• Banking Agencies Issue Updated Guidance on Leveraged Lending
  • May 28, 2013 | Author: George A. LeMaistre
  • Law Firm: Jones Walker LLP - Mobile Office
  • The federal bank regulatory agencies have released updated supervisory guidance for insured depository institutions that engage in "leveraged lending"-referring, according to the joint news release announcing the guidance, to "transactions characterized by a borrower with a degree of financial leverage that significantly exceeds industry norms."

    Issued jointly in March by the FDIC, the Comptroller of the Currency, and the Federal Reserve, the guidance is intended to update and replace one that the agencies issued in April 2001. While bank lending to more highly leveraged borrowers declined sharply in the financial downturn that began in 2007-08, the agencies say that the volume of such lending has been increasing since 2009, prompting issuance of the updated guidance.

    Any insured bank that engages in leveraged lending is expected, the guidance says, to develop, maintain, and use risk-management tools, systems, and policies that are appropriate for the institution, according to characteristics such as its size, earnings, liquidity, and capital, and the degree to which it’s involved in leveraged credit transactions, whether directly or through purchases of interests in such credits that are originated by other institutions.

    In regard to banks' management information systems ("MIS"), for example, the joint agency issuance says that "information and reporting should be tailored to the size and scope of each financial institution’s leveraged lending activities. The agencies would expect a global, complex financial institution with significant origination volumes or exposures to leveraged lending to have more complex MIS than a community bank with only a few exposures."

    The guidance says that "the vast majority of community banks should not be affected by this guidance," since the agencies "do not intend that a financial institution that originates a small number of less complex, leveraged loans should have policies and procedures commensurate with a larger, more complex leveraged loan origination business." Smaller banks that do engage in leveraged lending are urged to "discuss with their primary regulator the implementation of cost-effective controls appropriate for the complexity of their exposures and activities."

    According to the guidance, the objective of the agencies in issuing it is to make banks aware of the regulators' expectations for institutions that engage in leveraged lending, including the adoption and implementation by every such bank of measures designed to provide assurance, among other things:

    • That loan transactions with leveraged borrowers will be "structured to reflect a sound business premise, an appropriate capital structure, and reasonable cash flow and balance sheet leverage";
    • That every bank that engages in leveraged credit transactions will develop a definition of leveraged lending that is appropriate to the institution and "that facilitates consistent application across all business lines";
    • That each such institution will formulate well-defined underwriting standards, credit limits, and a concentration framework appropriate to its circumstances; and
    • That such institutions will have in place guidelines for periodic portfolio and pipeline stress testing, designed "to quantify the potential impact of economic and market conditions on" their asset quality, earnings, liquidity, and capital.

    The guidance further states that policies and procedures for leveraged lending should delineate the bank's "designated risk appetite," including clearly defined exposure limits, "should be supported by an analysis of the potential effect on earnings, capital, liquidity, and other risks that result" from leveraged lending, "and should be approved by its board of directors." The policies and procedures also should address, among other things, measures to ensure that risks are appropriately reflected in the bank's allowance for loan and lease losses, and should provide for appropriate oversight by senior bank management, including "adequate and timely reporting" to the board of directors.