NEW YORK, May 15 (LPC) – The US leveraged loan market is a specific credit risk that warrants attention as companies continue to layer on increasing amounts of debt, regulators will tell lawmakers at a Congressional hearing Wednesday.
Companies are borrowing high levels of debt compared to their earnings, with few lender protections and more liberal repayment terms, which needs to be watched, Comptroller of the Currency Joseph Otting is set to testify Wednesday before the Senate Committee on Banking, Housing and Urban Affairs, according to prepared remarks posted to the committee’s website.
But despite more aggressive lending terms, recent supervisory assessments show banks regulated by the Office of the Comptroller of the Currency (OCC) have satisfactory risk management practices for leveraged lending, according to Otting.
The OCC will continue to asses these institutions’ management of lending risks, but he attributed a more balanced risk management approach to leveraged lending guidance issued in 2013.
The OCC, Federal Reserve (Fed) and Federal Deposit Insurance Corp (FDIC) updated lending guidance, worried about weakening underwriting standards. They described loans without a full package of covenants as aggressive and expressed concerns about leverage of more than 6.0 times.
Six years later and debt compared to earnings at companies has soared with leverage for buyouts rising to an average of 6.96 times in the first quarter, up from 5.8 times in the first quarter of 2013 when regulators released the guidance, according to LPC data.
At the same time, almost 75% of broadly syndicated loans arranged in the first three months of the year were covenant-lite compared to 58.9% of loans issued in the same period in 2013, according to the data.
The aggressive terms have drawn the ire of Senator Elizabeth Warren, former Fed Chair Janet Yellen and Governor of the Bank of England Mark Carney who have all criticized the asset class, which has doubled in size to US$1.2trn since the credit crisis as years of low interest rates coupled with increasing demand from investors for floating-rate loans led to frothy market conditions.
“We continue to monitor how this combination of risks is evolving and to assess the adequacy of bank risk management and controls,” Otting said in the prepared remarks.
FDIC Chair Jelena McWilliams also expressed concerns about leveraged lending in her prepared testimony for Wednesday’s hearing on the oversight of financial regulators.
The regulator is carefully monitoring the market because a significant rise in leveraged loan defaults could have broader economic impacts that affect both bank and non-bank sponsors of leveraged loans, she said. It is also tracking growth in lending as well as concentrations of exposure at financial institutions and their underwriting standards.
Regulators will continue to perform semi-annual interagency assessments of loan underwriting standards known as the Shared National Credit (SNC) reviews, Otting said. In the most recent review cycle, regulators said in January that leveraged loan risk remained elevated even as risk in the overall portfolio of large syndicated bank loans had improved.
Otting’s comments echo the response he, McWilliams and Fed Chair Jerome Powell wrote in a February 25 letter to Warren, a Democrat running for President, who asked regulators last November about their plans to address risks in the leveraged loan asset class.
The regulatory heads acknowledged her concerns about the growth of the market, and resulting weaker lender protections, and said banks are expected to have prudent underwriting practices in place, according to the letter obtained by LPC. Deficient practices that relate to safety and soundness, they wrote, may result in supervisory action. (Reporting by Kristen Haunss. Editing by Michelle Sierra and Jon Methven)