News and Issuances

WASHINGTON — The volume of Shared National Credits (SNC) rose by 21% in 2006, the fastest pace since 1998, reflecting, in part, significant merger and acquisition lending, according to the SNC² review results released today by federal bank and thrift regulators.

The 2007 review noted an increase in the volume of criticized credits. However, the volume of criticized credits as a share of total SNC commitments remains low by historical comparison and is indicative of satisfactory credit quality. The review also included an assessment of underwriting standards and practices. Examiners found weakened underwriting standards in the syndicated lending market, particularly in non-investment grade or leveraged credit facilities.

The results of the review--reported by the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision--are based on analyses prepared in the second quarter of 2007.

Criticized credits³ as a percent of total commitments fell slightly to 5.0 percent from 5.1 percent a year ago (see Chart 1). Similarly, the ratio of classified commitments to total commitments dropped slightly to 3.1 percent from 3.3 percent last year. Total classified commitments rose by $9.7 billion, or 16 percent since 2006, with classified credits concentrated in the automotive and broadcast media sectors. Commitments rated special mention increased by $9.1 billion, or 27 percent from 2006.

Classified commitments held by United States (U.S.) domiciled banking organizations increased to $19.2 billion from $13.1 billion in 2006, while the classified ratio was only 2.0 percent, a slight increase of 40 basis points. This percentage is substantially below the 3.1 classified percentage of the entire SNC portfolio as U.S. banks continue to hold a significantly lower volume of the classified loans.

Classified commitments held by nonbank entities increased to $34.8 billion, representing nearly half of all classified credits. The volume of classified commitments held by nonbanks is particularly significant given their relatively small share (15.9 percent) of all SNC commitments.

These discussions of criticized credits and their ratios do not include the effects of hedging or other techniques that organizations often employ to mitigate risk.

Overview

In aggregate, the 2007 SNC portfolio included 7,686 credits totaling $2.3 trillion in credit commitments to 5,264 obligors. SNC commitments increased by $401 billion, or 21.4 percent over 2006 results. This is the largest percentage increase since 1998. The portfolio's growth reflects, in part, substantial merger and acquisition financing provided during 2006 and into early 2007. Total outstandings, or drawn amounts, of $835 billion were up 33.4 percent from the prior year, the largest increase in both dollar and percentage terms in the past 18 years. In addition, outstandings as a percent of total commitments increased from 33 percent in 2006 to 37 percent in 2007.

Criticized commitments rose to $114 billion, but still remain less than half of their peak dollar level in 2002. Criticized credits represent a modest 5.0 percent of total commitments, about the same rate experienced over the past three SNC reviews.

SNCs classified substandard rose $11.5 billion, or 20 percent from the 2006 review. The severity of the classified portfolio lessened this year as doubtful credits decreased $1.3 billion, or 54 percent (see Table 1), and credits classified as loss fell $400 million, a 34 percent reduction from the prior year. Nonaccrual⁴ classified credits fell 78 percent to $3.9 billion, and only represent 0.2 percent of the SNC portfolio.

Industry Trends

Credits in the Manufacturing sector continue to comprise the largest industry component of the SNC portfolio at $570 billion, or 25 percent of total SNC commitments, followed by Financial Services and Insurance at 20 percent, and Oil, Gas, Pipelines, and Utilities at 12 percent.

While Construction and Real Estate and Lodging and Transportation experienced the highest growth rates at 50 percent and 38 percent, respectively, the Manufacturing sector had the largest volume growth at $126 billion, or 31 percent of total growth in the SNC portfolio. Some of the larger subsector growth rates were in computer equipment, healthcare, and construction.

Criticized credits are heavily concentrated in the Manufacturing and Telecommunications and Cable (Telecom) sectors which again have the highest criticized and classified ratios. Together, these portfolios comprise 63 percent of total criticized credits and 72 percent of total classified credits.

Manufacturing criticized credits comprise 10.3 percent of the Manufacturing portfolio, an increase from 8.6 percent in 2006. This sector comprises 52 percent of total criticized credits and 59 percent of total classified credits compared to 41% and 43% respectively in 2006. The bulk of the criticized Manufacturing credits are concentrated in the automotive sector. Thirty-seven percent of the automotive sector is classified, representing 46 percent of total classified credits.

Telecom criticized credits comprise 8.9 percent of the Telecom portfolio, still high but an improvement from the 13.8 percent criticized rate in 2006. Telecom criticized credits comprise 11.3 percent of total criticized credits compared to 22% in 2006, and 13.5 percent of total classified credits compared to 24% in 2006. Over 85 percent of the Telecom criticized credits are in the broadcast media sector.

Trends by Entity Type

The portion of SNC commitments held by U.S. domiciled banking organizations edged down slightly from 44 percent to 43 percent, while the portion held by foreign banking organizations (FBOs) stayed at 41 percent (see Appendix C).

For more than a decade, lenders not regulated by the federal banking agencies or affiliated with banks, such as brokerage firms, mutual funds, insurance companies, and hedge funds, have taken on larger positions in the syndicated market. These nonbank institutions have increased their share to 16 percent of total commitments from 10 percent five years ago and 2 percent in 1996.

The quality of holdings also varied among entity types with classified commitments amounting to 2.0 percent of total commitments at U.S. banks compared with 1.9 percent at FBOs and 9.6 percent at nonbanks. Nonbank institutions continue to hold the largest portion of the SNC classified portfolio at 48 percent compared to 27 percent by U.S. banks and 25 percent by FBOs. U.S. bank holdings of classified credits did, however, increase from 21 percent to 27 percent over the past year, and classified credits held by banks insured by the FDIC increased from 17 percent to 22 percent.

SNC Underwriting

Rapid portfolio growth, weakening of underwriting standards, and the increase in criticized credits over the past year are indicative of increased credit risk. As such, banking organizations should ensure that underwriting standards are not compromised by competitive pressures. Consistent with safe and sound banking practice, agent banks should underwrite funding commitments in a manner reasonably consistent with internal underwriting standards. Examiners noted a significant volume of loans with liberal repayment terms such as little to no amortization prior to maturity, reliance on refinancing as a primary source of repayment, and lack of meaningful financial loan covenants such as leverage and fixed charge coverage ratios. Examiners also noted the backlog of leveraged loan commitments that cannot currently be distributed without incurring potential market losses and may need to be retained in portfolio. In addition, banking organizations should ensure underwriting processes include a comprehensive repayment capacity analysis that demonstrates a borrower's ability to repay debt over a reasonable period of time.

Appendix A

Appendix B⁵

Appendix C: Exposures by Entity Type

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