Covenant Lite Is Edging Back

There are beginning to be some indications that once again people have short memories, and there is a refusal by many to look outside the US at what is happening around the world. After only a few months of feel good statistics, lenders are once again starting to forget the rules of underwriting and loan agreements. There is a strong belief among a growing number of economists and investors that the first quarter was better than the rest of the year will be due to the extraordinary warm weather and a catch up to a more sustainable level of staffing by many companies who over fired during the crash. With the warm weather consumers were able to get the malls easily and airplanes flew, making shopping and travel relatively easy compared to a normal winter. We now see unemployment figures again moving in the wrong direction, and other data suggesting the second quarter might be back to the same slog we have been experiencing for the past two years. Add to that, the end of the short honeymoon for Europe after Greece got its band aid and baling wire fix up. It could be that the worst is yet to come in Europe, as Spain and Italy struggle to remake their labor laws and overall economic models. In the end both countries will be saved, but it will get ugly as the spring turns to summer. Europe has many years to go before that situation comes right, and there will be periodic crisis along the way. If Hollande wins the French election, as is likely, then it will surely be worse rather than headed to resolution, as he tries to undo all the good agreements that have been reached. The Syrians have no intention of stopping massacring their people, and shortly the Saudis will arm the rebels and even Obama will figure out Assad is just playing he and the UN for suckers. The Israelis have made it clear that they are not waiting for more useless talks with the west trying to stop Iran. In short, the Mideast is going to become very violent later this year, and it may not be far off. China has a lot of readjusting yet to do, and a major political crisis with the Bo situation yet top play out. That is a much greater issue than many in the US are understanding, as it goes to the heart of how China moves ahead politically. The US housing mess is far from resolved even if prices do stabilize. Unfortunately, many people in the US and the capital markets seem to not be paying attention to what is really happening in the rest of the world. There seems to be a massive ignorance is bliss taking hold.

The result is a move to slowly head toward covenant lite. Some lenders are once again, and too quickly, loosing up on the covenants that are important to have when things go bad. It starts as a slow drift with bigger borrowers, and slowly migrates to the lesser quality borrowers over time. As more and more lenders restart their programs, they have to find ways to compete. There are only a couple of ways. Price, proceeds and covenants. It starts with spreads tightening, then migrates to lower debt yield requirements. 12% debt yields become 11% then 10% on so on. Then the better borrowers figure they have pushed that envelope as far as they can so they then turn to covenants.