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By Sumit Desai, CFA | 06-20-2014 10:00 AM

Bank-Loan Fundamentals Have a Tailwind

The bank-loan market has supportive conditions for at least the next year, but near-term fundamental strength might not hold up against long-term outflows, says Western Asset's Michael Buchanan.

Sumit Desai: Hi. I'm Sumit Desai, fixed-income analyst on Morningstar's manager research team. Joining me today at the Morningstar Investment Conference is Michael Buchanan. Michael is head of global credit research at Western Asset Management.

Michael, thank you for joining me.

Michael Buchanan: Thanks for having me.

Desai: Michael, one of the hot topics at the conference this year has been where we are in the credit markets and specifically within high-yield bonds and floating-rate vehicles. Can you talk a little bit about your view of where we are?

Buchanan: I think one of our stronger views is that this is going to be one of the longer credit bull markets that we've witnessed in recorded history, and we don't just say that simply because that's an axe of ours. We say that because we think there are real, real reasons that motivate that. For instance, the severity of what happened in 2008 and the damage that did to corporate psyche, whether it's a CFO, a treasurer, a CEO, they're still very conservative. They're managing their balance sheets very conservatively. They're proactively refinancing. So, they really don't have a lot of near-term refinancing risk.

When we look forward, we still see very supportive fundamentals, and we think fundamentals are what has gotten us to this point since the recovery started. And we still see those fundamentals as a very strong, nice tailwind. We still think this credit market, despite valuations, has some room to go.

Desai: You mentioned valuations, a lot of, I guess, bears who look at this space would argue that valuations are getting a little bit overstretched and a little bit rich. Can you tell me your thoughts about how that plays out relative to the fundamentals?

Buchanan: I think that's exactly right. You have to compare valuations with fundamentals. You can't look at either in isolation, and I think, given how strong the fundamentals are, valuations look reasonable. They certainly don't look as cheap obviously as they were a year ago or two years ago, but I still think that when you look at it on a spread basis, there's room for spread compression. I still think that fundamentals are strong enough to motivate some spread tightening. If you look around the overall fixed-income landscape, I think what you're going to find is that credit, whether it's bank loans or high yield or investment-grade credit, will end up being a reasonable alternative to other fixed-income products.

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