Regulators Issue Updated Leveraged Lending Guidance
Federal bank regulatory agencies released updated supervisory guidance on leveraged lending, which has been increasing since 2009 after declining during the financial crisis.
The guidance from the Fed, FDIC and OCC covers transactions characterized by a borrower with a degree of financial leverage that significantly exceeds industry norms. The guidance replaces guidance issued in April 2001.
In a statement, the agencies said before the financial crisis, the volume of leveraged credit transactions grew tremendously and participation by non-regulated investors willing to accept looser terms increased. While leveraged lending declined during the crisis, volumes have since increased and prudent underwriting practices have deteriorated.
For example, some debt agreements have included features that weaken lender protection by excluding meaningful maintenance covenants and including other features that can limit lenders’ recourse in the event of weakened borrower performance. In addition, capital and repayment structures for some transactions, whether originated to hold or to distribute, have been aggressive. Management information systems at some institutions have proven less than satisfactory in accurately aggregating exposures on a timely basis.
It is important that banks provide leveraged financing to creditworthy borrowers in a safe and sound manner.
The guidance issued focuses attention on the following key areas:
This guidance applies to financial institutions supervised by the agencies that engage in leveraged lending activities. The number of community banks with substantial involvement in leveraged lending is small and they should be largely unaffected by this guidance.