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QCj'/h?* (c>3n& Fe d e r a l R e s e r v e B a n k o f N e w Yo r k N E W Y O R K , N. Y. 1 0 0 * 4 5 AREA CODE 212 720-55-45 F r e d e r i c k C. S c h a d r a c k E x e c u t i v e V ic e P r e s i d e n t November 15, 1989 TO THE CHIEF EXECUTIVE OFFICER OF ALL STATE MEMBER BANKS, BANK HOLDING COMPANIES, AND DOMESTIC OFFICES OF FOREIGN BANKS IN THE SECOND FEDERAL RESERVE DISTRICT. SUBJECT: In te ra g e n c y D e f i n it io n o f a "H ig h ly L ev eraged T r a n s a c t io n " . The t h r e e f e d e r a l ban kin g a g e n c ie s have r e c e n t ly adopted a u n iform in te ra g e n c y d e f i n i t i o n o f a " h ig h ly le v e r a g e d t r a n s a c t i o n " (HLT) f o r s u p e r v is o r y p u rp oses and a re d i s t r i b u t i n g th e d e f i n i t i o n to t h e i r r e s p e c t iv e s t a f f s as an exam iner g u i d e l i n e . In o r d e r t o keep you a b r e a s t o f th e se developm en ts, a copy o f the in te ra g e n c y statem ent i s e n c lo se d f o r your in fo rm a tio n . We a t the F e d e ra l R eserve b e l i e v e t h a t h ig h ly le v e r a g e d t r a n s a c t io n s d e se rv e v e ry c lo s e s c r u t in y and d i s c i p l i n e , both w ith r e g a r d t o e x i s t i n g and new c r e d i t s . C o n s is te n t w ith t h i s we e x p e c t a l l p a r t i c i p a n t s in such a c t i v i t i e s t o pay p a r t i c u l a r a t t e n t io n t o c o n t r o l, c r e d i t re v ie w , and r e l a t e d p ro c e d u re s . T h is statem ent amends th e F e d e ra l R e s e r v e 's e x i s t i n g g u i d e lin e s which w ere m ailed to you on March 13, 1989. I f you have any q u e s tio n s r e g a r d in g t h i s m a tte r, p le a s e c o n ta c t K ath leen A. O ' N e i l , V ic e P r e s id e n t and C h ie f F in a n c ia l Examiner ( T e l . No. (212) 720-5371) o r S u p e rv is in g Examiner G regory K. C a r r o l l , M u lt in a t io n a l Banking Department ( T e l . N o . ( 212) 720- 5887) . S in c e r e ly , E n c lo su re Comptroller of the Currency______ Federal Deposit Insurance Corporation Federal Reserve Board Ihe Office of the Ccnptroller of the Currency, the Federal Deposit Insurance Corporation, and the Board of Governors of the Federal Reserve System have jointly adopted a common definition of highly leveraged transactions (HLTs) as part of a coordinated effort to provide more effective supervision of bank involvement in these transactions. BACKGROUND As a result of growing public interest and increased supervisory concern about HLTs, the banking agencies have individually initiated supervisory activities and provided guidance to examiners about the special risks associated with this kind of financing. The regulators did not issue a definition of HLTs for supervisory purposes because bank involvement in HLTs was relatively recent and varied widely. In the absence of such a definition, banks adopted a wide range of definitions, same of which excluded transactions that were of interest to the supervisory agencies. Lack of a common definition created problems for supervisors, for banks themselves, which wanted to compare their own performance with that of their peers, and for investors and others interested in tracking the growth of bank involvement in highly leveraged financing. In developing a common definition for HLTs, the agencies recognized that transactions, industries, and individual companies differ, and that several factors may be considered in classifying a transaction as an HIT. In the regulatory definition, the principal classification criterion is the purpose of the transaction. That is, transactions that involve a buyout, acquisition, or recapitalization of an existing business would be candidates for inclusion as an HIT. A second criterion for HIT classification is whether the transaction is accomplished with a significant debt increase and results in a high level of leverage. The borrowing company*s ability to deal with a substantially higher debt burden is of primary importance, but the relative level of that debt is also significant The existence of higher debt levels requires oampanies to perform in a more rigid environment, in a more efficient manner, and with a lower margin for error. The determination of what constitutes a significant debt increase or high leverage depends on a variety of factors that may not be consistent for all industries and companies and may be subject to change. Nonetheless, the regulatory agencies believe it is desirable to have a common definition of what constitutes an HIT. Adoption of a uniform definition by the three federal banking agencies will not only facilitate supervision of bank HIT activities, but also help banks by providing a ccrron standard for tracking their own activities and comparing them with those of their peers. (Over) 2 amyrngN For supervisory purposes, a bank or bank holding company is considered to be involved in a highly leveraged transaction (HUT) when credit is extended or investment is made in a business where the financing transaction involves the buyout, acquisition, or recapitalization of an existing business. In addition to this purpose test, one of the following criteria must be met for the transaction to be considered an HUT: o Hie transaction at least doubles the subject company1s liabilities and results in a leverage ratio higher than 50%. o The transaction results in a leverage ratio higher than 75%. o. The transaction is designated an HIT by a syndication agent. In those cases where a credit meets the purpose test but is not covered by any of the criteria above, the bank supervisory agencies may nevertheless designate the credit as an HUT. It is anticipated that this would be done infrequently and only in material cases. The agencies will include all obligations of, and claims on, HUT borrowers, regardless of perceived credit quality or secured status. The leverage ratio is total liabilities divided by toted assets. Total liabilities include all forms of debt and claims, including all subordinated debt and non-perpetual preferred stock. Total assets include intangible assets. POLICY The three federal banking agencies are distributing this definition of HLTs to all their examining personnel for use in supervising HIT activities in commercial banks. In addition, copies of the definition are being sent to banks to increase their understanding of how the regulators define these transactions. Dean S. Marriott Senior Deputy Comptroller ~ ~ ~ J— ’’— the Currency Paul1 Q / ' tts Director of Bank Supervision Federal Deposit Insurance Corporation ji-r~William Taylor, Staff Director Division of Banking Supervision and Regulation Federal Reserve System
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