Comparing leveraged loans and high yield bonds: A guide (Part 4 of 7)
Leveraged loans (BKLN) are almost always secured or backed by a specific pledged asset or some form collateral. On the other hand, high yield bonds (JNK) may be secured or unsecured, though the majority is unsecured.
The “security” of secured loans refers to a pledge on specific assets of the issuing company to back the amount of the debt. In the case of leveraged loans, if an issuer defaults, bondholders have rights to liquidate the pledged asset and recover their investment, to the extent possible. This means that they get paid before other creditors with unsecured claims in the issuer.
Leveraged loans are typically senior secured instruments that rank highest in the capital structure. So in case of bankruptcy, the loans and secured bonds get paid first, followed by unsecured bonds, then preferred equity, and finally common shareholders.
The graph above shows the difference in yield between B-rated leveraged loans, which are secured, and B-rated unsecured bonds. The gap between both is largely attributed to the difference in security.
High yield bonds have maturities that generally range from seven to ten years, while leveraged loans have maturities that generally range from five to seven years. The driver of this difference is that secured debt must be repaid before unsecured debt (that is, mature before), or else the security of the secured debt becomes meaningless.
The longer the maturity, the higher the yield, as the investor has to hold the bond longer. Loans have shorter maturities since their principal value should be paid before that of the bonds in order to maintain their priority in repayment.
Plus, as we mentioned earlier, the longer maturity also makes a bond’s price more susceptible to changes in interest rates. Bonds with longer maturity have higher duration, which is a measure of the sensitivity of the bond’s price to changes in interest rates.
Please read the next part of this series to learn more about the debt term differences between leveraged loans and high yield bonds.
Browse this series on Market Realist:
- Part 1 - An investor’s guide to the US leveraged financial market
- Part 2 - Comparing leveraged loans and high yield bonds: Credit rating
- Part 3 - Comparing leveraged loans and high yield bonds: Interest rates
- Banking & Budgeting
- secured loans
- high yield bonds