Leveraged finance: The threat to corporate America
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Leveraged finance: The threat to corporate America

Multiples and lack of covenants in the leveraged finance market are firmly in the firing line of US regulators. Sponsors say they can handle the new rules. Banks are already looking for ways round them. But with regulators hell-bent on proving a point in 2015, what will happen when a leading US company struggles, or fails, to refinance a cov-lite loan?

“Our biggest worry is that the regulators are going to inadvertently undermine the ability of some very viable – albeit leveraged – companies to refinance. Many of these companies are also major employers and growth engines in the economy so this could get ugly”

Few things seem to get US regulators as worked up as covenant-lite lending. Having originally been seen as the last gasp of market excess before the crash in 2007, cov-lite loans have returned with a vengeance over the last couple of years. They now account for close to 70% of all new lending in the US leveraged loan market.

It is primarily this development that the contentious leveraged lending guidelines introduced by the OCC, the Fed and the FDIC last year (which focus on four areas – enterprise value, covenants, cashflows and leverage multiples) were designed to tackle. While the guidelines themselves have generated fierce debate over their much-flagged leverage cap, what the regulators really want to see is the return of covenants to lending – and fast.

The three regulators released revised leveraged lending guidelines in March 2013. The new rules stated that a leverage level of six times total debt to ebitda is of concern and that transactions should not be undertaken where the borrower has a total debt greater than four times ebitda or the ratio of senior debt to ebitda is greater than three times.

 Total leverage at origination (loans written after June 1, 2013)

The guidance covers leveraged lending where proceeds are used for buyouts, acquisitions or capital distributions, and is applied whether loans are held in a portfolio, marked for distribution or purchased participations.

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