C&B Notes

‘Cov-lite’: Another Way to Chase Yield

Investors are chasing yield by buying leveraged loans that are missing many of the typical creditor protections.

Many of the world’s most highly indebted companies have been able to issue new loans without covenants…The proportion of so-called “cov-lite” loans has soared to more than 50 per cent of all leveraged loan issuance so far this year, twice the level seen during the credit boom in 2007. Leveraged loans are issued by high-risk companies, such as those owned by private equity firms, and sold to investors through the credit markets.

Covenants typically set parameters that force a company to stay within a particular debt-to-earnings ratio, or keep earnings above a certain multiple of interest payments.  If covenants are breached, creditors can insist on a financial restructuring, even if the company is not close to bankruptcy.  Record inflows this year into funds which buy loans, plus demand from leveraged investment vehicles called collateralised loan obligations, have sent loan prices sharply higher and shifted negotiating power to the issuers of loans.

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“The cov-lite structure creates an opportunity for companies to take more financial and operational risks and transfers influence in a distressed credit from lenders to shareholders,” the rating agency wrote.  “Investors may not be fully compensated for the risks they are taking on.”  So far this year, $129bn of leveraged loans have been sold with cov-lite features, up from $22bn in the same period last year, according to S&P Capital IQ data.  Issuance was $96bn for the whole of 2007.