Junk-rated and oil and gas loans worry U.S. bank regulators

Banks’ exposure to junk-rated companies and the oil and gas sector remains high, according to an annual report on loan quality by U.S. bank regulators released Thursday.

The regulators gave a negative classification to $372.6 billion out of $3.9 trillion in loans impacted by the review, or 9.5 percent of the loans. Classified loans increased 9.4 percent from a year earlier.

While regulators cited progress by banks in improving underwriting practices, they complained in a press release with the report of “persistent structural deficiencies found in loan underwriting.”

The report could be an early sign of a shift in the credit cycle toward more conservative lending because of stress among some borrowers.

Criticism of loan quality in last year’s report focused on loans to junk-rated companies. This year’s report added worry about oil and gas loans. So called “classified” oil and gas loans – ones that received the three most negative ratings of “substandard,” “doubtful,” and “loss” – surged to 15 percent from just 3.6 percent a year ago.

“Aggressive acquisition and exploration strategies from 2010 through 2014 led to increases in leverage, making many borrowers more susceptible to a protracted decline in commodity prices,” the release stated.

The review could force banks to scale back loans to energy companies. In September the Office of the Comptroller of the Currency, which conducted the review with the Federal Reserve Board and the Federal Deposit Insurance Corporation, met with banks over the impact of fallen commodity prices on the ability of borrowers to repay loans.

The “shared national credit review” covers loans made by at least three or more federally regulated institutions, chiefly banks. Thursday’s report used data banks provided between Dec. 31, 2014 and March 31, 2015.

The three regulators in 2013 released stricter guidance on leveraged lending to avert the type of risky lending that led to the mortgage and financial crises. Thursday’s report said “examiners noted improved compliance” with that guidance.

J. Paul Forrester, a corporate finance lawyer at Mayer Brown in Chicago said Thursday’s report shows that “excluding oil and gas loans, the banks appear to be making progress.”

Regulators made it clear to banks months ago they would give heightened attention to loan performance and some banks dented their earnings by recording additional expenses to bolster reserves against potential losses.

At JPMorgan Chase & Co CFO Marianne Lake said on the company’s Oct. 13 earnings call the bank had already taken large reserves in the last few quarters. She added “if energy prices stay around these levels and recover slowly, we’re expecting, net, not to have material incremental reserves in the next quarter.”

(Corrects total of classified loans to $372.6 billion from $372.8 billion in second paragraph)

(Reporting by Dan Freed and Lynn Adler in New York- Additional reporting by Dan Wilchins– Editing by James Dalgleish)