The Handbook of Financial Instruments

Chapter 19 Leveraged Loans

Steven Miller

Managing Director PMD Group Standard & Poor’s

The leveraged loan market has evolved since the mid-1980s to an institutional investor-driven segment of the capital markets from the sole province of banks. Though the market retains some of the vestiges of a private market—including cumbersome documentation and transfer provisions and some measure of non-public information—institutional accounts now represent more than 50% of the funding for leveraged loans. As of September 30, 2001, roughly 80 institutional investors were active in the leveraged loan market.

These accounts are divided into three main segments: (1) retail mutual funds, (2) securitization vehicles, primarily collateralized loan obligations (CLOs), and (3) proprietary accounts of insurance companies, hedge funds, and a small number of pension funds; hedge funds and pensions tend to invest through total rate of return swaps.

As the institutional investor base has grown, banks’ appetite for leveraged loans has receded. In fact, most banks now are afflicted with anorexia when it comes to buying new loan assets. Since 1999, the number of banks that have actively bought leveraged loans on a retail basis¹ has withered to 31 as of September 30, 2001 from 110. The reasons are straightforward:

• Most banks are husbanding their capital for fee-generating businesses rather than investing in credit products; in fact, the chance of capturing fees as a memeber of the bond syndicate is one ...