The Office of the Comptroller of the Currency (OCC) has released its 2014 Shared National Credits (SNC) review (the 2014 SNC review). Highlights (or lowlights, depending on your viewpoint) include (emphasis added):
On the same day, the Board of Governors of the Federal Reserve System (FRB), the OCC and the Federal Deposit Insurance Corporation (FDIC and, together with the FRB and the OCC, US Banking Regulators) also issued their joint Shared National Credits Leveraged Loan Supplement 2014 (the 2014 Supplement) and related Frequently Asked Questions (FAQs) for Implementing March 2013 Interagency Guidance on Leveraged Lending.1
The 2014 Supplement provides additional commentary on the 2014 SNC review and states:
The review also found serious deficiencies in underwriting standards and risk management of leveraged loans. Overall, the SNC review showed gaps between industry practices and the expectations for safe-and-sound banking articulated in the guidance. Thirty-one percent of leveraged transactions originated within the past year exhibited structures that were cited as weak, mainly because of a combination of high leverage and the absence of financial covenants. Other weak characteristics observed included nominal equity and minimal de-leveraging capacity.
Covenant protection deteriorated, as evidenced by the reduced number of financial maintenance covenants, the use of net debt in many leverage covenants, and features that allow increased debt above starting leverage and the dilution of senior secured positions. In particular, transactions that increase leverage without a subsequent increase in cash flow generation (e.g., loans used to pay dividends to equity investors) should be viewed with greater caution. In many cases, examiners questioned the borrower capacity to repay newly underwritten loans if economic conditions deteriorated or if interest rates rose to historical norms. As noted in the 2013 guidance, financial institutions should ensure borrowers can 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.
Regarding SNC underwriting, the 2014 Supplement notes:
Weakness in underwriting was far more prevalent in leveraged lending compared with non-leveraged SNC loans. Thirty-one percent of leveraged transactions originated within the past year exhibited structures that were cited by examiners as weak, mainly because of a combination of high leverage and the absence of financial covenants. Other weak characteristics observed include: equity cures, nominal equity, and minimal de-leveraging capacity. In addition, covenant protection deteriorated, as evidenced by the reduced number of financial maintenance covenants, the use of net debt in leverage covenants, excessive headroom, springing features, and various accordion features that allow increased debt above starting leverage and the dilution of senior secured positions.
Similarly, the FAQs2 are offered by the US Banking Regulators to “foster industry and examiner understanding of the guidance and supervisory expectations for safe and sound underwriting and to promote consistent application of the guidance.”
1 For more information about the 2013 Leveraged Lending Guidance, see our March 27, 2013 Legal Update.
2 We have excerpted certain of the questions and responses from the FAQs regarding non-pass origination, permissible amendments, acceptable refinancing of special mention credits, multiple-tranche facilities, relevance of debt-to-enterprise value, 6x leverage not a “bright-line” test and other matters.
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