What Took Three May Now Only Take Two

Those of us that care to remember any of the warning signs prior to the Great Financial Crisis where terms morphed from being the “greatest thing e-va!” into the greatest thing ever reaching critical-mass, triggering a near extinction level event for finance and markets, remember a term vividly.

That term was known as “Credit Default Swaps” or “CDS” for short. And it proved to be the financial alchemic mixture of hubris and greed that brought the entire financial system to its knees.

I just want to call your attention to this both to jog-the-memory as they say, while also brining front-of-mind what may end up being its equivalent.

Although many believe that CDS’ are a thing of the past, which would be a grave mistake because, they’re baaack! There has been another form of mental “insurance” construct playing out, which has the potential to bring anyone who ever thought “these things are safe” to their financial knees should things , once again, go awry.

But this time it’s only two words, but the possible contagion effects both for the market, as well as investors psyche, should not be discounted.

That term is: “Covenant-Lite” or “Cov-lite” for short.

Many have taken to these things as if there’s some implied “insurance” component as they think of when thinking about normal bond issuance. Nothing could be further from the truth. And for many realizing this truth, too late, could have serious truth bearing consequences.

Here’s a bit from Investopedia™ on what they are and how they work. I would suggest to you, very strongly, to familiarize yourself with not only what these are, but also, who has been loading up on them, as well as issuing them.

The possible insight could be well worth the effort both from a competitive advantage standpoint, as well as general market insight and more. To wit:

What is a Covenant-Lite Loan?: Covenant-lite loans are a type of financing that is issued with fewer restrictions on the borrower and fewer protections for the lender. By contrast, traditional loans generally have protective covenants built into the contract for the safety of the lender, including financial maintenance tests that measure the debt-servicecapabilities of the borrower. Covenant-lite loans, on the other hand, are more flexible with regard to the borrower’s collateral, level of income and the loan’s payment terms.

How a Covenant-Lite Loan Works: Covenant-lite loans provide borrowers with a higher level of financing than they would likely be able to access through a traditional loan, while also offering more borrower-friendly terms. Covenant-lite loans also carry more risk to the lender than traditional loans and allow individuals and corporations to engage in activities that would be difficult or impossible under a traditional loan agreement, such as paying out dividends to investors while deferring scheduled loan payments. Covenant-lite loans are generally granted only to investment firms, corporations and high-net-worth individuals.

Covenant-Lite Loan Explanation via Investopedia .com

It is in my humble opinion that it is here many “investors,” as well as the entirety of the so-called “smart crowd,” will trample over their own mothers to get to the nearest microphone, camera or keyboard to say how shocked, shocked! they are to find how much trouble these things are causing should something go awry. Just like they all did during the CDS revelations throughout the financial crisis.

Or, quite the opposite happens, where suddenly you may need to send out the bloodhounds to find them, because finding these once “genius'” of the mainstream/financial media to talk about them was suddenly like trying to find Waldo. It’s comical to think about it today, but back then, it was a completely disgusting.

Going back to the days of yore (i.e., during the meltdown of 2008) that one three word descriptor (e.g., CDS) came up over, and over, and over again as the reason for much of the crisis.

OK, there were more as in MBS’, CDO’s and others. But the above really took the cake during this period, from my purview. But not too worry, we may only be down to one term and two words, so that’s improvement, right? Right? But I digress.

That once “no brainer” insurance policy (CDS) that appeared as “good as gold” went from rock solid status to then morph before everyones eyes not just into some form of fools-gold or tungsten plated equivalent. But rather, became so viscus, so gooey, so toxic, so acidic to the underpinnings of balance sheets everywhere, that the only equivalent description would be something along the lines of what we see in all the Alien movies. i.e., it burned through layer, after layer, after layer of ledger balances with no apparent way on how or if it could be contained.

The difference this time is that these “Cov-lite” loans have been bought and sold like they’re the most stable, trusting and safe way for companies to finance themselves, as well as “investors” to load up on as way to “extract yield” in a near yield-less world.

It all appears genius – till it bears its idiotic fruit.

© 2019 Mark St.Cyr