* Idea is to curb aggressive lending
* Follows rebuke of Credit Suisse
* Leverage over 6x seen as a problem
Having already turned up the heat on banks after rebuking Credit Suisse, regulators will now be able to dole out punishments quickly if they deem that these guidelines have been contravened.
“Forgiveness is easier to get than permission,” said Richard Farley, a leveraged finance partner in law firm Paul Hastings.
“Monthly audits mean the regulators can tell the banks to stop right there and then, and tell them the consequences if they don’t.”
Farley said there was a whole array of punishments the regulators could deliver.
“They could change the CAMELS rating of a bank, which measures its compliance and risk management and determines whether it is safe and solvent and could impact a bank’s cost of capital if lowered,” he said.
“They could also get tougher on approving bank’s capital plans and their ability to pay dividends, as well as fines. They could even revoke a bank’s Charter and remove their membership of the Fed,” said Farley.
Until very recently, the Federal Reserve, the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency (OCC) have monitored banks’ behavior annually in Shared National Credit (SNC) reviews that take place over the summer.
The focus of the audits will be on whether banks are adhering to guidelines, spelled out in March 2013, which say that a loan can be criticized or considered “non-pass” if a company cannot amortize or repay all senior debt from free cash flow, or half of its total debt, in five to seven years.
Leverage over six times is also seen as problematic.
The Fed, the FDIC and the OCC were not immediately available for comment.
Tightening The Screws
Bankers, who have complained for months about an uneven playing field between banks watched by the OCC and the Fed, welcomed the news.
“All the banks want is a level playing field and more consistent feedback about what doesn’t fit inside the box. There’s still too much left for interpretation at the moment,” said one market source.
“This means banks will not have to wait another year for feedback following the SNC review. There is a lot more ongoing feedback and the regulators in general are just being more active…and giving guidance that is more specific.”
Two market sources said the regulatory audits were monthly.
“Regulators are asking dealers to provide them with monthly reports of things that have closed during that month,” said one.
“They are looking at the deals that have closed, relevant credit metrics and amortizations. Rather than relying on third party information providers, regulators are gathering the information themselves.”
The audits are understood to be more broad based, and go beyond just looking at loans that banks have made, in order to get a better understanding of how each lender views different credits and how their business operates as a whole.
Another market source emphasized how regulators are already embedded in banks, by drawing comparisons to the overhaul of asset-backed security lending after the financial crisis. The focus now, he said, had just shifted to leverage lending.
“The audits look at the deals the banks have turned down, look at how the banks rate and classify each loan, and the process they go through to approve the credit. It’s about looking at the deals banks decide to do as well as those they don’t,” said the first source.
There is no doubt, however, that banks still have different interpretations of what the guidelines mean and which deals to push on.
Credit Suisse has been seen as the worst offender but JP Morgan caused a stir last week when it teamed up with unregulated lenders to underwrite a highly leveraged financing backing the $4.3 billion acquisition of business software maker Tibco.
Market sources said that the deal could contravene regulatory guidelines, as the leverage is well in excess of eight times.
Another source, however, said that JP Morgan must have been in close dialog with regulators before signing up for the deal.
Two other private equity firms have also stepped up to underwrite the Tibco buyout. Two market sources named Apollo as an underwriter on the deal, and a third named Merchant Capital Solutions, a capital markets business created by the Canada Pension Plan Investment Board, KKR and Stone Point Capital.
Apollo and KKR declined to comment.
Some people said that dynamic could become more common as regulatory moves shift risk away from banks into the shadow banking sector.
“If banks are living in fear of regulators constantly, this could accelerate shadow banking stepping in to take their place,” said Farley.
Reporting by Natalie Harrison and Michelle Sierra of Reuters IFR Magazine and Loan Pricing Corp.