Recent Regulatory Announcement May Increase Leverage Levels on Buyout Loans

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Further to our March 2, 2018 article, where we reported that Joseph Otting, the head of the Office of the Comptroller of the Currency (the “OCC”) cast doubt on the authority of the Leveraged Lending Guidance (the “Guidance”), the OCC announced recently through a joint statement with four other federal agencies that “supervisory guidance does not have the force and effect of law, and the agencies do not take enforcement actions based on supervisory guidance.”  Instead, they “outline[s] the agencies’ supervisory expectations or priorities and articulate the agencies’ general views regarding appropriate practices for a given subject area.”  In this joint statement, the agencies clarified that their intention is to “limit the use of numerical thresholds or other ‘bright-lines’ in describing expectations in supervisory guidance.”  These thresholds are more like examples and not requirements, the agencies said.

Introduced in 2013, the Guidance largely had been implemented by the regulated leverage finance sector as a set of baseline “rules” intended to reduce leverage.  The Guidance encouraged pro forma leverage ratios at or below 6x and companies were expected to be able to amortize at least 50% of its debt within five to seven years of closing.  However, with funding from regulated and unregulated sources, leverage for buyouts increased to 7.09x this past quarter, according to the LPC.  This is the first time leverage has exceeded 7.0x since the fourth quarter of 2007, according to this source.