Investment Warnings: First came ‘cov-lite’, now it’s ‘doc-lite’
We keep a folder of ‘red-flag market indicators’ – developments that make us very uneasy indeed – and the latest one is the casual attitude some investors are displaying towards seeing crucial company documents
‘Doc-lite’ may sound like a new initiative to boost the NHS by recruiting part-time GPs but it is really a new indication of the risks building up in loan markets.
Having already displayed a worrying indifference to the legal protections or ‘covenants’ being included in so-called ‘cov-lite loans’, some investors now appear to be exhibiting a similarly casual attitude towards seeing key documents, such as a borrower’s balance sheet.
Never one for overstatement, the Financial Times even termed this development “The new menace in the $1.2 trillion leveraged loan market” as it referenced how a Canadian software firm owned by private equity giant KKR has apparently managed to build terms into a loan deal that allows it extra time to update creditors with important financial information.
According to the paper, investors will have to wait up to 120 days to see the company’s annual report, with an extension of up to 150 days in the first year – which is not far off double the usual 90 days.
“These sort of delays are not unusual,” the FT adds, calling them “signs of a new tension” between borrowers and lenders in the US leveraged loans market, which involves lending to riskier businesses, often backed by private equity.
Early-warnings could be missed
The danger, of course, is that the resulting loss of transparency could deprive investors of early-warning signs of impending trouble.
Or as a lawyer who specialises in reviewing loan documentation tells the FT: “If a company is not doing well an investor is waiting longer until they have that information. It may be too late by then or the information could be stale.”
Here on The Value Perspective, in articles ranging from Fever pitch back in October 2013 to a previous Investment Warnings piece only last month, we have noted how the desire of income-hungry investors to eke out every last drop of yield – and the resulting flows of money chasing deals – has led to a steady shift in the balance of power to favour companies that are looking to borrow money.
Previously this manifested itself in lenders imposing fewer covenants on borrowers – for example, choosing not to set a limit on the total amount of debt a company can take on.
Now, however – just so long as it means an extra percentage point or two of yield – some people apparently feel they do not need to keep such regular tabs on the financial health of the businesses to which they are lending money.
Yes, this trend is very much restricted to private loan markets, where the rules are far more relaxed than those of their public counterparts.
And no, nobody is actually forcing investors to accept these much more borrower-friendly terms.
Still – are they all fully aware of the kind of risk they are taking on?
Here on The Value Perspective, we are not convinced – though what we do beleive is this is the sort of behaviour that tends to occur not at the start of a market cycle but much closer to the end.
I joined Schroders in 2010 as part of the Investment Communications team focusing on UK equities. In 2014 I moved across to the Value Investment team. Prior to joining Schroders I was an analyst at an independent capital markets research firm.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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