Regulators Respond to Questions on Leveraged Lending

By Bernie Mason, RMA’s Regulatory Affairs Liaison

Recently, RMA received a member inquiry seeking further clarification regarding the banking agencies’ 2013 Leveraged Lending Guidance. In 2014, the agencies issued Frequently Asked Questions regarding this guidance and included the statement that “leveraged lending multiples should be calculated at origination based on committed debt, including additional debt that the permit”. The RMA member questioned whether there was flexibility in the leverage calculation as it relates to certain scenarios, and provided some examples. 

RMA presented these questions to agency subject matter experts for response. What follows are the questions posed and the regulatory responses to each question.

Acquisition Line Set Up for Future Acquisitions

Question: How should the pro forma funded debt/EBITDA be calculated if the future pro forma EBITDA cannot be calculated until the line is drawn down?

Regulatory Response: If the amount of the additional debt can be quantified, i.e., if there is a maximum loan amount available (even if the draw down amount is discretionary on the part of the borrower), then the maximum additional amount should be included for the initial measurement of whether a borrower is leveraged or not (per the bank’s definition). Repayment capacity is measured against outstanding debt, but the determination of whether a borrower is leveraged occurs at origination or renewal/modification and does include committed debt. If there is additional debt than can be incurred, but it is dependent (for example) on the borrower achieving a certain level of EBITDA or a lower leverage level, then that amount of additional debt is unknown, and should not be added to the debt calculation at inception to determine whether the borrower is leveraged or not.

Seasonal Line of Credit

Question: Should the funded debt (full commitment) be included in the leverage calculation if the facility includes a clean down provision, leverage covenants, etc.?

Regulatory Response: The funded portion of the debt (on a line of credit) should be included in the leverage calculation. Regulators have viewed that lines of credit vary as to their controls. Some may be very strong but some may not have advance controls for a typical ABL. Ultimately total debt repayment is dependent on available cash flow of the borrower. Therefore, regulators want to evaluate, in line with the leveraged lending guidance, whether the borrower has the ability to de-lever to a sustainable level within a reasonable period of time (5-7 years). The loan agreements likely have their own specific calculations for covenants and other purposes, and those are suitable for the bank to calculate its own covenant compliance or other measurements. However, when regulators evaluate repayment, the cash flow available after other required cash outlays is what regulators focus on to assess debt repayment capacity against total funded debt.

Operating Line of Credit

Question: Would there be any flexibility as it relates to excluding an operating line of credit when reviewing the eligibility of a leveraged loan?

Regulatory Response: No – regulators do not view that an operating line of credit should be excluded when making the determination of whether a borrower is leveraged or not. Regulators do have an exception in the guidance (Footnote 5) wherein it is stated that the guidance is not meant to include ABLs “unless such loans are part of the entire debt structure of a leveraged obligor” and this thought process is consistent with the comments above. If there is an ABL debt or operating line of credit, and the borrower has other debt, enough to meet a bank’s internal leveraged definition, the operating line of credit should be included as debt that the borrower has incurred and may be required to repaid through cash flow.

Listen to Bernie Mason’s podcast discussing the regulatory agencies’ Leveraged Lending Guidance.

Washington, The Week Ahead - June 1-5, 2020

Read More

1Q 2020 Credit Trends in Commercial Lending

Read More

Hire a Hacker? How an Ethical Hacker Can Protect Your Financial Institution

Read More

comments powered by Disqus