OCC head hammers nail into the coffin of leveraged lending guidelines


Louise Bowman
Published on:

Comments at Las Vegas conference suggest banks ‘should have the right to do the leveraged lending that they want’.


Recent comments by Office of the Comptroller of the Currency (OCC) head Joseph Otting seem to have sealed the fate of the US leveraged lending guidelines, which were introduced by the organization he leads, the Fed and the Federal Deposit Insurance Corporation in 2013.

Those guidelines provoked uproar in the market when they were first mooted, but were grudgingly adhered to by most banks.

They stated that a leverage level of six-times total debt to ebitda was 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.

But speaking at the SFIG Vegas conference at the end of February, Otting stated that “institutions should have the right to do the leveraged lending that they want, as long as they have the capital and personnel to manage that and it doesn’t impact their safety and soundness”.

He said: “When the [idea of the] guidance came out – it was like people were afraid to jump over the line without feeling the wrath of Khan from the regulators. But you have the right to do what you want as long as it does not impair safety and soundness. It’s not our position to challenge that.”

Otting’s opposition to financial regulation is not hard to fathom. Before taking over at the OCC, he was president of CIT Bank, formed by the merger of OneWest Bank and CIT Group in 2015.

He had been at the helm of OneWest Bank, which was under a foreclosure-related consent order from 2011 to 2015. It was one of 12 mortgage servicers penalized by the OCC and the Office of Thrift Supervision for deficient mortgage servicing and foreclosure practices.

OneWest was set up in 2009 out of the ashes of failed lender IndyMac by Treasury secretary Steve Mnuchin.

Players such as Nomura, Jefferies and Macquarie have built their leveraged finance businesses since 2013, often doing transactions that the banks won’t lend to.

The writing for the leveraged lending guidelines seemed to already be on the wall in October when the Government Accountability Office (GAO) put them under review, the result of a request for clarification on their legal status that was made by US senator Pat Toomey. The GAO determined that they were a formal federal rule, not voluntary guidance, and as such could be voted down.

This is music to the ears of leveraged finance banks.

“Banks would welcome a relaxation of these rules as they have seen market share go to alternative lenders,” says one leveraged lending expert. “The debt to ebitda ratio guideline does not take into account debt service. The 10-year rate is half what it was prior to the financial crisis and a relaxation of the rules would be a reflection of this.”

Their removal would be enormously popular on Wall Street.

“Financial institutions are pushing very hard for the rules to be scrapped as leveraged finance is a good business for them. If the rules are scrapped, the market may become more stratified.

“While the banks will be able to consider deals that previously breached the six-times leverage guideline they will gravitate towards those where they may have an existing relationship with the sponsor and a belief that they are willing and able to inject more equity if needed. They will also be focused on larger deals and deals which offer the ability to earn ancillary business.”

Not all leveraged finance bankers have the champagne on ice, however. One senior executive at a large Wall Street bank urges caution. “This is absolutely not 'We have thrown the rules out',” he warns. “That kind of messaging [Otting’s comments] in a public forum indicates a loosening, but it is not the abandonment that the banks were looking for.”

If the guidelines were to be scrapped, it would be a complete reversal of the regulator’s position.

“The agencies recognize, of course, that leveraged funding is an important type of financing for the US and global economies, and the US banking system plays a key role in making credit available by syndicating credit to investors,” said Robert Cote, senior supervisory financial analyst, risk section, at the Federal Reserve when the guidelines were introduced.

“The banks must not unnecessarily heighten risks by originating and distributing poorly underwritten loans.”

He stated: “Revised guidance is designed to address these deficiencies and assist in providing leveraged lending to creditworthy borrowers in a safe and sound manner. Financial institutions must be able to demonstrate that they understand the risks and the potential impact of stressful events and circumstances on a borrower’s condition.

“Supervisors believe that if an institution is not willing or able to implement strong risk-management processes, they open themselves up to significant risk, and they should rethink their participation in this type of lending.”


Now, according to Otting, banks can do “what they want”. So, will they?

“It is hard to know what firms are going to do,” muses one US leveraged finance expert. “My guess is that this isn’t going to be the transformational event that people might think it will be. We won’t see a sea change in attitudes towards transactions: the risk and control apparatus at most firms hasn’t changed.”

The core of bank resistance to the guidelines was their uniform approach – setting restrictions on deals regardless of the sector they were in or the borrower involved. Many felt that whether the borrower is a cyclical or non-cyclical business, whether there is high and recurring free cash flow, long-dated contracts and low capex are all factors that should be taken into account.

“One size fits all is where the tensions were,” says the expert. “There were transactions that supported higher multiples, but different firms had different degrees of anxiety about proposing things.”

The regulators dismissed this view from the outset, stating that leverage levels of more than six times were a problem in most industries.

“Credit risk officers are going to be under pressure to approve deals that were at the guidelines before,” says one banker. “Like any rule, people are always looking for a way to push the envelope.

“I don’t think that it will be a major change, but until the rule is scrapped there will be somewhat queasy loosening. In order for the guidelines to be scrapped it would have to be put before Congress and that won’t happen overnight. They may keep it as a grey area and see how banks react.”

If the guidelines were to be scrapped, it would be a complete reversal of the regulator’s position.

While many US banks will cheer Otting’s words, they do not spell such good news for the unregulated players that have exploited the banks’ restrictions to move into the market. Players such as Nomura, Jefferies and Macquarie have built their leveraged finance businesses since 2013, often doing transactions that the banks won’t lend to. If the guidelines go, so does much of their competitive advantage. 

“Boutiques who made a business out of hanging out on the other side of a clearly demarcated line will now have a problem,” observes one expert. “Clients only picked them because the banks were not there.,” he claims.

“This makes it more difficult for unregulated entities,” agrees another banker. “They emphasize the fact that they are not regulated in order to win deals. But if the guidelines are scrapped this doesn’t result in anyone pulling away from the sector, it just levels the playing field.”

Banks in Europe will be watching developments closely as the European Central Bank (ECB) followed suit and introduced guidance on leveraged lending in November.

“If the guidelines are scrapped, European banks will be putting pressure on the ECB to follow suit and do the same,” says one banker.

Otting’s comments came as the deregulation bill, designed to roll back many aspects of the Dodd-Frank Act, is passing through the US Senate. He has emphasized the need for banks to get back into small-ticket lending as well as leveraged lending.

“We think that banks should get back into the small-ticket lending business,” said Otting. “In 2013, the OCC said that the industry did not want them to be in small-ticket consumer lending. The negative consequence of that is payday lenders, liquor stores and grocery stores filled that void.

“I’m not saying that [these] are bad businesses, but we think that there’s a big market there that’s underserved.”