ECB warns eurozone lenders of leveraged lending risk

Europe’s top financial supervisor has warned banks they will raise capital requirements unless they reduce exposure to risky lending to private equity acquisitions and other highly indebted borrowers.

Andrea Enria, chairman of oversight at the European Central Bank, said he planned to send a “Dear CEO” letter to the heads of the banks that provide most European leveraged loans to remind them of the regulator’s recommendation. .

“We are noticing some reluctance from banks to follow our guidelines,” he told a news conference on Thursday. “If in the end we are not satisfied with the progress, the stick of capital will be used.”

The eurozone-based banks that were most active in providing European leveraged loans last year were BNP Paribas, Deutsche Bank and Credit Agricole, according to Dealogic data.

The move marks an escalation in the ECB’s efforts to curb risk-taking with this type of lending in the euro zone. Leveraged loans typically fund businesses with high debt levels and poor credit ratings.

The Frankfurt-based regulator issued guidelines in 2017 calling on lenders to limit the number of leveraged loans that exceed six times the borrower’s income, or without some of the traditional clauses giving lenders the right to recover some of their money or renegotiate the terms of the loan if a borrower misses certain profit targets.

Since then, the average level of leverage in the European leveraged loan market has risen to five and a half times earnings, up from five times in 2017, while the proportion of so-called cov-lite loans with protection reduced lenders fell by half to 97 percent.

Ultra-low interest rates have fueled a rise in leveraged loans in recent years, many of which have been issued to fund buyouts backed by private equity groups.

Regulators fear that if economic growth disappoints or borrowing costs rise sharply, heavy debt loads could become unmanageable, accelerating the decline of heavily indebted companies and potentially exposing banks to losses.

The ECB said on Thursday that the disruption caused by a potential rise in interest rates was one of its main concerns, as it published the results of its annual assessment of capital requirements for the 115 lenders in the zone. euro that she oversees.

Enria said that while rising interest rates were generally positive for banks, allowing them to increase their profit margins by lending at a higher rate, he was concerned about the possibility of “sudden shocks” hitting “the marginal areas of banks’ balance sheets where they may have taken excessive risks”.

On a more positive note, the central bank said six banks were below its minimum capital target at the end of last year, up from nine a year earlier.

He said the six lenders had fallen below their minimum capital guidance “due to pre-pandemic structural issues” and would need to rebuild their capital buffers by the end of this year when the temporary relaxation of ECB rules due to the Covid crisis would expire.

Overall, the central bank said non-performing loans declined last year and banks maintained “strong” capital and liquidity positions. But he added that there were still uncertainties about the “future trajectory” of the pandemic and that other risks included cyberattacks, climate change, downward pressure on profitability and disruption caused by the rise in interest rates.

The ECB said “counterparty credit risk management practices are a specific source of concern” after the collapse of the Archegos family office left its lenders with big losses last year. As a result, “several banks have been subject to measures requiring them to review their risk quantification methodologies and broader risk control frameworks,” he added.

Deutsche Bank declined to comment on its leveraged lending business. BNP Paribas and Credit Agricole did not immediately respond to requests for comment.

Dorothy H. Lewis