Federal bank regulatory agencies update leveraged lending guidance

By Angela McDaniels

Tacoma, Wash., March 21 - Three government agencies released updated supervisory guidance on leveraged lending on Thursday.

The guidance replaces guidance issued in April 2001 and applies to financial institutions supervised by the agencies that engage in leveraged lending activities.

In a joint news release, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency said the volume of leveraged credit transactions has grown since the financial crisis, and "prudent underwriting practices have deteriorated."

For example, they said some debt agreements have excluded "meaningful maintenance covenants," capital and repayment structures for some transactions have been "aggressive," and management information systems at some institutions have proven "less than satisfactory in accurately aggregating exposures on a timely basis."

The guidance describes expectations for the risk management of leveraged lending activities and said institutions should develop and maintain

• Transactions structured to reflect a sound business premise, an appropriate capital structure and reasonable cash flow and balance sheet leverage;

• A definition of leveraged lending that facilitates consistent application across all business lines;

• Well-defined underwriting standards that define acceptable leverage levels and describe amortization expectations for senior and subordinate debt;

• A credit limit and concentration framework consistent with the institution's risk appetite;

• Management information systems that enable management to identify, aggregate and monitor leveraged exposures and comply with policy across all business lines;

• Pipeline management policies and procedures that provide for real-time information on exposures and limits and exceptions to the timing of expected distributions and approved hold levels; and

• Guidelines for conducting periodic portfolio and pipeline stress tests to quantify the potential impact of economic and market conditions on the institution's asset quality, earnings, liquidity and capital.

LSTA responds

The Loan Syndications and Trading Association applauded the agencies' decision to refine their guidance but said it remains concerned about a "one-size-fits-all" approach.

In a news release, the LSTA said it is gratified that the agencies decided to exclude asset-based loans and fallen angel credits from the guidance and that the agencies refined a rule requiring banks to analyze every financial sponsor in all sponsored transactions. The LSTA recommended that banks only be required to analyze and report on a sponsor when it guarantees a leveraged lending transaction.

On the other hand, the LSTA expressed concern that the agencies still require a company to show the ability to fully amortize its senior secured debt over five to seven years using base cash flows.

"Different industries operate with different levels of debt, and the LSTA believes imposing such a 'one-size-fits-all' model for all industries does not accurately represent different companies' risk profiles and runs the risk of reducing financing for many companies," LSTA said in a news release.

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