Most large public companies in need of debt financing issue unsecured bonds, which are then purchased by larger institutional investors.

Most large public companies in need of debt financing issue unsecured bonds, which are then purchased by larger institutional investors. For many nonpublic firms, or smaller and midsize companies or more complicated business situations, the public bond market is not a preferred option for issuing bonds and raising funds. One option for these firms to access funds is the leveraged loan market.

Leveraged loans, in this context, are loans often originated by larger banks that are secured by a lien on specific assets of the borrowing corporate entity. Usually, the rate on the loan floats periodically based on one of the publicized floating rate indexes. These loans almost always contain some sort of covenants designed to protect the loan originator if the credit status of the borrower declines precipitously. Along with the banks, a range of other institutional investors participate in this market.

Issuance in the leveraged loan market declined very dramatically in the 2008–2010 timeframe. Over the last year or two, issuance has picked up significantly. A sign this market may be overheating somewhat is the level of origination of covenant-lite loans. These are leveraged loans containing very lenient covenants and thus providing relatively less protection to the lender. Origination volumes of covenant-lite loans have returned to levels similar to those experienced in the 2006–2007 timeframe.

Another indicator of the investor appetite for leveraged loans is the interest margin of the loans being originated and then sold to the range of institutional investors. The interest margin represents the effective return above the floating rate index the lender expects to receive over the life of the loan. Based on various indexes that track the leveraged loan market, the interest margin on loans recently signed is about 1.8 percent to 1.9 percent. As recently as March and April of 2013, the average reported interest margin on new leveraged loans was about 2.5 percent to 3 percent.

As tracked by the Credit Suisse Leveraged Loan Index, the total return for the aggregate leveraged loan market was approximately 5.7 percent over the past year. With corporate defaults at a low point in the credit cycle, the total return for leverage loans has been relatively attractive even though the underlying floating rate indexes remain very low.

Activity in the leveraged loan market is one of the many indictors of the health of borrowing corporations and also the appetite of institutional investors to purchase these loans. In addition, the floating rate nature of the return on most leveraged loans provides additional comfort to those anticipating a rise in short-term interest rates.

Kirby Brown is the CEO of Beneficial Financial Group in Salt Lake City.