Compliance of the Day

Ensuring Accurate EBITDA in Leveraged Lending Leveraged lending continues to be a focus area for bank regulators due to the heightened credit risk associated with highly indebted borrowers. A key component of leveraged lending analysis is the calculation of EBITDA, which serves as a proxy for a borrower’s ability to service debt. However, some institutions have miscalculated EBITDA by including cash flows from guarantors, leading to inaccurate leverage ratios and improper loan classification. This post outlines regulatory expectations and examiner focus areas related to EBITDA calculations in leveraged lending. Leveraged lending typically involves borrowers with high levels of debt relative to earnings. Regulatory guidance, including the 2013 Interagency Guidance on Leveraged Lending issued jointly by the OCC, Federal Reserve, and FDIC, emphasizes the importance of consistent and accurate risk identification. One of the most common benchmarks used...

Key Examination Areas for Collateral-Dependent Loans Collateral-dependent loans are a common focus during regulatory examinations, particularly when assessing credit risk and loan loss allowances. These loans rely primarily on the sale or operation of collateral for repayment, especially when the borrower is experiencing financial difficulty. Examiners from the OCC, Federal Reserve, and FDIC expect banks to have clear, well-documented processes for identifying, valuing, and managing these loans in accordance with U.S. GAAP and regulatory guidance. This post outlines the core areas examiners typically review and offers practical insights into meeting supervisory expectations. Understanding Collateral-Dependent Loans Under Accounting Standards Codification (ASC) 326-20-35-5, a loan is considered collateral-dependent when repayment is expected to come substantially from the collateral’s operation or sale, and the borrower is experiencing financial difficulty as of the reporting d...

ACL Measurement for Collateral-Dependent Loans Allowance for credit losses (ACL) is a critical component of a bank’s financial and regulatory reporting. While U.S. GAAP under ASC 326-20 allows flexibility in how ACL is measured, regulatory reporting requirements are more specific when it comes to collateral-dependent loans. Some banks have mistakenly applied discounted cash flow (DCF) or probability of default/loss given default (PD/LGD) methods to collateral-dependent loans for regulatory reporting. However, regulatory guidance requires that the ACL for these loans be based on the fair value of the collateral. This post clarifies the correct approach and highlights examiner expectations. Under U.S. GAAP, banks may use various methods to estimate expected credit losses, including DCF, loss-rate, roll-rate, or PD/LGD models. However, when a loan is deemed collateral-dependent, the accounting standard permits, but does not require, measurement based on the fair value of the collate...

Independent Review of ACL Estimation Processes The Allowance for Credit Losses (ACL) is a critical component of a bank’s financial reporting and risk management framework. Regulators expect banks to maintain a sound and well-documented ACL estimation process. One key element of this expectation is the requirement for an independent review of the ACL methodology. While not all banks are subject to formal model risk management guidance, the Interagency Policy Statement on the Allowance for Credit Losses (updated April 2023) makes it clear that validation of the ACL process is essential for all institutions, regardless of size or complexity. The purpose of an independent review is to ensure that the ACL estimation process is reasonable, consistent with accounting standards, and free from bias. This review should be performed by individuals who are not involved in the development or execution of the ACL methodology. The goal is to provide an objective...