Alarm Bells Ring As OCC Reports Leveraged Loans Hit Record

Alarm Bells Ring As OCC Reports Leveraged Loans Hit Record

The good news is that consumer credit has had two consecutive quarters of sequential growth for the first time since the Great Recession, with retail credit reaching $12.96 trillion at the end of last year ($100 billion higher than 2012, and $1 trillion lower than the June 2008 peak). The bad news is that the growth has been driven by student loan debt, risky auto loans, and leveraged loans, says a recent report from the Office of the Comptroller of the Currency (OCC), a part of the US Treasury Department.

“Competition is resulting in eased underwriting across a variety of products. Weakening standards are particularly evident in indirect auto and leveraged lending; however, some easing in underwriting and increased risk layering are also occurring in other types of commercial loans,” says the report.

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Leveraged loans growth reminiscent of 2007

Leveraged loans hit a new high last year, which the OCC credits to institutional investors looking for higher yield products like collateralized loan obligations and retail loan funds, while already indebted businesses took advantage of the continued low rates. Merger and acquisition loans had their highest volume since 2007, making up 32% of new issuance, and the average debt to EBITDA multiple rose to 4.7x, also the highest level since 2007. Issuance of covenant-lite loans, which have fewer lender protections than normal loans, reached $258 billion last year, about two and half times the 2007 level.

“The combination of higher leverage, lower yields, tighter credit spreads, and weaker covenant protections provides ample evidence of increasing credit risk in the leveraged loan market,” says the OCC report.

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Competition undermining auto loan underwriting standards

“Across the industry, auto lenders are pursuing growth by lengthening terms, increasing advance rates, and originating loans to borrowers with lower credit scores,” says the OCC report. “The results have yet to show large-scale deterioration at the portfolio level, but signs of increasing risk are evident.”

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Auto loan growth was impressive throughout 2013, with banks reporting 11.3% growth in 3Q13 and 12.9% in 4Q13 (banks account for about 30% of the auto loan market), but the average loan-to-value (LTV) ratio has risen past 100% for the entire market. While LTV doesn’t tell you anything about the consumers taking out the loan, who might have great credit and want to take advantage of low rates, but a high LTV is generally seen as a higher risk loan.

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Average loss per vehicle also rising

But the average loss per vehicle has also been rising for the last two years, as seen by the year-on-year increase in average charge-offs. The OCC sees these as early warning signs, not necessarily a problem in and of themselves, and recommends keeping an eye on the auto loan market for further deterioration in credit quality.

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Michael has a Bachelor's Degree in mathematics and physics from Boston University and Master's Degree in physics from University of California, San Diego. He has worked as an editor and writer for several magazines. Prior to his career in journalism, Michael Worked in the Peace Corps teaching math and science in South Africa.
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