ECB Should Consider Firm Limits On Riskiest Leverage Loans

(Bloomberg) – The European Central Bank is weighing down the riskiest part of bank lending to indebted companies amid fears of a potential market explosion, according to people familiar with the matter.

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Officials at the ECB’s supervisory board have discussed capping newly created highly leveraged transactions to a certain share of individual bank balance sheets, the people said, asking not to be identified as the matter is private. Still, some members are reluctant to go this route if banks can show they are managing risk well, the people said. Talks are in their early stages and caps may not be the chosen action, they said.

The leveraged loan market has collapsed this year, particularly in the United States, as private equity firms pull out of businesses and investors seek to hedge against inflation. Deutsche Bank AG has counted on the lucrative business as a key contributor to its investment bank as a pandemic-triggered trade rally wears off. The German lender could be among the most affected banks if the ECB decides to impose restrictions.

Deutsche Bank’s leveraged lending unit generated more than $ 300 million in revenue in 2020, aided by leading roles in some of the biggest deals of the year, including $ 23 billion in loans to T-Mobile to acquire rival Sprint, according to data compiled by Bloomberg. The bank ranks eighth in leveraged loans in the United States, down from ninth last year, according to data, and fourth in Europe, the Middle East and Africa.

An ECB spokesperson and a Deutsche Bank spokesperson declined to comment.

Although banks have been more active lenders, they tend to sell most of the leveraged loans to investors and keep a small share on their books. For example, Deutsche Bank took out leveraged loans this year that would represent around 4% of its balance sheet, according to data compiled by Bloomberg. But leveraged debt capital markets accounted for just 1% of the company’s € 445 billion loan portfolio at the end of June, according to documents filed by the company. One of the concerns for regulators is whether willing buyers will be there in the event of a downturn.

Even before the pandemic raised the prospect of a wave of corporate failures, the central bank had urged companies to be cautious about leveraged finance.

In guidance released in 2017, the ECB defined leveraged finance as loans to businesses that result in debt amounting to four times the borrower’s earnings before interest, taxes, depreciation and amortization. Credit exposures where the borrower is held by one or more financial sponsors, such as private equity firms, also fall under the classification. Transactions with “high levels of leverage” – that is, debt greater than six times EBITDA at the start of the deal – should remain the exception as it “raises concerns” for most industries.

Deutsche Bank reduced the risk in the business after the ECB’s comments, CFO James von Moltke said in July. This came after Bloomberg reported the previous month that the lender faces higher capital requirements if it doesn’t slow the pace of leveraged lending.

European regulators are still concerned about the risk Deutsche Bank and other companies are taking in leveraged loans, according to people familiar with the matter. Barclays Plc, BNP Paribas SA and Credit Suisse Group AG are among Deutsche Bank’s biggest European rivals in the industry, according to data compiled by Bloomberg.

The German bank’s debt origination revenue rose 12% to € 416 million ($ 467 million) in the third quarter from a year earlier. He cited a “strong performance in leveraged debt capital markets, partially offset by the normalization of investment grade debt issuance.”

The ECB plans to prevent the build-up of “unmitigated risks” in leveraged finance by carrying out inspections in banks and taking into account underwriting standards, syndication risk management, appetite for the risk and capital requirements of banks, according to Elizabeth McCaul, a member of the ECB’s supervisory board.

“We are concerned about the increased risk in the leveraged loan market, which is driven by the search for yield in an environment of low and sustained interest rates,” she said Wednesday in a statement. speech. “Leverage issuance has continued to increase in Europe and elsewhere, and this has been accompanied by relaxation in lending standards.”

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