Syndication Quality Declines As Nonbank Lenders Flock In

WASHINGTON - The quality of syndicated lending is deteriorating while volume is soaring and the market is being invaded by thousands of new participants, according to a new study by federal banking regulators.

Considering its size - roughly $2 trillion of loans will be syndicated this year - relatively little statistical research has been done on this market. So three government researchers started crunching data gleaned from Shared National Credit exams done from 1995 to 1999. These inspections, done each May, grade all loans of $20 million or more that are shared by three or more creditors.

During the five years, the number of creditors participating in these large syndicated loans grew 61%, to 94,090. Nearly half were commercial banks, but the ranks of finance companies in the market more than doubled, to 2,763, and the broker-dealer total quintupled, to 1,212. The number of "other nondepository institutions" buying pieces of syndicated loans, such as mutual funds, quadrupled, to 10,660.

Still, the business is dominated by large commercial banks. During the period, the 10 largest banks led roughly 50% of the syndicated credits studied, 53.5% in 1999. These "agent" banks earn fees for negotiating the details of the loan, preparing the loan documents, recruiting the participants, and servicing the loan.

The study said that the number of agent banks "is rather small and has declined over time, most likely due to industry consolidation." In fact, the number of agents fell 35%, to 223, during the five years.

The average loan size rose steadily, reaching $209 million in 1999, up 21.5% from 1995. A big jump - 6.9% - occurred from 1998 to 1999. Though the average size of loans grew, however, the portion retained by agent banks declined, the study found. The average share held by agent banks fell to 22.3% in 1999, from 27.4% in 1995.

The study found that the quality of these syndicated loans dropped off in 1999. "There is a clear increase in the number of loans rated 'pass' between 1995 and 1998 followed by a decline in the percentage of 'pass' loans from 1998 to 1999," it stated. However, the researchers, who work at the Office of the Comptroller of the Currency and the Office of Thrift Supervision, warned against reading too much into this finding.

"While the increase in classified loans in 1999 might provide support for the concerns expressed by regulators over deterioration in credit underwriting standards," they said, it is "important to account for the age of loans, since new loans are typically 'pass' credits, and it usually takes a period of time before a loan rating deteriorates."

If a loan is fine, examiners assign a "pass" grade, but if any weakness exists it is "classified" and slotted into one of four categories such as "substandard." The study said a loan's chance of being classified increases during the first three years of its life, then flattens out. Yet the percentage of loan agreements made in 1998 and classified in 1999 was "far higher than other year-one loan experiences. Moreover, there is a very high share of loans made in 1997 that become classified in 1999."

The researchers tied these results to the huge increase in leveraged loans, which were more than 30% of syndicated loan volume by 1998, up from 10% in 1993.

The study also noted that by 1999 the share of classified versus pass credits held by agent banks was roughly equal. In all previous years, agent banks held a larger share of the classified credits. "It is quite striking that the difference in agent loan share between 'pass' and 'classified' loans disappears in 1999," the study said.

"People are more comfortable pricing and participating in low-quality credits," explained William W. Lang, deputy director of the OCC's policy analysis office and one of the study's three authors. "They feel more confident in their ability to price and manage the risk."

In an interview Wednesday, Mr. Lang said the study's findings will be updated next month using 2000 data from the Shared National Credit exam. Future research will focus on the stability of agent banks' fee income. "This has become such a big business," he said. "We want to know more about what characterizes these income flows. How that fee income moves with the business cycle. How volatile it is."

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