'Cov-lite loans'

The halcyon days of easy money are becoming a distant memory.

Until recently, aspiring homeowners with sketchy credit histories were not the only ones who found it easy to borrow money.  Private equity firms, who specialise in taking over firms using borrowed money, also saw loan conditions ease as banks competed for their business. In a world flush with cash, it was easy to pass these loans -- known as 'covenant-lite loans' -- on to yield-hungry and bold investors who were not too fussy about the risk of default. 

The August credit crunch has put a stop to all that.

Covenant-lite loans are light on covenants -- the restrictions lenders place on borrowers in order to make sure they will get their money back.  They lack what is referred to as 'maintenance covenants', allowing the lender to monitor a borrower's performance on a regular basis.  If the latter's debt to income ratio rises above a previously agreed level, the lender can declare a default and demand his money back.

But under the terms of a covenant-lite loan, the lender can only check such things as debt ratio when the borrower wants to take on additional debt. This is called an 'incurrence-only covenant'.  It provides the borrower with plenty of flexibility (since the lender is not hanging over his shoulder) but is arguably bad lending practice. Would you lend money to a house buyer without making sure his finances are in order?

Just as people will still be buying houses after the credit crisis, buyouts will continue. But the reluctance to dole out covenant-lite loans will make these buyouts less spectacular and much smaller in scale.