What are Leveraged Loans?

Leveraged loans are a type of syndicated loan for below investment grade companies (credit rating below BBB- or Baa3). Around 69% 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. Term loans are similar to traditional loans where funding is disbursed at origination and repaid over time, typically held by non-bank institutional lenders such as insurance companies, asset managers, etc. Revolvers are types of loans that can be repeatedly drawn upon and repaid like a credit card, typically originated and held by banks. The principal amount of term loans outstanding is estimated to be roughly double the size of revolving facilities.

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. While the residential mortgage market has around $10.6 trillion in loans outstanding and the broader fixed income markets have $50.9 trillion in securities outstanding, there are only $1.6 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 collateralized loan obligations (CLOs). CLO purchases continue to be a significant buyer of below investment grade corporate debt. According to the Federal Reserve, CLOs hold over 50% of outstanding institutional leveraged loans. In recent years, investors (typically funds) have increased the amount of lending they do directly with corporations, in direct lending arrangements. Direct lenders, which are not regulated by bank regulators and therefore not bound by regulatory constraints of banks, tend to focus on smaller loan sizes in broadly syndicated lending arrangements, albeit they are becoming more active in size.

Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency indicated that banks hold 63% of SNC bank-identified leveraged loans, most of which consist of higher rated and investment grade equivalent revolvers. Yet, banks hold only 24.4% of special mention and classified loans, i.e. those which present the most risk.

Authors

SIFMA Research Group
Katie Kolchin, CFA
Justyna Podziemska
Ali Mostafa