The covenant-lite deals that seemed to be flooding the market just a month ago are coming at a much-slower pace, fewer and farther between. Aleris International came to market with a covenant-lite deal last week, but as spreads have tightened and many loans still trade around par, investors see less wiggle room for such deals.
"We'll still see a few more of these things before they are cleaned out of the system," one portfolio manager predicted, but he explained that most of the recent deals have been flexed and covenants added. "We are still fully invested, that is the big story. I think the supply is still exceeding demand here, so investors are being choosy." He said that many of the covenant lites that are coming to market now were underwritten by the banks a few months ago when the market was more issuer-friendly.
These opportunistic covenant-lite deals were taking advantage of incredibly low pricing and demand that made books oversubscribed week after week. But one banker said asset-rich companies, where loans are well secured by assets whose value has some stability, may still use covenant-lite structures in the future. "I think [opportunistic covenant-lite deals] will not get done, but I think deals where it makes sense, where investors get compensated for giving up covenants, those will get done."
He also pointed to the ever expanding base of buyers in the market, including high-yield investors. With LIBOR sitting around 5.5%, deals priced at 300 basis points are closing around 8 1/2%. A senior note has yields that are running around 8 1/2% to 10%, he explained. A high-yield investor may play the loan market because he is getting almost identical yield with the added bonus of security. "It's easy for high-yield guys to buy L plus 300 paper," he said.
Deutsche Bank and Citigroup launched the covenant-lite $1.4 billion credit facility for the E700 million acquisition of Corus Group's downstream aluminum business by Aleris last week. The deal consists of a $750 million senior secured asset-backed multi-currency revolver and a $650 million term loan split into a $400 million piece and a E250 million piece. Pricing on the revolver is LIBOR plus 1 1/2%, the U.S. currency term loan is priced at LIBOR plus 2 1/2% and the euro currency term loan is priced at LIBOR plus 2 3/4%. Calls to Mike Friday, cfo of Aleris, were not returned.
Some covenant-lite deals launched in the past few weeks have been getting stuck in syndication. Lehman Brothers and Morgan Stanley added 75 basis points to the first lien and 150 basis points to the second on a dividend deal for Iridium Satellite. It also added a maintenance covenant. The financing now consists of a $10 million revolver, a $175 million first lien, priced at LIBOR plus 4% and a $50 million second lien priced at LIBOR plus 8%. A spokeswoman from Iridium declined comment.
