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Revolving credit lines hit their lowest point in two years in the first quarter. The decline underscored that competing forms of financing have become more affordable.
April 20 -
A slew of loan repricings, along with so-called covenant-lite deals, payment-in-kind toggles and dividend deals — the ingredients for a bubble are everywhere in the high-yield bond and leveraged loan markets.
February 11
Covenant-lite loans are making a comeback this quarter as investors with cash to spend have driven up demand.
The spate of activity underscores the broad array of issuers able to come to market with a cov-lite deal today and the fact that some pay significantly more than others.
So far this quarter, 10 covenant-lite deals raising a combined $11.6 billion have hit the U.S. market, according to Thomson Reuters LPC. This compares with nine of these loans totaling $3.6 billion issued in the first quarter. And consensus is that the trend will continue as long as demand outstrips supply and investors continue to hunger for yield.
"There's just so much liquidity in the market that, given the choice of holding onto your cash or investing in a cov-lite deal, you're going to go for it, especially if the yield is attractive," a loan investor said.
For the record, a loan deal is generally considered "covenant-lite" when it does not have financial maintenance covenants, which regularly test the borrower's financial health by looking at indicators such as liquidity, equity and leverage.
There are other types of protections that a loan might offer, such as covenants that in some way restrict a company's operating activity or investment expenditures. Additionally, the issuer may also have a revolver with maintenance covenants, though that doesn't help the term loan investors, as the revolver lenders have sole discretion to enforce or waive these agreements.
Though today's batch of covenant-lite loans are similar to the ones issued in 2011 — a total of $52.42 billion, according to Thomson Reuters — the current crop of deals differs from the cov-lite of the boom years. In 2006 and 2007 (by far the most voluminous year with $107.84 billion worth of deals) most covenant-lite loans were used for buyouts that left the issuers with leverage in the high-single-digit to low-double digit area. Today, refinancings and dividend recaps dominate, and leverage is commonly in the mid-double digits, market analysts say.
"Most [issuers today] are refinancing existing debt, and if they're refinancing debt with covenants, they're definitely testing the market. If they can get away with dropping the covenants they will," said Darin Schmalz, a director in the leverage finance group at Fitch Ratings. "Because of the aggressiveness in the market, companies can drop their covenants and maybe juice up pricing a little to entice more investors."
One of the most recent cov-lite loan packages to hit the market is a fine example of this. The $3.025 billion multi-tranche facility from Swiss chemical company Ineos — a deal led by Barclays (BCS) and JPMorgan Chase (JPM) that was upsized twice after price talk put the total yield in the low 7% area — will refinance debt. Ineos will also avoid more restrictive covenants on its existing loans.
To be sure, pricing itself on covenant-lite deals can vary quite a bit depending on any number of factors including credit quality and rating, leverage, use of proceeds and industry sector, market analysts say.
"It is largely driven by investor appetite and comfort in investing in a cov-lite deal in, say, an asset-light company versus a very asset-intensive company," said Christine Barto, a director in the bank loan and recovery group at Standard & Poor's. "Given the fact that investors have an observable valuation metric for the underlying collateral of an asset-intensive company, it may make them somewhat more comfortable investing in a cov-lite deal for such a company versus an asset-light company whereby the underlying collateral package is more difficult to value."
One example of this might be a newly launched $1 billion loan for Harbor Freight Tools, an online and national retail tool supplier based in California. That deal, led by Credit Suisse, is priced at Libor plus 400 bps, with an offer price of 99 cents on the dollar. It is a fairly average pricing despite the fact that the proceeds will in part go to pay a dividend, something the B+ company has a propensity for doing.
"The company's financial policies are very aggressive in our view, as evidenced by a history of debt-financed dividends, and we believe this will continue for the foreseeable future," S&P analysts said in an April 25 report.
Another retailer to manage a fairly modestly priced cov-lite deal this quarter was toymaker Toys "R" Us, which paid only Libor plus 375 bps, with an offer price of 98, on its $300 million term loan B. That's despite being, as Schmalz put it, squarely in the single-B category and having 6.2x leverage.
Other cov-lite deals this quarter come from issuers in a variety of other industries, including Syniverse Technologies, a provider of technology and business solutions for the global telecommunications industry, contact-lens solution maker Bausch & Lomb, and natural gas company EP Energy.
In a report published in January, Moody's Investors Service looked at 50 covenant-lite loans totaling $37 million that it rated in 2011, when deals had similar characteristics to the most recent crop of loans. The rating agency found that the median subordinated debt to the cov-lite loans was 36%; the median corporate family rating was B2; and the median loan rating was B1. Interestingly enough, 95% of the companies' capital structures included a revolver with covenants. And 78% were issued by companies with private equity sponsors.
"Private equity sponsors favor cov-lite loans features because they insulate their portfolio companies from negotiations with lenders if financial results differ from expectations, business plans change or the company pays shareholders a cash distribution," the Moody's analysts noted.
