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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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Distressed Debt Outlook: Lack of Leveraged Loan Covenants May Lengthen the Default Process

With more than $2.5 trillion outstanding in the U.S. high-yield bond and leveraged loan markets—twice that of pre-crisis volumes—and leverage at lofty levels, the opportunity set for investors specializing in buying up the debt of troubled companies could be significant. In time.

In this long bull market, default rates have remained stubbornly low, with the pool of debt trading in distress at nearly 80% less than the February 2016 peak. Right now, there just aren’t as many companies in distress as there used to be.

“Pickings for distressed investors are very slim right now, but that can change on a dime,” says Jeff Hammer, co-head of Houlihan Lokey’s illiquid financial assets practice, adding that this market has always proven to be one where you need to move quickly, and in size, in order to make the kind of returns that can carry you through to the next cycle.

Covenant erosion

Covenant erosion has been an ever-present concern for investors on both sides of the Atlantic over the last few years, and while a lack of investor protections is deemed unlikely to increase the overall default volume, it may lengthen the default process if there is no covenant-related event to force struggling borrowers to the bargaining table with their lenders. Such a delayed default could potentially worsen recoveries.

Among defaulted credits within the loan market, 81% of issuers in the S&P/LSTA Index in 2017 were covenant-lite. This compares to 55% in 2016 and to just 14.3% during the 2009 default peak. — Rachelle Kakouris

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European Leveraged Loan Default Rate Drops to Record Low

european leveraged loan default rate

In November, for the fifth month running, there were no defaults among loans in the S&P European Leveraged Loan Index (ELLI). As a result, the European leveraged loan default rate dipped to 1.16%, its lowest point since LCD began tracking this data in 2008, from 1.41% the previous month.

In the 12 months ended Nov. 30 the ELLI tracked €1.3 billion of institutional loan defaults and restructurings, down from €2.3 billion tracked at the end of 2016.

The ELLI default rate is calculated by summing up the par amount outstanding for issuers represented within the index that have defaulted in the last 12 months, and dividing that by the total amount outstanding in the index at the beginning of the 12-month period (excluding issuers that have already defaulted prior to this date).

For the purposes of this analysis, LCD defines “default” as (a) an event of default, such as a D public rating, a D credit estimate, a missed interest or principal payment, or a bankruptcy filing; or (b) the beginning stages of formal restructuring, such as the start of negotiations between the company and lenders, hiring of financial advisors, etc.

An historical low for loan defaults comes at an interesting time for the asset class. First off, the current bull-market credit cycle is chugging along in its ninth year, leading more than a few to speculate that defaults are bound to kick and (and soon).

Also, as credit market bears are fond of pointing out, part of the reason defaults remain low is that more and more issuers now take advantage of ‘covenant-lite’ loan structures, which place fewer restrictions on the borrower. Because of the cov-lite loans, issuers have much more room to maneuver in the face of financial obstacles, often putting off default proper (for a while, anyway, bears will add). – Staff reports

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Covenant-Lite Issuance Booms in European Leveraged Loan Market

The supply/demand imbalance that has characterized the leveraged loan market on both sides of the Atlantic for the bulk of 2017 has continued to allow arrangers to structure deals in an increasingly borrower-friendly way — the most glaring of these developments being the absence of maintenance covenants in loan documentation.

By the end of the third quarter, covenant-lite deals comprised 74% of issuance syndicated in Europe in the year to date, roughly the same as in the U.S. This compares with 60% for the full-year 2016, and 57% for the comparable year-over-year period. The percentage of covenant-lite deals has risen consistently since 2012, when such transactions comprised only 9% of full-year issuance.

Though now standard, cov-lite is not without its detractors, as these loans – which feature covenant protections more similar to high-yield bonds than to traditional leveraged loans – allow a borrower more flexibility before a potential default.

“[With cov-lite] there are no more early warning signals,” says a lawyer active in the syndicated loan market. “The first time you can actually do something as a lender is at payment default.” – Staff reports

You can read more about cov-lite loans in LCD’s Loan Primer. 

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LCD comps is an offering of S&P Global Market Intelligence. LCD’s subscription site offers complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.

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Leveraged Loans: Covenant-Lite Share of Market Inches to New High

US cov-lite share

With investors continuing to clamor for higher-yielding assets, issuance of riskier ‘covenant-lite’ credits in the U.S. leveraged loan market inched to another record high 2017’s third quarter, according to LCD.

Covenant-lite loans place fewer restrictions on a borrower, making them especially popular with issuers, and prominent when there is pronounced institutional investor demand.

They are  structured more like a high-yield (or ‘junk’) bond, as they have financial incurrence covenants – these require lender approval only if the borrower wants to take an action, like adding more debt – as opposed to more restrictive maintenance covenants – where a borrower has to meet quarterly financial tests.

(You can read more about how cov-lite loans work here.)

As of Sept. 30, 72.9% of the all U.S. leveraged loans outstanding feature a covenant-lite structure, up slightly from the previous month, according to the S&P Leveraged Loan Index. With total loan outstandings now at $947 billion (the most ever), that means there is some $690 billion of outstanding leveraged loan paper that is covenant-lite.

While the outstanding numbers are impressive, the new-issue levels of covenant-lite loans are even more eye-catching. So far in October, for instance, 82% of leveraged loans issued in the U.S. have been covenant-lite, nearly matching the full-month record of 84%, in August.

For reference, there outstanding share of cov-lite loans once year ago was 66%. Three years ago it was 58%. – Tim Cross

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