Banking Agencies Update Leveraged Lending Guidance

FDIC Federal Reserve OCC Bank Compliance

On March 21, the Federal Reserve Board, the OCC, and the FDIC issued final interagency guidance to ensure institutions provide leverage lending in a safe and sound manner by: (i) identifying the institution's risk appetite for leveraged finance, establishing appropriate credit limits, and ensuring prudent oversight and approval processes; (ii) establishing underwriting standards that clearly define expectations for cash flow capacity, amortization, covenant protection, collateral controls, and the underlying business premise for each transaction, and consider whether the borrower’s capital structure is sustainable; (iii) concentrating valuation standards on the importance of sound methods in the determination and periodic revalidation of enterprise value; (iv) accurately measuring exposure on a timely basis, establish policies and procedures that address failed transactions and general market disruptions, and ensure periodic stress tests of exposures to loans not yet distributed to buyers; (v) developing information systems that accurately capture key obligor characteristics and aggregate them across business lines and legal entities on a timely basis, with periodic reporting to the institution’s board of directors; (vi) considering in risk rating standards the use of realistic repayment assumptions to determine a borrower’s ability to de-lever to a sustainable level within a reasonable period of time; (vii) establishing underwriting and monitoring standards similar to loans underwritten internally; and (viii) performing stress testing on leveraged loans held in portfolio as well as those planned for distribution. The new guidance took effect on March 22, 2013, and institutions have until May 21, 2013 to comply.