TRLPC: Highly-leveraged U.S. loans continue unabated

NEW YORK, April 11 Fri Apr 11, 2014 1:28pm EDT

NEW YORK, April 11 (Reuters) - Banks keep underwriting highly leveraged loans for low-rated companies that are drawing U.S. regulators' attention, Thomson Reuters LPC data show, despite a looming review by the federal agencies that are trying to clamp down on these transactions.

There has been no let-up in deals that could run afoul of year-old regulatory hurdles, which require banks to hold more reserves and possibly pay fines, in the weeks leading up to reviews of their loan portfolios by the Office of the Comptroller of the Currency, the Federal Reserve and Federal Deposit Insurance Corp.

Bankers expect the annual Shared National Credit (SNC) quality reviews to help clarify how regulators will treat various leveraged loans.

Warning letters were sent to some banks last year urging compliance with Leveraged Lending Guidance published in March 2013, which is designed to avoid the type of systemic risk spurred by the originate-to-distribute mortgage loan market.

Bankers say that the guidelines are driving more judicious underwriting decisions, but 13 of the largest corporate leveraged buyout deals in the first quarter carried debt-to-Ebitda ratios of 6.24 times, on average, the LPC data show.

This is above the 6.0 times leverage that regulators deem as "criticized" assets that could spark penalties, but below 6.47 times in the fourth quarter of 2013. Leverage ratios averaged 6.21 times in full-year 2013, the highest since a pre-recession peak of 7.05 times in 2007.

Still grappling

Bankers are still grappling with which highly leveraged deals to underwrite to stay beneath regulators' radar after receiving the warning letters in the second half of 2013.

Arranging banks say they are choosing carefully, particularly on deals that may be criticized, and seeking more detail on exceptions to the guidelines that cover what banks underwrite and hold as well as distribute.

"If you ask everyone if there are deals you have been less aggressive on, the answer is yes," one banker said. "Chances are those are deals where we're not M&A advisers and we may not have that great a position with the client going forward," he added.

"I don't think there's been a deal that should have gotten done that didn't get done," the banker said. "I think it has started to affect behavior, but the amount of deals getting done in the market? No."

Banks are willing to do some criticized deals, but are wary not to have too many criticized loans in their portfolios. Decisions are often linked to fee-earning potential and relationships with private equity firms and the companies being bought.

As the second quarter begins, several new deals carry leverage in the 6.0-7.5 times area. These include Checkout Holding Corp, the borrower for marketing information provider Catalina Marketing's buyout; GYP Holdings, holding company of wallboard distributor Gypsum Management and Supply; and Renaissance Learning, which provides online assessments and data-powered teaching tools.

Bankers will soon know which tactics are optimal.

"The SNC review will get started later this spring, regulators will review data in the late summer and the public report is typically published in the fall," said OCC spokesman Bryan Hubbard. The OCC declined to comment on the leverage ratio data.

The review gauges the credit quality of large loan commitments owned by U.S. banks, foreign banking organizations and nonbanks.

Heavy competition

Insatiable investor demand for new U.S. leveraged loans is creating aggressive market conditions, pricing and deal structures. High purchase price multiples have boosted debt loads and leverage ratios for corporate buyouts in the first quarter, and that trend could continue.

"With fewer auctions and not a ton of opportunities, sponsors are competing heavily for the deals available, which is driving purchase price multiples higher and therefore leverage may go up as well," said Ioana Barza, Thomson Reuters LPC's director of analysis.

It is too early to assess the long-term impact on underwriting, however, particularly with the review pending, bankers and analysts agree.

"Sponsors may opt not to do deals due to high valuations and high purchase prices and pursue refinancing to reduce borrowing costs on existing debt or dividend recaps to take money off the table," she said.

While bankers hash through a heap of new regulations crafted to avert a repeat financial crisis, and to protect investors, a hunger for extra yield keeps luring those investors to higher-risk assets including leveraged loans.

Loan mutual funds, a measure of retail demand and exposure, are reaching an unbroken stretch of inflows nearing two full years.

The pace of CLO fund issuance, a reflection of institutional demand for the loans, is accelerating monthly this year as regulatory uncertainties specific to CLOs are being clarified. This has made for an ongoing borrower-friendly market for low-rated companies taking loans with fewer investor protections.

For now, the U.S. leveraged loan default rate is low, ending the first quarter at 1.4 percent, down from 2.2 percent the prior quarter and 3 percent in the first quarter a year ago, Moody's said in a report. "We believe the default rate will stay low as long as liquidity remains ample and distressed companies are able to access the market." (Editing By Jon Methven)

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