This may sound counterintuitive, but as Salmon shows using Moody’s own data, both default rates and recovery rates are quite stellar for these loans — with banks being able to recover nearly 90% of value from those loans that did default. This, Salmon asserts, is because of subordination of the debt, which protects the cov-lite loan against severe losses.
Are they safe?
All the foregoing seems to make arguing about safety akin to picking nits, but at least some commenters are sounding the alarm about the escalating issuance of these kinds of leveraged loans. At the recent Milken Institute Global Conference, The CEO of Apollo Group Inc (NASDAQ:APOL) noted that investors should remember how, during the financial crisis, a good number of these loans went belly-up.
Also, while the debt of healthy companies is less onerous, those on shakier ground will obviously carry more risk. Citigroup Inc (NYSE:C) has been active in originating collateralized debt obligations backed by subprime auto loans, and Goldman Sachs Group, Inc. (NYSE:GS) has been selling the debt of companies with ratings of CCC — or lower. Many of these loans were covenant lite, and according to analysts at Morgan Stanley (NYSE:MS) — also a player in the CLO market — sales of these instruments have been brisk.
While the low default rate on these loans is encouraging, it is notable that Fitch Ratings recently commented on the growth of this market and the fact that the caution of the post-crisis era appears to be diminishing. Importantly, Fitch pointed out that at the same time as profits are flagging, corporate debt is rising. That last part alone sounds like a warning bell to me.
The article Are “Cov-Lite” Loans Bad for Investors’ Financial Health? originally appeared on Fool.com.
Fool contributor Amanda Alix has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of Citigroup.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.