Cov-lite (or "covenant light") is financial

jargon Jargon is the specialized terminology associated with a particular field or area of activity. Jargon is normally employed in a particular communicative context and may not be well understood outside that context. The context is usually a partic ...

for loan agreements that do not contain the usual protective covenants for the benefit of the lending party. Although traditionally banks have insisted on a wide range of covenants that allow them to intervene if the financial position of the borrower or the value of underlying assets deteriorates, around 2006 the increasing strength of

private equity In the field of finance, the term private equity (PE) refers to investment funds, usually limited partnerships (LP), which buy and restructure financially weak companies that produce goods and provide services. A private-equity fund is both a t ...

firms and the decreasing opportunities for traditional corporate loans made by

bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Because ...

s fueled something of a "

race to the bottom Race to the bottom is a socio-economic phrase to describe either government deregulation of the business environment or reduction in corporate tax rates, in order to attract or retain usually foreign economic activity in their jurisdictions. Whil ...

", with syndicates of banks competing with each other to offer ever less invasive terms to borrowers in relation to leveraged buy-outs. In the wake of the

Financial crisis of 2007–08 Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of f ...

growth in the use of cov-lite loans stalled, but more recently they have increased in popularity again. Cov-lite lending is seen as riskier because it removes the early warning signs lenders would otherwise receive through traditional covenants. Against this, it has been countered that cov-lite loans simply reflect changes in bargaining power between borrowers and lenders, following from the increased sophistication in the loans market where risk is quickly dispersed through syndication or

credit derivative In finance, a credit derivative refers to any one of "various instruments and techniques designed to separate and then transfer the '' credit risk''"The Economist ''Passing on the risks'' 2 November 1996 or the risk of an event of default of a co ...

Covenants

Practices vary, but characteristically cov-lite loans remove the requirement to report and maintain

loan to value The loan-to-value (LTV) ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. In Real estate, the term is commonly used by banks and building societies to represent the ratio of the first mo ...

, gearing, and EBITDA ratios. More aggressively negotiated cov-lite loans might also remove * events of default relating to "material adverse change" of the position of the borrower * requirement to deliver annual accounts to the banks * restrictions on other third party debt * restrictions on negative pledges * requirements for bank approval to change the form of the debtor group's business

Concerns

Many at the time were alarmed by the development. In particular, ''

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'' thought it was a concerning and short-sighted development. The ''

Financial Times The ''Financial Times'' (''FT'') is a British daily newspaper printed in broadsheet and published digitally that focuses on business and economic current affairs. Based in London, England, the paper is owned by a Japanese holding company, Ni ...

'' endorsed the view of Anthony Bolton of

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, who warned on his retirement in May 2007 that cov-lite could be "the tinder paper for a serious reversal in the market","Bolton warns of bubble fuelled by “cov-lite” loans"
''

''. May 18, 2007. and the movement in the market was inexorable. Others argued that the move to cov-lite was a welcome simplification of loan documentation, fully justified as the banks would hedge their risk by transferring exposure to the loan in the CDO market. It was also pointed out at the time that cov-lite loans operated in a very similar way to bonds, but at lower values. The high-water mark of cov-lite loans came in the 2007 acquisition by

Kohlberg Kravis Roberts KKR & Co. Inc., also known as Kohlberg Kravis Roberts & Co., is an American global investment company that manages multiple alternative asset classes, including private equity, energy, infrastructure, real estate, credit, and, through its strate ...

, a US private equity firm, by way of a record $16bn cov-lite loan for its buy-out of

First Data First Data Corporation is a financial services company headquartered in Atlanta, Georgia, United States. The company's STAR Network provided nationwide domestic debit acceptance at more than 2 million retail POS, ATM, and Online outlets for nea ...

2007 credit crunch

The tendency towards cov-lite loans ended abruptly with the

2007 subprime mortgage financial crisis The United States subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the Financial crisis of 2007–2008, 2007–2008 global financial crisis. It was triggered by a large decline ...

. Some commentators subsequently sought to attribute the

credit crunch A credit crunch (also known as a credit squeeze, credit tightening or credit crisis) is a sudden reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from banks. A credit cr ...

arising from crisis to cov-lite loans, although the LBO market is almost entirely unconnected with the sub-prime mortgage market in terms of exposure. However, in the

which ensued, cov-lite loans significantly hampered the ability of banks to step in and both seek to rectify positions which were going bad, and to limit their exposure once matters had gone bad. The suggestion that banks risks were mitigated through the CDO market was difficult to sustain in light of difficulties in that market itself as a result of the credit crunch. In March 2011 the Financial Times reported that, in the three months prior, cov-lite loans to the value of $17bn had been issued.

Post credit-crunch market

As the credit markets recovered after all but shutting down in 2008–09, cov-lite loans returned to the syndicated loan market. Indeed, after seeing an impressive $86.7 billion in volume in 2012, cov-lite loans totaled some $93.5 billion through the first 3-plus months of 2013, just short of the record set in 2007. Unlike before the credit crunch, however, most covenant-lite loans in 2013 back refinancing/repricing of existing loans, as opposed to M&A/LBO deals. Due to borrower-friendly lending conditions in 2018, cov-lite loans as a percentage of outstanding leveraged loans in European markets reached 78%, compared to under 10% in 2013. The ubiquity of cov-lite in leveraged

corporate bonds A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, M&A, or to expand business. The term is usually applied to longer-term debt instruments, with maturity of ...

is a characteristic of the corporate debt bubble, which became a topic of increasing worry in the late 2010s.

References

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External links

Money Terms - "cov-lite"
Loans Contract clauses Private equity