Bank revenues from underwriting leveraged loans may decline as regulators step up scrutiny of underwriting standards, according to Keefe, Bruyette & Woods.
So far, "banks have not seemed to be affected by the current guidance" from supervisors yet they may "become more vigilant in the future about avoiding high-risk loans," KBW analysts Brian Kleinhanzl, Christopher Mutascio, Brian Klock and Matthew Dinneen wrote in a report dated June 1.
The Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. updated guidance for leveraged lending in March 2013 for the first time in more than a decade. The regulators said debt levels of more than six times earnings before interest, taxes, depreciation and amortization "raises concerns" and that minimum standards should consider a borrower's ability to repay and "delever to a sustainable level within a reasonable period."
Regulators will take "a hard look" at lending standards as they evaluate loans under their annual Shared National Credit exam, currently under way, the analysts wrote. "Banks may be getting additional clarity from regulators at this time about what is, or is not, deemed appropriate."
JPMorgan Chase & Co., Bank of America Corp., Credit Suisse Group AG, Deutsche Bank AG and Barclays Plc are the top five banks in leverage lending based on net revenues and represent about 42 percent of the market, according to the report.
If leverage-lending revenues decline 20 percent from last year and volumes are about the same, then earnings-per-share estimates for 2015 would be hurt by about 1 percent or less for the top 20 banks, the KBW analysts wrote.
Under a "worse case" scenario, with a 40 percent decline in revenues and a requirement that banks hold 50 basis points of capital against lending commitments, then earnings-per-share could fall as much as 5.8 percent for the most-affected banks, according to the report.
"We believe that this is a more likely scenario over a longer time period if regulators are trying to minimize systemic risk by targeting the activities predominantly associated with larger banks," the analysts wrote in the report.
The banking industry has collected an estimated $4.4 billion of fees this year from syndicated leveraged lending following $14.3 billion in all of 2013, according to the report.
U.S. banks face greater risk of reduced revenues from "tighter" underwriting guidance, with traditional broker- dealers poised to benefit from their retreat, according to KBW.
KKR & Co.-owned Brickman Group Ltd. tapped Jefferies Group LLC to lead a $725 million term loan backing its purchase of landscape business ValleyCrest Companies LLC, using a different group of underwriters than the one that arranged debt for its buyout just six months ago, according to data compiled by Bloomberg.
Morgan Stanley, Credit Suisse, Goldman Sachs Group Inc. and Royal Bank of Canada were among lenders who helped finance the buyout, and aren't involved in the financing for the ValleyCrest deal, Bloomberg data show. Some of the original lenders backed away from the deal due to regulatory concerns, two people with knowledge of the matter said last week.
