Back in November last year, OMNIA was invited to attend the Global Capital Leveraged Finance Conference in London. It was a great event – one that attracted issuers, investors and financial intermediaries from across the sector – and it was a chance to share best practice and network with some very talented and interesting people.
The event was particularly interesting for me because the keynote speaker – Patrick Amis, Director General of Micro-Prudential Supervision I at the European Central Bank – used the gathering as an opportunity to talk about the ECB’s new leveraged finance guidelines in force across Europe. It was interesting to hear his thoughts on the future of this kind of financial product, from the point of view of one of Europe’s major financial institutions.
But what exactly is leveraged finance, and why is it of particular interest to myself and the team at OMNIA?
Borrowing to build
To fully understand it however, it’s probably worth starting by looking at what is meant by the term ‘leveraged’ itself. In financial terms, it refers to an investment strategy in which the investor uses borrowed money – the idea being that by borrowing extra capital the investor is therefore able to increase the value of any potential return.
The term ‘leveraged’ can also be used to describe the debt that is used to finance a company’s assets. In this case, a company which is described as being highly leveraged is one that has taken on more debt than it has equity. So how does the idea of ‘leveraged finance’ fit into this overall picture?
A precision instrument
The first thing to understand is that leveraged financing is most often used in very specific situations – for example to help fund a buy-out, to repurchase shares or to invest in an asset that itself will then generate more cash. The point is that this kind of financing – which usually funds those companies or ventures whose debt is larger than would be considered normal for the industry – is a very specialist kind of funding to achieve often short-term objectives.
So how does leveraged financing work, and how is this kind of funding usually structured?
Via leveraged financing, the borrower gets the funding they need using their debt rather than equity or cash to secure the loan, while the lender will usually be able to charge higher fees as the risks are also higher.
In most cases leveraged financing will be offered by a specialist team within the investment banking division of a bank. They’ll primarily be concerned with looking to see how they can offer leveraged loans to clients in order to help them to fund ventures such as buyouts. Once they do, they will look at the debt options available to the client who is looking to borrow (this could be anything from bank debt, high-yield debts or syndicated loans) and will then offer advice and a plan for providing the leveraged finance to achieve the client’s aims.
The ultimate aim for these lenders is to increase any investment’s potential returns by helping to finance the purchase of investment assets, using debt to finance that purchase. They’re able to use debt in this way because in terms of risk the cost of debt is lower than that of equity, because the risk is perceived to be lower. Once they’ve agreed the structure with their client, they’ll then look for debt investors who will ultimately provide the capital the client needs.
Leveraged financing is an exciting and fast-moving area of our sector – it requires working on the development of the kind of creative solutions for clients that I really thrive on, and that I think we’re particularly good at developing here at OMNIA. I’ll certainly be keeping a close eye on developments and hope to be involved in this area of finance even more in the future.