Corporations with strong balance sheets are finding lenders willing to forego covenants; Moody’s worried.
Companies continue to take advantage of low rates to raise cash in the debt markets and in more and more cases, they’re getting great terms.
According to Standard & Poor’s Leveraged Commentary and Data, more than 25 percent of first-lien loans issued in 2011 have covenant-lite structures, which is a higher percentage than for all of 2007. Recent deals contributing to the increase include Del Monte’s $2.7bn LBO credit, J. Crew’s $1.2bn LBO loan and TransDigm’s $1.55bn refinancing, S&P LCD, said.
“Higher volume, naturally, reflects the fact that the price of maintenance covenants – along with most other loan features – is melting against the market’s technical heat,” S&P LCD said. “Indeed, the eight covenant-lite executions that have come to market so far this year have an average yield-to-maturity of 5.27% (L+368/1.39% floor/99.68 OID). That’s inside the 6.15% average for covenant-heavy loans (L+441/143/99.21%).”
With these returns, investors have been snapping up the debt, unafraid of worries that another crisis could leave them with worthless paper. They’ve also been given confidence by studies that show covenant-lite loans had a lower instance of default during the financial crisis than loans with traditional terms. “Lenders didn’t suffer worse credit outcomes by giving up maintenance covenants,” S&P LCD said. Now “many traditional loan managers that had foresworn covenant-lite structures during the downturn are reluctantly re-embracing these loans as a concession to today’s turbocharged technical environment.”
Moody’s doesn’t like it
But according to the FT, Moody’s is concerned. In a report Wednesday, the rating agency said the resurgence of covenant-lite loans “may be laying the groundwork for painful fallout from the next credit downturn.” Moody’s warned that companies with covenant-lite loans could default in an extended downturn and that “the pre-eminent risk is that a covenant-lite structure will postpone default, eroding value and recoveries available to creditors when the issuer finally becomes distressed or files for bankruptcy.”
However, Tony James, president of Blackstone, said in the company’s earnings call that covenant-lite loans have great benefits. Covenant-lite loans, he said, help preserve enterprise value, help preserve jobs and are good for the economy.