U.S. banks striving to bolster profits amid slow growth and new regulations are being warned against returning to riskier lending, including a type of funding used for mergers and acquisitions.
Leveraged loans, along with commercial and automobile lending, have seen declines in underwriting standards, the Office of the Comptroller of the Currency said today in a report on threats facing the national banks it oversees. The continuing low-rate environment is setting the industry up for future vulnerability as the firms chase yield by extending asset maturities, the OCC said.
“Credit risk is now building after a period of improving credit quality and problem loan clean-up,” the agency said in its Semiannual Risk Perspective. “Given these trends, the OCC will increase its attention on underwriting standards and encourage banks to diligently assess their credit risk appetite in this stage of the credit cycle.”
Even as banks reported record profits last year, overall revenue declined amid slow loan growth and a low-interest-rate environment that has squeezed net interest margins, the OCC said. With new rules closing once-lucrative revenue streams, banks have bolstered earnings by reducing loan-loss reserves as the economy recovers from the 2008 credit crisis.
In March 2013, the OCC, Federal Reserve and Federal Deposit Insurance Corp. released leveraged-lending guidelines and cited concerns about deterioration in underwriting and high debt levels. Leveraged lending has seen a recent boon from mergers and acquisitions, and the intense competition led to “higher leverage, lower yields, tighter credit spreads and weaker covenant protections,” the OCC said in today’s report.
“Any time you put out guidance, it’s going to take some time,” Darrin Benhart, Deputy Comptroller for Credit and Market Risk, told reporters asking about bank lending that pushes the limits of the guidance. The deals in question often have long pipelines, so the industry has needed time to adjust, Benhart said.
Regulators aren’t fixated on simple debt levels when watching banks’ compliance and tend to focus on “the company’s ability to repay the debt over a reasonable period,” he said. The agencies will monitor lending and compliance before “we think about additional enforcement activity.”