Mar 7, 2019

Covenant-lite loans dominate the market

Data: LCD, S&P Global Market Intelligence; Chart: Andrew Witherspoon/Axios
Data: LCD, S&P Global Market Intelligence; Chart: Andrew Witherspoon/Axios

The weakening credit quality in loans continues and is even picking up steam, data from S&P Global shows.

Why it matters: So-called covenant-lite loans account for nearly all leveraged loans originated in Europe so far this year and 85% of those issued in the U.S. in 2018.

What it means: The loans are called covenant-lite because they lack traditional loan requirements and offer less protection for lenders and investors than traditionally structured credits if borrowers default.

  • The loan structures were largely unheard of prior to 2010, being used in just 5% of U.S. loan originations, and not used in Europe at all until 2012.
  • "To me it's a late cycle indicator," said David Lebovitz, Global Market Strategist at JPMorgan Wednesday. "If you are a borrower and you are able to walk in and dictate the terms of your loan, basically have very few protections for the lender, you have to be in a pretty tight environment."
  • The loans are typically not held on bank balance sheets, helping the banks look healthier and less risky. However, the banks are largely just passing those risks on to asset managers and private equity firms.

The big picture: Not only are covenant-lite loans growing in the share of new loans issued, as of February their share of all outstanding leveraged loans reached 82% in Europe and 79% in the U.S. There is currently $928 billion of covenant-lite debt outstanding in the U.S. and 148 million euros worth in Europe.

  • "As a borrower, it's a great time. We don't need covenants on anything anymore. We want to buy a building, build a building, we can borrow as much as we want at the terms we want. It's great. The last thing I want is to be the guy who provides that funding on the other side," said JPMorgan Global Alternatives Managing Partner Anton Pil.
  • Yes, but: "This will end poorly. It's just a question of when," Pil added.
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