medium · Private Equity value-creation

What is the primary risk of a 'Covenant-Lite' loan for a lender, as described in the practitioners' treatise?

1. The interest rate is fixed for the entire loan term, exposing the lender to potential losses if benchmark market rates rise sharply during the hold period.
2. The borrower is contractually permitted to skip scheduled cash interest payments during any period in which trailing EBITDA falls below a set covenant threshold level.
3. The outstanding loan principal is automatically and irrevocably converted into common equity the instant the borrower's credit rating is downgraded by any major rating agency.
4. Lenders lose the ability to intervene early through 'maintenance' covenants, potentially allowing a borrower to deteriorate significantly before a default occurs.

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