Senior Bank Loan

What Is a Senior Bank Loan?

A senior bank loan is a debt financing obligation issued to a company by a bank or comparable financial institution and afterward repackaged and sold to investors. The repackaged debt obligation comprises of numerous loans. Senior bank loans hold legal claim to the borrower's assets over any remaining debt obligations.

Since it is viewed as senior to any remaining claims against the borrower, in the event of a bankruptcy, it will be the principal loan to be repaid before some other creditors, preferred stockholders, or common stockholders receive repayment. Senior bank loans are typically secured by means of a lien against the assets of the borrower.

How a Senior Bank Loan Works

Loans are frequently used to furnish a business with cash to proceed with its daily operations or whatever other capital necessities that it might have. The loans are generally backed by the company's inventory, property, equipment, or real estate, as collateral. Banks frequently take the different loans they make, repackage them into one debt obligation, and sell them off to investors as a financial product. The investors then receive the interest payments as the return on their investment.

Since senior bank loans are at the highest point of a company's capital structure, on the off chance that the company documents for bankruptcy, the secured assets are ordinarily sold and the proceeds are distributed to senior loan holders before some other type of lender is paid back.

By and large, the majority of businesses with senior bank loans that ended up filing for bankruptcy have had the option to cover the loans altogether, meaning the lenders/investors have been paid back. Since senior bank loans outweigh everything else in the repayment structure they are moderately safe, however they are as yet considered non-investment grade assets, as more often than not the corporate loans in the bundle are made to non-investment grade companies.

Senior bank loans normally have floating interest rates that change as per the London Interbank Offered Rate (LIBOR) or other common benchmarks. For instance, on the off chance that a bank's rate is LIBOR + 5%, and LIBOR is 3%, the loan's interest rate will be 8%. Since loan rates frequently change month to month or quarterly, interest on a senior bank loan might increase or diminish at customary spans. This rate is additionally the yield that investors will make on their investment. The floating rate part of a senior bank loan furnishes investors with protection against rising short term interest rates, as a protection against inflation.

In the repayment structure, after senior bank loans, which are ordinarily classified as first lien and second lien, comes unsecured debt trailed by equity.

Special Considerations

Businesses that take out senior bank loans frequently have lower credit ratings than their companions, so the credit risk to the lender is normally greater than it would accompany most corporate bonds. Also, the valuations of senior bank loans vacillate frequently and might be unpredictable. This was especially true during the financial crisis of 2008.

Due to their inherent risk and volatility, senior bank loans regularly pay the lender a higher yield than investment-grade corporate bonds. Be that as it may, in light of the fact that the lenders are guaranteed of getting at any rate some portion of their money back before the company's different creditors in the event of insolvency, the loans yield not exactly high-yield bonds, which carry no such commitment.

Investing in mutual funds or exchange traded funds (ETFs) that specialize in senior bank loans might appear to be legit for certain investors who are seeking customary income and who will expect the extra risk and volatility. Here's the reason:

• As a result of the loans' floating rate, when the Federal Reserve raises interest rates, the loans will deliver higher yields.
• Furthermore, senior bank loan funds normally have a risk-adjusted return more than a three-to-five-year period that makes them alluring to genuinely conservative investors. At the point when the loan funds underperform, bonds sell at a discount to par, expanding a financial backer's yield.

Investors can likewise take some consolation from the way that senior bank loan funds' average default rate generally is a moderately unassuming 3%.

Highlights

• Senior bank loans take priority over all of the other debt obligations of a borrower.
• Senior bank loans most frequently accompanied floating interest rates.
• By and large, lenders that issue senior bank loans have had the option to recover the entirety of the loan when the borrower has defaulted.
• In the event of a bankruptcy, senior bank loans receive payment before different creditors, preferred stockholders, and common stockholders, when the assets of the borrower are sold off.
• A senior bank loan is a corporate loan repackaged into a bundle of corporate loans that is sold to investors.
• Senior bank loans ordinarily give high-yield returns to investors and protection against inflation
• Senior bank loans are ordinarily secured by means of a lien against the assets of the borrower.