In part one of this series, we noted that the 2014 SNC Review sample was heavily skewed toward leveraged loans and to criticized assets. This purposeful focus does not, in itself, undermine the report’s explicit findings (at least about the review sample) but it certainly hinders simple, drive-by use of cherry-picked elements of the Review to make broad generalizations about the larger population of SNC (and leveraged) loans. If one were to examine high-performance automobiles in a NASCAR pit row and those being worked on in collision repair shops, it would be rather challenging to make valid generalizations of attributes of US automobiles writ large. So, let’s take a look ‘under the hood’ of the 2014 SNC review:
The overall severity of classifications declined… (source: SNC Review 2014)
Well, that seems to be positive news…let’s examine. Classified assets (those rated Sub-standard, Doubtful, or Loss) as a percent of total committed assets in the SNC universe – even with the stated examination bias of leveraged and criticized assets – continues to trend in the right direction. The relative proportion of Criticized assets has declined monotonically from the peak of 15.5% of the SNC universe in the 2009 review to 5.6% in the 2014 review (see Figure 1).
Many have argued that the immediate ‘pre-crisis’ level of Classified assets (see 2005-2007) was understated (subsequently followed by an over-correction at the height of the economic crisis) so direct comparison levels in of that era is flawed. That said, absolute levels of Classified assets in the SNC review declined 57% to $191.3 billion in the 2014 review from the 2009 peak level of $446.8 billion. The latter result is even more compelling as Total Committed SNC assets increased over half a billion dollars (up 17.6%) during the same period. So, while one will read a lot about leverage lending increasing in volume, after two years of attention under Leveraged Lending Guidance and two SNC reviews, we just don’t see massive increases in Classified assets – either in absolute or relative terms.
Sub-standard assets, the ‘best’ rating level of the Classified asset subset, are those that “are inadequately protected by the current sound worth and paying capacity of the obligor” (Source: SNC Review glossary). Classification into this category requires specific hurdles to be met due to the implications of adversely rated assets. In keeping with the overall trend of Classified assets, Sub-standard assets have fallen in both absolute terms (dropping $166 billion – over 49% – to $171 billion in 2014 from $337.1 billion in 2009) and in relative terms (falling t0 5.0% of Total Committed assets in 2014 from 11.7% in 2009). As we noted in “There Be Monsters?: Middle Market Lending and the SNC Review” – based on many media reports, one would expect the beasties to be showing up in the results – but we don’t see it in this review.
The even more severe classifications of Doubtful and Loss also have fairly prescriptive models so that loans thus classified are ‘worthy’ of the grade. And we see in Figure 2 that these two ratings classes have also improved making up just over 10% of total Classified loans in the 2014 Review – down from 25% in 2009.
Moreover, assets defined as Doubtful and Loss declined in both absolute and relative terms – with the combined 2014 SNC Doubtful and Loss total of $19.6 billion amounting to a mere 0.6% of Total Committed assets. We don’t suggest that this is a trivial amount, but when viewed along with low default rates for leveraged lending overall – it runs contrary to the narrative in so many ‘Chicken Little’ articles on leveraged lending we have read across 2013 and 2014.
Why this arcane review of Classified assets in the SNC review? Based on the definitional hurdles to place loans in these buckets, SNC reviewers would take care before placing loans here – but wouldn’t avoid doing so, if warranted. While someone might still assert that Classified assets are qualitatively “elevated,” based on the directional, relative performance, we remain guardedly optimistic. None of this means that the SNC Review’s complaint of underwriting weakness is void or remotely misplaced – or that a major shock to the economy wouldn’t adversely affect the leveraged loan asset class. But where we stand today, we simply don’t see current lending driving a major influx of problem loans as measured by the SNC Review’s Classified assets analysis.
In future posts we will look at the use of Special Mention to steer lending behavior and the disconnect between SNC levered loans and the vast majority of deals done in the market.