Junk Loans Still Lack Protections, Xtract Research Says

The majority of loans obtained by junk-rated borrowers in the U.S. this year lack typical lender protections, according to Xtract Research LLC.

Of the 164 credit agreements signed in the first four months of 2014, 109 lacked some financial-maintenance requirements that, when violated, can give lenders an opportunity to negotiate with the borrower, according to a report published today by Xtract Research. Pacts for 74 of those borrowers included a covenant that benefited part of the loan, usually the portion held by banks.

Lenders haven’t fully implemented underwriting standards outlined by U.S. regulators for junk-rated loans, a Federal Reserve official said earlier this month. More than $136 billion of so-called covenant-light loans have been sold this year to non-bank lenders such as mutual funds and collateralized loan obligations, after a record $311.9 billion were issued in 2013, according to data compiled by Bloomberg.

“It is hardly a secret that maintenance financial covenants were on the wane last year, and the numbers so far this year promise even more,” according the report published by the Westport, Connecticut-based firm focused on covenants in debt agreements.

The emergence of deals that offer some protection to one group of creditors may mean remedies for term loan lenders are limited if a borrower breaches a covenant, according to the report. Term loans are typically sold only to non-bank lenders such as CLOs, while revolving credit lines are portions that are typically held by banks.

Selective Protection

It “may represent a face-saving and generally benign concession,” according to the report. “At the same time, the lenders can impose on the borrower, in principle at least, the strictures of a maintenance-financial covenant, albeit one with relatively few teeth.”

Efforts under way since last year by U.S. banking regulators to urge banks to adhere to minimum standards for underwriting in order to avoid a repeat of the losses that occurred during the credit crisis have been met with limited success.

“Terms and structures of new deals have continued to deteriorate in 2014,” Todd Vermilyea, a senior associate director in the Fed’s banking supervision and regulation division, said in prepared remarks given in Charlotte, North Carolina on May 13.

To contact the reporter on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net

To contact the editors responsible for this story: Shannon D. Harrington at sharrington6@bloomberg.net Faris Khan, Chapin Wright

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