The Cov-lite Liquidity Advantage, Regulatory Pressures, and the Evolution of the Leveraged Loan Market

Following the global financial crisis (GFC), regulators made it harder for banks to retain leveraged loan exposure. We conjecture their actions increased the share of leveraged loan issuances with no maintenance covenants (cov-lite loans) because such loans are easier to sell. We find that, post-GFC, the share of cov-lite loan issuance increased more for banks facing stricter regulation, failing to pass a stress test outright, or exhibiting greater vulnerability to the severely adverse stress test scenario. We show that, as expected from theory, cov-lite loans have a liquidity advantage that lowers their credit spread and is higher for private firms.