Federal regulators on Friday (5 December) relaxed underwriting guidelines banks often cited as a barrier to leveraged lending and a boon for private credit. But multiple market players told 9fin they aren’t expecting syndicates to immediately jump back into the higher-leverage deals that have become the hallmark of direct lenders.
The Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) issued the joint statement rescinding a 2013 ruleset that largely governed underwriting standards for bank institutions. Notably, the Federal Reserve joined the FDIC and OCC in issuing the guidance in 2013 but did not join the latest rescission.
Eagle-eyed readers might remember that Treasury Secretary Scott Bessent alluded to this in May at the Milken Institute Global Conference, saying the OCC and FDIC heads would “redo” regulation around capital markets.
The guidance recommended higher scrutiny for loans that would post leverage higher than 6x. Banks were also guided to assess if an issuer could delever by at least half over the life of the loan as part of the underwriting process.
But the agencies, in a statement, cited “overly restrictive” regulations on banks, and as a result pushed “this type of lending outside of the regulatory perimeter.”
Traditional bank institutions are now permitted to underwrite loans to riskier companies that had previously been required to borrow from private markets.
NYU Stern professor James Finch said the 6x mark was an arbitrary restraint for credits in certain sectors that require high upfront leverage but showed consistent revenue generation down the line. Finch, a former US leveraged loan head at Credit Suisse, said he had to pass on deals due to the ire of regulators.
The restrictions sidelined banks from lending to those areas of the market, but didn’t cut off lending to firms deemed too risky based on their pro forma leverage.
“It allowed the markets to arbitrage around regulated entities,” he said. “Capital still flows and it’ll find a way to find a home.”
Tails are up, but no pouncing yet
Market players initially viewed the guidance pull as a tailwind for debt issuance next year. Bank of America analysts expect their forecast of $470bn of loan issuance will improve next year — particularly in 1H 26 — via PC to BSL refinancings.
But sellsiders speaking to 9fin said they were not racing to lever up deals, with one telling 9fin that it was too early to tell where the new regulatory redlines were. Another noted that the Fed, FDIC, and OCC will keep scrutinizing loans through uniform metrics by the Shared National Credit Program, which covers syndicated loans above $100m.
Nor is it immediately clear that the buyside and other credit market players will immediately stomach higher leverage. One banker said deals will still need to get high enough ratings from ratings agencies to draw investor attention. CLO buyers in particular are sensitive to the ratings of prospective loans as they issue debt themselves.
The administration’s timing also raised the eyebrows of one bank source, noting that the credit world is still grappling with the fallout of the First Brands and Tricolor.
“It’s entirely possible that they rescind these guidelines and management says, ‘I see the door’s open, but I’m not walking through it’,” they said.
King and Spalding finance attorneys Carolyn Alford and Kimberly Prior said banks should be more competitive in the marketplace for higher-levered deals due to their relatively lower cost of capital. However, they noted regulators still expect banks to set their own standards around lending and are still liable to government agencies in ways private lenders aren’t.
“We think adjustments in leveraged lending by banks will be gradual rather than sudden, remaining mindful of general principles of prudent risk management and of recent losses from higher leveraged deals struggling to perform,” they said.
Where the Street has had new names
In the years since the 2013 guidance was approved, private credit managers have changed the structural landscape of Wall Street. Direct lenders have progressively chipped away at the banks’ market share of leveraged buyouts, developing strong relationships with repeat borrowers and offering a differentiated product.
“On paper looks like it should help a bank compete, but I don't think we're too stressed over here. I think there's just too much of a long-term positive shift towards the private markets,” one private credit manager told 9fin.
Private credit is often pitched deals after they struggle in the BSL market. Last week, for example, 9fin reported that RBC is looking to private credit to offload debt after Novacap’s buyout of Integral Ad Science failed to garner enough syndication interest. Higher spreads and a more lenient risk appetite allow direct lenders to take riskier credits. Banks are also required to hold more capital as a cushion against potential loan losses.
Even if competition between banks and private credit firms is quite heated at the moment and the relaxation of leverage rules will increase that, those in the market say both sides will still serve as a complementary offering for sponsors.
“It’s not a zero-sum between banks and private credit,” Davis Polk financial institutions partner David Portilla said. “I think to the extent banks can step in and provide credit in those cases, and so can private credit funds, borrowers will have a choice between different lenders depending on what makes the most sense for a particular transaction.”
Prior to the announcement, competition between banks and private credit firms had seen steady growth. Both banks and private credit firms submitted bids for Hologic, and the Blackstone and TPG-backed healthcare company chose the BSL option. The two lending strategies eventually found a way to work together, however, as the bank package includes a sizeable $2bn second-lien tranche for direct lenders.
Although competition between lenders often results in financial incentives like spread compression, 9fin has reported on additional ways lenders can sweeten deals, including loan amortization holidays and longer revolver maturities. As the overlap of eligible deals increases, innovations outside pure economic terms could continue, Johns Hopkins adjunct finance professor Jeffrey Hooke said.
“One way they could compete is cutting the fees and offering more attractive restrictive covenants,” Hooke said.
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