Another Fine Mess U've Gotten Me Into: When Buying A Syndicated Loan Triggers Registration Under Regulation U

Client Alert

Regulation U, promulgated by the Federal Reserve Board (the “Board”), governs extensions of credit by entities other than broker-dealers 1 that are both (i) for the purpose of purchasing “margin stock” (or refinancing, known as “carrying,” such extensions of credit) and (ii) are secured, directly or indirectly,2 by margin stock. Most large syndicated commercial loans do not involve the acquisition of, or are not secured directly or indirectly by, margin stock, and therefore do not trigger any requirements under Regulation U. However, in the past year, several large syndicated commercial loans issued in the U.S. market have involved the direct use of loan proceeds to purchase margin stock, potentially triggering Regulation U registration or filing obligations for some lenders, including those that purchase in the primary syndication or in secondary-market transactions. Accordingly, nonbank lenders and purchasers of loans, including asset managers, should pay careful attention to any suggestion in the marketing materials for a new loan that the loan may be secured directly or indirectly by publicly-traded securities, as well as any disclaimer regarding Regulation U compliance by members of the lender group/syndicate.

REGULATION U: SUBSTANTIVE REQUIREMENTS

Regulation U limits leverage in the securities markets by regulating the collateral coverage ratio for loans that (i) are for the purpose, directly or indirectly, of acquiring or carrying margin stock (called “purpose credits”), and (ii) are secured, directly or indirectly, by margin stock. “Margin stock” is defined as equity securities that are traded on a national exchange but also includes most shares issued by registered investment companies, over-the-counter securities that are traded on the Nasdaq Stock Market's National Market, and certain securities that are convertible into or confer a right to acquire margin stock. Regulation U bars the extension of purpose credit secured by margin stock in an amount greater than the “maximum loan value” of the collateral securing the loan (i.e., a percentage of the market value, set by the Board). The Board has set the maximum loan value for margin stock at 50% of market value. So, for example, a loan for the acquisition of margin stock, secured only by the stock to be acquired, would be limited to approximately 50% of the purchase price of the stock.3 In addition, Regulation U imposes reporting, record-keeping, and filing requirements on both borrowers and lenders in respect of credits that are secured by margin stock.

REGULATION U IN THE SYNDICATED COMMERCIAL LOAN MARKET

Very few large, syndicated commercial loans are affected by the substantive requirements of Regulation U, because very few large, syndicated commercial loans involve the use of loan proceeds to acquire or carry publicly-traded securities. Most acquisition-finance loans only help one private buyer or group replace another and thus do not involve margin stock:going-private acquisitions and acquisitions of one public company by another are relatively rare in this space. Indeed, credit agreements will typically attempt to protect lenders from Regulation U...