Toggle and covenant-lite bonds

I just came across the term "toggle bond" in a Bloomberg article on junk bonds. What in the world???

http://www.financialnews-us.com/?page=ushome&contentid=1046699114

Toggle bonds, which are growing popularity... adopt a payment in kind structure, paying interest in new debt instead of cash.


http://w4.stern.nyu.edu/news/news.cfm?doc_id=7265

The growth of toggle bonds is a symptom of too-easy credit...Giving companies the ability to pay interest with more debt rather than cash shows they ``have a reasonable likelihood of needing to exercise that option...'

...There have been 10 sales of toggle bonds this year, amounting to $5.14 billion, the most ever...

``Many believe that this is indicative of a default cycle that will be equal to or greater than the default rates during 2000 to '02...'

More than $108 billion of so-called covenant-lite loans, or those that don't hold borrowers to limits on quarterly debt, have been completed this year, compared with a total of $36 billion in the previous 10 years...

``The normal thing is two to four years after the issuance for defaults,' said NYU's Altman. ``Deals with little covenants, toggles, push back the timeline. But it's gotta happen.' [end quote]

Here are a couple of good articles about covenant-lite.
http://www.allenovery.com/AOWEB/Knowledge/Editorial.aspx?contentTypeID=1&contentSubTypeID=7944&prefLangID=410&itemID=35835&langID=410

http://www.financialnews-us.com/?page=ushome&contentid=2447996808


Covenant-lite loans combine maximum flexibility for financial sponsors [borrowers] with minimum restrictions on a company's performance, particularly in relation to its debt servicing requirements, according to sponsors. In extreme cases, such terms could delay a company going into receivership, according to sources.

For sponsors, this is another welcome evolution in a market where they wield power disproportionate to that of lenders. One private equity sponsor said: “Covenant-lite loans provide maximum flexibility on how debt is repaid, while removing the volatility of a company's financial performance leading to a problem with the banks.”

In arranging covenant-lite loans, banks are employing techniques derived from the bond market. Led chiefly by the Americans, covenant lite-type terms have been available for some time through the capital markets in the form of high-yield bonds.

David Parker, executive director of debt advisory firm Blenheim Advisors, said: “Bank debt has relied on four main maintenance covenants relating debt to profits, cashflow and capital expenditure.” By contrast, high-yield bonds have relied on ratings provided by rating agencies to monitor the likelihood of default.

These are supported by “incurrence covenants” which typically restrict the company's ability to carry out corporate actions (rather than triggering a default) if the company breaches an agreed limit on its ratio of earnings before interest, tax, depreciation and amortisation to cash interest payments.

Banking covenant-lite is similar to this. Parker said: “While there is no definitive structure, typically the incurrence covenant is based on a ratio of net debt to ebitda.”

Mazzini said: “Covenant-lite terms of this kind delay the ability of banks to intervene because they are prevented from acting on early warning signs of a problem.”

The move to covenants more typical of quasi-equity debt structures makes it easier for borrowers to defer repayments, especially on subordinated debt tranches such as second lien.

...

“From a lender's perspective this argument is incoherent since covenants have been used to manage the fact that private equity investments are high risk. But for arranging banks this is no longer a concern since they will hold little, if any, of the debt. The real risk is held by institutional lenders.” [end quote]

All I can say is...NO THANKS!! I may get interested after the bubble pops.

Wendy