April 25, 2014 / 5:14 AM / 5 years ago

Fed, OCC differ in enforcing leveraged lending guidelines

NEW YORK (Reuters) - Some major U.S. banks are privately complaining that they are getting the short end of the regulatory stick when it comes to the profitable business of lending to heavily indebted companies.

A view shows the Federal Reserve building on the day it is scheduled to release minutes of the Federal Open Market Committee from August 1, 2012, in Washington August 22, 2012. REUTERS/Larry Downing

Banking and regulatory sources with direct knowledge of the situation said the U.S. Federal Reserve and the Office of the Comptroller of the Currency (OCC) appear to be taking different approaches to implementing a set of guidelines on leveraged loans, even though they issued them jointly in March last year.

The OCC, a division of the U.S. Treasury Department, is zealously implementing them, while the Fed is more relaxed about it, the sources said. While all major Wall Street banks are regulated by the Fed, the OCC oversees only those with national bank charters, which allow a bank to build a nationwide branch network.

The OCC, for example, is more frequently contacting banks about the issue and querying them extensively over their compliance in loans they make to heavily indebted companies. OCC-regulated banks have also received more verbal warnings as well as official letters demanding fixes than banks that are regulated just by the Fed in the United States, the sources said. Such letters and warnings are the first steps before fines and penalties.

The difference in approach, which even some regulatory sources privately admit exists, has meant that banks such as Credit Suisse Group AG and Goldman Sachs Group Inc are able to be more aggressive in making leveraged loans just because they are regulated by the Fed, not the OCC, the sources said.

As a result, these banks could gain ground at the expense of rivals that are regulated by the OCC, including JPMorgan Chase & Co, Bank of America Corp and Wells Fargo & Co, the sources said.

Complicating matters further, the guidelines are not prescriptive enough and leave room for interpretation, the sources said. One senior Wall Street executive said foreign banks are getting a pass from the Fed on deals that OCC-regulated banks can no longer do.

“We would hope going forward that these guidelines not only get applied to U.S. banks but get applied to international banks as well as for those entities that are not part of the banking system,” Bank of America Chief Financial Officer Bruce Thompson said, when asked about the issue in a conference call with reporters on April 16.

Eric Kollig, a spokesman for the Fed, declined to comment, as did Bryan Hubbard, a spokesman for the OCC. The banks declined to comment.

When the Fed and the OCC, along with the Federal Deposit Insurance Corp, first issued the guidelines in March last year, they wanted all banks to be more conservative about making leveraged loans, a category considered risky because the borrower takes on a lot of debt.

The guidelines were meant to ensure that banks do not end up with too much exposure to such companies and avoid a repeat of the financial crisis when the market for such loans evaporated and banks were left holding the loans.

Now, if the uneven implementation of the guidelines were to continue, it could have the effect of concentrating risk on some banks’ balance sheets.

Some sources said that it could create conditions that could eventually push risky lending entirely out of the regulated banking sector and into the lightly-regulated realm of shadow banking, consisting of firms such as private equity and hedge funds.

The details of how these guidelines are being implemented also provide a window into activity that tends to remain behind the scenes, and it gives weight to an oft-heard complaint on Wall Street these days - that various regulators are not speaking with one voice and that there is often not enough clarity in what they would like banks to do.

Regulatory sources said that there are different opinions on leveraged lending among the different agencies.

One regulatory source who spoke on the condition of anonymity because of rules against discussing internal negotiations publicly said his agency needs to “enforce more discipline on our side of the table.”

Still, the source added that if OCC-regulated banks do lose market share in the coming months, “from our perspective, that’s by design.”

While bankers say that the guidelines are driving more cautious underwriting decisions, it is not yet showing in market data, such as the rankings of banks by the amount of loans they issued.

OCC-regulated Bank of America, for example, has held on to its No. 4 spot in the U.S. leveraged loan league table in the 12 months since the guidance were issued, according to Thomson Reuters data. The top spots continue to be occupied by the same Fed-regulated banks - Barclays Plc, Credit Suisse and Royal Bank of Canada.

Banks won’t know how well they have followed the guidelines until after the regulators conduct an annual review of the banks’ loan books later this year.

Data on the average amount of leverage, which is measured as a ratio of a company’s debt to its cash flow, is also mixed since the guidelines were issued, with no clear direction on whether it is causing banks to be more conservative.

Bankers said they are nevertheless having an effect. In an interview on April 17, for example, Ruth Porat, the chief financial officer of OCC-regulated Morgan Stanley, said her bank was “passing on some deals as have a number of our peers.” Morgan Stanley is regulated by the OCC because it has a national bank charter.

Porat added that the strength in underwriting volumes for more creditworthy companies has more than offset lost revenue from those deals.

Still, it could have been a growing business opportunity for banks at a time when Wall Street’s many other businesses are also under pressure.

Leveraged loan issuance hit a record $1.14 trillion in the United States last year, up 72 percent from the year before, according to Thomson Reuters Loan Pricing Corp. Banks received $1.47 billion in fees in 2013 for U.S. leveraged loans, up 17 percent from 2012, according to Thomson Reuters and Freeman Consulting data.

“It tends to be a higher margin business than say just underwriting a corporate bond,” said Jeff Harte, a bank analyst with Sandler O’Neill.

Harte said that while the boom in high grade corporate debt issuance may be nearing its end, the growth in leveraged loans is “still pretty early stage” in this cycle.

Additional reporting by Peter Rudegeair in New York, editing by Paritosh Bansal and John Pickering

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