Senior Loans: "Cov-Lite" Doesn't Mean "No Covenants"
• “Cov-lite” senior loans does not mean without covenants.
• Whether a loan is “cov-lite” or not is just one of the many considerations that go into credit analysis.
• Prevailing “cov-lite” trends may not be good indicators of the overall quality in the senior loan market.
Senior loans continue to be attractive in the current environment. These loans–which carry very low interest rate risk as their coupons periodically adjust to short-term interest rates–may be compelling to investors seeking protection against rising treasury rates.1 Investors are paying increasingly close attention to developments in this nearly $775 billion asset class, as of fall 2013.
A number of stories have cropped up lately in the popular press ostensibly warning investors about the perceived dangers of senior loans. One of the more prevalent fears espoused about loans has been the trend toward more deals with covenant-lite or “cov-lite” covenant packages in the new issue loan market. While cov-lite issuance has been on the rise, the details about what cov-lite actually is and what it means for lenders may often be lost or misinterpreted.
It is important to remember that credit analysis is a complex process. We believe that investors are well-served to look beyond what may be simplistic headlines, and into the varied factors that contribute to credit fundamentals and the myriad of protections detailed in loan packages and covenants. The key insights, which all senior loan investors should understand about cov-lite, include:
- Cov-lite does not mean without covenants. Cov-lite refers only to the replacement of maintenance with incurrence covenants. Cov-lite loans still have many covenants that benefit the lender.
- Cov-lite does not necessarily mean a risky or carelessly underwritten loan package. Only a comprehensive analysis of all the covenants in a loan package can provide a complete picture of lender protections.
- Trends in cov-lite transactions are a weak indicator of deal quality at best. The strength of covenant packages should be expected to ebb and flow with the supply and demand for credit.
Read more about the asset class and the oft-misunderstood topic of cov-lite loans.
1. Short-term interest rates and longer term treasury rates may or may not move in tandem directionally or in magnitude.
These views represent the opinions of OppenheimerFunds and are not intended as investment advice or to predict or depict the performance of any investment. These views are subject to change based on subsequent developments.
Senior loans are typically lower rated (more at risk of default) and may be illiquid investments (which may not have a ready market). The underlying loans held in senior loan funds are subject to significant.
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