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OCC Bulletin 2024-29 | October 3, 2024
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Chief Executive Officers of All National Banks, Federal Savings Associations, and Federal Branches and Agencies; Department and Division Heads; All Examining Personnel; and Other Interested Parties
The Office of the Comptroller of the Currency (OCC) is issuing this bulletin to provide banks1 with guidance for managing credit risk associated with refinance risk. This bulletin does not address other risks, such as interest rate risk.2
This bulletin rescinds Banking Bulletin 1993-50, “Loan Refinancing.”
This bulletin applies to all banks with commercial loans.
This bulletin
Refinance risk is the risk that borrowers will not be able to replace existing debt at a future date under reasonable terms and prevailing market conditions. Refinance risk increases in rising interest rate environments and can be amplified by large volumes of loans set to mature in underperforming markets.3 If a borrower cannot refinance under current market conditions, a bank could be burdened with an underperforming or nonperforming loan. Refinance risk primarily affects loans with principal balances remaining at maturity and borrowers who rely on recurring debt to finance their capital structure or business operations. Examples of loan types most affected by refinance risk include interest-only loans, commercial real estate loans,4 leveraged loans, and revolving working capital lines. Fully amortizing loans to sound borrowers generally have lower refinance risk than loans that are not fully amortizing.
Refinance risk affects individual loans and portfolios of loans. A concentration in such loans could increase the cost and complexity of problem loan resolutions when borrowers are under stress. In addition, if a significant volume or amount of loans refinance during adverse economic conditions, it could constrain a bank’s capital or liquidity, threaten earnings, or hinder strategic initiatives.5
Refinance risk can be driven by external factors or borrower-specific factors. External factors that affect refinance risk include investor risk appetite and market liquidity; the current interest rate environment; inflation; or supply chain effects on the costs of goods, services, or labor. Refinance risk increases in rising interest rate environments because borrowers may be unable to service their debt at higher interest rates upon refinance. Refinance risk may also increase for some borrowers or portfolios because of declining industry fundamentals or changes in commodity prices. Borrower-specific drivers for heightened refinance risk include high leverage, constrained liquidity, a significant volume of near-term maturities, poor financial performance, or unpopular market sentiment.
Banks should have processes to identify, measure, monitor, and control refinance risk at both the transaction and portfolio levels. The tools to monitor refinance risk should be tailored to the bank’s size, complexity, risk profile, and types of lending. Sound transaction-level credit risk management practices include assessing refinance risk at underwriting, during ongoing monitoring, and near maturity. At the portfolio level, banks should have systems and processes to monitor the volume and cadence of upcoming loan maturities. Independent credit risk review should consider the level of refinance risk when determining an appropriate review scope and assessing credit quality.6
One common method to assess refinance risk at the transaction and portfolio level is multivariable stress testing. Transaction-level stress testing can provide insight into the borrower’s ability to meet refinancing requirements if the borrower’s financial condition declines or market conditions deteriorate (e.g., interest rates increase, market terms tighten, expenses increase, or collateral values fall). Portfolio-level stress testing can identify and measure the potential effect of changing market conditions on portfolio segments with higher refinance risk.7
Transaction-Level Risk Management and Risk-Rating Considerations
Banks should evaluate refinance risk when approving and structuring loans, during ongoing monitoring (e.g., annual reviews), near loan maturity, and when considering granting extensions or renewals. Refinance risk can also be a factor when risk-rating a loan. A prudent assessment of refinance risk includes a borrower’s refinancing needs, the performance of the underlying project or asset, the timing of a refinancing transaction (e.g., maturity), the amount and maturity dates of other debt, current market liquidity, and the cost of refinancing.
At origination, banks can structure a loan to mitigate refinance risk. For example, underwriting standards may include debt service coverage or loan-to-value requirements that provide a cushion if a borrower’s financial condition declines or market conditions deteriorate. Banks may also require covenants that preserve the borrower’s ability to refinance (e.g., leverage covenants or limits on incremental debt) or trigger action before maturity to protect the bank (e.g., debt service coverage ratios or liquidity ratios).
During ongoing monitoring and near maturity, management should conduct analysis to determine the borrower’s refinance requirements and ability to reasonably qualify for another market rate loan to cover the projected outstanding principal. The analysis can also provide insight into the likelihood that a borrower might seek refinancing prior to maturity (e.g., to support significant business expansion, because of a leveraged buyout, or to pay out a retiring partner). Effective analysis of refinance risk includes a loan’s performance compared with expectations at underwriting, the time horizon for a refinance event, borrower-specific factors, and external factors. Analysis should include determining whether a borrower can meet current underwriting standards, including prevailing interest rates, for similar loans. Banks should have refinance plans in place for borrowers with near-term refinancing needs. While market demand could affect a borrower’s ability to refinance, generally the stronger a borrower’s underlying financial performance, the more refinance options are available.
For loans maturing with an outstanding principal balance or otherwise likely to require near-term refinancing, credit risk ratings should take into account the likelihood that the borrower will be able to obtain refinancing without relying on distressed terms. Refinance risk is just one consideration in determining an appropriate risk rating and should be evaluated in the context of the borrower’s overall financial condition and debt service ability. While increased refinance risk does not automatically warrant a change in a loan’s risk rating, classification is appropriate when there are well-defined weaknesses that jeopardize repayment. Loans that are adequately protected by the current sound worth and debt service ability of the borrower, guarantor, or the underlying collateral8 generally are not adversely classified.9 Similarly, loans to sound borrowers that are modified in accordance with prudent underwriting standards are generally not adversely classified unless well-defined weaknesses exist that jeopardize repayment. Such loans, however, could be flagged for management’s attention or for inclusion in designated “watch lists.”
Portfolio-Level Analysis and Risk Management
Banks should have processes to identify, measure, monitor, and control refinance risk at the portfolio level. Assessing refinance risk at the portfolio level allows a bank to identify borrowers experiencing similar stresses, whether macroeconomic or specific to an industry or region.
Effective processes generally include
A bank can mitigate refinance risk by establishing criteria that define when it is appropriate to underwrite loans that will not fully amortize by maturity (e.g., interest-only loans, loans with balloon payments, or revolving loans) and prudent terms for such loans (e.g., re-margining requirements, covenants, or cleanup requirements). Underwriting criteria can also detail the prudent use of interest rate swaps and caps. Banks can further mitigate refinance risk by setting appropriate underwriting exception limits, controls, and reporting (e.g., limiting loans underwritten with covenant-lite structures or with marginal debt service coverage or loan-to-value ratios).
Setting and adhering to concentration limits can protect the balance sheet from potential refinancing shocks and bank capital from outsized losses when refinance options are limited. Refinance risk can occur across different lending products, and it is prudent for management to consider whether refinance risk creates correlated exposures not otherwise identified, especially during a deteriorating economic environment.10
Loans Restructured Under a Prudent Loan Workout Plan
The OCC encourages banks to work proactively and prudently with borrowers who are, or may be, unable to meet their contractual payment obligations during periods of financial stress. An effective loan workout arrangement should improve the bank’s prospects for repayment of principal and interest, be consistent with sound banking and accounting practices, and comply with applicable laws and regulations.11
Management should consider refinance risk when developing an effective workout strategy. In some cases, as part of a prudent workout plan, a loan originally underwritten with fully amortizing terms is restructured with an outstanding principal payment at maturity. Management should appropriately risk-rate and manage such loans. Management should also measure and monitor the volume of modified and restructured loans. When assessing refinance risk at the portfolio level, management should consider the volume of modified or restructured loans that will no longer fully amortize by maturity.
If management determines that a loan refinance represents a modification or accommodation to a borrower experiencing financial difficulty,12 management should perform further analysis to determine whether the loan no longer shares similar risk characteristics with other loans and should be reviewed individually when determining an appropriate allowance for credit loss. Management should also determine whether the loan is collateral-dependent.13
Please contact Barry Mills, Director for Commercial Credit Risk Policy, at (202) 649-6220.
Grovetta N. Gardineer Senior Deputy Comptroller for Bank Supervision Policy
1 “Banks” refers collectively to national banks, federal savings associations, and federal branches and agencies of foreign banking organizations.
2 For interest rate risk guidance, refer to OCC Bulletin 2010-1, “Interest Rate Risk: Interagency Advisory on Interest Rate Risk Management,” and OCC Bulletin 2012-5, “Interest Rate Risk Management: FAQs on 2010 Interagency Advisory on Interest Rate Risk Management.”
3 A large volume of loans scheduled to mature in an underperforming market is often referred to as a “maturity wall.”
4 Higher refinance risk is also common in construction and development loans, which are typically interest-only, and other commercial real estate loans, which are generally underwritten to the life of the property, often 15 to 30 years, but mature after a much shorter term, often three to five years. For more information specific to commercial real estate lending, refer to the “Commercial Real Estate Lending” booklet of the Comptroller’s Handbook.
5 Refinance risk can affect a bank’s interest rate risk when a material amount of loans on the balance sheet with higher levels of refinance risk mature at the same time or within a tight time frame. Loans that are unable to refinance at market terms could result in an unplanned asset/liability price mismatch on a bank’s balance sheet.
6 For more information about credit risk review, refer to OCC Bulletin 2020-50, “Credit Risk: Interagency Guidance on Credit Risk Review Systems.”
7 For more information on stress testing, refer to OCC Bulletin 2012-33, “Community Bank Stress Testing: Supervisory Guidance,” and OCC Bulletin 2012-14, “Stress Testing: Interagency Stress Testing Guidance.”
8 Collateral value alone is not sufficient to preclude adverse classification when well-defined weaknesses are present. Loans that rely on cash flow generating collateral as the primary source of repayment would need to generate sufficient cash flow to repay the debt under reasonable terms.
9 For more information on risk ratings, refer to the “Rating Credit Risk” booklet of the Comptroller’s Handbook.
10 For more information on concentration risk, refer to the “Concentrations of Credit” booklet of the Comptroller’s Handbook.
11 For more information on prudent loan workouts for commercial real estate loans, refer to OCC Bulletin 2023-23, “Credit Administration: Final Interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts.”
12 Loan modifications to borrowers experiencing financial difficulty should be reported in accordance with call report instructions.
13 For more information, refer to OCC Bulletin 2023-11, “Current Expected Credit Losses: Interagency Policy Statement on Allowances for Credit Losses (Revised April 2023).”
