WASHINGTON — Despite industry strides to improve underwriting of leveraged commercial loans, the national portfolio of large, syndicated credits is still teeming with underwriting concerns and other risks, according to a regulatory report released Thursday.
The 2015 Shared National Credits review found that an elevated 9.5% of SNC commitments — business loans totaling at least $20 million shared by three or more banks — demonstrate some form of weakness. Overall syndicated loans continue to grow, but continued problems with loans to highly-leveraged borrowers drove an increase in criticized SNC assets, the regulators said. The portfolio was also weakened by hits to the oil and gas industry, which is dealing with declining energy prices.
"The SNC examination observed that the significant decreases in O&G market prices have impaired many O&G companies' ability to pay interest and principal, and has led to some defaults," the Federal Deposit Insurance Corp., Federal Reserve Board and Office of the Comptroller of the Currency said in the report. "In addition, companies incurred significant debt to fund drilling programs, and their capital structures became unsustainable in the face of lower oil prices."
Yet similar to recent SNC reviews, the regulators continued to home in on leveraged loan problems. Of all syndicated credits demonstrating problems — those that fall in either the "special mention" or "classified" categories — the vast majority were leveraged. Classified loans include those considered "substandard," "doubtful" or "loss." Leveraged loans made up nearly 83% of all "special mention" commitments, 65% of substandard loans and 59% of all loans in nonaccrual status.
The regulators pointed to improvements in underwriting of leveraged loans in the second half of the period covered by the review and progress in complying with 2013 guidance on leveraged lending. But weak underwriting still persists, the agencies said, including deterioration in loan covenants. Generally, 28% of SNC loan transactions reviewed demonstrated weakness in underwriting standards. (The review sample comprised $1.04 trillion of the $3.9 trillion commitments SNC portfolio.)
"The persistent structural deficiencies found in loan underwriting by the agencies warrant continued attention," the regulators said in a press release.
The most recent SNC report is one in a series highlighting concerns about leveraged lending. The 2013 report found "material widespread weaknesses in underwriting" of leveraged loans. Meanwhile, the Financial Stability Oversight Council — charged with overseeing systemic threats — has also held briefings on the implications of leveraged loan defaults.
"Leveraged lending transactions were the primary driver of this deterioration," the report said. "The most frequently cited underwriting deficiencies identified during the 2015 SNC review were minimal or no loan covenants, liberal repayment terms, repayment dependent on refinancing, and inadequate collateral valuations. The weak underwriting structures were in part attributable to aggressive competition and market liquidity."
Overall SNC commitments rose by 15% from the 2015 review. The dollar volume of outstanding syndicated loans rose 19% to $1.87 trillion. The 9.5% of commitments considered "classified" or "special mention" was a slight half-point decline from the previous mark for troubled credits. The figure continues to gradually come down from a peak of 22.3% in 2009, but it is still high compared to before the crisis.
"The agencies noted a significant increase in leveraged lending volumes and continued loose underwriting, as evidenced by weak capital structures and provisions that limit the lenders ability to manage risk," the report said.
But underwriting of leveraged loans was not all to blame, the regulators said. A "sudden and sustained decline in oil prices since" the middle of 2014 has also hurt the credit quality of borrowers in the energy sector. The report said 11% of loans considered "special mention" or worse were made to the oil and gas industry. For commitments to the commodity sector overall, 10.5% were classified or special-mention. Classified commitments in the sector jumped nearly 66% from the previous year to $72.1 billion.
The report said some energy companies have hedged against the price drops, but revenue might not be sustainable, which could hurt future cash flows.
"As a result, companies are preserving liquidity by deferring development drilling, cutting general and administrative expenses through layoffs and where possible, incurring high-priced term debt to pay down reserve-based lines and increase borrowing availability," the agencies said.
However, the review praised banks' efforts to restructure credit for oil and gas firms.
"Banks are showing flexibility in working with borrowers by relaxing leverage covenants and allowing customer's time to curtail borrowing base over-advances," the report said. "The banks and customers are taking reasonable actions during this stressed environment."
Nonbanks continue to gain more share of the SNC portfolio, particularly classified credits. Nonbanks owned 67% of all SNC classified credits, compared with 17.8% for U.S. banks and 15.2% for foreign banking companies.