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The Washington Post reports that the U.S. Office of the Comptroller of the Currency, which regulates massive multinational banks like JP Morgan and Bank of America, has seen a rise in risky corporate lending by banks.Blame for the slow economic recovery is often been partially apportioned to banks. Since the crisis, the major banks have accumulated an incredible amount of excess reserves – money that could be getting loaned to finance fledgling entrepreneurs.
But the OCC’s report reveals a disturbing trend: the corporate loans banks have been shelling out are risky, and based on loosened lending standards. Banks are “signing off on deals that provide limited lender protection” while relaxing “the criteria they use to determine whether to issue loans to highly indebted companies.” This is known as leveraged finance, and these loans are often packaged, securitized, and sold to hedge funds, who gobble them up in a search for yield.
Covenant lite deals, which place less restrictions on the borrower’s ability to service his or her debt, now account for 30% of corporate lending – and are trending towards pre-recession levels, as shown in this chart from the OCC’s report:
The report notes that “38 per cent of survey recipients loosened their standards on highly leveraged lending.” Darrin Behart, deputy comptroller at the OCC, claims that explosion in leveraged loans has been driven by the major banks’ desire for “some type of earning asset.”Because these deals are often packaged (i.e. securitized) and sold, they don’t appear on banks’ balance sheets. No doubt, there are elements of a principal-agent problem here – banks have less reason to care about the quality of loans if they’re let off the hook in the case of a borrower’s default.
The impetus for the recent financial crisis was the mass proliferation of a securitized product (MBS) that was worth much less and was far riskier than credit agencies or most players in the market believed. Bank bankruptcies and bailouts ensued while the world plunged into recession.
In the same manner, the continued spread of pools of low-quality securitized corporate loans could derail the economic recovery and once again cripple global financial markets.
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