Banking agencies report credit quality up some, but risk still elevated in leveraged loans

A 2018 review of large syndicated bank loans showed a decline in portfolio risk due to improving conditions in most sectors, but the dollar volume of loans rated lower than “pass,” as a percentage of total loans, remains elevated compared with levels seen in prior economic cycles, the nation’s three federal banking regulators said in a report Friday.

Noting that the review finds increased risks associated with leveraged lending, the report by the Federal Reserve Board (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) says banks should update their credit risk management practices as the risk profile of borrowers and the industry changes.

Friday’s report was on the agencies’ most recent Shared National Credit (SNC) Program Review. The report reflects the results of reviews in 2018 covering SNC program loans originated by or before March 31, 2018.

From Fed/FDIC/OCC Shared National Credit Review report.

The report summary says the level of loans in the SNC portfolio that are “special mention or classified” declined largely due to improving economic conditions in the oil and gas sectors. Special mention and classified commitments (explained in greater detail later) are “non-pass” loans, the report notes.

“Despite the improvement, special mention and classified commitment levels remain elevated compared to prior economic cycles (see exhibit 3),” the report says. “A significant portion of the special mention and classified commitments are concentrated in transactions that agent banks identified as leveraged loans.”

The 2018 SNC portfolio included 8,571 credit facilities to 5,314 borrowers, totaling $4.4 trillion, up from $4.3 trillion in 2017, the agencies said in Friday’s release. U.S. banks held the greatest volume of SNC commitments at 44.3% of the portfolio, followed by foreign banking organizations and other investor entities such as securitization pools, hedge funds, insurance companies, and pension funds. Effective Jan. 1, 2018, the agencies increased the minimum aggregate loan commitment threshold to be included in the review from $20 million to $100 million. Under the revised definition, loan commitments increased modestly compared with levels reported in 2017; however, the number of borrowers and credit facilities has declined.

Reviewed loan commitments were stratified by the severity of their risk – special mention, substandard, doubtful, or loss, the last three of which are known as “classified.” Overall, the level of loans rated below “pass,” as a percentage of the total SNC portfolio, decreased year-over-year from 9.7% to 6.7%. Leveraged lending was the primary contributor to the overall “special mention” and “classified” rates, comprising 73% of “special mention” and 86% of “classified” commitments. Investors outside the banking industry held the greatest volume of “special mention” and “classified” commitments, followed by U.S. banks and foreign banking organizations.

The agencies conduct SNC reviews in the first and third calendar quarters with some banks receiving two reviews and others receiving a single review each year. The agencies issue a single statement annually that includes combined findings from the previous 12 months. This practice presents a complete view of the entire SNC portfolio, which can be compared with prior years’ reports. The next report will be published following the third quarter 2019 SNC examination.

Shared National Credit review finds some improvement in credit quality, risk remains elevated in leveraged loans

Shared National Credit Program Review Report