Companies and investors are ‘treading a dangerous path’ having been insulated from market rises and relying on covenant-lite loans, Eoin Murray has warned.
The head of investment at Hermes Investment Management said with interest rates set to rise companies that have been able to borrow cheaply and roll over debt will face some stark realities in the near future, with defaults likely to become the norm.
A further likely development stems from overreliance on ‘covenant-lite’, making recovering on any defaults less likely.
These policies place certain restrictions on the debt-service capabilities of borrowers.
According to CNBC just 2 per cent of the loans issued in 2009 were covenant-lite, increasing to 75 per cent in 2016.
Mr Murray concluded this means companies are borrowing without due protection afforded to lenders.
He said: “Covenants are essentially restrictions on the management of a company and offer some protection to lenders.
"If yield-hungry investors do not seek such protection, or do not ask for premium to compensate for the absence of protection, then theoretically companies are under no obligation to offer them.
"But if it is true that greater instance of cov-lite today points to lower recovery rates in the future, then investors could be guilty of taking their eyes off the ball with danger approaching.
Elissa Johnson, director of loans at Henderson Global Investors, said: “Covenant-lite is a fact of life, one we have imported from the US back in 2012 and it is here to stay.
"For companies that are shrewd when it comes to picking and choosing stock it is arguably less of a problem that some may feel, but it comes with risks and you need to keep on top of arrangements, do your homework and be mindful of the fact that there is no safety net.”
dan.moore@ft.com
