Results of the Shared National Credit review of syndicated bank loans.

The quality of large syndicated bank loans showed marked improvement this year, according to the Shared National Credit (SNC) review released on September 15, 2004, by federal bank and thrift institution regulators. (1) Adversely rated loans continue to subside, although certain industries continue to have a high concentration of them.

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 commitments classified as either substandard, doubtful, or loss fell $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. (2) Commitments rated special mention decreased $22.4 billion, or 41 percent, in contrast to 2003, when they fell $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.

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, classified loans have well defined weaknesses, including default in some cases. (3) 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 6 percent from the previous 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 previous year, to $500 billion.

For the 2004 review, total loan commitments classified as substandard fell $57 billion, or 51 percent from the previous year, while doubtful credits dropped $16.8 billion, or 57 percent. Commitments classified as loss fell $4.3 billion, down 40 percent from the previous 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 classified loans not accruing interest fell at a slower rate (41 percent), to $30.1 billion. (4)

Industry Trends

The quality of the SNC portfolio improved markedly in all industries. (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 $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 the previous year's 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 entities each edged up 1 percentage point, to 46 percent and 12 percent respectively. (6) The share held by foreign banking organizations (FBOs) continued to decline, totaling 42 percent in 2004. 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 previous 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 outstandings not accruing interest improved for all entity types. Most notably, U.S. banks experienced a 57 percent decline.

Risk Management by Banks

Banking organizations remain vigilant in identifying problem credits and have generally reflected the appropriate risk rating in their internal ratings of credits in the SNC program. Although credit quality has improved, banking organizations must continue to carefully monitor the condition of their borrowers to ensure that they promptly identify and address any emerging weaknesses and adjust loan loss allowance levels appropriately. (7)

NOTE. The charts, tables, and appendixes to this announcement are available at www.federalreserve.gov/boarddocs/press/bcreg/2004/ 20040915.

(1.) The Shared National Credit (SNC) Program was established in 1977 by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency. In 2001 the Office of Thrift Supervision became an assisting agency. With a few exceptions, the annual program, which seeks to provide an efficient and consistent review and classification of large syndicated loans, generally covers loans or loan commitments of at least $20 million that are shared by three or more financial institutions.

(2.) Loan commitments included both drawn and undrawn portions of a loan or loan facility.

(3.) Excerpt from Federal Reserve's SR Letter 79-556 defining regulatory classifications: Classification ratings are defined as Substandard, Doubtful, and Loss. A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. An asset classified as doubtful has all the weakness inherent in one classified substandard with the added characteristic that the weaknesses make the collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Assets classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.

Excerpt from June 10, 1993, Interagency Statement on the Supervisory Definition of Special Mention:

Assets

A Special Mention asset has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution's credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

(4.) Loans not accruing interest are defined for regulatory reporting purposes as "loans and lease financing receivables that are required to be reported on a non-accrual basis because (a) they are maintained on a cash basis due to a deterioration in the financial position of the borrower, (b) payment in full of interest or principal is not expected, or (c) principal or interest has been in default for ninety days or longer, unless the obligation is both well-secured and in the process of collection." Non-accrual classifieds are those funded or outstanding portions of loans classified as substandard and doubtful that are not accruing interest. For 2004 this consisted of $19.2 billion in loans rated substandard and $11.7 billion rated doubtful.

(5.) Note that the current industry totals categorizes borrowers according to 2002 NAICS codes, in contrast to previous releases of SNC data, which categorized borrowers according to 1997 NAICS codes.

(6.) Nonbanks include independent investment brokerages, investment vehicles, and other institutional investors.

(7.) For further guidance, institutions should refer to the July 12, 1999, Joint Interagency Letter to Financial Institutions on the allowance for loan losses, as well as the July 2, 2001, Interagency Policy Statement on Allowance for Loan and Lease Losses (ALLL) Methodologies and Documentation for Banks and Savings Institutions.