Bank Loan Portfolios are Carrying Too Much Risk

By Hal M. Bundrick

NEW YORK (MainStreet) ¿ Banks are holding too many risky assets, at levels double the amount held prior to the global financial crisis, according to an analysis by Fitch Ratings. A review of major U.S. bank portfolios conducted by the FDIC and the Office of the Comptroller of the Currency (OCC) shows evidence that "competition among lenders is heightening risks in and outside the banking system," according to the ratings firm.

Fitch believes that underwriting standards have diminished in the four years following the financial crisis, posing risks for "both bank and nonbank lenders going forward."

The complex loans held in major U.S. banks' Shared National Credit (SNC) portfolios total around $3 trillion, or 20% of the U.S. GDP. The inter-agency report says high-risk, or "criticized" assets, comprise $302 billion (or 10%) of total SNC commitments. This level was down just 60 basis points from 2012 after a 2.1% decline between 2011 and 2012.

"Actual criticized loan volume increased 2.4% year over year and is about double precrisis levels, highlighting the degree of asset risk remaining in the system four years after the start of the recovery," Bain Rumohr of Fitch Ratings writes in an analysis.

"We believe the level of criticized assets remaining in SNC portfolios and the observed increase in riskier assets is a concern, given the current fragile state of the U.S. economy, which has a substantial impact on the credit quality of these large loans," the analysis continues. "Furthermore, we remain focused on the potential impact on loan quality, particularly in commercial and industrial (C&I) portfolios, once short-term rates begin to rise along with debt payments. We believe that recent C&I loan loss rates, which are below long-term historical averages, are unsustainable and have also been deflated given somewhat higher growth rates in lending activity over recent periods."

The Fitch analysis of the SNC report says that underwriting, particularly in commercial and industrial loans, has weakened amidst intense competition for loan growth.

The report indicates that more than one-third (34%) of recently originated leverage loans were cited for weak underwriting, due to a combination of high leverage and absence of covenants.

"This will likely cause C&I loan loss rates to increase over coming quarters," Rumohr says.

--Written by Hal M. Bundrick for MainStreet