Logical Analysis Report

Key Focus

  • What we potentially have is a market-wide test of how (issuers) react."
    The game changer for leveraged investors has been the gradual whittling away of the maintenance covenants that require borrowers to comply with periodic tests of debt to earnings ratios to remain compliant with lending agreements.
    Michael Dakin, a partner at Clifford Chance, said it was like driving your car with the warning indicators for the oil, gas and engine all switched off.
    "I can be cruising along down the road but if I'm not managing those things separately and any of them go, it's a real catastrophic result," he said.
    Rob Mathews, a partner at Baker McKenzie, said the issue for investors in covenant-lite debt was that they might only find out about a company's difficulties when there's an actual default, or a request for an interest payment delay.
    "The repercussion of that might be that by the time these defaults are identified, it's too late to take proactive steps to fix things," he said.
    MASSAGING EARNINGS
    Another crucial change to debt agreements has been the modification of the definition of earnings before interest, taxes, depreciation and amortization, a metric underlying many of the tests borrowers much pass to avoid breaching agreements.
    Many deals now allow firms to add one-off costs or projected earnings increases to their current earnings to make them appear healthier financially, potentially even staving off default.
    According to Reorg, 85% of the high-yield bonds sold in Europe in 2019 allowed for so-called cost add-backs, up from about 50% in 2016.
    Lawyers specialising in leveraged finance deals said corporate clients were now considering how they could use one-off cost add-backs due to the coronavirus crisis to mitigate the impact of the pandemic on their earnings.
    "They have clear flexibility to do it in a number of deals we have looked at," said Mathews at Baker McKenzie.
    Another focus point for investors is debt capacity
  • But they said the longer it lasts, the more aggressive they're likely to be.
    "There's lots of money that is being written off right now, so there's a huge reason for sponsors to try and pull out as much collateral as possible," said Azhar Hussain, head of global credit at Royal London Asset Management.
    Some bankers said investors hungry for high yields lapped up covenant-lite debt even though they had misgivings about the terms, allowing arrangers to push through deals ever more favourable for borrowers.
    "We would engage with people on the basis of being serious and try to work around some of their issues
  • Whereas only 15% of loans in 2010 were deemed covenant-lite, now more than 80% lack clauses that might trigger warnings about a company's finances or stop it stripping out assets, according to S&P Global Market Intelligence.
    Covenants on European high-yield bonds have also became more than twice as permissive over the past decade, according to financial intelligence provider Reorg.
    Tricomi said the main questions from investors spooked by the impact of the crisis on balance sheets were how much extra debt borrowers can raise, which assets can be moved out of their reach and what actually counts as collateral for their debt.
    THE FINE PRINT
    The Bank of International Settlements, the U.S. Federal Reserve and the International Monetary Fund, among others, have all warned about the deterioration in lending standards and with defaults set to spike to up to 10% according to Moody's, buyers of covenant-lite debt may soon find out how risky it may be.
    "The use of flexible covenants has not been tested in a stress environment," said Lisa Gundy, senior covenant officer at the ratings agency

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High Level Topics

  • DEBT
  • INVESTORS
  • EARNINGS
  • COVENANT-LITE

    • High Level Abstractions

  • DEBT(6, 0 Order)
  • ( DEBT )(6, 0 Order)  top
  • ( DEBT, INVESTORS )(5, 1st Order)  top
  • ( DEBT, INVESTORS, EARNINGS )(1, 2nd Order)  top
  • ( DEBT, INVESTORS, COVENANT-LITE )(3, 2nd Order)  top
  • ( DEBT, INVESTORS, CORONAVIRUS )(2, 2nd Order)  top
  • ( DEBT, INVESTORS, BONDS )(3, 2nd Order)  top
  • ( DEBT, INVESTORS, SO-CALLED )(2, 2nd Order)  top
  • ( DEBT, INVESTORS, ONE-OFF )(1, 2nd Order)  top
  • ( DEBT, INVESTORS, LOAN )(1, 2nd Order)  top
  • ( DEBT, INVESTORS, INTEREST )(1, 2nd Order)  top
  • ( DEBT, INVESTORS, HIGH-YIELD )(2, 2nd Order)  top
  • ( DEBT, INVESTORS, CRISIS )(2, 2nd Order)  top
  • ( DEBT, INVESTORS, COST )(1, 2nd Order)  top
  • ( DEBT, EARNINGS )(2, 1st Order)  top
  • ( DEBT, COVENANT-LITE )(4, 1st Order)  top
  • ( DEBT, CORONAVIRUS )(2, 1st Order)  top
  • ( DEBT, BONDS )(4, 1st Order)  top
  • ( DEBT, SO-CALLED )(2, 1st Order)  top
  • ( DEBT, ONE-OFF )(1, 1st Order)  top
  • ( DEBT, LOAN )(1, 1st Order)  top
  • ( DEBT, INTEREST )(1, 1st Order)  top
  • ( DEBT, HIGH-YIELD )(3, 1st Order)  top
  • ( DEBT, CRISIS )(3, 1st Order)  top
  • ( DEBT, COST )(1, 1st Order)  top
  • INVESTORS(6, 0 Order)
  • ( INVESTORS )(6, 0 Order)  top
  • ( INVESTORS, EARNINGS )(1, 1st Order)  top
  • ( INVESTORS, COVENANT-LITE )(4, 1st Order)  top
  • ( INVESTORS, CORONAVIRUS )(3, 1st Order)  top
  • ( INVESTORS, BONDS )(4, 1st Order)  top
  • ( INVESTORS, SO-CALLED )(3, 1st Order)  top
  • ( INVESTORS, LOAN )(2, 1st Order)  top
  • ( INVESTORS, HIGH-YIELD )(3, 1st Order)  top
  • ( INVESTORS, CORPORATE )(3, 1st Order)  top
  • ( INVESTORS, STAVING )(2, 1st Order)  top
  • ( INVESTORS, ONE-OFF )(1, 1st Order)  top
  • ( INVESTORS, INTEREST )(1, 1st Order)  top
  • EARNINGS(2, 0 Order)
  • ( EARNINGS )(2, 0 Order)  top
  • COVENANT-LITE(5, 0 Order)
  • ( COVENANT-LITE )(5, 0 Order)  top
  • ( COVENANT-LITE, EARNINGS )(2, 1st Order)  top
  • ( COVENANT-LITE, BONDS )(4, 1st Order)  top
  • ( COVENANT-LITE, HIGH-YIELD )(4, 1st Order)  top
  • ( COVENANT-LITE, SO-CALLED )(3, 1st Order)  top
  • ( COVENANT-LITE, LOAN )(2, 1st Order)  top
  • ( COVENANT-LITE, CRISIS )(3, 1st Order)  top
  • ( COVENANT-LITE, STAVING )(2, 1st Order)  top
  • ( COVENANT-LITE, ONE-OFF )(1, 1st Order)  top
  • ( COVENANT-LITE, KEEP )(1, 1st Order)  top
  • ( COVENANT-LITE, INVESTMENT )(1, 1st Order)  top

    • References