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 The Office of the Comptroller of the Currency has already told
banks to avoid some of the riskiest junk loans to companies, but is
alarmed that banks may still do such deals by sharing some of the
risk with asset managers.
"We do not see any benefit to banks working with alternative asset
managers or shadow banks to skirt the regulation and continue to
have weak deals flooding markets," said Martin Pfinsgraff, senior
deputy comptroller for large bank supervision at the OCC, in a
statement in response to questions from Reuters.
Among the investors in alternative asset managers are pension funds
that have funding issues of their own, he said.
"Transferring future losses from banks to pension funds does not aid
long-term financial stability for the U.S. economy," he added.
The breadth of the statement from the OCC is unusual because it
technically oversees banks and not asset managers.
Regulators are eyeing a number of risks to the financial system as
they aim to prevent a repeat of the mortgage bubble that spurred the
2008-2009 financial crisis. They are not comfortable with different
players sharing risk if the total level of risk in the system is
getting dangerously high.
That may be happening with leveraged loan issuance, which hit a
record $1.14 trillion in the U.S. in 2013, up 72 percent from the
year before, according to Thomson Reuters Loan Pricing Corp (LPC).
A measure of the riskiness of these loans has also been rising — the
average size of the debt for companies taking these loans in 2013
was 6.21 times a form of cash flow known as EBITDA or earnings
before interest, tax, depreciation and amortization, up from 5.86
times in 2012 and the highest since 2007, LPC said.
The OCC's comments show how emboldened regulators now feel as they
seek to curb threats to the financial system. Under the 2010
Dodd-Frank financial reform bill, the OCC, the Federal Reserve and
the Federal Deposit Insurance Corporation are among the regulators
that belong to the Financial Stability Oversight Council, which is
charged with finding and stopping potential sources of financial
crashes.
It remains to be seen what tools bank regulators belonging to FSOC
can use when dealing with non-banks.
Meredith Coffey, executive vice president of the Loan Syndications
and Trading Association (LSTA), which counts alternative asset
managers among its members, declined to comment on the role of the
alternative asset managers in leveraged finance.
No major asset manager would comment for this story. Some
alternative asset managers carrying out private equity deals,
including Blackstone Group LP, Apollo Global Management LLC, KKR &
Co LP, Ares Management LLC and Carlyle Group LP, have credit
investment arms and business development companies that have been
financing leveraged buyouts as banks pass on some of the deals.
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The OCC, Fed, and the FDIC issued guidelines to banks last year to
limit their risk-taking for leveraged loans. But regulators are no
more sanguine with asset managers taking on this risk given their
investors include underfunded public pension plans. They are also
worried about the growth of the so-called shadow banking sector,
which includes non-bank lenders such as hedge funds and money market
funds.
Officials at the Federal Reserve and the FDIC declined to comment.
THE JUNKIEST JUNK
Regulators are most alarmed about leveraged loans to companies with
the poorest credit quality. Many of the loans helped to finance
buyouts and to fund payouts to private equity firms in the form of
dividends.
The regulators' guidelines to banks last year called for borrowing
companies to be able to pay down all of their senior debt in five to
seven years, or to be able repay half of their total debt in a
similar time frame. These have been followed up by individual
letters to some lenders.
Debt levels where total borrowings are more than six times EBITDA,
after asset sales, may also be viewed as problematic, regulators
said.
As a result, banks appear to be paying some heed to regulators'
warnings, and are becoming increasingly selective about which
highly-leveraged U.S. company loans they are willing to underwrite.
That's where asset managers believe they have an opportunity.
Besides doing deals that banks turn down, alternative asset managers
have been exploring ways to team up with banks to share risk on the
deals, including ways for the funds to be the first to take losses
if the loans head south.
And the vast majority of deals that alternative asset managers help
finance are in the so-called middle market, typically involving
companies with revenue of less than $1 billion. But many of the
credit funds have aspirations to do bigger deals.
Some bigger deals are getting done now. For example, when buyout
firm Sycamore Partners agreed to buy apparel retailer Jones Group
Inc in November for $1.2 billion, KKR's credit investment arm
committed 70 million pounds ($116 million) in debt and $60 million
in equity financing for the deal, according to a regulatory filing.
(Reporting by Greg Roumeliotis; editing by Dan Wilchins, Martin
Howell and Eric Walsh)
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