By: David Etter, Managing Director- Loan Review Services
There are many reasons why banks are adding new asset classes to their portfolios, the most common of which is that they are looking to bolster earning assets in a time of very thin net interest margins combined with very modest loan demand. We want to offer some topics to consider about one asset class that we are seeing more community banks adding to their portfolios for the first time.
The asset class we are speaking to is loans that are considered to be “Leveraged Loans” under the Interagency Guidance on Leveraged Lending – FDIC FIL 13-2013, or OCC 2013 -9, or FRB SR 13-3. Additional guidance was provided in the November 7, 2014 “Frequently Asked Questions (FAQ) for Implementing March 2013 Interagency Guidance on Leveraged Lending.” Loans that meet the criteria of “Leveraged Loans” typically come to the institution via one of two origination channels:
- A financial institution purchasing a participation in certain Shared National Credits (“SNC’s”) or other Syndicated Loans. Note: Not all SNC’s or Syndicated Loans are “Leveraged Loans”.
- A financial institution purchases a participation in a C&I transaction from a national packager/program that meets the criteria of “Leveraged Loans”.
- The definition of “Leveraged Loan” under Regulatory Guidance is a combination of Use of Proceeds and Leverage of the Borrower.
The Interagency Guidance outlines very specific underwriting and portfolio management requirements for financial institutions. One key take-away is the requirement for the buyer to perform these functions themselves with qualified staff on a regular basis (many of the key tasks are to be completed quarterly) and to not rely on the underwriting/
portfolio management or enterprise valuation of the seller or lead institution. We strongly recommend that banks comply with the Interagency Guidelines in general and specifically address within its Underwriting Memorandum the bank’s conclusion as to why or why not the credit facility is considered to be a “Leveraged Loan,” as well as the borrower’s ability to de-lever for loans considered to be Leveraged Loans. Other key requirements include (usually) quarterly covenant monitoring, updating de-leveraging testing and updating enterprise value.
We would also like to address a misconception for some in the industry that smaller institutions do not have to meet the Interagency Guidelines. This misconception came about from comments the Comptroller of the Currency made at an ABS conference in Las Vegas in February 2018 as reported in a law firm industry report. This industry report purports that the Comptroller put forward the idea “that banks could step outside the guidelines if they have the capital to support that without threatening their financial well-being.” This was clarified by the Comptroller in May 2018 where he stated “if banks do lend outside the recommendations, then what the Office of the Comptroller of the Currency (OCC) is looking for is that the banks are doing this prudently.” He further stated that “What we would look for is if they are doing it in a safe and sound manner…We want to make sure they have the capital and the talent to evaluate that kind of activity and that the risk profile has been approved” (emphasis added) (Schwarzberg, 2018).
In short, the Interagency Guidance on Leveraged Lending has not been rescinded and Banks should have the proper policies, resources and controls in place if they are to lend into this segment.
Schwarzberg, J. (2018, May 24) OCC head says leveraged lending guidance needs no revisions. Retrieved from https://www.reuters.com/article/llg-revisions/occ-head-says-leveraged-lending-guidance-needs-no-revisions-idUSL2N1SV24T