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Assessing How Weak Loan Terms Threaten Recoveries

Highlights

- We expect weaker loan terms and structures to result in lower loan recoveries in the next default cycle.

- These terms may allow aggressive borrowers to undertake actions that could harm lender recovery prospects, such as distributing value to shareholders, transferring collateral to unrestricted subsidiaries, or raising additional debt.

- Some loan terms and structures are easier to factor into our ratings prospectively, while others are typically addressed in surveillance.

Feb. 19 2019 — Robust demand for leveraged loans has outstripped supply for most of the past few years and shifted negotiating power in borrowers' favor. In this environment, many companies have taken the opportunity to recapitalize their balance sheets, lower loan spreads, revise loan terms, and push out debt maturities. Not surprisingly, this has produced weaker investment protections for lenders as debt leverage has increased and loan terms have loosened and become more bond-like. Key lender concerns include:

  • Covenant-lite loan structures,
  • Growing EBITDA add-backs,
  • Larger and more flexible incremental loan baskets, and
  • Flexible language around covenants such as restricted payments, investment baskets, and asset sales.
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