What is a leveraged loan?
While there is no universally accepted definition, leveraged loans are generally considered to be loans extended by financial institutions to sub investment grade (lower than BBB-) corporations that already have significant levels of debt.
The US Federal Reserve (Fed) and the European Central Bank (ECB) define them as any loan granted to a company whose outstanding debt is more than four times its annual earnings and at the end of 2021, the level of leveraged loan issuance was at an all-time high.
While Europe limits the amount of debt that can be taken on to six times EBITDA, the US removed the limits resulting in organisations being well in excess of six times EBITDA. Loans are senior, meaning loan investors rank higher in the capital structure than other creditors (including bond investors) and get repaid first if there is a default. They are also secured, meaning investors have a claim on the assets of the borrower if a default happens. In contrast, most bonds are unsecured.
To put this into perspective, while 50% of the junk bond market borrowers carry credit ratings near the top of the investment grade level, only 25% of the leveraged loan borrowers have a rating of BB, while the remaining group are lower. With ending recession fears, many credit strategists are on the lookout for a wave of downgrades and subsequent defaults.
While there is no universally accepted definition, leveraged loans are generally considered to be loans extended by financial institutions to sub investment grade (lower than BBB-) corporations that already have significant levels of debt.
The US Federal Reserve (Fed) and the European Central Bank (ECB) define them as any loan granted to a company whose outstanding debt is more than four times its annual earnings and at the end of 2021, the level of leveraged loan issuance was at an all-time high.
While Europe limits the amount of debt that can be taken on to six times EBITDA, the US removed the limits resulting in organisations being well in excess of six times EBITDA. Loans are senior, meaning loan investors rank higher in the capital structure than other creditors (including bond investors) and get repaid first if there is a default. They are also secured, meaning investors have a claim on the assets of the borrower if a default happens. In contrast, most bonds are unsecured.
To put this into perspective, while 50% of the junk bond market borrowers carry credit ratings near the top of the investment grade level, only 25% of the leveraged loan borrowers have a rating of BB, while the remaining group are lower. With ending recession fears, many credit strategists are on the lookout for a wave of downgrades and subsequent defaults.
