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Leveraged-Loan Stress Prompts U.S. to Discuss Ways to Ease Pain

Jesse Hamilton

(Bloomberg) -- Wall Street regulators have discussed ways they could help the stressed-out leveraged-loan market, which is showing signs of a funding crunch from the pain the coronavirus is inflicting on the U.S. economy.

Officials at federal agencies have talked about relaxing lending guidelines to make it easier for banks to extend additional financing to troubled companies, said a person familiar with the matter. One option could be issuing an announcement that makes clear regulators won’t likely object to risky funding arrangements that they’ve previously frowned upon, said the person who requested anonymity because the discussions might not lead to any actions.

Read More: Leveraged Loan Dip Signals Default Surge Amid Funding Crisis

The conversations aren’t related to the Federal Reserve’s ongoing efforts to pump cash into markets besieged by the coronavirus. So any revisions to how regulators supervise leveraged lending wouldn’t be akin to other recent Fed moves, such as its decisions to underpin money-market mutual funds and the commercial paper that corporations rely on to meet short-term funding needs.

Leveraged lending is high-interest financing offered to companies with shaky credit histories. The $1.1 trillion market is exhibiting turmoil not seen since the 2008 financial crisis, with prices plunging on loans made to the most indebted businesses. Concerns are growing that there will be a wave of defaults as pathways close for borrowers to obtain fresh funding.

Talks on adjusting leveraged-lending expectations are preliminary, so it’s not clear the idea will make the cut as regulators roll out new rules and policy statements to respond to the slowing economy.

The Fed, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. have limited reach into the leveraged-loan market, because much of the riskiest financing has been provided to companies by so-called shadow banks that the agencies’ don’t directly regulate.

Read More: Leveraged or Junk, These Risky Loans Thrill Investors

One of the watchdogs’ strongest means of influencing deals is guidance they issued in 2013. It sets suggested boundaries for Wall Street banks, such as not piling more debt on businesses that have already surpassed a high threshold.

However, regulators more recently assured banks they wouldn’t pursue enforcement actions to hold lenders to the guidance, making it little more than recommendations for safe lending practices. Still, the document does impact bank behavior. So if regulators relaxed their expectations by issuing a new statement, it could be welcomed by a leveraged-loan industry that needs liquidity.

Spokespeople for the Fed and OCC declined to comment on the discussions, and the FDIC didn’t respond to a request for comment.

Even if watchdogs do offer relief, the danger signs emerging in the leveraged-loan market may still leave banks hesitant to provide new financing and make investors extremely skittish about buying the debt.

Leveraged loans are most often packaged, or securitized, into so-called collateralized loan obligations, or CLOs. That has raised concerns among some lawmakers and analysts that pain could be spread to investors around the world if there are widespread defaults.

Read More: CLO Spreads Spike to 2009 Levels as Investors Rush to Raise Cash

Another worry is that the significant increase in leveraged-loan issuance in recent years could make any downturn worse, as businesses that tapped the market -- and employ thousands of workers -- falter. The coronavirus threatens to make that fear a reality.

The heads of U.S. financial regulators are scheduled to gather March 23 for a meeting of the Financial Stability Oversight Council. The council -- established after the 2008 financial crisis to ward off future threats -- will discuss “market developments related to the COVID-19 virus,” including in both open and closed sessions, according the Treasury Department’s website.

Any relief for the leveraged-loan market would be yet another example of banking agencies relaxing their guidelines and rules to make as much credit available amid the onslaught from the coronavirus.

The Fed, OCC and FDIC are mulling changes to bank leverage limits and accounting rules. They’ve already urged lenders to dip into the capital buffers they maintain as a defense against financial shocks.

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