By Simon Miller

US agencies have proposed revisions to leveraged finance guidance.

The board of governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency are seeking comment on proposed revisions to the interagency leveraged finance guidance issued in 2001.

Although there has been a decrease in leveraged lending since the financial crisis, volumes have increased but at the cost of deteriorating underwriting practices according to the agencies.

They warnd that as the market has grown, debt agreements have frequently included features that provided relatively limited lender protection, including the absence of meaningful maintenance covenants and the inclusion of other features that could "affect lenders’ recourse in the event of weakened borrower performance".

In addition, capital structures and repayment prospects for some transactions, whether originated to hold or to distribute, have been aggressive.

The agencies added: "Management information systems (MIS) at some institutions have proven less than satisfactory in accurately aggregating exposures on a timely basis, and many institutions have found themselves holding large pipelines of higher-risk commitments at a time when buyer demand for risky assets diminished significantly."

They continued: "Leveraged finance is an important type of financing for the economy, and banks play an integral role in making credit available and syndicating that credit to investors. It is important that banks help provide financing to creditworthy borrowers in a safe and sound manner."

In light of the market’s evolution, the agencies propose replacing the 2001 guidance with revised leveraged finance guidance that refocuses attention to five key areas:
• Establishing a Sound Risk-Management Framework: The agencies expect that management and the board identify the institution’s risk appetite for leveraged finance, establish appropriate credit limits, and ensure prudent oversight and approval processes.
• Underwriting Standards: These outline the agencies’ expectations for cash flow capacity, amortization, covenant protection, and collateral controls and emphasise that the business premise for each transaction should be sound and its capital structure should be sustainable irrespective of whether underwritten to hold or to distribute.
• Valuation Standards: These concentrate on the importance of sound methodologies in the determination and periodic revalidation of enterprise value.
• Pipeline Management: This highlights the need to accurately measure exposure on a timely basis, the importance of having policies and procedures that address failed transactions and general market disruption, and the need to periodically stress test the pipeline.
• Reporting and Analytics: This emphasises the need for MIS that accurately capture key obligor characteristics and aggregates them across business lines and legal entities on a timely basis. Reporting and analytics also reinforce the need for periodic portfolio stress testing.

Comments on the proposed guidance must be submitted to the agencies no later than June 8, 2012.

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