(Bloomberg) -- European banks preparing to comply with guidelines on leveraged lending will steer clear of the most aggressive deals, but are trying to work out how to remain competitive as some of the requirements appear overly harsh with the penalties for any breach still unclear.
The European Central Bank’s guidelines, which come into effect on Nov. 16, are intended to improve monitoring of leveraged lending that comes under the ECB’s purview in a market that has grown by more than a third in the last three years.
They are also designed to curb excesses in how banks structure deals: a cornerstone is that deals with total leverage above six times must “remain exceptional”.
Loan syndicate desks certainly don’t want to rile the regulators. If they think there is a good reason to go beyond what the ECB is guiding, they will do it, and be ready with a defense -- although they won’t want to do it often, according to a head of syndicate at a European arranging bank, who asked not to be identified because the matter is sensitive.
But some elements of the guidelines are seen as unreasonable and disconnected from the normal day-to-day business of the market. So although European banks may become more cautious in the loans they make, they may choose in some cases to take a loose interpretation.
Points of Debate
Banks are unhappy with various elements of the guidelines. Most commonly flagged are the requirements that when they are calculating total debt, banks must treat shareholder loans as debt, and also that they should include a borrower’s incremental debt capacity that it could potentially raise in the future.
But this definition of total debt could put even conservatively structured transactions above the six times leverage threshold.
Banks will be meeting with regulators in the coming weeks to discuss the guidelines and will be looking for clarity, and there are hopes that the central bank will eventually alter some of the contentious points.
A spokeswoman for the ECB declined to comment.
In the meantime, banks will take a careful but pragmatic line and will hope the regulator shares this approach.
“I think banks will come up with a defensible policy that may not be in accordance with the most cautious reading of each and every point in the guidelines, but that is reasonable and well thought out,” says Christopher Kandel, partner at Latham & Watkins. “My prediction is that the regulator will accept this.”
The biggest uncertainty that European banks face is that they don’t know what penalties the ECB will impose if a bank deviates from the guidelines.
While there are no brightline rules to determine whether an individual deal is a “pass” or “fail” credit, it could be as much as a year until consequences for aggressive lending start to become clear.
Banks look at what happened in the the U.S. market, where the regulators clarified their stance on their own guidelines a year after they were first introduced.
Only a small number of prominent arranging banks are captured by the ECB’s guidelines, so even if these do become more conservative, the European leveraged loan market overall may see little immediate impact on leverage multiples or deal structuring practices.
This is so because many other arrangers -- U.K., Swiss, Japanese and U.S. banks -- aren’t constrained by the ECB and they already compete fiercely for business. Some of these fall under similar guidelines of the U.S. regulators.
However, just as the ECB’s guidelines come into play, the U.S. version could be diluted or might even disappear, after the U.S. Government Accountability Office’s determined last month that the guidelines can be reviewed by Congress.
(Ruth McGavin is a leveraged finance strategist who writes for Bloomberg. The observations she makes are her own and are not intended as investment advice.)
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