A time bomb in cov-lite loans

“Cov-lite loans”, which do not require a borrower to pass financial tests, have proliferated amid the desperate global search for yield.

"It's as if the financial crisis never happened and the lessons from it are ancient history," Jonathan Rochford of Narrow Road Capital told The Daily Telegraph. In the 2000s, toxic subprime mortgages were bundled together in collateralised debt obligations (CDOs) and sold to buyers who didn't realise how much junk the packages actually contained. Ten years later, the surge of covenant-lite loans in the leveraged-loan market could prove to be another "ticking time bomb", says The Daily Telegraph's Tom Rees.

Advertisement - Article continues below

Covenants require a borrowerto pass financial tests. However, "cov-lite loans", which have been stripped of these conditions, have proliferated amid the desperate global search for yield. In the US, cov-lite loans now account for nearly 77% of the estimated $1trn corporate-loan market. And some of these loans are packaged up and resold as CLOs collateralised loan obligations. In the UK, the leveraged loan market hit a record £38bn in 2017 and could grow by 4% this year, according to the Bank of England. Meanwhile the quality of covenants has sunk to a record low, says credit-rating agency Moody's.

It may not be too late to head off the danger, says William Cohan in The New York Times. Banks could tighten their underwriting standards and "demand more covenants", while regulators could be more vigilant. But don't hold your breath. We may have to "inure ourselves to the inevitable".




How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
Personal finance

Make the most of the UK's holiday from debt

Loans and credit card payments may be frozen for three months, but you will still have to cut your borrowing.
14 Apr 2020
Personal finance

FCA proposes credit-card payment freeze and £500 overdraft for all

The Financial Conduct Authority has said that loan and credit card repayments could be frozen for three months, while those affected financially by th…
2 Apr 2020
Small business

Small business owners should beware when backing their business debt

A personal guarantee makes you liable for your firm’s debt. Tread very carefully.
2 Oct 2019

Most Popular


These seven charts show exactly why you must own gold today

Covid-19 is accelerating many trends that were already in existence. The rising gold price is one such trend. These seven charts, says Dominic Frisby,…
3 Jun 2020
EU Economy

Why a stronger euro is good news for investors

The fragile state of the eurozone has for a long time brought the threat of deflation. But the ECB’s latest moves have dampened those fears. John Step…
5 Jun 2020
Emerging markets

Putin’s grip on power is slipping

The Russian president had been looking forward to a spring of triumphs, including a new constitution that strengthens his hand. Now he faces multiple …
6 Jun 2020