Withdrawal of Leveraged Lending Guidance Opens a New Road for Banks

The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation have pulled the old rules on leveraged loans. The rules had limited how banks handle loans to heavily indebted companies — many deals that exceeded six times a company’s yearly earnings drew fast pushback from regulators.

The agencies have now ended the guidance, and the 2014 FAQs. This has cleared a path that banks have not seen in more than 10 years.

The change is big. It follows other moves that unshackle how banks use their balance sheets. Banks now can make these loans with fewer limits. They can take on deals that used to raise red flags. The move definitely signals a lighter touch from regulators.

The change, which may affect lenders that serve consumers and small businesses, also adds to concerns that looser rules may draw more bank money to large corporate deals. Banks may pause funding warehouse lines used by nonprime lenders.

Big company loans can pay a bigger return than these warehouse lines, so banks may choose the higher pay deals when they can. Less funding increases costs and rations availability. Lenders will also need to look for cash from private funds as well as bond deals, which will likely cost more and pressure margins.

Subprime lenders may squirm as banks experiment with new deals. Some may feel nonplussed immediately while others will see it build over time. Cash may move toward corporate loans. These deals can offer higher returns during good markets, but they may squeeze small lenders.

Market Impact

Banks may respond fast, and some may move before the market settles. Some may return to large corporate deals, and others may increase the size of the loans they already fund. Banks will spend more money on corporate risk, and they may cut funding for consumer loan buyers. Terms will likely get more stringent.

The end of leveraged lending guidance could bring several changes to how banks operate.

Nonbank lenders are likely to endure increased reviews from warehouse partners. Banks may raise the rate on warehouse lines. They may cut advance rates or ask for more cash. They may also shorten how long lenders can use a line. Higher costs may materialize in places that rely on bank funding.

This trend may grow as banks choose large corporate deals that offer strong returns. Lenders that need flexible cash flow tools may have to settle for fewer choices. Some may draw upon outside funds that charge higher rates.

Funding Pressure

Banks look for the best way to use their balance sheets, and deregulation makes this easier as banks select deals that may offer strong returns. This may also change how banks buy ABS bonds. They may buy fewer bonds when they put more money into corporate loans.

This may raise costs for lenders that package and sell loans. They may move part of their funding toward private credit and other high cost sources. They may then choose deals that look strong in a rising market. If they do, subprime and small business lenders may see fewer funding channels.

This may raise prices for credit seekers and add strain during slow months. In addition, it could limit access for nonprime borrowers when lenders deal with higher funding costs. It may also limit access for nonprime borrowers when lenders deal with higher funding costs. 

It will likely be harder for lenders to wrangle stable terms. Small lenders that serve riskier borrowers may deal with more pressure. That’ll happen if banks turn to higher-return deals. These lenders work with small margins so they need a steady stream of cash from banks.

Deregulation Trend

Banks have seen several rules eased this year, which makes it simpler for banks to take on bigger deals. They also shape how banks choose between high return loans and other uses of their money. The changes impact lenders that rely on banks for steady cash. 

It’s quite the laundry list:

• The Fed eased how it scores bank supervision. This gave banks more room when they take on large deals.
  
• The OCC made parts of its exams less strict. Banks now face fewer questions when they make higher risk loans.
  
• The CFPB slowed several actions this year. This added to the sense that rules are lighter.
  
• The end of the leveraged loan guidance fits these steps. Each one buried a rule that previously restrained banks.

These exemplify a larger trend. Looser rules may guide how banks act in the months ahead. In addition, they may affect how they split money between corporate loans and warehouse lines. These choices can push up funding costs for lenders that serve nonprime borrowers.

Bottom Line

The end of the leveraged lending guidance is a milestone. It adds to a year filled with steps that decrease limits on how banks use their capital. Banks may take on more corporate risk. They may offer less support to lenders that serve nonprime borrowers.

The change comes during a time of broad deregulation. Banks will seek new returns across the credit world.