The dominance of the covenant-lite structure in the ever-growing U.S. leveraged loan market is continuing into 2019, though the market share these ostensibly riskier credits hold seems to have plateaued.
At the end of January, 78.8% of all outstanding U.S. leveraged loans were covenant-lite, according to LCD. That’s down slightly from the record 79.2% the previous month, to levels seen during most of 2018’s fourth quarter.
The current figure means there’s some $922 billion of cov-lite credits outstanding, as the U.S. leveraged loan market now totals $1.17 trillion, according to the S&P/LSTA Loan Index.
Cov-lite loans are less restrictive to debt issuers and the private equity shops that sponsor them, while offering lenders and institutional investors less protection than do traditionally covenanted deals. Broadly speaking, cov-lite credits have bond-like incurrence covenants, which come into play only if the borrower takes a specific action, such as issuing more debt or making certain acquisitions. Traditionally structured loans have maintenance covenants, where borrowers must pass regular, agreed-to tests of financial performance, such as minimum levels of cash flow and maximum levels of leverage.
Cov-lite has become something of a lightning rod as loan market detractors – with an eye on what already is an inordinately long credit cycle – say these deals will see lower-than-usual recoveries in instances of default, due to the lack of ‘early’ warnings that full covenants might provide investors.
Indeed, while data points on this topic are necessarily thin – the U.S. leveraged loan default rate has been at or below historical norms for years – there is some research that shows investors in cov-lite loans will recover less, in cases of default.
S&P last summer looked at cov-lite loans emerging from bankruptcy in 2014-2017 (again, the sample is relatively thin). The ratings agency found that cov-lite loans, on average, recovered 72%, compared to an 82% average recovery on fully-covenanted loans.
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