U.S. banks may soon face tougher regulatory enforcement of guidelines aimed at curbing highly leveraged corporate loans, says Moody’s Investors Service in a new report.
The rating agency says that banking regulators, including the U.S. Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corp. (FDIC), have warned that banks found to have unsound practices, based on leveraged lending guidance released in 2013, could be subject to enforcement actions. This enforcement could follow regulators’ annual review of syndicated loans, which will be released soon, Moody’s notes.
“U.S. regulators are increasingly focused on getting banks to exercise restraint when originating or participating in these loans,” says Allen Tischler, senior vice president at Moody’s. “But U.S. corporate leveraged-loan volume has risen to record levels in recent years and underwriting standards are still loosening.”
Moody’s says it expects regulators to criticize more loans than they did in the last review of these loans in 2013. “There is no sign yet of a reversal in the general trend towards weaker covenants, larger credit lines, narrower pricing and other indications of slacker underwriting,” added Tischler.
And, it says, this could lead to actions, including issuing enforcement orders or assigning low supervisory ratings to banks, that can prevent banks from obtaining regulatory approvals and impede banks’ business plans. However, Moody’s also says that this increase in enforcement would be credit positive for banks, “because more aggressive underwriting has increasingly threatened to undermine the balance sheet repair they have undertaken.”
For corporate borrowers and investors in collateralized loan obligations, Moody’s says that tougher enforcement will likely have a mixed impact. “Tighter lending standards would prevent some companies from borrowing to fund aggressive transactions, such as shareholder distributions, that would drive their leverage higher and increase future default risk, but they could also hamper refinancing for some already weak companies, possibly leading to default,” says the rating agency.
And, it says that the outcome could be similarly mixed for CLOs, “as changes in credit standards for loans would affect both the performance of existing deals and the issuance of new ones.”