Editor's letter


Rumblings of concern about growing risk in the loan market are intensifying into full-blown tremors as the phenomenon of covenant-lite loans reaches new heights. In May, private equity firm Kohlberg Kravis Roberts announced its plans to fund a buyout of First Data Corp with a whopping $16 billion of covenant-lite loans, more than double the previous record of $7 billion in the buyout of Univision Communications.

So-called 'cov-lite' loans, which lack performance-related guarantees, have been characterised as a "timebomb", while top UK fund manager Anthony Bolton said it was a question of "when rather than if" this bubble explodes.

Behind the headline-grabbing news, the numbers are even more disturbing. A study of more than 7,000 syndicated loans over the past 10 years from Fitch Ratings found a sudden drop in covenant protection in 2007. Just 52% of loans in the first quarter of 2007 had any guarantees at all in place - down from 68% in 2006 and 80% in 2004. And investors were already worried before that Q1 dip: in December 2006, more than 50% of investors responding to a Fitch poll thought leveraged loan covenant protection was inadequate - up from just over 40% six months earlier.

Analysts are concerned that with a small handful of private equity firms now powering so much investment banking business, banks are being coerced into providing covenant-lite financing for them. But another less obvious trend is perhaps even more revealing: banks are increasingly parcelling up and selling on these loans: they're not the ones holding the risk any more.

The bottom line for investors has to be: watch out.

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