Riskier companies are increasingly getting credit agreementsthat allow them to raise the amount of future cost savings toappear more creditworthy, boosting potential losses forinvestors.

The tweaks make it easier for borrowers to stay in compliancewith their loan terms and add more debt, according to CharlesTricomi, a senior analyst at covenant research firm XtractResearch.

“There is too much money chasing too few loans,” Tricomi said.“Lenders are really at a disadvantage and have to agree to theseterms significantly against their own interest, terms that theyshould be fighting off.”

Whittling away standards that keep a lid on leverage levels mayleave investors with soured assets, according to Tricomi. This ishappening just as the credit cycle is peaking, prompting warnings from S&P Global Ratings that companies in the U.S.have taken on so much debt that they're at least as vulnerable todefaults and downgrades as they were leading up to the 2008financial crisis.

“The market is so much leveraged on the side of the borrower atthis point, and they are forcing lenders to swallow a lot of thingsthat they wouldn't otherwise take,” Tricomi said. “In the eventthere is a default, there is a greater likelihood of lowerrecoveries.”

Issuance of leveraged loans has been declining in the last fewyears, with loan sales funding U.S. buyouts plunging more than 30%from 2015, according to data compiled by Bloomberg. This shortageis giving companies more power to negotiate better terms withinvestors who have little choice but to go along because yields onother assets are at rock bottom amid central bank stimulus.

A unit of US Foods Holding Corp., a food distributor controlledby KKR & Co. and Clayton Dubilier & Rice, got a $2.2billion loan in June that excludes limitations on so-calledadd-backs that allow the company to raise earnings and decreaseleverage, according to Tricomi. Aspect Software Inc., atelecommunications company, obtained a $387 million loan inMay backing its exit from bankruptcy with similar terms, Tricomisaid.

A representative for Aspect Software based in Chelmsford, Mass.,declined to comment on its loans and the terms of the debt.Representatives for US Foods didn't respond to a call and e-mailrequesting comment on the loan.

Earlier this year, Valeant Pharmaceuticals International Inc.loosened its credit pact with lenders to allow it to use more add-backs. At the time, a spokeswoman declined tocomment.

European Trend

The practice of abandoning the caps has also crept into someEuropean deals, according to Jane Gray, co-head of Europeanresearch at Covenant Review LLC.

“I've seen this in European mid-cap sponsor deals,” Gray said.“It is still off market and we would consider it egregious,”because the norm in Europe remains for future savings to becapped.

Investors obviously place faith that private-equity companiesthat back a lot of the borrowers in the leveraged-loan market will“make a reasonable judgment on the amount of savings that can beadded back,” said Suhrud Mehta, a London-based partner at MilbankTweed Hadley & McCloy, who has also seen an increase in thepractice in Europe. “This is where the market is headed.”

While companies have been getting better terms in the Europeanloan market in the last 12 months due to the scarcity of largedeals, lenders can live with that provided the underlying borroweris strong enough, according to Ian Brown, head of strategic debtfinance at Lloyds Banking Group Plc's commercial banking unit.

“Some deals have seen some pushback but equally a number ofdeals with punchy terms have been getting good traction in themarket,” said Michael Curtis, co-head for European loans atIntermediate Capital Group Plc, which has 22 billion euros ($25billion) of assets under management. In the face of looser terms,investors should remain disciplined, he said.

“It all comes down to the fact that in this market, borrowershold the strings,” Xtract's Tricomi said.

Bloomberg News

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