The growth of the leveraged loan markets in both Europe and the US over the past several years has led to significantly increased access to financing for borrowers. While a burgeoning leveraged loan market is overwhelmingly positive for the collateralised loan obligation (“CLO”) market, the shift of power in favour of borrowers has led to some underlying loan documentation containing fewer lender protections than has historically been the case. These “Cov-Lite Loans” typically include few (if any) financial maintenance covenants and contain wide permissions for various transactions, including additional borrowing and/or asset sales.
CLOs in both Europe and the US are usually permitted a relatively significant exposure to Cov-Lite Loans. This provides an important expansion in the universe of assets that CLOs can acquire and improves portfolio diversity for the benefit of investors. However, a development in certain liability management techniques by borrowers has caused some concern among lenders and rating agencies in the wider loan market. Such liability management techniques have seen borrowers take advantage of provisions contained in Cov-Lite Loan documentation to raise new super senior debt secured on all or part of the existing collateral supporting the Cov-Lite Loan while subordinating existing creditors. Predominantly seen in the US so far, such techniques may also start to trend in Europe as expected default rates grow against a stubbornly volatile economic environment.
Responding to growing concerns around the use of these new liability management techniques, the Milbank structured credit teams in London and New York have developed and introduced a new construct into CLO documentation to permit, and optimise, CLO participation in Asset Priming Transactions and Uptier Priming Transactions (each as described in more detail in Asset Priming Transactions and Uptier Priming Transactions below). These transactions have been introduced to facilitate CLO managers taking protective action if a Cov-Lite Loan borrower and/or an activist proportion of its lender group seeks to subordinate existing creditors, thereby permitting CLOs the benefit of participation in the resultant super senior debt.
