Lack of covenants seen delaying defaults

By Emily Chasan

NEW YORK (Reuters) - Bankruptcy experts have been forecasting a surge in corporate loan defaults this year, but it is materializing more slowly than expected as years of easy lending offered a bevy of ways for companies to avoid typical loan requirements, experts in distressed companies said at the Reuters Restructuring Summit this week.

In the boom years, there was so much competition to make loans that typical loan covenants used to monitor cash flows and other measures of companies' ability to repay their debts were dropped from deals.

Dubbed "covenant lite," such structures allowed companies to fall into default only when they could not repay their debts.

"A lot of people who are experiencing any (earnings) declines, that would normally have busted covenants, that would normally have had to refinance, are being insulated," said Tony Alvarez II, co-founder of financial advisory and turnaround firm Alvarez & Marsal at the Reuters Restructuring Summit in New York this week.

As credit markets tightened last summer, covenants became popular again, but there are hundreds of companies that now find themselves in risky cash flow situations and may be able to avoid the difficult talks with lenders that they would have had in the past.

"Covenants used to be the trigger to alert banks ...something is not right," Third Avenue Management portfolio manager Michael Fineman said, noting that covenants gave companies and lenders the opportunity to figure out if there was a one-time problem at the company or greater difficulties.

"...without those triggers, there is no reason for these two parties to come together, because the companies themselves are

not going to come and start negotiating if they don't have to," Fineman added.

This could extend some needed restructurings at least into 2011, said James Sprayregen, co-head of the restructuring group at Goldman Sachs.

"The covenant lite situations are going to get stretched out longer," Sprayregen said. "Even if they were equally as troubled as a company without covenant lite because there's no requirement that they come back to the table and speak with their lenders until they have a cash issue."

Potentially, Sprayregen said, the lack of covenants could allow companies to deny their problems until they are desperate.

For companies, bankruptcy experts say there are real benefits to detecting and addressing their problems early. For example, it could allow troubled companies to go into a reorganization while their cash positions are still strong and make them look better to potential buyers.

"PIK toggles", which were popularly used in leveraged buyouts are also another problem from the easy lending years, Third Avenue's Fineman said at the summit. "PIK," which stands for "payment in kind," allows companies to bypass traditional triggers, by letting the borrower add interest payments to the loan's principal or use assets other than cash to make interest payments.

However, bankruptcy experts were confident that any troubled company will eventually face a day of reckoning.

When a loan matures, companies may find that they will be unable to refinance it at similar levels of leverage or pay it back, experts said.