Private equity firms grateful for looser deal terms

By Megan Davies

NEW YORK (Reuters) - Private equity firms, battered by the financial meltdown, are now thankful for deals that were cushioned with looser loan covenants and debt restructuring terms as they steer acquired companies through stormy seas.

But while the new wriggle room allows temporary relief to PE-owned companies it isn't clear whether the softer covenants introduced during the recent boom will resolve underlying problems in the investments or just delay them.

"The jury is still out as its a relatively recent phenomenon," said Russell Solomon, senior vice president of corporate finance at credit rating firm Moody's Investors Service. He said so-called covenant-light deals extend the life of a company because the normal default triggers are not there.

Lenders could be worse off since it takes them longer to get a seat at the bargaining table because there are less trigger points to a default and they could also have less muscle to renegotiate terms.

Covenant-light deals lack the traditional restrictions on borrowers, while pay-in-kind deals, also called PIK-Toggle, allow firms to defer interest payments in favor of issuing more debt.

"Our fundamental concern is the extent it prolongs the ability for more senior creditors to take action," said Solomon, referring to covenant-light loans. He said that could result in lower recovery prospects for creditors.

Issuance of covenant-light loans peaked in the second quarter of 2007 with $32.96 billion sold, nearly five times more than the same period the previous year, according to data from Reuters LPC (RLPC).

Deals signed included the $17.6 billion buyout of Freescale Semiconductor and the $26 billion takeover of payment processor First Data Corp, according to RLPC.

Looser covenants typically mean investors put a discount on the debt, reflecting the higher risk.

Recent bid levels on First Data's LBO loan, which was structured and sold during the private equity bubble, were in the range of 71 cents to 73 cents on the dollar, according to RLPC.

But Getty Images, a buyout deal with a tighter covenant package reached after the frothy market collapsed, had recent bid levels on its LBO debt in the range of 87 cents to 88 cents, said RLPC.

Similarly, electing to use a PIK-Toggle option can been viewed as sign of stress. Moody's said in a recent report it expects the number of companies using a PIK option to increase over the next year as operating cash flow shrinks and tight credit markets make it difficult to refinance long-term debt.

"It's a calculation -- whether its worth say 13 percent a year to have more cash now and guarantee getting through the next two years," said Stephen Moseley, president of private equity advisory business StepStone Group LLC. "I think most companies today would rather have the cash in the bank."

Moody's said in an October report that during the last two quarters at least 11 high-yield issuers, including casino operator Harrah's and retailer Claire's Stores, elected to use the PIK option or said they intended to do so.

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