Middle-market lenders hold line on inking cov-lite loans

Covenant-lite refers to loans that do not have the traditional protective financial covenants that when tripped can serve as early warning signs to lenders and investors in a deteriorating credit scenario.

The less restrictive structure is increasingly common in the middle market, but only above a certain threshold, said speakers on the middle-market lending panel at the LSTA’s 18th Annual Conference held October 17 in New York.

“The big difference is the credit story. In the middle market there has to be a rock solid credit story,” said panelist Edward Ribaudo, managing director at GE Capital Markets. Tranche size is also important, he noted, as the investors committing to covenant-lite loans are typically broadly syndicated investors. “You need larger tranches to attract that investor base.”

Middle-market covenant-lite loan issuance soared in 2013, reaching $6.94 billion in the first three quarters compared to a total $4.78 billion in 2012, according to Thomson Reuters LPC. LPC defines middle market as total facility size of $500 million or less issued to borrowers with $500 million or less in revenues.

Despite the steady march of covenant-lite structures in 2013, there is consensus among lenders that $50 million in EBITDA roughly marks the minimum threshold to snag a covenant-lite deal. Only three issuers with $50 million in EBITDA or less have sealed covenant-lite loans this year, sources said.

In particular, companies with contracted revenues have been big winners in the covenant-lite space, noted one lender, not unlike CAMP Systems, the global provider of aircraft maintenance and information services, so often cited by lenders as the poster child for middle-market covenant-lite transactions.

With approximately $46 million in EBITDA the company inked a $345 million covenant-lite first- and second-lien buyout loan in May 2012 backing its highly leveraged sale to GTCR from Warburg Pincus.

Lenders love the credit, citing its largely unrivaled position as the go-to reference for its industry, its highly recurring, media-like revenues and established subscriber base.

Two of the three issuers in 2013 are also noted for recurring revenues. Learfield Communications, a sports marketing company, sealed a $330 million leveraged buyout loan. The deal, marketed with approximately $50 million in forward EBITDA, was well received by investors for its predictable, contracted revenues. Pricing was cut on the first- and second-lien loans during syndication.

Hemisphere Media Group Inc, a $40 million EBITDA company, raised the spread on its $175 million refinancing loan by 50bp to LIB+500, but clinched the deal. Pro forma total leverage is 4.3 times.

Notably, Sprint Industrial Holdings, with highly cyclical revenues and just $38 million in EBITDA, sealed its $220 million first- and second-lien refinancing at the tight end of price guidance. Last week, a fourth issuer, Utility Services Associates, which had launched a $215 million covenant-lite buyout loan, reversed course and added a net total leverage covenant during syndication.

A Moody’s ratings report notes that the company’s strong credit metrics are offset by its small scale, high customer concentration and lack of geographic and end-market diversification.

Though large market terms ushered in by private equity sponsors and arrangers playing down market have resulted in looser structures and higher leverage levels at lower spreads, the numbers indicate that the majority of middle market covenant-lite deals are extended to borrowers at the larger end of the spectrum where the large institutional investor base is more active.

Covenant-lite works for highly liquid transactions where investors can easily exit the loan, selling out of the position at certain trigger points, said a middle market lender.

Large corporate borrowers have secured covenant-lite loans in record numbers in 2013, benefiting from a prolonged supply-demand imbalance. Yield-starved investors competing for assets are willing to provide leveraged loans at issuer-friendly terms.

And though covenant-lite loans have long been a lightening rod in the loan market, a robust institutional investor base is providing steady demand for newly issued loans in the primary market, anchored by support in the secondary market.

“Covenant-lite loans are trading at, or actually tighter, yields than most transactions of comparable risk in the secondary market, and that’s a great indication of the acceptance of investors and managers in terms of the types of deals in the market,” said Scott Baskind, managing director at Invesco, of the broadly syndicated loan market, speaking on the LSTA’s Secondary Trading & Liquidity panel.

Leela Parker is a reporter for RLPC in New York