"Any statistician will tell you, a good outcome for a bad risk doesn't mean the risk wasn't bad; it just means you happened to get lucky."
Back in February 2011, we discussed the dangerous return of Cov-lite loans financing. Back In February 2011, during the Wharton School of Business annual restructuring conference, many panelists voiced their concerns on the return of the worst practices leading to the burst of the credit bubble, namely the return of many dangerous financing practices:
As a reminder from our 2011 conversation, we referred to what Bethany McLean, known for her work on the Enron scandal and the 2008 financial crisis, said in her article - Corporate Subprime - The default crisis that never happened:
Old habits die hard:
According to Nicole Bullock from Financial Times on the 10th of May in her article - Cov-lite loans make post-crisis comeback:
"In April, companies obtained $7.6bn of cov-lite loans, equivalent to more than 40 per cent of so-called institutional loans extended to companies in the US, according to S and P Capital IQ LCD, a research group. That is the highest monthly proportion since May 2007.
Cov-lite loans extend credit to low-rated corporate borrowers, but strip out some of the traditional protection for lenders. That protection is financial covenants that trigger a default if a borrower’s financial health declines while it is still making agreed interest payments.
"Unintended consequences" of low rates environment have led to a flurry of issuance of Cov-lite loans again in the market.
Standard and Poors indicated in a LCD Daily Wrap-up from the 27th of April, such a resurgence of these bad financing habits coming back to play:
also on the 27th from the same LCD Daily:
"Schrader cov-lite loans allocate, break atop OIDs
Corporate loans typically include provisions, or what we call covenants. They can trigger a "default" if finances deteriorate, even if the borrower is still paying interest. This forces the company to negotiate with the bank lenders, often allowing them to force a restructuring. Covenants also act as early warning system when the credit metrics of company start to deteriorate.
According to Moody's, as reported by Patricia Kuo and Katrina Nicholas in Bloomberg today - Europe Leveraged Loan Defaults May Rise to 25%, Moody’s Say:
From the same article:
Standard and Poor's Leveraged Loan Index Description (Market Value Index Level) - source Bloomberg:
The Europe leverage loan price picture - source Bloomberg:
Looking at the above graph, we do think investors happened to have been very lucky, once. Indeed, as any statistician would tell you, it was a good outcome for a bad risk. It doesn't mean a good outcome is going to happen again...
"You can't bank on the outcome."