US banking regulator treads cautiously on leveraged loan market

WASHINGTON (Reuters) – A U.S. banking regulator says banks should be increasingly aware of activity in the leveraged loan market, warning that the sector’s rapid growth by non-banks could pose challenges. future risks for the financial sector.

FILE PHOTO: Joseph M. Otting speaks after being sworn in as Comptroller of the Currency in Washington, U.S. November 27, 2017. REUTERS/Joshua Roberts/File Photo

The U.S. Office of the Comptroller of the Currency (OCC) highlighted lending to highly indebted businesses in its semi-annual risk report released on Monday.

While bank lending in this sector does not appear excessively risky, the OCC cautioned that near-record issuance in this sector, driven by non-banks like private equity firms and hedge funds, deserves special attention.

“Banks, in general, we feel comfortable with their underwriting and performance in the leveraged loan market. But it’s clearly something we all need to watch,” said US Comptroller Joseph Otting on a call with reporters.

Leveraged loans have recently attracted attention in Washington. Democratic Senator Elizabeth Warren pressed regulators earlier this month about underwriting standards in that market.

The Federal Reserve is also hearing from more parties concerned about the leveraged loan market and how it could complicate future economic downturns.

Randal Quarles, the Fed’s vice chairman for supervision, said earlier on Monday that the US central bank was studying banks’ exposure to leveraged debt.

Speaking in New York, he noted that banks do not have most leveraged loans or secured loan obligations on their books, but the issue and potential risks they pose are being explored. to analyse.

Average leverage for large corporate loans is at an all-time high, the OCC noted in its report, adding that banks can sometimes be indirectly exposed to riskier loans in the space through investments in debt funds or private equity funds.

Overall, the OCC found that credit quality on bank loans was generally strong, but noted that credit risk is building up. Growing competition for new loans, especially from non-banks, is pushing banks to consider riskier loans, the regulator has warned.

The OCC has also identified cybersecurity as a key operational risk for banks. Otting called it a “critical risk” which, if not properly managed, could pose a fundamental threat to financial institutions.

The regulator noted that banks rely on third-party providers for a range of services, which can present their own risks if not properly monitored.

“Cybercrime and espionage are increasingly targeting third-party service providers to gain access to banking information or systems,” the OCC warned.

Reporting by Pete Schroeder, editing by G Crosse

Priscilla C. Carnegie