What is a 'Senior Bank Loan'

A senior bank loan is a debt financing obligation issued by a bank or similar financial institution to a company or individual that holds legal claim to the borrower's assets above all other debt obligations. The loan is considered senior to all other claims against the borrower, which means that in the event of a bankruptcy the senior bank loan is the first to be repaid before all other interested parties receive repayment. Because senior bank loans are usually secured via a lien against the assets of the borrower, if the borrower should enter a state of bankruptcy in the future, the assets used to secure the senior bank loan must be used to repay the senior bank loan before other creditors, preferred stockholders or common stockholders receive any payment.

BREAKING DOWN 'Senior Bank Loan'

Senior bank loans help businesses continue daily operations. The loans are typically backed by company inventory, property, equipment or real estate. Because senior bank loans are at the top of a company’s capital structure, the secured property is typically sold and proceeds are distributed to loan holders before other lenders are paid. Historically, the majority of businesses with senior bank loans that ended up filing for bankruptcy were able to cover the loans entirely.

Pros and Cons of Senior Bank Loans

Senior bank loans have floating rates that fluctuate according to the London Interbank Offered Rate (LIBOR) or other benchmark. For example, a bank’s rate is LIBOR + 5%, and LIBOR is 4%. Therefore, the loan yield is 9%. Because loan rates often change monthly or quarterly, interest on the loan may increase or decrease at regular intervals. This helps protect investors from rising short-term interest rates that make bond prices decrease, as well as against inflation.

Because businesses receiving senior bank loans often have lower credit ratings, credit risk is typically greater than with other types of bonds. For this reason, valuations of senior bank loans fluctuate often and may be volatile. This was especially true during the big bank crisis of 2008.

Because of senior bank loans’ volatility, they typically have higher yields than investment-grade corporate bonds. However, because the lenders are paid back before other creditors in case of insolvency, the loans yield less than high yield bonds.

Investing in Senior Bank Loan Funds

Investing in senior bank loan funds may be beneficial for investors seeking regular income. Typical loan funds yield 5% to 6%. Because of the loans’ floating rate, when the Federal Reserve increases interest rates, loans have greater yields. Also, senior bank loan funds typically have a risk-adjusted return over a three-to-five-year period that makes them attractive to conservative investors. When the loan funds underperform, bonds sell at a discount to par, increasing an investor’s yield. In addition, the loan funds’ average default rate historically is 3%, making the funds even more attractive to investors.

RELATED TERMS
  1. Loan

    The act of giving money, property or other material goods to ...
  2. Standing Loan

    A type of loan where payments are made of interest only. Repayment ...
  3. Commercial Loan

    A debt-based funding arrangement that a business can set up with ...
  4. Senior Stretch Loan

    A specific type of loan to a business entity, which possesses ...
  5. Call Loan

    A loan provided to a brokerage firm and used to finance margin ...
  6. Origination

    The process of creating a home loan or mortgage. During the origination ...
Related Articles
  1. Investing

    BKLN: PowerShares Senior Loan ETF

    Read an in-depth analysis of the PowerShares Senior Loan ETF, which is an innovative product tracking the US senior leveraged loan corner.
  2. Investing

    Rate Hike Fears Lure Investors to This ETF

    ETFs holding these types of bonds are flourishing amid rate hike chatter.
  3. Financial Advisor

    Do Senior Loans Belong in Your Porfolio? (BKLN, BXFZX)

    Fixed income is supposed to be a stable part of an investment portfolio. How do senior loans fit in and at what risk?
  4. 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.
  5. Personal Finance

    Understanding Loans

    A loan is the act of giving money, property or other material goods to another party with the expectation of being repaid.
  6. Personal Finance

    Personal Loans vs. Car Loans

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

    Different Needs, Different Loans

    Find out what options are available when it comes to borrowing money.
  8. Investing

    Be Your Own Loan Shark With Bank Loan Funds

    Investors who take on a little risk in senior loan funds may be rewarded handsomely as prices reset in the next few years.
  9. 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.
  10. Personal Finance

    How Banks Set Interest Rates on Your Loans

    Many factors go into how banks set interest rates for loans. Use this information to negotiate the best possible rate when you're borrowing.
RELATED FAQS
  1. 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 >>
  2. What are the pros and cons of life insurance policy loans?

    Find out the pros and cons of borrowing against your life insurance policy to help you decide if this loan type is the right ... Read Answer >>
  3. 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 >>
  4. Federal student loan rates: who sets them, why they vary

    Federal student loan rates are set by Congress, not by banks. Learn more about who gets what rate, and how often they get ... Read Answer >>
Hot Definitions
  1. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  2. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  3. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  4. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  5. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
  6. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities ...
Trading Center