'Covenant-Lite' Loans Face Heavy Hits Article

By PETER LATTMAN "Covenant-lite" loans, a hallmark of the buyout boom, were supposed to give private-equity owned companies the flexibility to ride out a recession. The ride is now getting very bumpy. Nicknamed for their loose loan requirements -- "covenants" in banker-speak -- two big-name covenant-lite deals are showing signs of stress, underscoring the pernicious effect this recession is having on companies that borrowed money on even the most lenient of terms. On Monday, Apollo Management-owned silicones maker Momentive Performance Materials warned that its earnings decline could result in their violating the liberal covenants on its loans, resulting in a possible default. And, last week, Moody's Investors Service said there is a "high probability" that weak financial results posted by private-equity owned Clear Channel Communications Inc. will cause the radio giant to violate the loose covenants on its loans this year. Covenant-lite loans grew to almost 19% of all bank debt outstanding, from about 1% at the beginning of 2006, according to Standard & Poor's Leveraged Commentary & Data. Buyers of Freescale Semiconductor, Neiman Marcus and Aramark Corp. all used the loans to finance their acquisitions. Private-equity executives say that the magnitude of the downturn could result in more covenant violations in the months ahead. Representatives for Clear Channel and Momentive declined to comment. Loan covenants traditionally protect banks from the deteriorating financial performance of a borrower. If the borrower fails to meet certain standards, lenders can ask for their money back or try to seize property. To avoid busting their covenant-lite loans, both companies are slashing costs, including layoffs at Clear Channel and salary cuts at Momentive. Future moves to stave off default could involve refinancing of their debt, selling assets or raising more equity -- all challenging in this environment. They also could ask banks for a waiver or an amendment of the covenants, though lenders have been largely unforgiving of late. For now, these companies are struggling under staggering debt loads. Bain Capital and Thomas H. Lee Partners's equity investment in Clear Channel accounts for only 13% of the company's capital structure. Apollo's equity investment in Momentive accounted for 17% of the purchase price. Clear Channel's debt package weighs especially heavily on the radio giant. This year it has to make more than $1 billion in annual interest payments amid worsening radio and billboard advertising markets. Clear Channel's covenants call for a ratio of its secured debt to Ebitda of no more than 9.5 times. At the end of 2008, that ratio stood at 6.4 times. Though it would appear that the company has breathing room, business conditions continue to deteriorate rapidly, says Moody's analyst Neil Begley. If the company cannot stanch its earnings decline, its debt-to-earnings ratio could rapidly rise. "The terms were so lenient that the banks lending to Clear Channel were protected by anything short of a catastrophe," said Mr. Begley. "The problem is that this environment can be fairly classified as a catastrophe." A similarly grim outlook exists for Momentive, the manufacturer of silicon-based products used in the automobile, homebuilding and furniture industries. In December 2006, Apollo acquired 90% of General Electric's advanced materials division for $3.9 billion and renamed it Momentive. The Albany, N.Y., business lost $997 million in 2008, compared with a $254 million loss in 2007, with customer demand weak in "all regions of the world and across all product lines," said Momentive's chief executive on the company's earnings call Monday. Momentive carries a $3.9 billion total debt load, according to Standard & Poor's. Late Tuesday, S&P lowered its ratings on Momentive by two notches and placed it on credit watch for a further downgrade. Write to Peter Lattman at peter.lattman@wsj.com