Definition Liquid Credit Financing (LCF) is the provision of leverage and secured financing against portfolios of liquid credit instruments. These instruments primarily include price-transparent, publicly traded assets such as syndicated loans and corporate bonds. LCF is typically facilitated by specialized trading desks within investment banks, offering liquidity to institutional investors like hedge funds and credit funds.
Core Structures LCF transactions are generally structured through two main mechanisms:
Total Return Swaps (TRS): Derivatives that allow investors to gain synthetic exposure to the returns of a reference asset (e.g., a loan or bond index) without owning the asset directly. This method is often used for leverage and operational efficiency.
Asset-Based Lending (ABL): Financing facilities where the borrower’s portfolio of liquid credit assets serves as collateral. These facilities are subject to haircuts and margining based on the market volatility and liquidity of the underlying assets.
Market Impact
Liquidity Support: By enabling leveraged investors to finance bond and loan portfolios, LCF expands the active investor base. This deepens secondary markets and supports trading volumes, which can tighten credit spreads during normal market conditions.
Shock Amplification: In periods of market stress, LCF can act as a transmission channel for volatility. Declining asset prices may trigger margin calls, forcing leveraged investors to sell liquid, high-quality assets to raise cash. This "fire sale" dynamic can depress prices further, amplifying the initial market shock.
