| NEW YORK, March 31
NEW YORK, March 31 U.S. covenant-lite lending is
moving into a more aggressive phase as banks make more
concessions and loosen loan terms further to offer even greater
flexibility to private equity companies and U.S. firms in a
The new deals, dubbed 'covenant-lite 2.0' by investors,
allow companies to pile on more debt, encouraged by investors'
seemingly insatiable demand for floating-rate loans.
Covenant-lite lending has already attracted the attention of
regulators, who are concerned about overheating in the wider
U.S. credit market.
A record $238 billion of U.S. covenant-lite loans were
issued in 2013 and around $68 billion of covenant-lite loans
have been issued so far this year, according to Thomson Reuters
Covenant-lite loans have also spread to Europe, which saw
its first 'pure' euro-denominated covenant-lite loan for French
animal feed maker Ceva Sante last week.
Traditional covenant-lite loans have no maintenance
covenants. The new covenant-lite 2.0 deals allow companies to
increase the size of restricted payments baskets, and issue
extra debt at whatever rates borrowers' choose.
These changes are being seen increasingly frequently but are
not popular with all investors, many of whom are becoming
worried about recovery prospects in the event of a default.
"Some of the tricky print in covenant-lite 2.0 is bothering
us much more than 1.0 because it can change loan to value
(ratios) and lead to lower recovery in the event of default,"
said Scott Page, director of Floating Rate Loans at Eaton Vance.
Companies are mounting the size of restricted payments
baskets, which usually limit the amount of debt that companies
can use to pay dividends or other shareholder payouts, or are
tweaking them so that they can be bypassed altogether if firms
hit certain leverage ratios.
Several recent M&A deals have had large synergy adjustments
that have raised eyebrows from investors.
The size of incremental facilities, a feature of pre-crisis
loans which allows companies to add debt in the future up to a
specified amount, is also growing.
The incremental basket on the new $1.275 billion credit from
SunGard Data Systems spinoff SunGard Availability Services was
cut to $200 million from $400 million during syndication (with
no change to limits on the ratio debt), and the restricted
payment basket was chopped to $35 million from $75 million to
provide more protection to lenders.
Other concessions include removing Most Favoured Nation
(MFN) status for lenders, which prevents companies from issuing
new debt with higher interest without compensating existing
Investors are spending more time studying credit agreements
as a result and are pushing back on deals including a $2.35
billion loan backing talent agency WME's acquisition of IMG, due
to aggressive add-backs and integration risk.
"A significant number of managers will tell you they're
spending more time in the credit documents and being very
selective. But just because you might see terms weakening, it
doesn't mean there aren't good companies to lend money to," said
Jonathan DeSimone, a managing director at Sankaty Advisors.
Deep fault lines
More aggressive covenant lite loans are appearing as
leverage ratios are rising and the use of subordinated junior
debt instruments is growing, all of which point to red-hot
market conditions reminiscent of the peak of the market in 2007.
Leverage ratios have been climbing in the last couple of
years and are now slightly higher than 2007 for most rating
levels, according to a December 2013 report from Moody's
The use of second-lien loans, which have a second claim over
assets in the event of a default and are structurally
subordinated to first-lien loans, is also rising. January and
February saw $7.4 billion of second-lien loans issued, compared
to about $4.5 billion in the same period last year, Thomson
Reuters data shows.
Looser lending standards could bring bigger losses to
investors in the next default cycle. While the effects may not
be immediate now, they could become more apparent in a worsening
economy or when the Federal Reserve's liquidity spigot is turned
The speculative-grade default rate of 1.95 percent on a
trailing 12-month basis in February, is the lowest level since
December 2011, according to a March report from Standard &
Poor's. Borrowers have however pushed out maturities on
speculative-grade debt and 71 percent of the debt is not due
until 2017-2018, according to a February report from Moody's.
The market will also be able to find market-clearing pricing
to mitigate the risk of any loan.
"Pricing and leverage multiples are the key determinants,
and then the other provisions - whether you have a financial
covenant or how many, where the cushions are set, uncapped
restricted payments baskets based on a test, or uncapped debt
incurrence based on a test - those are derivative of where the
leverage between the issue and the lenders is on those first two
points," a lawyer representing corporate lenders said.
(Editing By Tessa Walsh and Jon Methven)