NEW YORK (
)--The subprime housing boom was accompanied by a boom in leveraged lending, but somehow companies with weak credit--and the investors who bought their debt--turned out far better than homeowners and the investors who bought theirs.
You've heard of liars, no doc, or stated income loans, but you may not have heard of covenant lite loans, which were similar in some respects--except they were for companies rather than home buyers. With covenant lite loans, the lenders agreed to give up many of their customary rights, so that if a borrower ran into trouble, it could pay later, rather than being forced into bankruptcy.
This sounds like a recipe for disaster--except that, largely, it worked.
"It really did help a lot of our clients get through the crisis in a way where there was no harm done to the bank lenders," said Jason Kanner, partner at Kirkland & Ellis, in a panel discussion at the Loan Syndications & Trading Association annual conference in New York Wednesday. Kanner, who represents corporate borrowers, added that covenant lite loans are "great," and is pleased that they are returning to the market.
Martin Fridson, CEO of FridsonVision LLC and a veteran high yield bond market strategist concedes that--even though he was initially skeptical of covenant lite deals--they performed better than he thought they would through the crisis.
"It's a fair statement that--yes--in the financial crisis and the recession that ensued a lot of companies that were viewed as certain defaults in fact got through the crisis, avoided bankruptcy and the loans eventually recovered their value," Fridson said in an interview.
Fridson isn't yet convinced, however, that covenant-lite deals will perform as well in the future.
He argues that one of the reasons corporate borrowers were able to avoid default is that the Federal Reserve was pumping massive emergency stimulus into the economy--effectively bailing out many corporate borrowers. Further, if covenant-lite deals do fail, the consequences are more severe for lenders.
"The reason cov-lites might hurt lenders, rather than help them, is that they may prolong the period of decline before the company defaults," Fridson wrote in a follow-up email. "That means that the company will have more time to dissipate assets (through losses and sale of assets to generate cash) before defaulting. So the average recovery on defaulted loans may be lower than it would have been absent the heavy issuance of cov-lite loans."
Written by Dan Freed in New York
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