United States: US Bank Regulators Publish FAQs And 2014 SNC Review Of Leveraged Lending

On November 7, 2014, the Office of the Comptroller of the Currency ("OCC"), the Board of Governors of the Federal Reserve System ("Federal Reserve") and the Federal Deposit Insurance Corporation ("FDIC") (collectively, the "agencies") released the widely anticipated answers to Frequently Asked Questions (the "FAQs") relating to the March 2013 interagency guidance on leveraged lending (the "2013 Guidance"). The agencies simultaneously released the Shared National Credit ("SNC") Program 2014 Review, which includes a supplement relating exclusively to leveraged loans (the "SNC Leveraged Loan Supplement" and, together with the FAQs, collectively, the "Additional Guidance").1

The Additional Guidance provides insight into how the agencies are interpreting and implementing the criteria set forth in the 2013 Guidance, and is designed to assist in the development of a shared understanding among the industry and examiners of supervisory expectations for safe and sound underwriting of leveraged loans. The Additional Guidance also sends a direct warning to originators of leveraged loans, either to ensure that their leveraged loan businesses are conducted in line with the 2013 Guidance or to shut them down.

"[B]anks must not heighten risk by originating and distributing poorly underwritten and low-quality loans. A poorly underwritten or low-quality loan that is pooled with other loans or is participated with other institutions can generate excessive risk to the financial system. The 2013 Guidance addresses the agencies' supervisory focus and risk management expectations for supervised financial institutions involved in leveraged lending activities. Institutions that participate in this lending activity without implementing strong risk management processes consistent with the guidance will be criticized by the appropriate agency. Underwriting standards for loans originated to hold, distribute, or purchased [sic] should be similar and consistent with board approved risk criteria and lending policies. The agencies believe that an institution unwilling or unable to implement strong risk management processes will incur significant risks and should cease their participation in this type of lending until their processes improve sufficiently."2

How did we get here? And where are we?

The SNC Program was jointly established in 1977 by the agencies to provide an efficient and consistent review and classification system for large syndicated loans by financial institutions supervised by the agencies. The SNC review provides a qualitative assessment of those institutions' syndicated loans and promotes consistency among loan origination standards irrespective of how the originator is chartered or by whom it is supervised. The SNC review is conducted annually; however, the SNC Leveraged Loan Supplement states that, because of the agencies' findings, "supervisors will increase the frequency of their reviews around this business line to ensure risks are well understood and well controlled."

The agencies issued the 2013 Guidance on leveraged lending on March 21, 2013. In the final release, the agencies stated that it "is not a rulemaking action,"3 but rather a set of standards that institutions should use to assess their risk management frameworks for leveraged lending. "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."4

As low-interest rates (encouraged in significant measure by the Federal Reserve's bond-buying program) and highly liquid loan market conditions prevailing in recent years have contributed to a competitive environment among originators of leveraged loans – evidenced by "covenant lite" terms, flexible capital structures and historically higher leverage – regulators have become increasingly focused on compliance with the 2013 Guidance. A series of public announcements and confidential supervisory criticism of institutions' origination standards, widely covered in the press, have made the 2013 Guidance a leading topic on the agenda in deal committees, industry conferences and board rooms. Sharpening the tone of the discussion, institutions subject to the 2013 Guidance have wryly observed that as they have pulled back from the origination of market deals, many have been done by unregulated funds and other institutions to which the 2013 Guidance does not apply.5


1 The agencies' Joint Press Release announcing the Additional Guidance is available at: http://www.federalreserve.gov/newsevents/press/bcreg/20141107a.htm

2 SNC Leveraged Loan Supplement at 7 (emphasis added).

3 78 Fed. Reg. 17,766, 17,770 (March 22, 2013).

4 Id. At 17,771.

5 The Guidance applies to all Federal Reserve-supervised, FDIC-supervised or OCC-supervised financial institutions, including insured depository institutions, financial holding companies, bank holding companies and their non-bank subsidiaries, and the US branches and agencies of foreign banks that are "substantially engaged in leveraged lending activities." For purposes of the Guidance, "Financial institutions" means national banks, federal savings associations, and Federal branches and agencies supervised by 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, including such institutions' non-banking subsidiaries. The Guidance does not apply to unregulated entities like hedge funds, private equity sponsors and their affiliates, mezzanine funds and unregulated commercial lenders, nor to entities that are regulated but not by the agencies, like independent broker dealers and foreign financial institutions operating in the United States other than through a branch, agency or banking subsidary. See 78 Fed. Reg. 17,767 at FN 2.

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