Junk Loan Market Getting "Silly And Sillier": Cov Lite Loans At All-Time High

By Katy Burne at The Wall Street Journal

Its almost summertime, and the lending is easy. Companies with junk ratings from Kate Spade to nut specialist Diamond Foods have been borrowing cash with few strings attached.

Lending to weaker companies on easy terms is becoming more and more common as investors' appetite for higher-yielding debt grows stronger and the Federal Reserve keeps money flowing at ultralow rates. Since the financial crisis, companies have been able to borrow more without offering investors what were once considered standard protections against possible losses.

More than half of the loans in the $747 billion U.S. market for loans made to junk-rated companies don't have financial "covenants," triggers that could cause a borrower to shore up its health, including periodic tests of overall debt levels and cash flow to cover scheduled interest payments. Thus far this year through Thursday, 62% of leveraged loans lacked these regular requirements, up from 57% for all of 2013, according to S&P Capital IQ LCD.

The shift recalls a boom era for loan deals that led up to the 2008 financial crisis. Easy lending terms are once again appearing as part of an expansion of credit to riskier borrowers, including companies often being bought out or financed by private-equity firms.

Even with weaker loan contracts, corporate defaults have been held down and troubled companies have been able to refinance their debts at much lower rates due in part to Fed-provided liquidity.

Some investors are worried. "Things started to get silly in 2013, and now they're getting even sillier," said David Sherman, president of Cohanzick Management LLC, which oversees $1.7 billion in assets. He has reduced his ownership of leveraged loans and generally doesn't buy so-called "covenant lite" deals. "We have seen this film before."

Leveraged loans, including loans with and without financial covenants, now yield 5.03% as of Wednesday, compared with 3.81% for investment-grade corporate bonds, according to J.P. Morgan. Leland Hart, head of the bank-loan team at BlackRock Inc., overseeing more than $10 billion in leveraged loans, said covenant-lite loans had fewer defaults than standard loans in many of the years after the financial crisis. Most companies that can do those deals are healthy enough to repay their debts, he said.

Still, by having fewer strings attached to their loans, borrowers are once again able to build flexibility to take on more debt or to pay dividends to owners such as private-equity firms.

Outdoor clothier Eddie Bauer arranged $225 million of loans in April to make a dividend payment to its private-equity owner, Golden Gate Capital. A spokeswoman declined to comment.

Kate Spade borrowed to refinance debt in April, and its $400 million term loan required the New York-based company to maintain no regular financial targets, according to Xtract Research LLC. A representative for Kate Spade declined to comment....

Covenant-lite loans comprise 54% of loans in a leveraged-loan index run by J.P. Morgan Chase. That is the highest in the bank's index data going back to 2007, and it is up from 46% at the end of last year.

The share of Securities and Exchange Commission-registered covenant-bearing loans that feature just one is at its highest point ever, around 35%, according to Thomson Reuters' unit Loan Pricing Corp. That is up from 31.5% in 2012 and 21% in 2007.

Issuance of leveraged loans in the U.S. has reached $531 billion so far this year, compared with $549 billion to this point last year, which was the busiest pace since 1987, said Thomson Reuters' LPC unit.


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