| March 26
March 26 U.S. bank regulators issued the first
risk controls in a dozen years for lending to faltering
companies, tempering some proposals the flourishing industry
viewed as most egregious and expensive.
The new standards, crafted to avert a repeat of the type of
bubble that sank the U.S. housing market and helped trigger a
recession, define more loans as leveraged or criticized for
Banks will have to hold reserves to buffer potential losses
on the larger pool of loans being classified as leveraged,
deterring some lending and raising borrower costs on available
credit, the Loan Syndications and Trading Association said. The
refined leveraged loan definition, however, is less overarching
"While leveraged lending declined during the crisis, volumes
have since increased and prudent underwriting practices have
deteriorated," the Federal Reserve Board, Federal Deposit
Insurance Corp and Office of the Comptroller of the Currency
said in a March 21 joint statement detailing the final guidance.
U.S. leveraged loan issuance broke records in February. The
$156 billion issued sprinted past the prior high of $118 billion
in 2007, Thomson Reuters LPC data show. Lending was dominated by
refinancing rather than M&A or leveraged buyouts.
Regulators have long worried that some debt agreements lack
meaningful maintenance covenants while including features that
can limit lenders' recourse if a borrower falters. They noted
the importance of "providing leveraged financing to creditworthy
borrowers in a safe and sound manner," and characterized some
capital and repayment structures as "aggressive."
Loans that are light on covenants already beat quarterly
issuance records in the first two months of this year, and are
poised to soon top volume for all of 2012.
The agencies, which proposed the guidance a year ago, were
compelled to tighten safety standards by the spike in pre-crisis
leveraged credit and non-regulated investors.
Banks essentially had the year to prepare for harsher
leveraged loan definitions, some of which were eased, noted
Ernie Patrikis, partner at White & Case LLP. The regulators
feared reverting to pre-crisis easy lending and were unlikely to
backpedal much, he added.
"There is a regulatory cost, so borrowers will be paying
more," said Patrikis. "But I really don't see this as a shocking
announcement that will have a material impact on credit."
To the extent that banks cannot comply, or are deterred by
associated costs, others could step up to fill in gaps, several
industry sources said.
Representatives at several banks did not respond to requests
The new blueprint likely averts a repeat of rigid 1989
guidance that repelled lenders concerned about boosting required
regulatory capital for leveraged transactions, most sources
agreed. That version nearly a quarter century ago was replaced
with softer 2001 guidance that stood until now.
By removing a reference to fiduciary responsibility, the
regulators addressed loan industry concerns of heightened bank
exposure to misplaced liability. The LSTA had argued that
underwriters are not getting paid to provide insurance, which is
essentially what a fiduciary standard requires.
The agencies also eliminated fallen angels - loans to
companies that start out as investment-grade but later sink to
junk - and asset-based loans from their proposed leveraged loan
An August comment letter to the agencies from the LSTA and
American Bankers Association countered that leveraged loans
should refer only to those deemed leveraged when originated.
On the other hand, the agencies rejected a number of
industry concerns and still have expansive definitions of
leveraged and criticized loans, according to the LSTA.
Loans with senior debt divided by EBITDA (earnings before
interest, taxes, depreciation and amortization) greater than
three times, or total debt divided by EBITDA greater than 4
times will likely be considered leveraged.
Loans on banks' books and to Business Development Company
and Collateralized Debt Obligation warehouses may also be
considered leveraged, boosting leveraged loan books due to
definitional changes rather than loan quality, LSTA added.
A loan may be criticized for repayment risk if a company
fails to show the ability to amortize from free cash flow all
senior debt or half of total debt within five to seven years.
The guidance also states that a leverage level after asset
sales, of the amount of debt that must be serviced from
operating cash flow, in excess of 6 times total debt/EBITDA
raises concerns for most industries.
The LSTA said "imposing such a 'one-size-fits-all' model for
all industries does not accurately represent different
companies' risk profiles and runs the risk of reducing financing
for many companies."