Creditflux Newsletter

Unless lenders work together, more borrowers will get away with waiving their loan covenants

Wolseley is tired of covenant waivers and the whole supposedly consensual process by which stretched borrowers throw themselves on the mercy of their lenders and ask for a little flexibility to help ease them through a difficult patch. Loans have covenants to protect lenders. We don’t have enough lenders at the moment so those left need all the protection they can get.

In the heady days of 2005-2007, borrowers took great pleasure in taking covenants out of loan documents, resulting in the egregious excuse for creditor protection known as “covenant lite” loans.

I never met anyone who said they bought covenant lite loans; everyone said they offered no protection. But doyens of the loan market muttered that everything would be OK with loans that had traditional covenants. When the economy turned and a covenant tripped, debtors would take control of the company, and, as long as it could be sold for a half decent multiple, senior creditors would get all their money back.

If only it were so. Today, credit conditions are tight and lending standards tighter. So are covenants protecting lenders? Not a bit. Where companies get close to covenants they ask for the dreaded “covenant waiver”. Desks all over the financial world are groaning under the weight of waiver request documentation.

“Market conditions are a bit unpredictable at the moment, so do you mind if we suspend covenant calculations for a while?” they ask. “We’re going to breach the net debt coverage covenant,” they say. “Do you mind if we reset it?”

Sometimes these requests come with the offer of a small fee or even an increase in the spread, but these tend to be token gestures rather than adequate compensation for extra risk. Wolseley notes that one borrower asked for most of its covenants to be torn up and in exchange offered a derisory spread increase that only partly reversed the “reverse flex” (spread tightening) it had imposed upon lenders when the deal was launched. In this case the company didn’t get what it asked for. (Or maybe, figuratively speaking, it did).

  The particular object of Wolseley’s ire is the practise of offering blackleg lenders a so called “early bird” fee for accepting waivers. This tactic is designed to appeal to those zombie lenders (often CLO managers) which are in no place to analyse the impact of the waiver on their rights as creditors. With no analysts to examine the waiver request, no bandwidth to make calls to other lenders, and a desperate need for cash to pass their own CLO covenant tests these lenders are happy to sign up to (almost) anything.

Consequently, the task of those more robust lenders that are trying to organise concerted action is made harder. Other insidious, but understandable tactics designed to fragment the shared interests of lending groups is to offer large “sweetheart” fees to large lenders, which are then either silenced or asked to encourage the small fry who don’t benefit from sweetheart deals to sign up.

In this way discord and suspicion are sown among lenders, making united action in other situations difficult.

Lenders need to learn, and learn quickly, that their best interests are served by standing together, forming lending groups, communicating efficiently and taking a united stance. It’s a bit like the scene in Gladiator, one of Wolseley’s favourite films, where the crazed charioteer cuts down isolated gladiators one by one until Maximus persuades them to stand together in the middle of the amphitheatre and turn the tables.

Wolseley is a leading practitioner in the credit market. Feedback is welcome at wolseley@creditflux.com