Leveraged Loan

If I tell you that the U.S. market has a potential of another financial crisis after the one in 2007, how many of you will believe me? Ok, whoever doesn’t believe my warning now will change your mind after my presentation today. I guess this topic will be much more hotter than the current weather in Houston. One more thing, as this is an open discussion, so everyone is more welcome to join with me today

First, I just remind you about the financial crisis in 2007. Anyone here can tell me what is the main factor that leads to a big disaster in our financial market?

That is the problem of home-mortgage loan involved in the housing bubble. Most people always say high housing price, which means high-valued collateral, encourages the bank to make loans more easily and lead to the crisis. However, to me, the housing price is just not the cause but also the effect of easy loan-making. The chart can illustrate why I say so

In order to help more borrowers qualify for mortgages, many lenders designed home loans that didn’t require borrowers to make sufficiently large monthly principal and interest payment. We also have a special case of “subprime loan”. This term means the loan made for borrowers whose income can’t truly cover the obligated principal and payment. With these easy allowances, many mortgage loans were made. Then, people get money and buy more houses. Of course, when demand is over supply, the house price will go up which lead to the increase in collateral. This circle will go on and on, then finally boom… the house price reaches its peak and fall down without any control. And what is the result? Banks must write down their assets, so either they sell assets or obtain new equity and debt to replace the lost capital due to the write-down. Banks were stuck in the credit disaster and many files bankruptcy.

I spend much time to recall you about our past financial crisis because what I gonna discuss now have a similar context and who know can lead to the same result.

That is leveraged loan. We know home loan is loan to buy home, so what is leveraged loan? This is the loan made to heavily indebted company to finance growth, acquisitions and capital investments. With the same concept of home-mortgage loan, bank will underwrite the loan and hold some on their balance sheet but also package and sell most of the debt to the investors. This type of securitization is an attraction to investors because they can earn higher return compared to low-yielding government and