Feb. 9 (Bloomberg) -- The five banks that helped finance the takeover of Lyondell Chemical Co. have lost at least $3.7 billion, and that figure may climb to more than $8 billion, which would make the leveraged buyout the costliest in history for lenders.

Goldman Sachs Group Inc., Citigroup Inc., UBS AG, Merrill Lynch & Co. and ABN Amro Holding NV agreed to underwrite the $20.9 billion takeover of Houston-based Lyondell by Basell AF, a Rotterdam company controlled by Ukraine-born billionaire Len Blavatnik, in the second half of 2007. LyondellBasell Industries, the world’s biggest maker of polyolefins used in products ranging from bottle caps to auto parts, filed for bankruptcy last month as demand evaporated in the global recession.

The financing includes $8 billion of low-ranking loans still held by the banks that may be worthless, said three people with knowledge of the situation who declined to be identified because the information isn’t public. That would eclipse about $5 billion of potential losses from Tribune Co., the Chicago- based media firm that filed for bankruptcy protection Dec. 8.

“I can’t think of any bigger flameouts,” said Steven Kaplan, a professor at the University of Chicago Booth School of Business. “If all of that debt gets wiped out, that could set a new mark for losses from financing a buyout.”

The collapse of LyondellBasell adds to record losses for the five banks that already have disclosed combined asset writedowns of more than $200 billion and have been forced to accept government-backed bailout funds during the worst credit crisis since the Great Depression.

Bank Writedowns

Edinburgh-based Royal Bank of Scotland Group Plc, which inherited the Lyondell debt after buying parts of Dutch bank ABN Amro last year, has written down the value of its stake by 1 billion pounds ($1.47 billion). Citigroup, the U.S. bank that got a $52 billion government bailout, said on Jan. 8 that it took a $1.4 billion loss on $2 billion of Lyondell debt. Goldman Sachs, the largest securities firm before converting into a bank last year, reported losses of $850 million from Lyondell loans.

UBS, the biggest Swiss bank, and Charlotte, North Carolina- based Bank of America Corp., which bought Merrill Lynch in January, haven’t disclosed the size of the writedowns.

Piers Townsend, a spokesman for RBS in London, and Doug Morris of UBS declined to comment on the possibility of further losses. Scott Silvestri, a spokesman at Bank of America, Danielle Romero-Apsilos of New York-based Citigroup and Michael DuVally of Goldman Sachs in New York also declined to comment.

‘Burning Bed’

So-called first-lien loans to Lyondell, which are paid back ahead of other creditors, have tumbled almost 50 percent to 22.6 cents on the dollar since the bankruptcy filing, according to London-based pricing service Markit. Each of the five banks holds $1.6 billion of so-called second- and third-lien loans, the people familiar with the situation said.

Lyondell’s losses dwarf those from the busted LBOs of the 1980s, such as Ohio Mattress Co., the $965 million takeover dubbed “the burning bed” by bond traders. The most costly buyout of the decade was Federated Department Stores Inc., in which lenders ended up losing about $2 billion, according to Kaplan at the University of Chicago.

Debt used to fund more recent buyouts plummeted in value after the onset of the credit crunch. The S&P/LSTA Leveraged Loan Index lost $202 billion since June 2007, plunging to 65.3 cents on the dollar from above face value.

More than $250 billion in the high-yield bond market has been wiped out since June 2007, according to indexes compiled by New York-based Merrill Lynch. Debt rated below Baa3 by Moody’s Investors Service and less than BBB- by S&P is considered junk, or in the case of loans, leveraged.

‘Deals on the Edge’

While ratings companies estimate senior lenders in buyout loans have historically recovered about 70 cents on the dollar, Mark Pibl, head of research at NewOak Capital LLC in New York, said the average will be closer to 50 percent. Defaults on loans and high-yield bonds may reach 30 percent in the next two years, he said.

“Lyondell isn’t going to be the last,” Pibl said. “There are a lot of deals on the edge. The biggest losers will be the private equity funds.”

New York-based JPMorgan Chase & Co., Citigroup and other investment banks were stuck with more than $230 billion of loans promised to private equity companies before the credit crisis began in August 2007.

Citigroup reduced its leveraged finance commitments to $10 billion from $43.2 billion at the end of last year, an investor presentation from the bank shows. Goldman Sachs had $9.3 billion of high-risk, high-yield lending commitments at the end of 2008, down from $41.9 billion the previous year, according to a regulatory filing. UBS reported having $4.7 billion of leveraged finance commitments at the end of September.

Tribune Bankruptcy

JPMorgan, the biggest U.S. bank by market value, was left holding $1 billion of loans for Sam Zell’s Tribune Co., when it filed for bankruptcy protection on Dec. 8, court documents show. The value of Tribune loans fell to less than 30 cents on the dollar from 70 cents in September, Markit data show.

Tribune’s lenders may recover only 49 percent of $8.5 billion of loans, and only 10 percent of a $1.6 billion bridge loan, according to Jake Newman, an analyst at CreditSights Inc. in New York. That would mean losses of about $5.8 billion.

JPMorgan also holds distressed loans of Chrysler LLC, the automaker bought by New York-based Cerberus Capital Management LP in 2007, after underwriting $7 billion of debt along with Citigroup, Morgan Stanley, Bear Stearns Cos. and Goldman Sachs.

Blavatnik’s Bid

Citigroup, Merrill and Goldman Sachs offered to provide financing for the Lyondell acquisition in July 2007, according to a regulatory filing. Amsterdam-based ABN Amro agreed a month later to participate in the deal, and UBS in Zurich followed in October, said a person familiar with the matter.

“It was pretty deep into the subprime crisis,” says Jonathan Macey, a professor of corporate finance and securities law at Yale University in New Haven, Connecticut.

Blavatnik, chairman of New York-based Access Industries Holdings LLC, which owned Basell, didn’t put any of his firm’s money toward buying Lyondell. The 51-year-old U.S. citizen, who emigrated from Russia in 1978 and has an MBA from Harvard Business School, also holds stakes in Russian oil company TNK-BP Holding, aluminum producer United Co. Rusal and Warner Music Group Corp.

Christina Stenson, a spokeswoman for Access, Blavatnik’s closely held company, declined to comment.

First-Lien Loans

Banks curbed potential losses from financing the Lyondell acquisition by selling parts of the $12.5 billion of first-lien loans last May for more than 90 cents on the dollar, New York- based S&P reported. Apollo Management LP, the New York buyout firm, bought $1.9 billion of Citigroup’s first-lien Lyondell loan for about 85 cents on the dollar.

Lyondell filed for bankruptcy protection on Jan. 6, listing debts of more than $19 billion and assets of about $27 billion.

Apollo and other creditors also may face losses, depending on the value of the company when it emerges from bankruptcy. The first-lien portions of the loan that the private equity firm bought get repaid first in bankruptcies and probably will be valued at 76 cents on the dollar, said Andrew Brady, an analyst at CreditSights Inc. in New York.

“It’s a cyclical company,” Brady said. “How much will be there at the end of bankruptcy remains to be seen. As of today, there is significant destruction.”

Extra Fees

Banks and other lenders could offset some of their losses by earning fees and interest providing $8 billion of debtor-in- possession, or DIP, financing. The loans pay interest of at least 13 percent and provide fees of 7 percent, according to S&P. Among the DIP lenders are UBS, Apollo and Cerberus.

Royal Bank of Scotland, now controlled by the U.K. government, has $3.47 billion of loans to Lyondell, UBS has secured claims of $2.7 billion and Merrill has $2.16 billion, according to court documents.

The record losses from this cycle will only delay another buyout trend, says Christopher Garman, chief executive officer of Garman Research LLC in Orinda, California, and a former head of high-yield strategy at Merrill Lynch.

“Financial markets don’t learn,” Garman said. “The cycle for leveraged buyouts will never go away. We may not see it for another 20 years, but at some point there will be a similar phenomenon.”

To contact the reporters on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Jonathan Keehner in New York at jkeehner@bloomberg.net.

Last Updated: February 9, 2009 02:36 EST