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

jargon Jargon, or technical language, is the specialized terminology associated with a particular field or area of activity. Jargon is normally employed in a particular Context (language use), communicative context and may not be well understood outside ...

for

loan agreement A loan agreement (also known as a lending agreement) is a contract between a borrower and a lender which regulates the mutual promises made by each party. There are many types of loan agreements, including "facilities agreements", "Revolving credi ...

s 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 Private equity (PE) is stock in a private company that does not offer stock to the general public; instead it is offered to specialized investment funds and limited partnerships that take an active role in the management and structuring of the co ...

firms and the decreasing opportunities for traditional corporate loans made by

bank A bank is a financial institution that accepts Deposit account, 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 m ...

s fueled something of a "

race to the bottom Race to the bottom is a Socioeconomics, socio-economic concept describing a scenario in which individuals or companies compete in a manner that incrementally reduces the utility of a product or service in response to perverse incentives. This pheno ...

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

2008 financial crisis The 2008 financial crisis, also known as the global financial crisis (GFC), was a major worldwide financial crisis centered in the United States. The causes of the 2008 crisis included excessive speculation on housing values by both homeowners ...

, 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 corp ...

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 loan, 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 society, building societies to represent t ...

, gearing, and

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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 pledge Negative pledge is a provision in a contract which prohibits a party to the contract from creating any security interests over certain property specified in the provision. Negative pledges often appear in security documents, where they operate to ...

s * 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 ''

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'' 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 private-equity and investment company. , the firm had completed private-equity investments in portfolio companies with approximately $710 billion of total ...

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

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2007 credit crunch

The tendency towards cov-lite loans ended abruptly with the

subprime mortgage crisis The American subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010, contributing to the 2008 financial crisis. It led to a severe economic recession, with millions becoming unemployed and many busines ...

. Some commentators subsequently sought to attribute the

credit crunch A credit crunch (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 crunch generally ...

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

References

{{reflist Loans Contract clauses Private equity