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Leveraged Loans

One-line definition

Senior secured, floating-rate debt issued by below-investment-grade borrowers — the bank-loan-market cousin of high-yield bonds, with a different risk profile driven by that combination of secured status and floating coupons.

Key differences from high-yield bonds

  • Rate: loans float (reference rate, typically SOFR, plus a fixed margin); high-yield bonds are almost always fixed-rate. A loan investor's income rises automatically as rates rise, but so does the borrower's interest bill — floating-rate exposure cuts both ways.
  • Seniority: loans are typically senior secured (first claim on collateral); high-yield bonds are typically senior unsecured. This is the single biggest driver of loans' historically higher recovery rates in default.
  • Covenants: loans traditionally carried maintenance covenants (tested every quarter regardless of issuer action); the rise of "covenant-lite" loans over the 2010s eroded much of that distinction, moving loan covenant packages closer to bonds' incurrence-only style — see fundamental credit analysis.
  • Pricing convention: loans are typically quoted on a discount margin basis (spread to the floating reference rate) rather than a fixed-rate yield or spread-to-Treasury, since their coupon already floats with the reference rate.

Why PMs care

Rates going up is a genuinely different event for a loan book than a high-yield bond book: loan coupons reset higher (helping loan holders' income, but also raising the exact borrowers' debt-service burden that interest coverage measures). A PM choosing between the two isn't just picking a different point on the credit curve — they're picking a different interest-rate exposure and a different position in the capital structure for essentially the same underlying company, in many cases the same issuer with both a loan and a bond outstanding simultaneously.

Why this isn't implemented in src/pm

The mechanics that differ from a fixed-rate bond — floating-rate resets, discount-margin pricing, prepayment/call optionality specific to loan documentation — are a materially different computation from this repo's fixed-coupon bond-pricing functions, and the same "small transparent function" discipline that keeps OAS and HRP conceptual-only applies here: better to state the comparison clearly than ship an under-tested loan pricer. The credit ratio functions in fundamental credit analysis — leverage, coverage, fixed-charge coverage — apply identically to a loan issuer as to a bond issuer, since they're properties of the borrower, not the instrument.

Common mistakes

  • assuming loans are always safer than high-yield bonds because of seniority alone — a loan and a bond from the same over-levered issuer are both exposed to that issuer's fundamental deterioration, seniority only changes the recovery outcome if default happens
  • ignoring rate-reset risk in a rising-rate environment — a floating coupon protects the investor's income, but rising debt service can push a marginal borrower toward the exact covenant breach or default that erases the seniority advantage
  • treating "covenant-lite" as a recent, minor development rather than a structural shift in the loan market's risk profile over the past decade-plus

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