In the Trump era, Wall Street banks have been testing the limits of what they can get away with in piling risky loans onto highly indebted companies. They may have finally crossed a line.
A top Federal Reserve official fired a rare public warning Wednesday, saying that banks appear to be chasing increasingly dangerous deals and foregoing protections against borrowers going bust.
“There may be a material loosening of terms and weaknesses in risk management,” Todd Vermilyea, the Fed’s head of risk surveillance and data, told bankers at a conference in New York. “Some institutions could be taking on risk without the appropriate mitigating controls.”
The warnings come after watchdogs have spent most of the year expressing confidence about the health of the $1.3 trillion market for leveraged loans. They acknowledged that some firms were putting together transactions that were risky by the standards of just a few years ago, but said it was happening outside the tightly regulated banking sector, thus mitigating threats to the financial system.
For now, the Fed might not be doing much more than waving caution flags. Federal regulators have made clear in recent months that banks aren’t likely to face punishments for financing risky loans.
Higher Leverage
What changed? Deals like one from September in which underwriters including Citigroup Inc., Morgan Stanley and Goldman Sachs Group Inc. joined KKR Capital Markets in arranging $6.7 billion of loans and bonds in the buyout of Envision Healthcare Corp.
That saddled Envision with a debt load that was around seven times a measure of its earnings, a level well above the six times limit that regulators offered as guidance for banks in 2013. More and more loans are leaving borrowers with debt above that limit.
Loosening regulation of Wall Street has been a central theme in Washington under President Donald Trump. On leveraged lending, the industry got an assist last year when regulators had to step back from the 2013 guidelines, which had driven a number of transactions to nonbank lenders.
At the prodding of Republicans in Congress, the Government Accountability Office reviewed the guidance and determined that the Fed and other agencies had overstepped their authority and needed congressional approval for it to be a rule.
Following the decision, Comptroller of the Currency Joseph Otting said banks could do as much leveraged lending as they wanted provided they had sufficient capital to offset the risks, and it doesn’t impair their soundness. Just last week, Otting said the banking industry had “really kind of stayed on the rails” and that private-equity firms were doing the riskiest leveraged lending.