A growing corporate debt trend is secured transactions involving leveraged loans: borrowers more frequently have been allowed to freely transfer these assets to non-guarantors.
This was the case in more than 82% of secured transactions this year, up from about 55% last year, according to a business loans and debt report from credit research firm Covenant Review. The report isn't available to the public.
That means leveraged loans are being treated more like high-yield bonds, which have typically been associated with the free flow of value concept.
"This ability to move assets out of the collateral pool securing the applicable debt provides the borrower … with enhanced flexibility," the report said.
The hunt for yield appears to be behind this trend of weakening protections, Shweta Rao, senior director at global financial intelligence firm Reorg, said.
"Once an innovation is accepted in one document, it often finds its way into the templates of other sponsors, and then eventually becomes common," Rao said, pointing to the portability carveout as a change of control in high yield bonds.
The experience of COVID-19 has created a consensus in the financial community that covenants in leveraged loans and high yield bonds in the primary markets are pandemic-proof, Rao said.
Looser bond indentures, ratio debt restrictions
Two other trends are emerging from this environment, according to the report: frequent elimination of ratio debt as credit quality decreases, particularly for leveraged loans, and the loosening of high-yield bond indentures.
On the latter trend, bond indentures now tend to be looser than leveraged loan credit agreements, reverting more to historical norms.
The trend to eliminate ratio debt for leveraged loans appears to be fairly widespread, Anthony Canale, global head of research at Covenant Review and the author of the report, said.
"Thus far, we have seen a number of deals where the bonds were marketed with the $1 of ratio debt condition eliminated entirely," Canale said.
Companies he named: Academy, AMC Entertainment, Ancestry, Aspen Insurance, Diamond Sports, Envision Healthcare, Flexential, Global Medical Response, New Fortress Energy, PetSmart (which deal was later pulled), Refinitiv, White Cap, and Zayo.
He called this development particularly worrisome for investors concerned about the ability of a stressed issuer to "pull a J. Crew-type transaction" and remove assets from the credit.
Canale said the trends seem to line up with recent history of high-yield bond covenants generally being looser than the corresponding provisions in leveraged loans.
Where the bonds and the loans were different, it was far more often the case that the bonds were looser than the corresponding loans with respect to credit category, Canale said.
"That trend has accelerated meaningfully," Canale said. "For example, in a previous report, the bonds were looser than the loans in at least a third (i.e., 33.3%) of the secured transactions in only three of the 16 discrete categories we reviewed. In this data set, the bonds were looser than the loans in at least a third of the secured transactions in 11 of those 16 categories.
"By contrast, in none of the 16 categories we reviewed were the loans looser than the bonds in at least a third of the secured transactions," he said.