Maintain guidance provisions

Recordkeeping Provisions Associated with Guidance on Leveraged Lending

FR4203_20130322_ffr

Maintain guidance provisions

OMB: 7100-0354

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§ 1016.5(a)—Disclosure (institution)—
Annual privacy notice to customers
requirement—A national bank or
Federal savings association must
provide a clear and conspicuous notice
to customers that accurately reflects its
privacy policies and practices not less
than annually during the continuation
of the customer relationship.
§ 1016.8—Disclosure (institution)—
Revised privacy notices—If a national
bank or Federal savings association
wishes to disclose information in a way
that is inconsistent with the notices
previously given to a consumer, the
national bank or Federal savings
association must provide consumers
with a clear and conspicuous revised
notice of the national bank’s or Federal
savings association’s policies and
procedures and a new opt out notice.
§ 1016.7(a)—Disclosure (institution)—
Form of opt out notice to consumers; opt
out methods—Form of opt out notice—
If a national bank or Federal savings
association is required to provide an
opt-out notice under § 1016.10(a), it
must provide a clear and conspicuous
notice to each of its consumers that
accurately explains the right to opt out
under that section. The notice must
state:
• That the national bank or Federal
savings association discloses or reserves
the right to disclose nonpublic personal
information about its consumer to a
nonaffiliated third party;
• That the consumer has the right to
opt out of that disclosure; and
• A reasonable means by which the
consumer may exercise the opt out
right.
A national bank or Federal savings
association provides a reasonable means
to exercise an opt out right if it:
• Designates check-off boxes on the
relevant forms with the opt out notice;
• Includes a reply form with the opt
out notice;
• Provides electronic means to opt
out; or
• Provides a toll-free number to opt
out.
§§ 1016.10(a)(2) and 1016(c)—
Consumers must take affirmative
actions to exercise their rights to prevent
financial institutions from sharing their
information with nonaffiliated parties—
• Opt out—Consumers may direct
that the national bank or Federal savings
association not disclose nonpublic
personal information about them to a
nonaffiliated third party, other than
permitted by §§ 1016.13–1016.15.
• Partial opt out—Consumer also may
exercise partial opt out rights by
selecting certain nonpublic personal
information or certain nonaffiliated

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third parties with respect to which the
consumer wishes to opt out.
§§ 1016.7(h) and 1016(i)—Reporting
(consumer)—Consumers may exercise
continuing right to opt out—Consumer
may opt out at any time—A consumer
may exercise the right to opt out at any
time. A consumer’s direction to opt out
is effective until the consumer revokes
it in writing or, if the consumer agrees,
electronically. When a customer
relationship terminates, the customer’s
opt out direction continues to apply.
Type of Review: Extension of a
currently approved collection.
Affected Public: Businesses or other
for-profit; individuals.
Estimated Annual Number of
Institution Respondents: Initial Notice,
3; Annual Notice and Change in Terms,
1,793; Opt-out Notice, 897.
Estimated Average Time per Response
per Institution: Initial Notice, 80 hours;
Annual Notice and Change in Terms, 8
hours; Opt-out Notice, 8 hours.
Estimated Subtotal Annual Burden
Hours for Institutions: 21,760 hours.
Estimated Annual Number of
Consumer Respondents: 2,526,802.
Estimated Average Time per
Consumer Response: 0.25 hours.
Estimated Subtotal Annual Burden
Hours for Consumers: 631,701 hours.
Estimated Total Annual Burden
Hours: 653,461 hours.
Comments: The OCC issued a 60-day
Federal Register notice on January 14,
2013. 78 FR 2720. No comments were
received. Comments continue to be
invited on:
(a) Whether the collection of
information is necessary for the proper
performance of the functions of the
OCC, including whether the information
has practical utility;
(b) The accuracy of the OCC’s
estimate of the information collection
burden;
(c) Ways to enhance the quality,
utility, and clarity of the information to
be collected;
(d) Ways to minimize the burden of
the collection on respondents, including
through the use of automated collection
techniques or other forms of information
technology; and
(e) Estimates of capital or start-up
costs and costs of operation,
maintenance, and purchase of services
to provide information.
Dated: March 18, 2013.
Michele Meyer,
Assistant Director, Legislative and Regulatory
Activities Division.
[FR Doc. 2013–06585 Filed 3–21–13; 8:45 am]
BILLING CODE 4810–33–P

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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
[Docket ID OCC–2011–0028]

FEDERAL RESERVE SYSTEM
[OP–1438]

FEDERAL DEPOSIT INSURANCE
CORPORATION
Interagency Guidance on Leveraged
Lending
The Office of the Comptroller
of the Currency (OCC), Department of
the Treasury; Board of Governors of the
Federal Reserve System (Board); and the
Federal Deposit Insurance Corporation
(FDIC).
ACTION: Final guidance.
AGENCY:

SUMMARY: The OCC, Board, and the
FDIC (collectively, the ‘‘agencies’’) are
issuing final guidance on leveraged
lending. This guidance outlines for
agency-supervised institutions highlevel principles related to safe-andsound leveraged lending activities,
including underwriting considerations,
assessing and documenting enterprise
value, risk management expectations for
credits awaiting distribution, stresstesting expectations, pipeline portfolio
management, and risk management
expectations for exposures held by the
institution. This guidance applies to all
financial institutions supervised by the
OCC, Board, and FDIC that engage in
leveraged lending activities. The
number of community banks with
substantial involvement in leveraged
lending is small; therefore, the agencies
generally expect community banks to be
largely unaffected by this guidance.
DATES: This guidance is effective on
March 22, 2013. The compliance date
for this guidance is May 21, 2013.
FOR FURTHER INFORMATION CONTACT:
OCC: Louise A. Francis, Commercial
Credit Technical Expert, (202) 649–
6670, [email protected]; or
Kevin Korzeniewski, Attorney,
Legislative and Regulatory Activities
Division, (202) 649–5490, 400 7th Street
SW., MS 7W–2, Washington, DC 20219.
Board: Carmen Holly, Supervisory
Financial Analyst, Policy Section, (202)
973–6122, [email protected];
Robert Cote, Senior Supervisory
Financial Analyst, Risk Section, (202)
452–3354, [email protected]; or
Benjamin W. McDonough, Senior
Counsel, Legal Division, (202) 452–
2036, [email protected];
Board of Governors of the Federal
Reserve System, 20th and C Streets
NW., Washington, DC 20551.

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Federal Register / Vol. 78, No. 56 / Friday, March 22, 2013 / Notices
FDIC: Thomas F. Lyons, Senior
Examination Specialist, Division of Risk
Management Supervision, (202) 898–
6850, [email protected]; or Gregory S.
Feder, Counsel, Legal Division, (202)
898–8724, [email protected]; 550 17th
Street NW., Washington, DC 20429.
SUPPLEMENTARY INFORMATION:

pipelines. Financial institutions
unprepared for such stressful events and
circumstances can suffer acute threats to
their financial condition and viability.
This final guidance is intended to be
consistent with sound industry
practices and to expand on recent
interagency issuances on stress-testing.3

I. Background
On March 30, 2012, the agencies
requested public comment on the joint
Proposed Guidance on Leveraged
Lending (the proposed guidance) with
the comment period closing on June 8,
2012.1 The agencies have reviewed the
public comments, and are now issuing
final guidance (final guidance) that
includes certain modifications
discussed in more detail in section II of
this SUPPLEMENTARY INFORMATION.
As addressed in the final guidance,
the agencies expect financial
institutions to properly evaluate and
monitor underwritten credit risks in
leveraged loans, to understand the effect
of changes in borrowers’ enterprise
values on credit portfolio quality, and to
assess the sensitivity of future credit
losses to these changes in enterprise
values.2 Further, in underwriting such
credits, financial institutions should
ensure borrowers are able to repay
credits when due, and that borrowers
have sustainable capital structures,
including bank borrowings and other
debt, to support their continued
operations through economic cycles.
Financial institutions also should be
able to demonstrate they understand the
risks and the potential impact of
stressful events and circumstances on
borrowers’ financial condition. Recent
financial crises underscore the need for
financial institutions to employ sound
underwriting, to ensure the risks in
leveraged lending activities are
appropriately incorporated in the
allowance for loan and lease losses and
capital adequacy analyses, monitor the
sustainability of their borrowers’ capital
structures, and incorporate stress-testing
into their risk management of leveraged
loan portfolios and distribution

II. Discussion of Public Comments
Received

1 See 77 FR 19417 ‘‘Proposed Guidance on
Leveraged Lending’’ dated March 30, 2012 at
https://www.federalregister.gov/articles/2012/03/
30/2012-7620/proposed-guidance-on-leveragedlending.
2 For purposes of this final guidance, the term
‘‘financial institution’’ or ‘‘institution’’ includes
national banks, federal savings associations, and
federal branches and agencies supervised by the
OCC; state member banks, bank holding companies,
savings and loan holding companies, and all other
institutions for which the Federal Reserve is the
primary federal supervisor; and state nonmember
banks, foreign banks having an insured branch,
state savings associations, and all other institutions
for which the FDIC is the primary federal
supervisor.

3 See interagency guidance ‘‘Supervisory
Guidance on Stress-Testing for Banking
Organizations With More Than $10 Billion in Total
Consolidated Assets,’’ Final Supervisory Guidance,
77 FR 29458 (May 17, 2012), at http://www.gpo.gov/
fdsys/pkg/FR-2012-05-17/html/2012-11989.htm,
and the joint ‘‘Statement to Clarify Supervisory
Expectations for Stress-Testing by Community
Banks,’’ May 14, 2012, by the OCC at http://
www.occ.gov/news-issuances/news-releases/2012/
nr-ia-2012-76a.pdf; the Federal Reserve at
www.federalreserve.gov/newsevents/press/bcreg/
bcreg20120514b1.pdf; and the FDIC at http://
www.fdic.gov/news/news/press/2012/pr12054a.pdf.
See also FDIC Final Rule, Annual Stress Test, 77 FR
62417 (Oct. 15, 2012) (to be codified at 12 CFR part
325, subpart C).

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The agencies received 16 comment
letters on the proposed guidance.
Comments were submitted by bank
holding companies, commercial banks,
financial trade associations, financial
advisory firms, and individuals.
Generally, most comments expressed
support for the proposed guidance;
however, several comments
recommended changes to and
clarification of certain provisions in the
proposed guidance.
The comments highlighted the
following as primary issues of concern
or interest or areas that could benefit
from further explanation:
• The potential effect of the proposed
guidance on community and mid-sized
financial institutions;
• Definition of leveraged lending;
• Proposed exclusions for ‘‘fallen
angels’’ and asset-based loans, and
investment grade borrowers;
• Reporting requirements of deal
sponsors;
• Proposed alternatives to the delevering expectations;
• Effect of covenant-lite and paymentin-kind (PIK)-toggle loan structures;
• Methods used to determine
enterprise value;
• Potential overall management
information systems (MIS) burden
presented by the proposed guidance;
and
• Fiduciary responsibility of a
financial institution for loans that it
originates.
In response to these comments, the
agencies have clarified and modified
certain aspects of the guidance as
discussed in the following section of
this Supplemental Information.

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A. Terminology
One purpose of the final guidance is
to update and replace guidance issued
in April 2001, titled ‘‘Interagency
Guidance on Leveraged Financing’’
(2001 guidance). The 2001 guidance
covered broad risk management issues
associated with leveraged finance
activities. This final guidance focuses
on leveraged lending activities
conducted by financial institutions.
Therefore, to promote clarity and
consistency, the agencies have used the
term ‘‘leveraged lending’’ in the final
guidance in place of all references to
‘‘leveraged finance’’ that appeared in the
proposed guidance. This change is
intended to focus the applicability and
scope of the final guidance on specific
types of leveraged lending transactions;
those leveraged loans originated by
financial institutions.
B. Scope
Several comment letters expressed
concern about the potential effect of the
proposed guidance on community banks
and mid-sized institutions. The
comments stressed that small financial
institutions also can have exposure to
leveraged loans. All of the comments
expressed concern that the definition of
leveraged lending used in the proposed
guidance would encompass a significant
number of portfolio loans originated by
financial institutions, particularly small
and mid-sized banks, including, but not
limited to, traditional asset-based
lending portfolios. One comment
expressed concern that the guidance
could be misinterpreted to require
community banks to document and bear
the burden of proof as to why certain
transactions are not considered
leveraged lending. Another comment
noted that community banks with an
insignificant amount of leveraged
lending should not have to follow the
same risk management framework as
financial institutions with significant
amounts of leveraged lending, as
defined in the proposed guidance. Some
comments suggested that the proposed
guidance should exclude financial
institutions under a certain asset or
capital size, or exclude transactions
under a certain dollar threshold.
In response to these comments, the
agencies have decided to apply the final
guidance to all financial institutions
that originate or participate in leveraged
lending transactions. However, the
agencies agree with comments that a
financial institution that originates a
small number of less complex leveraged
loans should not be expected to have
policies and procedures commensurate
with those of a larger financial

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institution with a more complex
leveraged loan origination business.
Therefore, the final guidance addresses
mainly the latter type of leveraged
lending. However, any financial
institution that participates in rather
than originates leveraged lending
transactions should follow applicable
supervisory guidance regarding
purchased participations. To clarify the
supervisory expectations for these types
of loans, the agencies have incorporated
the section on ‘‘Participations
Purchased’’ from the 2001 guidance into
the final guidance.
Although the agencies elected to
adopt a definition of leveraged lending
that encompasses all business lines, the
agencies do not intend for this guidance
to apply to small portfolio commercial
and industrial loans, or traditional assetbased lending loans. The agencies have
added language to the final guidance to
clarify these concerns.
C. Definition
The agencies received five comments
regarding the proposed definition of a
leveraged lending transaction. A
number of comments expressed concern
over a perceived ‘‘bright line’’ approach
to defining leveraged loans and
proposed that institutions should be
able to set their own definitions based
on the characteristics of their portfolios.
The agencies agree that various
industries have a range of acceptable
leverage levels and that financial
institutions should do their own
analysis to define leveraged lending.
The proposed guidance addressed this
issue by providing common definitions
of leveraged lending and directing an
institution to define leveraged lending
in its internal policies. The proposed
guidance also indicated that numerous
definitions of leveraged lending exist
throughout the financial services
industry. However, the proposed
guidance stated that institutions’
policies should include criteria to
define leveraged lending in a manner
sufficiently detailed to ensure consistent
application across all business lines and
that are appropriate to the institution.
Therefore, the agencies believe the
definition of leveraged lending
described in the proposed guidance was
appropriate, and have retained that
definition in the final guidance.
In addition, the agencies received
comments on using earnings before
interest, taxes, depreciation, and
amortization (EBITDA) as a measure to
define leverage. Some comments
expressed concern that small banks
focus on the balance sheet measure of
leverage (total debt to tangible net
worth) rather than the cash flow

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measure of leverage presented in the
proposed guidance definition. Other
comments viewed the ratio as a ‘‘bright
line’’ and suggested that financial
institutions should develop their own
definition and leverage measure based
on an institution’s business lines. The
agencies agree that each financial
institution should establish its metrics
for defining leveraged loans and include
those indicators in its credit policies.
However, the EBITDA-based leverage
measure presented in the proposed
guidance represented the supervisory
measure that may be used as an
important factor to be considered in
defining leveraged loans based on each
institution’s credit products and
characteristics. The agencies believe
that having a consistent definition for
supervisory purposes will help to
ensure a consistent application of the
guidance. Accordingly, the agencies are
retaining this definition from the
proposed guidance in the final
guidance.
D. Information and Reporting
The agencies received a number of
comments about the discussion in
portions of the proposed guidance on
management information systems (MIS)
that financial institutions should
implement. Comments stated it would
be burdensome for small financial
institutions to implement the same
reporting mechanisms as large financial
institutions. Another comment
suggested that smaller as well as midsized institutions should discuss the
risks with their regulators to implement
appropriate procedures.
To clarify supervisory expectations
for MIS requirements, the final guidance
notes 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. Moreover, the final guidance
notes that each institution should
consider appropriate, cost-effective
measures for monitoring leveraged
lending given the size and scope of that
institution’s leveraged lending
activities.
E. Additional Comments
One comment requested that the
definition of leveraged lending be
modified so as not to include ‘‘fallen
angels.’’ These are loans that do not
meet the definition of leverage loans at
origination, but migrate into the
definition at a later date due to changes

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in the borrower’s financial condition.
The comment suggested that the
inclusion of these loans in the definition
would skew reporting and tracking of
the portfolio, duplicate monitoring
activities, and increase costs without
any benefit to financial institutions or to
the regulators. The agencies agree that
‘‘fallen angels’’ should not be included
as leveraged lending transactions, but
should be captured within the financial
institution’s broader risk management
framework. Therefore, the agencies have
stated in the final guidance that a loan
should be designated as leveraged only
at the time of origination, modification,
extension, or refinance.
One comment suggested that the
sponsor evaluation standards in the
proposed guidance are administratively
burdensome and that financial
assessments of deal sponsors by lenders
should be limited to those sponsors that
provide a financial guaranty. The
agencies agree that the ability to obtain
financial reports on sponsors may be
limited in the absence of a formal
guaranty. Accordingly, the final
guidance removes the statement that an
institution generally should develop
guidelines for evaluating deal sponsors
and instead focuses on deal sponsors
that are relied on as a secondary source
of repayment. In those instances, the
final guidance notes that a financial
institution should document the
sponsor’s willingness and ability to
support the credit.
Some comments also suggested
exclusions for both asset-based loans
and ‘‘investment-grade’’ borrowers. As
stated previously, the agencies
acknowledge that traditional asset-based
lending is a distinct product line and is
not included in the definition of a
leveraged loan unless the loan is part of
the entire debt structure of a leveraged
obligor; therefore, the agencies have
clarified this point in the final guidance.
In terms of a borrower’s
creditworthiness, the agencies do not
believe it would be appropriate to
exclude high-quality borrowers from the
guidance. Prudent portfolio
management of leveraged loans, which
is a goal of this guidance, covers all
loans, including those made to the most
creditworthy borrowers. Importantly,
the agencies strongly support the efforts
of financial institutions to make loans
available to creditworthy borrowers,
particularly in small and mid-sized
institutions that extend prudent
commercial and industrial loans. All
loans and borrowers except those
excluded in the final guidance will be
subject to the definitions as outlined in
the guidance.

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Federal Register / Vol. 78, No. 56 / Friday, March 22, 2013 / Notices
The agencies also received comments
concerning the ability of borrowers to
repay 50 percent of the total debt
exposure over a five-to-seven year
period. Some comments viewed this
measure as a restrictive ‘‘bright line’’
while others proposed alternatives.
The measure in the proposed
guidance was meant as a general guide
to reflect that institutions should
establish, in their policies, expectations
and measures for reducing leverage over
a reasonable period of time. The final
guidance retains the expectation of
reasonable de-levering, and the agencies
have revised the Underwriting
Standards section of the final guidance
to state that institutions should consider
reasonable de-levering abilities of
borrowers, such as whether base case
cash flow projections show the ability to
fully amortize senior secured debt or
repay a significant portion of total debt
over the medium term. In addition, the
agencies have revised the Risk Rating
Leveraged Loans section of the final
guidance to include the measure as an
example, stating that in the context of
risk rating of leveraged loans,
supervisors commonly assume that the
ability to fully amortize senior secured
debt or the ability to repay at least 50
percent of total debt over a five-to-seven
year period provides evidence of
adequate repayment capacity.
One comment referred to covenantlite and PIK-toggle loan structures, and
recommended that the agencies impose
tighter controls around loans with such
features. The agencies believe these
types of structures may have a place in
the overall leveraged lending product
set; however, the agencies recognize the
additional risk in these structures.
Accordingly, although the final
guidance does not have a different
treatment for such arrangements, the
agencies will closely review such loans
as part of the overall credit evaluation
of an institution.
One comment suggested that the
agencies impose more conservative
guidelines for determining enterprise
value. The comment recommended that
the agencies require financial
institutions to use business appraisers
and to follow Internal Revenue Service
(IRS) appraisal guidelines when the
institution is estimating the enterprise
value of a firm. The intent of the
agencies is not to impose real property
appraisal and valuation standards to
enterprise valuation methods or to
require a formal business appraisal for
all loans relying on enterprise value as
a source of repayment. The goal of the
final guidance is to clarify those
methods considered credible for
determining enterprise value based on

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common practices in the industry.
These methods, if conducted properly,
produce reliable results. Accordingly,
the final guidance does not require that
an evaluation be conducted by a
business appraiser in determining
enterprise value. The agencies’
expectation is that a financial
institution’s internal policies should
address the source and method of any
enterprise value estimate.
The agencies received four comments
regarding the burden imposed by the
proposed guidance, stating that
implementation will add to the high
costs that financial institutions already
face. One comment noted there was no
cost benefit analysis provided with the
proposed guidance. To address these
concerns, the final guidance emphasizes
that an institution needs to have sound
risk management policies and
procedures commensurate with its
origination activity in and exposures to
leveraged lending. Moreover, the final
guidance notes that a financial
institution’s risk management
framework for leveraged lending should
be consistent with the institution’s risk
appetite, and complexity of exposures.
The agencies believe the
implementation of any additional
systems or processes needed to promote
safe-and-sound leveraged lending
should be considered a component of an
institution’s overall credit risk
management program.
One comment noted that financial
institutions in a credit transaction do
not have fiduciary responsibilities to
loan participants when underwriting
and syndicating leveraged loans. The
agencies agree and have not included a
reference to fiduciary responsibility in
the final guidance.
III. Administrative Law Matters
A. Paperwork Reduction Act Analysis
In accordance with the Paperwork
Reduction Act (PRA) of 1995 (44 U.S.C.
3506; 5 CFR part 1320, Appendix A.1),
the agencies reviewed the final
guidance. The agencies may not conduct
or sponsor, and an organization is not
required to respond to, an information
collection unless the information
collection displays a currently valid
Office of Management and Budget
(OMB) control number. The OCC and
FDIC have submitted this collection to
OMB for review and approval under 44
U.S.C. 3506 and 5 CFR part 320. The
Board reviewed the final guidance
under the authority delegated to it by
OMB. While this final guidance is not
being adopted as a rule, the agencies
have determined that certain aspects of
the guidance constitute collections of

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information under the PRA. These
aspects are the provisions that state that
a financial institution should have (i)
Underwriting policies for leveraged
lending, including stress-testing
procedures for leveraged credits; (ii) risk
management policies, including stresstesting procedures for pipeline
exposures; and, (iii) policies and
procedures for incorporating the results
of leveraged credit and pipeline stress
tests into the firm’s overall stress-testing
framework. The frequency of
information collection is estimated to be
annual.
Respondents are financial institutions
with leveraged lending activities as
defined in the guidance.
Report Title: Guidance on Leveraged
Lending.
Frequency of Response: Annual.
Affected Public: Financial institutions
with leveraged lending.
OCC:
OMB Control Number: To be assigned
by OMB.
Estimated number of respondents: 25.
Estimated average time per
respondent: 1,350.4 hours to build;
1,705.6 hours for ongoing use.
Estimated total annual burden: 33,760
hours to build; 42,640 hours for ongoing
use.
Board:
Agency information collection
number: FR 4203.
OMB Control Number: To be assigned
by OMB.
Estimated number of respondents: 41.
Estimated average time per
respondent: 1,064.4 hours to build;
754.4 hours for ongoing use.
Estimated total annual burden: 43,640
hours to build; 30,930 hours for ongoing
use.
FDIC:
OMB Control Number: To be assigned
by OMB.
Estimated number of respondents: 9.
Estimated average time per
respondent: 986.7 hours to build; 529.3
hours for ongoing use.
Estimated total annual burden: 8,880
hours to build; 4,764 hours for ongoing
use.
The estimated time per respondent is
an average that varies by agency because
of differences in the composition of the
financial institutions under each
agency’s supervision (for example, size
distribution of institutions) and volume
of leveraged lending activities.
The agencies received two comments
in response to the information
collection requirements under the PRA.
Both comments mentioned how
substantially burdensome the guidance
will be to implement. The agencies
recognize that the amount of time

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required of any institution to comply
with the guidance may be higher or
lower than the estimates, but believe
that the numbers stated are reasonable
averages.
One comment also noted the absence
of a cost-benefit analysis and questioned
whether the additional information
systems required undermines the utility
of the information collection. In
response to the general comments about
burden, the agencies have made various
modifications to the proposed guidance,
including clarifying the application of
the guidance to community banks and
other smaller institutions that are
involved in leveraged lending. In the
SUPPLEMENTARY INFORMATION section, the
agencies also highlighted their
expectations that MIS and other
reporting activities would be tailored to
the size and the scope of an institution’s
leveraged lending activities. In addition,
the implementation of any new systems
would be part of an institution’s overall
credit risk management program. These
comments are discussed in more detail
in the general comment summary in
Section II of the SUPPLEMENTARY
INFORMATION.
Comments continue to be invited on:
(a) Whether the collection of
information is necessary for the proper
performance of the Federal banking
agencies’ functions, including whether
the information has practical utility;
(b) The accuracy of the estimates of
the burden of the information
collection, including the validity of the
methodology and assumptions used;
(c) Ways to enhance the quality,
utility, and clarity of the information to
be collected;
(d) Ways to minimize the burden of
the information collection on
respondents, including through the use
of automated collection techniques or
other forms of information technology;
and
(e) Estimates of capital or start-up
costs and costs of operation,
maintenance, and purchase of services
to provide information.
Comments on these questions should
be directed to:
OCC: Because paper mail in the
Washington, DC area and at the OCC is
subject to delay, commenters are
encouraged to submit comments by
email if possible. Comments may be
sent to: Legislative and Regulatory
Activities Division, Office of the
Comptroller of the Currency, Attention:
1557–NEW, 400 7th Street SW., Suite
3E–218, Mail Stop 9W–11, Washington,
DC 20219. In addition, comments may
be sent by fax to (571) 465–4326 or by
electronic mail to
[email protected]. You may

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personally inspect and photocopy
comments at the OCC, 400 7th Street
SW., Washington, DC 20219. For
security reasons, the OCC requires that
visitors make an appointment to inspect
comments. You may do so by calling
(202) 649–6700. Upon arrival, visitors
will be required to present valid
government-issued photo identification
and to submit to security screening in
order to inspect and photocopy
comments.
All comments received, including
attachments and other supporting
materials, are part of the public record
and subject to public disclosure. Do not
enclose any information in your
comment or supporting materials that
you consider confidential or
inappropriate for public disclosure.
Additionally, please send a copy of
your comments by mail to: OCC Desk
Officer, 1557–NEW, U.S. Office of
Management and Budget, 725 17th
Street NW., #10235, Washington, DC
20503, or by email to: oira
[email protected].
FDIC: Interested parties are invited to
submit written comments. All
comments should refer to the name of
the collection, ‘‘Guidance on Leveraged
Lending.’’ Comments may be submitted
by any of the following methods:
• http://www.FDIC.gov/regulations/
laws/federal/propose.html.
• Email: [email protected].
• Mail: Gary Kuiper (202) 898–3877,
Federal Deposit Insurance Corporation,
550 17th Street NW., NYA–5046,
Washington, DC 20429.
• Hand Delivery: Comments may be
hand-delivered to the guard station at
the rear of the 550 17th Street Building
(located on F Street), on business days
between 7 a.m. and 5 p.m.
As the final guidance discusses the
importance of stress-testing as part of an
institution’s risk management practices
for leveraged lending activity, the
agencies note that they expect to review
an institution’s policies and procedures
for stress-testing as part of their
supervisory processes. To the extent
they collect information during an
examination about a financial
institution’s stress-testing results,
confidential treatment may be afforded
to the records under exemption 8 of the
Freedom of Information Act (FOIA), 5
U.S.C. 552(b)(8).
B. Regulatory Flexibility Act Analysis
The final guidance is not a
rulemaking action. Thus, the Regulatory
Flexibility Act (5 U.S.C. 603(b)) does not
apply to the guidance. However, the
agencies have considered the potential
impact of the guidance on small banking
organizations. For the reasons discussed

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in sections I and II of this
Supplementary Information, the
agencies are issuing the guidance to
emphasize the importance of properly
underwriting leveraged lending
transactions and incorporating those
exposures into stress and capital tests
for institutions with significant
exposures to these credits.
The agencies received comments
about the potential burden of this
guidance on small banking
organizations. The final guidance is
intended for banking organizations
supervised by the agencies with
substantial exposures to leveraged
lending activities, including national
banks, federal savings associations, state
nonmember banks, state member banks,
bank holding companies, and U.S.
branches and agencies of foreign
banking organizations. Given the
average dollar size of leveraged lending
transactions, most of which exceed $50
million, and the agencies’ observations
that leveraged loans tend to be held
primarily by very large or global
financial institutions, the vast majority
of smaller institutions should not be
affected by this guidance as they have
limited exposure to leveraged credits.
Interagency Guidance on Leveraged
Lending
The text of the guidance is as follows:
Purpose
The Office of the Comptroller of the
Currency (OCC), Board of Governors of
the Federal Reserve System (Board), and
Federal Deposit Insurance Corporation
(FDIC) (collectively the ‘‘agencies’’) are
issuing this leveraged lending guidance
to update and replace the April 2001
Interagency guidance 1 regarding sound
practices for leveraged finance activities
(2001 guidance).2 The 2001 guidance
addressed expectations for the content
of credit policies, the need for welldefined underwriting standards, the
importance of defining an institution’s
risk appetite for leveraged transactions,
1 OCC Bulletin 2001–18; http://www.occ.gov/
news-issuances/bulletins/2001/bulletin-2001–
18.html; Board SR Letter 01–9, ‘‘Interagency
Guidance on Leveraged Financing’’ April 9, 2001;
http://www.federalreserve.gov/boarddocs/srletters/
2001/sr0109.html; and, FDIC Press Release PR–28–
2001; http://www.fdic.gov/news/news/press/2001/
pr2801.html.
2 For the purpose of this guidance, references to
leveraged finance, or leveraged transactions
encompass the entire debt structure of a leveraged
obligor (including loans and letters of credit,
mezzanine tranches, senior and subordinated
bonds) held by both bank and non-bank investors.
References to leveraged lending and leveraged loan
transactions and credit agreements refer to all debt
with the exception of bond and high-yield debt held
by both bank and non-bank investors.

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and the importance of stress-testing
exposures and portfolios.
Leveraged lending is an important
type of financing for national and global
economies, and the U.S. financial
industry plays an integral role in
making credit available and syndicating
that credit to investors. In particular,
financial institutions should ensure they
do not unnecessarily heighten risks by
originating poorly underwritten loans.3
For example, a poorly underwritten
leveraged loan that is pooled with other
loans or is participated with other
institutions may generate risks for the
financial system. This guidance is
designed to assist financial institutions
in providing leveraged lending to
creditworthy borrowers in a safe-andsound manner.
Since the issuance of the 2001
guidance, the agencies have observed
periods of tremendous growth in the
volume of leveraged credit and in the
participation of unregulated investors.
Additionally, debt agreements have
frequently included features that
provided relatively limited lender
protection including, but not limited to,
the absence of meaningful maintenance
covenants in loan agreements or the
inclusion of payment-in-kind (PIK)toggle features in junior capital
instruments, which lessened lenders’
recourse in the event of a borrower’s
subpar performance. The capital
structures and repayment prospects for
some transactions, whether originated to
hold or to distribute, have at times been
aggressive. Moreover, management
information systems (MIS) at some
institutions have proven less than
satisfactory in accurately aggregating
exposures on a timely basis, with many
institutions holding large pipelines of
higher-risk commitments at a time when
buyer demand for risky assets
diminished significantly.
This guidance updates and replaces
the 2001 guidance in light of the
developments and experience gained
since the time that guidance was issued.
This guidance describes expectations for
the sound risk management of leveraged
lending activities, including the
importance for institutions to develop
and maintain:
3 For purposes of this guidance, the term
‘‘financial institution’’ or ‘‘institution’’ includes
national banks, federal savings associations, and
federal branches and agencies supervised by the
OCC; state member banks, bank holding companies,
savings and loan holding companies, and all other
institutions for which the Federal Reserve is the
primary federal supervisor; and state nonmember
banks, foreign banks having an insured branch,
state savings associations, and all other institutions
for which the FDIC is the primary federal
supervisor.

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• Transactions structured to reflect a
sound business premise, an appropriate
capital structure, and reasonable cash
flow and balance sheet leverage.
Combined with supportable
performance projections, these elements
of a safe-and-sound loan structure
should clearly support a borrower’s
capacity to repay and to de-lever to a
sustainable level over a reasonable
period, whether underwritten to hold or
distribute;
• A definition of leveraged lending
that facilitates consistent application
across all business lines;
• Well-defined underwriting
standards that, among other things,
define acceptable leverage levels and
describe amortization expectations for
senior and subordinate debt;
• A credit limit and concentration
framework consistent with the
institution’s risk appetite;
• Sound MIS that enable management
to identify, aggregate, and monitor
leveraged exposures and comply with
policy across all business lines;
• Strong pipeline management
policies and procedures that, among
other things, provide for real-time
information on exposures and limits,
and exceptions to the timing of expected
distributions and approved hold levels;
and,
• Guidelines for conducting periodic
portfolio and pipeline stress tests to
quantify the potential impact of
economic and market conditions on the
institution’s asset quality, earnings,
liquidity, and capital.
Applicability
This guidance updates and replaces
the existing 2001 guidance and forms
the basis of the agencies’ supervisory
focus and review of supervised financial
institutions, including any subsidiaries
or affiliates. Implementation of this
guidance should be consistent with the
size and risk profile of an institution’s
leveraged activities relative to its assets,
earnings, liquidity, and capital.
Institutions that originate or sponsor
leveraged transactions should consider
all aspects and sections of the guidance.
In contrast, the vast majority of
community banks should not be affected
by this guidance as they have limited
involvement in leveraged lending.
Community and smaller institutions
that are involved in leveraged lending
activities should discuss with their
primary regulator the implementation of
cost-effective controls appropriate for
the complexity of their exposures and
activities.4
4 The agencies do not intend that a financial
institution that originates a small number of less

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Risk Management Framework
Given the high risk profile of
leveraged transactions, financial
institutions engaged in leveraged
lending should adopt a risk
management framework that has an
intensive and frequent review and
monitoring process. The framework
should have as its foundation written
risk objectives, risk acceptance criteria,
and risk controls. A lack of robust risk
management processes and controls at a
financial institution with significant
leveraged lending activities could
contribute to supervisory findings that
the financial institution is engaged in
unsafe-and-unsound banking practices.
This guidance outlines the agencies’
minimum expectations on the following
topics:
• Definition of Leveraged Lending
• General Policy Expectations
• Participations Purchased
• Underwriting Standards
• Valuation Standards
• Pipeline Management
• Reporting and Analytics
• Risk Rating Leveraged Loans
• Credit Analysis
• Problem Credit Management
• Deal Sponsors
• Credit Review
• Stress-Testing
• Conflicts of Interest
• Reputational Risk
• Compliance
Definition of Leveraged Lending
The policies of financial institutions
should include criteria to define
leveraged lending that are appropriate to
the institution.5 For example, numerous
definitions of leveraged lending exist
throughout the financial services
industry and commonly contain some
combination of the following:
• Proceeds used for buyouts,
acquisitions, or capital distributions.
• Transactions where the borrower’s
Total Debt divided by EBITDA (earnings
before interest, taxes, depreciation, and
amortization) or Senior Debt divided by
EBITDA exceed 4.0X EBITDA or 3.0X
EBITDA, respectively, or other defined
complex, leveraged loans should have policies and
procedures commensurate with a larger, more
complex leveraged loan origination business.
However, any financial institution that participates
in leveraged lending transactions should follow
applicable supervisory guidance provided in the
‘‘Participations Purchased’’ section of this
document.
5 This guidance is not meant to include assetbased loans unless such loans are part of the entire
debt structure of a leveraged obligor. Asset-based
lending is a distinct segment of the loan market that
is tightly controlled or fully monitored, secured by
specific assets, and usually governed by a
borrowing formula (or ‘‘borrowing base’’).

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levels appropriate to the industry or
sector.6
• A borrower recognized in the debt
markets as a highly leveraged firm,
which is characterized by a high debtto-net-worth ratio.
• Transactions when the borrower’s
post-financing leverage, as measured by
its leverage ratios (for example, debt-toassets, debt-to-net-worth, debt-to-cash
flow, or other similar standards
common to particular industries or
sectors), significantly exceeds industry
norms or historical levels.7
A financial institution engaging in
leveraged lending should define it
within the institution’s policies and
procedures in a manner sufficiently
detailed to ensure consistent application
across all business lines. A financial
institution’s definition should describe
clearly the purposes and financial
characteristics common to these
transactions, and should cover risk to
the institution from both direct
exposure and indirect exposure via
limited recourse financing secured by
leveraged loans, or financing extended
to financial intermediaries (such as
conduits and special purpose entities
(SPEs)) that hold leveraged loans.
General Policy Expectations
A financial institution’s credit
policies and procedures for leveraged
lending should address the following:
• Identification of the financial
institution’s risk appetite including
clearly defined amounts of leveraged
lending that the institution is willing to
underwrite (for example, pipeline
limits) and is willing to retain (for
example, transaction and aggregate hold
levels). The institution’s designated risk
appetite should be supported by an
analysis of the potential effect on
earnings, capital, liquidity, and other
risks that result from these positions,
and should be approved by its board of
directors;
• A limit framework that includes
limits or guidelines for single obligors
and transactions, aggregate hold
portfolio, aggregate pipeline exposure,
and industry and geographic
concentrations. The limit framework
should identify the related management
approval authorities and exception
tracking provisions. In addition to
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6 Cash

should not be netted against debt for
purposes of this calculation.
7 The designation of a financing as ‘‘leveraged
lending’’ is typically made at loan origination,
modification, extension, or refinancing. ‘‘Fallen
angels’’ or borrowers that have exhibited a
significant deterioration in financial performance
after loan inception and subsequently become
highly leveraged would not be included within the
scope of this guidance, unless the credit is
modified, extended, or refinanced.

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notional pipeline limits, the agencies
expect that financial institutions with
significant leveraged transactions will
implement underwriting limit
frameworks that assess stress losses, flex
terms, economic capital usage, and
earnings at risk or that otherwise
provide a more nuanced view of
potential risk; 8
• Procedures for ensuring the risks of
leveraged lending activities are
appropriately reflected in an
institution’s allowance for loan and
lease losses (ALLL) and capital
adequacy analyses;
• Credit and underwriting approval
authorities, including the procedures for
approving and documenting changes to
approved transaction structures and
terms;
• Guidelines for appropriate oversight
by senior management, including
adequate and timely reporting to the
board of directors;
• Expected risk-adjusted returns for
leveraged transactions;
• Minimum underwriting standards
(see ‘‘Underwriting Standards’’ section
below); and,
• Effective underwriting practices for
primary loan origination and secondary
loan acquisition.
Participations Purchased
Financial institutions purchasing
participations and assignments in
leveraged lending transactions should
make a thorough, independent
evaluation of the transaction and the
risks involved before committing any
funds.9 They should apply the same
standards of prudence, credit
assessment and approval criteria, and
in-house limits that would be employed
if the purchasing organization were
originating the loan. At a minimum,
policies should include requirements
for:
• Obtaining and independently
analyzing full credit information both
before the participation is purchased
and on a timely basis thereafter;
• Obtaining from the lead lender
copies of all executed and proposed
8 Flex terms allow the arranger to change interest
rate spreads during the syndication process to
adjust pricing to current liquidity levels.
9 Refer to other joint agency guidance regarding
purchased participations: OCC Loan Portfolio
Management Handbook, http://www.occ.gov/
publications/publications-by-type/comptrollershandbook/lpm.pdf, Loan Participations, Board
‘‘Commercial Bank Examination Manual,’’ http://
www.federalreserve.gov/boarddocs/supmanual/
cbem/cbem.pdf, section 2045.1, Loan
Participations, the Agreements and Participants;
and FDIC Risk Management Manual of Examination
Policies, section 3.2 (Loans), http://www.fdic.gov/
regulations/safety/manual/section32.html#otherCredit, Loan Participations, (last
updated Feb. 2, 2005).

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loan documents, legal opinions, title
insurance policies, Uniform Commercial
Code (UCC) searches, and other relevant
documents;
• Carefully monitoring the borrower’s
performance throughout the life of the
loan; and,
• Establishing appropriate risk
management guidelines as described in
this document.
Underwriting Standards
A financial institution’s underwriting
standards should be clear, written and
measurable, and should accurately
reflect the institution’s risk appetite for
leveraged lending transactions. A
financial institution should have clear
underwriting limits regarding leveraged
transactions, including the size that the
institution will arrange both
individually and in the aggregate for
distribution. The originating institution
should be mindful of reputational risks
associated with poorly underwritten
transactions, as these risks may find
their way into a wide variety of
investment instruments and exacerbate
systemic risks within the general
economy. At a minimum, an
institution’s underwriting standards
should consider the following:
• Whether the business premise for
each transaction is sound and the
borrower’s capital structure is
sustainable regardless of whether the
transaction is underwritten for the
institution’s own portfolio or with the
intent to distribute. The entirety of a
borrower’s capital structure should
reflect the application of sound
financial analysis and underwriting
principles;
• A borrower’s capacity to repay and
ability to de-lever to a sustainable level
over a reasonable period. As a general
guide, institutions also should consider
whether base case cash flow projections
show the ability to fully amortize senior
secured debt or repay a significant
portion of total debt over the medium
term.10 Also, projections should include
one or more realistic downside
scenarios that reflect key risks identified
in the transaction;
• Expectations for the depth and
breadth of due diligence on leveraged
transactions. This should include
10 In general, the base case cash flow projection
is the borrower or deal sponsor’s expected estimate
of financial performance using the assumptions that
are deemed most likely to occur. The financial
results for the base case should be better than those
for the conservative case but worse than those for
the aggressive or upside case. A financial institution
may make adjustments to the base case financial
projections, if necessary. The most realistic
financial projections should be used when
measuring a borrower’s capacity to repay and delever.

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standards for evaluating various types of
collateral, with a clear definition of
credit risk management’s role in such
due diligence;
• Standards for evaluating expected
risk-adjusted returns. The standards
should include identification of
expected distribution strategies,
including alternative strategies for
funding and disposing of positions
during market disruptions, and the
potential for losses during such periods;
• The degree of reliance on enterprise
value and other intangible assets for
loan repayment, along with acceptable
valuation methodologies, and guidelines
for the frequency of periodic reviews of
those values;
• Expectations for the degree of
support provided by the sponsor (if
any), taking into consideration the
sponsor’s financial capacity, the extent
of its capital contribution at inception,
and other motivating factors.
Institutions looking to rely on sponsor
support as a secondary source of
repayment for the loan should be able
to provide documentation, including,
but not limited to, financial or liquidity
statements, showing recently
documented evidence of the sponsor’s
willingness and ability to support the
credit extension;
• Whether credit agreement terms
allow for the material dilution, sale, or
exchange of collateral or cash flowproducing assets without lender
approval;
• Credit agreement covenant
protections, including financial
performance (such as debt-to-cash flow,
interest coverage, or fixed charge
coverage), reporting requirements, and
compliance monitoring. Generally, a
leverage level after planned asset sales
(that is, the amount of debt that must be
serviced from operating cash flow) in
excess of 6X Total Debt/EBITDA raises
concerns for most industries;
• Collateral requirements in credit
agreements that specify acceptable
collateral and risk-appropriate measures
and controls, including acceptable
collateral types, loan-to-value
guidelines, and appropriate collateral
valuation methodologies. Standards for
asset-based loans that are part of the
entire debt structure also should outline
expectations for the use of collateral
controls (for example, inspections,
independent valuations, and payment
lockbox), other types of collateral and
account maintenance agreements, and
periodic reporting requirements; and,
• Whether loan agreements provide
for distribution of ongoing financial and
other relevant credit information to all
participants and investors.

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Nothing in the preceding standards
should be considered to discourage
providing financing to borrowers
engaged in workout negotiations, or as
part of a pre-packaged financing under
the bankruptcy code. Neither are they
meant to discourage well-structured,
standalone asset-based credit facilities
to borrowers with strong lender
monitoring and controls, for which a
financial institution should consider
separate underwriting and risk rating
guidance.
Valuation Standards
Institutions often rely on enterprise
value and other intangibles when (1)
Evaluating the feasibility of a loan
request; (2) determining the debt
reduction potential of planned asset
sales; (3) assessing a borrower’s ability
to access the capital markets; and, (4)
estimating the strength of a secondary
source of repayment. Institutions may
also view enterprise value as a useful
benchmark for assessing a sponsor’s
economic incentive to provide financial
support. Given the specialized
knowledge needed for the development
of a credible enterprise valuation and
the importance of enterprise valuations
in the underwriting and ongoing risk
assessment processes, enterprise
valuations should be performed by
qualified persons independent of an
institution’s origination function.
There are several methods used for
valuing businesses. The most common
valuation methods are assets, income,
and market. Asset valuation methods
consider an enterprise’s underlying
assets in terms of its net going-concern
or liquidation value. Income valuation
methods consider an enterprise’s
ongoing cash flows or earnings and
apply appropriate capitalization or
discounting techniques. Market
valuation methods derive value
multiples from comparable company
data or sales transactions. However,
final value estimates should be based on
the method or methods that give
supportable and credible results. In
many cases, the income method is
generally considered the most reliable.
There are two common approaches
employed when using the income
method. The ‘‘capitalized cash flow’’
method determines the value of a
company as the present value of all
future cash flows the business can
generate in perpetuity. An appropriate
cash flow is determined and then
divided by a risk-adjusted capitalization
rate, most commonly the weighted
average cost of capital. This method is
most appropriate when cash flows are
predictable and stable. The ‘‘discounted
cash flow’’ method is a multiple-period

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valuation model that converts a future
series of cash flows into current value
by discounting those cash flows at a rate
of return (referred to as the ‘‘discount
rate’’) that reflects the risk inherent
therein. This method is most
appropriate when future cash flows are
cyclical or variable over time. Both
income methods involve numerous
assumptions, and therefore, supporting
documentation should fully explain the
evaluator’s reasoning and conclusions.
When a borrower is experiencing a
financial downturn or facing adverse
market conditions, a lender should
reflect those adverse conditions in its
assumptions for key variables such as
cash flow, earnings, and sales multiples
when assessing enterprise value as a
potential source of repayment. Changes
in the value of a borrower’s assets
should be tested under a range of stress
scenarios, including business conditions
more adverse than the base case
scenario. Stress tests of enterprise
values and their underlying
assumptions should be conducted and
documented at origination of the
transaction and periodically thereafter,
incorporating the actual performance of
the borrower and any adjustments to
projections. The institution should
perform its own discounted cash flow
analysis to validate the enterprise value
implied by proxy measures such as
multiples of cash flow, earnings, or
sales.
Enterprise value estimates derived
from even the most rigorous procedures
are imprecise and ultimately may not be
realized. Therefore, institutions relying
on enterprise value or illiquid and hardto-value collateral should have policies
that provide for appropriate loan-tovalue ratios, discount rates, and
collateral margins. Based on the nature
of an institution’s leveraged lending
activities, the institution should
establish limits for the proportion of
individual transactions and the total
portfolio that are supported by
enterprise value. Regardless of the
methodology used, the assumptions
underlying enterprise-value estimates
should be clearly documented, well
supported, and understood by the
institution’s appropriate decisionmakers and risk oversight units. Further,
an institution’s valuation methods
should be appropriate for the borrower’s
industry and condition.
Pipeline Management
Market disruptions can substantially
impede the ability of an underwriter to
consummate syndications or otherwise
sell down exposures, which may result
in material losses. Accordingly,
financial institutions should have strong

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risk management and controls over
transactions in the pipeline, including
amounts to be held and those to be
distributed. A financial institution
should be able to differentiate
transactions according to tenor, investor
class (for example, pro-rata and
institutional), structure, and key
borrower characteristics (for example,
industry).
In addition, an institution should
develop and maintain:
• A clearly articulated and
documented appetite for underwriting
risk that considers the potential effects
on earnings, capital, liquidity, and other
risks that result from pipeline
exposures;
• Written policies and procedures for
defining and managing distribution
failures and ‘‘hung’’ deals, which are
identified by an inability to sell down
the exposure within a reasonable period
(generally 90 days from transaction
closing). The financial institution’s
board of directors and management
should establish clear expectations for
the disposition of pipeline transactions
that have not been sold according to
their original distribution plan. Such
transactions that are subsequently
reclassified as hold-to-maturity should
also be reported to management and the
board of directors;
• Guidelines for conducting periodic
stress tests on pipeline exposures to
quantify the potential impact of
changing economic and market
conditions on the institution’s asset
quality, earnings, liquidity, and capital;
• Controls to monitor performance of
the pipeline against original
expectations, and regular reports of
variances to management, including the
amount and timing of syndication and
distribution variances, and reporting of
recourse sales to achieve distribution;
• Reports that include individual and
aggregate transaction information that
accurately risk rates credits and portrays
risk and concentrations in the pipeline;
• Limits on aggregate pipeline
commitments;
• Limits on the amount of loans that
an institution is willing to retain on its
own books (that is, borrower,
counterparty, and aggregate hold levels),
and limits on the underwriting risk that
will be undertaken for amounts
intended for distribution;
• Policies and procedures that
identify acceptable accounting
methodologies and controls in both
functional as well as dysfunctional
markets, and that direct prompt
recognition of losses in accordance with
generally accepted accounting
principles;

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• Policies and procedures addressing
the use of hedging to reduce pipeline
and hold exposures, which should
address acceptable types of hedges and
the terms considered necessary for
providing a net credit exposure after
hedging; and,
• Plans and provisions addressing
contingent liquidity and compliance
with the Board’s Regulation W (12 CFR
part 223) when market illiquidity or
credit conditions change, interrupting
normal distribution channels.
Reporting and Analytics
The agencies expect financial
institutions to diligently monitor higher
risk credits, including leveraged loans.
A financial institution’s management
should receive comprehensive reports
about the characteristics and trends in
such exposures at least quarterly, and
summaries should be provided to the
institution’s board of directors. Policies
and procedures should identify the
fields to be populated and captured by
a financial institution’s MIS, which
should yield accurate and timely
reporting to management and the board
of directors that may include the
following:
• Individual and portfolio exposures
within and across all business lines and
legal vehicles, including the pipeline;
• Risk rating distribution and
migration analysis, including
maintenance of a list of those borrowers
who have been removed from the
leveraged portfolio due to
improvements in their financial
characteristics and overall risk profile;
• Industry mix and maturity profile;
• Metrics derived from probabilities
of default and loss given default;
• Portfolio performance measures,
including noncompliance with
covenants, restructurings,
delinquencies, non-performing
amounts, and charge-offs;
• Amount of impaired assets and the
nature of impairment (that is,
permanent, or temporary), and the
amount of the ALLL attributable to
leveraged lending;
• The aggregate level of policy
exceptions and the performance of that
portfolio;
• Exposures by collateral type,
including unsecured transactions and
those where enterprise value will be the
source of repayment for leveraged loans.
Reporting should also consider the
implications of defaults that trigger pari
passu treatment for all lenders and,
thus, dilute the secondary support from
the sale of collateral;
• Secondary market pricing data and
trading volume, when available;

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• Exposures and performance by deal
sponsors. Deals introduced by sponsors
may, in some cases, be considered
exposure to related borrowers. An
institution should identify, aggregate,
and monitor potential related exposures;
• Gross and net exposures, hedge
counterparty concentrations, and policy
exceptions;
• Actual versus projected distribution
of the syndicated pipeline, with regular
reports of excess levels over the hold
targets for the syndication inventory.
Pipeline definitions should clearly
identify the type of exposure. This
includes committed exposures that have
not been accepted by the borrower,
commitments accepted but not closed,
and funded and unfunded commitments
that have closed but have not been
distributed;
• Total and segmented leveraged
lending exposures, including
subordinated debt and equity holdings,
alongside established limits. Reports
should provide a detailed and
comprehensive view of global
exposures, including situations when an
institution has indirect exposure to an
obligor or is holding a previously sold
position as collateral or as a reference
asset in a derivative;
• Borrower and counterparty
leveraged lending reporting should
consider exposures booked in other
business units throughout the
institution, including indirect exposures
such as default swaps and total return
swaps, naming the distributed paper as
a covered or referenced asset or
collateral exposure through repo
transactions. Additionally, the
institution should consider positions
held in available-for-sale or traded
portfolios or through structured
investment vehicles owned or
sponsored by the originating institution
or its subsidiaries or affiliates.
Risk Rating Leveraged Loans
Previously, the agencies issued
guidance on rating credit exposures and
credit rating systems, which applies to
all credit transactions, including those
in the leveraged lending category.11
The risk rating of leveraged loans
involves 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. For
example, supervisors commonly assume
that the ability to fully amortize senior
11 Board SR Letter 98–25 ‘‘Sound Credit Risk
Management and the Use of Internal Credit Risk
Ratings at Large Banking Organizations;’’ OCC
Comptroller’s Handbooks ‘‘Rating Credit Risk’’ and
‘‘Leveraged Lending’’, and FDIC Risk Management
Manual of Examination Policies, ‘‘Loan Appraisal
and Classification.’’

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srobinson on DSK4SPTVN1PROD with NOTICES

secured debt or the ability to repay at
least 50 percent of total debt over a fiveto-seven year period provides evidence
of adequate repayment capacity. If the
projected capacity to pay down debt
from cash flow is nominal with
refinancing the only viable option, the
credit will usually be adversely rated
even if it has been recently
underwritten. In cases when leveraged
loan transactions have no reasonable or
realistic prospects to de-lever, a
substandard rating is likely.
Furthermore, when assessing debt
service capacity, extensions and
restructures should be scrutinized to
ensure that the institution is not merely
masking repayment capacity problems
by extending or restructuring the loan.
If the primary source of repayment
becomes inadequate, the agencies
believe that it would generally be
inappropriate for an institution to
consider enterprise value as a secondary
source of repayment unless that value is
well supported. Evidence of wellsupported value may include binding
purchase and sale agreements with
qualified third parties or thorough asset
valuations that fully consider the effect
of the borrower’s distressed
circumstances and potential changes in
business and market conditions. For
such borrowers, when a portion of the
loan may not be protected by pledged
assets or a well-supported enterprise
value, examiners generally will rate that
portion doubtful or loss and place the
loan on nonaccrual status.
Credit Analysis
Effective underwriting and
management of leveraged lending risk is
highly dependent on the quality of
analysis employed during the approval
process as well as ongoing monitoring.
A financial institution’s policies should
address the need for a comprehensive
assessment of financial, business,
industry, and management risks
including, whether
• Cash flow analyses rely on overly
optimistic or unsubstantiated
projections of sales, margins, and
merger and acquisition synergies;
• Liquidity analyses include
performance metrics appropriate for the
borrower’s industry; predictability of
the borrower’s cash flow; measurement
of the borrower’s operating cash needs;
and ability to meet debt maturities;
• Projections exhibit an adequate
margin for unanticipated merger-related
integration costs;
• Projections are stress tested for one
or more downside scenarios, including
a covenant breach;
• Transactions are reviewed at least
quarterly to determine variance from

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plan, the related risk implications, and
the accuracy of risk ratings and accrual
status. From inception, the credit file
should contain a chronological rationale
for and analysis of all substantive
changes to the borrower’s operating plan
and variance from expected financial
performance;
• Enterprise and collateral valuations
are independently derived or validated
outside of the origination function, are
timely, and consider potential value
erosion;
• Collateral liquidation and asset sale
estimates are based on current market
conditions and trends;
• Potential collateral shortfalls are
identified and factored into risk rating
and accrual decisions;
• Contingency plans anticipate
changing conditions in debt or equity
markets when exposures rely on
refinancing or the issuance of new
equity; and,
• The borrower is adequately
protected from interest rate and foreign
exchange risk.
Problem Credit Management
A financial institution should
formulate individual action plans when
working with borrowers experiencing
diminished operating cash flows,
depreciated collateral values, or other
significant plan variances. Weak initial
underwriting of transactions, coupled
with poor structure and limited
covenants, may make problem credit
discussions and eventual restructurings
more difficult for an institution as well
as result in less favorable outcomes.
A financial institution should
formulate credit policies that define
expectations for the management of
adversely rated and other high-risk
borrowers whose performance departs
significantly from planned cash flows,
asset sales, collateral values, or other
important targets. These policies should
stress the need for workout plans that
contain quantifiable objectives and
measureable time frames. Actions may
include working with the borrower for
an orderly resolution while preserving
the institution’s interests, sale of the
credit in the secondary market, or
liquidation of collateral. Problem credits
should be reviewed regularly for risk
rating accuracy, accrual status,
recognition of impairment through
specific allocations, and charge-offs.
Deal Sponsors
A financial institution that relies on
sponsor support as a secondary source
of repayment should develop guidelines
for evaluating the qualifications of
financial sponsors and should
implement processes to regularly

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monitor a sponsor’s financial condition.
Deal sponsors may provide valuable
support to borrowers such as strategic
planning, management, and other
tangible and intangible benefits.
Sponsors may also provide sources of
financial support for borrowers that fail
to achieve projections. Generally, a
financial institution rates a borrower
based on an analysis of the borrower’s
standalone financial condition.
However, a financial institution may
consider support from a sponsor in
assigning internal risk ratings when the
institution can document the sponsor’s
history of demonstrated support as well
as the economic incentive, capacity, and
stated intent to continue to support the
transaction. However, even with
documented capacity and a history of
support, the sponsor’s potential
contributions may not mitigate
supervisory concerns absent a
documented commitment of continued
support. An evaluation of a sponsor’s
financial support should include the
following:
• The sponsor’s historical
performance in supporting its
investments, financially and otherwise;
• The sponsor’s economic incentive
to support, including the nature and
amount of capital contributed at
inception;
• Documentation of degree of support
(for example, a guarantee, comfort letter,
or verbal assurance);
• Consideration of the sponsor’s
contractual investment limitations;
• To the extent feasible, a periodic
review of the sponsor’s financial
statements and trends, and an analysis
of its liquidity, including the ability to
fund multiple deals;
• Consideration of the sponsor’s
dividend and capital contribution
practices;
• The likelihood of the sponsor
supporting a particular borrower
compared to other deals in the sponsor’s
portfolio; and,
• Guidelines for evaluating the
qualifications of a sponsor and a process
to regularly monitor the sponsor’s
performance.
Credit Review
A financial institution should have a
strong and independent credit review
function that demonstrates the ability to
identify portfolio risks and documented
authority to escalate inappropriate risks
and other findings to their senior
management. Due to the elevated risks
inherent in leveraged lending, and
depending on the relative size of a
financial institution’s leveraged lending
business, the institution’s credit review
function should assess the performance

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Federal Register / Vol. 78, No. 56 / Friday, March 22, 2013 / Notices

of the leveraged portfolio more
frequently and in greater depth than
other segments in the loan portfolio.
Such assessments should be performed
by individuals with the expertise and
experience for these types of loans and
the borrower’s industry. Portfolio
reviews should generally be conducted
at least annually. For many financial
institutions, the risk characteristics of
leveraged portfolios, such as high
reliance on enterprise value,
concentrations, adverse risk rating
trends, or portfolio performance, may
dictate more frequent reviews.
A financial institution should staff its
internal credit review function
appropriately and ensure that the
function has sufficient resources to
ensure timely, independent, and
accurate assessments of leveraged
lending transactions. Reviews should
evaluate the level of risk, risk rating
integrity, valuation methodologies, and
the quality of risk management. Internal
credit reviews should include the
review of the institution’s leveraged
lending practices, policies, and
procedures to ensure that they are
consistent with regulatory guidance.
Stress-Testing
A financial institution should develop
and implement guidelines for
conducting periodic portfolio stress
tests on loans originated to hold as well
as loans originated to distribute, and
sensitivity analyses to quantify the
potential impact of changing economic
and market conditions on its asset
quality, earnings, liquidity, and
capital.12 The sophistication of stresstesting practices and sensitivity analyses
should be consistent with the size,
complexity, and risk characteristics of
the institution’s leveraged loan
portfolio. To the extent a financial
institution is required to conduct
enterprise-wide stress tests, the
leveraged portfolio should be included
in any such tests.

srobinson on DSK4SPTVN1PROD with NOTICES

12 See

interagency guidance ‘‘Supervisory
Guidance on Stress-Testing for Banking
Organizations With More Than $10 Billion in Total
Consolidated Assets,’’ Final Supervisory Guidance,
77 FR 29458 (May 17, 2012), at http://www.gpo.gov/
fdsys/pkg/FR-2012-05-17/html/2012-11989.htm,
and the joint ‘‘Statement to Clarify Supervisory
Expectations for Stress-Testing by Community
Banks,’’ May 14, 2012, by the OCC at http://
www.occ.gov/news-issuances/news-releases/2012/
nr-ia-2012-76a.pdf; the Board at
www.federalreserve.gov/newsevents/press/bcreg/
bcreg20120514b1.pdf; and the FDIC at http://
www.fdic.gov/news/news/press/2012/pr12054a.pdf.
See also FDIC Final Rule, Annual Stress Test, 77 FR
62417 (Oct. 15, 2012) (to be codified at 12 CFR part
325, subpart. C).

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Conflicts of Interest
A financial institution should develop
appropriate policies and procedures to
address and to prevent potential
conflicts of interest when it has both
equity and lending positions. For
example, an institution may be reluctant
to use an aggressive collection strategy
with a problem borrower because of the
potential impact on the value of an
institution’s equity interest. A financial
institution may encounter pressure to
provide financial or other privileged
client information that could benefit an
affiliated equity investor. Such conflicts
also may occur when the underwriting
financial institution serves as financial
advisor to the seller and simultaneously
offers financing to multiple buyers (that
is, stapled financing). Similarly, there
may be conflicting interests among the
different lines of business within a
financial institution or between the
financial institution and its affiliates.
When these situations occur, potential
conflicts of interest arise between the
financial institution and its customers.
Policies and procedures should clearly
define potential conflicts of interest,
identify appropriate risk management
controls and procedures, enable
employees to report potential conflicts
of interest to management for action
without fear of retribution, and ensure
compliance with applicable laws.
Further, management should have an
established training program for
employees on appropriate practices to
follow to avoid conflicts of interest, and
provide for reporting, tracking, and
resolution of any conflicts of interest
that occur.
Reputational Risk
Leveraged lending transactions are
often syndicated through the financial
and institutional markets. A financial
institution’s apparent failure to meet its
legal responsibilities in underwriting
and distributing transactions can
damage its market reputation and
impair its ability to compete. Similarly,
a financial institution that distributes
transactions which over time have
significantly higher default or loss rates
and performance issues may also see its
reputation damaged.
Compliance

Frm 00150

Dated: February 19, 2013.
Thomas J. Curry,
Comptroller of the Currency.
Board of Governors of the Federal Reserve
System, March 8, 2013.
Robert deV. Frierson,
Secretary of the Board.
Dated at Washington, DC, this 11th day of
March, 2013.
Federal Deposit Insurance Corporation.
Valerie J. Best,
Assistant Executive Secretary.
[FR Doc. 2013–06567 Filed 3–21–13; 8:45 am]
BILLING CODE 4810–33–P; 6210–01–P; 6714–01–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service
Community Volunteer Income Tax
Assistance (VITA) Matching Grant
Program—Availability of Application
Packages
Internal Revenue Service (IRS),
Treasury.
ACTION: Notice.
AGENCY:

The legal and regulatory issues raised
by leveraged transactions are numerous
and complex. To ensure potential
conflicts are avoided and laws and
regulations are adhered to, an
institution’s independent compliance
function should periodically review the
institution’s leveraged lending activity.
This guidance is consistent with the

PO 00000

principles of safety and soundness and
other agency guidance related to
commercial lending.
In particular, because leveraged
transactions often involve a variety of
types of debt and bank products, a
financial institution should ensure that
its policies incorporate safeguards to
prevent violations of anti-tying
regulations. Section 106(b) of the Bank
Holding Company Act Amendments of
1970 13 prohibits certain forms of
product tying by financial institutions
and their affiliates. The intent behind
Section 106(b) is to prevent financial
institutions from using their market
power over certain products to obtain an
unfair competitive advantage in other
products.
In addition, equity interests and
certain debt instruments used in
leveraged transactions may constitute
‘‘securities’’ for the purposes of federal
securities laws. When securities are
involved, an institution should ensure
compliance with applicable securities
laws, including disclosure and other
regulatory requirements. An institution
should also establish policies and
procedures to appropriately manage the
internal dissemination of material,
nonpublic information about
transactions in which it plays a role.

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SUMMARY: This document provides
notice of the availability of the
application package for the 2014
Community Volunteer Income Tax
13 12

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U.S.C. 1972.

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