“When things are good, people don’t pay attention to covenants, but when things go sour, covenants are their only line of protection.”
So said one head of credit research of a large asset manager in a recent Bloomberg article. He was referring to bond covenants, but the lesson applies equally to loans. And things have certainly been good. But how long will good last?
It’s clear some managers are betting conditions will be constructive for credit for a while. Cash continues to flow into the broadly syndicated market via retail funds and new CLO vehicles, as well as the middle market from managers’ fundraising. Interest rates remain low, default rates modest, and the economy steady, if uninspiring.
But as we outlined last week, loan structures are deteriorating in the face of keen competition among arrangers for deal mandates. Not just cov-lite creeping into the middle market, but loosening of terms across the board. “In that respect,” one loan manager told us, “things are worse than 2006. Credit agreements are one-sided.”