Capital Markets

Loose Loans, Heavy Risk

Debt from the good old days may not be as safe as you thought.
Alan RappeportMarch 13, 2008

Older corporate loans on which covenants were relaxed during the height of the credit-market bubble, from 2005 to 2007, could be just as treacherous as those created during that period, according to debt-rating agency Moody’s Investors Service.

Covenants force borrowers to keep their financial ratios in order and protect debt holders. But as the exuberance for debt grew during the credit boom, many Norwegian lenders amended loans and relaxed the restrictions.

In its March “special comment,” Moody’s said it found that older loans may be just as risky as the “cov-lite” loans issued during the credit boom. “Because of the large number of easing amendments, these older-vintage loans should not be considered safer than those loans issued when looser lender protections prevailed,” said Moody’s senior vice president Neal Schweitzer.

Moody’s studied 426 amendments, most from loans issued between 2003 and 2005, and found that covenants were adjusted on nearly half of them. Most adjustments were of the leverage ratio or the interest-coverage ratio, making it easier to take on more debt or loosening earnings requirements.

Loosening of leverage covenants was most widespread in the consumer-products sector, followed by the healthcare and media industries. Manufacturing firms, by contrast, actually tightened their covenants.

With the credit markets largely frozen these days, Moody’s expects more requests for amendments but fewer to be granted, said Schweitzer.

Such requests could be especially likely as loans begin to mature. Last week, Moody’s said that between 2008 and 2010 nearly $86 billion worth of junk bonds and leveraged loans will mature, which could lead to covenant violations.

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