Trouble has emerged in a corner of the financial market where groups of lenders cobbled together large loans for corporations that were hampered by the pandemic, according to a report from federal regulators Thursday.
About 12.4% of loans in the syndicated credit market last year were deemed “classified” or “special mention” — nearly double the 6.9% seen one year earlier, the report from the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency showed.
Such a jump has not been seen since the financial crisis, when the percentage of troubled loans eventually crested at 22%, data from the agencies show.
A big question facing regulators and the market is how quickly will the vaccine rollout translate to an economic turnaround, said Kingman Penniman, president of the investment firm KDP Asset Management, which specializes in bank loans.
“When banks see the regulators come and put their loans on special mention, they get queasy,” Penniman said. “There are some banks that say anything that could be penalized, we don’t want them on our books.”
In such situations, banks can work with a borrower to bring the loan into good standing or sell the debt from their books.
The data comes from examinations regulators conducted in the first and third quarters of 2020 as COVID-19 spread and shuttered businesses.
The $5.1 trillion of loans in the syndication market was a 5% increase from the year before. Banks hold about 44% of those loans, and the rest are held by nonbanks and foreign bank organizations.
But banks have just one in four of the nearly $630 billion in loans flagged as “classified” or “special mention.”
Loans labeled classified are substandard, doubtful or losing money, while those in the special mention category are considered to have potential weaknesses “that could result in further deterioration of the repayment prospects or in the institution's credit position in the future,” according to regulators' definitions.
The trouble appears concentrated in five industries most hurt by the virus: oil and gas, real estate, retail, entertainment and recreation, and transportation services.
The oil and gas business had the most outstanding syndicated loans last year, totaling about $383 billion. About 23.3% of those were deemed classified or special mention, up from 10.7% in 2019, according to the report.
While the market for loans to airlines and other transportation services was smaller at about $59 billion last year, more than 56% of them were either classified or special mention, up from 15.1% the year before.
Problems are also concentrated in leveraged loans, which are considered riskier and come with more relaxed terms that allow companies to pile on more debt, and have been highlighted as posing higher risk in the past few years. Leveraged loans make up about half of the syndicated national credit market, and banks hold about $1.5 trillion of them.
Nearly 30% of leveraged loans to the key industries regulators have highlighted at risk from the pandemic were tagged as classified or special mention in 2020, compared to 11.7% of other kinds of loans to these businesses.
This rise in risk throughout the syndicated credit market is partly behind bank decisions to stockpile massive reserves to guard against loan losses last year, resulting in a full percentage point increase in the amount of reserves in the system and more detailed oversight of their books, according to the report.
“Many agent banks have strengthened their risk management systems since the prior downturn and are better equipped to measure and monitor risks associated with leveraged loans in the current environment,” the regulators said in the report.
Despite the issues examiners uncovered last year, analysts and traders who monitor these loans are optimistic that massive losses can be avoided.
The data was gathered at a time when companies were drawing down their credit lines from banks en masse so they could keep cash on hand while the economy closed up, resulting in the kind of leverage buildup that could land loans into a riskier category, Penniman said.
“You’re looking at these companies at the depth of the pandemic,” Penniman said. “They’re all increasing their leverage to improve their liquidity.”
Any effect the vaccine rollout has had on this slice of the market would not show up until regulators examine these books again this year, an OCC spokesman said in an email.
“Regulators constantly work with supervised institutions to ensure they have robust risk management processes in place and properly mitigate risks in their profile,” the spokesman said. “It is worth pointing out that while we did observe increasing risk overall, the majority of classified credits are held by nonbank institutions.”
Penniman said most loans in the syndicated market are currently trading “at par,” meaning without steep discounts traders can sometimes get if they bet on debt that’s considered risky. And going forward, there could be an opportunity for these companies to refinance what debt they’ve taken on.
“It will be dramatically different than when they looked at them a year ago,” Penniman said.
