The federal banking agencies have published guidance in the form of answers to frequently asked questions (“FAQs”) on the Interagency Guidance on Leveraged Lending jointly issued by the agencies on March 22, 2013. According to the FAQs released on November 13, it is not acceptable for a bank to articulate a leveraged loan definition that requires a loan to meet a “purpose test,” such as buyout, acquisition, or capital distribution, in addition to other criteria. The agencies said that they expect banks to establish sound underwriting and risk management processes for a broad range of credits to leveraged borrowers, and that management should consider each of the common characteristics discussed in the leveraged lending guidance individually to identify leveraged loans for purposes of the institution’s internal definition. The FAQs clarify that excluding loans from the leveraged lending category solely because they do not meet a purpose test is inconsistent with a comprehensive risk management framework for leveraged lending. The FAQs also discuss how a bank should classify a loan as leveraged lending and how to determine whether an asset-based loan may be excluded from leveraged lending. According to the FAQs, the asset-based loan exclusion under the leveraged lending guidance is meant to allow exclusion of asset-based loan facilities when they are the dominant source of ongoing funding for a borrower.

     Nutter Notes: According to the federal banking agencies, the leveraged lending guidance is intended to help banks strengthen risk management frameworks to ensure that leveraged lending activities do not increase risk in the banking system through the origination and distribution of poorly underwritten and low-quality loans. The guidance contained in the FAQs is intended by the agencies to promote consistent application and implementation of the leveraged lending guidance, particularly with respect to loans with non-pass risk ratings, trading desk activities, underwriting standards, and examinations. The FAQs also address differences between the leveraged lending guidance and the FDIC’s deposit insurance assessment rule. The FDIC defines higher-risk commercial and industrial loans differently than leveraged loans defined under the leveraged lending guidance. The FDIC assessment rule contains several specific tests to determine whether a C&I loan is considered higher risk for deposit insurance assessment purposes (which is generally applicable to the risk-based assessment rate of institutions with total assets over $10 billion), whereas the leveraged lending guidance does not establish a uniform definition for leveraged loans. The FAQs apply to all banks, including community institutions, though the agencies recognize that only a limited number of community institutions have exposure to leveraged loans.