The investigative arm of Congress said Thursday that US bank guidelines on leveraged lending are subject to Congressional review, clearing the way for them to possibly be overturned.
The US Government Accountability Office said the guidelines, which critics say have hampered the leveraged debt market, are under the purview of the Congressional Review Act of 1996, which they would not be if the GAO had deemed them to be less formal instruments of policy.
The decision could have profound consequences for leveraged buyouts, or acquisitions that typically load the companies being bought with a lot - and sometimes too much - debt.
The guidelines, crafted after the last financial crisis, urge banks not to make loans to companies with a debt-to-earnings ratio greater than six times - or to companies unable to pay down their debt quickly.
Market participants say the guidelines effectively require banks to abide by them or face scrutiny from regulators.
“We certainly turned away deals because of the guidelines,” said one leveraged finance banker at a regulated institution.
The GAO’s decision followed a request in March from US Senator Pat Toomey, who suggested that they functioned as law - and thus usurped the prerogatives of Congressional lawmakers.
Toomey asked the GAO to determine whether they amount to a formal rule that could then be reviewed - and even voted down - under the 1996 law.
In its response on Thursday, the GAO said it was indeed a rule “subject to the requirements of the CRA”.
The Federal Reserve, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency - the agencies that serve as the main US bank regulators - announced the guidelines in 2013.
They argued that the guidelines did not rise to the level of a rule.
“Agencies have a responsibility to live up to their obligations under the Congressional Review Act. When they don’t, Congress should hold them accountable,” Toomey said Thursday.
“I will explore steps to do so.”
CHANGE AHEAD?
The decision could reshape the competitive landscape, as banks such as Jefferies and Nomura not regulated by the agencies have been able to win market share in the LBO space from regulated banks that have been hemmed in by the guidance.
“Reversing this guidance would be positive for the bigger domestic and foreign banks active in New York as they could once again make larger leveraged loans,” Jaret Seiberg, an analyst at Cowen and Company, wrote in a note on Thursday.
“This would likely come at the expense of the non-bank financial firms that have stepped into this business.”
Market participants now must wait to see if Congress will take up the matter and if the agencies will opt to start fresh and submit a new version of the guidelines.
Richard Farley, chair of the leveraged finance group at law firm Kramer Levin, said it was likely that the agencies would come up something “dramatically less onerous”.
“It almost certainly means that there will be an easing of the regulatory burden on regulated banks that make leveraged loans,” he told IFR.
Representatives for the OCC and the FDIC said the agencies are reviewing the GAO’s findings. A spokesman for the Federal Reserve declined to comment.
Some in the market expressed doubt that Congress could muster consensus to get rid of the guidelines altogether, given that memories of the carnage of the financial crisis are still fresh.
“This could be potentially politically fraught,” said Jacques Schillaci, a lawyer at Linklaters who focuses on advising US banks.
Cowen’s Seiberg warned a vote in Congress to void the guidance could create a “race to the bottom” on leveraged lending standards.
He said a Senate confirmation of Joseph Otting at the top of the OCC could be a more likely path to loosening the existing guidance.
More pressure on the agencies could also come directly from the White House.
In a report to President Donald Trump in June, the Treasury Department argued the guidance should be re-issued for public comment and refined to reduce ambiguity.
“Irrespective of what Congress does, there are things that need to be tweaked,” said Elliot Ganz, general counsel of the Loan Syndications and Trading Association.
“We agree with the Treasury position that banks should have more ability to manage their own portfolios and their own credit risk.”