Out With The Old Covenants, In With The Loose

September 17, 2007

Investors appear to have mixed feelings about covenants; while many kick and scream when covenants on a deal come lite, some say the tests don't really matter all that much. One investor told us back in August that the brouhaha surrounding the covenant-lite trend was a bit of a tempest in a teapot.

However, for those who do have concerns about covenants, new analysis from Moody's Investors Service shows how much some covenants have loosened recently, as those placed on previously completed deals cut loose to dance the covenant-lite vogue.

The ratings agency looked at a total of 425 Moody's rated loans, and of those, 100 had an amendment to their maximum leverage covenant between January 2005 and June 2007.

The average amended leverage ratio on these deals loosened by two-thirds of one times debt to Ebitda.

For those loans that amended in the first half of 2007-21 of the 100-the average loosened by one-half of one times debt to Ebitda. More specifically, the average maximum leverage ratio at the agreement date was 5.45x debt to Ebitda; with the amendment of the covenant, the leverage ratio loosened to 5.96x.

"One of the takeaways for portfolio managers and credit managers is that on loans that were purchased by them during this time period of January '05 through June of '07, there were substantial changes to the originally agreed maximum leverage ratio that may have a bearing on the credit parameters they through they had in place, but which have now changed," said Neal Schweitzer, senior vice president in Moody's syndicated loan ratings group.

Another important covenant for investors, interest coverage ratios, also saw some loosening on average. Of the 65 deals that were amended from January 2005 to June 2007, the average interest coverage ratio dropped by 20%, loosening to 1.9x from 2.4x. For the 16 deals amended in the first half of 2007 the average interest coverage ratio dropped by 16%, loosening to 1.7x from 2.1x.

"To the extent that portfolio managers and credit managers ... have not actively paid attention to the amendment process for the existing loans in their portfolios, it is important for them to understand the increased headroom for leverage and looser interest coverage that exists in their portfolio," Schweitzer said.

Of course, ultimately it depends on whether the portfolio managers have these loans in their portfolio. But if they do, it is something to think about.

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