The European Central Bank ("ECB") recently launched a public consultation, open until 27 January 2017, on draft guidance for certain credit institutions to develop clear and consistent definitions, measures and monitoring with regard to leveraged transactions.
The guidance makes, amongst others, the following recommendations:
- that banks put in place a unique and overarching definition of leveraged transactions;
- that banks clearly define their strategy for leveraged transactions, as well as their appetite for underwriting and syndicating such transactions (the guidance recommends that leveraged transactions where the total debt to EBITDA ratio exceeds 6.0 times should only be underwritten in exceptional circumstances);
- that banks make sure, through a robust credit approval process and regular monitoring of leveraged portfolios, that leveraged transactions adhere to the bank's stated risk appetite standards; and
- that bank's senior management receive regular comprehensive reports about leveraged transactions carried out.
The first point to note is that the draft guidance is non-binding, and applies only to "significant credit institutions" supervised by the ECB under the single supervisory mechanism ("SSM") regulation a list of "significant credit institutions" supervised by the ECB can be found here. This means that "less significant" credit institutions and institutions in member states outside the SSM (such as the UK) are outside the scope of the guidance, although branches of UK banks established in a country to which the SSM applies may be caught.
The draft guidance proposes that "leveraged transactions" are transactions which meet one of the following criteria:
(i) loans or credit exposures, whether in the banking book or the trading book, where the borrower's post-financing level of leverage exceeds a total debt to EBITDA ratio of 4.0 times, judged at any of origination, modification, extension or refinancing; or
(ii) loans or credit exposures where the borrower is more than 50% owned or controlled by a financial sponsor (defined as an investment firm that undertakes private equity investments and/or leveraged buyouts of companies with the intention of exiting those investments on a medium term of more than six months).
It is worth noting that EBITDA is referred to on an unadjusted basis and transactions where the borrower is majority owned or controlled by a financial sponsor, regardless of leverage, would be caught by the guidance. The following are not expected to be covered by the definition:
(i) loans with natural persons, credit institutions or investment firms;
(ii) loans where the own consolidated exposure of the credit institution is below 5million;
(iii) loans secured by an asset that pertains to asset based loans;
(iv) commercial real estate financing;
(v) project finance loans; and
(vi) trade finance.
Generally, the guidance provides detailed recommendations for banks' policies and procedures around leveraged lending. However, the scope of institutions to which the draft guidance applies may limit its application.