Full text of Federal Reserve Bank of New York Circulars : 10516. Highly Leveraged Transactions

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

FEDERAL RESERVE BANK
OF NEW YORK
Circular No. 10516 ”1
February 25, 1992

[

J

HIGHLY LEVERAGED TRANSACTIONS
Phasing Out of Formal Supervisory Definition of HL%
To All State Member Banks, Bank Holding Companies, and Branches
and Agencies o f Foreign Banks, in the Second Federal Reserve District:

Following is the text o f a statem ent issued by the Board of Governors of the Federal R eserve System:
The Federal Reserve Board has voted to discontinue use of the supervisory definition of highly leveraged transactions
(HLTs) after June 30, 1992. The Board will also discontinue the reporting of HLT exposure by banking organizations it
regulates after the June 30, 1992, reporting date.
In the interim, the Board has approved revisions to the supervisory definition of HLTs to be used by banks and bank
holding companies for reporting their HLT exposure as of March 31, 1992, and June 30, 1992.
Although the Board will phase out the use of the formal supervisory definition of HLTs, guidance previously issued
by the Board for assessing individual credits that finance corporate restructurings and for evaluating internal processes
for initiating and reviewing these credits will continue to be used by examiners for this purpose.
Due to the complex nature and level of risk associated with such HLT financings, boards of directors and management
at banking organizations will be expected to continue to monitor carefully their banking organization’s risk exposure to
these credits.
Similar action to discontinue use of the HLT definition and reporting has also been approved by the Comptroller of
the Currency and the Federal Deposit Insurance Corporation.
Printed below is the text o f the joint notice on this matter, by the C om ptroller o f the Currency, the FDIC, and
the Board o f G overnors, as published in the Federal Register of February 11. Q uestions may be directed to our D o­
m estic Banking D epartm ent (Tel. No. 212-720-7535).
E. G era ld C o rr ig a n ,
President.
DEPARTM ENT OF TH E TREASURY
Office of the Comptroller of the
Currency

(Docket No. 91-7]
FEDERAL DEPOSIT INSURANCE
CORPORATION

[Docket No. 050984]
FEDERAL RESERVE SYSTEM

[Docket No. R-0734]
The Supervisory Definition of HighlyLeveraged Transactions

AGENCIES: Office of the Comptroller of
the Currency, Treasury (OCC); Federal




Deposit Insurance Corporation (FDIC);
and Board of Governors of the Federal
Reserve System (Board).
ACTION:

Notice.

The Office of the Comptroller
of the Currency, the Federal Deposit
Insurance Corporation and the Board of
Governors of the Federal Reserve
System have approved: (1) The
discontinuance, after June 30,1992, of
the supervisory definition of highlyleveraged transactions (HLTs); and (2)
the discontinuance of the reporting of
HLT exposure by banking organizations
regulated by the agencies after the June
30,1992 reporting date. In the interim,
the agencies have approved revisions to
sum m ary:

the supervisory definition of HLTs to be
used by banks and bank holding
companies for reporting their HLT
exposure as of March 31,1992 and June
30,1992.
Although the agencies will phase out
the use of the formal supervisory
definition, guidance previously issued
by each agency for assessing individual
credits that finance corporate
restructurings and for evaluating
internal processes for initiating and
reviewing these credits will continue to
be used by examiners for this purpose.
Due to the complex nature and level of
risk associated with such financings,
boards of directors and management at
banking organizations will be expected
to continue to monitor carefully their

10516
banking organization’s risk exposure to
these credits.

DATES: Effective date. February 11,1992.

Compliance dates. The use o f the
supervisory definition o f highlyleveraged transactions by the agencies
w ill be discontinued effective after the
June 30,1992 financial reporting date for
banking organizations regulated by the
agencies. In the period preceding
discontinuance o f the definition,
revisions to the definition have been
approved for reporting H L T exposure as
o f M arch 31,1992 and June 30,1992.
FOR FURTHER INFORMATION CONTACT:
O CC: John W . Turner, National Bank
Examiner, (202/874-5170), C h iefs
N ational Bank Exam iner’s Office.
FDIC: G arfield Gimber, Examination
Specialist, (202/898-6913), Division o f
Supervision.
Board: Todd Glissm an, Supervisory
Financial A nalyst (202/452-3953), or
W illiam Spaniel, Senior Financial
A nalyst (202/452-3469), Division o f
Banking Supervision and Regulation. For
the hearing impaired only,
Telecommunications Device for the D eaf
(‘‘T D D ’’), Dorothea Thom pson (202/4523544).

SUPPLEMENTARY INFORMATION: O n July
10.1991, the agencies published for
comment the supervisory definition o f
highly-leveraged transactions (56 FR
31464. July 10,1991). The agencies
sought comment on all aspects o f the
H L T definition and criteria, as w ell as
comments on specific issues raised by
questions which the agencies had
received. The comment period expired
on September 26,1991. The agencies
received over 265 comments on the
proposal.
A fter reviewing the status o f the H LT
definition, considering comments
received from the public, and evaluating
proposed revisions, the agencies have
approved the phase out o f the
supervisory definition o f H L T s and the
discontinuance o f reporting o f H L T ’s
after the June 30,1992 financial reporting
by banking organizations. The agencies
have also approved revisions to the
definition for use by banking
organizations in reporting their H LT
exposure as o f M arch 30,1992 and June
30.1992.
The agencies, in approving the phase
out o f the supervisory definition of
H L T s, have taken under consideration
the public comments received on the
H L T definition, the current status of
H L T credits, the reduced level o f merger
and acquisition activity in recent
months, and the reluctance of lenders, in
some cases, to extend credit to sound
borrowers. The agencies considered all
options for maintaining or phasing out




supervisory oversight o f highlyleveraged transactions. These included
phasing out the definition, giving banks
the flexibility to establish their own
individual definitions, and proposing
revisions to the supervisory definition.
W h ile the agencies did not favor the
immediate discontinuance o f the
definition, the agencies believe that the
H LT definition has largely accomplished
its purposes and have approved the
phase out o f the definition. The
definition encouraged financial
institutions to focus attention on the
need for internal controls and review
mechanisms to monitor these types o f
financing transactions. The definition
also encouraged financial institutions to
structure highly leveraged credits in a
manner consistent with the risks
involved. The H L T definition has played
a role in helping the bank regulatory
agencies identify these credits and
monitor the risks associated with H LT
portfolios over time. A t the same time,
the supervisory definition o f highlyleveraged transactions w a s not intended
to impart supervisory criticism.
W ith the phase out o f the definition,
the agencies’ examiners w ill continue to
evaluate, on an annual basis, those
credits meeting the Shared National
Credit Program criteria to assess the risk
posed to insured depository institutions
and holding companies by the individual
credits, and such credits w ill b e subject
to supervisory criticism w hen
appropriate. A ll other credits w ill be
reviewed, as appropriate, through the
normal examination process. Examiners
w ill continue to thoroughly review each
borrow er’s financial condition, income
and cash flow; the value o f any
collateral or guarantees; the quality and
continuity o f the borrow er’s
management; the borrow er’s ability to
service its debt obligations; and other
credit quality considerations. Consistent
with sound banking practice, banking
organizations w ill continue to be
expected to have systems in place to
monitor the risks associated with
segments o f their lending portfolios,
including highly leveraged credits.
The agencies have adopted revisions
to the definition to address concerns
raised by the application and content of
the definition. These revisions in the
definition are to be used by banking
organizations during the period
preceding the discontinuance o f the
definition to report the level o f their
H LT exposure as o f M arch 30,1992 and
June 30,1992. These revisions include:
(1) A llo w in g banking organizations to
delist certain companies from H LT
status that adequately service debt and
clearly demonstrate superior cash flow,

2

relative to their respective industry or
peer group; (2) reducing the timeframe ii>
which a com pany's performance is
evaluated before being delisted from
H L T status; (3) delisting companies,
previously designated as H L T s ,
emerging from Chapter 11 bankruptcy
that are no longer highly leveraged; and
(4) excluding certain loans from H LT
reporting w hen fully collateralized by
cash or cash equivalent securities.
Cash F lo w Test
A cash flo w test w a s not included in
the original supervisory H LT definition
or delisting criteria. Although delisting
criteria state that cash flo w coverage is
to be taken into consideration w hen
reviewing the overall performance o f a
borrow er for delisting, a specific
measure w a s not defined. The reason for
not incorporating a specific cash flow
test w a s because (1) the definition w a s
implemented to provide a consistent
means o f aggregating and monitoring a
type o f financing transaction, thus
relying heavily on a purpose test and an
easily-calculated leverage test; (2) it w a s
deemed problematic to develop a
universal cash flo w measure that could
be used for all industries; and (3) there
w a s a desire to avoid any impression
that the definition implied a supervisory
criticism o f a credit, noting that cash
flo w is a primary factor in credit quality
reviews.
The agencies, in publishing the
supervisory definition o f highlyleveraged transactions for comment,
specifically sought comment on the
appropriateness o f the inclusion o f a
cash flo w measure. A majority of
comments from both compnaies and
banks strongly favored the use o f a cash
flo w test in the H L T definition,
particularly for delisting purposes. Some
favored a standardized cash flo w test;
others favored an industry-specific cash
flo w test; and some expressed a
preference for both. Several banks
stated, however, that it w ould be
difficult to implement a cash flow
measure for initially designating credits
as H LT s because the analysis w ould
have to be based on cash flow
projections and not on historical
performance.
In light o f the comments received, the
agencies review ed potential cash flow
measures including a debt service
coverage ratio, an interest coverage
ratio, and a ratio measuring the
magnitude o f debt in relationship to
operating cash flow. A ll measures
proved difficult to define adequately,
particularly for use in analyzing
companies in different industries.
M oreover, it w a s found to be extremely
difficult to establish a standardized

10516
level of "acceptable” cash flow that
could be applied to all industries.
The agencies concluded that it was
not appropriate to adopt a standarized
cash flow test; rather, the agencies
believe that banking organizations
should analyze pertinent cash flow
ratios for individual HLT companies,
then make a determination as to the
quality and strength of each company’s
cash flow performance, subject to
examiner review. Under the revision
approved by the agencies, the credits of
a highly leveraged company could be
considered eligible for delisting by
banking organizations on a case-by-case
basis, if the company demonstrates
superior cash flow coverage, relative to
the company’s-industry or peer group,
and the company has adequately
serviced debt for a reasonable period of
time since its last buyout, acquisition or
leveraged recapitalization.

order to be delisted would be
eliminated.
The agencies believe that allowing
companies that deleverage themselves
to be delisted sooner from HLT status
should encourage companies to improve
their capitalization and credit standing
by reducing leverage and issuing
additional equity. These substantive
changes to HLT delisting criteria are
expected to allow a significant number
of companies to be removed from HLT
status, given the number of companies
recently issuing equity and the number
of HLTs that have now aged beyond
three years.
Delist Certain Companies Emerging
From Chapter 11 Bankruptcy

In previous guidance, post­
reorganization debt (after a company
emerges from Chapter 11 bankruptcy) of
a company that was designated HLT
prior to bankruptcy proceedings
Reduce Timeframes for Delisting
retained an HLT designation until the
company became eligible for delisting.
Presently, a borrower designated as
Although a company was often
an HLT must show good performance
deleveraged as a result of the
for a minimum of two years from the
reorganization, the company could not
date of the transaction before being
be delisted for at least two years from
eligible for delisting from HLT status.
After two years, if leverage 1 has been the date it was designated as an HLT.
Several comments stated that a
reduced below 75 percent, a borrower
company should not be designated HLT
becomes eligible for delisting. If a
upon emerging from Chapter 11
borrower remains highly leveraged,
reorganization if leverage is below 75
however, the borrower must
demonstrate performance for a period of percent. It was indicated that continuing
the HLT designation could interfere with
up to four years before being eligible to
these companies’ ability to obtain post­
be delisted from HLT status.
reorganization financing. The agencies
Upon considering the comments
recognize that the purpose of Chapter 11
received, the agencies have determined
of the bankruptcy code is to help
that the delisting criteria should be
reorganize
companies pursuant to a
amended by:
court-approved plan. Further, many
(a) Reducing the delisting timeframe
reorganized companies emerging from
from two years to one year for
bankruptcy are no longer highly
companies that deleverage below 75
leveraged and are, in essence, operating
percent or were designated as HLTs
with a new balance sheet.
under the “doubling of liabilities to
Reflecting these views, the Congress
greater than 50 percent" leverage test.
in
the recently passed banking
Under this standard, companies would
legislation “Federal Deposit Insurance
have to continue to meet general
Corporation Improvement Act of 1991"
performance criteria to be delisted.
(section 474) amended the Federal
(b) Reducing the delisting timeframe
Deposit Insurance Act to prohibit a
from four years to three years for
federal banking agency from designating
companies that remain highly leveraged. by regulation or otherwise a corporation
A company would have to demonstrate
as a highly-leveraged transaction (HLT)
performance for three consecutive years solely because such corporation is or
since its last highly-leveraged
has been a debtor or bankrupt under
transaction and have a positive net
Title 11, if after confirmation of
worth in order to be eligible for
reorganization, such corporation would
delisting. The requirement that a
not otherwise be highly leveraged. In
company’s leverage ratio not
implementing the Congressional intent
significantly exceed its industry norm in underlying this amendment, the agencies
believe that this should serve to
1 The leverage ratio ia d efined as total liabilities
emphasize the role played by the
divided by total liabilities div id ed by to tal a sse ts as
bankruptcy code and remove any
reflected on financial statem e n ts p rep ared in
implied hindrance to this type of
acco rd an ce w ith generally accep ted accounting
principles (GAAP).
lending.




3

Exclude Certain Fully Collateralized
Loans from H L T Status

Comments were received on the
inclusion of certain loans fullycollateralized by cash or cash
equivalent securities in an HLT
company's aggregate HLT exposure. It
was indicated that the purpose of these
fully-collateralized loans is generally not
to take on additional debt for
acquisition or restructuring purposes. It
was also noted that a company
arranging such a loan had sufficient
liquid resources available on its balance
sheet and, therefore, would not have
needed to borrow such funds. Given
these reasons, the agencies have found
it appropriate to exclude certain fullycollateralized loans from HLT reporting
by banking organizations.
Other comments

Comment letters expressed support
for several additional revisions to the
HLT definition that the agencies have
decided not to adopt at this time.
Potential revisions that were not
adopted include (1) exempting
companies with investment-grade senior
debt from HLT designation and (2)
excluding debt of certain subsidiaries
from a consolidated company’s HLT
designation.
Under HLT guidelines, it is possible
for a company with investment-grade
senior debt to be designated an HLT if
the company has been involved in
significant merger and acquisition
activity and has very high leverage.
Comment letters indicated, however,
that very few such companies exist.
To date, investment-grade companies
have not been exempted from the HLT
definition because of a desire to (1)
avoid including credit quality criteria in
the definition; (2) avoid inequitable
treatment for companies that may meet
investment grade criteria but are too
small to be evaluated by the major
rating agencies; and (3) avoid
dependence on outside credit rating
agencies, noting that credit quality of a
company can quickly deteriorate under
the burden of heavy debt.
Based on comment letters received,
the agencies have determined that
exempting companies with investmentgrade senior debt from HLT designation
would appear to have little impact on
the number of companies designated as
HLTs, but it would serve to reinforce the
perception that an HLT designation
conveys credit quality information or
criticism. Some comments noted that
financial institutions could publicly
disclose the level of investment-grade
companies in their HLT portfolios, thus
mitigating criticism by analysts of this

10516
portion of their portfolios. Given that
exempting investment-grade companies
from HLT designation could further
reinforce negative perceptions
concerning the overall credit quality of
HLT loan portfolios, the agencies
decided not to adopt such a change.
Comments were received on the
inclusion of the debt of subsidiaries as
part of the aggregate HLT exposure.
According to the HLT guidelines, if a
company satisfies the HLT purpose and
leverage tests on a consolidated basis,
then a loan to any part of the
organization is designated HLT. Also, if
a subsidiary satisfies the HLT criteria
and its debt level is significant enough
to cause the consolidated organization
to meet HLT leverage criteria, then all
debt of the entire organization is
designated HLT.
The review of financial statements
and calculation of the leverage ratio for
HLT purposes is conducted using
generally accepted accounting principles
(GAAP). Analyzing companies on a
consolidated basis when determining
HLT status is considered consistent with
GAAP. Moreover, experience with
consolidated organizations has shown
that when one aspect of a company’s
operations becomes imperiled, the entire
organization may be negatively
impacted.
Although a significant number of
comments favored excluding debt of
certain subsidiaries from a parent
company's HLT designation if
appropriate protective covenants are
maintained between the parent and
subsidiary, the agencies found
significant problems related to the use
and review of protective covenants.
Protective covenants cited as examples
include restrictions on the movement of
assets between parent and subsidiary
companies, limitations on the payment
of dividends to a parent company,
restrictions on inter-company debt, and
so forth. Each protective covenant,
however, is unique, thus requiring a very
difficult and time consuming review and
evaluation process to determine its
strength. Also, protective covenants may
not work as specified when a company
is in financial difficulty or enters
bankruptcy proceedings. Experience has
shown that technical separation of
companies through the use of loan
covenants has not always been effective
in protecting a company against
liabilities emanating from its parent,
subsidiary, or affiliate, especially in
bankruptcy situations where the
separation between parent and
subsidiary can and has been breached.
Given a desire to adhere closely to
GAAP whenever possible, the influence
that parent companies can exert over




so-called "stand alone” subsidiaries
when financial needs arise, and the
difficulties invovled in evaluating and
enforcing protective covenants, the
agencies have determined not to exclude
certain subsidiaries of HLT parent
companies from the HLT designation.
Definition and Guidance Regarding
Highly-Leveraged Transactions
(“H LTs”), As Revised

Summary o f Definition
A bank or bank holding company is
considered to be involved in a highlyleveraged transaction when credit is
extended to or investment is made in a
business where the financing
transaction involves the buyout,
acquisition, or recapitalization of an
existing business and one of the
following criteria is met:
(a) The transaction results in a
liabilities-to-assets leverage ratio higher
than 75 percent; or
(b) The transaction at least doubles
the subject company’s liabilities and
results in a liabilities-to-assets leverage
ratio higher than 50 percent; or
(c) The transaction is designated an
HLT by a syndication agent or a federal
bank regulator.
Additional Guidance on theDefinition
of HLTs
A highly-leveraged transaction is a
type of financing which involves the
restructuring of an ongoing business
concern financed primarily with debt.
The purpose of an individual credit is
most important when initially
determining HLT status. Once an
individual credit is designated as an
HLT, all currently outstanding and
future obligations of the same borrower
are also included in HLT totals. This
includes working capital loans and other
ordinary credits, until such time as the
borrower is delisted.
The regulatory purpose of the HLT
definition is to provide a consistent
means of aggregating and monitoring
this type of financing transaction. It
must be pointed out that the HLT
designation does not imply a
supervisory criticism of a credit. Before
any HLT or any other credit is criticized,
an examiner should review a whole
range of factors on a credit-by-credit
basis. These factors include cash flow,
general ability to pay interest and
principal on outstanding debt, economic
conditions and trends, the borrower’s
future prospects, the quality and
continuity of the borrower’s
management, and the lender’s collateral
position. Participation of banking
organizations in highly-leveraged

4

transactions is not considered
inappropriate so long as it is conducted
in a sound and prudent manner,
including the maintenance of adequate
capital and loan loss reserves to support
the risks associated with these
transactions.
Borrowers having questions regarding
the HLT definition should first refer
these questions to their bankers.
Bankers should then refer questions they
cannot answer to the bank’s primary
federal regulator.
Purpose Test
To become eligible for designation as
an HLT, a financing transaction must
involve the buyout, acquisition, or
recapitalization of an existing business,
domestic or foreign. This definition
encompasses traditional leveraged
buyouts, management buyouts,
corporate mergers and acquisitions, and
significant stock buybacks. Leveraged
Employee Stock Option Plans (ESOPs)
are also included when used to acquire
or recapitalize an existing business.
For purposes of satisfying the HLT
purpose test, a leveraged
recapitalization involves a replacement
of equity with debt on a company’s
balance sheet by means of a stock
repurchase or dividend payout.
Refinancing existing debt in a company
is not deemed to be a leveraged
recapitalization.
Exclusions from the HLT Definition
Single Asset or Lease: This purpose
test exludes the acquisition or
recapitalization of a single asset or lease
(e.g., a large commercial building or an
aircraft), or a shell company formed to
hold a single asset or lease, from the
HLT definition. Although such an
acquisition may be highly leveraged, the
asset or lease, in and of itself, is not
considered an ongoing business concern
and, therefore, is not intended to be
included in the HLT category. However,
the acquisition or recapitalization of a
leasing corporation which invests in
fleets of equipment for leasing, or a
building company which invests in real
estate projects would satisfy the HLT
purpose test.
Threshold Test: Loans and exposures
to any obligor in which the total
financing package, including all
obligations held by all participants, does
not exceed $20 million, at the time of
origination, may be excluded from HLT
designation. Nonetheless, there may be
some banking organizations that in the
aggregate have significant exposure to
transactions below the threshold level.
It is expected that those organizations
would continue to monitor closely these

10516
transactions as part.of their aggregate
HLT exposures.
Historical Cutoff Date: An HLT
transaction not included in the Shared
National Credit Program, that meets or
exceeds the $20 million test, may be
excluded from HLT designation if it
originated prior to January 1.1987, the
original terms and conditions of the
credit are materially unchanged, the
credit has not been criticized by
examiners, and the financial condition
of the debtor has not deteriorated.
Debtor-in-Possession Financings:
Court-approved debtor-in-possession (or
trustee-in-possession) Financing for a
business concern in Chapter 11
reorganization proceedings will
generally be exempt from HLT
designation. All pre-petition debt of an
HLT borrower and any post­
reorganization debt (after a company
emerges from Chapter 11 bankruptcy)
will continue to be included in HLT
exposure until delisting occurs.
Loarjs Fully Collateralized With Cash
or Cash Equivalents: All loans (credit
facilities) that are fully-collateralized
with cash or cash equivalents are
excluded from HLT reporting by banking
organizations. Cash collateral consists
of a deposit in the financial institution
advancing the loan proceeds, segregated
and under the control of the financial
institution, and unequivocally pledged to
secure the loan. Cash equivalents are
deemed to include U.S. Government and
certain other readily-marketable
securities qualifying for a zero riskweight under risk-based capital
standards. Cash equivalents must be
held in custody by and unequivocally
pledged to the lending financial
institution.
Leverage Tests

In addition to the purpose test, one of
the following criteria must be met for the
transaction to be considered an HLT:
(1)
The transaction at least doubles
the subject company’s liabilities and
results in a total liabilities to total assets
(leverage) ratio higher than 50 percent.
Note: The purpose of this leverage test is to
capture transactions in which a company
must suddenly deal with a substantially
higher debt burden. The greatest risk in a
credit exposure is not necessarily the
absolute level of debt but may be the impact
on a company of significant new debt. A key
HLT success factor is ability to handle a
sudden, large increase in debt.

The ‘‘doubling of liabilities" is
intended to capture those transactions
where new debt is used to facilitate the
buyout, acquisition, or recapitalization
of a business. If the sum of the acquiring
and acquired companies’ liabilities
wouid double as a result of the new debt




taken on to effect the combination of the
companies, then the transaction is
considered an HLT, and all exposure to
the company is designated an HLT. It is
not intended to cover a doubling
resulting from the simple addition of the
existing liabilities of the two companies.
Any refinanced portion of old debt in
a transaction should continue to be
treated as old debt for purposes of
applying this leverage test. Further, if
there was no debt in either company
prior to the transaction, then any new
debt will result in a "doubling of
liabilities."
In an acquisition involving one or
more operating divisions of a company
(as opposed to stand-along
subsidiaries), existing liabilities of the
seller associated with specific operating
assets being transferred in the
transaction may be allocated to the
resulting company for purposes of
applying the "doubling of liabilities"
test. The burden of proof is on the
resulting company and its financial
institution(s) to substantiate that the
allocation of the seller’s liabilities to the
resulting company is appropriate.
When calculating a company’s
leverage for the purpose of this test,
captive Finance company subsidiaries
and subsidiary depository institutions
should be excluded from the
consolidated organization.
(2) The transaction results in a total
liabilities to total assets (leverage) ratio
higher than 75 percent.
Note: When a company's leverage ratio
exceeds 75 percent, the determination of
whether exposure to the company is
designated an HLT further depends on the
composition of the company’s total liabilities
after the transaction. If a significant portion
of the liabilities (generally 25 percent or more
of total liabilities) derives from buyouts,
acquisitions, or recapitalizations, either past
or present, then all exposure to the company
is designated an HLT. If, after the
transaction, debt related to buyouts,
acquisitions, or recapitalizations, either past
or present, represents less than 25 percent of
total liabilities, then the exposure to the
company need not be designated an HLT.
Again, when calculating a company’s
leverage for the purpose of this test, captive
Finance company subsidiaries and subsidiary
depository institutions should be excluded
from the consolidated organization.

(3) The transaction is designated an
HLT by a syndication agent.
In specific cases, the bank supervisory
agencies may also designate a
transaction as an HLT even if it does not
meet the conditions outlined above. (It is
anticipated that this would be done
infrequently and only in material cases).
5

Definition of the Leverage Ratio
The leverage ratio is total liabilities
divided by total assets as reflected in
financial statements prepared in
accordance with generally accepted
accounting principles (G A A P ). Total
assets o f the resulting enterprise include
intangible assets (such as goodw ill).
Total liabilities include all forms o f debt
(including any new debt taken on to
facilitate the transaction) and claims,
including all subordinated debt and nonperpetual preferred stock. Perpetual
preferred stock is generally considered
equity for purposes o f calculating H L T
leverage. H ow ever, exceptions could be
m ade on a case-by-case basis if the
stock has characteristics more akin to
debt than equity.
O ff-balance sheet exposure, including
claims related to foreign exchange
contracts, interest rate sw aps, and other
risk protection or cash management
products may normally be excluded
from H L T exposure as long as their
credit equivalent exposure is small
relative to other types o f obligations. (It
is expected, however, that internal
management information and control
systems be in place to capture these
exposures.)
If a parent company uses "double
leverage" (that is, takes on debt and
downstream s it as equity to a
subsidiary) to assist a subsidiary in an
H L T purpose-related transaction, then
the debt at the parent company w ill be
considered H L T purpose-related debt
w hen calculating leverage for the
company on a consolidated basis.
In an acquisition involving a pure
assumption o f debt with no new debt
issued, the transaction is not designated
an H L T unless the resulting com pany’s
aggregate outstanding H L T purposerelated debt (from all previous
transactions) is significant (generally 25
percent or more o f total liabilities) and
the 75 percent leverage test is satisfied.

Consolidation o f HLT Exposure
A ll credit extended to, or investments
m ade in an H L T should be aggregated
with any ordinary business loans to, or
investments in, the same obligor.
If a company satisfies the H L T
purpose and leverage tests on a
consolidated basis, then a loan to any
part o f the organization is deemed to be
an HLT. O n the other hand, if only a
subsidiary o f a company satisfies the
H L T tests, then the subsidiary could
“ stand alone" as an HLT; however, if
the subsidiary's debt level is significant
enough to cause the consolidated
organization to meet H L T leverage
criteria, then all debt o f the entire
organization is designated HLT.

10516
Guarantees of Payment
If a parent company supplies an
irrevocable, unconditional guarantee of
payment on behalf of its subsidiary and
the leverage of the consolidated
organization does not meet HLT
leverage criteria, then the subsidiary
will generally not be designated an HLT.
On the other hand, if the subsidiary's
leverage is significant enough to cause
the consolidated organization to meet
HLT leverage criteria, then all debt of
the entire organization is accorded HLT
status.
(Note: Third-party guarantees and
guarantees by related subsidiaries of a
company have no effect on the HLT
designation. While these types of guarantees
offer credit enhancement benefits which will
be taken into consideration during the review
of individual credits by examiners, they
generally lack the stronger bonds of support
inherent in the relationship between a parent
and its subsidiary.)

When a foreign parent company
provides the equivalent of an
irrevocable and unconditional guarantee
of payment on behalf of a subsidiary,
the subsidiary’s debt will normally not
be designated as HLT debt as long as
the consolidated organization does not
meet HLT leverage criteria and the
following two conditions are met:
(1) Written opinions from legal
counsel in the country of origin and the
United States are provided which state
that the equivalent of a written
guarantee of debt repayment exists
which is irrevocable and unconditional:
and
(2) The credit files in the U.S. banking
organizations lending to the subsidiary
contain consolidated financial
statements for the foreign parent stated
in U.S. dollars under U.S. accounting
rules.
Agent and Lead Bank Responsibility
To ensure consistent application of
the definition, the agent or lead bank is
responsible for determining whether or
not a transaction qualifies as an HLT.
The agent or lead bank is charged with
the timely notification to participants
regarding the status of the transaction
and of any change in that status, i.e.
designation as an HLT or delisting as an
HLT.




The responsibility of the agent or lead
bank to determine HLT status does not
preclude a participant bank from
designating a transaction as an HLT or
relieve a participant from performing its
own credit analysis. Examiners will
review transactions for compliance with
the HLT definition in the context of the
Shared National Credit Program and
during regular on-site examinations.
Delisting Criteria
HLT exposure of a given borrower
may be removed from HLT status upon
satisfying one of the following criteria:
(a) Credits of a company emerging
from protection under Chapter 11 of the
U.S. Bankruptcy Code at the
consummation of a court-approved plan
of reorganization will be immediately
delisted from HLT status, if the
company's leverage ratio is less than 75
percent at the time of reorganization.
(b) A borrower's credits that were
designated as HLTs under the “doubling
of liabilities to greater than 50 percent"
leverage test or that have reduced
leverage to less than 75 percent will be
considered eligible for delisting if the
company has performed well for one
year (since its last buyout, acquisition,
or leveraged recapitalization involving
financing) and demonstrates an ability
to continue satisfactorily servicing debt.
To verify adequate performance and
validate the appropriateness of financial
projections of a company, the lender
should conduct a thorough review of the
obligor to include, at a minimum, overall
management performance against the
business plan, cash flow coverages,
operating margins, industry risk, and
status of asset sales, if applicable.
(c) Credits of a company whose
leverage continues to exceed the 75
percent leverage test will be considered
eligible for delisting by banking
organizations on a case-by-case basis, if
the company demonstrates superior
cash flow coverage, relative to the
company’s industry or peer group, and
the company has adequately serviced
debt for a reasonable period of time
since its last buyout, acquisition, or
leveraged recapitalization involving
financing. To verify strong performance,
the lender should conduct a thorough
review of the obligor to include, at a

6

minimum, the quality and strength of
cash flow coverages, operating margins,
reduction in leverage, appropriateness
of the company’s financial projections,
overall management performance
against the business plan, industry risk,
and status of asset sales, if applicable.
Credits delisted in this manner will
subsequently be reviewed, and
potentially subject to relisting, by
examiners during the normal course of
an examination.
(d)
Credits of a company whose
leverage continues to exceed the 75
percent leverage test will be considered
eligible for delisting if the company has
performed adequately for at least three
years since its last buyout, acquisition,
or leveraged recapitalization involving
financing; and the company has a
positive net worth. To verify adequate
performance and validate the
appropriateness of financial projections
of a company, the lender should conduct
a thorough review of the obligor to
indude, at a minimum, overall
management performance against the
business plan, cash flow coverages,
operating margins, industry risk, and
status of asset sales, if applicable.
It is expected that banks will maintain
records of delisted exposures and
reasons for delisting. After delisting, any
significant changes in the obligor's
financial condition should cause the
exposure to be reviewed for relisting.
Record pertaining to delisting and
relisting of HLTs will be reviewed by
examiners in the context of the Shared
National Credit Program and/or regular
on-site examinations.
Dated: February 6,1992.
Robert L Clarke,
Comptroller of the Currency.

Hoyle L. Robinson,
Executive Secretary of the Federal Deposit
Insurance Corporation.

William W. Wiles,
Secretary of the Board of Governors of the
Federal Reserve System.
[FR Doc. 92-3185 Filed 2-10-92: 8.45 am)
BtUJMQ COOES: 4*10-W-M, *714-0V-M, S210-S«-M