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Shared National Credits Program
2014 Leveraged Loan Supplement

Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
Office of the Comptroller of the Currency
Washington, D.C.
November 2014

Contents
Executive Summary – 2014 SNC Supplemental Leveraged Loan Commentary...................................... 3
About the Leveraged Loan Subset of the 2014 SNC Review................................................................. 4
Leveraged SNC Portfolio ................................................................................................................... 4
Leveraged SNC Credit Quality ........................................................................................................... 4
Leveraged Loan Underwriting ............................................................................................................ 5
Impact of Interagency Guidance on Leveraged Lending ....................................................................... 6

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Executive Summary – 2014 SNC 1 Supplemental Leveraged Loan Commentary
The 2014 interagency Shared National Credit (SNC) Review focused significant attention on leveraged
lending, including assessing the March 2013 Interagency Guidance on Leveraged Lending (2013
guidance). The review found that risk in the overall SNC portfolio was centered in the leveraged
portfolio, noting a criticized rate of 33.2 percent for leveraged loans compared with 3.3 percent for the
non-leveraged portfolio. While the high criticized rate for leveraged loans illustrates the risk inherent in
this portfolio, the pass portion of the leveraged portfolio carried more than the normal degree of risk, as
these borrowers were considered to be more vulnerable to risk rating downgrades during an economic
downturn. The analysis also showed that borrower leverage was not the sole driver of an adverse rating
classification; rather, it was an important factor because of its influence on repayment capacity. The
agencies stress that institutions should employ safe and sound practices when engaging in the origination,
purchase and/or distribution of leveraged loans.
The review also found serious deficiencies in underwriting standards and risk management of leveraged
loans. Overall, the SNC review showed gaps between industry practices and the expectations for safeand- sound banking articulated in the guidance. Thirty-one percent of leveraged transactions originated
within the past year exhibited structures that were cited as weak, mainly because of a combination of high
leverage and the absence of financial covenants. Other weak characteristics observed included nominal
equity and minimal de-leveraging capacity.
Covenant protection deteriorated, as evidenced by the reduced number of financial maintenance
covenants, the use of net debt in many leverage covenants, and features that allow increased debt above
starting leverage and the dilution of senior secured positions. In particular, transactions that increase
leverage without a subsequent increase in cash flow generation (e.g., loans used to pay dividends to
equity investors) should be viewed with greater caution. In many cases, examiners questioned the
borrower capacity to repay newly underwritten loans if economic conditions deteriorated or if interest
rates rose to historical norms. As noted in the 2013 guidance, financial institutions should ensure
borrowers can repay credits when due, and that borrowers have sustainable capital structures, including
bank borrowings and other debt, to support their continued operations through economic cycles.
The 2014 SNC review also identified several areas where institutions need to strengthen risk management
practices. Risk management failures observed during the SNC examination include: inadequate support
for enterprise valuations and/or reliance on dated valuations, weaknesses in credit analysis, and
overreliance on sponsor’s projections.
The agencies recognize that leveraged lending is an important type of financing for the U.S. and global
economies, and that the U.S. banking system plays a key role in making credit available by syndicating
credit to investors. However, banks must not heighten risk by originating and distributing poorly
underwritten and low quality loans. Institutions that participate in this lending activity, without
implementing strong risk management processes consistent with the 2013 guidance, will be subject to
criticism by the appropriate agency. As a result of the recent SNC leveraged lending findings, supervisors
will increase the frequency of reviews around this business line to ensure risks are well understood and
well controlled.

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The SNC program, governed by an interagency agreement among the Board of Governors of the Federal
Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the
Currency (the agencies), is designed to review and assess risk in the largest and most complex credits
shared by multiple financial institutions. The program provides uniform treatment of, and increased
efficiency in, the risk analysis and classification of shared credits.
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About the Leveraged Loan Subset of the 2014 SNC Review
For the 2014 SNC review, supervisors placed significant emphasis on reviewing leveraged loans to
evaluate safety and soundness of bank underwriting and risk management practices relative to
expectations articulated in the 2013 guidance. This supplement highlights SNC findings specific to
leveraged loans. The 2014 SNC review included an examination of 782 leveraged loan obligors with
$623 billion in commitments or 63.9 percent of leveraged SNC borrowers, representing 81 percent of all
leveraged loans by dollar commitment. Results of the review are based on analyses prepared in the
second quarter of 2014, using credit-related data provided by federally supervised institutions as of
December 31, 2013 and March 31, 2014.
Reporting agent institutions determine which loans are considered leveraged loans and they do not use
identical definitions. The 2013 guidance states that the policies of financial institutions should include
criteria to define leveraged lending that are appropriate for their institution. The criteria should focus on a
measurement of leverage that makes sense for the institution’s activities.

Leveraged SNC Portfolio
The 2014 leveraged SNC portfolio totaled $767
billion in commitments (of $3.4 trillion in total
SNC commitments) with 1,229 obligors and
2,494 facilities. As illustrated in Figure 1, the
leveraged portfolio (denoted in the red bar)
showed significant growth year-over-year.
However, the agencies’ 2013 SNC data
collection efforts did not include all agent banks
that originated leveraged loans. The 2014
review expanded the data request to all reporting
institutions.
The five largest industry segments represented in the leveraged portfolio are: Media/Telecom ($112
billion), Healthcare ($85 billion), Durable Manufacturing ($78 billion), Finance/Insurance ($78 billion)
and Utilities ($50 billion). These five sectors represented, in aggregate, 52.6 percent of all leveraged
commitments, among 24 industry segments tracked by the agencies.

Leveraged SNC Credit Quality
The percentage of criticized and classified leveraged assets2 is very high at 33.2 percent and 19.0 percent,
respectively. Leveraged loans make up 72.9 percent of all SNC special mention assets, 75.3 percent of all
substandard loans, 81.6 percent of all doubtful loans and 83.9 percent of all nonaccrual loans. The
prevalence of leveraged lending is the primary contributor to the overall SNC criticized rate of 10.1
percent. Highly leveraged borrowers typically have limited financial flexibility and are particularly
susceptible to negative changes in the competitive and economic environment. For this reason, the pass
portion of the leveraged portfolio also carries more than the normal degree of risk. Continued growth in
leveraged originations or an economic downturn would further elevate the volume of non-pass credits in
the overall SNC portfolio. The 2013 guidance states that financial institutions should ensure that they do
not heighten risk in the financial system by originating poorly underwritten loans, and the guidance
outlines high-level principles related to safe-and-sound leveraged lending activities. Within that context,
banks should not originate non-pass risk rated (special mention or worse) leveraged loans.

2

See SNC Press Release for definitions of Criticized and Classified.

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The 2014 SNC review found that institutions continue to originate a large volume of non-pass
transactions at inception to either hold or distribute. Further, the SNC review noted that institutions were
also participants in non-pass SNC transactions. As explained in the 2013 guidance, the origination of
leveraged transactions, whether for investment or distribution, should have a sound business premise, an
appropriate capital structure, and reasonable cash flows that support the borrower’s ability to repay and to
de-lever to a sustainable level over a reasonable period.
Given the supervisory concern noted with leveraged lending, the agencies expect that all firms with
leveraged loan exposure will:
•
•
•
•

Establish underwriting standards to prevent the origination of new non-pass credit.
Establish policies to enhance the credit position of non-pass borrowers seeking refinance of
current credit structures.
Set prudent limits for leveraged transactions to highly cyclical industries that would struggle to
meet obligations during a down cycle.
Set prudent limits for leveraged transactions that do not result in increased cash flow for the
borrower, such as dividend recapitalizations.

Leveraged Loan Underwriting
Weakness in underwriting was far more prevalent in leveraged lending compared with non-leveraged
SNC loans. Thirty-one percent of leveraged transactions originated within the past year exhibited
structures that were cited by examiners as weak, mainly because of a combination of high leverage and
the absence of financial covenants. Other weak characteristics observed include: equity cures, nominal
equity, and minimal de-leveraging capacity. In addition, covenant protection deteriorated, as evidenced
by the reduced number of financial maintenance covenants, the use of net debt in leverage covenants,
excessive headroom, springing features, and various accordion features that allow increased debt above
starting leverage and the dilution of senior secured positions.
The SNC sample included the refinancing of non-pass leveraged loans where the transactions did not
evidence meaningful improvements in structure or controls. Steps taken by institutions to strengthen nonpass credits were generally limited to a reduction in interest rate or an extension of maturity, which are
insufficient for meeting supervisors’ expectations for such credits. The agencies expect a strategy that
actively pursues and executes meaningful improvements in structure or controls during the refinancing of
a non-pass borrower. These can include, but are not limited to, implementation of new covenants or
tightening of existing covenants; equity injections; line reduction; step-ups to a term loan A structure with
increased amortization; the addition of collateral; restrictions on new acquisitions; or issuance of
additional debt. The agencies do not view reductions in pricing, extension of maturities or a decrease in
bank exposure as substantive actions to place the borrower on a path towards a pass rating.
The 2013 guidance describes prudent practices for risk limits and risk management, among other things.
It was not intended to discourage institutions from providing financing to borrowers engaged in workout
negotiations. Workouts typically include existing transactions rated at least substandard or doubtful, prior
to a refinancing, or transactions identified or managed under an institution’s problem loan policy. For
special mention loans that were refinanced, examiners noted that institutions frequently did not identify
and document efforts to strengthen these credits. Credit approval documents should clearly identify and
document the mitigating actions taken to strengthen risk management concerns at refinance. Examiners
also noted the absence of interim goals or metrics that could be measured periodically to track progress
toward eventually achieving a pass rating.
Lastly, examiners noted an overreliance on borrower/sponsor base case projections when evaluating
borrower performance.
For some credits, Earnings before Interest, Taxes, Depreciation, and
Amortization (EBITDA) calculations used to determine leverage and measure repayment capacity
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included difficult- to- support adjustments, such as unrealized cost savings from mergers and acquisitions.
In addition, EBITDA growth rates used in projections to measure repayment capacity appeared overly
optimistic and differed significantly from historical performance. All institutions should evaluate current
and potential transactions in the context of internally generated base case scenarios to support compliance
with internal underwriting standards, leveraged lending definitions, and enterprise valuation calculations.
Examiners also noted unrealistic stress scenarios and a lack of documentation around stress testing.
Institutions should stress these base case scenarios to sufficiently measure borrower sensitivities to
economic downturns. Institutions should fully document these processes and include the institutions’
base case scenario and underlying assumptions that drive financial projections.

Impact of Interagency Guidance on Leveraged Lending
The 2014 SNC review identified several areas where institutions need to strengthen compliance with the
guidance, including provisions addressing borrower repayment capacity, leverage, underwriting and
enterprise valuation. While the institutions have formally addressed many of the risk management issues
noted in the guidance, execution and full implementation has not been achieved. Examiners noted
numerous exceptions at all the large agent institutions that originate leverage loans.
The 2013 guidance sets expectations
around borrower repayment capacity at 50
percent of total debt over a five to seven
year period. Figure 2 shows expectations
for borrower capacity to repay debt on the
population of leveraged credits in the
sample. The data uses borrower-provided
projections to estimate capacity to repay
for transactions occurring after June 1,
2013.
Where projections were not
available for the entire seven year period,
the agencies took the final year of
available information and carried it
forward to complete a seven year time
horizon. Using the maximum time of seven years, the chart shows that only 77 percent of borrowers are
projected to repay 50 percent of total debt within seven years, compared to 83 percent prior to June 1,
2013.

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Figure 3 uses a similar methodology to analyze
leverage levels in transactions occurring after
June 1, 2013. The guidance states that
leverage in excess of 6.0X raises supervisory
concern.
As illustrated in Figure 3, a
significant volume of credit carries leverage
over this threshold. In particular, 15 percent of
transactions showed leverage in excess of
8.0X.
Not
surprisingly,
transactions
where
repayment capacity failed to meet minimum
expectations or leverage exceeded 6.0X were
far more likely to be criticized. Additionally, fifty-four percent of loans originated since June 2013 to
obligors with leverage in excess of 6.0X were criticized.
The agencies recognize that leveraged lending is an important type of financing for the U.S. and global
economies, and the U.S. banking system plays a key role in making credit available by syndicating credit
to investors. However, banks must not heighten risk by originating and distributing poorly underwritten
and low-quality loans. A poorly underwritten or low-quality leveraged loan that is pooled with other
loans or is participated with other institutions can generate excessive risk to the financial system. The
2013 guidance addresses the agencies’ supervisory focus and risk management expectations for
supervised financial institutions involved in leveraged lending activities. Institutions that participate in
this lending activity without implementing strong risk management processes consistent with the
guidance will be criticized by the appropriate agency. Underwriting standards for loans originated to
hold, distribute, or purchased should be similar and consistent with board approved risk criteria and
lending policies. The agencies believe that an institution unwilling or unable to implement strong risk
management processes will incur significant risks and should cease their participation in this type of
lending until their processes improve sufficiently. As a result of the recent SNC leveraged lending
findings, supervisors will increase the frequency of reviews around this business line to ensure risks are
well understood and well controlled.

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