A recent challenge to the legality of leverage lending guidance could have broad implications for issuers, underwriters and investors in corporate loans. But the end result could be added complexity, rather than a wholesale easing of restrictions on lending to heavily indebted companies, according to participants at an industry conference in New York.
The guidance effectively blocks banks from making loans to companies that have a debt-to-earnings ratio greater than six times, or are unable to pay down a significant portion of their debt quickly. It was promulgated four years ago, in March 2013, by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and Federal Deposit Insurance Corp.
In March of this year, Sen. Pat Toomey, R-Pa., ask the Government Accountability Office to determine the formal status of the guidelines, arguing that they constituted rules, and not simply guidance, for the purpose of the Congressional Review Act. If the GAO concurs, the rules must be submitted to Congress for formal approval. The CRA allows the House and Senate to disapprove, and effectively undo, agency rules by a simple majority vote within 60 days
Meredith Coffey, executive vice president of the Loan Syndications and Trading Association, called Toomey’s request “a shot across the bow.”
She ticked off the industry’s concerns with the guidance, which is somewhat vague. It generally prohibits banks from lending to companies classified as “no pass” credits, those unable to repay all of their senior debt from cashflow over the next five years. Also, the definition of a leveraged loan, one that results in a company have leveraged of 3x at the senior level and 4x overall, captures many companies considered by credit rating agencies to be investment grade. This forces banks to put the loans in their leveraged portfolios, triggering reporting requirements Coffey described as “onerous,” especially for regional and community banks.
“The classic example is Coca-Cola ... say what you will about sugary drinks, this is not a junk company,’ she quipped during a panel at IMN’s annual conference on CLOs and leveraged lending.
The LSTA thinks it’s likely that the GAO will conclude that the guidance is indeed a rule. “As Toomey pointed out, you can’t call something guidance when it has the effect of a rule,” said Elliot Ganz, the trade group’s general counsel.
What happens after the GAO comes out with its decision “is very much a political question,” Ganz said.
He noted that CRA has been used 13 times so far under the Trump Administration. Each time, it was something former president Barak Obama pushed through at the end of his term, “which is precisely what CRA was meant to do. Here, we have something different; [leveraged lending guidance] was put out in 2013, so it’s been in effect for four years, but because it was never published, it’s subject to the CRA if it’s a rule.”
Travis Norton, policy advisor and counsel at Brownstein Hyatt Farber Shreck, called CRA “a very powerful tool that allows congress to take back power it has conceded to the administrative state.”
Whether Congress would move to reject the guidance is unclear; various law firms have characterized the prospect as either quite possible, unclear. or very likely. Norton is more skeptical, however. He noted that the number of representatives and senators who know what leverage lending guidance is can probably be counted on one hand. “The learning curve is going to be very steep,” he said.
Even guidance survives a vote in Congress, a determination that leveraged lending guidance constitutes a rule will allow various banking regulators to interpret the guidance, and this could muddy the waters, according to Eugene Ludwig, chief executive of Promontory Financial Group and a former comptroller of the currency. “My guess is they don’t do exactly the same thing,” he said. “The problem is that there’ll be volatility,” with regulators at various agencies taking different stances on the safety and soundness of different aspects of the rules.
“At the end of the day [determination that lending guidance is a rule] sends a message in one direction, but it is not a 180-dgree U-turn,” Ludwig said. Rather, “it will add a degree of complexity.”
As banks pulled back on lending to highly leveraged companies, nonbank lenders such as business development companies and private equity firms have stepped in. This direct-lender disintermediation is especially evident in the middle-market debt segment. Ironically, the warehouse capital needs of these direct lenders are funded by banks.
Sen. Toomey has requested a response from the GAO by June 1.