In March 2013, the Office of the Comptroller of the Currency (the “OCC”) of the Treasury Department, the Board of Governors of the Federal Reserve System (the “Board”), and the FDIC issued final guidance on leveraged lending. The guidance can be found at 78 Federal Register 17766. The guidance covered all financial institutions supervised by the OCC, the Board and the FDIC. Among other things, the guidance provided that such institutions should avoid financing takeover deals that putting debt on a company of more than six times its EBITDA “raises questions for most industries.” The OCC, the Board, and the FDIC subsequently sent letters to a number of big banks requesting compliance with the guidelines. Since the guidelines were issued, the regulators have warned that lending standards have deteriorated.

Dealogic reported that banks generated $7.1 billion of fees in 2013 providing financing for private equity deals.

Martin Pfinsgraff, the OCC’s Senior Deputy Controller for large banks, has been quoted as follows:

The impact on private equity, a significant driver of what we see as risky practices, is an intended consequence of our actions.” (Emphasis added.)

Mr. Pfinsgraff also noted that dividend recapitalizations were a focus of the OCC.

Several of the Big Four public PE firms (BX, KKR, APO and CG) have warned in regulatory filings that the guidelines could impact their returns.

Citigroup reportedly did not participate in KKR’s buyout of landscaping company Brickman Group in part because of the new guidelines (the Brickman deal was reported to have a 6.8 times debt-to-EBITDA ratio). Morgan Stanley, Goldman Sachs and Credit Suisse were among the banks that financed the Brickman Group acquisition by KKR, but all three declined to participate in Brickman Group’s acquisition of rival landscape company ValleyCrest (owned by Michael Dell’s investment firm).

Jefferies Group, not regulated by the OCC, the Board or the FDIC, is leading the ValleyCrest financing. Jefferies did not participate in the original Brickman Group financing.

J.P. Morgan and Bank of America reportedly also declined to participate in Carlyle’s acquisition of Johnson & Johnson’s blood-testing unit due, in part, to the new guidelines (debt to EBITDA in that deal was reportedly at 6.9).

New U.S. leveraged buyouts with a debt-to-EBITDA ratio above 6 were 27% of transactions for 2013, the highest percentage since 2007 (when the percentage of such deals was 52%).

Interestingly, the lending operations of the larger PE firms have seen expanding opportunities because of the guidelines.

Riverstone Holdings, a large energy-focused private equity firm formed by Pierre F. Lapeyre, Jr. and David M. Leuschen, two former members of Goldman Sachs’ Global Energy & Power Group, is reportedly raising a $1 billion fund to provide loans to buyers of energy companies and other assets. Riverstone has raised $27 billion since its founding in 2000. In 2013, CVC Capital Partners and Providence Equity Partners expanded their loan operations.