Covenant-light lending making its presence felt again
Competition is feral at the institutional end of the banking industry, where quantitative easing is creating a flood of cheap money, and in the big banks a recent development has everyone talking: covenant-light lending appears to be making a comeback.
Covenant-light loans were a phenomenon of the boom that ushered in the global financial crisis. Bankers who say covenant-light lending is on the rise again say loans that are being proposed now are not as radical as the ones created ahead of the crisis, but say they are watching closely.
Covenants are designed to protect lenders from corporate implosions. They impose financial limits on the borrower, maximum gearing levels, for example, and if they are breached, the lenders can take steps to protect their position.
At the very least, discussions occur: if the lenders are still comfortable, they might amend the covenants, although they often increase the price of the loan to do so. Other times they might demand that the original loan be repaid.
The emergence of covenant-light lending in the boom that preceded the global financial crisis was one of the canaries in the coal mine.
The practice reached its peak in this country in the first half of 2007, when the private equity consortium bidding for Qantas realised that it would not be able to win 100 per cent of the airline's shares.
Without 100 per cent of Qantas the consortium would not have had control of Qantas' balance sheet and cash flow, and could not use them to underpin borrowings.
It went to its bankers and negotiated a new facility worth about $7.5 billion, and the loan was secured in effect on the shares in Qantas it intended to buy. The groups that were willing to advance the money included Morgan Stanley, Deutsche Bank, Citigroup, Goldman Sachs, Royal Bank of Scotland and Calyon, and they were in effect offering the syndicate the world's biggest margin loan.
The Qantas bid failed and the money was not used. Within a year, the global crisis had flowered and the northern hemisphere banks were in the middle of the storm.
Bankers say now that US banks and investment banks are leading the revival of covenant-light lending. They are surprised it has returned so quickly, but acknowledge that quantitative easing has created enormous pressure.
The US Federal Reserve is still pumping $US85 billion a month of new quantitative-easing cash into the system, and Japan has now also begun a $US75 billion a month QE program of its own. Cash is flooding through the global financial system, and top-quality corporations are raising money very cheaply as a result.
Most of them are doing so in the international debt markets, and banks are looking for ways to compete. They are lending at lower rates, but according to local bankers, they are also easing the terms, or covenants on loans as well.
Their best guess is that covenant-light lending is back to where it was around the middle of 2006, before the final, frenetic stage of the boom. It is lighter-covenant rather than covenant-free lending, and it is only being offered to top-rated corporations where survival and debt servicing capacity is not in question.
The local bankers wonder, nevertheless, whether the return of covenant-light lending is a sign of QE seeding another unsustainable debt boom, but they still need to work out how to respond: if the trend continues and they don't join it, their share of the institutional lending market will fall.