A priority bank loan is a debt-financed bond that is issued by a bank or financial institution similar to a business, then repackaged and sold to investors. The newly packaged debt bond consists of several loans. Priority bank loans have a legal right to the borrower`s assets before any other obligation. 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. Priority bank loans typically have variable interest rates that vary depending on the London Interbank Borrowing Rate (LIBOR) or other current benchmarks. For example, if a bank`s interest rate is libor + 5% and LIBOR is 3%, the loan interest rate is 8%. Since credit interest rates often change monthly or quarterly, the interest rates on a priority bank loan can rise or fall at regular intervals. This interest rate is also the return that investors will get with their investment. The variable-rate aspect of a priority bank loan provides investors with protection against rising short-term interest rates as protection against inflation. Since it is considered a priority for all other claims on the borrower, in the event of bankruptcy, it will be the first loan repaid before other creditors, preferred shareholders or common shareholders are repaid. Priority bank loans are usually secured by a right of pledge against the borrower`s assets. Companies that take out priority bank loans often have a lower credit rating than their competitors, so the credit risk for the lender is generally higher than for most corporate bonds.
In addition, valuations of priority bank loans often vary and can be volatile. This was especially true during the 2008 financial crisis. Investors can also be reassured that the average default rate of priority bank credit funds is relatively modest at 3% in the past. Since priority bank loans are at the top of a company`s capital structure, secured assets are typically sold and the proceeds are distributed to priority loan holders before another type of lender is repaid when the business goes bankrupt. Investing in investment funds or Exchange Traded Funds (ETFs) that specialize in priority bank loans can be useful for some investors who are looking for a steady income and are willing to take on the extra risk and volatility. The reason for this is that in the repayment structure, according to priority bank loans, which are generally classified as the first right of pledge and the second right of pledge, unsecured debts, followed by equity. . . .