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US Bank Regulators Release Supervisory Guidance on Leveraged Lending
Practical Law Legal Update 9-525-4153 (Approx. 3 pages)
US Bank Regulators Release Supervisory Guidance on Leveraged Lending
by PLC Finance
| Published on 26 Mar 2013 • USA (National/Federal) |
US bank regulators released new supervisory guidance on leveraged lending, offering high-level guidance to supervised institutions on leveraged lending, which replaces existing guidance.
On March 22, 2013, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Federal Reserve Board of Governors jointly published updated guidance on leveraged lending in the Federal Register. The agencies published the guidance to respond to concerns that lenders' underwriting practices do not adequately address risks in leveraged lending with appropriate allowances for losses, as was demonstrated in the financial crisis. The guidance focuses on, among other things:
- Definition of Leveraged Lending. The agencies accept that there are numerous accepted definitions of leveraged lending in the financial services industry and that, because different industries have a range of acceptable leverage levels, financial institutions should undertake their own analysis to define leveraged lending. However, each institution should define leveraged lending in its internal policies using criteria that are sufficiently detailed to ensure consistent application across all business lines.
- Underwriting Standards. An institution's underwriting standards should accurately reflect the institution's appetite for risk in leveraged lending and should define expectations for:
- cash flow capacity;
- amortization;
- covenant protection;
- collateral controls; and
- the underlying business reason for each transaction.
Additionally, institutions should consider whether or not the capital structure of the borrower is sustainable, regardless of the purpose of the loan. - Valuation Standards. Valuation standards should ensure accurate initial valuation and periodic re-valuation of entities engaged in leveraged borrowing.
- Pipeline Management. Proper pipeline management should:
- enable institutions to accurately measure the exposure of their current portfolios;
- outline responses to portfolio and market disruptions; and
- require stress tests that take into account potential loans in determining an entity's prospective financial health.
- Reporting and Analytics. Proper reporting requires that, at least quarterly, characteristics and trends in an institution's exposure to higher risk credits (including leveraged lending) should be reported to the institution's management, with summaries provided to the board of directors. Risk analytics should be run across business lines and legal entities to ensure that over-concentration of risk does not occur.
- Risk Rating Leveraged Loans. Using realistic assumptions, institutions should ensure the proper risk rating of individual loans to determine a borrower's ability to repay its debt over varying periods of time.
- Participants. Standards for the external underwriting and monitoring of loans should be similar to loans issued, underwritten and monitored internally.
- Stress Testing. Stress testing should be carried out in accordance with existing interagency issuances on this subject and should include both outstanding and potential loans.
This guidance becomes effective May 21, 2013 and will be taken into account during assessments by any of the agencies of an institution's risk management framework. As few community banks are substantially involved in the leveraged lending market, this guidance is expected to have minimal impact on the majority of community banks.
For more information on leveraged lending, see Practice Note, Lending: Overview: Investment Grade Loans and Leveraged Loans.