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Syndicated Loan Losses Still Loom

Federal banking agencies find credit quality has improved slightly, but the poor underwriting of 2006 and 2007 continues to present problems for banks and investors.
Vincent Ryan, CFO.com | US
October 5, 2010

While the performance of individual banks' loan portfolios recovers, many of the large corporate loans that they underwrite pieces of are still in jeopardy of defaulting and causing losses.

The credit quality of syndicated loans held by U.S. banks and other investors remained weak this year, although it improved slightly over 2009. Meanwhile, the market for such loans continued to shrink. The findings come from the Shared National Credits Review, a study conducted in the second quarter by federal banking agencies of loans of $20 million or more that are funded by three or more federally supervised financial institutions.

The percentage of syndicated loans that may present some possibility of loss to investors, are uncollectible, or exhibit potential weaknesses that need correcting fell this year, but was still the second highest on record. These syndicated loans are still threatening banks' and institutional investors' balance sheets.

The overall Shared National Credits portfolio totaled $2.5 trillion in 2010. In its report, the Federal Reserve said "the volume of poorly underwritten credits originated in 2006 and 2007 continued to adversely affect the overall credit quality of the portfolio. Refinancing risk within the portfolio is significant, with nearly 67% of criticized assets maturing between 2012 and 2014."

"Criticized" loans fell to $448 billion, or 18% of the total portfolio, down from 22% in 2009. A criticized loan is one that the banking agencies rate "special mention," "substandard," "doubtful," or "loss." Special-mention credits are those that "exhibit potential weakness and could result in further deterioration if uncorrected," substandard credits are those inadequately protected by the collateral pledged for the paying capacity of the borrower, doubtful credits are those where collection or liquidation in full is highly questionable, and credits rated "loss" are deemed uncollectible and should be charged off.

Classified credits — a group that does not include the "special mention" category — also fell, to 12% from 15.5% in 2009.

Clearly, banks are clearing their books of poor-quality loans, albeit slowly. Actual loan losses fell 72%, to $15 billion, and nonaccrual loans — in which the borrower is not expected to pay the full interest or principal due, or principal or interest has been in default for 90 days or longer — declined 12%, to $151 billion.

Better operating performance, debt restructurings, and bankruptcy resolutions — as well as improved access to bond and equity markets — were cited as the reason overall syndicated loan quality improved somewhat.

Automotive-sector loans led the rebound, said the Fed, with the percentage of criticized automotive industry syndicated loans falling to 17%, from 63% last year. On the other hand, the media and telecommunications industry led all industries in criticized loans, with $94 billion, followed by real estate and construction with $60 billion and finance and insurance with $49 billion.

Poorly rated syndicated loans were disproportionately owned by nonbank institutional investors. They owned 53% of classified assets ($161 billion) and 58% of nonaccrual assets, although they owned the smallest share (21%) of all loans. Nonbanks include securitization pools, hedge funds, insurance companies, and pension funds. U.S. banks insured by the Federal Deposit Insurance Corp. owned 22.7% of classified credits and 18.1% of nonaccrual loans.

Total outstanding shared loans fell 22.5%, to $1.2 trillion. Loan commitments, which include the undrawn portion of loan agreements, fell 12.6%, to $2.5 trillion.

Corporations continue to show reluctance to tap their unused loan amounts. Outstanding loans represented 48% of total commitments, down 6% from 2009. That "[backs up] recent comments from banks that line utilization rates remain close to all-time lows," says a CreditSights report released Wednesday.

Indeed, in a CFO banking survey of 647 finance executives last month, 32% of companies said they had not drawn down any of their credit lines. Another 19.1% had tapped less than 50% of their total lines of credit.

Syndicated loan issuance actually ramped up in the third quarter, however, data that the Shared National Credits Review does not reflect. Globally, syndicated loan issuance rose to $1.96 trillion as of October 1, from $1.36 trillion in 2009, according to Dealogic. The loan market continues to be outstripped, however, by issuances of high-yield bonds.




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