WASHINGTON — Though credit risk for large syndicated loans fell in recent months, regulators remain worried about banks' involvement in leveraged credit and the oil and gas sector, according to a report released Wednesday by the federal banking regulators.
The agencies' Shared National Credits program report, which looks at large credits shared by multiple banks, found that the ratio of commitments rated as an adverse risk dropped to 8.1% in the six months that ended March 31, from 11.1% in 2014. Despite the improvement, regulators noted, the overall risk level remains high.
“Risk in the portfolio of large syndicated bank loans declined slightly but remains elevated,” said the report, which was released by the Office of the Comptroller of the Currency, Federal Deposit Insurance Corp. and Federal Reserve.
The agencies' biggest concerns centered on leveraged loans and the oil and gas sector.
“The agencies continue to be concerned that any downturn in the economy would result in a significant increase in the already considerable adversely risk rated leveraged lending exposure,” said the report, which is released twice a year. “Leveraged loan transactions typically exhibit limited financial flexibility due to a combination of elevated financial risk and weak loan structure regardless of risk rating.”
In the two-quarter period starting October 2016, leveraged loans accounted for 64.9% of all shared national credit loans that were flagged as credit risks. Specifically, the regulators pointed to underwriting weaknesses, including ineffective covenants, “liberal” repayment terms and incremental debt provisions.
Overall, regulators said there were improvements in underwriting and risk management in leveraged loans in response to interagency guidance released in 2013.
“Most agent banks are now better equipped to project future cash flows to assess borrower repayment capacity and enterprise valuations, which better align with basic safety and soundness principles,” the agencies said.
But some observers questioned regulators' guidance, noting that it should have been done through official rulemaking, rather than simple guidance.
"The regulators attack on leveraged lending is a prime example of how they have abused their power by issuing guidance rather than by notice and comment rulemaking," said J.W. Verret, a professor at George Mason University.
The agencies also warned that banks are still increasing their investments in oil and gas, an industry viewed as risky.
Oil and gas loans comprised 25.7% of all shared national credit loans flagged between October 2016 and March of this year, the report said. Such loans represented $467.3 billion, or 10.9%, of total shared national credit commitments in 2017, the report found. That was a slight decrease from 2016, during which the industry held $502.9 billion in oil and gas lending commitments.
“These weaknesses have been exacerbated by exploration and production (E&P) companies with high leverage, primarily a result of debt-funded acquisitions during previous drilling expansion,” the report said.
Overall, the percentage of criticized credits dropped to 9.7% from 10.3% at the same point last year. Commitments rated special mention or classified decreased slightly to $417.6 billion during that time. The share of credits rated special mention and classified held by nonbank entities fell from 60.8% in 2016 to 56.1% in 2017.