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Fed Says Banks Haven’t Fully Implemented Loan Guidelines

Banks haven’t fully implemented underwriting standards outlined by U.S. regulators for junk-rated loans, a Federal Reserve official said today.

“Terms and structures of new deals have continued to deteriorate in 2014,” Todd Vermilyea, a senior associate director in the Fed’s banking supervision and regulation division, said today in prepared remarks given in Charlotte, North Carolina.

Bank supervisors have been insisting on minimum standards for underwriting in order to avoid a repeat of the losses that occurred during the credit crisis as issuance of the debt rose to an all-time high in 2013, with $355 billion of new loans arranged, according to data compiled by Bloomberg. The amount of borrowings made that lack typical lender protections also rose to at least a five-year high of $313 billion last year.

“Judging from aggregate market data, it appears that many banks have not yet fully implemented standards set forth in the interagency guidance,” Vermilyea said, according to the prepared remarks.

The Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency released leveraged-lending guidelines in March 2013.

Covenant Exclusion

The exclusion of “meaningful maintenance covenants” is a sign that “prudent underwriting practices have deteriorated,” the agencies said in a statement last year accompanying the release of the underwriting guidelines.

The guidance said debt levels of more than six times earnings before interest, taxes, depreciation and amortization, or Ebitda, “raises concerns.” Underwriting standards should also consider a borrower’s ability to repay and “delever to a sustainable level within a reasonable period of time,” the regulators said in the statement.

Regulators followed up last year and issued a Matter Requiring Attention (MRA) to many of the large underwriting banks telling them they should “deter” the origination, distribution and participation in credits that have a non-pass risk rating at inception.

“Clearly much more work remains to be done and stronger supervisory action may be needed,” Vermilyea said.

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