October 26, 2020 - Last week the federal banking agencies issued an important notice of proposed rulemaking (“NPR”) that would formally establish that regulatory guidance is non-binding and cannot form the basis for a Matter Requiring Attention letter (“MRA”). The proposed rulemaking mirrors, and would codify as a formal rule, an interagency statement (the “2018 Statement”) issued by the federal agencies in September 2018. The NPR responds to a petition for rulemaking filed by the Bank Policy Institute and the American Bankers Association in November 2018.
Why is this proposed ruling so important to the loan market? As we noted when the 2018 Statement was issued, bank lenders were confused on exactly what the 2013 Leveraged Lending Guidance (“LLG”) required them to do. The LLG laid out “guidelines” around leveraged lending, including a view that banks should not originate “non-pass” loans (in particular, loans to companies that could not demonstrate the ability to repay all their senior debt or half their total debt from base cash flows in five to seven years). In 2014, the agencies issued a series of MRAs and bankers began to conform more strictly to this guidance, seemingly treating it as if it were a rule rather than traditional guidance. But in early 2017, Senator Pat Toomey (R. PA) asked whether the LLG was actually a rule and therefore needed to conform to the Congressional Review Act before becoming effective. In late 2017, the GAO agreed with that view and the 2018 Statement followed. In it, the agencies specifically said that “supervisory guidance does not have the force and effect of law” and the agencies “do not take enforcement actions based on supervisory guidance.” Even more specifically, the agencies said that they will limit the use of numerical thresholds, or “bright-lines”, and will only use them as examples (not requirements). They also stated that they will not “criticize” an institution for a “violation” of supervisory guidance.
In the NPR, the agencies recognize the distinction between issuances that serve to implement acts of Congress (“rules” or “regulations”) and non-binding “supervisory guidance documents”. Regulations create binding legal obligations while supervisory guidance is issued “to advise the public prospectively of the manner in which the agency proposes to exercise a discretionary power” and does not create binding legal obligations.
The NPR codifies the 2018 Statement and adds some clarifying changes, the most important of which is to make clear that the term “criticize” includes the issuance of MRAs and similar supervisory criticisms. As such, the agencies reiterate that examiners will not base such supervisory criticism on a “violation” or non-compliance with supervisory guidance. Finally, in response to a request that supervisory criticisms should not be “generic” or “conclusory” references to safety and soundness, the agencies agree that supervisory criticisms will be “specific as to practices, operations, financial conditions, or other matters that could have a negative effect on the safety and soundness of the financial institution, could cause consumer harm, or could cause violations of laws, regulations, final agency orders, or other legally enforceable conditions.”
The agencies have requested comments to the NPR within 60 days from its publication in the Federal register and the LSTA, which welcomes the extra layer of clarity provided by the proposed rule, expects to weigh in in due course.