Leveraged Finance vs Corporate Finance – Explain It
Leveraged finance investment banking is often a part of corporate finance strategies in speculative-grade companies. Leveraged finance (LevFin) raises debt capital for corporations and private equity firms through loan syndication and underwriting bond offerings. Companies commonly avail of LevFin for the following reasons:
- Capital Expenditures
- Leveraged Buyouts
- Mergers and Acquisitions
- Recapitalisations
- Refinancing Old Debts
Since corporate finance is concerned with the company’s financial strategies to aid growth, leveraged finance investment banking is often availed. Corporate finance addresses how corporations handle funding sources, accounting, capital structuring, and take investment decisions. This branch of finance focuses on maximising shareholder value with intensive planning and strategy implementations.
Leveraged Finance vs Corporate Finance
Corporate finance includes investment banking by default. Raising debts is often the only way a corporation can meet its financial needs. Additionally, LevFin focuses on the needs of speculative-grade companies, i.e. companies with BBB or Baa credit ratings or lower. These are high-risk corporations with existing mountains of debt.
Leveraged finance investment banking meets these needs through leveraged loans, speculative-grade bonds, and mezzanine debt. While leveraged loans (as the name suggests) are secured debt options, bonds and mezzanine debt are unsecured. However, leveraged finance overall is an expensive option for corporations, with higher interest rates.
These interest rates emerge from the risk of loan defaults and bankruptcy. Since the company’s LevFin investors loan already have lower credit ratings, giving them a loan is a risk. To curb some of the ill effects, investors increase interest rates with rigorous security interventions for their speculative-grade borrowers.
Therefore, leveraged finance is a part of a corporate finance strategy. However, there are some key distinctions between LevFin and general investment banking in corporate finance.
How LevFin Differs from Investment Banking
One of the main distinctions between leveraged finance and investment banking, in general, is the deal volume corporations see. In LevFin groups, entire floors are often dedicated to the process of selling financial leverage to speculative-grade borrowers. This process includes:
- Proposing deals to existing or new clients (“originating deals)
- Following capital markets
- Trading in and out of loan and bond positions
- Selling financial products to investors
- Monitoring the firm’s relationship with issuers’ loans and bonds
Pure investment banks do not have such a high debt transaction volume. Instead, they dedicate smaller groups to each function listed above, allowing them to be a debt capital markets generalist. LevFin is also usually a part of the DCM group, depending on the volume of deals and group size.
The Commercial Roots of Leveraged Finance
While LevFin is usually associated with investment banking, this is not necessarily the case. Many financial institutions offer financing packages similar to leveraged finance investment banking without providing additional M&A and IPO advice. They do not have a coverage group or an industry platform and belong to the private loan market. Therefore, there are no limitations regarding lending solutions.
Since the capital finance department in a corporation goes where the interest is lowest for large loans, the investment bank status is no longer a necessity. In this scenario, leveraged finance retains its commercial lending roots, not resembling investment banking too much. However, a large proportion of LevFin corporations are also leaders in investment banking, merging the two fields further.
Changing Definitions
Over time, the traditional conception of investment banking about providing solutions and advice to companies is abating. Under the traditional definition, LevFin would be distinct from investment banking in providing financial products as solutions. However, the modern definition of investment banking incorporates financial transaction execution, too, making it nearly identical to leveraged finance.
Within leveraged finance investment banking, the bank also covers the company and works with DCM teams to structure loans and high-yield bonds for the company’s financing needs. Therefore, as definitions change and the scope of investment banking increases, LevFin is increasingly coming under corporate finance.
Most corporate finance groups today take investment banking very seriously. If they fall below the BBB or Baa credit rating, they often have no choice but to turn to leveraged finance. Therefore, while leveraged finance is narrower in its focus, it is still a large part of corporate finance – although corporate finance is, understandably, a much broader category.
Pranab Bhandari is an Editor of the Financial Blog “Financebuzz”. Apart from writing informative financial articles for his blog, he is a regular contributor to many national and international publications namely Tweak Your Biz, Growth Rocks ETC.
