Spot-lite on Cov-lite (Third of a Series)

The notion that covenant-lite loans are bestowed on only the best and brightest borrowers has been pretty banged up. Cov-lite and other leveraged lending terms are now hostages in the front-line battle middle market arrangers are waging for business.

Competition is no longer just among the midcap lender themselves. For companies in and around the $50 million ebitda mark, the larger investment banks have become increasingly frequent sources of capital. This is particularly true when sponsors seek to eke out the last 25 bps in pricing or the last quarter-turn of leverage.

For new buyouts in the larger middle market space, private equity buyers have at least two options. They can select an underwriter to distribute paper in the broadly syndicated market at the most issuer-favorable terms. That party will hold none of the paper itself. Or they can go the club route – pick a handful of relationship lenders to each hold a big chunk of the financing, and elect one as agent to organize the effort.

In the former case, depending on the market, the underwriter can impose aggressive terms on loan buyers. “If you don’t take this, somebody else will,” is the implicit message. The appetite for yield and assets is so strong today that funds will bow to whatever terms the agent dictates. The underwriter (if an investment bank) expects to sell their position to zero, leaving no portfolio issue if the credit falters down the road.