Senior Loans

Characteristics and Attributes of Senior Loans*

• High risk-adjusted returns

• Low volatility

• Large, liquid market

• Higher average recovery rates

• Positive returns in every year from January 1992
  through December 2006
  

*(Source: Standard and Poor's LCD)

What is a Senior Loan?

Senior Loans are debt obligations issued by public and private companies with a need for capital.  Companies typically issue Senior Loans in the form of a term loan with a maturity of 5 to 7 years.  The proceeds generated from the Senior Loan issuance are often used for acquisitions, recapitalizations, restructurings and leveraged buyouts. 

Senior Loans are also known as Leveraged Loans,       Syndicated Loans, Senior Secured Loans,       or Below-Investment Grade Bank Debt.

Senior Loans can be segmented into two categories, leveraged and investment grade.  Leveraged Senior Loans are comparable to the high-yield bond market from a ratings and leverage perspective.  In most instances, a loan will be classified as a Leveraged Loan if it has debt ratings of below Baa3/BBB- from Moody’s and S&P, respectively.

Investment grade loans do not typically offer fully funded lending opportunities and therefore do not often represent attractive returns for non-bank investors.

Characteristics of a Senior Loan

• Senior Claim on Assets and Stock.  Senior Loans generally occupy the highest priority claim for principal and interest payments.  In the event of a default, Senior Loans are typically repaid first and, subject to the adequacy of the company’s assets, repaid in full prior to other classes of junior (or subordinated) debt and all types of equity. 

• Secured by Stock and Assets.  Further enhancing the likelihood of higher recoveries in the event of default, Senior Loans benefit from being secured by specific collateral, including but not limited to assets of the borrower such as, inventory, accounts receivable, property, plant, equipment and real estate.

• Floating Rate Coupon. The majority of Senior Loans bear interest based on a floating rate index such as LIBOR, the Prime Rate or other such “base rate”. These base rates may reset daily, weekly, monthly or less frequently. In contrast to high-yield bonds with a fixed coupon, the floating rate coupon of Senior Loans may serve to insulate Senior Loans from the effects of rising or falling interest rates.

• Corporate Borrowers. Corporate borrowers can be public or private companies with a need for capital and demonstrated capacity to repay. Today, commercial banks and investment banks originate, underwrite and syndicate Senior Loans for their corporate clients in the same fashion that they have been doing for many years in the high-yield bond market.

Senior Loans Exhibit High Risk-Adjusted Returns, Low Volatility and Low Correlation to Other Asset Classes

Senior Loans as an asset class have exhibited high risk-adjusted returns when compared to other asset classes. Additionally, their returns have consistently exhibited low correlation to other asset classes.

Sharpe Ratios*
(1997 - 2Q08)

Sources: Standard & Poor's; S&P/LSTA; Merrill Lynch; Bloomberg.      * Sharpe Ratios measure risk-adjusted performance. It is calculated by subtracting the risk-free rate from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.

Senior Loan Correlations with Other Asset Classes
(1997 - 2Q08)

Sources: Standard & Poor's; S&P/LSTA; Merrill Lynch; Bloomberg.

Lower Default Rates

Over the past 30+ years, “spikes” in the default rate in speculative or non-investment grade bonds have historically been followed by periods of lower-than-average default rates.

During periods of high defaults, investors and lenders tend to tighten underwriting standards, resulting in more conservatively structured bonds and Senior Loans.

High Yield Bond and Senior Loan Default Rates
(1977-2007)

Source: Credit Suisse  Data for senior loans began to be collected in 1992. No significant statistics exist prior to this date.

Current default statistics reflect the quality of recently issued Senior Loans.

Senior Loan Default Rate by Number of Issuers
(lagging 12 months)
(1998 - 2Q08)

Source: Standard and Poor’s LCD and S&P/LSTA Leveraged Loan Index

Higher Average Ultimate Recovery Rates

Because Senior Loans are typically secured, holding a senior claim on assets, and are generally subject to certain performance maintenance covenants, Senior Loan lenders are often in a better position to negotiate with equity holders before a company gets into financial difficulties. The loan or credit agreement is typically designed to protect the lender’s (or Senior Loan investor’s) interests by defining what future operating and financial performance is acceptable, specifying defaults and remedies, and detailing how modifications to the agreement can be implemented. Senior Loan maintenance covenants vary and are generally tighter (i.e. more restrictive) than high-yield bond covenants. Covenants typically become more restrictive as credit quality declines, allowing the lender a greater degree of influence over the investment.

Senior Loan covenants essentially provide an “early warning” to the lenders and historically have contributed to keeping Senior Loan default rates approximately 20% lower than high-yield bond default rates. And because they are senior and secured, recoveries on Senior Loans from 1995 to 2007 significantly exceeded recoveries on high-yield bonds.

Institutional Leveraged Loan vs. High Yield Bond Recovery Rates

Source: Credit Suisse

* The information contained herein does not constitute a distribution, an offer to sell or the solicitation of an offer to buy any securities or investment services. Past performance is not intended to imply nor should it be considered to be a promise or guarantee of future performance. Funds managed by Four Corners may fail to achieve stated investment objectives. Investors should consult with their brokers or investment advisers prior to considering an investment in any Four Corners products. Statistical data for senior loans began to be collected in 1992. No significant statistics exist prior to this date.