We are considering a new business line similar to making a loan backed by a company’s receivables, but instead we would actually purchase the receivables, with the requirement that the company buy back bad accounts. We would charge a flat fee for the transaction, a portion of which would go into a reserve account to cover invoices that don’t pay. In some cases, the company’s debt to equity position is 19 to 1. We know that banks are permitted to purchase accounts receivable, but do you think our regulator would consider these to be highly leveraged transactions?

We cannot provide definitive guidance on whether the transactions you have described would be considered highly leveraged transactions.

Purchases of accounts receivables generally are classified as loans for reporting purposes. Interagency guidance on leveraged lending does not define highly leveraged loans, or even leveraged loans. Instead, banks are expected to establish their own metrics for defining what constitutes leveraged and highly leveraged loans.

The interagency guidance does outline four common characteristics of a leveraged loan: (1) loan proceeds are used for buyouts, acquisitions, or capital distributions; (2) the borrower’s total debt exceeds its earnings before interest, taxes, depreciation and amortization by four times; (3) the borrower is recognized in the debt markets as a highly leveraged firm, which is characterized by a high debt-to-net-worth ratio; and (4) the borrower’s post-financing leverage, as measured by its leverage ratios, significantly exceeds industry norms or historical levels.

We are not aware of any law, regulation or guidance that indicates that a reserve account or a recourse provision — such as the ones in the transactions that you described — would alter whether a transaction is considered leveraged when the transaction has these four characteristics. Based on the facts provided, we cannot determine whether any of these common criteria are met in your case. If you find that the interagency characteristics apply to these transactions, then they likely would be considered highly leveraged loans.

For resources related to our guidance, please see:

Interagency Guidance on Leveraged Lending (March 22, 2013) (“A financial institution engaging in leveraged lending should define it within the institution’s policies and procedures in a manner sufficiently detailed to ensure consistent application across all business lines.”)

Interagency Guidance on Leveraged Lending (March 22, 2013) (“[N]umerous definitions of leveraged lending exist throughout the financial services industry and commonly contain some combination of the following: Proceeds used for buyouts, acquisitions, or capital distributions . . . Transactions where the borrower’s Total Debt divided by EBITDA (earnings before interest, taxes, depreciation, and amortization) or Senior Debt divided by EBITDA exceed 4.0X EBITDA or 3.0X EBITDA, respectively, or other defined levels appropriate to the industry or sector . . . A borrower recognized in the debt markets as a highly leveraged firm, which is characterized by a high debt-to-net-worth ratio . . . Transactions when the borrower’s post-financing leverage, as measured by its leverage ratios (for example, debt-to-assets, debt-to-net-worth, debt-to-cash flow, or other similar standards common to particular industries or sectors), significantly exceeds industry norms or historical levels.”)

FAQs for Implementing March 2013 Interagency Guidance on Leveraged Lending, Q1 (November 7, 2014) (“Institutions should use the characteristics outlined in the guidance as a starting point for developing an institution-specific definition of leveraged loans, which should take into account the institution’s individual risk management framework and risk appetite.”)

FFIEC Call Report Instructions, Glossary, A-54 (“Among the extensions of credit reportable as loans in Schedule RC-C, which covers both loans held for sale and loans that the reporting bank has the intent and ability to hold for the foreseeable future or until maturity or payoff, are: . . . factored accounts receivable . . .”)