The U.S. Leveraged Loan Market: A Primer
Oct 01, 2004
Glenn Yago and Don McCarthy

Throughout history, innovation has driven the development of the financial markets, and over the last 20 years, the syndicated loan market has provided particularly fertile ground for financial innovation. From a relatively esoteric field involving commercial banks syndicating lines of credit, financial innovations have helped it develop into a broad, dynamic market encompassing both an efficient primary market that originates syndicated credits and a liquid secondary trading market where prices adjust to reflect credit quality and market conditions.

The development of an efficient and liquid syndicated loan market in the U.S. has greatly impacted its capital markets. The syndicated loan market bridges the private and public fixed-income markets and provides borrowers with an alternative to high yield bonds and illiquid bilateral commercial bank loans. It provides much-needed credit to lower-rated companies and has strengthened the bankruptcy process in the U.S. through its facilitation of DIP (debtor-in-possession) lending.

Today's syndicated loan market benefits banks also; in times of adversity, they can sell portions of the syndicated credits into a relatively liquid secondary market and actively manage the risk in their loan portfolios. This allows banks to avoid unnecessary lending restrictions when the economy contracts and thus the impact of an inefficient "credit crunch."

The development of the secondary market for syndicated loans has led to the creation of a new asset class with greater return per unit of risk than many other fixed-income assets and low correlations with most other classes of assets.

This paper sets forth the origins and milestones of the quiet revolution that has been the growth of the syndicated loan market. The leveraged portion of the market, the part of the market where most innovation has occurred, receives special attention.

This analysis provides a primer to investors and other parties interested in a market that has, without great fanfare, been one of the most rapidly growing and innovating sections of the U.S. capital market in the past 20 years. It explores issues related to the main features of the primary market using the most recent data available and details the characteristics of the secondary market. Investment returns, as well as the risks of the asset class, particularly credit risk, receive special attention.