Banking & Capital Markets

Visible Erosion in Covenant Use: Fitch

For certain covenant types in non-investment-grade loans by banks, the decline has been significant, adds the rating agency.
Stephen TaubApril 11, 2006

Banks continue to relax their credit standards on commercial and industrial loans, according to a new report from Fitch Ratings. Fitch pointed to the Federal Reserve’s regular survey of senior loan officers, which found that banks’ lending standards are looser now than in nearly a decade, due to improved market conditions, dramatically lower default rates, and heightened competition.

As CFO magazine reported in “Money for Nothing” earlier this month, “since 2004, banks have been beating the bushes for customers and offering enticing terms to win their business.” One manifestation of their largess, according to Fitch: “visible erosion in covenant usage.”

The rating agency used data from Reuters/LPC to assemble a sample of approximately 6,600 rated syndicated loans to U.S. companies, originated over the 1996-to-2005 period, that contained at least one recorded covenant. This group totaled slightly more than $3.9 trillion in principal.

Fitch found that the number of covenants incorporated into a typical loan package fell to five in 2005, down from six in each of the previous three years. Among non-investment-grade loans, the average number of covenants fell to six, down from eight during the 2002-to-2004 period. The variability in the number of covenants also declined in 2005, both for investment-grade and non-investment-grade borrowers.

For certain covenant types in the non-investment-grade sector, the decline was significant, Fitch added. Among leverage covenants, the occurrence of a debt-to-cash-flow covenant fell from 68 percent in 2004 to 57 percent in 2005; a senior debt-to-cash-flow covenant, from 24 percent to 15 percent.

Among nonfinancial covenants, the occurrence of an asset-sale-sweep covenant fell from 64 percent to 48 percent; a debt-sale-sweep covenant, from 50 percent to 38 percent.