"Lite" loans may sideline lenders in U.S. downturn

By Jonathan Keehner

NEW YORK (Reuters) - While a U.S. recession would be bad news for a company burdened by debt after its leveraged buyout, a downturn would be worse for those that loaned the money.

That's because many LBOs, struck when markets were sloshing with liquidity, provide few protections for lenders like hedge funds and banks.

"A lot of bankers and financial advisors are probably having to sit back and watch in a frustrated way as companies deteriorate, but not so rapidly that the companies breach whatever minimal covenants there are," said Patrick Daniello, JPMorgan (JPM.N: Quote, Profile, Research, Stock Buzz) managing director, special credits.

At the same time, underwriters of LBO loans are having an increasingly difficult time selling the debt.

The buyout wave that peaked last year was fueled in part by "covenant lite" loans, which carry less protection through control mechanisms or default triggers that measure a company's liquidity. This could leave lenders with their hands tied if cash flow dwindles at newly private companies.

"Deals that were structured in recent years had loose-to-nonexistent covenant packages," said Brian Trust, a partner at law firm Mayer Brown LLP who works on bankruptcies and restructurings. "In a transaction with light triggers, the lender initially bears more risk."

According to Reuters Loan Pricing Corp, more than $300 billion of LBO loans have been issued since the beginning of 2006 -- more than the prior 10 years combined.

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