What is Leveraged Lending?

Leveraged Loans are a type of syndicated loan made to below investment grade companies, i.e., companies with a credit rating below BBB-/Baa3. Many well-known companies fall into this category, including: Burger King, Chrysler, Dell, American Airlines and Avis. According to the Loan Syndications and Trading Association, over 70% of companies in America hold below investment grade ratings. A leveraged loan may be originated for a variety of reasons – general corporate purposes, refinance an existing loan, part of a recapitalization, finance a leveraged buyout, etc.

The two most common kinds of financing facilities are term loans and revolving facilities. A term loan is similar to a traditional loan where funding is disbursed at origination and repaid over time. These loans are typically held by non-bank, institutional lenders, such as insurance companies, asset managers, or other entities. A revolving facility is a type of loan that can repeatedly be drawn upon and repaid like a credit card. Revolving loans are typically originated and held by banks. The principal amount of term loans outstanding is estimated to be roughly double the size of revolving facilities outstanding.

How Big is the Market and Who Holds Leveraged Loans?

The leveraged loan market is a small but important piece of the U.S. financial system. In terms of size, the mortgage market has roughly $10 trillion in mortgage loans outstanding, and the broader fixed-income markets have a total outstanding of over $42 trillion. There are $1.7 trillion in leveraged loans outstanding.

Leveraged loans are primarily held by banks, non-bank companies (insurance companies, finance companies), asset managers (in a loan mutual fund) or securitizations called collateralized loan obligations (CLOs). CLOs hold $615 billion in leveraged loans (roughly 1/3 of the leveraged loans outstanding). In recent years, investors (typically funds) have increased the amount of lending they do directly with corporations, in so-called “direct lending” arrangements. Direct lenders, which are not regulated by the bank regulators and thus aren’t bound by various regulatory constraints that banks have, tend to focus on smaller loan sizes than typical in broadly-syndicated lending arrangements but are becoming more active in size.

The most recent Shared National Credit Report issued by the Fed, OCC, and FDIC showed that banks hold approximately 45% of the total loans reviewed by the regulators, but only 20% of the “special mention” and “classified” loans, those which present the most risk.

Credits

SIFMA Research Group
Katie Kolchin, CFA
Sharon Sung
Justyna Podziemska

Securitization and Corporate Credit
Chris Killian