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Fe d e r a l R e s e r v e B a n k
of
N e w Yo r k
N E W Y O R K , N. Y. 1 0 0 4 5
AREA CODE 21?
720-6375
C h e s t e r B. F e l d b e r g
E x e c u t iv e V ic e P r e s i d e n t
Om •
•/ £5/3
February 6, 1992
TO THE CHIEF EXECUTIVE OFFICERS OF
ALL STATE MEMBER BANKS, BANK HOLDING COMPANIES,
AND DOMESTIC OFFICES OF FOREIGN BANKS
IN THE SECOND FEDERAL RESERVE DISTRICT
SUBJECT:
Highly Leveraged Transactions
On July 10, 1991, the staffs of the three Federal bank
regulatory agencies requested public comment on all aspects of
the Highly Leveraged Transaction ("HLT") definition and criteria.
In response to these comments, and in recognition that it has
served its intended purpose, the HLT definition will be
discontinued, for regulatory reporting purposes, effective July
1, 1992. The enclosed interagency document explains the
rationale for the phase-out of the regulatory definition, and
outlines a modified version, effective January 21, 1992, which is
to be used for the March 31 and June 30 reporting periods. A
more detailed explanation will be published in the Federal
Register within the next two weeks and a copy forwarded to you at
that time.
The modified definition, which will also be used during
the 1992 Shared National Credit Program, involves among other
things, the following revisions: (1) shortens the existing
delisting timeframes, (2) allows HLTs that meet certain criteria
and exhibit superior cash flow to be delisted, and (3) exempts
credits that are emerging from protection under Chapter 11
bankruptcy from the designation, if the leverage ratio is below
75% at the time of reorganization. As with other specific types
of credit concentrations, examiners will continue to review and
report weaknesses in loans or groups of loans in the context of
the examination program.
The enclosed interagency document supplements the
Federal Reserve's existing supervisory guidelines and
interpretations on the HLT definition, dated February 16, 1989,
October 25, 1989, February 6, 1990 and February 15, 1991.
(Over)
2
Chief Executive Officers
February 6, 1992
FEDERAL RESERVE BANK OF NEW Y O R K -------------
Af'l05lS
Copies of these documents are available from the Circulars
Division of this Bank (Tel. No. (212) 720-5216). If you have any
questions regarding this matter, please contact Andrew Collins,
Examiner, Domestic Banking Department (Tel. No. (212) 720-7535).
Yours sincerely,
Chester B. Feldberg
Executive Vice President
Enclosure
Comptroller of the Currency
Federal Deposit Insurance Corporation
Federal Reserve Board
January 21, 1992
Highly-Leveraged Transactions
To address concerns with the supervisory definition of
highly-leveraged transactions (HLTs), the federal bank regulatory
agencies published a request for comment in the Federal Register
on July 10, 1991. The agencies sought comment on all aspects of
the HLT definition and criteria, as veil as comments on specific
issues raised by questions vhich the agencies had received.
Upon reviewing the current status of the HLT definition,
considering over 260 comments received from the public, and
evaluating various options, the agencies intend to phase out use
of the definition and to discontinue regulatory reporting of HLTs
by banking organizations effective after the June 30, 1992
reporting date.
In making a decision to phase out use of the HLT definition,
the agencies determined that the definition has largely
accomplished its original purposes. In particular, the HLT
definition encouraged financial institutions to focus attention
on the need for internal control and review mechanisms to monitor
this type of financing transaction. It also highlighted the need
for financial institutions to structure highly-leveraged credits
in a way that is consistent with the risks involved.
Furthermore, circumstances have changed since the definition
was implemented. Merger and acquisition activity has declined
significantly. Companies have more recently been improving their
capitalization and credit standing by deleveraging and issuing
equity. Also, the agencies recognize that the HLT definition may
be having an undue effect on pricing and availability of credit
to certain highly-leveraged borrowers.
Although the banking agencies plan to discontinue use of the
supervisory HLT definition and related reporting, all highlyleveraged credits vill continue to be closely reviewed in the
examination process. As with any commercial loan, an examiner
vill continue to thoroughly review the borrower's financial
condition, Income, and cash flow; the value of any collateral or
guarantees; the quality and continuity of the borrower's
management; and the borrower's ability to service its debt
obligations. Guidance previously issued by each agency for
assessing individual credits that finance corporate
restructurings and for evaluating internal processes for
initiating and reviewing such credits vill 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
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management at banking organizations will be expected to continue
to monitor carefully their bank's risk exposure to these credits.
In response to concerns expressed in comment letters, the
agencies are also making certain interim revisions to the HLT
definition. Revisions are effective with first quarter reporting
by banking organizations. They include (1) reducing the
timeframes for delisting eredits from HLT status; (2) allowing
banking organisations to delist certain companies from HLT status
that adequately service debt and clearly demonstrate superior
cash flow, relative to their respective industry or peer groups;
(3) delisting each eompany (with a previous HLT designation)
emerging from Chapter 11 bankruptcy from the HLT designation
whose leverage, after reorganisation, is less than 75 percent;
and (4) excluding certain loans from HLT reporting that are
fully-collateralised with cash or cash equivalents.
To implement these revisions, the following changes are
being made to the HLT definition:
*
All delisting criteria will be replaced with the following:
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
Wi05lS(*-J
- 3 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 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 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.
*
Certain fully-collateralized loans will be excluded from HLT
reporting by banking organizations as follows:
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 risk-weight under risk-based capital
standards. Cash equivalents must be held in custody by and
unequivocally pledged to the lending financial institution.
@FedFRASER