All over the world, the loan market can prove to be a confusing concept to fully get your head around. In the US, it works a little differently to elsewhere and there are some specific terms that you should get your head around if you want to totally understand the market as well as which loans are available and not just find a suitable loan to start a new business.
Naturally, there are many different types of loans available, these may vary depending upon whether you want to start a business like an online travel agency or you are looking for a personal loan in order to buy something you need or deal with other financial issues.
Loans actually involve more than two parties, even though it may be assumed that there is just a lender and a borrower. The market is more complex than that. Loans, and the options on loans, form a financial market that can be traded. Investors play a key role.
Traditionally there are fixed income products within the loan market, but these do not necessarily have a high upside in terms of income. The loan market has driven the investors to look for better returns and this often leads to them turning to the Leveraged Loan market as opposed to the fixed income market. These types of loans also allow for diversity within a portfolio that may have less confidence as a result of the European debt crisis and want to mitigate investment risks elsewhere in the world.
Investment-grade loans are agreements between lenders and borrowers, but sub-investment grade loans are syndicated, so they are a balance of a private equity share of a business or business loan.
What Is a Leveraged Loan?
Leveraged loans are common for investors looking for value. There aren’t actually rules for how to define a leveraged loan, some just use the interest margin as a guide, or the rating provided such as Ba3 or BB. Rating agencies such as Moodys set these ratings based on risk levels.
Leveraged loans are higher interest and given to people who may struggle to get traditional fixed-rate lending. As such, they are at a higher risk of the lender defaulting. This means more potential returns, but a risk of defaulting that is high.
Leveraged loans are given to both companies and individuals with a history of debt issues. Lenders find that these have more of a cost to the borrower and therefore more of a chance to return higher yields, but there is risk involved if they do not get the money paid back.
An interesting overview of some of the issues that come with defaulting can be found by reading “The Big Short” – an overview of the financial crash in 2008.
The LMA and the Loan Market
Since the issues around the financial crash, the role of the LMA has become even more vital. LMA stands for “Loan Market Association”.
They promote syndicated loans across the world in many different regions and help to work with lenders, law firms and other borrowers.
The LMA was actually formed in 1996, but they continue to grow and cover over 65 countries working with commercial, investment banks, law firms and even rating agencies.
They promote the benefits of these leveraged loans and try to remove any of the barriers and jargon/confusion surrounding the industry for those who want to get involved. The loan market needs investors in order to function. The LMA helps with market guidance, education and even regular discussion with regulators and legislating bodies.
The Loan Market for Consumers
The loan market varies hugely based on a credit rating. If your credit score is good then the options for P2P loans and bank loans will probably be a lot more, and you may also receive better rates. People investing in these syndicated loans can do so with minimal risk.
People looking for personal loans for fair credit or even for poor credit scores will find they have to pay a little more in terms of interest, as well as having their options for lending limited. It’s worth remembering this when considering loans as investments as there is greater chance of profits but also a risk of having to deal with a lot of people defaulting on the loans, especially if the country is in the middle of an economic downturn.
While the loan market is quite complex in a number of ways, our basic overview should help you to understand some of the products available for lenders and also, the prospect of making money for investors involved in the US loan market. A sturdy portfolio can include both leveraged loans and fixed price, low-risk loans with less yield. The amount of risk taken is up to the individual.