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US regulatory agencies could curb buyout leverage

31 Mar 2014

Updated supervisory guidance on leveraged lending from federal bank regulatory agencies could curb leveraged buyouts of the kind favoured by the private equity industry, hitting buyout firms’ earnings.

The guidance from the Federal Reserve Board, the Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency covers transactions characterised by a borrower with a degree of financial leverage that “significantly exceeds industry norms”.

Leveraged lending has been increasing since 2009 after declining during the financial crisis.

Before the financial crisis, the volume of leveraged credit transactions grew tremendously and participation by non-regulated investors willing to accept looser terms increased, the agencies said.

“While leveraged lending declined during the crisis, volumes have since increased and prudent underwriting practices have deteriorated. For example, some debt agreements have included features that weaken lender protection by excluding meaningful maintenance covenants and including other features that can limit lenders’ recourse in the event of weakened borrower performance. In addition, capital and repayment structures for some transactions, whether originated to hold or to distribute, have been aggressive. Management information systems at some institutions have proven less than satisfactory in accurately aggregating exposures on a timely basis.”

US buyout firm KKR recently warned that such measure could potentially impact its returns. In its recent annual report, it said, “To the extent that such guidance limits the amount or cost of financing we are able to obtain for our transactions, the returns on our investments may suffer.”

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