Risk

Lenders Scrub Syndicated Loan Portfolios

The credit quality of large corporate loans improved in the last year, but there are plenty of weak and deteriorating credits still on the books.
Vincent RyanAugust 29, 2011
Banks and other investors have cleaned up their corporate loan portfolios, but there is still some work left. The credit quality of syndicated loans held by U.S. banks and other investors has improved for the second straight year, but loans exhibiting weakness or that may be uncollectible remain high compared with pre-financial crisis levels. 
So said the Federal Reserve and two other federal banking regulators in an annual study called the Shared National Credits Review. The study looks at business loans of $20 million or more that are funded by three or more federally supervised financial institutions.
These portfolios of large loan commitments, which are owned by U.S. and foreign banks as well as nonbanks, continued to be affected by the class of poorly underwritten loans originated in 2006 and 2007, said the federal banking agencies. 
In the report released last week, the agencies said total “criticized” loans declined more than 28%, to $321 billion. Nonaccrual loans — in which the borrower is not expected to pay the full interest or principal due, or the principal or interest has been in default for 90 days or longer — fell to $101 billion from $151 billion.
Criticized loans are broken down into four categories: special mention, substandard, doubtful, and  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. In the 2011 study, loans rated as doubtful or loss — the two weakest categories — fell 50%, to $24 billion.
Weak or weakening credits are largely held by nonbanks — investors in the so-called shadow banking system. While these investors — including securitization pools, hedge funds, insurance companies, and pension funds — owned 20% of total syndicated loan commitments, as of last week’s report they held 60% of the nonaccrual loans. Banks insured by the Federal Deposit Insurance Corp., on the other hand, owned only 15% of nonaccrual loans. 
By industry, the media and telecommunications sector had the highest amount of criticized loan volumes, with $70 billion. Finance and insurance followed with $37 billion, and loans to real estate and construction borrowers represented $35 billion of the criticized portfolio. The sector with the highest percentage of criticized loans was entertainment and recreation.
In a sign of lower demand for large business loans, total syndicated loan commitments increased less than 1% from the 2010 review, and remained at about $2.5 trillion. The dollar amounts companies have actually drawn down fell $93 billion, to $1.1 trillion, a decline of 8%. Corporations continue to keep a lot of dry powder on their balance sheets, as outstanding loan amounts represented 44% of total commitments, down from 48% in 2010. 
In the report, the federal banking agencies called the refinancing risk for many businesses “elevated,” citing the nearly $2 trillion, or 78% of syndicated loans, that mature by the end of 2014.