March 12 (Bloomberg) -- Financial regulators in the U.S. are considering clarifications to their leveraged-loan guidelines to ensure banks are interpreting them correctly in order to limit risky lending, according to four people with knowledge of the matter.
The Federal Reserve and the Office of the Comptroller of the Currency put together a list, described as frequently asked questions, that seeks to answer some of the banks’ queries, said the people, who asked not to be identified because the plans are private. The regulators are discussing whether they will develop a version that would be sent to the banks and distributed publicly as well, one of the people said.
Some of the biggest banks including Goldman Sachs Group Inc. and JPMorgan Chase & Co received letters from the Fed and the OCC in September, asking them to devise plans for tighter lending policies within 30 days. Six months earlier, regulators issued guidelines for junk-rated loans citing deteriorating underwriting conditions. The lack of consensus shows the difficulty of implementing broad guidelines aimed at keeping excessive risk-taking from roiling the market.
“There are quite a number of issues of interpretation that need to be clarified,” Alan Avery, a partner in the corporate department at law firm Latham & Watkins, said in a telephone interview. The way banks and regulators are “interpreting and applying some aspects” of the leveraged-lending guidelines “seems to be quite varied, especially from one agency to another, and even within institutions.”
Regulators are seeking to set minimum standards in the market that saw its largest year of issuance in 2013 with $352.2 billion of new loans arranged, according to data compiled by Bloomberg. Banks stand to earn lucrative fees for underwriting leveraged loans, which are issued to back buyouts and help companies refinance existing debt.
There have been $51.5 billion of new leveraged loans arranged in the U.S. this year, compared with $48.6 billion during the same time period in 2013, according to Bloomberg data. Loans returned 4.5 percent last year, according to the S&P/LSTA Leveraged Performing Loan Index Market Value Return.
Eric Kollig, a Federal Reserve spokesman, and Bryan Hubbard, an OCC spokesman, declined to comment. Tasha Pelio, a JPMorgan spokeswoman, and Tiffany Galvin, a Goldman Sachs spokeswoman, also declined to comment.
Fed officials have singled out leveraged loans as an example of excessive risk-taking as they look for signs of asset-price bubbles fueled by a benchmark interest rate that’s been near zero for more than five years.
Leveraged loans are rated below BBB- by Standard & Poor’s and less than Baa3 at Moody’s Investors Service.
Fees for underwriting leveraged loans can be about two percentage points, or $20 million on a $1 billion credit, according to two people with knowledge of such deals.
The Fed, OCC and Federal Deposit Insurance Corp. released the leveraged-lending guidance in March 2013. The exclusion of “meaningful” covenants is a sign that “prudent underwriting practices have deteriorated,” and that debt levels of more than six times earnings before interest, taxes, depreciation and amortization, or Ebitda, “raises concerns,” the regulators said in the guidelines and a March 21 statement accompanying the release.
The advisory also said underwriting standards should consider a borrower’s ability to repay and “delever to a sustainable level within a reasonable period.”
The Fed and OCC followed up with letters starting in September that said banks should establish policies that deter the origination of loans classified as having a deficiency that might lead to a loss.
“Guidelines are supposed to be applied with the discretion of banks and regulators,” said Avery, who is based in New York. “It’s a question of how it is evaluated and enforced.”
Because the leveraged-lending guidelines “aren’t a rule, you don’t know exactly what the consequences would be” for not following them, he said.
The regulators have been meeting with bankers during the past several weeks to discuss their responses to the letters, according to five people who participated in the meetings.
The Loan Syndications and Trading Association, the leveraged loan market’s main trade group, held a Feb. 6 meeting at its New York offices with bank representatives to discuss how they are interpreting the leveraged-lending guidance, according to five people with knowledge of the meeting, who asked not to be identified because it was private.
Meredith Coffey, an executive vice president at the LSTA, declined to comment.
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