Leveraged loan market remains uncertain amid increased scrutiny

Regulators have warned against excessive leveraged lending.

Two weeks ago, the Federal Deposit Insurance Corporation, Federal Reserve System and the Office of the Comptroller of the Currency issued a warning on the practice of leveraged lending as part of its Shared National Credit Program. These loans have declined since regulators began scrutinizing them more closely, but the agencies still cautioned that they can be harmful to the U.S. economy.

As this blog reported at the time, they also published a list of frequently asked questions to help banks comply with new regulations. The administration has been tightening leveraged loan rules in an effort to cut down on lending to companies with low credit scores or debt levels above six times their earnings before interest, taxes, depreciation and amortization (EBITDA).

As part of the report, regulators identified assets they say are at risk of default, and about three quarters of those were leveraged loans. The FAQs clarified several points related to the updated rules, but it is largely still up to the lenders' discretion whether to underwrite potentially risky loans. While the agencies want to discourage these practices, they will be lenient when it comes to evaluating banks based on their leveraged lending.

"The agencies seem to indicate that they understand some of these nuances," said Mayer Brown partner Paul Forrester to Reuters. "Even so, it's clear that there are other companies for which an arranger will not be able to meet the guidelines and we need to come up with a special way to think about them."

Lenders can use loan amortization software to easily assess the risk involved in any potential deal. This will help them comply with all federal regulations and reduce the threat of default.