Leveraged Loan

What Is a Leveraged Loan?

A leveraged loan is a loan extended to a company that already has a substantial debt load or a below-investment-grade credit rating (typically rated BB+ or below). These loans are arranged by banks that syndicate them — sell them to — institutional investors such as CLOs, mutual funds, and hedge funds.

Key Characteristics

• Floating rate: Leveraged loans pay a spread over SOFR (formerly LIBOR), making them naturally hedged against rising short-term interest rates
• Senior secured: Most leveraged loans are secured by the borrower's assets, giving lenders priority in bankruptcy
• Cov-lite: Since ~2010, most leveraged loans have "covenant-lite" terms — fewer financial maintenance covenants — which benefits borrowers but provides lenders less early warning of deterioration
• Callability: Borrowers can prepay without penalty after a short lockup, meaning the effective duration is low

LBO Connection

Leveraged loans are the primary funding mechanism for private equity leveraged buyouts (LBOs). When a PE firm acquires a company, it typically uses 50–70% debt (largely leveraged loans) and 30–50% equity. The loan sits on the acquired company's balance sheet, not the PE firm's.

Floating Rate Appeal

Because leveraged loans pay SOFR + a spread (e.g. SOFR + 400bps), they are one of the few fixed-income instruments that directly benefit from rising rates — their coupon rises automatically. This made them extremely popular during the 2022 rate hiking cycle.

Risks

• Default risk: These are below-investment-grade credits
• Liquidity risk: The secondary market is less liquid than bonds; prices can gap sharply in a selloff
• Refinancing cliff: When loans mature simultaneously (a "wall"), companies face refinancing risk if credit markets are closed