Leveraged finance
Capital MarketsThe business of arranging debt for below investment grade borrowers, principally to fund buyouts and acquisitions.
Also written: lev fin
Leveraged finance covers debt raised by companies rated below investment grade, most visibly the term loans and high yield bonds funding private equity transactions.
The two main instruments differ in useful ways. Term loans are floating rate, senior secured, prepayable without penalty and held largely by funds and CLOs. High yield bonds are typically fixed rate, longer dated, carry call protection restricting early repayment, and often sit below the loans in the structure.
The desk's job is to underwrite and syndicate: committing to provide the financing so the sponsor can bid with certainty, then selling it down to investors. The gap between commitment and syndication is where the bank carries real risk, as market conditions can move against it.
It is intensely cyclical, because both the availability and cost of this debt determine what sponsors can pay. When the leveraged market closes, buyout activity stops almost immediately.
Worked example
A buyout needs 550 of debt: 350 of term loan B at three month Euribor plus 425 basis points, and 200 of senior secured notes at a 7.5% fixed coupon.
The loan is floating, prepayable at par and held by CLOs and funds. The notes are fixed, carry two years of call protection, and are held by high yield investors.
The bank commits to the full 550 so the sponsor can bid with certainty, then syndicates it down. The gap between commitment and syndication is where the bank carries real market risk.