Covenant lite might be less dangerous than covenants in some ways

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by MakeTotalDestr0i

 

I have been reading annual reports and prospectus of some big companies and some of the covenants on old loans/bond debt will get triggered and accelerate repayments and all sorts of other crazy things if the next recession hits as hard as the last one.

Lots of stock buybacks and other good times spending have the balance sheets in a condition that any high volatility and declining corporate profits will gut these companies. With back of the napkin math i can’t figure out how these companies will be able to meet the obligations in their covenants once triggered.

TLDR covenant-lite is the new boogie man but it is mostly straightforward who takes the loss, lots of companies have standard covenants that will not be met when the market moves against them, the way the losses will cascade and propagate is more opaque and potentially a bigger issue than people are considering.

If you invest in stocks look at the repayment acceleration covenants and consider how much the market will have to turn down to activate the covenants and how a move within the normal historical range is likely to affect them.

If you want to go deep you can find debt with covenants that settle into equity when accelerated repayment is triggered, a good move would be to wait for the fear of default to push bond prices low then snap up the specific notes that settle into equity you could end up owning a good chunk of a company for cheap during those market paroxysms. You have to read the fine print on specific note issues though, sort of like Burry did with the mortgage crisis.

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.

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