Leverage Is Back: Wall Street Takes Cues From Hands-Off Feds

(Bloomberg) -- Three words have finally set Wall Street deal-makers loose: President Donald Trump.

Officially, the Trump administration has yet to rewrite Obama-era rules restricting how much debt banks can pile onto companies in buyouts. But a spate of recent transactions shows financiers are letting go of their concerns about the lending guidelines that had tied their hands in recent years.

And they’re doing so just as Wall Street’s buyout titans are demanding greater sums of cash so that they can take down bigger game -- like Blackstone Group LP’s $17 billion purchase this week of the financial-data arm of Thomson Reuters Corp.

“If the cops say you can have open containers in Central Park, what do you think is going to happen,” said Richard Farley, who runs the leveraged-finance practice at Kramer Levin Naftalis & Frankel LLP. “Listen to all the comments and the signals are clear -- the bright line features of the guidance have been cast into doubt.”

Take Carlyle Group LP’s buyout of workers-comp vendor MedRisk last month. Barclays Plc helped underwrite $705 million of debt to finance the deal, pushing the company’s borrowings to levels that Moody’s Investors Service estimates will reach seven times earnings.

It’s the kind of deal that big banks like Barclays had been turning down in recent years -- allowing the less-regulated Jefferies Group to suddenly become America’s biggest arranger of buyout debt -- because it would have likely caught the attention of regulators. The rough interpretation of the guideline, bankers at the big firms say, was that any deal with a leverage ratio well above six times earnings would attract unwanted attention.

Fading Angst

That angst is fading quickly. Goldman Sachs Group Inc., UBS Group AG and Bank of America Corp. have all arranged debt for buyout deals over the past few weeks that pushed leverage levels. And then there were the deals for Avantor Inc. and anti-virus software maker McAfee LLC from last fall that raised eyebrows in the market.

Last year, 6.6 percent of all LBO deals had leverage ratios of at least seven times, up from just 3.4 percent in 2016, according to data from LCD, a unit of S&P Global Market Intelligence.

Underwriting standards "adhere to the guidelines" and there are no plans to change those standards at our bank, according to A.J. Murphy, head of global capital markets at Bank of America. Other banks on similar deals declined to comment.

Previous Excesses

And, to be clear, it isn’t that banks have suddenly reverted to the heady days before the financial crisis, when private equity firms loaded companies like radio broadcaster Clear Channel and Texas power producer Energy Future with debt loads so massive that they were forced to restructure.

The 2008 buyout of Clear Channel, now known as iHeartMedia Inc., pushed its debt to more than eight times earnings before interest, taxes, depreciation and amortization, or Ebitda. The company skipped a bond payment this week and may need to file for bankruptcy if it can’t cut a deal with its lenders.

It was excesses like these that prompted the Obama administration to pursue tighter leveraged-buyout restrictions as part of their crackdown on the financial industry in the aftermath of the global crisis. Officials at the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation issued new guidelines to make sure banks weren’t taking on too much risk in buyout deals.

Open Markets

Those principles also took into account how quickly companies can pay down the mountain of debt they had taken on. But it is increasingly being felt that federal regulators are willing to refrain from using veto power and instead leave the decision in the hands of banks to exercise their own credit judgment, according to interviews with senior leveraged finance bankers.

To add to the renewed confidence is the incredibly open credit market that’s willing to gobble up any new debt deal brought to it, which has paved the way for the jumbo Blackstone deal.

And it comes at a time when across financial markets there are signs of banks and other institutions beginning to push the envelope.

“Amid a stronger market backdrop where people feel it’s more willing to absorb more aggressive terms, combined with a regulatory backdrop that is clearly more forgiving," said Mike Terwilliger, a New York-based portfolio manager at Resource America Inc., which oversees more than $9 billion. "I think this is the time you’re going to see some of those previously established boundaries get pushed a bit.”

Last fall, the Government Accountability Office said the lending guidelines needed to be subject to congressional review, leaving their applicability in question. That was followed by banking regulators telling Congress that they plan to reissue guidelines that previously forced regulated banks to shun risky deals.

"I tend to think large players in this marketplace have good information on what regulators are thinking, and I think there’s a consistent view that they’re not going to be punishing you on the basis of leverage levels," Farley said. "It isn’t just navel gazing. it’s informed decision-making."

--With assistance from Lisa Lee

To contact the reporters on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net, Sally Bakewell in New York at sbakewell1@bloomberg.net, Kiel Porter in New York at kporter17@bloomberg.net.

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Elizabeth Fournier at efournier5@bloomberg.net, Shannon D. Harrington, Kenneth Pringle

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