| NEW YORK
NEW YORK Jan 15 Banks are becoming increasingly
selective about which highly-leveraged U.S. company loans they
are willing to underwrite as they start to heed regulators'
warnings to curb looser lending practices.
Investor demand for deals that regulators view as risky,
including a $1.1 billion loan for software maker Applied Systems
, shows no signs of abating, but banks are looking at
new transactions more carefully to try to avoid raising red
flags with regulators.
U.S. market watchdogs are trying to clamp down on loans with
higher leverage levels and dodgier repayment prospects, seeking
to avert the problems emanating from the mortgage market that
spurred the last financial markets meltdown and recession.
Regulators sent letters in late 2013 to banks warning that
they were not following leveraged lending guidelines that were
updated in March for the first time in a dozen years.
The guidelines increased the number of loans deemed to be
leveraged on banks' books. Banks have to hold more capital to
buffer potential losses on riskier assets, which could restrict
new leveraged loans that lenders are able to underwrite.
"We've passed on deals that have gotten done in the
marketplace, that don't meet or do meet the guidelines, and I'm
sure we've done deals that others have passed on," a banker
said. "Good deals will continue to get done. We take credit
views and client views."
Loans can be categorized as "criticized" if companies are
not able to to amortize or repay all of their senior debt from
free cash flow or half of their total debt in five to seven
Leverage levels exceeding six times Debt to Earnings Before
Interest, Tax, Depreciation and Amortization (EBITDA) after
asset sales are also viewed as problematic.
Banks are now focusing on companies that are able to meet
the criteria to avoid deals being criticized. They are still
prepared to underwrite some riskier loans but are now picking
the deals that will go against the guidelines more
"The regulators have said that they expected deals
to be rare in occurrence. The banks are all grappling with how
many are acceptable and what rare is," a second banker said.
Banks are already rejecting deals based on their leverage
profile after considering whether the deals will meet the
guidelines, sources said.
Fewer banks willing to underwrite new highly leveraged deals
could discourage private equity firms that are trying to raise
buyout financing and impact M&A volume.
"Sponsors will have to go to more banks to find takers," a
third banker said.
Loans that finance dividend payments to private equity firms
are expected to be hit, along with loans for middle-market
companies that generate less fees.
Large fees may tempt some banks to underwrite
highly-leveraged loans despite the guidelines, but there likely
will be less competition for these deals.
"Fees will definitely play a factor. If a bank is made a 50
percent bookrunner and there is a meaningful fee, then they
might do it, but if they're not and it's a non-pass from the
regulators, then it becomes more doubtful," a fourth banker
Buyout loans that could be considered criticized under the
guidelines are still seeing overwhelming demand from
asset-hungry investors as cash continues to pour into loans.
Investors are piling on to floating-rate assets with the Federal
Reserve's tapering of its massive bond buying program seen
leading to rising interest rates.
Highly leveraged loans including the $1.1 billion loan
backing Applied Systems' purchase by private equity firm Hellman
& Friedman and a $3.7 billion loan financing the Carlyle Group's
purchase of Johnson & Johnson Inc's ortho clinical
diagnostics are being carefully watched in the market.
With debt of roughly eight times EBITDA, Applied Systems is
the most highly levered transaction since the financial crisis,
sources said. Although this could mean that the deal fails
regulators' tests, it has already proven popular with investors.
Orders from investors topped $5 billion - nearly five times
the size of the financing - on January 10 before the commitment
deadline and pricing was also cut, sources said.
Applied Systems is seen as a strong credit and has shown an
ability to deleverage by reducing debt, which is leading
investors to question whether the deal would fail regulators'
criteria, the sources added. The loan price rose once it entered
the secondary market on Wednesday, traders said.
"People are happy doing 7.9 times total leverage, more so
for this company (Applied Systems) than they are doing 5.9 times
or 6.9 times for most other companies," the second banker said.
The $3.7 billion financing backing private equity firm
Carlyle Group's $4.1 billion to $4.5 billion purchase of Johnson
& Johnson Inc's ortho clinical diagnostics could also run afoul
of regulatory guidelines.
The acquisition deal, which has expected leverage of around
six times, is seen being signed by Friday, although could be
delayed, bankers said. Barclays and Goldman Sachs are leading
Credit Suisse, Goldman and Barclays declined to comment.