Junk-Loan Guidelines Said to Allow Banks to Restructure

U.S. regulators seeking to stem loosening underwriting standards in the market for junk loans are giving banks flexibility when they restructure existing loans that lessen their own risk, according to a person with knowledge of the guidance.

The leeway adds clarity to leveraged-lending guidelines released in March 2013 by the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. The Fed and OCC more recently have been increasing pressure on banks to improve their underwriting standards and in September started sending letters demanding they come up with a plan for tighter policies.

“We are using supervisory tools and regulations, both to make the financial system more robust and to pay particular attention to areas where we’ve spotted concerns, like leveraged lending, which is very much a focus of our supervision,” Fed Chair Janet Yellen said yesterday during a news conference according to a transcript.

While the loan standards outline specific criteria as worrisome -- such as debt levels of more than six times earnings before interest, taxes, depreciation and amortization -- they also allow for restructuring deals to make them less risky, said the person, who asked not to be identified because the discussions are private.

Curbing Risk

Lenders could reduce their risk by lowering borrowing costs, making amortization periods shorter or strengthening covenants. Leveraged loans are rated below BBB- by Standard & Poor’s and less than Baa3 at Moody’s Investors Service. (MCO)

There is flexibility in the guidance and the Fed expects to see an improvement in credits through restructurings, said Barbara Hagenbaugh, a spokeswoman for the central bank in Washington. Stephanie Collins, a spokeswoman for the OCC in Washington, and Andrew Gray, an FDIC spokesman, declined to comment.

A Fed official warned in May that banks still haven’t fully implemented the underwriting standards.

“Judging from aggregate market data, it appears that many banks have not yet fully implemented standards set forth in the interagency guidance,” Todd Vermilyea, a senior associate director in the Fed’s banking supervision and regulation division, said May 13, according to prepared remarks given in Charlotte, North Carolina.

To contact the reporter on this story: Kristen Haunss in New York at khaunss@bloomberg.net

To contact the editors responsible for this story: Shannon D. Harrington at sharrington6@bloomberg.net Faris Khan

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