On November 10, the OCC issued a bulletin clarifying how banks should treat personal and corporate guarantees when assigning risk ratings to commercial credits. The bulletin focuses on corporate guarantees and does not address U.S. government guarantees. The guidance applies to all OCC-supervised banks, including community banks. The OCC emphasized that a credit’s risk rating depends on its specific facts and circumstances and focuses on the risk of default, meaning the borrower’s ability to service the debt from its primary source of repayment. Guarantor support is generally a secondary or tertiary source of repayment. For most credits with well-defined weaknesses, a guarantee alone generally will not support a pass rating; a guarantee more commonly supports a “special mention” rating or prevents a more severe rating such as “doubtful” or “loss.” However, the OCC noted a strong guarantee may support a pass rating in limited circumstances, generally where the credit was prudently underwritten and the guarantor’s financial strength mitigates both the risk of default and the risk of loss.

The bulletin provides that a guarantee can improve a credit’s rating only if the guarantor shows both “capacity” and “willingness” to support the debt. Capacity is shown through current guarantor financial information, generally including verification of liquid assets and, in most cases, a global cash flow analysis. Banks should consider whether the guarantor can cover all of the guarantees it has outstanding, and without current financial information a bank generally cannot rely on the guarantee to improve the rating. Willingness may usually be presumed until support is actually needed, but it is not shown where a guarantor tries to avoid its obligations through litigation or protracted renegotiation.

Beyond the guarantor itself, the form of the guarantee matters. A guarantee that was not properly authorized may be unenforceable and does not improve a rating. How much risk an enforceable guarantee mitigates depends on whether it addresses the risk of default (the stronger form) or only the risk of loss, whether it is irrevocable (a guarantee the guarantor can revoke without the bank’s consent generally provides no mitigation), whether it is contingent or unconditional, and whether it is capped, in which case it helps only up to the capped amount. An unconditional, irrevocable payment guarantee is generally the strongest form.