Data Show Major Improvement in Credit Quality, Decreasing Volume of Loan Commitments

WASHINGTON—The quality of large syndicated bank loans showed marked improvement this year, according to the Shared National Credit (SNC)¹ review released today by federal bank and thrift regulators. Adversely rated loans continue to subside, although certain industries continue to have a high concentration of adversely rated loans.

The results — 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 2004 and reflect business and economic conditions at that time.

Total loan commitments² classified as either substandard, doubtful or loss fell by $78.2 billion, or 51 percent, from the previous year, compared with a net decrease of $4.9 billion, or 3 percent, the year before. Commitments rated special mention decreased by $22.4 billion, or 41 percent, in contrast to 2003 when they fell by $23.8 billion, or 30 percent. None of these figures includes the effects of hedging or other techniques that organizations often employ to mitigate risk.

The ratio of classified loan commitments to total commitments fell to 4.8 percent, the lowest level since 2000, as industry charge-off trends and demand in the secondary market for lower quality assets removed many of the weakest loans from the banking system. Total adversely rated credits (classified and special mention combined) also fell considerably, to 6.9 percent of total commitments (see Chart 1 below).

Adversely rated credits (also known as criticized credits) are the total of loans classified substandard, doubtful, and loss—and loans rated special mention. Classified credits are only those rated substandard, doubtful, and loss. Under the agencies' Uniform Loan Classification Standards,³ classified loans have well-defined weaknesses, including default in some cases. Special mention loans exhibit potential weaknesses, which may result in further deterioration if left uncorrected.

Overview

In aggregate, the 2004 SNC Program covered 7,490 credits totaling $1.5 trillion in loan commitments to 4,746 borrowers. Total commitments were down by 6 percent from the prior year and down 25 percent from the 2001 peak of $2.0 trillion. This is consistent with market data pointing to lower customer demand, tighter underwriting standards, and attractive capital market financing alternatives. Total outstandings, or drawn amounts, were down 17 percent from the prior year to $500 billion.

For the 2004 review, total loan commitments classified as substandard fell $57 billion, or 51 percent from the prior year, while doubtful credits dropped by $16.8 billion or 57 percent (see Table 1 below). Commitments classified as loss fell $4.3 billion, down 40 percent from the prior year. Doubtful and loss amounts reflect the continued downward migration of credits with previously identified weakness. While total classified commitments fell sharply, the portion of outstanding nonaccrual⁴ classified loans fell at a slower rate (41 percent) to $30.1 billion.

Table 1 SNC Classifications ($ billions)

Industry Trends

The quality of the SNC portfolio improved markedly in all industries (see Appendix B).⁵ The strongest improvement occurred in the Manufacturing sector, with a $23 billion, or 54 percent, decline in classified commitments. Classified credits in the Oil, Gas, Pipelines and Utilities segment fell $13.9 billion, but remained at significantly elevated levels, with 13.8 percent of commitments classified. The Telecommunications and Cable segment also exhibited improvement, although exposure to previously identified weaknesses still linger. Well-documented problems facing airlines continue to drive classifications in the Lodging and Transportation segment. Other segments such as Financial Services and Insurance and Construction and Real Estate showed modest classification rates that were below those for the entire SNC program. Credits identified for special mention fell by $22.4 billion with strong declines experienced in every industry except Telecommunications and Cable. These declines were driven by a migration of a portion of prior year special mention credits to classified categories, as well as a decline in newly identified credits with potential weaknesses. Of total losses in 2004, $3.6 billion, or 56 percent, were directly attributable to the weakened Energy sector, most of which is related to outcomes of bankruptcy filings. The remaining losses were spread widely across a variety of industries.

Trends by Entity Type

During 2004, the share of SNC commitments held by U.S. banks and nonbank entities⁶ each edged up 1 percentage point to 46 percent and 12 percent, respectively. The share held by foreign banking organizations (FBOs) continued to decline, totaling 42 percent in 2004 (see Table 2). All types of lenders experienced a decline in classified assets during 2004, with U.S. banks showing the largest improvement, down 57 percent from the prior year. The quality of holdings also varied among entity types, with classifieds amounting to 3 percent of total commitments at U.S. banks, compared with 5 percent at FBOs and 13 percent at nonbanks. Total nonaccrual outstandings improved for all entity types. Most notably, U.S. banks experienced a 57 percent decline.

Table 2 Exposures by Entity Type