Covenant-lite wriggles into life: Fitch

Banks are loosening covenants and showing a pre-GFC disposition to select corporate credit risk, Fitch Ratings said last night.

In a commentary to introduce its latest European Leveraged Loan Chart Book, Fitch Ratings said that the European leveraged loan market was "showing greater stability at any time since the global credit crisis, while suffering from tepid primary market issuance and active refinancing of legacy issuer into higher-risk structures."

Fitch said: "the rapid development of credit funds associated with traditional fixed-income and alternative asset management platforms translates into institutional investor demand for loans outstripping supply from valuation-challenged financial sponsors.

"Investors are accepting pre-crisis leverage multiples of up to seven times operating profit in some cases."

There was "an unprecedented surge in covenant-lite structures," Fitch said.

"These have nonetheless failed to entice sponsors to outbid strategic corporate investors and public equity markets in vendor auctions," Fitch noted - a factor that may only stimulate demand from determined customers.

Issuance and refinancing activity through April 2015 illustrated the demand and supply imbalance, Fitch said.

It said it "observed only 12 primary market transactions in the first four months of 2015.

"In addition, loan structures increasingly exhibit a bias towards covenant loose and covenant-lite terms and conditions.

"Loans with a full set of financial covenants reached its lowest level ever, at ten per cent of issuance, from 30 per cent in 2014, and nearly 80 per cent in 2012.

"Despite the steady decline in underwriting standards since the return of institutional investor demand in 2013, this has not translated into lower primary market credit spreads or a material decline in equity cushions," Fitch said.

"Strategic corporate trade buyers with lower internal rate-of-return benchmarks and greater scope to enact cost cuts have included larger equity cushions than financial sponsors while embracing leveraged loans as a primary acquisition financing instrument."