Impact of Leveraged Lending Guidance: evidence from nonbank participation in syndicated loans
| DOI | https://doi.org/10.1108/JFRC-11-2021-0099 |
| Published date | 20 April 2022 |
| Date | 20 April 2022 |
| Pages | 567-595 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Natalya Schenck,Lan Shi |
Impact of Leveraged Lending
Guidance: evidence from nonbank
participation in syndicated loans
Natalya Schenck and Lan Shi
Office of the Comptroller of the Currency, Washington, District of Columbia, USA
Abstract
Purpose –The purpose of thisstudy is to examine the impact of supervisory LeveragedLending Guidance
(LLG) (2013–2014) on risk and structure of syndicated loans arranged by the largest US banks with
participationof nonbank lenders.
Design/methodology/approach –This study uses supervisory shared national credit loan-level
data from 2010 to 2015 and DealScan loan origination data and use linear regressions with clustered
standard errors.
Findings –This study finds that the impact of the LLG was mixed. Incidence and risk of leveraged
lending declined following the Guidance, as reflected in lower nonbank syndicate participation.
However, the covenant protections weakened and loan spreads at origination declined. This study also
provides evidence that some risky lending originations shifted to nonbank entities outside of the
banking regulatory environment.
Originality/value –This study contributes and expands literature on the impact of regulatory guidanceon
loan risk, terms and structure,focusing on nonbank participation in syndicated commercial loans.
Keywords Banking regulation, Syndicated loans, Leveraged lending, Nonbanks
Paper type Research paper
1. Introduction
After the 2008 financial crisis, which originatedwith a residential housing crisis, investors’
pursuit of yields amid a sustained period of low interest rates may have contributed to a
rebounding of riskier commercial lending [1]. In 2013, federal regulators strengthened their
supervision of high-yieldleveraged loans. The Interagency Guidance on Leveraged Lending
was issued on March 21, 2013 (“Leveraged Lending Guidance,”(LLG) or 2013 Guidance)
jointlybytheOffice of the Comptroller of the Currency (OCC), the Board of Governors of the
Federal Reserve System and the Federal Deposit Insurance Corporation (FDIC) [2]. A clarifying
publication was issued on November 7, 2014 (further referred to as 2014 frequently asked
questions (FAQs) [3].
Leveraged lending, given its large sizeand complexity, is often conducted in the form of
syndicated loans [4]. Startingwith the large leveraged buyout (LBO) loans of the mid-1980s,
the syndicated loan market has become the dominantway for issuers to tap banks and other
institutional capital providersfor loans (S&P Capital IQ, 2014). The syndicated loan market
has been steadily growing sincethen. According to the Shared National Credit (SNC) annual
reports, which tracks the largest and most complex credits shared by multiple regulated
The views herein are those of the authors and do not necessarily represent the views of the Office of
the Comptroller of the Currency or the U.S. Department of the Treasury.
Impact of
Leveraged
Lending
Guidance
567
Received21 November 2021
Revised18 February 2022
14March 2022
Accepted14 March 2022
Journalof Financial Regulation
andCompliance
Vol.30 No. 5, 2022
pp. 567-595
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-11-2021-0099
The current issue and full text archive of this journal is available on Emerald Insight at:
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financial institutions,the SNC portfolio has grown from less than $2tn in total commitments
in the late 2000s to be above $4tnin 2017 [5].
Nonbanks have been playing an increasingly important role in the syndicate loan
market, particularly in leveraged loans,because nonbanks, facing different levels of capital
regulation than traditionalbanks, can afford a different tradeoff than banksin the risk-yield
frontier [6]. As a result, loans to leveraged borrowers, especially to the borrowers whose
credit ratings are speculative grade and who were paying premiums above London
Interbank Offer Rate (LIBOR), are the ones that attract the interest of nonbank term loan
investors (S&P Capital IQ, 2014) [7]. Given the US banks’limited direct exposure to
leveraged loans, the leveraged loans held by the banks “do not appear to present notable
risks to financial stability.”However, economic downturns could negatively impact
nonbanks’lending and reduce access to financing by nonfinancial firms (Congressional
Research Service, 2019).
While several studies have analyzed thevarious aspects of the syndicated loan market,
our paper is more closely related to Calem et al. (2020) and Kim et al. (2018).Calem et al.
(2020) examine the effect of prudential policieson the supply of credit in the USA, including
the impact of 2013 LLG on speculative-grade syndicatedloan originations using SNC (large
corporate syndicated credit [LCSC]) data. They find that bank originations of speculative
credit (term loans) declined significantly following 2014 Guidance clarification. Primary
focus of our study is the impact of the 2013 Guidance and 2014 FAQs on the loan syndicate
structure and share of nonbank funding within the syndicates that include participation of
the regulated banks.
Kim et al. (2018) provide an in-depth analysis of the impact of loan syndicatio non t he
entire leveraged lending market and conclude that the 2013 LLG achieved the goal of
reducing leveraged lending at the banks but may have been less successful in
improving the stability of the financial system. Our study, using confidential
supervisory data on banks, focuses on the effect on syndicate loans arranged by banks,
complementing the existing studies. One distinct advantage of supervisory data used in
our study is that it have accurate information on participation, including the exact
dollar commitment, of each syndicate participant. These data not only include loan
origination information but also follow the loan syndicate performance and provide
participation structure, such as a listing of the syndicate’sa gent and its participants, on
a quarterly basis. Exploiting the strength of our data, we focus on nonbank
participation as a central variable to capture the risk in syndicate facilities originated
by the regulated banks.
While our supervisory data have detailed information on nonbank participation in
syndicate loans originated by the regulated banks, there is no consistent definition of
leveraged loan across participating banks. DealScan data, containing information on an
important variable, spread over LIBOR, help us to define leveraged lending more
consistently in our data sample. DealScan also contains information on covenants at
origination, another critical dimension of risk in leveraged lending. Neither the leveraged
lending industry nor banking regulators offer a single definition of a leveraged loan.
Because LCSC data do not have borrower rating or spread information, we use a loan
purpose to define a leveraged loan in the first portion of our analysis. Then, in our merged
sample with DealScan, we use an alternate definitionof leveraged lending, LIBOR spread at
origination.
We find that nonbank participation in the syndicates reported by the largest regulated
depository institutionspeaked during the “uncertainty”period after the issuance of the 2013
Guidance and declined significantly afterregulatory constraints on leveraged lending were
JFRC
30,5
568
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