March 26 (Reuters) - 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 repayment.
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 than feared.
“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 for comment.
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 definition.
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.”