With the amount of commercial real estate loans scheduled for maturity over the next several years expected to increase significantly, there is accompanying heightened risk that some borrowers may be unable to replace their maturing debt with new debt under reasonable terms and prevailing market conditions (refinance risk). On October 3, 2024, the Office of the Comptroller of the Currency (“OCC”) issued OCC Bulletin 2024-29, which provides guidance to banks in the management of credit risk associated with refinancing commercial loans. The bulletin, which applies to all banks with commercial loan portfolios, outlines that refinance risk affects both individual loan transactions and loan portfolios and can be driven by both external and borrower-specific factors. The bulletin highlights the need for banks to have related risk management processes that are appropriate for their size, complexity, risk profile and loan types.
At the transactional level, appropriate risk management practices include analyzing refinance risk at all stages of the loan cycle: during underwriting and through ongoing monitoring, the period near loan maturity, and when the bank is evaluating extensions or renewals. At the underwriting stage, the bulletin notes that loans can be structured to mitigate refinance risk through the use of debt service coverage or loan-to-value requirements or the use of appropriate covenants that enhance the borrower’s ability to refinance the loan or that trigger protective rights of the bank before maturity. Through ongoing monitoring and as the loan approaches maturity, banks should assess the borrower’s ability to qualify for a new loan under current market terms and the likelihood that a refinancing may be sought prior to maturity and should develop a refinance plan for the borrower as loan maturity approaches. In assigning appropriate credit ratings, banks should also account for the borrower’s ability to refinance the loan without having to agree to distressed terms.
In addition to assessing refinancing risk at a loan transaction level, the guidance also notes that banks should assess refinance risk at a portfolio level to identify borrowers that may experience similar stress. The OCC notes that effective risk management processes at the portfolio level should include the ability to identify and monitor the volume and amount of loans maturing and segments affected by external risk factors, stress testing of high refinance risk portfolios, risk appetite limits, and risk reporting. Banks can mitigate portfolio refinance risk by defining appropriate underwriting for loans not expected to fully amortize by maturity, outlining appropriate terms for those loans, and establishing underwriting exception limits, controls and reporting.
The guidance concludes by noting that banks are encouraged to work proactively and prudently with borrowers who are, or may be, unable to meet their loan obligations.
