Since it takes precedence over all other claims against the borrower, in the event of bankruptcy, it will be the first loan to be repaid before other creditors, preferred shareholders or common shareholders receive repayment. Senior bank loans are usually secured by a lien on the borrower`s assets. Investing in mutual funds or exchange-traded funds (ETFs) that specialize in senior bank loans may make sense for some investors who are looking for regular income and are willing to take on the extra risk and volatility. Here`s why: Because of their inherent risk and volatility, senior bank loans typically earn the lender a higher return than senior corporate bonds. However, since lenders are certain to recover at least some of their money from other creditors of the business in the event of insolvency, loans are less profitable than high-yield bonds that do not contain such a promise. Investors can also be reassured that the average default rate of priority bank funds is relatively modest at 3% in the past. In the past, the majority of companies with priority bank loans that ended up declaring bankruptcy were able to fully cover the loans, meaning that lenders/investors were repaid. Since priority bank loans are prioritized in the repayment structure, they are relatively safe, although they are still considered non-investment assets, given that business loans are most often granted to non-investment firms. Senior bank loans typically have variable interest rates that fluctuate based on the London Interbank Offered Rate (LIBOR) or other common benchmarks. For example, if a bank`s interest rate is LIBOR + 5% and LIBOR is 3%, the loan interest rate is 8%. Since lending rates often change monthly or quarterly, the interest rates on a senior bank loan can rise or fall at regular intervals.
This interest rate is also the return that investors will get from their investment. The variable-rate aspect of a senior bank loan provides investors with protection against rising short-term interest rates as protection against inflation. In the repayment structure, after first-tier bank loans, which are generally classified as first and second privilege, there are unsecured debts, followed by equity. Since senior bank loans are at the top of a company`s capital structure, secured assets are typically sold and the proceeds are distributed to senior loan holders before another type of lender is repaid if the company files for bankruptcy. A senior bank loan is a debt financing security issued by a bank or financial institution similar to a business, then repackaged and sold to investors. The repackaged debt instrument consists of several loans. Senior bank loans have a legal right to the borrower`s assets on all other debt instruments. Companies that take out senior bank loans often have a lower credit rating than their competitors, so the credit risk for the lender is usually higher than with most corporate bonds.