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Leveraged Loans: Another New Record for Covenant-Lite

cov-lite us leveraged loans

The share of the $1.06 trillion in outstanding U.S. leveraged loans that is covenant-lite hit yet another record in July, at 77.8%, according to LCD. It is the 15th straight month that cov-lite credits have set an all-time high.

That could well continue.

So far in 2018, 82% of leveraged loans that have been completed in the U.S. syndications market has been cov-lite, amid solid market demand, as institutional investors and retail loan funds continue to sit atop impressive stores of cash. Indeed, assets under management at U.S. loan funds hit a record $176 billion in July, according to Lipper and LCD. That figure has grown from roughly $110 billion in early 2016, when investor interest in the asset class took off amid expectations of long-awaited rate hikes by the Fed (leveraged loans are floating rate, an asset class that tends to fare well in rising rate environments).

Cov-lite loans are in some ways structured akin to high yield bonds, in that they feature incurrence covenants, as opposed to the more restrictive maintenance covenants.

With an incurrence covenant a debt issuer would have to meet a specific financial test only if it wanted to undertake a particular action (like borrow money to fund a dividend to a private equity sponsor, for instance). Under a maintenance covenant the issuer would need to meet regular, specific financial tests, even if it did not want to undertake that dividend deal.

Market pros agree that the cov-lite loan structure will hinder recoveries on bank loans, whenever the current credit cycle turns and defaults begin to mount, though the jury is out as to just how much of a hit recoveries will take.

One hint: S&P’s LossStats, and LCD, conducted analysis on recoveries of cov-lite loans that defaulted before the 2008-09 financial crisis, versus those that were structured and defaulted after the crisis. The later-vintage group of cov-lite loans saw an average discounted recovery of 56%, compared to a 78% average recovery on the earlier deals (though the data in the later sample is thin, as there have been few leveraged loan defaults during this cycle). You can read more about this LossStats analysis here. – Staff reports

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Covenant-lite Leveraged Loans: After Default, Whither Recoveries?

Covenant-lite has been the talk of the leveraged loan market for a while now.

Specifically, when the current, long-running credit cycle finally turns, how much less will investors recover on these loosely structured deals, if they end up in default, than on defaulted loans offering traditional safeguards?

covenant-lite loan recoveries

It is far from an academic question. Right now roughly 78% of the more than $1 trillion in outstanding U.S. leveraged loans are cov-lite, compared to just 29% in 2007, at the peak of last credit cycle (and just before the financial crisis).

Cov-lite loans place fewer restrictions on a borrower than do traditionally structured credits. They have soared in popularity over the past few years as institutional and retail investors have poured tens of billions into the U.S. leveraged loan asset class, looking to take advantage of continued rate hikes by the Fed – leveraged loans are floating rate – and, recently, a steady rise in LIBOR.

For a glimpse into how the current cov-lite market dominance might hinder recoveries on leveraged loans in cases of default, LCD looked at average recoveries on cov-lite credits undertaken prior to 2010 – before the financial crisis – and those undertaken after 2010 (so-called cov-lite 2.0), using data from LossStats.

While the data set for recent-vintage cov-lite loans that have entered and emerged from the default/distressed exchange/bankruptcy processes is necessarily thin – leveraged loan default rates have been stubbornly low for much of the current credit cycle – it offers insight into how today’s cov-lite loan binge might impact recoveries.

Specifically, the average discounted recovery rate on cov-lite loans undertaken before 2010 is 78%. That figure drops to 56% for cov-lite loans originated in 2010 and after, according to LossStats.

For purposes of this analysis LCD has used discounted, as opposed to nominal, recoveries. Because restructurings can last years (and years), eliminating the noise of time is important to maintain comparability. The discounted recovery time-values the nominal recovery back to the date of default using the pre-petition default rate, normalizing recoveries over long periods of analysis, and creating parity among the recovery outcomes from various events.

It is important to note, again, that the data set for cov-lite is thin indeed. There are only 40 of those defaulted instruments in total, and only 13 in the 2010-or-later pool. We should also bear in mind that this pool represents cov-lite debt that has defaulted, then recovered. The lurking danger of cov-lite is not just the risk of poor recoveries. It is also the risk of “zombie” credits that do not default, but simply limp through a prolonged downturn. The costs and risks to investors in that scenario is not captured in these recovery numbers.

That being said, there are clear indicators that cov-lite issued after the credit crunch—the 2.0 incarnation—will be more problematic in recovery than were its 1.0 predecessors.

This story is abstracted from a longer piece of analysis by LCD’s Ruth Yang, based on data from S&P’s LossStats.

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Leveraged Loans: As Cov-Lite Levels Grow, Debt Cushion Shrinks

cov-lite cushion
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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Leveraged Loans: Cov-Lite Volume Reaches Yet Another Record High

The amount of leveraged loan outstandings that are covenant-lite hit another record in May, the 13th new high in as many months, according to LCD.

Loan market experts say the preponderance of these more loosely-structured deals will negatively affect recoveries on this debt – once the long-running credit cycle turns, and defaults begin to mount – though opinions vary as to just how severe that impact will be.

To the numbers: As of May 31, 77.4% of U.S. leveraged loan outstandings were cov-lite. The leveraged loan asset class recently became a $1 trillion market, meaning there is upwards of $800 billion of cov-lite loans outstanding, according to LCD.

Cov-lite deals in some ways are structured akin to high-yield (aka junk) bonds, and are less restrictive than fully covenanted loans. Cov-lite credits feature incurrence covenants, meaning an issuer must meet financial tests only if it wants to take particular actions (pay a dividend to its private equity owner, for instance).

Their acceptance in the global leveraged loan market has soared in recent years, particularly as institutional and retail investors pile into the asset class in an effort to take advantage of loans’ floating rating structure, amid continued rate hikes by the Fed. – Staff reports

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Leveraged Loans: Covenant-Lite Share of Market Hits Record 77%

cov lite

April saw another record for covenant-lite issuance in the U.S. leveraged loan market.

By month-end, a full 77% of first-lien institutional loans outstanding were cov-lite, up slightly from the previous month, according to LCD.

The cov-lite market share has grown steadily, from roughly 60% in 2015, as retail investors and CLOs flooded the market with cash, looking to take advantage of the floating rate asset class amid rate hikes by the Fed.

Cov-lite loans have been in the spotlight over the past few years as their share of the market has grown. Detractors say these deals – which are structured akin to high yield bonds, offering less protection to lenders – could significantly impact recoveries when the current, long-running, issuer-friendly credit cycle turns.

In 2007, before the financial crises and at the end of the last credit cycle, cov-lite loans accounted for roughly 20% of U.S. leveraged loans outstanding. – Staff reports

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Leveraged Loans: Covenant-Lite Issuance From Riskiest Borrowers Surges in Europe

b minus european loan issuance

Leveraged loan issuance from lower-rated borrowers has been driving activity in Europe lately (link), with covenant-lite deals leading the way.

As of April 20, in fact, there was €8.16 billion of cov-lite loans from issuers rated B- outstanding, according to LCD’s European Leveraged Loan Index (ELLI). That’s up from €6.58 billion at the end of March and from €3.51 billion one year ago.

Cov-lite loans have been in the spotlight of late as their use has skyrocketed, first in the U.S., then in Europe. These credits are structured akin to a high yield bond in that they feature incurrence covenants, as opposed to the more restrictive maintenance covenants.

With an incurrence covenant a debt issuer would have to meet a specific financial test only if it wanted to undertake a particular action (like borrow money to fund a dividend to a private equity sponsor, for instance). Under a maintenance covenant the issuer would need to meet regular, specific financial tests, even if it did not want to undertake that dividend deal.

Cov-lite detractors say these transactions could put investors and lenders in a precarious position, as they might not become aware if a borrower is nearing financial distress until a point where traditional remedies are no longer viable. – Staff reports

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Leveraged Loans: Yet Another Covenant-Lite Record


Covenant-lite credits continue to dominate the U.S. leveraged loan market.

These deals, which offer loan investors protection that is more akin to a junk bond than a traditional senior secured credit, now account for 76.58% of the approximately $994 billion of U.S. leveraged loans outstanding as of March 31, according to LCD.

That’s yet another record. For perspective, just 60% of the market was cov-lite at the end of 2014.
The predominance of cov-lite has prompted concern in various corners of the leveraged finance world, as some market players think the preponderance of these deals will hinder recoveries on leveraged loans once the current issuer-friendly credit cycle – now in its 10th year – turns.

Historically, cov-lite loans have defaulted at a lower rate than fully-covenanted loans. This seems counter-intuitive, but in cycles past it was better-quality borrowers that were afforded covenant-lite deals, sources explain.

Today, amid much talk of credit deterioration in the U.S. leveraged loan market – a result of sustained retail investor demand for deals – cov-lite has become the market norm. Again, the cov-lite amount preceding the financial crisis was but a fraction of the volume seen today, leading many to point out that the U.S. loan market is well into uncharted territory.

Some background. Historically, leveraged loans have featured maintenance covenants, which are fairly restrictive. They would require an issuer to meet regular financial tests, regardless of whether the issuer was undertaking some action (issuing a dividend, for instance).

Today, however, a covenant-lite loan is more likely to feature incurrence covenants, which are far less restrictive. These generally require an issuer to be in compliance only if takes a particular action (paying a dividend, making an acquisition, issuing more debt).

This scenario has prompted investors to complain that, in theory, cov-light issuers today can come closer to default before lenders and investors have any recourse, or even receive warning of possible default. – Staff reports

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Yet Another Record for US Covenant-Lite Loan Issuance

The share of outstanding leveraged loans that are covenant-lite crept to another record high in February, reaching 75.8%, according to LCD and the S&P/LSTA Loan Index.

At the end of February the amount of U.S. leveraged loans outstanding was $984 billion, meaning there is now $745 billion of covenant-lite loan debt held by institutional investors.

The share of outstanding cov-lite loans matches the rate that newly-issued loans are cov-lite, according to LCD. Of the nearly $92 billion of U.S. leveraged term debt issued so far this year, $69 billion is cov-lite, according to LCD.

Cov-lite deals in some ways are structured akin to high yield bonds. They feature incurrence covenants, meaning an issuer must meet financial tests only if it wants to take particular actions (pay a dividend to its private equity owner, for instance). Fully covenanted loans, on the other hand, are far more restrictive. They entail maintenance covenants, where an issuer must meet financial tests each quarter, whether or not it wants to undertake an action.

Historically, cov-lite loans have defaulted at about the same rate – or slightly less often – than traditionally covenanted loans, though at the end of the last credit cycle – coinciding with the financial crisis of 2007-08 – there was a fraction of the cov-lite loan amount outstandings that there is today.

You can read more about how cov-lite loans work in LCD’s Loan Market Primer (it’s free).

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Riskier Leveraged Loan Issuers Load up on Cov-Lite Deals

Covenant-lite loans – the borrower-friendly debt instrument that some worry will hinder recoveries once the long-running bull-market credit cycle turns – have dominated the U.S. leveraged loan segment for several years now.

But as institutional investor appetite for higher-yielding assets continued hot throughout 2017, increasingly the cov-lite universe has become comprised of lower-rated, riskier, single-B credits.

Indeed, by the end of 2017 there was roughly $390 billion of single-B cov-lite loans outstanding, according to LCD. That’s far and away a record, and up dramatically from the $320 billion at year-end 2016 (the total had grown to $396 billion as of last week, by the way).

Just how strong has appetite been for these riskier deals, even without the investor protection that fully-covenanted loans offer?

single-B cov-lite by rating

Single-B credits accounted for 72% of U.S. cov-lite issuance last year –or $272 billion – the highest share since 2012, when these deals took up 82% of the cov-lite segment. In 2012, however, this sample totaled a paltry $52 billion, as the U.S. leveraged loan market was still proceeding cautiously after the financial crisis, a few years previous.

Cov-lite activity in the single-B segment has continued into 2018. While issuance in that ratings category had dipped to 58% of all cov-lite deals so far this year, it was as high as 82% a few weeks ago, according to LCD.

Cov-lite loans less restrictive for a debt issuers, compared to traditionally leveraged loans. Their popularity has surged over the past few years, particularly as retail investors poured money into the loan asset class in anticipation of higher interest rates. – Tim Cross

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Leveraged Loans: Another Record for US Covenant-Lite Market Share

cov-lite US share

Covenant-lite loans, an issuer-friendly feature that offers less protection for lenders and investors than traditionally structured credits, now account for a record 75% of outstanding U.S leveraged loans, according to LCD.

January is the 10th straight record month for cov-lite market share, as those credits remain the norm in a lending segment that has just completed a year of unprecedented issuance. As recently as 2015 the cov-lite share of the market was roughly 60%.

Cov-lite deals in some ways are structured akin to high yield bonds. They feature incurrence covenants, meaning an issuer must meet financial tests only if it wants to take particular actions (pay a dividend to its private equity owner, for instance). Fully covenanted loans, on the other hand, are far more restrictive. They entail maintenance covenants, where an issuer must meet financial tests each quarter, whether or not it wants to undertake an action.

Cov-lite loans are not without their detractors, of course. Market bears say the massive amount of cov-lite debt now outstanding will impact recoveries on leveraged loans when the current credit cycle – now approaching its tenth year – turns.

Historically, cov-lite loans have defaulted at about the same rate – or slightly less often – than traditionally covenanted loans, though at the end of the last credit cycle – coinciding with the financial crisis of 2007-08 – there was a fraction of the cov-lite loan amount outstandings that there is today.

About the overall record U.S. leveraged loan issuance in 2017: There was $502 billion of higher-yielding institutional issuance last year, along with $146 billion or pro rata credits (revolving debt and amortizing term loans, usually bought by banks, as opposed to other investors), for a total of $649 billion, according to LCD. – Tim Cross

You can read more about how cov-lite loans work in LCD’s Loan Market Primer (it’s free).

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