Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

U.S. bank regulators are going after risky lending, but they're having a tough time reining it in. What's the fix? 

The Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. have spent the last three-and-half years enforcing guidance designed to restrict banks within their purview from extending loans that lift a company's indebtedness into a territory that sets off alarms.

Although there is no bright line, regulators have said a Debt/Ebitda ratio above 6 raises concern for most industries. Plenty of deals are still getting done at these leverage levels, with the help of alternative lenders.
Source: LCD, an offering of S&P Global Market Intelligence

Regulators fear that without their intervention, a chunk of corporate America may be unable to repay excessive borrowings and could be forced into bankruptcy when interest rates eventually rise. A secondary fear is that, as happened during the global financial crisis, banks will be left on the hook for some of this debt if they're unable to sell it to investors.

The increased scrutiny has been somewhat successful in deterring banks from risky lending -- or, as in the case of the Fed's warning about Goldman Sachs's recent financing of the UFC buyout, has raised red flags when they do. But even when banks have retreated, borrowers have been able to find ready financing from alternative lenders. The latest example of this is workforce-management company Kronos, which is currently raising $3.4 billion in new loans as part of a refinancing. The loans -- marketed at a minimum interest rate of 4 percent and 8.25 percent, respectively -- are being arranged by Nomura Holdings, Jefferies Group and Australia's Macquarie Group, institutions that aren't subject to the U.S. regulatory guidance.

Odds are good that the loans will be snapped up by yield-hungry, sophisticated investors, who will crunch the numbers and conclude that such loans aren't that risky. In this case, Kronos is backed by three private equity firms (Hellman & Friedman, JMI Equity and Blackstone) and one sovereign wealth fund (Singapore's GIC), all of which would be putting their own stakes in precarious positions by burdening the company with more debt than it can handle.

Shadow Banks in the Spotlight
Lenders not subject to guidance issued by U.S. bank regulators in 2013 have been seizing their moment
Source: Bloomberg

This raises questions: What good is the leveraged-lending guidance if it's only partially effective in curbing the overall practice? Agencies say that financial institutions should "[provide] leveraged lending to creditworthy borrowers in a safe-and-sound manner." So if traditional banks like Credit Suisse, Bank of America and JPMorgan are sidelined, shouldn't the next step be to ensure alternative lenders adhere to the same standards applied to their larger peers rather than have free reign? 

A report by law firm Kramer Levin Naftalis & Frankel notes that if the agencies are concerned with the conduct of non-bank entities in the leveraged lending market, they can communicate those concerns to other regulatory authorities with the ability to exert influence over those industry participants. It wouldn't be a heavy lift to lob a call or send a memo across to the SEC (which oversees the likes of Jefferies and Golub Capital) or to foreign banking regulators in nations like Japan and Australia (which oversee Nomura and Macquarie, respectively). 

All in a Cycle
Higher deal multiples generally imply higher leverage multiples. Both will retreat when the cycle turns, meaning regulated banks will likely recapture any lost share of leveraged loan deals
Source: Pitchbook

Regulators said in July that they remain concerned that losses could "rise considerably" in the next downturn, in part due to such risky loans . With banks under their watch towing the line for the most part,  the agencies should seize the moment to broaden their scope if they really want to eradicate that risk. 

Still, the Kronos situation -- in which non-bank lenders are placing debt on a "best efforts" basis  -- raises another, perhaps more philosophical thought: Without the ability to curb it altogether, perhaps regulators shouldn't have bothered with their crusade against this type of lending in the first place.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Or more specifically, Libor plus 400 basis points and Libor plus 825-850 basis points.

  2. Moody's says Kronos's debt load will rise to 8.7 times its Ebitda, which is high but arguably manageable for software companies that have strong free cash flow.

  3. Ironically, a portion of these loans are covenant-lite, meaning that in a downturn, poor financial metrics may not trigger any lender protections that could force the company to restructure. 

  4. Regulators said origination of the deals they deem most risky (labeled "non-pass") fell to a de minimis level during the first quarter of 2016. 

  5. This means they would not be on the hook for the debt in the event of a downturn.

To contact the author of this story:
Gillian Tan in New York at

To contact the editor responsible for this story:
Beth Williams at