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Basics Of Leveraged Loan Market

Leveraged loan is a syndicated loan, which is mainly issued by borrowers with high borrowing levels. There are two broad ways to differentiate between a leveraged and a conventional loan. They are credit ratings and loan's initial interest rate spread over LIBOR. Highly levered borrowers are generally sub investment grade companies and require paying higher spreads. Any loan which is rated BB and below is considered as a leveraged loan. Moreover, Bloomberg defines these loans as any loan with a spread of over 250 bps on the LIBOR.

These loans are traded in secondary market and therefore are viewed as an alternate investment class to HY bonds. Except higher yields, there are several differences between these two asset classes. Leveraged loans are generally perceived as relatively less risky investment compared to high yield bonds. They are generally secured by the operating assets of the issuer, unlike high yield bonds. Therefore the former shows a better recovery rate. They also exhibit lower secondary market price volatility on a relative basis. They are floating rate securities while high yield bonds are typically fixed interest rate investments. This offers duration advantage to such loans. One more important benefit that these loans has over high yield bonds the former's very tight covenant package, which helps investor to apply more forceful control over borrowers.

In a risk-on investment environment, most investors generally look at equities and risky bonds and move away from safe asset class like government bonds of the strongly rated sovereigns. That said, considering a very large size of this market, traditional junk bond investors should expand their scope of investments into leveraged loans.

The higher allocation into this asset class has the potential to offer equity-like returns from secured floating rate securities, which are generally active in both primary as well as secondary market.

It is a mature market in both the US and Europe. As per FT, in the past one year, US debt managers have raised more than USD50bn of new collateralized loan obligation vehicles to acquire senior secured leveraged loans issued by borrowers in the US and Europe. Given a significant yield compression of high yield bonds in recent years, this market offers some attractive high yield investment opportunities for fixed income investors and wealth managers.

Over the past 12 months, European non-investment grade unsecured bonds have offered investors less than 6.0% yield. On the other hand, less accessible senior debt assets have provided investors with a yield of 4.75% over cost of funds.

In summary, leveraged loan is an attractive asset class in a HY investment space owing to their seniority to high yields bonds and benefits including tangible asset cover, and better recovery rates.