Fixed Income Special Interest Group

Hi team -

I'm using these fine spring days to read up on leveraged loans, and I've just come across the following:

"As a rule of thumb, a loss in the event of default typically occurs once the enterprise value of a company deteriorates below the value of its outstanding debt, i.e., a loan-to-value (LTV) ratio of more than 100%."

I don't understand this. In my view, the enterprise value of a company never falls below the value of its outstanding debt, unless perhaps its equity value would be zero and its cash position positive at the same time, and I don't see how that would happen? Can anyone help?

Many thanks.

Hey,

See the below reply!

RE: Leveraged loans, defaults and enterprise value

By definition, EV = Equity + Net debt (Total debt - C&CE).

In a stressed scenario, equity can trade down to zero (or some form of option premium) and debt can trade below par, causing market‑value EV to fall below the outstanding debt balance-i.e. an LTV over 100%-which is precisely when lenders begin to incur losses on default. Therefore, what is read is a good thumb rule.

A helpful way to think about it is the Merton model: equity is like a call option on firm assets, and once assets are worth less than debt, that option is out‑of‑the‑money, and debt holders bear the loss.

Hope this helps!

Cheers!