Amid a flurry of merger and acquisition activity that has relied heavily on borrowing, the Federal Reserve Board is considering taking steps that would limit the use of debt to finance corporate takeovers, sources said yesterday.
It had been reported earlier this week that the Fed was considering a proposal that would limit the use of high-yielding, risky "junk bonds" to finance corporate takeovers. But Fed sources said yesterday the proposal currently under consideration is much broader than that.
Fed sources said the proposal now under consideration would restrict the use of all forms of debt securities used to finance takeovers to 50 percent of the acquisition price. Sources said these restrictions would apply to both unrated junk bonds and rated investment-grade bonds.
Fed sources also said existing regulations already limit the amount of bank financing that can be used in certain takeovers. Therefore, if the new proposal is adopted, all of the most commonly used forms of takeover borrowing would be restricted.
"This is an antitakeover device they are considering under considerable pressure from Congress," another source said yesterday. "I think this is a far-reaching and inappropriate extension of existing regulations. It would be far more appropriate if whatever rule is promulgated is done in the light of day. I don't see how something as big and broad as this should be done in the dark."
The Fed is considering the matter following requests to clarify its existing margin requirements that limit the use of borrowed funds to purchase stock, sources said. The requests to clarify existing rules came from members of Congress, from parties involved in T. Boone Pickens Jr.'s unsuccessful attempt to acquire Unocal Corp. earlier this year, and from parties involved in Pantry Pride Inc.'s recent successful junk-bond financed takeover of Revlon Inc.
Since the Fed proposal involves the clarification of an existing rule rather than the issuing of a new regulation, it is possible that there will be no opportunity for official public comment, sources said. However, Rep. Timothy E. Wirth (D-Colo.), chairman of the House subcommittee that has held extensive hearings on takeovers, sent a letter to Federal Reserve Board Chairman Paul A. Volcker yesterday asking the Fed to solicit public comment. Wirth also asked Volcker to explain the Fed's plan to the House subcommittee on telecommunications, consumer protection and finance before taking any action.
One source said that while no decision has been made yet about whether to restrict the use of debt in takeovers, the Fed may act promptly. Two high-ranking Fed members, Vice Chairman Preston Martin and governor Martha Seger, have said in the past that they are opposed to using the Fed's margin rules in this manner.
In recent months, Fed officials and others have expressed concern that the explosion in junk-bond takeover financing, and the addition of other kinds of debt to the balance sheets of corporate takeover targets, threaten the nation's financial system by adding too much debt. But it was the requests from outsiders to clarify certain rules, not concern about the takeover boom, that prompted the Fed's consideration of the new proposal, sources said.
The regulation in question is Fed Regulation G, sources said. This regulation restricts the amount of credit that parties other than banks or brokers can extend to purchase stock. Thus far it has not been used to restrict the use of bond financing for takeovers. However, the Fed has been asked to issue a clarification of the rule and is under pressure to extend the rule to all forms of bond-financed takeovers.
In takeovers, bonds frequently are exchanged for the stock of a target company. Even if the Fed extends Regulation G to bonds used to finance takeovers, sources said, creative Wall Street financiers could develop new ways to use bonds in takeovers that would put them outside of the Fed's proposal. In addition, it appears that the Fed's rules would apply only to those takeovers in which the stock of the target company was used as collateral for the bonds.
One Fed source said the question to be answered is: "If an extender of credit depends virtually exclusively on listed securities stocks for the backup collateral for his loans, shouldn't he be subject to Regulation G?"
Sources said the regulation would not affect takeovers where more than 50 percent of the acquisition price consisted of cash and stock.