Federal Register / Vol. 77, No. 62 / Friday, March 30, 2012 / Notices 19417 

1This proceeding originally was captioned as an 

‘‘acquisition’’ exemption, but the described 

transaction, as clarified, involves only an operating 

agreement. The proceeding has been re-captioned 

accordingly. 

2ATRR initially filed its verified notice of 

exemption on November 25, 2011. On December 16, 

2011, ATRR filed a request that its notice of 

exemption be held in abeyance until further notice, 

which the Board granted by decision served on 

December 20, 2011. ATRR filed an amended 

verified notice on March 2, 2012, and a letter 

supplementing and clarifying its amended verified 

notice on March 20, 2012. 

3A copy of the operating agreement was 

submitted with the notice of exemption. See 

Anthony Macrie—Continuance in Control 

Exemption—N.J. Seashore Lines, Inc., FD 35296, 

slip op. at 3–4 (STB served Aug. 31, 2010). 

4See Effingham R.R.—Pet. for Declaratory 

Order—Constr. at Effingham, IL, NOR 41986 et al. 

(STB served Sept. 18, 1998), aff’d sub nom. United 

Transp. Union-Ill. Legislative Bd. v. STB, 183 F.3d 

606 (7th Cir. 1999). 

5ATRR’s verified notice of exemption is deemed 

to have been filed on March 20, 2012, the date 

ATRR filed its latest supplement. 

DEPARTMENT OF TRANSPORTATION 

Surface Transportation Board 

[Docket No. FD 35390] 

Affton Terminal Railroad Company— 

Operation Exemption1—Affton 

Trucking Company 

Affton Terminal Railroad Company 

(ATRR), a noncarrier, has filed a verified 

notice of exemption 2 under 49 CFR 

1150.31 to operate, pursuant to an 

agreement with Affton Trucking 

Company (ATC),3 approximately 2.0 

miles of railroad right-of-way and 

trackage and transloading facilities in 

St. Louis, Mo. (the Line). 

According to ATRR, there are no 

mileposts associated with the trackage, 

which is located at ATC’s transloading 

facility in St. Louis. ATRR states that 

the trackage is used in conjunction with 

interchanging outbound carloads of 

grains and related products as well as 

plastic pellets and related products with 

the Terminal Railroad Association of St. 

Louis and BNSF Railway Company and 

inbound carloads for transloading into 

trucks for final delivery. ATRR also 

states that there are plans to phase in 

additional trackage that ATRR will 

operate. 

ATRR asserts that because the 

trackage in question will constitute the 

entire line of railroad of ATRR, this 

trackage is a line of railroad under 49 

U.S.C. 10901, rather than spur, 

switching or side tracks excepted from 

Board operation authority by virtue of 

49 U.S.C. 10906.4

The transaction may not be 

consummated until April 19, 2012 (30 

days after the notice of exemption was 

filed).5

ATRR certifies that its projected 

annual revenues as a result of this 

transaction will not exceed levels that 

will qualify it as a Class III rail carrier. 

If the verified notice contains false or 

misleading information, the exemption 

is void ab initio. Petitions to revoke the 

exemption under 49 U.S.C. 10502(d) 

may be filed at any time. The filing of 

a petition to revoke will not 

automatically stay the effectiveness of 

the exemption. Petitions to stay must be 

filed no later than April 12, 2012 (at 

least seven days before the exemption 

becomes effective). 

An original and 10 copies of all 

pleadings, referring to Docket No. FD 

35390, must be filed with the Surface 

Transportation Board, 395 E Street SW., 

Washington, DC 20423–0001. In 

addition, a copy of each pleading must 

be served on David C. Dillon, Dillon & 

Nash, Ltd., Suite 719, 111 West 

Washington Street, Chicago, IL 60602. 

Board decisions and notices are 

available on our Web site at 

www.stb.dot.gov. 

Decided: March 27, 2012. 

By the Board. 

Rachel D. Campbell, 

Director, Office of Proceedings. 

Raina S. White, 

Clearance Clerk. 

[FR Doc. 2012–7696 Filed 3–29–12; 8:45 am] 

BILLING CODE 4915–01–P 

DEPARTMENT OF THE TREASURY 

Submission for OMB Review; 

Comment Request 

March 28, 2012. 

The Department of the Treasury will 

submit the following information 

collection request to the Office of 

Management and Budget (OMB) for 

review and clearance in accordance 

with the Paperwork Reduction Act of 

1995, Public Law 104–13, on or after the 

date of publication of this notice. 

DATES: Comments should be received on 

or before April 30, 2012 to be assured 

of consideration. 

ADDRESSES: Send comments regarding 

the burden estimate, or any other aspect 

of the information collection, including 

suggestion for reducing the burden, to 

the (1) Office of Information and 

Regulatory Affairs, Office of 

Management and Budget, Attention: 

Desk Officer for Treasury, New 

Executive Office Building, Room 10235, 

Washington, DC 20503, or email at 

OIRA_Submission@OMB.EOP.GOV and 

to the (2) Treasury PRA Clearance 

Officer, 1750 Pennsylvania Ave. NW., 

Suite 11020, Washington, DC 20220, or 

on-line at www.PRAComment.gov. 

FOR FURTHER INFORMATION CONTACT: 

Copies of the submission(s) may be 

obtained by calling (202) 927–5331, 

email at PRA@treasury.gov, or the entire 

information collection request maybe 

found at www.reginfo.gov. 

Alcohol and Tobacco Tax and Trade 

Bureau (TTB) 

OMB Number: 1513–0020. 

Type of Review: Revision of a 

currently approved collection. 

Title: Application for and 

Certification/Exemption of Label/Bottle 

Approval. 

Form: TTB F 5100.31. 

Abstract: The Federal Alcohol 

Administration Act requires the labeling 

of alcohol beverages and designates the 

Treasury Department to oversee 

compliance with regulations. This form 

is completed by the regulated industry 

members and submitted to TTB as an 

application to label their products. TTB 

oversees label applications to prevent 

consumer deception and to deter 

falsification of unfair advertising 

practices on alcohol beverages. 

Affected Public: Private Sector: 

Businesses or other for-profits. 

Estimated Total Burden Hours: 

67,566. 

Dawn D. Wolfgang, 

Treasury PRA Clearance Officer. 

[FR Doc. 2012–7792 Filed 3–29–12; 8:45 am] 

BILLING CODE 4810–31–P 

DEPARTMENT OF THE TREASURY 

Office of the Comptroller of the 

Currency 

[Docket ID OCC–2011–0028] 

FEDERAL RESERVE SYSTEM 

[OP–1439] 

FEDERAL DEPOSIT INSURANCE 

CORPORATION 

Proposed Guidance on Leveraged 

Lending 

AGENCY: Office of the Comptroller of the 

Currency, Treasury (‘‘OCC’’); Board of 

Governors of the Federal Reserve 

System (‘‘Board’’ or ‘‘Federal Reserve’’); 

and the Federal Deposit Insurance 

Corporation (‘‘FDIC’’). 

ACTION: Proposed joint guidance with 

request for public comment. 

SUMMARY: The OCC, Board, and the 

FDIC (collectively, the Agencies) request 

comment on proposed guidance on 

leveraged lending (proposed guidance). 

mstockstill on DSK4VPTVN1PROD with NOTICES

19418 Federal Register / Vol. 77, No. 62 / Friday, March 30, 2012 / Notices 

1For purposes of this guidance, the term 

‘‘financial institution’’ means national banks, 

federal savings associations, and Federal branches 

and agencies supervised by the OCC; state member 

banks, bank holding companies, and all other 

institutions for which the Federal Reserve is the 

primary federal supervisor; and state nonmember 

insured banks and other institutions supervised by 

the FDIC. 

The proposed guidance outlines highlevel principles related to safe and 

sound leveraged lending activities, 

including underwriting considerations, 

assessing and documenting enterprise 

value, risk management expectations for 

credits awaiting distribution, stress 

testing expectations and portfolio 

management, and risk management 

expectations. This proposed guidance 

would apply to all Federal Reservesupervised, FDIC-supervised, and OCCsupervised financial institutions 

substantively engaged in leveraged 

lending activities. The number of 

community banking organizations with 

substantial exposure to leveraged 

lending is very small; therefore the 

Agencies generally expect that 

community banking organizations 

largely would be unaffected by this 

guidance. 

DATES: Comments must be submitted on 

or before June 8, 2012. 

ADDRESSES: 

OCC 

Please use the title ‘‘Proposed 

Leveraged Lending Guidance’’ to 

facilitate the organization and 

distribution of the comments. You may 

submit comments by any of the 

following methods: 

• Email: 

regs.comments@occ.treas.gov. 

• Mail: Office of the Comptroller of 

the Currency, 250 E Street SW., Mail 

Stop 2–3, Washington, DC 20219. 

• Fax: (202) 874–5274. 

• Hand Delivery/Courier: 250 E Street 

SW., Mail Stop 2–3, Washington, DC 

20219. 

Instructions: You must include 

‘‘OCC’’ as the agency name and ‘‘Docket 

Number OCC–2011–0028’’ in your 

comment. In general, OCC will enter all 

comments received into the docket and 

publish them on the Regulations.gov 

Web site without change, including any 

business or personal information that 

you provide such as name and address 

information, email addresses, or phone 

numbers. Comments received, including 

attachments and other supporting 

materials, are part of the public record 

and subject to public disclosure. Do not 

enclose any information in your 

comment or supporting materials that 

you consider confidential or 

inappropriate for public disclosure. 

You may review comments and other 

related materials that pertain to this 

notice by any of the following methods: 

• Viewing Comments Personally: You 

may personally inspect and photocopy 

comments at the OCC, 250 E Street SW., 

Washington, DC. For security reasons, 

the OCC requires that visitors make an 

appointment to inspect comments. You 

may do so by calling (202) 874–4700. 

Upon arrival, visitors will be required to 

present valid government-issued photo 

identification and to submit to security 

screening in order to inspect and 

photocopy comments. 

• Docket: You may also view or 

request available background 

documents and project summaries using 

the methods described above. 

Board 

When submitting comments, please 

consider submitting your comments by 

email or fax because paper mail in the 

Washington, DC, area and at the Board 

may be subject to delay. You may 

submit comments, identified by Docket 

No. OP–1439, by any of the following 

methods: 

• Agency Web Site: http:// 

www.federalreserve.gov. Follow the 

instructions for submitting comments at 

http://www.federalreserve.gov/ 

generalinfo/foia/ProposedRegs.cfm. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• Email: 

regs.comments@federalreserve.gov. 

Include docket number in the subject 

line of the message. 

• FAX: (202) 452–3819 or (202) 452– 

3102. 

• Mail: Jennifer J. Johnson, Secretary, 

Board of Governors of the Federal 

Reserve System, 20th Street and 

Constitution Avenue NW., Washington, 

DC 20551. 

All public comments are available 

from the Board’s Web site at http:// 

www.federalreserve.gov/generalinfo/ 

foia/ProposedRegs.cfm as submitted, 

unless modified for technical reasons. 

Accordingly, your comments will not be 

edited to remove any identifying or 

contact information. Public comments 

may also be viewed electronically or in 

paper form in Room MP–500 of the 

Board’s Martin Building (20th and C 

Street NW., Washington, DC 20551) 

between 9 a.m. and 5 p.m. on weekdays. 

FDIC: You may submit comments by 

any of the following methods: 

• Agency Web site: http:// 

www.FDIC.gov/regulations/laws/ 

federal/propose.html. Follow the 

instructions for submitting comments. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

• Email: comments@FDIC.gov. 

Include ‘‘Leveraged Lending Guidance’’ 

in the subject line of the message. 

Comments received will be posted 

without change to http://www.FDIC.gov/ 

regulations/laws/federal/propose.html, 

including any personal information 

provided. 

• Mail: Robert E. Feldman, Executive 

Secretary, Attention: Comments/Legal 

ESS, Federal Deposit Insurance 

Corporation, 550 17th Street NW., 

Washington, DC 20429. 

• Hand Delivery/Courier: Guard 

station at the rear of the 550 17th Street 

Building (located on F Street), on 

business days between 7 a.m. and 5 p.m. 

(EDT). 

FOR FURTHER INFORMATION CONTACT: 

OCC: Louise Francis, Commercial 

Credit Technical Expert, 202–874–5170, 

250 E Street SW., Washington, DC 

20219. 

Board: Lawrence A. Rufrano, Senior 

Financial Analyst, (202) 452–2808, 

Mary Aiken, Manager, Risk Policy, (202) 

452–2904, or Benjamin W. McDonough, 

Senior Counsel, (202) 452–2036, Legal 

Division, Board of Governors of the 

Federal Reserve System, 20th and C 

Streets NW., Washington, DC 20551. 

FDIC: William R. Baxter, Senior 

Examination Specialist, 202–898–8514, 

wbaxter@fdic.gov, 550 17th Street NW., 

Washington, DC 20429. 

SUPPLEMENTARY INFORMATION: 

I. Background 

All financial institutions 1 should 

have the capacity to properly evaluate 

and monitor underwritten credit risks, 

to understand the effect of changes in 

borrowers’ enterprise values upon credit 

portfolio quality, and to assess the 

sensitivity of future credit losses to 

changes in enterprise values. Further, in 

underwriting such credits, institutions 

need to ensure that borrowers are able 

to repay credit as due and at the same 

time that borrowers have capital 

structures, including their bank 

borrowings and other debt, that support 

the borrower’s continued operations 

through economic cycles (that is, have 

a sustainable capital structure). 

Institutions should also be able to 

demonstrate that they understand their 

risks and the potential impact of 

stressful events and circumstances on 

borrowers’ financial condition. The 

Agencies have previously provided 

guidance to financial institutions for 

their involvement in leveraged lending. 

The recent financial crisis further 

underscored the need for banking 

organizations to employ sound 

mstockstill on DSK4VPTVN1PROD with NOTICES

Federal Register / Vol. 77, No. 62 / Friday, March 30, 2012 / Notices 19419 

2 ‘‘Annual Stress Test,’’ Notice of Proposed 

Rulemaking, 77 FR 3408 (January 24, 2012). 

3SR 01–9, ‘‘Interagency Guidance on Leveraged 

Financing,’’ April 17, 2001, OCC Bulletin 2001–8, 

FDIC Press Release PR–28–2001. 

4For the purpose of this guidance, references to 

leveraged finance or leveraged transactions 

encompass the entire debt structure of a leveraged 

obligor (including senior loans and letters of credit, 

mezzanine tranches, senior and subordinated 

bonds). References to leveraged lending and 

leveraged loan transactions and credit agreements 

refer to the senior loan and letter of credit tranches 

held by both bank and non-bank investors. 

underwriting, to ensure that the risks in 

leveraged lending activities are 

appropriately incorporated in the 

Allowance for Loan and Lease Losses 

and capital adequacy analyses, to 

monitor the sustainability of their 

borrowers’ capital structures, and to 

incorporate stress testing into their risk 

management of both leveraged 

portfolios and distribution pipelines, as 

banking organizations unprepared for 

stressful events and circumstances can 

suffer acute threats to their financial 

condition and viability. The proposed 

guidance is intended to be consistent 

with industry practices while building 

upon the recently proposed guidance on 

Stress Testing.2

II. Principal Elements of the Proposed 

Guidance 

In April 2001, the Agencies (and 

Office of Thrift Supervision) issued 

guidance 3 regarding sound practices for 

leveraged finance 4 activities (2001 

Guidance). The 2001 Guidance 

addressed expectations for the content 

of credit policies, the need for welldefined underwriting standards, the 

importance of defining an institution’s 

risk appetite for leveraged transactions, 

and the importance of stress testing 

exposures and portfolios. 

Since the issuance of that guidance, 

the Agencies have observed tremendous 

growth in the volume of leveraged credit 

and in the participation of nonregulated investors. As the market has 

grown, debt agreements have frequently 

included features that provided 

relatively limited lender protection, 

including the absence of meaningful 

maintenance covenants in loan 

agreements and the inclusion of 

payment-in-kind (PIK)-toggle features in 

junior capital instruments (i.e., a feature 

where the borrower has the option to 

pay interest in cash or in-kind, which 

increases the principal owed), both of 

which lessen lenders’ recourse in the 

event that a borrower’s performance 

does not meet projections. Further, the 

capital structures and repayment 

prospects for some transactions, 

whether originated to hold or distribute, 

have at times been aggressive in light of 

the overall risk of the credit. 

Absent meaningful limits and to 

support burgeoning demand from 

institutional investors, the pipeline of 

aggressively priced and structured 

commitments has grown rapidly. 

Further, 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. 

In light of these changes, the Agencies 

have decided to replace the 2001 

Guidance with new leveraged finance 

guidance (proposed guidance). The 

proposed guidance describes 

expectations for the sound risk 

management of leveraged finance 

activities, including the importance of 

institutions developing and 

maintaining: 

• Transactions that are structured to 

reflect a sound business premise, an 

appropriate capital structure, and 

reasonable cash flow and balance sheet 

leverage. Combined with supportable 

performance projections, these 

considerations should clearly support a 

borrower’s capacity to repay and delever to a sustainable level over a 

reasonable period, whether 

underwritten to hold or distribute. 

• A definition of leveraged finance 

that facilitates consistent application 

across all business lines. 

• Well-defined underwriting 

standards that, among other things, 

define acceptable leverage levels and 

describe amortization expectations for 

senior and subordinate debt. 

• A credit limit and concentration 

framework that is consistent with the 

institution’s risk appetite. 

• Sound MIS that enable management 

to identify, aggregate, and monitor 

leveraged exposures and comply with 

policy across all business lines. 

• Strong pipeline management 

policies and procedures that, among 

other things, provide for real-time 

information on exposures and limits, 

and exceptions to the timing of expected 

distributions and approved hold levels. 

The proposed guidance replaces 

existing leveraged finance guidance and 

forms the basis of the Agencies’ 

supervisory focus and review of 

supervised financial institutions, 

including, as applicable, subsidiaries 

and affiliates involved in leveraged 

lending. In implementing the guidance, 

the Agencies will consider the size and 

risk profile of an institution’s leveraged 

portfolio relative to its assets, earnings, 

liquidity, and capital. Although some 

sections of this proposal are intended to 

apply to all leveraged lending 

transactions (e.g., underwriting), the 

vast majority of community banks 

should not be affected by this guidance 

as they have no exposure to leveraged 

credits. The limited number of 

community and smaller institutions that 

are involved in leveraged lending 

activities should discuss with their 

primary regulator implementation of 

cost-effective controls appropriate for 

the complexity of their exposures and 

activities. 

III. Administrative Law Matters 

A. Paperwork Reduction Act Analysis 

In accordance with the Paperwork 

Reduction Act (PRA) of 1995 (44 U.S.C. 

3506; 5 CFR part 1320, Appendix A.1), 

the Agencies reviewed the proposed 

guidance. The Agencies may not 

conduct or sponsor, and an organization 

is not required to respond to, an 

information collection unless the 

information collection displays a 

currently valid OMB control number. 

The Agencies have determined that 

certain aspects of the proposed guidance 

may constitute a collection of 

information. In particular, these aspects 

are the provisions that state a banking 

organization should (i) have 

underwriting policies for leveraged 

lending, including stress testing 

procedures for leveraged credits; (ii) 

have risk management policies, 

including stress testing procedures for 

pipeline exposures; and (iii) have 

policies and procedures for 

incorporating the results of leveraged 

credit and pipeline stress tests into the 

firm’s overall stress testing framework. 

The frequency of information collection 

is estimated to be annual. Respondents 

are banking organizations with 

leveraged lending activities as defined 

in the guidance. 

Report Title: Guidance on Leveraged 

Lending. 

Frequency of Response: Annual. 

Affected Public: Banking 

Organizations with Leveraged Lending. 

OCC 

OMB Control No.: To be assigned by 

OMB. 

Estimated number of respondents: 25. 

Estimated average time per 

respondent: 1,350.4 hours to build; 

1,705.6 hours for ongoing use. 

Estimated total annual burden hours: 

33,760 hours to build, 42,640 hours for 

ongoing use. 

Board 

Agency information collection 

number: FR 4203. 

mstockstill on DSK4VPTVN1PROD with NOTICES

19420 Federal Register / Vol. 77, No. 62 / Friday, March 30, 2012 / Notices 

5SR 01–9, ‘‘Interagency Guidance on Leveraged 

Financing,’’ April 17, 2001, OCC Bulletin 2001–8, 

FDIC Press Release PR–28–2001. 

6For the purpose of this guidance, references to 

leveraged finance or leveraged transactions 

encompass the entire debt structure of a leveraged 

obligor (including senior loans and letters of credit, 

mezzanine tranches, senior and subordinated 

bonds). References to leveraged lending and 

leveraged loan transactions and credit agreements 

refer to the senior loan and letter of credit tranches 

held by both bank and non-bank investors. 

OMB Control No.: To be assigned by 

OMB. 

Estimated number of respondents: 41. 

Estimated average time per 

respondent: 1,064.4 hours to build, 

754.4 hours for ongoing use. 

Estimated total annual burden hours: 

43,640 hours to build; 30,930 hours for 

ongoing use. 

FDIC 

OMB Control No.: To be assigned by 

OMB. 

Estimated number of respondents: 9. 

Estimated average time per 

respondent: 986.7 hours to build; 529.3 

hours for ongoing use. 

Estimated total annual burden hours: 

8,880 hours to build, 4,764 hours for 

ongoing use. 

The estimated time per respondent is 

an average that varies by agency because 

of differences in the composition of the 

institutions under each agency’s 

supervision (e.g., size distribution of 

institutions) and volume of leveraged 

lending activities. 

The Agencies invite comments on the 

following: 

(1) Whether the proposed collection 

of information is necessary for the 

proper performance of the regulatory 

function; including whether the 

information has practical utility; 

(2) The accuracy of the estimates of 

the burden of the proposed information 

collection, including the cost of 

compliance; 

(3) Ways to enhance the quality, 

utility, and clarity of the information to 

be collected; and 

(4) Ways to minimize the burden of 

information collection on respondents, 

including through the use of automated 

collection techniques or other forms of 

information technology. 

Additionally, please send a copy of 

your comments regarding these 

proposed information collections by 

mail to: Desk Officer, U.S. Office of 

Management and Budget, 725 17th 

Street NW., #10235, Washington, DC 

20503, or by fax to (202) 395–6974. 

These information collections are 

authorized pursuant to the following 

statutory authorities: 

OCC: National Bank Act, (12 U.S.C. 1 

et seq.; 12 U.S.C. 161) and the 

International Banking Act (12 U.S.C. 

3101 et seq.) 

Board: Sections 11(a), 11(i), 25, and 

25A of the Federal Reserve Act (12 

U.S.C. 248(a), 248(i), 602, and 611), 

section 5 of the Bank Holding Company 

Act (12 U.S.C. 1844), and section 7(c) of 

the International Banking Act (12 U.S.C. 

3105(c)). 

FDIC: Federal Deposit Insurance Act, 

(12 U.S.C. 1811 et seq.) and the 

International Banking Act (12 U.S.C. 

3101 et seq.). 

The agencies expect to review the 

policies and procedures for stress 

testing as part of their supervisory 

processes. To the extent they collect 

information during an examination of a 

banking organization, confidential 

treatment may be afforded to the records 

under exemption 8 of the Freedom of 

Information Act (FOIA), 5 U.S.C. 

552(b)(8). 

B. Regulatory Flexibility Act Analysis 

While the guidance is not being 

adopted as a rule, the Agencies have 

considered the potential impact of the 

proposed guidance on small banking 

organizations using the considerations 

that would apply if the Regulatory 

Flexibility Act (5 U.S.C. 603(b)) were 

applicable. For the reason discussed in 

the Supplementary Information above, 

the Agencies are issuing the proposed 

guidance to emphasize the importance 

of properly underwriting leveraged 

lending transactions and incorporating 

those exposures into stress and capital 

tests for institutions with significant 

exposures to these credits. Based on its 

analysis and for the reasons stated 

below, the Agencies believe that the 

proposed guidance will not have a 

significant economic impact on a 

substantial number of small entities. 

Nevertheless, the Agencies are seeking 

comment on whether the proposed 

guidance would impose undue burdens 

on, or have unintended consequences 

for, small organizations. 

Under regulations issued by the Small 

Business Administration (SBA), a small 

banking organization is defined as a 

banking organization with total assets of 

$175 million or less. See 13 CFR 

121.201. The guidance being proposed 

by the Agencies is intended for banking 

organizations supervised by the 

Agencies with substantial exposures to 

leveraged lending activities, including 

national banks, federal savings 

associations, state nonmember banks, 

state member banks, bank holding 

companies, and U.S. branches and 

Agencies of foreign banking 

organizations. Given the sheer size of 

leveraged lending transactions, most of 

which exceed $50 million, and the 

Agencies’ observations that leveraged 

loans tend to be held primarily by large 

or global banking institutions with total 

assets that are well above $175 million, 

the effects of this guidance upon smaller 

institutions are expected to be 

negligible. Banking organizations that 

are subject to the proposed guidance 

therefore substantially exceed the $175 

million total asset threshold at which a 

banking organization is considered a 

small banking organization under SBA 

regulations. 

In light of the foregoing, the Agencies 

believe that the proposed guidance, if 

adopted in final form, would not have 

a significant economic impact on a 

substantial number of small entities. As 

noted above, the Agencies specifically 

seek comment on whether the proposed 

guidance would impose undue burdens 

on, or have unintended consequences 

for, small organizations and whether 

there are ways such potential burdens or 

consequences could be addressed in a 

manner consistent with the guidance. 

IV. Proposed Guidance 

The text of the proposed guidance is 

as follows: 

Purpose 

In April 2001, the Agencies (Office of the 

Comptroller of the Currency, Board of 

Governors of the Federal Reserve System, 

Federal Deposit Insurance Corporation, and 

Office of Thrift Supervision) issued 

guidance 5 regarding sound practices for 

leveraged finance 6 activities (2001 

Guidance). The 2001 Guidance addressed 

expectations for the content of credit 

policies, the need for well-defined 

underwriting standards, the importance of 

defining an institution’s risk appetite for 

leveraged transactions, and the importance of 

stress testing exposures and portfolios. 

Since the issuance of that guidance, the 

Agencies have observed tremendous growth 

in the volume of leveraged credit and in the 

participation of non-regulated investors. As 

the market has grown, debt agreements have 

frequently included features that provided 

relatively limited lender protection, 

including the absence of meaningful 

maintenance covenants in loan agreements 

and the inclusion of payment-in-kind (PIK)- 

toggle features in junior capital instruments, 

both of which lessened lenders’ recourse in 

the event of a borrower’s subpar 

performance. Further, the capital structures 

and repayment prospects for some 

transactions, whether originated to hold or 

distribute, have at times been aggressive. 

Absent meaningful limits and to support 

burgeoning demand from institutional 

investors, the pipeline of aggressively priced 

and structured commitments has grown 

rapidly. Further, 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 

mstockstill on DSK4VPTVN1PROD with NOTICES

Federal Register / Vol. 77, No. 62 / Friday, March 30, 2012 / Notices 19421 

7Cash should not be netted against debt for 

purposes of this calculation. 

8Higher quality borrowers not initially 

designated as part of the leveraged portfolio, but 

which otherwise meet the institution’s definition, 

should be added to the portfolio if their financial 

performance and prospects deteriorate (i.e., fallen 

angels). 

commitments at a time when buyer demand 

for risky assets diminished significantly. 

In light of these changes, the Agencies have 

decided to replace the 2001 Guidance with 

new leveraged finance guidance (2012 

Guidance). The 2012 Guidance describes 

expectations for the sound risk management 

of leveraged finance activities, including the 

importance for institutions to develop and 

maintain: 

• Transactions that are structured to reflect 

a sound business premise, an appropriate 

capital structure, and reasonable cash flow 

and balance sheet leverage. Combined with 

supportable performance projections, these 

should clearly support a borrower’s capacity 

to repay and de-lever to a sustainable level 

over a reasonable period, whether 

underwritten to hold or distribute. 

• A definition of leveraged finance that 

facilitates consistent application across all 

business lines. 

• Well-defined underwriting standards 

that, among other things, define acceptable 

leverage levels and describe amortization 

expectations for senior and subordinate debt. 

• A credit limit and concentration 

framework that is consistent with the 

institution’s risk appetite. 

• Sound MIS that enable management to 

identify, aggregate, and monitor leveraged 

exposures and comply with policy across all 

business lines. 

• Strong pipeline management policies 

and procedures that, among other things, 

provide for real-time information on 

exposures and limits, and exceptions to the 

timing of expected distributions and 

approved hold levels. 

Applicability 

This issuance replaces existing leveraged 

finance guidance and forms the basis of the 

Agencies’ supervisory focus and review of 

supervised financial institutions, including 

subsidiaries and affiliates. Implementation of 

this guidance should be consistent with the 

size and risk profile of an institution’s 

leveraged portfolio relative to its assets, 

earnings, liquidity, and capital. Although 

some sections of this guidance should apply 

to all leveraged transactions (e.g., 

underwriting), the vast majority of 

community banks should not be affected by 

this guidance as they have no exposure to 

leveraged credits. The limited number of 

community and smaller institutions that have 

leveraged lending activities should discuss 

with their primary regulator implementation 

of cost-effective controls appropriate for the 

complexity of their exposures and activities. 

Risk Management Framework 

Given the high risk profile of leveraged 

exposures, institutions engaged in leveraged 

financing should adopt a risk management 

framework that has an intensive and frequent 

review and monitoring process. The 

framework should have as its foundation 

written risk objectives, risk acceptance 

criteria, and risk controls. The lack of robust 

risk management processes and controls in 

institutions with significant leveraged 

finance activities could contribute to a 

finding that the institution is engaged in an 

unsafe and unsound banking practice. This 

guidance outlines minimum regulatory 

expectations and covers the following topics: 

• Definition of Leveraged Finance. 

• General Policy Expectations. 

• Underwriting Standards. 

• Valuation Standards. 

• Pipeline Management. 

• Reporting and Analytics. 

• Rating Leveraged Loans. 

• Other Key Risk Management 

Components. 

• Credit Analysis. 

• Problem Credits. 

• Deal Sponsors. 

• Credit Review. 

• Conflicts of Interest. 

• Anti-tying. 

• Reputation Risk. 

• Securities Laws. 

• Compliance. 

Definition of Leveraged Finance 

Institutions’ policies should include 

criteria to define leveraged finance. 

Numerous definitions of leveraged finance 

exist throughout the financial services 

industry and commonly contain some 

combination of the following: 

• Proceeds are used for buyouts, 

acquisitions, or capital distributions. 

• Transactions where the borrower’s Total 

Debt/EBITDA (earnings before interest, taxes, 

depreciation, and amortization) or Senior 

Debt/EBITDA exceed 4.0X EBITDA or 3.0X 

EBITDA, respectively, or other defined levels 

appropriate to the industry or sector.7

• Borrower that is recognized in the debt 

markets as a highly leveraged firm, which is 

characterized by a high debt-to-net-worth 

ratio. 

• Transactions where the borrower’s postfinancing leverage, when measured by its 

leverage ratios, debt-to-assets, debt-to-networth, debt-to-cash flow, or other similar 

standards common to particular industries or 

sectors, significantly exceeds industry norms 

or historical levels.8

Institutions engaging in this type of activity 

should define leveraged finance within their 

policies in a manner sufficiently detailed to 

ensure consistent application across all 

business lines. 

Examiners should expect the bank’s 

definition to describe clearly the purposes 

and financial characteristics common to 

these transactions, and this definition should 

include the bank’s exposure to financial 

vehicles, whether or not leveraged, that 

engage in leveraged finance activities. 

General Policy Expectations 

An institution’s credit policies and 

procedures for leveraged finance should 

address the following items: 

• Management should identify the 

institution’s risk appetite, which should 

include clearly defined amounts of leveraged 

finance that the institution is willing to 

underwrite (pipeline limits) and leveraged 

loans it is willing to retain (i.e., transaction 

and aggregate hold levels). The designated 

risk appetite should be supported by an 

analysis of the potential effect on earnings, 

capital, liquidity, and other risks that result 

from these positions, and should be approved 

by the board of directors. 

• A limit framework that includes limits or 

guidelines for single obligors and 

transactions, aggregate hold portfolio, 

aggregate pipeline exposure, and industry 

and geographic concentrations. The limit 

framework should identify the related 

approval authorities and exception tracking 

provisions. In addition to notional pipeline 

limits, underwriting limit frameworks that 

assess stress losses, flex terms, economic 

capital usage, and earnings at risk or 

otherwise provide a more nuanced view of 

potential risk are expected from institutions 

with significant leveraged finance exposure. 

• Ensuring that the risks of leveraged 

lending activities are appropriately reflected 

in an institution’s Allowance for Loan and 

Lease Losses and capital adequacy analyses. 

• Credit and underwriting approval 

authorities, including the procedures for 

approving and documenting changes to 

approved transaction structures and terms. 

• Appropriate oversight by senior 

management, including adequate and timely 

reporting to the board. 

• The expected risk-adjusted returns for 

leveraged transactions. 

• Minimum underwriting standards (see 

Underwriting Standards below). 

• The degree to which underwriting 

practices may differ between primary loan 

origination and secondary loan acquisition. 

Underwriting Standards 

An institution’s underwriting standards 

should be clear, written, measurable, and 

accurately reflect the institution’s risk 

appetite for leveraged finance transactions. 

Institutions should have clear underwriting 

limits regarding leveraged transactions, 

including the size that the institution will 

arrange both individually and in the 

aggregate for distribution. Originating 

institutions should be mindful of 

reputational risks associated with poorly 

underwritten transactions, which may find 

their way into a wide variety of investment 

instruments and exacerbate systemic risks 

within the general economy. At a minimum, 

underwriting standards should consider: 

• Whether the business premise for each 

transaction is sound and its capital structure 

is sustainable regardless of whether the 

transaction is underwritten for the 

institution’s own portfolio or with the intent 

to distribute. The entirety of a borrower’s 

capital structure should reflect the 

application of sound financial analysis and 

underwriting principles. 

• A borrower’s capacity to repay and its 

ability to de-lever to a sustainable level over 

a reasonable period. As a general guide, base 

case cash-flow projections should show the 

ability over a five-to-seven year period to 

fully amortize senior secured debt or repay 

at least 50 percent of total debt. Projections 

should also include one or more realistic 

downside scenarios that reflect the key risks 

identified in the transaction. 

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• Expectations for the depth and breadth 

of due diligence on leveraged transactions. 

This should include standards for evaluating 

various types of collateral, and it should 

clearly define credit risk management’s role 

in such due diligence. 

• Standards for evaluating expected riskadjusted returns. The standards should 

include identification of expected 

distribution strategies, including alternative 

strategies for funding and disposing of 

positions during market disruptions, and the 

potential for losses during such periods. 

• Degree of reliance on enterprise value 

and other intangible assets for loan 

repayment, along with acceptable valuation 

methodologies, and guidelines for the 

frequency of periodic reviews of those 

values. 

• Expectations for the degree of support 

provided by the sponsor (if any), taking into 

consideration their financial capacity, the 

extent of their capital contribution at 

inception, and other motivating factors. 

• Whether credit agreement terms allow 

for the material dilution, sale or exchange of 

collateral or cash flow-producing assets 

without lender approval. 

• Credit agreement covenant protections, 

including financial performance (such as 

debt to cash flow, interest coverage or fixed 

charge coverage), reporting requirements, and 

compliance monitoring. Generally, a leverage 

level after planned asset sales (i.e., debt that 

must be serviced from operating cash flow) 

in excess of 6x for Total Debt/EBITDA raises 

concerns for most industries. 

• Collateral requirements in credit 

agreements that specify acceptable collateral 

and risk-appropriate measures and controls, 

including acceptable collateral types, loan-tovalue guidelines, and appropriate collateral 

valuation methodologies. Standards for assetbased loans should also outline expectations 

for the use of collateral controls (e.g., 

inspections, independent valuations, and 

lockbox), other types of collateral and 

account maintenance agreements, and 

periodic reporting requirements. 

• Whether loan agreements provide for 

distribution of ongoing financial and other 

relevant credit information to all 

participants/investors. 

Nothing in the preceding standards should 

be considered to discourage providing 

financing to borrowers engaged in workout 

negotiations, or as part of a pre-packaged 

financing under the bankruptcy code. Neither 

are they meant to discourage well-structured 

standalone asset-based credit facilities to 

borrowers with strong lender monitoring and 

controls, for which banks should consider 

separate underwriting and risk rating 

guidance. 

Valuation Standards 

Lenders often rely upon enterprise value 

and other intangibles when (1) evaluating the 

feasibility of a loan request, (2) determining 

the debt reduction potential of planned asset 

sales, (3) assessing a borrower’s ability to 

access the capital markets, and (4) estimating 

the strength of a secondary source of 

repayment. Lenders may also view enterprise 

value as a useful benchmark for assessing a 

sponsor’s economic incentive to provide 

financial support. Given the specialized 

knowledge needed for the development of a 

credible enterprise valuation and the 

importance of enterprise valuations in the 

underwriting and ongoing risk assessment 

processes, enterprise valuations should be 

performed or validated by qualified persons 

independent of the origination function. 

Conventional appraisal theory provides 

three approaches for valuing closely held 

businesses—asset, income, and market. Asset 

approach methods consider an enterprise’s 

underlying assets in terms of its net goingconcern or liquidation value. Income 

approach methods consider an enterprise’s 

ongoing cash flows or earnings and apply 

appropriate capitalization or discounting 

techniques. Market approach methods derive 

value multiples from comparable company 

data or sales transactions. Although value 

estimates should reconcile results from the 

use of all three approaches, the income 

approach is generally considered the most 

common and reliable method. There are two 

common methods to the income approach. 

The ‘‘capitalized cash flow’’ method 

determines the value of a company as the 

present value of all the future cash flows that 

the business can generate in perpetuity. An 

appropriate cash flow is determined and then 

divided by a risk-adjusted capitalization rate, 

most commonly the weighted average cost of 

capital. This method is most appropriate 

when cash flows are predictable and stable. 

The ‘‘discounted cash flow’’ method is a 

multiple-period valuation model that 

converts a future series of cash flows into 

current value by discounting those cash 

flows at a rate of return (discount rate) that 

reflects the risk inherent therein and matches 

the cash flow. This method is most 

appropriate when future cash flows are 

cyclical or variable between periods. Both 

methods involve numerous assumptions, and 

supporting documentation should therefore 

fully explain the evaluator’s reasoning and 

conclusions. 

When an obligor is experiencing a financial 

downturn or facing adverse market 

conditions, a lender should reflect those 

adverse conditions in its assumptions for key 

variables such as cash flow, earnings, and 

sales multiples when assessing enterprise 

value as a potential source of repayment. 

Changes in the value of a firm’s assets should 

be tested under a range of stress scenarios, 

including business conditions more adverse 

than the base case scenario. Stress testing of 

enterprise values and their underlying 

assumptions should be conducted and 

documented both at origination of the 

transaction and periodically thereafter, 

incorporating the actual performance of the 

borrower and any adjustments to projections. 

The institution should perform its own 

discounted cash flow analysis to validate the 

enterprise value implied by proxy measures 

such as multiples of cash flow, earnings, or 

sales. 

Valuations derived with even the most 

rigorous valuation procedures are imprecise 

and ultimately may not be realized. 

Therefore, institutions relying on enterprise 

value or illiquid and hard-to-value collateral 

should have policies that provide for 

appropriate loan-to-value ratios, discount 

rates, and collateral margins. Based on the 

nature of an institution’s leveraged lending 

activities, establishing limits for the 

proportion of individual transactions and the 

total portfolio that are supported by 

enterprise value may be appropriate. 

Whatever the methodology, assumptions 

underlying enterprise valuations should be 

clearly documented, well supported, and 

understood by institutions’ appropriate 

decision-makers and risk oversight units. 

Examiners should ensure that the valuation 

approach is appropriate for the company’s 

industry and condition. 

Pipeline Management 

Market disruptions can substantially 

impede the ability of an underwriter to 

consummate syndications or otherwise sell 

down exposures, which may result in 

material losses. Accordingly, institutions 

should have strong risk management and 

controls over transactions in the pipeline, 

including amounts to be held and those to be 

distributed. An institution should be able to 

differentiate transactions according to tenor, 

investor class (e.g., pro-rata, institutional), 

structure, and key borrower characteristics 

(e.g., industry). In addition, an institution 

should develop and maintain: 

• A clearly articulated and documented 

appetite for underwriting risk that considers 

the potential effects on earnings, capital, 

liquidity, and other risks that result from 

these positions. 

• Written procedures for defining and 

managing distribution fails and ‘‘hung’’ 

deals, which are identified by an inability to 

sell down the exposure within a reasonable 

period (generally 90 days from closing). The 

institution’s board should establish clear 

expectations for the disposition of pipeline 

transactions that have not been sold 

according to their original distribution plan. 

Such transactions that are subsequently 

reclassified as hold-to-maturity should also 

be included in reports to management and 

the board of directors. 

• Guidelines for conducting periodic stress 

tests on pipeline exposures to quantify the 

potential impact of changing economic/ 

market conditions on asset quality, earnings, 

liquidity, and capital. 

• Controls to monitor performance of the 

pipeline against original expectations, and 

regular reports of variances to management, 

including the amount and timing of 

syndication/distribution variances, and 

reporting if distribution was achieved 

through a recourse sale. 

• Reports that include individual and 

aggregate transaction information that 

accurately portrays risk and concentrations 

in the pipeline. 

• Limits on aggregate pipeline 

commitments and periodic testing of such 

exposures under different market scenarios. 

• Limits on the amount of loans that an 

institution is willing to retain on its own 

books (i.e., borrower/counterparty and 

aggregate hold levels), and limits on the 

underwriting risk that will be undertaken for 

amounts intended for distribution. 

• Policies and procedures that identify 

acceptable accounting methodologies and 

controls in both functional as well as 

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9FRB SR 98–25 ‘‘Sound Credit Risk Management 

and the Use of Internal Credit Risk Ratings at Large 

Banking Organizations;’’ OCC Handbooks ‘‘Rating 

Credit Risk’’ and ‘‘Leveraged Lending;’’ FDIC Risk 

Management Manual of Examination Policies, 

‘‘Loan Appraisal and Classification.’’ 

dysfunctional markets, and that direct 

prompt recognition of losses in accordance 

with generally accepted accounting 

principles. 

• Policies and procedures addressing the 

use of hedging to reduce pipeline and hold 

exposures. Policies should address 

acceptable types of hedges and the terms 

considered necessary for providing hedge 

credit (netting) for exposure measurement. 

• Plans and provisions addressing 

contingent liquidity and compliance with 

Regulation W (12 CFR part 223) when market 

illiquidity or credit conditions change, 

interrupting normal distribution channels. 

Reporting and Analytics 

The Agencies expect financial institutions 

to diligently monitor higher risk credits, 

including leveraged loans. An institution’s 

management should receive comprehensive 

reports about the characteristics and trends 

in such exposures at least quarterly, and 

summaries should be provided to the board 

of directors. Policies should identify the 

fields to be populated and captured by an 

institution’s MIS, which should yield 

accurate and timely reporting to management 

and the board that may include: 

• Individual and portfolio exposures 

within and across all business lines and legal 

vehicles, including the pipeline. 

• Risk rating distribution and migration 

analysis, including maintenance of a list of 

those borrowers who have been removed 

from the leveraged portfolio due to changes 

in their financial characteristics and overall 

risk profile. 

• Industry mix and maturity profile. 

• Metrics derived from probabilities of 

default and loss given default. 

• Portfolio performance measures, 

including noncompliance with covenants, 

restructurings, delinquencies, nonperforming amounts and charge-offs. 

• Amount of impaired assets and the 

nature of impairment (i.e., permanent, 

temporary), and the amount of the Allowance 

for Loan and Lease Losses attributable to 

leveraged lending. 

• The aggregate level of policy exceptions 

and the performance of that portfolio. 

• Exposure by collateral type, including 

unsecured transactions and those where 

enterprise value is a source of repayment for 

leveraged loans. Reporting should also 

consider the implications of defaults that 

trigger pari passu treatment for all lenders 

and thus dilute secondary support from 

collateral value. 

• Secondary market pricing data and 

trading volume when available. 

• Exposure and performance by deal 

sponsor. 

• Gross and net exposures, hedge 

counterparty concentrations, and policy 

exceptions. 

• Actual versus projected distribution of 

the syndicated pipeline, with regular reports 

of excess levels over the hold targets for 

syndication inventory. Pipeline definitions 

should clearly identify the type of exposure 

(e.g., committed exposures that have not been 

accepted by the borrower, commitments 

accepted but not closed, and funded and 

unfunded commitments that have closed but 

have not been distributed). 

• Guidelines for conducting periodic 

portfolio stress tests (including pipeline 

exposures) or sensitivity analyses to quantify 

the potential impact of changing economic/ 

market conditions on asset quality, earnings, 

liquidity, and capital. The sophistication of 

stress-testing practices and sensitivity 

analysis should be consistent with the size, 

complexity, and risk characteristics of the 

leveraged loan portfolio. The leveraged 

portfolio also should be included in any 

enterprise-wide stress tests. 

• Total and segment leveraged finance 

exposures, including subordinated debt and 

equity holdings, alongside established limits. 

Reports should provide a detailed and 

comprehensive view of global exposure, 

including situations where institutions have 

indirect exposure to an obligor or are holding 

a previously sold position as collateral or as 

a reference asset in a derivative. 

• Borrower/counterparty leveraged finance 

reporting should consider exposures booked 

in other business units throughout the 

institution, including indirect exposure such 

as default swaps and total return swaps 

naming the distributed paper as a covered or 

reference asset or collateral exposure through 

repo transactions. Additionally, the 

institution should consider positions held in 

available for sale or traded portfolios or 

through structured investment vehicles 

owned or sponsored by the originating 

institution or its subsidiaries or affiliates. 

Risk Rating Leveraged Loans 

The Agencies have previously issued 

guidance on rating credit exposures and 

credit rating systems, which applies to all 

credit transactions, including those in the 

leveraged lending category.9

Risk rating leveraged loans involves the 

use of realistic repayment assumptions to 

determine the borrower’s ability to de-lever 

to a sustainable level within a reasonable 

period of time. If the projected capacity to 

pay down debt from cash flow is nominal, 

with refinancing the only viable option, the 

credit will usually be criticized even if it has 

been recently underwritten. In cases where 

leveraged loan transactions have no 

reasonable or realistic prospects to de-lever, 

a substandard classification is likely. 

Furthermore, when assessing debt service 

capacity, extensions and restructures should 

be scrutinized to ensure that they are not 

merely masking repayment capacity 

problems. 

If the primary source of repayment 

becomes inadequate it would generally be 

inappropriate to consider enterprise value as 

a secondary source unless that value is well 

supported. Evidence of well-supported value 

may include binding purchase and sale 

agreements with qualified third parties or 

through valuations that fully consider the 

effect of the borrower’s distressed 

circumstances and potential changes in 

business and market conditions. For such 

borrowers, when a portion of the loan may 

not be protected by pledged assets or a wellsupported enterprise value, examiners 

generally will rate that portion doubtful or 

loss and place the loan on nonaccrual. 

Other Key Risk Management Components 

Credit Analysis 

Effective underwriting and management of 

leveraged finance risk is highly dependent on 

the quality of analysis employed during the 

approval process as well as ongoing 

monitoring. Policies should address the need 

for a comprehensive assessment of financial, 

business, industry, and management risks 

including, but not limited to, whether: 

• Cash flow analyses rely on overly 

optimistic or unsubstantiated projections of 

sales, margins, and merger and acquisition 

synergies. 

• Liquidity analyses include performance 

metrics appropriate for the borrower’s 

industry, predictability of the borrower’s 

cash flow, measurement of the borrower’s 

operating cash needs, and ability to meet 

debt maturities. 

• Projections exhibit an adequate margin 

for unanticipated merger-related integration 

costs. 

• Projections are stress tested for several 

downside scenarios, including a covenant 

breach. 

• Transactions are reviewed at least 

quarterly to determine variance from plan, 

the risk implications thereof, and the 

accuracy of risk ratings and accrual status. 

From inception, the credit file should contain 

a chronological rationale for and analysis of 

all substantive changes to the borrower’s 

operating plan and variance from expected 

financial performance. 

• Enterprise and collateral valuations are 

derived or validated independently of the 

origination function, are timely, and consider 

potential value erosion. 

• Collateral liquidation and asset sale 

estimates are conservative. 

• Potential collateral shortfalls are 

identified and factored into risk rating and 

accrual decisions. 

• Contingency plans anticipate changing 

conditions in debt or equity markets when 

exposures rely on refinancing or the issuance 

of new equity. 

• The borrower is adequately protected 

from interest rate and foreign exchange risk. 

Problem Credit Management 

Financial institutions should formulate 

individual action plans when working with 

borrowers that are experiencing diminished 

operating cash flows, depreciated collateral 

values, or other significant variance to plan. 

Weak initial underwriting of transactions, 

coupled with poor structure and limited 

covenants, may make problem credit 

discussions and eventual restructurings more 

difficult for lenders as well as result in less 

favorable outcomes. 

Institutions should formulate credit 

policies that define expectations for the 

management of adversely rated and other 

high-risk borrowers whose performance 

departs significantly from planned cash 

flows, asset sales, collateral values, or other 

important targets. These policies should 

stress the need for workout plans that contain 

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19424 Federal Register / Vol. 77, No. 62 / Friday, March 30, 2012 / Notices 

quantifiable objectives and measureable time 

frames. Actions may include working with 

the borrower for an orderly resolution while 

preserving the institution’s interests, sale of 

the credit in the secondary market, or 

liquidation. Problem credits should be 

reviewed regularly for risk rating accuracy, 

accrual status, recognition of impairment 

through specific allocations, and charge-offs. 

Deal Sponsors 

Institutions should develop guidelines for 

evaluating the qualifications of financial 

sponsors and implement a process to 

regularly monitor performance. Deal 

sponsors may provide valuable support to 

borrowers such as strategic planning, 

management, and other tangible and 

intangible benefits. Sponsors may also 

provide a source of financial support for a 

borrower that fails to achieve projections. 

Institutions generally rate borrowers based on 

their analysis of the borrowers’ standalone 

financial condition. However, lending 

institutions may consider support from a 

sponsor in assigning an internal risk rating 

when the institution can document the 

sponsor’s history of demonstrated support as 

well as the economic incentive, capacity, and 

stated intent to continue to support the 

transaction. However, even with documented 

capacity and a history of support, a sponsor’s 

potential contributions may not mitigate 

examiner criticism absent a documented 

commitment of continued support. An 

evaluation of a sponsor’s financial support 

should include the following: 

• Sponsor’s historical performance in 

supporting its investments, financially and 

otherwise. 

• Sponsor’s economic incentive to 

support, including the nature and amount of 

capital contributed at inception. 

• Documentation of degree of support (e.g., 

guarantee, comfort letter, verbal assurance). 

• Consideration of the sponsor’s 

contractual investment limitations. 

• To the extent feasible, a periodic review 

of the sponsor’s financial statements and 

trends, and an analysis of its liquidity, 

including the ability to fund multiple deals. 

• Consideration of the sponsor’s dividend 

and capital contribution practices. 

• Likelihood of supporting the borrower 

compared to other deals in the sponsor’s 

portfolio. 

• Guidelines for evaluating the 

qualifications of financial sponsors and a 

process to regularly monitor performance. 

Credit Review 

Institutions should have a strong and 

independent credit review function with a 

demonstrated ability to identify portfolio 

risks and documented authority to escalate 

inappropriate risks and other findings to 

senior management. Due to the elevated risk 

inherent in leveraged finance, and depending 

on the relative size of an institution’s 

leveraged finance business, it may be prudent 

for the institution’s credit review function to 

examine the leveraged portfolio more 

frequently than other segments, go into 

greater depth, and be more selective in 

identifying personnel to assess the 

underlying transactions. Portfolio reviews 

should generally be conducted at least 

annually. For many institutions, the risk 

characteristics of the leveraged portfolio, 

such as high reliance on enterprise value, 

concentrations, adverse risk rating trends, or 

portfolio performance, may dictate more 

frequent reviews. 

Institutions should staff their internal 

credit review function appropriately and 

ensure that it has sufficient resources to 

ensure timely, independent, and accurate 

assessments of leveraged finance 

transactions. Reviews should evaluate the 

level of risk and risk rating integrity, 

valuation methodologies, and the quality of 

risk management. Internal credit reviews also 

should encompass a review of the 

institution’s leveraged finance practices, 

policies and procedures to ensure that they 

are consistent with regulatory guidance. 

Conflicts of Interest 

Institutions should develop appropriate 

policies to address and prevent potential 

conflicts of interest. For example, a lender 

may be reluctant to use an aggressive 

collection strategy with a problem borrower 

because of the potential impact on the value 

of the lender’s equity interest. A lender may 

receive pressure to provide financial or other 

privileged client information that could 

benefit an affiliated equity investor. Such 

conflicts also may occur where the 

underwriting bank serves as financial advisor 

to the seller and simultaneously offers 

financing to multiple buyers (i.e., stapled 

financing). Similarly, there may be 

conflicting interests between the different 

lines of business or between the institution 

and its affiliates. These and other situations 

may arise that create conflicts of interest 

between the institution and its customers. 

Policies should clearly define potential 

conflicts of interest, identify appropriate risk 

management controls and procedures, enable 

employees to report potential conflicts of 

interest to management for action without 

fear of retribution, and ensure compliance 

with applicable law. Further, management 

should establish responsibility for training 

employees on how to avoid conflicts of 

interest, as well as provide for reporting, 

tracking, and resolution of any conflicts of 

interest that occur. 

Anti-Tying Regulations 

Because leveraged finance transactions 

often involve a number of types of debt and 

several bank products, institutions should 

ensure that their policies incorporate 

safeguards to prevent violations of anti-tying 

regulations. Section 106(b) of the BHC Act 

Amendments of 1970 prohibits certain forms 

of product tying by banks and their affiliates. 

The intent behind section 106(b) is to prevent 

institutions from using their market power 

over certain products to obtain an unfair 

competitive advantage in other products. 

Reputational Risk 

Leveraged finance transactions are often 

syndicated through the bank and 

institutional markets. An institution’s 

apparent failure to meet its legal or fiduciary 

responsibilities in underwriting and 

distributing transactions can damage its 

reputation and impair its ability to compete. 

Similarly, institutions distributing 

transactions that over time have significantly 

higher default or loss rates and performance 

issues may also see their reputation damaged 

in the markets. 

Securities Laws 

Equity interests and certain debt 

instruments used in leveraged finance 

transactions may constitute ‘‘securities’’ for 

the purposes of federal securities laws. When 

securities are involved, institutions should 

ensure compliance with applicable securities 

laws, including disclosure and other 

regulatory requirements. Institutions should 

also establish procedures to appropriately 

manage the internal dissemination of 

material nonpublic information about 

transactions in which it plays a role. 

Compliance Function 

The legal and regulatory issues raised by 

leveraged transactions are numerous and 

complex. To ensure that potential conflicts 

are avoided and laws and regulations are 

adhered to, an independent compliance 

function should periodically review an 

institution’s leveraged finance activity. 

Additional information is available in the 

Agencies’ existing guidance on compliance 

with laws and regulations. 

Conclusion 

Leveraged finance is an important type of 

financing for the economy, and the banking 

industry plays an integral role in making 

credit available and syndicating that credit to 

investors. Institutions should ensure they do 

not heighten risks by originating poorly 

underwritten deals that find their way into a 

wide variety of investment instruments. 

Therefore, it is important this financing be 

provided to creditworthy borrowers in a safe 

and sound manner that is consistent with 

this guidance. 

Dated: March 19, 2012. 

John Walsh, 

Acting Comptroller of the Currency. 

By order of the Board of Governors of the 

Federal Reserve System, March 22, 2012. 

Jennifer J. Johnson, 

Secretary of the Board. 

Dated at Washington, DC, this 26th Day of 

March 2012. 

Federal Deposit Insurance Corporation. 

Valerie J. Best, 

Assistant Executive Secretary. 

[FR Doc. 2012–7620 Filed 3–29–12; 8:45 am] 

BILLING CODE 4810–33– 6210–01– 6714–01–P 

DEPARTMENT OF THE TREASURY 

Bureau of the Public Debt 

Proposed Collection; Comment 

Request 

ACTION: Notice and request for 

comments. 

SUMMARY: The Department of the 

Treasury, as part of its continuing effort 

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