OCC 2001 - 18

Comptroller of the Currency
Administrator of National Banks
Subject: Leveraged Finance
Description: Sound Risk Management Practices

TO: Chief Executive Officers of National Banks, 
Department and Division Heads, and All 
Examining Personnel 

The Office of the Comptroller of the Currency (OCC), 
the Board of Governors of the Federal Reserve System, 
the Federal Deposit Insurance Corporation, and the Office of 
Thrift Supervision have jointly issued the attached 
guidance on "Sound Risk Management Practices" for leveraged finance. 

Over the past year, the leveraged finance portfolios of many 
banking organizations have deteriorated, driven in part by 
the relaxation of sound lending standards in past years.  In 
response, affected institutions have strengthened their 
lending standards and are amending their risk management practices. 
The purpose of this guidance is to describe the sound practices 
supervisors expect and to facilitate their adoption.

Leveraged financing has been an important financing vehicle 
for mergers and acquisitions, business recapitalizations, and 
business expansions.   In these transactions, financial leverage 
significantly exceeds industry norms as measured by various debt, 
cash flow, or other ratios.  Consequently, the ability of leveraged 
borrowers to respond to changing economic conditions or unexpected 
events is usually diminished, which has significant implications for 
an institution's overall credit risk exposure and which poses 
challenges to bank risk management systems. 

Leveraged finance activities can be conducted safely and soundly 
if a bank’s risk management structure provides for appropriate 
underwriting, pricing, monitoring, and controls.  This guidance 
describes the essential elements of that risk management: 
comprehensive credit analysis, frequent monitoring, and 
detailed portfolio reports.  Only by recognizing the importance 
of these essentials can banks understand and manage the 
inherent risk in leveraged finance portfolios.  

Many leveraged transactions are underwritten with reliance 
on the imputed value of a business ("enterprise value").  
Such values are often highly volatile.  The guidance stresses 
the importance of sound methods of valuing enterprises, regular 
stress testing of these values, and continual monitoring of them.  
The statement also describes how to risk-rate leveraged finance 
loans and how to factor enterprise value into a risk rating.  

The guidance is effective immediately.


For further information, please contact Credit Risk Division (202) 874-5170.

	
_________________________________
David D. Gibbons
Deputy Comptroller for Credit Risk

Attachment

 
 


Date: April 9, 2001	Page 1 of 2