December 19, 2019 - As discussed nearby, while the OCC’s Semiannual Risk Assessment flagged LIBOR cessation as an emergent risk, its tone was balanced on credit risk. First, the OCC noted that “[c]redit quality remains strong, as measured by traditional performance metrics”. However, they are watching this space, noting that these metrics are “lagging indicators that may not fully capture embedded risk from elevated corporate borrowing, higher corporate leverage [and] eased underwriting standards”.
On leveraged lending, in particular, the OCC noted that risk remains elevated “but has been relatively stable in 2019”. There are higher leverage levels and aggressive repayment assumptions. Nonetheless, “leveraged loans held in bank portfolios are generally of satisfactory credit quality, and holdings of collateralized loan obligations are generally of high quality. (The emphasis is ours and we believe it is deserved as some commentators appear to be applying assumptions of excessive risks to bank holdings of CLO AAA tranches.)
Finally, the OCC has a few words of concern for non-bank lenders and – shall we say – guidance for the banks. The agency observes that “[s]ignificant leveraged loan exposure exists outside the federal banking system, resulting in less transparency and more uncertainty on the systemic credit impact from a material economic downturn”. (We would note that we have heard such concerns directly from the agencies’ mouths; this is not a passing fancy.) On the “guidance” front, the OCC said that it continues to assess bank lending practices and expects banks to promptly identify changes in credit risk, employ effective risk mitigation strategy and maintain appropriate loan loss allowance methodologies. It concludes the section with the admonition that “banks should consider the potential cumulative effect on the US financial system from underwriting and distribution of weakly syndicated loans.”