U.S. Fed warns of more bank scrutiny over leveraged loans

(Reuters) - A senior Federal Reserve official warned banks on Tuesday the central bank may have to take further action to ensure compliance with U.S. guidance on leveraged lending, in the clearest sign yet it is seeking to dispel a perception that it is lenient.

Banking and regulatory sources told Reuters last month that the Office of the Comptroller of the Currency (OCC) is zealously pursuing the implementation of leveraged loan guidelines it and the Fed issued jointly last year. By contrast, the Fed is more relaxed, these sources said.

On Tuesday, however, the Fed made some of its most hawkish comments on the matter. In prepared remarks to the 2014 Credit Markets Symposium in Charlotte, North Carolina, Todd Vermilyea, senior associate director for banking supervision and regulation at the Fed, warned of potentially more scrutiny following regulatory letters sent to banks last year titled “Matter Requiring Attention.”

“Recent industry level data suggest that despite the issuance of the leveraged lending guidance and the MRAs, terms and structures of new deals have continued to deteriorate in 2014,” Vermilyea said in his opening statement, a copy of which was provided by a Fed spokeswoman.

“A lot of work has been done to date by the agencies to assess compliance with the guidance, but clearly much more work remains to be done and stronger supervisory action may be needed,” he added.

The issuance of leveraged loans, often referred to as “junk rated,” rose to a record $1.14 trillion in the United States last year, up 72 percent from the year before, according to Thomson Reuters Loan Pricing Corp.

Banks received $1.47 billion in fees in 2013 for U.S. leveraged loans, a 17 percent increase from 2012, according to Thomson Reuters and Freeman Consulting data.

A difference in approach between the Fed and the OCC, which even some regulatory sources privately admit exists, has meant that banks such as Credit Suisse Group AG CSGN.VX and Goldman Sachs Group Inc GS.N are able to be more aggressive in making leveraged loans just because they are regulated by the Fed, not the OCC, the sources have told Reuters.

As a result, these banks could gain ground at the expense of rivals that are regulated by the OCC, including JPMorgan Chase & Co JPM.N, Bank of America Corp BAC.N and Wells Fargo & Co WFC.N, these sources have said.

Vermilyea said the Fed, OCC and Federal Deposit Insurance Corp intend to use the upcoming regulatory examinations later this year, referred to as the Shared National Credit (SNC) review, to assess banks’ conduct and adherence to “safe and sound lending standards”.

Last year’s SNC review revealed large gaps between industry practices and guidelines, Vermilyea said. The review showed weaker underwriting and large volumes of loans that did not have the capacity to amortize in reasonable periods, he added.

Complicating matters, the guidelines are not prescriptive enough and leave room for interpretation, bankers have complained.

Reporting by Greg Roumeliotis in New York; Editing by Steve Orlofsky