Banks lose discipline in the face of investor liquidity.
Alongside covenant-lite structures and low interest rates, companies can now enjoy borrowing via loans with either weak call protection or none at all. In January, for example, less than 60 percent of first lien leveraged loans had call protection. Another 12 percent had unusually short, six month call protection, according to S&P Leveraged Commentary and Data.
LCD attributes the change to a great deal of liquidity in the market making lenders undisciplined. That liquidity may continue to grow. According to JP Morgan Chase, European high yield funds saw a Eur523 million inflow in the week ending January 23. The week before that saw a Eur523 million inflow.
Likewise, in the US, there was a $437 inflow into high yield funds in the week ending January 23, and $524 million for the week before.
Call protection – essentially, prepayment fees – on loans were a rarity until 2010, when loan investors demanded they be included in transactions to reduce their prepayment risk. Rates were falling and investors were worried that companies would refinance. In 2009, only 21 loans had call provisions. The next year, over 150 had the provisions.