Article

Leveraged Lending Guidelines

Posted by Melinda Toy on Dec 03, 2015 06:00:00 AM

Topic: ALL

Person looking at reports

On March 22, 2013, the Office of the Comptroller of the Currency (OCC) and the Board of Governors of the Federal Reserve System (FRB) and the Federal Deposit Insurance Corporation ( FDIC) released their final guidance on leveraged lending activities. The final is guidance based on the latest revision and updated to the inter-agency leveraged finance guidance first issued in April of 2001.

The guidance is intended to provide parameters consistent in size and risk profile for an institution’s leveraged lending activities. The guidance provides suggested targets and prudent underwriting standards including the need for meaningful capital structure, covenants, and repayment assumptions for financial institutions based on size and risk. Each bank is responsible for establishing, defining, and maintaining lending policies appropriate to the individual institution.

What exactly is a leveraged loan?

A leveraged loan is defined by purpose first and then key items of measurement. Additionally, a loan or transaction is designated “leveraged” at the time of origination, modification, extension, or refinance.

Bank Mutual uses two principal tests to determine if a loan or transaction is leveraged:

  1. Purpose Test: When credit is extended or investment is made in a business where the financing transaction involves the buyout, acquisition or re-capitalization of an existing business.

  2. Balance Sheet Test: The transaction results in a substantial increase in the borrower’s leveraged ratio.

Leveraged is higher than 75%, or a two-fold increase in the borrower’s liabilities resulting in a leveraged ratio higher than 50%.

What additional items or key measurement factors are considered?

Capitalization Structure

Each transaction is unique but typically includes senior or bank debt in the form of a term loan and a revolving line of credit with an equity contribution in the form of cash and/or subordinated debt in the form of a term loan, preferred or common stock. Distributions to the equity sponsors and/or shareholders are typically limited.

Cash Flow Leverage

For a transaction to be considered “bankable” the bank looks to structure the loan where Senior Cash Flow Leverage is not greater than 3.00x and Total Cash Flow Leverage is not greater than 4.00x.

Collateral Short Fall or Air Ball

If there is a collateral short fall or “airball”, the bank looks to eliminate this within 36 months or less. Oftentimes the loan(s) will be structured with a cash scoop component that accelerates the repayment of the debt with the use of excess cash as defined by a calculation based on EBITDA and the addition or subtraction of negotiated items agreed to by the borrower and the lending institution.

Learn more about Bank Mutual’s Commercial team.