Deleverage

What is Deleveraging?

Deleveraging, or degearing, is simply the opposite of leveraging, or borrowing.  It is the act of reducing the use of borrowed funds.  These borrowed funds can exist in the form of equity issued to stockholders, bonds issued to investors, issuance of commercial paper, and taking out syndicated bank loans to name a few.

Companies will utilize leverage to kickstart growth in their companies; however, if their plans do not go as expected, they will be forced to pay down their debts, or deleverage their balance sheet by selling their own assets.  Higher levels of leverage are often seen in startup companies in the small cap sector or even smaller.

Recent Example of Deleveraging

The term deleverage was made popular by investment banks on Wall Street.  Over the past decade, it has become increasingly more difficult for banks to produce profits for their clients in the stock market and therefore, they turned their attention to the housing market where home price were increasing at large clips every year.  Interest rates were cheap and mortgage backed securities were providing consistent returns.  They started borrowing, or leveraging, at incredibly high levels; 30 to 35 times their assets in some cases.  As you can see, the slightest move higher made them alot of money while even the slightest move lower could have serious negative implications.  This is exactly what happened when the housing market started to tumble.  Firms were forced to liquidate their assets, or deleverage, and did so almost in fire sale fashion.  Many banks were forced to file for bankrupcy protection while others forced to merge with other banks.