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.”

Chippingaway at standards that keep a lid on leverage levels may leaveinvestors with soured assets, according to Tricomi. This ishappening just as the credit cycle is peaking, prompting warningsfrom S&P Global Ratings that companies in the U.S. have takenon so much debt that they're at least as vulnerable to defaults anddowngrades as they were leading up to the 2008 financialcrisis.

“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 30percent from 2015, according to data compiled by Bloomberg. Thisshortage is giving companies more power to negotiate better termswith investors who have little choice but to go along becauseyields on other assets are at rock bottom amid central-bankstimulus.

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,Massachusetts, declined to comment on its loans and the terms ofthe debt. Representatives for US Foods didn't respond to a call ande-mail requesting comment on the loan.

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 are getting better terms in the European loanmarket in the last 12 months due to the scarcity of large deals,lenders can live with that provided the underlying borrower isstrong 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 remaindisciplined, he said.

But till then companies will continue to get flexible terms onleveraged loans.

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

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