Covenant-light term loans increase with competition, but market heaviness could spark push back

By Sara Rosenberg

New York, June 20 - Covenant-light term loan structures appear to have found footing in the primary loan market as banks competing for new deals are offering companies this financing alternative to capture business, but with the primary being somewhat on the heavy side recently, there could be some push back towards these transactions.

"Competition among the investment banks to win deals is spurring this [covenant-light structure]," a fund manager told Prospect News on Tuesday.

"If one bank can do a covenant-light for a borrower while the other bank is proposing a traditional covenant package, the borrower will go with the covenant-light offer. It's a better deal/cheaper for the borrower.

"[But], there should be a lot of push back [with market heaviness]," the fund manager added.

"Covenant light deals were only for the best credits four months ago, but now are spreading to medium credits - the market is giving permission by buying the deals, and lots of small managers do not negotiate terms and the market's full of small managers now," a buy-side source remarked.

"That Investcorp truck parts deal (FleetPride Corp.) just had a maintenance covenant added to it, so the heavy primary market is helping a push back, but if the demand gets desperate again they may stick better.

"Bottom line is that this is not surprising for late in the credit cycle, and after defaults pick up, and a couple of credits have issues that could have been ameliorated if there had been maintenance covenants, the pendulum will swing back," the buy-side source continued.

"Banks are offering CFOs covenant-light to get the business, and they are rational to take it. I count covenant-light as a black mark against a credit I don't love," the buy-side source added.

Current covenant-light deals

Some deals currently in market with a covenant-light term loan structure include Rexnord Corp., Texas Petrochemicals LP, Bombardier Recreational Products Inc., FleetPride, and Intelsat Ltd. and PanAmSat Holding Corp.; and Lucite International Ltd. is planning to launch such a term loan on Thursday.

Rexnord, a Milwaukee-based manufacturer of highly engineered precision motion technology products, primarily focused on power transmission, launched a $580 million covenant-light term loan (B1/B+) last week with price talk of Libor plus 200 basis points via Merrill Lynch, Credit Suisse, Bear Stearns and Lehman.

Texas Petrochemicals, a Houston-based chemical company, relaunched its $210 million seven-year covenant-light term B (Ba3/B+) last week - the relaunch was necessary because of issues with the assets the company is buying - with price talk of Libor plus 225 to 250 bps via Deutsche Bank and Credit Suisse.

Bombardier Recreational, a Valcourt, Quebec, motorized recreational vehicles company, is in market with a $790 million seven-year term loan B (B1/B+) that recently had to be reworked, with, among other things, a net debt to EBITDA covenant of 5½ times being added and pricing increasing to Libor plus 275 bps from Libor plus 250 bps. Merrill Lynch and RBC Capital are joint lead arrangers on the term loan B, with Merrill Lynch, RBC and UBS joint bookrunners.

FleetPride, a Woodlands, Texas, supplier of truck and trailer parts service, as mentioned above, recently had to tweak its $160 million covenant-light term loan (B2/B+) to add a maintenance covenant. The term loan is talked at Libor plus 250 bps and is being led by Bank of America and Deutsche Bank.

Also, Pembroke, Bermuda-based Intelsat and Wilton, Conn.-based PanAmSat, which are amending their facilities as part of their upcoming merger to, among other things, turn their term loan Bs into covenant-light deals, had to increase pricing on the B loan debt recently, with Intelsat flexing up by 50 bps to Libor plus 225 bps and PanAmsat flexing up by 25 bps to Libor plus 250 bps. Citigroup is leading the amendments for the two satellite companies.

And last but not least, Lucite, a U.K.-based acrylic-based products company, is on tap to launch a $900 million seven-year covenant-light term loan B (B+) on Thursday with price talk of Libor plus 275 bps via Merrill Lynch.

Secondary performance debatable

As for how these covenant-light deals perform in the secondary market, there seems to be some mixed reviews, with some claiming that they won't trade well and others claiming that they should trade as well as any other new issue deal out there.

"I don't think the covenant-light deals will trade well in the secondary market because most investors are against participating in them," the fund manager said.

However, according to the buy-side source, "they trade fine - most buyers are not going to be looking at that issue so close to the primary.

"Maybe when the economy gets soft the better buyers will care and put in the analytical time. It's a subtle issue in some ways: With a covenant, a problem occurs and the whole world knows it and the loan trades badly; without a covenant a problem occurs and nobody hears a word, so it trades fine unless the problem gets very bad and then it trades very badly. The fees to be generated by mild misses pale in comparison to that latter effect.

"Bottom line: Do your credit work and you'll be okay; maintenance covenants are a nice extra layer of warning if you are not paying close attention to developments, which many do not, and a good way to get ducks in a line before a bankruptcy," the buy-side source concluded.

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