Borrowers are getting more flexibility in US
cov-lite deals than before the crisis. But changing market
sentiment is dictating availability from week to week, with
some US counsel seeing maintenance covenants creep back this
Up to 25% of 2011’s leveraged loans
have been cov-lite (according to Standard &
Poor’s), which now means no maintenance covenant
in term loans but a leverage ratio in the revolver.
The revolver market is thinner than the term loan
market, so borrowers have had to accept a financial covenant
here, according to Davis Polk & Wardwell partner Joseph
But term loan lenders have fought over the past
months to include a cross default combined with a 45-day
standstill provision, so they can benefit from the leverage
ratio. "This has been a hot topic for negotiation in the US,"
said White & Case partner Eric Leicht.
But a cross acceleration provision has now become
the norm in cov-lite deals, said Hadley.
One of the biggest differences between pre and
post-crisis deals is the revolver’s leverage ratio
being a springing covenant that takes effect only if the
facility has been drawn in the preceding quarter.
By managing their cashflows, including through
equity cures injected before the quarter’s end,
borrowers can avoid having the covenant tested at all. Some
more aggressive sponsor term sheets go further and ask for the
covenant to be tested only if the revolver is outstanding at
the quarter end.
"This basically means that the borrower could have
revolving loans outstanding 361 days during the year but never
have to comply with a financial maintenance covenant,"
explained Michael Goldman, practice lead of Cravath Swaine
& Moore’s banking practice. Goldman, who acts
for lenders, said he has not had to agree to this.
Another change to pre-crisis covenants is the
leverage ratio applying to pari passu debt as
well as junior and unsecured debt. Starting in 2010, for the
first time borrowers are not being required to deleverage and
instead are being allowed to incur debt that ranks equal to the
banks’ collateral positions.
"This is one of the big structural changes from
pre-crisis, and could adversely affect lender recoveries in a
default," said Goldman.
Two features from 2006/2007 that have returned are
net senior secured leverage ratios and aggressive definitions
Cash holdings are carved out of the debt figure
used in a net leverage ratio, making it easier for the sponsor
to comply. It appeared in other loans in the previous cycle,
but generally not in cov-lite deals. It adds a new level of
cash management and covenant flexibility for cov-lite
borrowers, said Sullivan & Cromwell partner Hydee
Ebitda is moving towards bond-like definitions,
particularly in financial sponsor-backed deals, meaning lenders
have potentially less protection than they thought. Borrowers
are being permitted to inflate their Ebitda figure by adding
back expenses deemed nonrecurring or unusual.
A fickle market
While the past months have proven that cov-lite has
survived the financial crisis, this month some US counsel have
seen leverage ratios and even interest coverage tests slip back
into deals that were expected to be structured as cov-lite.
"Certainly this past week, lenders were pushing
back on covenant lite in some deals and seeking to put one if
not two financial covenants back into the term loans," Hadley
told IFLR last week.
It’s too early to say whether this is
a shift or just a glitch in the market. Most banking lawyers
think cov-lite "has legs" and will become more prevalent. This
contrasts to Europe, where news of the first cov-lite deal
since the crisis last week was met with surprise by
There are, however, other signs that the market
could turn. JCrew’s $1.2 billion cov-lite loan in
March, for example, features a margin of Libor plus 325 basis
points when its senior secured leverage ratio drops to
Some say margins and leverage converging can be the
first signs of a bubble. "To me, that’s a sign
that the market is getting a little overheated," said one
It seems likely, however, that last
week’s developments suggest that in the US the
structure has become a function of supply and demand.
"As a question of institutional acceptance, cov-ite
loans are back. As a question of investor appetite, it depends
on overall market conditions," James Florack, a partner with
A key condition over the past months has been
pricing. Lawyers hear from bankers that the pricing
differential between cov-lite and traditional loans is
tightening. "I think the pricing premium for cov-lite has been
shrinking – but it’s a fickle market,"
Lawyers do agree that cov-lite has returned faster
than expected. In 2008, people predicted it
wouldn’t be back for a long time, but over the
past four months there has been an abrupt switch to acceptance
of cov-lite terms.
"It seems as though the cycle has shortened up,"