OCC lending guidelines fail to bite as US leveraged lending surges on

Louise Bowman
Published on:

The US leveraged loan market is braced for the results of the 2014 Shared National Credits (SNC) survey, the annual review of bank syndicated lending by the Office of the Comptroller of the Currency (OCC), the Federal Reserve and the Federal Deposit Insurance Corporation.

The results of the review, which covers all loans of at least $20 million provided by three or more institutions, will be scrutinized for evidence of any impact that the stricter stance taken by the regulators on leveraged lending standards this year have had.

When Euromoney spoke to bankers in New York during the summer, the impression was the guidelines have had a limited impact.

"The OCC guidelines have had a modest impact," says one senior DCM banker in New York. "We have seen highly levered deals that the banks won’t touch, but they are being done by others."

Richard Zogheb-large
The guidelines were left vague. There has been some verbal guidance, but everyone expects further clarification on the heels of the annual lending reviews

Richard Zogheb

The guidelines restrict bank lending to deals with more than six-times leverage.

The September 2013 SNC survey criticized 42% of leveraged lending in the market, triggering the issuance by the regulators of stern letters to the banks telling them to get their houses in order.

Several high-profile deals subsequently saw OCC-regulated banks replaced by foreign banks or broker dealers, triggering widespread concern about the impact the new rules will have on what is a lucrative business line for the banks.

When some of the original lenders to KKR’s $1.6 billion leveraged buyout (LBO) of Maryland-based landscape management company Brickman in November 2013 did not appear on the ticket for a subsequent $725 million loan to back the purchase of ValleyCrest Companies, it was seen as a sign of things to come.

The original LBO, which had a leverage multiple of 6.5 times, was lead managed by Morgan Stanley, but the loan for the ValleyCrest acquisition was led by broker dealer Jefferies and Credit Suisse.

One leveraged finance banker Euromoney spoke to emphasized how careful the bank was being. "We are very careful to only do things that we know will pass credit," he says. "For existing deals, we try to make sure that the new transaction improves the credit."

Big fear

The big fear among leveraged finance banks on Wall Street is that they will have to cede ground in leveraged finance to non-OCC-regulated banks, foreign banks and non-banks as a result of the tougher guidelines.

It isn’t hard to fathom why. According to a recent report published by Keefe, Bruyette & Woods, syndicated leveraged lending generated $14.3 billion fees to the banks in 2013 and by June had generated $4.4 billion in 2014.

An examination of league-table positions at the beginning of September suggests such concerns are not unfounded. According to Dealogic, the top-ranked US marketed LBO bookrunners from January to September were Credit Suisse, Deutsche Bank and Barclays – all European banks.

The equivalent ranking for January to September 2013 has Barclays in the top spot followed by Citi and JPMorgan. JPMorgan slips from third to fourth this year while Citi slips out of the top 10 altogether. Jefferies moves up from 10th to ninth in the ranking for 2014.

Foreign banks in the US are regulated by the Fed, which has applied the new guidelines less stringently than the OCC. The latter has taken a tougher stance with the domestic lenders under its jurisdiction.

It seems premature to conclude that the OCC guidelines are the sole cause of this reshuffle at the top: the three European lenders have always been strong in US leveraged lending. And anecdotal evidence suggests application of the new rules has been patchy at best.

"The OCC guidelines haven’t been implemented by the banks 100%," claims one large US-based asset manager. "There has been some effort but it has been sporadic. The banks are trying to figure out how aggressive they can be."

It is for this reason the market awaits the SNC survey outcome with such interest. If the results show little has changed, despite the regulators’ firm rhetoric, the ante might be upped yet again.

"The guidelines were left vague," says Richard Zogheb, co-head of capital markets origination at Citi in New York. "There has been some verbal guidance, but everyone expects further clarification on the heels of the annual lending reviews."

Tougher stance

A tougher stance could see business move not only to broker dealers but also to other non-bank lenders. Zogheb believes, however, that the threat to the banks from such lenders is being somewhat overstated.

"Hedge funds and asset managers are looking at the OCC guidelines as an opportunity," he says. "But this business requires an enormous amount of capital, a distribution network and expertise."

On the face of it, the regulators’ aim of reducing risky lending behaviour in the high-yield loan market seems to have borne little fruit.

According to Brandywine Global Investment Management, the percentage of US lending that is now covenant-lite is 61.6% compared with 25% in 2007 and 7.4% in 2006. The percentage of those loans rated just single-B is 53% (32.7% in 2007, 24.5% in 2006). The volume of loans written to fund dividends and buybacks stands at $61.2 billion, compared with $38.2 billion in 2007 and $40.3 billion in 2006.