Leveraged Loan
AdvancedA leveraged loan is a loan made to a company that already has a high level of debt or a low credit rating, usually below investment grade, typically carrying a floating interest rate higher than loans to stronger borrowers.
Leveraged loans are commonly used to finance leveraged buyouts by private equity firms, acquisitions, refinancing and payouts to shareholders. They are usually arranged as syndicated loans and secured against the borrower's assets.
Because borrowers are riskier, lenders charge higher interest rates, usually a benchmark rate plus a margin. For example, a leveraged loan might pay the benchmark rate plus 3.5 percentage points.
Many leveraged loans are bought by institutional investors, such as collateralized loan obligations, mutual funds and insurers, rather than held by banks. Over the past two decades, many have been issued as covenant-lite loans, with fewer protections for lenders.
Leveraged loans offer investors relatively high income and, because rates float, some protection against rising interest rates. But they carry significant credit risk, especially during economic downturns, when defaults rise. Regulators monitor the leveraged loan market closely because of its size and links to the wider financial system.
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