In the third quarter, net charge-offs as a percentage of average loans at regional and community banks covered by Stevens & Co. rose to 0.11% from 0.04% in the same period a year ago. These figures include both consumer and commercial charge-offs.
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Deposit costs aside, the health of commercial borrowers is now a major concern for bank investors.
Corporate lending problems have risen in recent months as financially troubled companies have begun to close in a relatively benign environment, and few analysts expect the credit deterioration to be as severe as it was after the 2008 financial crisis.
But it's clear that this is the start of what analysts are calling a “credit normalization.” Bank lending had been unusually healthy during the pandemic, but now more commercial borrowers are in trouble and banks are starting to write off bad loans.
Some bankers have said the issues are “one-off” problems with specific borrowers and don't signal stress across loan portfolios.But investors are concerned that these isolated incidents will start to add up over the next year.The difficulty of telling which banks will face bigger problems has many equity investors staying away from the banking sector as a whole.
“The problem facing many investors right now is that it's hard to get a sense of credit quality and how banks are going to perform in a worsening credit environment,” said Andrew Terrell, a banking analyst at Stevens.
In the third quarter of this year, net charge-offs as a percentage of average loans at regional and community banks tracked by Stevens rose to 0.11% from 0.04% in the same period last year. These figures include both commercial and consumer charge-offs.
U.S. consumers are feeling the stress faster than businesses, with inflation, high interest rates and dwindling savings causing some to fall behind on credit card payments. For many credit card issuers, bad debts are approaching or already exceeding pre-pandemic levels.
Regional banks, many of which serve fewer consumers, have been relatively insulated from pressure from consumers, but concerns about their commercial real estate portfolios persist and nonreal estate lending to commercial borrowers is starting to improve, even as problem loans remain modest.
One recent corporate bankruptcy was shocking. Mountain Express Oil, a Georgia-based company that supplied oil to hundreds of gas stations, had received a $218.5 million loan from a group of banks. But the oil distributor filed for bankruptcy, and the banks involved in the loans said they were unlikely to ever get their money back. This is harder to accept than a reorganized bankruptcy, where some of the money could be recovered.
Chris McGrarty, an analyst at Keefe, Bruett & Woods, said the 100% loss rate was unexpected and reinforced investors' usual wariness of banks participating in syndicated loans. Unlike lending directly to companies, syndicated loans put banks at a distance from borrowers, giving them less control if things go wrong. Losses tend to be larger and less predictable.
During third-quarter earnings calls, the CEOs of the affected banks said the problems at Mountain Express Oil were temporary and expressed confidence in their remaining syndicated loan exposures.
Excluding the loan, First Horizon's balance sheet “remains in very good condition,” Chief Executive Officer Brian Jordan told analysts last month. The Memphis, Tennessee-based bank led the syndicated loan for Mountain Express Oil Co.
KBW's McGrarty said it was natural that concerns about oil marketer bankruptcies were “growing” because it came after a long period when investors didn't have to worry too much about the health of bank loans.
“The normalization process is going well. It's still going pretty well, but the trends are working against us,” he said.
Nowhere is this more evident than in the trucking industry, which is in deep financial trouble after a strong 2020. During the pandemic, consumers stayed home and spent big on furniture, electronics, and appliances. But as the world reopened, consumers rapidly shifted to travel, entertainment, and restaurants, and suddenly trucking companies with less inventory to ship were in trouble.
Trucking giant Yellow Co. filed for bankruptcy in August, part of a bloody and tragic saga that has pushed the decades-old company into collapse.
The collapse of a small community bank in Sac City, Iowa, appears to be due to its focus on trucking loans. It's the fifth bank failure this year. The bank was small, with just $66 million in assets, but regulators had previously harshly criticized the bank for being too dependent on trucking, forcing it to close due to “significant loan losses.”
Trucking loans likely make up a much smaller share of total lending at many other banks, exposing them to regulators for being too reliant on one area, but a loan failure in one area reduces the cushion a bank has built up to absorb problems in other areas.
Other commercial sectors don't appear to be feeling that pain, said Stephens' Terrell, but across industries, some already struggling businesses are feeling the effects of higher interest rates.
“When things are going really well, there's help from above to restructure anything you want,” Terrell said. But when the business cycle turns, “the weakest operators are the first to go under.”
Bankers say they are closely monitoring their commercial real estate portfolios, especially office loans, as occupancy rates in office buildings fall amid a rise in remote and hybrid work. Banks are building up reserves in case such loans go bad, and are classifying more CRE loans as “nonaccrual” credit, according to ratings firm Fitch Ratings.
Any problems would likely “fell disproportionately on regional banks with greater exposure to CRE,” Fitch analysts wrote in a note this week.
“However, banks are generally well-positioned to absorb further 'normalization,'” they wrote.