Bankers may have to get used to seeing lax loan requirements in corporate debt agreements, as the “covenant lite” loans made popular in the earlier part of the decade may be one feature of the years before the credit crisis to survive.
Covenant lite loans were particularly popular in 2005, 2006 and 2007 and used to finance the blockbuster leveraged buyouts of those years. So experts cautioned there are still several years until they reach maturity and face potential default.But for now, banks appear to be swinging the pendulum back toward the boom years.”We have in fact seen some deterioration in covenant standards, which is a sign of it being an issuer’s market rather than an investor’s market currently,” Martin Fridson, global credit strategist at BNP Paribas Asset Management, said at the Reuters Restructuring Summit this month.The structures, which prevented companies from falling into default on their loans until they could not repay their debts, provided the necessary flexibility for companies to get through the recession, turnaround professionals said at the summit.
“From an owner’s point of view, covenant lite did exactly what it was supposed to do,” said Steve Smith, global head of restructuring at UBS.
“Many more companies would’ve had a lot more distress if they’d had a full set of covenants.”
While some blame the years of easy lending for surprising banks with a slew of bad loans at the height of the credit crisis, corporate managers were grateful for them as they tried to adapt to the recession without defaulting on their loans.
“It’s hard to run a business,” Jay Goffman, co-head of the Global Restructuring Group at law firm Skadden, Arps, Slate, Meagher & Flom LLP, said at the summit.
“There is no crystal ball and some days it goes up, and some days it goes down. And the more leeway you have in running the business, the better off you are.”
The lack of covenants may have also staved off a higher-than-expected corporate default rate this year. Companies couldn’t trip nonexistent covenants when they first ran into trouble, so many waited until it looked like they wouldn’t be able to repay their debt to renegotiate with lenders.
That has been one of the pressures driving banks to amend and extend loans rather than force a company to default, Rob McMahon, senior managing director of GE Capital’s restructuring finance group told the summit.
“There is one covenant you cannot get around, and that is going to be maturity,” McMahon said.
The global corporate default rate fell to a fresh low of just 4 percent in September, down from 13.2 percent at this time last year, Moody’s said earlier this week.
In fact, there are now signs that loans lacking stringent covenants are coming back into the market, even after banks tightened requirements for loans during the credit crisis.
“They don’t call them covenant lite anymore, but it’s a lot more relaxed in terms of covenants than it was a year ago,” Goffman said.
Emily Chasan is a Reuters correspondent in New York.