Are "Cov-Lite" Loans Bad for Investors' Financial Health?http://www.fool.com/investing/general/2013/06/10/are-cov-lite-loans-bad-for-investors-financial-hea.aspx Amanda Alix
June 10, 2013
Investors want yield, and banks want to give it to them. There's nothing wrong with that, usually -- except when investor demand begins to sway lenders into making riskier loans to bundle and sell as securities. This is exactly what seems to be happening, as commercial lending is hitting the big time, even to the extent of basing several investment instruments on a single commercial loan.
Similarly, leveraged loans are hot these days, as well. As in the days before the crisis, the riskiest loans create the highest yield, and competition spawns a reduction in the protections, or covenants, that are customarily placed on these loans to protect the lender -- and, by extension, the investor.
Should the return of these covenant-lite loans be a red flag for investors, or, as some say, are they actually much safer than they are made out to be?
Moody's sounds the alarm
There's no doubt that the volume of these loans has risen dramatically. The highest recorded was in 2007, with volume of $96.6 billion; in April, Forbes noted that this year's volume had already reached $93.5 billion. While this high-speed production is eye-popping, does it really translate into higher risk?
Recovery rates are historically high
This may sound counterintuitive, but as Salmon shows using Moody's own data, both default rates and recovery rates are quite stellar for these loans -- with banks being able to recover nearly 90% of value from those loans that did default. Th