| |||||||||||||||||||||||
| |||||||||||||||||||||||
 Covenant-lite deals may help companies avoid bankruptcy in tough times; too bad there aren't many of them.
Amidst the handwringing over the credit crunch and a recession, the leveraged debt market seems to take heart in the received wisdom that a seemingly inevitable spike in default rates will be blunted by the lack of covenants found in many loans of recent vintage.
The loose covenants, market participants and observers have widely argued, will keep lenders from forcing borrowers into default in the event of temporary business slowdowns. This will limit the universe of defaulters to those who can no longer make interest payments. But how many credits do these covenant-lite borrowers compose? Not many, apparently. According to a study by Moody's Investors Service, the percentage of issuers without financial covenants totals only 10% of all borrowers. A large portion of the rest face tough times with the usual complement of covenants. In fact, the Moody's study claims that some 292 corporate issuers, or 11% of those surveyed for the study, face the likelihood of breaching at least one financial covenant in their loan agreements this year. That could push the companies into costly negotiations with lenders or, in some cases, into Chapter 11. "Covenant violations among the lowest-rated credits will likely lead to costly restructurings in the form of sharply increased loan pricing, high amendment fees, reduced borrowing availability and shortened maturities," says the study. "In some cases, covenant violations may prompt a company to seek bankruptcy protection." "Here's proof the covenant-lite story was oversold," says Martin Fridson, president of high-yield research firm FridsonVision LLC. "Many issuers do have tight covenants, and they are the ones that are most likely to breach them." Although Moody's doesn't specify how many of those 292 issuers could travel the bankruptcy route, it cautions that while in the past companies in covenant default would have been able to "easily" negotiate amendments and waivers with lenders, today's risk-averse environment creates a very different scenario. While lenders cope with their own losses, there's the potential for "a minefield for borrowers," with lenders almost certain to extract whatever they can in negotiations following a tripped covenant. As the ratings agency puts it: "Driven by lender or borrower fatigue typically following several rounds of loan restructuring, issuers may seek Chapter 11 bankruptcy protection in order to preserve cash and gain flexibility. ... In some instances, an expected covenant breach may result in preemptive action by the borrower." Moody's notes that 2008 has seen 13 defaults through March 31. Of those, eight had tripped at least one covenant before defaulting. So what about covenant-lite borrowers? According to one leveraged finance banker, those lucky companies may see lower default rates than the rest. The reason? Even with the lax credit standards that preceded last summer's crunch, only companies with the strongest cash flows got a free pass on their covenants from the market. Steve Miller, an analyst at Standard & Poor's Leveraged Commentary & Data, notes that up until the second quarter of last year, most of the covenant-lite deals were stronger credits, such as Neiman Marcus Group Inc., which registered a 0.4% gain in sales in March, even as most of its luxury retailing competitors reported declines. According to S&P's data, 18% of the companies in its high-yield index have covenant-lite structures, although that number jumped to 35% for those that borrowed money in 2007, at the tail of the credit boom. The argument that the universe of covenant-lite deals is self-selecting resembles one Standard & Poor's made in 2006 in a study of default rates among companies that issued debt to fund dividend recaps. In that study, S&P said the default rate for companies undergoing recaps between 1995 and 2003 was 6%. That compared to an 11% default rate for all LBO'd companies in the same period. Indeed, only companies with strong cash flows seemed able to get money for recaps from banks in the form of loans or from bond investors through high-yield notes. Figures. -- Vipal Monga See the full issue of the 4.28 Deal newsweekly Categories Deal Video
    Community
 Elsewhere on The Deal.comDealwatch
The Deal MagazineCorporate Dealmaker
The Deal VideoCategories
Blog roll
Archives
| |||||||||||||||||||||||
|
|
|
|
|
©Copyright 2009, The Deal, LLC. All rights reserved. Please send all technical questions, comments or concerns to the Webmaster.
