The largest financial regulators in the U.S. annually review the nation's largest and most complicated credits to assess potential risks. The latest report shows improvement.
Rob Hajduch, Principal Credit Analyst
In January 2019, the Board of Governors of the Federal Reserve System (Fed), the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) released their annual joint review and risk assessment of large and complex credits extended by multiple regulated financial institutions. The exam, officially titled the Shared National Credit Program (SNC), was begun in 1977 to ensure impairment accounting treatment consistency of large loan syndications totaling $20 million or more. The program has been modified subsequently to increase the minimum number of participating institutions in a given syndication from two to three, while the minimum loan commitment size has been raised from $20 million to $100 million.
The 2018 exam covered 8,571 individual loan commitments totaling $4.4 trillion. Loans with which the agencies find underwriting deficiencies or otherwise are likely to experience some level of loss are termed "Classified" and fall into one of three categories: Loss, Doubtful and Sub-standard. Loan commitments meriting the "Special Mention" label exhibit potential weakness that - if left unaddressed - are vulnerable to further deterioration. The total "Criticized" population includes credits in the three Classified categories plus the Special Mention commitments. The agencies reported a total Criticized rate of 6.7%, which represents the lowest level reported since 2007.
In the most recent two exams the agencies specifically focused on leveraged lending, defined as those loans possessing weakened structures, aggressive borrower repayment capacity assumptions, and / or other layered risks. While leveraged loan commitments represented approximately 47% of total shared commitments, they accounted for nearly 87% of commitments classified as Sub-standard, roughly 45% of Doubtful commitments, 76% of nonaccrual loans and approximately 73% of commitments identified as Special Mention. To the positive, while U.S. and foreign banks collectively accounted for approximately 78% of total SNC commitments, non-bank financial institutions - including insurance companies, mutual funds, hedge funds and collateralized loan obligations -held most of the worst performing credit commitments, with a Classified rate of nearly 12% vs. 2% each for domestic and foreign banks. On a gross basis, non-banks' share of Classified commitments was roughly equivalent to 180% of combined U.S. and foreign bank exposure.
While non-bank holdings of commitments in nonaccrual status - loans that are no longer accruing interest and typically 90 to 180 days delinquent - were not as pronounced, the exposure was nevertheless more than double (114%) that of traditional banks as well.
The results reinforce our conviction that regulators are proving more effective in identifying risk concentrations in the banking system, as well as being more proactive in pressing institutions to address deficiencies. We remain sanguine in our outlook for the sector for the foreseeable future.
Board of Governors of the Federal Reserve System, et.al, "Shared National Credit Program, 1st and 3rd Quarter 2018 Examinations," January 2019.