CHICAGO--(BUSINESS WIRE)--The Shared National Credit (SNC) Program's 2014 review released by US banking regulators last Friday showed limited improvements in the overall levels of criticized loans, which Fitch Ratings says provides regulators' with greater justification to strengthen oversight. The report specifically noted plans to increase the frequency of leveraged lending reviews to ensure the level of risk is identified and managed.
The SNC program pays special attention to highly leveraged lending at US banks where ratios of debt to EBITDA can exceed six times. This year's report noted that while many risk management practices have been addressed at US banks, numerous exceptions were still cited at all of the large banks that originate leverage loans.
The report highlights that after declining during the financial crisis, the volume of leveraged lending has been increasing and underwriting standards have deteriorated. The agencies estimated that whereas 83% of borrowers could be expected to repay 50% of their loans within seven years prior to June 1, 2013, only 77% could do so as of earlier in 2014.
According to the report, criticized assets remain stubbornly elevated at 10.1%, up 0.1% from last year. The agencies noted that the stalled progress of the last several years was "troubling given the current economic environment and low interest rates."
In our analysis, we remain focused on the potential affect high leverage will have on asset quality, once short-term rates begin to rise along with debt payments, particularly in commercial and industrial (C&I) portfolios. We believe that recent C&I loan loss rates, which are below long-term historical averages, are unsustainable and have also been deflated given somewhat higher growth rates in lending activity over recent periods. While near-term refinance risk is low, with just 15% of commitments scheduled to mature in 2014 and 2015, 39% are expected to mature in 2016 and 2017, when rates likely are to be higher.
One point that offsets our concerns is the fact that nonbank entities are among the primary buyers of these higher risk leveraged loans and are the largest holders of criticized assets within the SNC portfolio.
Special mention loans (i.e. loans not exposing institutions to sufficient risk to warrant adverse rating, but have potential weaknesses that deserve management's close attention) rose to 4.4% of total loans in the review, up from 3.8% in last years' review and up from 3.6% in 2012, potentially signaling that competition among lenders is heightening risks inside and outside the banking system. Special mention dollar volume increased significantly, 29.6% from the 2013 level. The rise could also signal regulators' stepped up efforts to be more punitive.
Classified loans (i.e. loans fitting one of any of the categories '"special mention," "substandard," "doubtful," or "loss") dropped to 5.6% of the total loans, down from 6.2% last year, and 7.0% in 2012's review, signaling improving credit quality. The overall severity of classifications also declined since prior year.
The 2014 SNC portfolio covered over $3.4 trillion in debt (funded and unfunded), over 9,778 credit facilities and approximately 6,166 borrowers. A total of $975 billion in loans was used as a sampling of the portfolio, with a weighting toward non-investment-grade and criticized credits. The results of the review are based on analyses prepared in the second quarter of 2014 using credit related data provided by federally supervised institutions as of Dec. 31, 2013, and March 31, 2014.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.