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High-Yield Lending: It’s Good Until It’s Not

Joseph L. Pagliari
The Journal of Portfolio Management Special Real Estate Issue 2017, 43 (6) 138-161; DOI: https://doi.org/10.3905/jpm.2017.43.6.138
Joseph L. Pagliari Jr.
is a clinical professor of real estate at the University of Chicago Booth School of Business in Chicago, IL
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Abstract

Despite the recent popularity of high-yield lending, surprisingly little has been written exploring the highly bifurcated nature of these investments. In this article, the author focuses on pricing these instruments, exploring the potential risks involved and illuminating some of their complexities and nuances (e.g., tranches of different sizes and different positions in the capital stack; mezz debt, which is really equity; covenant-light versus covenant-heavy loan documents; and whether the high-yield has sufficient liquidity to protect its position). In so doing, the author uses an equilibrium approach in which the cost of indebtedness (1) is tied to the expected return on the asset (which, in turn, is a function of the asset’s risk) and (2) increases geometrically with increases in the project’s loan-to-value ratio. The lender has effectively sold a put option to the non-recourse borrower. As the author notes, it is a daunting challenge to determine whether these intricacies have been fairly priced.

TOPICS: Real assets/alternative investments/private equity, fixed income and structured finance

  • © 2017 Institutional Investor, LLC
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The Journal of Portfolio Management: 43 (6)
The Journal of Portfolio Management
Vol. 43, Issue 6
Special Real Estate Issue 2017
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High-Yield Lending: It’s Good Until It’s Not
Joseph L. Pagliari
The Journal of Portfolio Management Sep 2017, 43 (6) 138-161; DOI: 10.3905/jpm.2017.43.6.138

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High-Yield Lending: It’s Good Until It’s Not
Joseph L. Pagliari
The Journal of Portfolio Management Sep 2017, 43 (6) 138-161; DOI: 10.3905/jpm.2017.43.6.138
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  • Article
    • Abstract
    • A GENERAL THEORY OF PRICING RISKY DEBT
    • THE YIELD CURVE PRICES EACH TRANCHE
    • CONSIDERING ASSET-LEVEL VOLATILITY
    • A NOTE ON LEVERED LOANS
    • SOME ADDITIONAL COMPLEXITIES AND NUANCES
    • THE SECURITY’S ASYMMETRIC NATURE IS ATTENUATED BY THE PROMOTE
    • RETURNS TO HIGH-YIELD LENDING VERSUS LEVERED EQUITY
    • CONCLUDING REMARKS
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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