Current leveraged lending guidance in the U.S. economy should be “refined with the objective of reducing ambiguity”, according to the U.S. Treasury’s June 12, 2017 report (the “Report”). Despite a robust leveraged lending market reaching $875 billion in 2016, as the report explains, uncertainty about regulatory guidance has tempered leveraged lending, “ultimately result[ing] in fewer leveraged loans by banks.”
The Report’s recommendations are twofold: first, the prior 2013 leveraged lending guidance is to be reissued for public comment with the objective of clarifying (a) the definition of leveraged loans and (b) how exactly regulators will enforce compliance with the guidance; second, greater emphasis is to be given to other factors than the 6.0 times EBITDA leverage ratio. Both recommendations aim to reassure arrangers and investors alike in leveraged lending space of greater consistency.
The Report comes in the wake of concerns that ambiguity around the definition of leveraged loans has stymied further growth in leveraged lending activities. Banks failing to comply with regulators’ demands could face greater scrutiny from regulators and even a credit-ranking downgrade. Given these risks, in combination with unclear penalties for noncompliance, the Report expresses a concern that lending institutions are relying on far more conservative metrics in issuing leveraged loans. Secretary Steven T. Mnuchin has urged that such guidance provide “swift relief, particularly to community banks.”
Whether a review of the guidance will actually benefit arrangers and investors remains unclear. The Report criticizes the 2013 guidance for providing no “bright line” regarding acceptable leverage and instead suggests that banks “should be encouraged to incorporate a clear but robust set of metrics” in lieu of “solely relying on a 6x leverage ratio”. It also heralds greater “consistency in supervision, examination and enforcement.” However, it does not indicate how the new guidance will achieve such greater consistency in enforcement where regulators no longer rely on a single, leverage ratio metric, but rather multiple metrics, yet to be defined. As the impact of the new guidance remains uncertain, parties engaged in leveraged lending activities should remain alert to developments on this front.