RSS FeedBy M. Isi Eromosele
Leveraged finance usually refers to corporate debt with relatively high credit risk. Leveraged finance has long attracted financial policy scrutiny because of the risks it poses for banks.
In earlier years, portfolio credit losses were the main risk. In recent years, a wider variety of participants have risen up in the leverage finance market, even as the characteristics of loans and the channels through which they are distributed have changed.
Even if banks do not ultimately intend to hold the loans they underwrite, the issuance process can give rise to warehousing risk.
Changes In The Leveraged Loan Market
The term, “Leveraged Loan”, arose in the early 1990s as a means of distinguishing relatively safe corporate loans from riskier ones at a period when the majority of loans were unrated and held by banks.
Leveraged loans were usually syndicated to groups of banks at origination and held to maturity by syndicate members, with little secondary market trading. All through the 1990s, the typical deal included a large revolving line of credit (RC) and one or more amortizing term loans (TL) with an original term of maturity of five years or less.
Much has changed in the leveraged finance market since the 1990s. Bank consolidations, heightened competition in retail banking and greater participation by institutional investors in the leveraged loan market have been key factors driving this change.
Deal sizes have grown larger, many loans are now rated by the credit agencies and liquidity in the secondary market has increased. Additionally, greater participation by institutional investors has led to a fall in banks’’ primary loan market share.
As a result, banks’ direct exposure to leveraged debt has declined as well. However, banks now have more indirect exposure to leveraged loans through securitization vehicles that use leveraged loans as collateral assets.
In recent years, loan characteristics have evolved in response to institutional investor preferences. As an example, arranger banks have partly or fully replaced tranches that appeal to commercial banks with those designed to appeal to institutional investors.
Leveraged debt markets have been one locus of the chaos in global financial markets that began in mid-2007. This has resulted in a sharp decline in issuance and a large increase in leveraged loan credit spreads in light of weak investor demands.
Trends In Debt Issuance
Issuance in the leveraged loan and high-yield bond market has deteriorated sharply following the credit market turmoil of the past few years, suggesting that access to funding through leveraged loans has been severely affected. High-yield bond issuance volume is far smaller than syndicated loan volume, especially in the United States.
Until recently, leveraged finance issuance volumes were smaller in European markets than in the United States. The difference was there because a larger proportion of European firms still arrange loans bilaterally with banks.
However, the European syndicated loan market have picked up some momentum, signaling a transition towards more market-oriented loan financing by mid-sized and large European firms.
Issuance volume remain relatively small in the Asian markets, perhaps because traditional bank lending (without syndication) still plays a dominant role in debt finance for most firms in the region in contrast to leveraged finance, which is more market oriented.
M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance
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