Lite fear

They tell me of a place where covenant-lite terms flowed like the current of a mighty river. Borrower friendly issuance cascaded from on high, washing over an insatiable deal market like a waterfall. Liquidity wasn’t a dream, it was a reality. I believe they called this distant land, “2007”.

Then again, maybe it was “2013”. 

A recently released Partners Group study that cited S&P’s data found that 53 percent of loans issued in the US during the first half could be characterised as ‘covenant-lite’. The term of course refers to loans that contain few, if any, protective terms for the lender.

Forbes has reported extensively on the trend, noting that: “Through 8th August there has been $162 billion of covenant-lite loan issuance in the US, more than five times the amount seen at this point in 2012, and easily topping the $86 billion of cov-lite deals logged all of last year.”

On one hand, this is a great sign. Leveraged loan issuance has been buoyed by the high demand for refinancing existing debt, and a ready pool of liquidity successfully begun to erode the so-called ‘Refinancing wall’ many speculated would damage the economy once billions of LBO debt reached maturity and borrowers failed to repay. On the other hand, it also (obviously) implies that lenders are taking greater risks to put their capital to work.

From a borrower perspective, it’s certainly welcome. “If you are approaching the latter years of your credit facility … some sponsors are taking advantage of that excess financing in the marketplace to take advantage of lower interest rates,” says Dechert’s Jay Alicandri in the upcoming edition of Private Debt Investor. “There’s an exorbitant amount of supply of capital to provide loans in the market place.”

Alicandri is careful to stipulate that people are still being careful – the leverage multiples typically associated with cov-lite issuance are well below what was being offered before the crisis.

That hasn’t been the case in Europe, where Thomson Reuters recently indicated multiples had reached a five year peak. The average total leverage multiple reached 5.75x on large buyouts (those with debt packages in excess of €500 million) in the second quarter, the highest quarterly average since Q1 in 2008 when they reached 6.08x.

Europe has yet to adopt covenant-lite terms to the same degree the US has however – only 10 percent of first half deals could be characterised as such, according to Partners Group. However, that may change in the near future.

“The US is dominated by cov-lite, and we haven’t seen that yet in Europe. But we have seen cov-loose,” says Marlborough Partners’ Jonathan Guise, who was interviewed for a piece on leveraged loan issuance that can be found in the September issue of PDI. “You’re in a pretty good position as a borrower to push the terms aggressively, and some of the larger sponsors have been very successful in doing that.”

So, leveraged multiples are creeping inexorably upwards, and the market is awash with liquidity. In 2007, that scenario didn’t have a happy ending. Let’s hope that this time, both the providers and users of credit have learnt their lessons. If the market improves and M&A volumes rise, the demand / supply imbalance that exists on the debt front should balance, reducing the pressure on issuers to loosen terms, and potentially diminishing the likelihood of borrowers pushing leverage multiples to imprudent levels.