| NEW YORK
NEW YORK Oct 14 Companies including drywall and
building materials manufacturer Continental Building Products
are including exceptions in US leveraged loan credit agreements
that could bypass auditors' opinions and make it harder for
banks to declare a default.
These 'going concern' exceptions are a sign that lender
protections are continuing to erode as companies take advantage
of liquid market conditions and a lack of deals to win more
favorable borrowing terms.
The exceptions could prevent lenders from calling a default
if auditors say that a borrower may not be able to meet its
financial covenants in the next 12 months, according to
Lenders are seeing this as further curbing their ability to
correct problems quickly and may mean that they are unable to
limit companies' access to cash before covenants are breached.
Including going concern exceptions "removes a key lever
lenders had on the ability to call an event of default," said
Enam Hoque, an analyst at Moody's Investors Service.
Covenants are sets of tests that borrowers have to meet.
They often give the first indication that companies may be in
trouble and offer lenders a chance to revise credit agreements
and increase pricing to compensate for higher risk.
Many US leveraged loans are now 'covenant lite' as the tests
have been stripped out of loans in recent years, a development
regulators see as a sign that prudent underwriting practices
In the most recent Shared National Credit, an examination of
the largest syndicated loans, regulators said credits still had
"ineffective or no covenants."
In the first nine months of the year, about 60% of
institutional loan volume, US$160bn, was covenant lite, compared
to 25% in 2007, according to Thomson Reuters LPC data.
The Office of the Comptroller of the Currency (OCC) "and
other regulators have highlighted concerns regarding the
weakness or lack of covenants in leveraged lending," said Bryan
Hubbard, an OCC spokesman.
Spokespeople for the Federal Reserve (Fed) and the Federal
Deposit Insurance Corp (FDIC) could not immediately comment.
Loan credit agreements require companies to deliver
financial statements without any qualifications that are often
called clean audit opinions, according to Jed Zobitz, a managing
partner in the corporate department at law firm Cravath, Swaine
Auditors can include a provision that says they are not
completely confident a company will be able to function as a
going concern in the next 12 months.
Lenders may able to call a default if auditors include a
going concern qualification in their opinion, as this often
violates an affirmative covenant regarding delivery of financial
statements, said Jeff Ross, a partner in the finance and private
equity group at law firm Debevoise & Plimpton.
"It used to be very straightforward, a couldn't
have any going concern delivered with its annual financial
statement," said Ian Feng, an analyst at Covenant Review.
Private equity firms are taking advantage of strong market
conditions to win concessions. Sponsors are asking for
exceptions, first for upcoming maturities and then for potential
financial covenant breaches, Feng said.
The August credit agreement for hotel operator Extended
Stay's loan includes exceptions to going concern opinions
relating to an upcoming maturity date and a potential inability
to satisfy any financial covenant, according to filings.
Food manufacturer AdvancePierre's June credit agreement
includes similar exceptions, the filings show. Spokespeople for
the companies could not comment.
Lenders can still call a default with going concern
exceptions in place, but only after companies breach covenants.
This could allow troubled companies to increase their leverage
by drawing down revolving credits, which are typically barred by
The additional leverage "ultimately increases risk for
lenders and loan investors," Hoque said.
However, proponents of the exceptions, which include private
equity owners and some investors, think lenders should not call
defaults before maintenance covenants are breached as a
company's financial position could improve after an auditors
opinion is released.
The Fed, the OCC and the FDIC said in updated leveraged
lending guidance that leverage levels of more than six times
Total leverage for large buyouts was 6.02 times in the first
nine months of the year, down from 6.18 times in 2013 when the
guidance was issued, according to LPC data.
More borrowers are expected to ask for going concern
exceptions going forward, to lenders' dismay.
Going concern language "has traditionally been viewed as an
opportunity to get management to the negotiating table and to
the extent you don't have that, it's not a helpful thing," said
Jonathan Insull, a portfolio manager at Crescent Capital Group.
(Reporting by Kristen Haunss; Editing By Tessa Walsh)