GUIDANCE ON RISK MANAGEMENT OF LEVERAGED FINANCING.The federal bank regulatory agencies regulatory agency Independent government commission charged by the legislature with setting and enforcing standards for specific industries in the private sector. The concept was invented by the U.S. on April 11, 2001, issued guidance on sound risk-management practices for institutions engaged in leveraged financing. The guidance, issued by the Board of Governors of the Federal Reserve System Board of Governors of the Federal Reserve System The managing body of the Federal Reserve System, which sets policies on bank practices and the money supply. , the Federal Deposit Insurance Corporation Federal Deposit Insurance Corporation (FDIC), an independent U.S. federal executive agency designed to promote public confidence in banks and to provide insurance coverage for bank deposits up to $100,000. , the Office of the Comptroller of the Currency The Office of the Comptroller of the Currency (or OCC) was established by the National Currency Act of 1863 and serves to charter, regulate, and supervise all national banks and the federal branches and agencies of foreign banks in the United States. , and the Office of Thrift Supervision The Office of Thrift Supervision (OTS) was established as a bureau of the Treasury Department in August 1989 as part of a major Reorganization Plan of the thrift regulatory structure mandated by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) (12 U.S.C.A. , augments previously issued individual statements. Over the past year, deterioration has emerged in the leveraged finance portfolios of many banking organizations, 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 clarify supervisors' expectations regarding sound practices and facilitate their adoption. Leveraged financing has been an important financing vehicle for mergers and acquisitions, business recapitalizations, and business expansions. These transactions are characterized by a degree of financial leverage that significantly exceeds industry norms measured by various debt, cash flow, or other ratios. Consequently, leveraged borrowers generally have a diminished ability to respond to changing economic conditions or unexpected events, creating significant implications for an institution's overall credit-risk exposure and challenges for bank risk-management systems. Leveraged finance activities can be conducted in a safe and sound fashion if pursued with a risk-management structure that provides for appropriate underwriting, pricing, monitoring, and controls. This guidance highlights the need for comprehensive credit analysis processes, frequent monitoring, and detailed portfolio reports to better understand and manage the inherent risk in these leveraged finance portfolios. Many leveraged transactions are underwritten with reliance on the imputed value Imputed value Refers to the value of an asset, service, or company that is not physically recorded in any accounts but is implicit in the product, e.g., the opportunity cost of cash remaining in a savings account and not invested. of a business ("enterprise value"), which often exhibits a high degree of volatility. The guidance stresses the importance of sound valuation methodologies and ongoing stress testing Determining the durability of a system by pushing it to its limits. Stress testing a network is performed by transmitting excessive numbers of packets or attempting to break in illegally. and monitoring of enterprise values. The statement also provides guidance about the risk rating of leveraged finance loans and how enterprise value should be evaluated in the risk-rating process. |
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