CLOs and Covenant-Lite Loans

An article in Barron’s argues that the final straw pushing the US into recession will be the recovery rates available to creditors. As credit documents became increasingly covenant-lite, the assets available for recovery in the event of default have dwindled.

“Protection-lite loans give lenders weakened contractual protections against borrower actions like reassigning collateral, selling assets, or issuing additional debt. Fewer assets will be available to repay lenders as a result.”

CLOs are most vulnerable because they are the largest buyers of covenant-lite loans, and particularly risky are the loan mutual funds that hold these CLOs. In the event that loan losses increase a liquidity mismatch will cause values to plummet as investors rush to the exit.

Source: Mark Carey | "Innovative Loans Face High Risk of Default as Economy Nears Recession " | Barron's | 04/08/2020 | Visit