The use of leveraged loans has increased in the current market due to slow growth and low rates. One of the reasons for the importance of leveraged loans is that as far as fixed income portfolios are concerned, they offer a unique option of diversification.
What Is A Leveraged Loan?
A leveraged loan, as the name suggests, is a loan that has been given by a group of lenders to a commercial entity or an individual for commercial purposes. A leveraged loan, also known as senior secured credit, is unlike other loans since it is administered, arranged, and structured by a number of commercial investment banks. All of these are known as the arrangers. It is also possible for these loans to be sold off to other investment institutions or banks.
These debts are commonly given by companies that have ratings just below or some way below the ones required to become investment grade. These debts are senior as in more important to the other debts taken by the company. Securing of these loans is typically done with the use of a lien on assets of the company.
These loans unlike the other loans will typically have higher rates of interest than the ones that you would get a normal loan for. But the fact that they are given to companies already on loans means that they are financing outlets for companies that cannot go to banks for more. In the world of investment banking and giving of loans, the rate of interest highlights the risk associated with the loan being defaulted. The higher the rates of interest, the more chances the lender feel that their loan may be defaulted.
Great Risk And A Greater Reward
Leveraged loans are popular in the market largely because they offer a relative value that is better than its other nearest investment opportunity rivals such as investment grade bonds and high yield bonds.
The benefits you get from a bond and leveraged loans in the market today are almost similar. Yet, the trump that leveraged loans have over the other is that the lenders of a leveraged loan will have a greater protection since they are senior debts.
Unlike other classes of fixed income, when you invest in a leveraged loan, they are offered with a lien claim on the business’s underlying assets in case the business goes bankrupt. Typically, leveraged loan lenders will have covenants in place to safeguard their interest and ensure the solvency of the business.
Common Uses Of Leveraged Loans
There are many reasons why leveraged loans are used by commercial businesses. Here is a list of some of the most common reasons behind the popularity of leveraged loans:
- To support hefty business transactions that includes M&As and require considerable finances
- To address your company’s debt issues by having to refinance it
- To generally fund a project or any business-related corporate purpose
- To ensure that the balance sheet of the company is recapitalized and its books updated
Leveraged Loans are an important part of the economic environment prevalent in the world today.