Covenant-lite has all but defined the $1 trillion U.S. leveraged loan market lately, as increasing numbers of speculative-grade corporate borrowers take advantage of this debt structure, amid sustained investor appetite in the asset class.
In fact, issuance of cov-lite loans – which are less restrictive for a borrower, and thereby offer lenders less protection than do traditionally covenanted credits – hit yet another record last month. Roughly 77% of all outstanding loans are now cov-lite.
The rapid growth of cov-lite has raised eyebrows, to say the least, as the current borrower-friendly credit cycle enters its tenth year (that’s a long time between spikes in defaults).
But it’s not just the sheer volume of cov-lite outstandings that are important. LCD recently looked at the debt cushion of outstanding loans – the amount of debt in a borrower’s capital structure that is subordinated to the senior loan – and found that, increasingly, today’s cov-lite deals have little or no debt cushion beneath them. This is important because, as LCD research has shown, the lack of a debt cushion significantly lessens what an investor will recover on a loan, if that credit defaults.
How much has this debt cushion eroded? As of May 31, 23% of all cov-lite loans did not have any debt, such as a mezzanine tranche, high yield bond, or other, below the cov-lite facility. That’s an all-time high, and is up from 18% five years ago, and from just 10% at the end of 2007 (shortly before the financial crisis), according to LCD.
As a result, cov-lite loan outstandings are not only at record levels, but a greater portion of these transactions do not have any debt cushion to absorb losses in case of a default. – Staff reports
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