February 6, 2020 - The Shared National Credit Program report released last week found that banks’ credit risk exposure to leveraged loans remains elevated.
The report, reflecting a federal interagency review and assessment of the most complex credits shared by financial institutions, found that many leveraged loans possess “weak structures” that were not materially present in previous downturns.
The weak structures, the report states, “include some combination of high leverage, aggressive repayment assumptions, weakened covenants, or permissive borrowing terms that allow borrowers to draw on incremental facilities materially present in previous downturns.”
The weak structures are the product of strong investor demand enabling borrowers to obtain friendlier terms, the report states.
While banks have adopted credit risk management practices in response to these elevated risks, these practices have not been tested in an economic downturn.
The report recommends that banks ensure their new risk management practices are robust enough to handle “changing market conditions” and that revenue, growth, and cost savings assumptions made during credit analyses are appropriate. Banks should also consider how future recovery rates might differ from historical recovery rates and how a downturn in leveraged lending could impact other customers and borrowers.
The SNC Program is governed by the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency. The Program assesses risks and risk management practices of the most complex credits shared by multiple financial institutions.