Margin protection dives as cov-lite remains dominant in Europe – report

Covenants continue to loosen in Q3 across several areas including margin protection and the way leverage is calculated for acquisitions.

Margin protection for lenders on European deals has rapidly declined in the third quarter of 2018, according to analysis by data provider Debt Explained.

A report on European credit conditions in Q3 2018 found that just 9 percent of deals were applying margin rachets in the event of a default. Typically, in the case of a default covenants would cause loans to automatically revert to their highest level in the ratchet.

Debt Explained said there has been a steady decline in protection observed over the past 12 to 18 months, falling to 50 percent of deals which would see this protection kick-in on any event of default (EoD) in Q2 2018 before the rapid decline seen in the most recent quarter.

The bulk of deals now only apply this covenant upon a payment, insolvency or financial statement / compliance certificate EoD, with 64 percent of deals having this covenant in place, up from just 17 percent in Q4 2017.

The quarter also saw a further weakening in the period over when cost savings and synergies from acquisitions are expected to be realised as the basis for leverage calculations. Periods of 12 months, which offer the best protection for investors, are now present in less than 10 percent of cases while deals with between 18 and 24 month periods now dominate, accounting for almost 50 percent of the market.

Overall, covenant lite remains the norm in the market in Q3 2018, though a limited number of deals contained a leverage maintenance covenant, often called cov-loose, according to Debt Explained’s analysis.