Federal agencies propose revisions to leveraged finance guidance

By Angela McDaniels

Tacoma, Wash., March 26 - The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency are seeking comment on proposed revisions to the interagency leveraged finance guidance issued in 2001, according to a press release from the agencies.

Volume in the leveraged debt markets has increased since the financial crises while "prudent underwriting practices have deteriorated," the agencies said.

The agencies expressed concern about the frequent absence of "meaningful maintenance covenants" in debt agreements and the "aggressive" capital structures and repayment prospects for some transactions.

"Management information systems at some institutions have proven less than satisfactory in accurately aggregating exposures on a timely basis, and many institutions have found themselves holding large pipelines of higher-risk commitments at a time when buyer demand for risky assets diminished significantly," the agencies said.

Revised guidance

In light of the market's evolution, the agencies propose replacing the 2001 guidance with revised leveraged finance guidance that refocuses attention to five key areas:

• Establishing a sound risk-management framework. The agencies expect an institution's management and board to identify the institution's risk appetite for leveraged finance, establish appropriate credit limits and ensure prudent oversight and approval processes;

• Underwriting standards. These outline the agencies' expectations for cash flow capacity, amortization, covenant protection and collateral controls and emphasize that the business premise for each transaction should be sound and its capital structure should be sustainable whether it is underwritten to be held or to be distributed;

• Valuation standards. These concentrate on the importance of sound methodologies in the determination and periodic revalidation of enterprise value;

• Pipeline management. This highlights the need to accurately measure exposure on a timely basis, the importance of having policies and procedures that address failed transactions and general market disruption and the need to periodically stress test the pipeline; and

• Reporting and analytics. This emphasizes the need for management information systems that accurately capture key obligor characteristics and aggregates them across business lines and legal entities on a timely basis. Reporting and analytics also reinforce the need for periodic portfolio stress testing.

Comments on the proposed guidance may be submitted to the agencies at regs.comments@occ.treas.gov through June 8.

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