Credit Quality of Large Corporate Loans Improving

Credit Quality of Large Corporate Loans Improving

photo of bank signFor the third straight year, the credit quality improved for large corporate loans and loan commitments held by U.S. bank organizations, foreign bank organizations, and nonbanks, according to the 2012 Shared National Credits (SNC) review conducted by the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.

The dollar volume of "criticized loans" declined 8.1 percent from 2011, to $295 billion. That figure represents 10.6 percent of total loans and commitments, which is down from 12.7 percent in 2011, but still a high ratio compared to prefinancial crisis levels. In each year from 2004 through 2007, for instance, the SNC review categorized roughly 5 percent of assets as "criticized," which means assets were rated special mention, substandard, doubtful, and loss. Credits rated "special mention" are not as troubled as the other categories but exhibit potential weakness and could result in further deterioration if uncorrected.

The SNC review analyzes loans or commitments of at least $20 million that are collaboratively made by three or more regulated financial institutions. These group loans, or shared credits, generally are made by larger institutions. One of the main purposes of the SNC review is to ensure that the different regulatory agencies use consistent methods and criteria to rate the shared credits.

Borrowers doing better
As was the case in the 2011 SNC review, the changes in credit quality resulted from improved operating performance by borrowers, debt restructurings, bankruptcy resolutions, and greater borrower access to capital via the bond and equity markets, according to the 2012 review.

The SNC review examines credit quality by industry group. In the 2012 study, the media and telecommunications industry group had the highest dollar volume of criticized credits, with $66 billion. Finance and insurance followed with $34 billion, then utilities with $30 billion. Although these three groups had the largest dollar volume of criticized loans, the three groups with the highest rate of criticized loans were entertainment and recreation (28.3 percent), media and telecommunications (24.6 percent), and transportation services (22.7 percent). However, each of these industry groups was improved over the preceding year.

Weak underwriting still haunts portfolios
The SNC review revealed the ongoing influence of exposure to loans made with weak underwriting standards in 2006 and 2007.

The 2012 review included an evaluation of underwriting standards on SNCs that were originated in 2011. While the overall quality of underwriting in 2011 was significantly better than in 2007, the review noted some easing of standards, specifically in leveraged finance credits, compared to the relatively tighter standards of 2009 and the second half of 2008. The federal banking regulatory agencies expect to finalize revised guidance on leveraged lending to form the basis of the agencies' supervisory focus and review of financial institutions involved in leveraged lending.

The 2012 review showed a reduction in classified assets across all entity types, and nonbanks continued to disproportionately participate in highly stressed classified credits. While nonbank entities own the smallest share of SNC commitments, they continued to hold the largest volume and percentage of classified credits at $122 billion, or 62.4 percent of all classified credits. Nonbank entities include securitization pools, hedge funds, insurance companies, and pension funds.

August 30, 2012