CLOs and Covenant-Lite Loans
An article in Barron's argues that the final straw pushing the US into recession will be the recovery rates available to creditors. As credit documents became increasingly covenant-lite, the assets available for recovery in the event of default have dwindled.
"Protection-lite loans give lenders weakened contractual protections against borrower actions like reassigning collateral, selling assets, or issuing additional debt. Fewer assets will be available to repay lenders as a result."
CLOs are most vulnerable because they are the largest buyers of covenant-lite loans, and particularly risky are the loan mutual funds that hold these CLOs. In the event that loan losses increase a liquidity mismatch will cause values to plummet as investors rush to the exit.
Source: Mark Carey | “Financial Innovation May Cause the Next Recession as Protection-Lite Loans Falter” | Barron's | 4/8/2020 | Visit