Leveraged Finance: Concepts, Methods, and Trading of High-Yield Bonds, Loans, and Derivatives

CHAPTER 3

Leveraged Loans

The investor base in the leveraged loan market has been in flux ■ since the end of 2007, with a number of nontraditional investors looking to get in (e.g., equity funds, distressed investors, private equity) and others trying to trim exposure (e.g., select hedge funds). In this chapter, we provide an overview of the loan market, with topics ranging from a description of a typical loan to changes in market dynamics.

A TALE OF TWO LOANS

Lessons sometimes have to be relearned in the financial markets, particularly when new participants enter a market. Consider the loan market—the fact that a senior loan is “secured” does not in itself guarantee the loan’s credit quality or profit potential. To illustrate in more detail, consider two loans in the retail space issued by fictitious companies Northern and Southern, respectively. Key considerations for each company are outlined in Table 3.1.

Northern is a retail store chain with a terrific market share in its home base. That ends its good points. The stores and their equipment were old, and they were in bad locations. A larger, well-capitalized store chain had saturated a neighbouring market and was poised to invade Northern’s territory.

If anyone knew these facts, they kept quiet about them. Northern’s equity buyout firm was simultaneously doing another deal in a different part of the country. It did not, to put it gently, volunteer a lot of negative facts about Northern. The arranger of the loan was looking ...