September 13, 2018 - Since its reissuance in 2013, lenders have been periodically confused on exactly what the Leveraged Lending Guidance requires them to do. This week, the regulators sought to clarify their position on supervisory statements, creating considerable conversation and speculation (and potentially a bit more confusion). We discuss all this below – and invite you to hear the Federal Reserve’s perspective on Leveraged Lending at the LSTA Annual Conference on October 24, 2018.

As most folks know, the Leveraged Lending Guidance was released in 2013 and 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, thanks to some publicized punishments, bankers realized that they probably should conform more strictly to this guidance. But in early 2017, Senator Pat Toomey asked whether Leveraged Lending Guidance was actually a rule and therefore needed to conform with the Congressional Review Act before it was effective. In late 2017, the GAO agreed with that view. In early 2018, Comptroller of the Currency Otting famously said “Guidance is guidance”. And then, this week, the regulatory agencies looked to provide more clarity.

First, on Tuesday, the Fed, FDIC, OCC and National Credit Union Administration issued an “Interagency Statement Clarifying the Role of Supervisory Guidance”. In it, they specifically say 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 will limit the use of “bright-lines” and will only use them as examples (not requirements) and they will not criticize an institution for a “violation” – their quotation marks – of supervisory guidance. On Thursday, SEC Chairman Jay Clayton added his view, noting that “all staff statements are nonbinding and create no enforceable legal rights or obligations of the Commission or other parties.”

So what does this mean? MoFo responded philosophically, noting that too often since the financial crisis the distinction between regulatory requirements and supervisory guidance has been blurred. Instead of simply being “guidance”, it has too often been viewed as stating inflexible requirements. This week’s statements clarify that the ultimate goal of supervisory statements should be safety and soundness, not compliance with details of the guidance.

But what does it actually mean for, for instance, Leveraged Lending Guidance? Davis Polk focuses in on this issue, noting that there is no longer any such thing as a “violation” of guidance and suggesting that the agencies probably no longer can use bright line tests (like 6x leverage or strict repayment capacity tests). Furthermore, Davis Polk reported that the Guidance was reputedly used in the past to issue MRAs and MRIAs. Perhaps no more?

Clearly, we will continue to review, analyze and discuss this news. And, on a related note, we would be remiss if we didn’t mention that Todd Vermilyea, Head of Risk Surveillance & Data at the Federal Reserve Board, will be sharing the Fed’s view on “Outlook for Leveraged Lending”