 34% leveraged as of the end of December 2009. The team believes the use of leverage will continue to benefit shareholders in the periods ahead.
Invesco Van Kampen Dynamic Credit Opportunities Performance and Positioning
The portfolio benefited from rising loan prices in both the U.S. and Europe. The fund’s NAV was up 6.76% for the most recent quarter and 71.39% for the full year 2009. The fund’s NAV was down -4.97% since the inception on 6/26/07. As you may recall, the invesco van kampen Senior Loan team manages the domestic portion of the portfolio, while Avenue Capital is the sub-advisor for the European component. At quarter end, the portfolio held approximately 62% in U.S. investments and 38% in Europe. For the quarter, the European senior loan market outperformed the U.S. market, but lagged for the full year period. The S&P European Leveraged Loan Index was up 5.13% for the fourth quarter, which brings the year to date return for the European market to 44.01%. The European loan market benefited from some of the same trends as the U.S. market. Loan prepayments in Europe continue to increase with over €3.5 billion in prepayments in the fourth quarter. Rising prepayments and a lack of meaningful new issuance has provided a strong technical environment for loan prices. In addition, the improving credit fundamentals and the prospect for declining default rates in Europe in 2010 have benefited loan prices.
The fund benefited from the use of leverage for the period as loan prices in both the U.S. and Europe generally rose. As of the end of December 2009, the fund was 20% leveraged. The team believes the use of leverage will continue to benefit shareholders in the periods ahead.
Outlook for the Senior Loan Asset Class
The team has a favorable outlook for the asset class in the periods ahead. Given the significant performance of the asset class year-to-date, it seems many investors are now questioning if there are additional opportunities in the asset class going forward. While we have certainly witnessed a dramatic rally, we still believe there is value at today’s prices. With loan prices on average at 87 cents on the dollar at year-end, and the potential for a declining level of defaults into 2010, the team believes there are still compelling investment opportunities in senior secured loans.
Additionally, while investors continue to have the ability to purchase loans at what we believe are relatively attractive values, investors are also positioning themselves well should short-term interest rates begin to rise in the future. Since senior loans pay a floating interest rate, should short-term rates move higher, senior loan investors could benefit through increasing distribution yields. This can act as a nice compliment to fixed rate investments that typically face a head wind in a rising interest rate environment. Overall, they believe there is still value in the senior loan market, and over the intermediate term, investors may be rewarded with increasing average loan prices.
Closed End performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. For the most recent month-end performance figures, please visit the performance section or speak with your financial advisor. Investment returns, net asset value (NAV) and common share market price will fluctuate and trust shares, when sold, may be worth more or less than their original cost.
The information reflects the views of the Portfolio Manager and the Senior Loan Group as of December 31, 2009. These views may change in response to changing circumstances and market conditions. These comments do not purport to represent a complete picture of the Senior Loan marketplace nor the future performance of any Invesco Van Kampen product. The forecasts and opinions in this piece are not necessarily those of Invesco Van Kampen, and may not actually come to pass.
Risk Considerations
There is no assurance that the closed-end fund will achieve its investment objective. Like stocks, a closed end fund’s share price will fluctuate with market conditions and other factors. At the time of sale your shares may have market price set above or below net asset value and may be worth more or less than your original investment. Accordingly, it is possible to lose money investing in the trusts. Fixed-income securities are subject to credit and interest-rate risk. Credit risk refers to the ability of an issuer to make timely payments of interest and principal. Investments in securities rated below investment grade (commonly known as ”junk bonds”) present greater risk of loss to principal and interest than investment in higher-quality securities. Interest-rate risk refers to fluctuations in the value of a fixed income security resulting from changes in the general level of interest rates. In a declining interest-rate environment, the portfolio may generate less income. In a rising interest-rate environment, bond prices fall. Senior Loan The Borrower, under a Senior Loan, may fail to make scheduled payments of principal and interest, which could result in a decline in the value of the bond. There is no guarantee that the collateral securing a Senior Loan will be sufficient to protect against losses or a decline in income in the event of a Borrower’s non-payment of principal and/or interest. Senior Loans made in connection with leveraged buyout transactions, recapitalizations, and other highly leveraged transactions are subject to greater risks than are other Senior Loans. Senior Loans may be rated below investment grade. Debt securities rated below investment grade are viewed by rating agencies as having speculative characteristics and are commonly known as ”junk bonds”. Leverage Should a Trust employ leverage, the portfolio may experience increased volatility. Derivative instruments. Investments in derivatives could magnify volatility. Foreign Securities. The Trust may invest in foreign securities; should it do so, the portfolio may be subject to additional currency, political, economic, and market risks.
The information presented contains forward-looking statements. Investors are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date in which they are made and which reflect management’s current estimates, projections, expectations or beliefs, and which are subject to the risks and uncertainties that may cause actual results to differ materially.
Past performance is no guarantee of future results. The index shown is not meant to depict the performance of any specific investment and the index shown does not include any expenses, fees or sales charges, which would lower performance. The indices shown are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.
Definitions: The S&P/LSTA Leveraged Loan Index consists largely of institutional loans and is intended to illustrate the performance of these loans. S&P European Leveraged Loan Index is a multi-currency index including all loan facilities with a minimum spread of Euribor +125 and at least one year term at inception.
NAV per share is determined by dividing the value of the trust’s portfolio securities, cash and other assets, less all liabilities, by the total number of common shares outstanding. Total return assumes an investment at the beginning of the period, reinvestment of all distributions for the period in accordance with the trust’s dividend reinvestment plan, and sale of all shares at the end of the period.
