Leveraged Loans Still Risky as Underwriting Improves, Fed Says

  • Agencies also flag oil lending as a particular weak spot
  • Regulators looked through $4.1 trillion in multi-firm loans

The risk from leveraged lending at U.S. banks remains high even as the industry improves its underwriting practices, according to a report from agencies including the Federal Reserve.

“Notwithstanding the riskiness of the existing portfolio, the agencies noted improved underwriting and risk management practices,” according to the report released Friday by the Fed, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency. The regulators review major, multi-firm loans to spotlight hazards in large-scale lending and said leveraged loans continue to be the point of greatest risk.

The report, known as the Shared National Credits Program 2016 Review, noted that because poorly rated assets continue to be at higher levels than in previous periods of economic expansion, a downturn could trigger higher-than-usual losses. Overall, the portfolio of these big loans increased about $194 billion to $4.1 trillion from last year, the agencies said.

The annual report has been conducted by the agencies since 1977 to assess risk in the largest and most complex credits shared by multiple financial institutions. In the reviews, the banking agencies comb through multi-firm loans exceeding $20 million. In leveraged lending, banks and other lenders underwrite the financing and syndicate it to investors such as mutual funds. The report found that nonbank entities are the primary buyers of riskier loans.

Leveraged loans -- a type of high-yield debt that grew increasingly attractive as the Fed has maintained a near zero interest-rate policy -- make up 63 percent of all the credit considered inadequate by regulators in the review, rated as “special mention” or “classified” commitments. Oil and gas industry lending continued to be a source of particular weakness, according to the report.

The agencies issued leveraged-lending guidelines in 2013, declaring “prudent underwriting practices have deteriorated,” and they said a debt level of more than 6 times a measure of earnings raises concern. They’ve since maintained pressure on banks, directing them to originate loans that are in good standing, but Friday’s report noted “continued progress toward full compliance.”

In 2015, the regulators increased the once-a-year examinations to twice each year, though the report on their findings is still only issued annually.

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