Fitch: Covenant-Lite Loans Make Comeback
U.S. covenant-lite loans have made a significant comeback in the leveraged finance market reflecting investor willingness to take on more risk in exchange for higher yields, according to a report by Fitch Ratings.
Year-to-date, covenant-lite loan issuance totaled $49 billion. The strong growth in covenant-lite loan issuance has continued into the fourth quarter. In October 2012, covenant-lite issuance represented 31% of institutional loan issuance, the highest percentage since the end of the credit crisis.
The growth of covenant-lite issuance coincides with the increase in collateralized loan obligation (CLO) issuance. Year-to-date, over $37 billion of CLOs have been issued versus $13 billion in all of 2011. The leveraged loan market remains heavily dependent on the CLO investor class, with CLOs representing approximately 45% of the current leveraged loan buyer base. The growth of both leveraged loan and covenant-lite issuance remains supported by the growth of primary CLO issuances.
Based on the limited number of covenant-lite defaults, Fitch estimates the average covenant-lite term loan recovery rate between 55%-60%. This compares to an average overall loan recovery rate of approximately 62% between 2008-2009, when most of the defaults occurred.
Recently, many borrowers have combined an asset-backed lending (ABL) revolver in conjunction with a cash flow-based covenant-lite term loan. The combined ABL and covenant-lite structure provides a borrower greater flexibility and more advantageous pricing. However, an ABL revolver ahead of a covenant-lite term loan could adversely impact future recovery rates on covenant-lite loans.
To review the full “Covenant-Lite Loans” report, click here.