Leveraged Loans: Is High Leverage Risk Priced in?

44 Pages Posted: 3 Dec 2020 Last revised: 21 Dec 2020

See all articles by David Newton

David Newton

University of Bath - School of Management

Steven Ongena

University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)

Ru Xie

University of Bath, School of management

Binru Zhao

University of Bath - School of Management

Date Written: December 1, 2020

Abstract

The economic downturn caused by the Covid-19 pandemic accentuates extant concerns about the leveraged loan market. Using a novel dataset, we show that leveraged loan spreads have declined for nonbank-facilities since the introduction of the Interagency Guidance on Leveraged Lending (IGLL) and the ensuing “frequently asked questions for implementing the March 2013 guidance”. The decline in leveraged loan spreads is significant for highly leveraged borrowers, especially when involving term loans. We further demonstrate that risk shifting issues associated with the high level of Collateralized Loan Obligations issuance strongly explain the decline of nonbank leveraged loan spreads. In addition, a higher degree of information asymmetry, driven by an increase in covenant-lite loan issuance and weaker investor protection, are strongly associated with the narrowed leverage risk premium.

Keywords: Leverage Risk, Syndicated Loan Pricing, Leveraged Loan, Risk Shifting

JEL Classification: G21, D82, G34

Suggested Citation

Newton, David and Ongena, Steven R. G. and Xie, Ru and Zhao, Binru, Leveraged Loans: Is High Leverage Risk Priced in? (December 1, 2020). Swiss Finance Institute Research Paper No. 20-111, Available at SSRN: https://ssrn.com/abstract=3741693 or http://dx.doi.org/10.2139/ssrn.3741693

David Newton

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Steven R. G. Ongena

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Ru Xie (Contact Author)

University of Bath, School of management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Binru Zhao

University of Bath - School of Management

Claverton Down
Bath, BA2 7AY
United Kingdom

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