Bloomberg News

Covenant-Lite Loans Default Less Than All Issuers, Moody’s Says

June 08, 2011

June 7 (Bloomberg) -- Companies with covenant-lite loans defaulted less than issuers that had bank debt with a full package of financial conditions, according to a report from Moody’s Investors Service.

In an analysis of 104 U.S. covenant-lite loans issued between 2005 and 2007, 15 defaulted for a 7.8 percent default rate, according to the report. That compares with a default rate of 10.35 percent for all rated North American corporate issuers.

Defaults are lower because covenant-lite debt limits a bank lender’s ability to force a company to restructure, Moody’s said. The first-lien loans in these deals also had higher recovery rates compared with other defaulted debt, David Keisman, senior vice president at Moody’s in New York, wrote in the report.

“They didn’t have to come back to the banks and renegotiate,” Keisman said in a telephone interview, regarding the reason the default rate was lower on covenant-lite loans.

Covenant-lite loans offer flexibility to a company to get through a “rough patch” rather than being forced by lenders into bankruptcy or a restructuring, Moody’s said. The “opposing view” is that the loans will diminish a company’s value, while an earlier restructuring would allow investors to recover more of their money, according to the report.

Of the 15 covenant-lite defaults, seven were distressed exchanges, where the bank debt didn’t default, Keisman said. The default rate for covenant-lite loans only, as opposed to companies with covenant-lite debt, was 4.1 percent, according to the report. Thomson Reuters LPC provided Moody’s with the covenant-lite loan information.

‘Saw an Opportunity’

“When seven out of the 15 are distressed exchanges, you can say they saw an opportunity and took advantage of it,” Keisman said. Almost 70 percent of the loans were for companies backed by private equity, according to the report.

In comparing the defaulted first-lien covenant-lite loans with 136 non-financial corporate issuers that emerged from default between the fourth quarter of 2008 and the first quarter of 2011, the covenant-lite loans had an 89.6 percent recovery compared with 81.5 percent for the other issuers, according to the report.

--Editors: Chapin Wright, Richard Bedard

To contact the reporter on this story: Kristen Haunss in New York at khaunss@bloomberg.net

To contact the editor responsible for this story: Faris Khan at fkhan33@bloomberg.net


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