August 3, 2016 - August 3, 2016 – The 2016 Shared National Credit Review, published last Friday, had good news and less-good news in it. We discussed the good news in the LSTA Newsletter last Friday: In short, banks are almost entirely conforming with the Leveraged Lending Guidance when they originate loans. So, this week, we focus on the “less-good” news.
To wit: While new loan originations are pretty clean, banking examiners are concerned about the state of existing loan portfolios – particularly at this stage of an economic expansion. (See Exhibit 3 on p. 6.) The share of “classified” credits – those risk rated substandard, doubtful or loss – increased 25% to $285 billion. Meanwhile the share of “criticized” credits – which are classified loans plus “special mention” loans – increased by 13% to $421 billion. (For context, the whole SNC portfolio is $4.1 trillion.) The SNC Review notes that this “high level of credit risk stems from a large share of risky leveraged finance loans underwritten on weak practices, and the significant decline in oil and gas prices … that has reduced repayment capacity of [oil and gas] obligors”.
So that is SNC’s high-level takeaway. But having inquiring minds – and high pain thresholds – we dug into SNC Reviews (past and present) to see exactly what the numbers say. One thing that jumped out: The SNC Executive Summary notes that high level of credit risk comes from a large share of risky leveraged finance loans. However, a deep dive into the numbers seems to indicate less deterioration in the leveraged universe than elsewhere.
We begin that deep dive here. (Gird yourself.) First, classified credits at US banks increased 57% to $63.9 billion, while classified credits at foreign banks grew 55% to $54 billion. In contrast, classified credits held by non-banks increased “only” 9% to $167.2 billion. As non-banks generally have a higher risk appetite than banks, it’s not surprising that they hold more classified loans. What may be surprising is that their classified loan growth rate is far lower than at banks.
Why is that? Maybe it is because the leveraged loan portfolio actually held up better than some other portfolios. In Appendix B on page 9, the 2016 SNC Review handily lays out the size each category of criticized asset. We note that classified assets increased 25% to $285 billion in 2016, while criticized assets increased 13% to $421 billion. The next stage – what happened to leveraged lending – takes more digging. On page 6 of the 2016 SNC Review, we find leveraged loans’ share of criticized assets, and were able to convert that to dollars. In effect, $168 billion of leveraged loans are classified and $267 billion are criticized. All told, roughly 17% of the leveraged portfolio is classified.
But how are leveraged portfolios trending relative to the rest of the SNCs? To determine this, we dug up the 2015 SNC Review, found leveraged lending’s share of SNC’s classified and criticized universe, and converted that to dollars. The result? In 2015, leveraged lending appeared to have $149 billion of criticized loans and $268 billion of classified loans. When we compare 2015 and 2016 levels, we find that leveraged classified loans increased by 12.8% and criticized leveraged loans actually decreased by 0.5%. That is waybelow the increase (25% for classified, 13% for criticized) for the entire SNC universe.
Why did troubled loans in the leveraged portfolio grow so much more slowly than elsewhere? The answer may be in the Oil & Gas portfolio. As pointed out on p. 7 of the SNC Review, classified Oil & Gas borrowers doubled in the past year, climbing from $38.2 billion in 2015 to $77 billion this year. Thus, O&G credits account for 69% of the $57 billion increase in classified loans. And O&G credits are primarily on banks’ balance sheets – not in institutional coffers.