Alert April 03, 2012

Federal Banking Agencies Propose Changes in Leveraged Finance Guidance

The FDIC, FRB and OCC (collectively, the “Agencies”) jointly released proposed revisions to the Agencies’ leveraged finance guidance issued in 2001.  As revised, the proposed guidance (the “Proposed Guidance”) would address issues raised (e.g., limited lender protections, the absence of meaningful maintenance covenants) in connection with the recent “tremendous growth” observed by the Agencies in the volume of leveraged credit and in the participation of non-regulated investors.  The Agencies stated that the Proposed Guidance “outlines high-level principles related to safe and sound leverage lending activities” and applies to transactions “characterized by a borrower with a degree of financial or cash flow leverage that significantly exceeds industry norms as measured by various debt, cash flow or other ratios.”  The Agencies noted that very few community banking organizations have a substantial exposure to leveraged lending.

The Proposed Guidance, stated the Agencies, would refocus lenders’ attention on:

(1)   risk management frameworks (e.g., credit limits, volume limits on leveraged finance transactions);

(2)   underwriting standards (e.g., cash flow capacity, covenant protection, collateral control);

(3)   valuation standards (determination of, and updates to, calculations of enterprise value);

(4)   timely measurement of transactions “in the pipeline” (e.g., need for periodic stress tests); and

(5)   reporting and analysis (e.g., information systems that accurately capture key obligor characteristics and aggregates them across business lines and legal entities).

Comments on the Proposed Guidance are due by June 8, 2012.