Despite efforts by regulators and banks to improve underwriting of commercial leveraged loans, the number of troubled large syndicated credits jumped again this year, according to a report released Friday by federal regulators.
The 2016 Shared National Credit Review found that 10.3% of such loans — business loans totaling more than $20 million that are shared by at least three institutions — had weaknesses, a jump from 9.5% a year ago. Overall, troubled credits rose 13% to $421.4 billion.
As in previous years, leveraged lending and exposures to the oil and gas sector were the primary drivers of troubled credits. Leveraged loans made up 63.3% of all "special mention and classified commitments," the regulatory terminology for credits that demonstrate weakness. Oil and gas lending represented just 12.3% of the SNC portfolio overall, but 18% of classified credits. Troubled oil and gas loans totaled $77 billion, double their level in 2015.
"The latest review showed the level of adversely rated assets remained higher than in previous periods of economic expansion, raising the concern that future losses and problem loans could rise considerably in the next credit cycle," the regulators said in a press release. "The elevated level of risk observed during the recent SNC examination stems from the high inherent risk in the leveraged loan portfolio and growing credit risk in the oil and gas (O&G) portfolio."
The overall SNC portfolio grew to $4.1 trillion, up from $3.91 trillion a year earlier. Classified commitments — those rated substandard, doubtful or loss — grew to 6.9% of the portfolio, up from 5.8% in 2015.
The report, released by the Office of the Comptroller of the Currency, the Federal Reserve Board and the Federal Deposit Insurance Corp., noted improvements in underwriting practices.
"Underwriters continued to better align practices with regulatory expectations," the regulators said, and "investor risk appetite moderated away from transactions at the lower end of the credit spectrum."
Still, regulators continue to see "gaps" between industry practices and recent regulatory guidance regarding leveraged loans.
"Examiners again raised concerns about borrowers' capacity to repay certain new originations — both underwritten and refinanced loans — if economic conditions deteriorated, or if interest rates rose to historical norms," the SNC report said. "The agencies continue to be concerned that any downturn in the economy would likely result in a significant increase in the already considerable adversely rated leveraged lending exposure, especially considering the limited financial flexibility present in many of the credits not currently adversely rated. "
The agencies also flagged remaining weaknesses in underwriting practices, citing structures with ineffective or no covenants and liberal repayment terms.
U.S. banks held the greatest volume of shared credits, with 44.9% of the portfolio, followed by foreign banks and nonbanks. The share of credits rated special mention or worse that were held by nonbanks fell to 60.8% in 2016 from 68% a year earlier.
The SNC release on Friday comes significantly earlier than in previous years. Last year the regulators did not release exam results until November, a delay from the traditional September release.
But regulators have now implemented a semi-annual exam schedule, conducting exams twice a year for the first and third calendar quarters for some institutions. Results from the exams are still combined and published annually to ensure the SNC is comparable to previous reports. The next report is scheduled to be released following the first quarter 2017 exam.