Compliancex

The heart of financing in many merger and acquisitions is so-called leveraged financing–which really means debt used as a means to backstop a contemplated deal.

Obviously there are inherent risks in these transactions, and as a result, federal regulators intend to revamp rules for banks and other firms that finance M&A’s. The three bodies overseeing these deals, the Federal Reserve, the FDIC, and the OCC, believe the guidelines last issued in 2001 need an overhaul and the agencies are seeking public comments on the proposal by June 8.

In sum, leveraged buyouts will need to be for a “sound business premise” that is built on an “appropriate capital structure” that maintains “reasonable” cash flows and “balance sheet leverage.”

Or, in plain English, there needs to be a good reason to do a deal, and enough cash on hand to complete the transaction so that investors are not left holding junk bonds if a deal turns sour.

Of course, these parameters still leave firms  plenty of room for leverage and given the fact that the market has been quieter since the economic crisis, some regulatory clarity may help restart this sector. As with any other regulatory proposal, there will be a large response from the financial community. And since financial firms are putting up the cash and syndicating the debt backing these plays, that input can lend itself to creating workable guidelines.

But the ultimate goal is to give bank examiners the ability to determine whether banks are meeting the “new” standards. The Wall Street Journal report notes that regulators are concerned about LBO’s that may have “included features that provide relatively limited lender protection” in the event a borrower fails to make payments.

While private-equity backed buyouts often offered “little protection for lenders” their role is far different than more tightly controlled banks and large financial firms. In short, the federal watchdogs will force banks to have more self restraint. Of course, the new capital rules being implemented by Dodd-Frank in the US and the Basel III accord in the EU will see these firms on a shorter leash than before.

Kyle Colona is a New York based freelance writer and a Feature Writer for the Compliance Exchange. He has an extensive background in legal and regulatory affairs in the financial services sector and his work has appeared in a variety of print and on-line publications.