Loading the player...

What is a 'Leveraged Loan'

A leveraged loan is extended to companies or individuals that already have considerable amounts of debt. Lenders consider leveraged loans to carry a higher risk of default, and as a result, a leveraged loan is more costly to the borrower. Leveraged loans for companies or individuals with debt tend to have higher interest rates than typical loans; these rates reflect the higher level of risk involved in issuing the loan.

BREAKING DOWN 'Leveraged Loan'

In business, leveraged loans are also used in the leveraged buyouts (LBOs) of other companies. A leveraged loan is structured, arranged and administered by at least one commercial or investment bank. These institutions are called arrangers and subsequently may sell the loan, in a process known as syndication, to other banks or investors to lower the risk to lending institutions.

A Leveraged Loan

There is no exact criteria for defining a leveraged loan. Some market participants base it on a spread. For instance, many of the loans pay a floating rate, typically based on LIBOR plus a stated interest margin. If the interest margin is above a certain level, it is considered a leveraged loan. Others base it on the rating, with loans rated below investment grade, which is categorized as Ba3, BB- or lower from the rating agencies Moody's and S&P.

S&P's Leveraged Commentary & Data (LCD), which is a provider of leveraged loan news and analytics, places a loan in its leveraged loan universe if the loan is rated BB- or lower. Alternatively, a loan that is nonrated or BBB- or higher is classified as a leveraged loan if the spread is LIBOR plus 125 basis points or higher and is secured by a first or second lien.

Price Flex

Typically, banks are allowed to change the terms when syndicating the loan, which is called price flex. The interest margin can be raised if demand for the loan is insufficient at the original interest level in what is referred to as upward flex. Conversely, the spread over LIBOR can be lowered, which is called reverse flex, if demand for the loan is high.

Reasons for a Leveraged Loan

Companies typically use a leverage loan to finance mergers and acquisition (M&A), recapitalize the balance sheet, refinance debt or for general corporate purposes. M&A could take the form of an LBO. This occurs when a company or private equity company purchases a public entity and takes it private. Typically, debt is used to finance a portion of the purchase price. A recapitalization of the balance sheet occurs when a company uses the capital markets to change the composition of its capital structure. A typical transaction issues debt to buy back stock or pay a dividend.

RELATED TERMS
  1. Leveraged Loan Index - LLI

    A market-weighted index that tracks the performance of institutional ...
  2. Call Loan

    A loan provided to a brokerage firm and used to finance margin ...
  3. Direct Consolidation Loan

    A loan that combines two or more federal education loans into ...
  4. Leverage

    1. The use of various financial instruments or borrowed capital, ...
  5. Standing Loan

    A type of loan where payments are made of interest only. Repayment ...
  6. Refinance

    1. When a business or person revises a payment schedule for repaying ...
Related Articles
  1. Investing

    Explaining Leveraged Loans

    Leveraged loans are loans extended to companies or people who already have large amounts of debt.
  2. Personal Finance

    Understanding Term Loans

    A loan from a bank for a specific amount that has a specified repayment schedule and a floating interest rate.
  3. Insights

    An Introduction to Government Loans

    Government loans further policymakers' efforts to create positive social outcomes by offering timely access to capital for qualified candidates.
  4. Investing

    Leverage: Is It Good for Your Portfolio?

    Discover the concept of financial leverage. Learn multiple ways to get leverage in your portfolio, and decide if leverage is a good idea for you.
  5. Personal Finance

    Personal Loans vs. Car Loans

    How to tell whether a personal loan or a car loan is better for you.
  6. Personal Finance

    All About Government Loans

    There are many reasons to seek a government loan rather than one from a private lender. Government loans typically have low interest rates and offer fixed or subsidized options, as well as deferred ...
  7. Personal Finance

    How To Apply For a Personal Loan

    Learn about different avenues for applying for a personal loan, and learn valuable tips to help you get your personal loan application approved.
  8. Managing Wealth

    Unsecured Personal Loans: 8 Sneaky Traps

    If you are seeking a personal loan, be aware of these pitfalls before you proceed.
  9. Personal Finance

    Different Needs, Different Loans

    Find out what options are available when it comes to borrowing money.
RELATED FAQS
  1. What are the typical repayment terms for a syndicated loan?

    Learn more about syndicated loans and how they are structured, specifically including the typical repayment terms for a syndicated ... Read Answer >>
  2. What are the risks of having both high operating leverage and high financial leverage?

    In finance, the term leverage arises often. Both investors and companies employ leverage to generate greater returns on their ... Read Answer >>
  3. What is considered a reasonable interest rate for a syndicated loan?

    Discover how syndicated loans work, why they are beneficial for businesses, and what is considered a reasonable interest ... Read Answer >>
  4. Are secured personal loans better than unsecured loans?

    Read about the differences between secured loans and unsecured loans and how they are used. Learn about forms of collateral ... Read Answer >>
  5. Who generally structures a syndicated loan?

    Learn what syndicated loans are, including how they are structured and administrated, usual payment terms and costs associated ... Read Answer >>
  6. Besides operating leverage, what are other important forms of leverage for businesses?

    Learn about what other forms of leverage exist for businesses besides operational leverage, and the primary leverage metrics ... Read Answer >>
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center