AI advancements are enabling lenders to better predict residual values, a boon for the equipment finance industry as machines become increasingly tech heavy.
The global market for AI in financial services is expected to grow 34.3% annually to $249.5 billion in 2032 from 2025, according to Verified Market Research. The global predictive AI market is projected to hit $88.6 billion by 2032, a more than fourfold increase from 2025, according to research firm Market.us.
The potential benefits of AI for predicting residuals are especially relevant for equipment lenders as autonomous solutions, telematics systems, GPS systems and other machine technologies enter the market. Lenders have been reluctant to finance new tech-heavy machines due to residual-value uncertainty. The uncertainty is driven by:
Limited historical performance data;
Rapid obsolescence; and
Lack of a resale market.
Nearest neighbor
Fintechs and lenders can overcome these hurdles by deploying the “nearest-neighbor technique” with machine learning, Timothy Appleget, director of technology services at Tamarack Technology, an AI and data solutions provider, told FinAi News’ sister publication Equipment Finance News.
The nearest-neighbor method uses proximity to make predictions or classifications about the grouping of an individual data point, according to IBM. The technique helps “fill gaps in data that don’t exist,” Appleget said.
For example, rather than just gathering scarce residual-value data for autonomous equipment, lenders and fintechs should seek data for the technologies enabling them — or other asset types with similar systems.
Data integrity is crucial during this process, Tamarack President Scott Nelson told EFN.
“If I can find an asset type that’s inside the definition of this more techy thing, then that’s like a nearest neighbor,” he said.
Borrower behavior
Borrower behavior is also an important factor to consider when developing AI tools for predicting residuals, Nelson said.
“One of the biggest effects on residuals is usage. So, an interesting question would be: Is anybody out there trying to aggregate data about the operators to predict the behavior of the people moving this equipment around?”
— Scott Nelson, president, Tamarack Technology
To achieve this, fintech-lender partners can take advantage of the data collection and transmission capabilities of emerging equipment technologies, such as telematics, Nelson said. Even simple tech, like shock and vibration sensors, can aid this process, he said.
“You get two things immediately: You get runtime, because anytime the thing is vibrating, it’s running,” he said. “If you’ve got runtime, you’ve got hours on the engine, which is one of the big factors. The shock sensors tell you whether or not it got into an accident or whether or not it was abused.”
“That runtime data can also be converted into revenue generation. How often is this thing generating revenue?”
— Scott Nelson, president, Tamarack Technology
Integrating operator-behavior data with predictive AI could help lenders gain a competitive edge because many take a conservative approach when financing relatively new assets, Appleget said.
“This additional asset-behavioral data, to me, opens up the potential for having more flexibility in the residual values you set for a specific asset,” he said. “If you have that level of sophistication, you can gain a considerable advantage.”
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Space for rent inside of the Penn 2 building in New York City in May 2024. Vornado Realty Trust paused parts of its massive redevelopment plan to remake Penn Station last year after high interest rates and the shift to working from home triggered a crisis in the commercial real estate market.
Stephanie Keith/Bloomberg
While banks’ solid underwriting of office loans is largely keeping credit issues in check for now, some lenders may need to ramp up their reserves to cover the possibility of loans flopping, according to a recent analysis by Moody’s Investors Service.
The loan-by-loan analysis of 41 anonymous banks’ commercial real estate portfolios outlines the spectrum of pain that institutions are facing. Even though Moody’s found that banks’ underwriting was more conservative than the ratings firm had anticipated, the higher-for-longer interest rate environment is increasing the need for banks to shore up their capital, said Stephen Lynch, vice president and senior credit officer at Moody’s.
“If that continues to stay elevated, it’s going to put pressure on all asset classes, Lynch said. “It made us re-assess the risk levels of these banks with higher CRE concentrations. Even if underwriting for a particular institution was good, how do you compensate for that higher asset risk?”
Moody’s found that, on average, the banks should be holding about twice the amount of reserves they currently have to cover potential office losses.
The ratings firm also determined that banks were generally more cautious about the future of office loans than they were about other types of commercial real estate. Expected defaults on office properties are at a decades-long high, according to a recent bulletin from the Federal Reserve Bank of St. Louis. The sector is a top concern for analysts and investors, as work-from-home trends and high interest rates put pressure on the values of those properties.
Highlighting those concerns, banks’ average current expected credit loss, or CECL, reserves for their office portfolios were 2.2%, or roughly double those of their multifamily and other property loans, according to the Moody’s report.
Moody’s was able to evaluate 40 banks’ office portfolios, and while it did not disclose the size range of those banks, it did say that their office portfolios totaled $31.9 billion.
Each bank seemed to evaluate their CECL reserves differently, but those with more office loans tended to allot more reserves, said Darrell Wheeler, head of commercial mortgage-backed securities research at Moody’s.
Wheeler said what surprised him, though, were the outliers. Some 10 institutions have CECL reserves equal to or higher than what Moody’s assessed, with one bank having alloted double the amount of recommended reserves. (Seven banks did not provide their loan-level CECL reserves to Moody’s.)
The office loans reviewed for the report appeared relatively stable compared with all office loans across the country, Wheeler said. Among the banks in the Moody’s report, the average office vacancy rate was 13.8%, while nationwide second-quarter trends show that vacancies in the office sector set a historical record at 20.1%.
The industry’s exposure to the CRE sector is getting banks in hot water even when specific loans appear solid. Federal Reserve data shows a correlation between higher CRE loan concentrations and lower bank stock returns.
“Concentrations are what usually get banks into trouble,” Lynch said. “Even if we view the underwriting good, the risk appetite of management to allow that concentration to exist factors into our ratings.”
Most banks currently need to have higher levels of capital and liquidity than they would in a lower-rate environment, he said, describing that conclusion as the “thesis” for recent actions the ratings firm took against certain banks.
Moody’s announced last month that it put six banks on review for downgrade due to their concentrations in commercial real estate: First Merchants, F.N.B. Corp., Fulton Financial, Old National Bancorp, Peapack-Gladstone Financial and WaFd.
The Moody’s report didn’t highlight many cohesive trends across office loans, though, Wheeler said, since individual loans at different banks are so disparate.
The St. Louis Fed’s bulletin also noted the variance in risk across commercial real estate, but it found a correlation between the size of office properties and their expected risk of default. In other words, larger spaces tend to be riskier, the St. Louis Fed researchers found.
Jordan Pandolfo, an economist at the St. Louis Fed who co-wrote the bulletin, said that while CRE concentration is a risk, it’s important to evaluate the differences between sectors, property types, geographies, banks’ underwriting and their loss provisioning.
“The big takeaway there is that commercial real estate risks are incredibly varied,” Pandolfo said, referring to the St. Louis Fed’s findings. “So it’s quite difficult to identify which banks carry the most exposure risk to CRE based upon certain statistics like concentration ratios, or what percentage of their portfolio is commercial real estate.”
There’s a disconnect right now between jittery investors’ perceptions of banks’ commercial real estate exposures and the same banks’ confident assertions about those portfolios. And it’s showing no signs of easing.
Concerns about the riskiness of some CRE loans, especially in the office sector, have been hitting banks’ stock prices like a game of Whac-A-Mole. Although it seems safe to assume that the asset class will experience some stress, experts say it’s difficult to accurately assess individual loans without information that the banks often don’t provide.
As banks begin to report second-quarter earnings next month, many institutions with outsized CRE portfolios will seek to share enough information to convey stability without getting so deep in the weeds that they put investors on alert or break confidentiality agreements.
The asset class is idiosyncratic, depending on variables like geography and sector, but banks’ relationships with their borrowers and sponsors can be part of a story unseen by the public.
Jon Winick, CEO of the bank advisory firm Clark Street Capital, said there are reasons to worry about commercial real estate, but that data from banks’ earnings reports don’t jibe with a doomsday story.
“Now, the apocalyptic narrative could be completely accurate,” Winick said. “But you have to concede that there is a difference between the actual facts on the ground, what banks have seen so far in non-performing assets and what the market perception is.”
That nuance may not help banks much, though, given that investors are painting all CRE-heavy banks with a broad brush.
“When it comes to investing in banks, with investors, a lot of times they shoot first and ask questions later,” said Brandon King, an analyst at Truist Securities, in an interview. “You see that with the stock price reactions.”
Banks and thrifts hold close to $3 trillion of commercial real estate debt in the United States, according to Trepp data cited by the Federal Reserve Bank of St. Louis. Non-performing loans and net charge-offs have increased since the smooth-sailing days of 2021 and 2022, but are still hovering around, or even below, pre-pandemic levels at most institutions. CRE delinquencies are still on the rise, but the pace of the increase has begun to slow down, per data from S&P Global Market Intelligence.
Still, fresh worries continue to stir up markets. In the last few weeks, both Bank OZK and Axos Financial saw their stock prices take one-day hits of up to about 15% following reports from analysts and investors.
In May, a Citigroup analyst double-downgraded Little Rock, Arkansas-based OZK from “buy” to “sell” due to apprehension about two of its property loans — involving a 1.7 million square-foot life sciences construction project on the San Diego waterfront and a mixed-use property in Atlanta. In the report, Citi analyst Benjamin Gerlinger wrote that the rating change was rooted in the lack of tenant demand at the life sciences development and the 300,000 square feet of office space in the Atlanta building.
In response to Citi’s report, Bank OZK issued more information about the loans in a public filing, including loan-to-value ratios and the amount funded so far. The bank also reiterated confidence in its projects and capital partners. The additional disclosures helped stabilize the $36 billion-asset bank’s stock price.
However, Citi reiterated its sell rating, and OZK’s value has continued to slide, falling 23% in the last month. Piper Sandler analysts wrote in a note that they were maintaining their “overweight” position in OZK, adding that although the bank may record losses in its CRE portfolio, investors’ reaction to the Citi report was excessive.
A week after Citi released its report on OZK, Hindenburg Research disclosed its short position in Axos Financial, which the investment firm said, per its research, was “exposed to the riskiest asset classes with lax underwriting standards and a loan book filled with multiple glaring problems.”
Axos clapped back in a public filing, claiming that the Hindenburg report contained “a series of inaccuracies and innuendo that included false, incomplete and misleading allegedly factual information” regarding its loans. The bank also provided additional information to rebut assumptions made in the Hindenburg report, and wrote that its loan structure provides “a strong collateral protection even in adverse market scenarios.”
Axos’ stock price recovered some of its lost value, but it has still fallen more than 16% in the last month. Axos declined to comment for this story. OZK did not reply to multiple requests for comment.
A recent analysis by the St. Louis Fed suggests there’s a correlation between higher CRE exposure and negative stock returns at U.S. banks.
As regulators have become more focused on banks’ CRE exposure, those lenders with higher concentrations in the asset class have seen valuation dips, per a recent note by Piper Sandler analyst Stephen Scouten. In the last month, the banks whose stock values have declined the most are the ones with the highest CRE concentrations.
Bank OZK has faced scrutiny over its exposure to a 1.7 million square-foot life sciences project on the San Diego waterfront.
Adobe Stock
Investors who are brave enough to take the plunge by buying regional bank stocks loaded with CRE could have a big upside opportunity, given the right market conditions, Scouten said.
“We found an important part of this exercise to be our realization that many of these banks are being painted with the same broad brush, but that there are nuances within each bank’s exposure that will likely lead to a litany of different outcomes,” Scouten wrote.
Scouten noted that regulators seem to be pushing banks not to allow their CRE portfolios to exceed more than 300% of their risk-based capital. At Axos, the CRE to risk-based capital ratio was 238.8%, and Bank OZK’s was 365.9%, per Piper Sandler’s most recent data.
OZK and Axos are the latest examples of banks facing stock turbulence due to CRE worries, but they aren’t the most extreme cases. Earlier this year, New York Community Bancorp’s stock price tumbled some 80% after it announced that it was preparing for major unexpected losses in its real estate portfolio. (New York Community’s problems went beyond its commercial real estate exposure. The company also disclosed deficiencies in its risk management and underwriting, finally raising a $1 billion lifeline investment to overcome investors’ fears in the spring.)
Amid concerns about CRE credit quality, Moody’s Investors Service also announced earlier this month that six banks were under review to be downgraded. F.N.B. Corp., First Merchants Corp., Fulton Financial, Old National Bancorp, Peapack-Gladstone Financial and WaFD — all regional banks with major CRE portfolios — are on the credit agency’s list for a deeper dive.
At Peapack-Gladstone in New Jersey, one-third of the bank’s total loans involve rent-regulated multifamily properties, according to Moody’s. Such loans have also been a source of concern for New York Community. Peapack-Gladstone did not respond to a request for comment.
David Fanger, a senior vice president at Moody’s, said the ratings firm evaluates CRE concentration in conjunction with other earnings metrics to score a bank’s credit performance. He said equity markets are more precarious.
“When there are public announcements about commercial real estate, that can certainly drive the equity market, fairly or not,” Fanger said. “The fact is, banks are opaque. Commercial real estate lending, in particular, is opaque.”
The broken telephone dynamic between what banks say and how markets behave isn’t new. Fears about how CRE losses will impact banks have persisted for years, but they continue to build, and experts say that more institutions will face choppy waters because of their concentrations in the sector.
More disclosure by banks, and more patience from investors, could steady the ship, Winick said.
“I do believe some sort of storm is coming. It’s just, we don’t know what it’ll look like,” he said. “The mistake the regional [banks] will make is to completely deny the issue…. You can say the doomsayers are exaggerating, but you have to acknowledge that there are issues.”
Earlier this month, Eagle Bancorp in Bethesda, Maryland, filed a shelf registration statement that would allow it to raise up to $150 million.
Eagle Bancorp in Bethesda, Maryland, set the table to raise money after a bruising first-quarter loss and a steep credit provision linked to an office property in downtown Washington, D.C.
The $11.6 billion-asset Eagle this month filed a shelf registration statement with the Securities and Exchange Commission for the offering of up to $150 million. It enables the company to increase debt and issue common or preferred stock at any point over the next three years.
Eagle Chief Financial Officer Eric Newell described the move in an interview “as good corporate housekeeping” that “gives us flexibility” — as opposed to a sign the company needs to raise capital.
He said that, should the company raise money, it would likely be done through a debt or preferred stock offering. Newell also noted that Eagle has subordinated debt maturing in September, and the shelf registration allows the company “to be opportunistic” as it considers refinancing that obligation.
Eagle recorded a $35.2 million provision for credit losses in the first quarter on an office property in Washington whose value was reappraised at about half of its prior value.
Commercial real estate makes up more than 60% of the bank’s loans. Urban office CRE, in particular, is under pressure across the industry as landlords grapple with higher vacancy rates amid enduring remote work trends.
Eagle’s shares traded between $19 and $20 intraday Thursday, down more than 30% from the start of the year.
Though Newell described Eagle’s recentcredit quality challenges as manageable and its core earnings power as strong, the registration does give the company options to raise money should it need to offset more credit issues in its CRE portfolio.
Newell said federal government work forces that pepper the capital city’s downtown have been affected by remote work. But he emphasized that the bank’s CRE book is spread across various sectors and markets, including the D.C. suburbs. He said the first quarter office hit was not indicative of systemic issues in the bank’s loan book.
“Not every office property is downtown, and not every CRE credit is an office loan,” Newell said.
Michael Jamesson, a principal at the bank consulting firm Jamesson Associates, said lenders are increasingly scrutinizing their CRE portfolios and charge-offs are accumulating. But, he said, banks for the most part are reporting “one-off or two-off” loan problems and ensuring investors that the isolated challenges are not thought to mark the beginning of broader and rapid credit quality deterioration.
“Now, banks always say that, but the data seems to validate the story for now,” Jamesson said. “At this juncture, it looks like we’llget through this with some scars, yes, but not many fatal wounds.”
Provisions for expected credit losses across all U.S. banks declined in the first quarter to $21.1 billion from $24.4 billion the prior quarter, according to S&P Global Market Intelligence data. The decline came as net charge-offs held essentially flat at $20.3 billion. First-quarter provisions as a percentage of charge-offs fell to 104% from 121% the previous quarter, suggesting banks on the whole seeimproving conditions ahead, according to S&P Global.
“I’m sure we’ll see more signs of stress at points this year, and some banks will have more problems than others,” Jamesson said. “I don’t see a calamity in waiting.”
In its SEC filing earlier this month, Eagle said if it decides to raise all or some of the $150 million, it could use the money to refinance debt — its debt maturing in the fall totals about $70 million — or it could use the funds to bolster capital, pay dividends or buy back shares.
For the first quarter, the company reported net charge-offs of $21.4 million, up from $11.9 million the previous quarter. Nonperforming assets of $92.3 million equated to 0.79% of total assets, up from 0.57%.
Capital levels were lower than in 2023, but all measures exceeded regulatory requirements. Eagle described its capital positions as “strong.”
At the close of the first quarter, the common equity ratio, tangible common equity ratio, and common equity Tier 1 capital to risk-weighted assets ratio were 10.85%, 10.03%, and 13.80%, respectively.
Eagle reported a net loss of $338,000 for the first quarter, compared to net income of $20.2 million for the fourth quarter of 2023.
However, the bank’s pre-provision net revenue of $38.3 million for the first quarter was nearly even with the prior quarter’s $38.8 million.
“We earn really well,” Newell said. He said that, once the bank works past the recent credit set-back, this could be evident in future quarters.
As far as downtown Washington office properties, Newell said some areas of the federal government have proven slow to bring workers back to offices full time. But he said Eagle is bullish on the nation’s capital because the long-term trajectory of the federal government is one defined by substantial growth. The District of Columbia’s economy, by extension, is likely to expand in tandem.
Of the capital’s ties to federal spending, Newell said, “we believe it is still a differentiator in a positive way.”
New York Community Bancorp’s new management team has plotted out a path to improved profitability, but they say 2024 will be a “transition year.” It remains to be seen just how rocky the next eight months will be.
The Long Island-based company, whose apartment-heavy commercial lending portfolio landed it in hot water earlier this year, warned investors Wednesday there will be more pain in coming quarters as it continues to root out troubled loans. Charge-offs and loan-loss provisions will be elevated this year before returning to more normal levels in 2025 and 2026, executives said.
Borrowers have so far shown “amazing resiliency,” new CEO Joseph Otting, the former top bank regulator, told analysts during the company’s first-quarter earnings call. Still, net charge-offs were $81 million during the quarter, while the provision for loan losses totaled $315 million — far above where both metrics were a year earlier. Nonperforming loans also skyrocketed year over year, totaling $798 million as of March 31.
The company said it is guiding for $750 million-$800 million in provisions for all of this year. It then expects that figure to drop to $150 million-$200 million next year and in 2026.
Analysts say there are still a lot of unknowns. One big question: How will New York Community, which has gone through significant turmoil since late January, ultimately close the gap between its current performance metrics and what the management team is aiming to achieve by 2026?
“I think it’s clearly still in the early stages” of a turnaround, said David Smith, an analyst at Autonomous Research who covers the bank. “They put out a more robust and detailed set of expectations than most investors expected, but it’s still a ‘Prove it’ story.”
Otting, who has been CEO for about eight weeks, expressed confidence that the new management team and restructured board of directors can get the $112.9 billion-asset company back to profitability. The company reported a $327 million net loss in the first quarter.
Otting, along with former Treasury Secretary Steven Mnuchin, turned around the failed IndyMac Bank and eventually sold it for a large profit. The two teamed up again in the New York Community rescue, which required a $1 billion capital infusion.
“We’ve done this before,” Otting said on the call. “And we feel we can do it again.”
Investors seemed to agree, at least a little, driving up the stock price by 30% Wednesday to $3.44 per share.
New York Community’s troubles began on Jan. 31 when the company reported a sizable fourth-quarter loss, signaled trouble in its commercial real estate loan portfolio and slashed its dividend, sparking a 37% decline in its share price. The sell-off continued in February, in part because of ongoing uncertainty about the company’s loan books. The surprise $1 billion investment, led by Mnuchin, was intended to ease the turmoil and bolster the company’s capital levels.
The plan laid out Wednesday includes both short-term and medium-term goals.
In the near term, New York Community, which is the parent company of Flagstar Bank, plans to sell or run off noncore assets, work out problem loans and reduce its operating expenses. Medium-term targets include diversifying the loan portfolio, which is currently dominated by multifamily loans; growing core deposits as a way to improve the company’s funding base; and increasing fee income.
A deal to sell noncore assets worth about $5 billion may be in the works, management said Wednesday, though they did not provide additional details about the asset class.
By the fourth quarter of 2026, New York Community aims to achieve a return on average assets of 1% and a return on average tangible common equity of 11%-12%. It is also targeting a common equity Tier 1 capital ratio of 11%-12%. That ratio was 9.45% in the first quarter.
Return on average assets was negative 1.13% in the first quarter, while return on average tangible common equity was negative 10.02%.
“We’ve done this before,” New York Community Bancorp CEO Joseph Otting said Wednesday, in reference to the earlier turnaround of a failed bank that he and former Treasury Secretary Steven Mnuchin engineered. “And we feel we can do it again.”
Patrick T. Fallon/Bloomberg
In recent weeks, the new management team has taken a “deep dive” into the health of the bank’s commercial real estate portfolio, said Craig Gifford, New York Community’s chief financial officer. The review covered both the bank’s $36.9 billion multifamily book and its $3.1 billion office loan portfolio.
The office portfolio makes up just 4% of the bank’s loans, but it’s part of a sector that’s been suffering a “high degree of stress,” Gifford said. The review of office loans, conducted with the help of an independent party, has thus far covered 75% of that portfolio.
Executives have set aside a sizeable chunk of reserves to cover potential stress in their office loans. The bank said that its ratio of reserves to total office loans was about 10%, significantly above most of its peer banks.
The comparable figure is significantly smaller for New York Community’s much-larger multifamily loan book, where the allowance for loan losses was 1.3% of the portfolio. The bank has examined its top 250 multifamily loans, but it has yet to take an in-depth look at 64% of the portfolio.
Given how much of the multifamily loan book still needs to be reviewed, “I think there’s uncertainty there,” Peter Winter, an analyst at D.A. Davidson, said Wednesday.
The multifamily sector has been hit hard, particularly rent-stabilized buildings in New York City, where landlords’ ability to raise rents has been drastically hampered by a 2019 state law. The new rent restrictions come on top of far stronger eviction protections for nonpaying tenants, along with ballooning maintenance and insurance costs, said Seth Glasser, a New York City multifamily broker at the firm Marcus & Millichap.
The value of rent-regulated buildings in New York has been “annihilated,” Glasser said, with potential sale prices falling by 50% or more. Few potential buyers want the buildings since they have “no business model,” and few lenders would finance any deal, he added.
“There’s some really significant distress that continues to emerge,” Glasser said. “It feels like it’s getting worse every month.”
Otting noted that the buildings’ expenses have risen sharply, but he also said that the limited number of vacant apartments means the buildings have a “pretty solid” revenue stream.
New York Community believes the probability of defaults is rising, Otting said, but the multifamily portfolio so far “has held up very well” as borrowers keep making their payments.
Otting also expressed optimism that multifamily borrowers will remain relatively healthy even as their currently low interest rates reprice upward. So far, borrowers have been able to adjust to higher payments with “almost no delinquencies,” said Gifford, the bank’s CFO.
New York Community has brought on an experienced hand at managing loans that may fall into trouble. James Simons, who formerly ran loan workouts at U.S. Bank in Minneapolis, joined New York Community as a “special advisor to the CEO” to evaluate the health of its borrowers and whether it needs to set aside more reserves to cover potentially troubled loans, Otting said.
“The information is available to us,” he said. “We just need to formulate that information in the right way.”
The medium-term plan is to lower New York Community’s long-standing concentration in commercial real estate. The bank’s former chief executive, Thomas Cangemi, kick-started that journey with the 2022 acquisition of the consumer mortgage heavyweight Flagstar Bancorp in Troy, Michigan.
Just a few months after it completed the deal for Flagstar, New York Community acquired large portions of the failed Signature Bank. The acquisitions vaulted New York Community over $100 billion of assets, putting it into a category that prompts additional scrutiny from bank regulators.
During the lengthy process to acquire Flagstar, the company switched its primary federal regulator from the Federal Deposit Insurance Corp. to the Office of the Comptroller of the Currency. On Wednesday, Otting, who formerly led the OCC, said the company was “not ready to be regulated” by that agency.
“So we have a lot of catching up to do to get our standards up,” Otting said. “But we’re committed to doing that, and we’ve hired the people who understand what that looks like.”
The company’s diversification plan also covers its deposits. Otting said the bank is focusing on continuing to grow core deposits — part of its ongoing shift away from New York Community’s legacy model of funding multifamily loans with higher-cost certificates of deposit, which has included bringing in new depositors from Flagstar and Signature.
New York Community has recently lost some bankers to smaller rivals, including Peapack-Gladstone Financial and Dime Community Bancshares, raising the risk that departing bankers will bring customers’ deposits with them.
But the company’s deposits have stayed resilient after initial outflows in February, when its sharp stock decline prompted some depositors to leave. The bank started 2024 with $81.5 billion of deposits, a figure that dropped to $76.1 billion on March 7, when Mnuchin’s investment group announced plans to pump in new capital.
Deposits then fell slightly to $74.9 billion at the end of the first quarter, but they ticked up by $300 million as of April 29, according to company executives.
For years, both Fifth Third and Huntington have been eyeing growth opportunities outside of their home bases in the Midwest.
Bloomberg
Higher-for-longer interest rates are dampening commercial loan demand at regional banks, but Texas expansions are helping two midsize lenders, Fifth Third Bancorp and Huntington Bancshares, to lasso middle-market clients.
The Ohio-based banks are seeing more stability from business clients in the Lone Star State than in some other parts of their footprints, Fifth Third and Huntington leaders said Friday on first-quarter earnings calls. Fifth Third has been building a middle-market banking operation in major metro areas of Texas for the last five years, and Huntington recently tapped a Texas market president in Dallas to cultivate its local commercial business.
While the Southeast, including the Carolinas and Florida, has been core to both banks’ growth plans, lending in the land where everything’s bigger has been helping them offset the negative impacts of economic uncertainty at a time when the near-term interest rate outlook remains unknown.
Texas, Florida and North Carolina have all consistently seen a rise in gross domestic product, population and company relocations in the last five years, priming them for financial institutions’ expansion plans.
“Texas has been a really nice story for us,” Fifth Third CEO Tim Spence said on the bank’s earnings call. “It’s a really nice complement to the strong commercial banking team that we built out in California a few years back, in terms of expanding the middle-market footprint. So we expect to see growth in that area.”
The $214.5-billion Fifth Third first planted a flag in Texas more than a decade ago with an energy vertical, and it began augmenting its middle-market business in earnest in 2019, focusing on Houston and Dallas. The company now employs some 175 folks in the state, with a concentration in commercial and industrial loans, Spence said.
Huntington’s operation in Texas is much newer and smaller. The $193.5 billion-asset bank unveiled its Texas expansion plans in February, but it’s already seeing results in the form of both loans on the books and a burgeoning pipeline for future credits.
Huntington Chairman and CEO Steve Steinour recently visited Dallas, where the Columbus, Ohio-based bank planted its initial Texas office.
“I really like our new colleagues,” who are led by market president Clint Bryant, Steinour said Friday in an interview. He added that the Texas economy is “booming.”
Huntington is eyeing a gradual statewide expansion as it solidifies its footing. Its business plan calls for serving Texas middle-market clients with revenues under $1 billion.
Huntington announced in October that it would enter 2024 in expansion mode. Since then, it has launched an expansion into the Carolinas and established verticals in fund finance, healthcare and Native American banking.
Texas is the most recent initiative, but Huntington may not be done. The company is open to adding new bankers and capabilities, Steinour said Friday on a conference call with analysts.
To date, the new markets and verticals have produced a loan pipeline “approaching $2 billion,” as well as a sizable deposit portfolio, Chief Financial Officer Zach Wasserman said on the conference call. “The early traction has been really positive,” he said.
Huntington announced quarterly net income totaling $419 million Friday, a 30% year-over-year decline that it attributed to higher funding costs. On the plus side, Huntington reported solid year-over-year growth in loans and deposits, and executives said that they expect both trends to continue throughout 2024.
The bank reiterated previously stated guidance calling for full-year 2024 deposit growth in the 2% to 4% range, with Wasserman suggesting the end result would be nearer the top end.
In a similar vein, Steinour labeled Huntington’s commercial loan pipeline “very robust,” adding that it grew each month during the quarter ending March 31. The company’s 2024 guidance targets loan growth in the 3% to 5% range.
Approximately 40% of the first-quarter loan and deposit growth that Huntington reported originated in its new markets and verticals, according to Wasserman.
Investors appeared to view Huntington’s results in a positive light. Shares closed up about 1% at $13.28 Friday.
Fifth Third beats estimates
While Fifth Third’s end-of-period loan balances were down 1% from the prior quarter to $117 billion, middle-market loan demand in Texas, along with longer-term geographic priorities like Tennessee, the Carolinas, Kentucky and Indiana was a bright spot, Spence said.
Overall, the bank brought in $480 million of net income in the first quarter, down 2% sequentially. The bank beat analysts’ estimates on net interest income, expenses and fees. Its stock pricewas up 6% Friday, to $36.25.
Piper Sandler analysts wrote in a note that most investors expected Fifth Third to soften its 2024 performance expectations, but by maintaining its guidance and logging a “better-than-expected” first-quarter performance, the bank’s earnings report “looks like a win.”
Fifth Third Chief Financial Officer Bryan Preston said on the call that the Cincinnati-based bank expects its full-year average total loans to be down 2% from 2023, but that commercial and consumer balances should increase in low-single-digit percentage points by the end of the fourth quarter.
Spence added that any loan growth will likely be driven by taking market share. Fifth Third’s middle-market clients aren’t pessimistic per se, but they also aren’t leaning forward on merger-and-acquisition or inventory-building opportunities, he said.
“The places where we are expecting to see growth in the second half of the year are the places where we made investments to be able to do it,” Spence said.
In 2023, Fifth Third’s middle-market loan production was split 50-50 between its Midwest markets, including Chicago, and other parts of the country. The latter geographies include the Southeast markets, plus Texas and California.
Bank of America’s credit card losses hit their highest levels since before the pandemic in the first quarter, the company reported Tuesday.
Angus Mordant/Bloomberg
Though Bank of America’s profits dipped in the first quarter as it built a larger cushion for bad credit cards and office loans, bank executives are optimistic they’ve pulled the appropriate levers to manage credit going forward.
The Charlotte, North Carolina-based bank reported that its net charge-offs increased by more than 80% from the same period last year, from $807 million to $1.5 billion, as consumers struggled to pay off their credit card debt and turbulence in the commercial real estate sector continued. To manage the rising credit risk, Bank of America posted a $1.3 billion provision for credit losses, up from $931 million a year earlier.
“All of this is still well within our risk appetite and our expectations, and it’s consistent with the normalization of credit we’ve discussed with you in prior calls,” Chief Financial Officer Alastair Borthwick said Tuesday on the bank’s quarterly earnings call.
Bank of America reeled in net income of $6.8 billion last quarter, down from $8.2 billion in the first quarter of 2023, dampened in part by the credit-loss provision and a special assessment from the Federal Deposit Insurance Corp. related to bank failures last spring. The bank’s stock price fell Tuesday by 3.5% to $34.68.
The company provided more information about its exposure to office loans, which has been a hot topic among regional banks that tend to have bigger office loan portfolios. Bank of America has about $17 billion in office loans, which is just 1.6% of its loan book. Some 12% of the bank’s office loans were classified as nonperforming in the first quarter, while 16 loans were charged off.
Some $7 billion of the company’s office loans, or roughly 41% of its portfolio, are slated to mature this year. About half that figure will mature in 2025 and 2026, which implies the losses have been “front-loaded and largely reserved,” Borthwick said.
“We’re using a continuous and thorough loan-by-loan analysis, and we’re quick to recognize impacts in the commercial real estate office space through our risk ratings,” Borthwick said on the company’s earnings call. “As a result … we’ve taken appropriate reserves and charge-offs.”
Banks’ property loans have faced increased scrutiny in recent months, though most of the focus has been on regional lenders. Among the U.S. megabanks, Wells Fargo also reported an annual rise in charge-offs in its commercial real estate portfolio in the first quarter.
Bank of America’s bigger credit troubles last quarter, however, were in the consumer sector, which accounted for two-thirds of its credit losses. Credit card charge-offs hit a rate of 3.62%, their highest level since a decline during the COVID-19 pandemic, when consumers were buoyed by government assistance.
Over the next few quarters, it appears that BofA’s credit card losses may stay at existing levels, or even increase, said David Fanger, senior vice president of the financial institutions group at Moody’s Investors Service.
“Credit card losses are above pre-pandemic levels, and that’s somewhat unexpected,” Fanger said. “It’s not unique to Bank of America, but it’s certainly something that bears watching. It is a headwind. It is now contributing pretty significantly to their provisions in the quarter.”
Despite the rise in charge-offs, Fanger described the bank’s credit performance in the first quarter as “resilient.”
During the quarter, Bank of America logged relatively stagnant loan growth. High interest rates have not only tamped down loan demand, but they have also driven up the cost of deposits.
“Generally speaking, a higher-for-longer [rate environment] is probably better for banks,” he said. “The question will become, ‘Why are rates higher? What’s going on in the economy? Are we talking about inflation? Is it under control? Is it coming down?’” He went on to indicate that inflation does now appear to be under control.
Moody’s Fanger argued that Bank of America’s positive view of the interest rate outlook implies that the company doesn’t anticipate significantly more credit losses.
He also said that Bank of America’s net interest margin, which increased for the first time in four quarters, implies that the strain of higher rates on deposit costs is starting to steadily abate. The bank’s net interest margin of 2.5%, including global markets, was up from 2.47% in the fourth quarter of last year.
The Federal Reserve on Wednesday indicated that interest rates could be coming down this year. The KBW Nasdaq Bank Index rose more than 2% for the day and is up roughly 4% for the year to date.
But bank stocks are treading lightly and may need further signals from the Federal Reserve that interest rate cuts are in the cards for this year to mount a serious rally.
Henk Potts, market strategist at Barclays Private Bank, said he sees the realistic possibility for “the Fed to start cutting rates in June,” but “the path of policy still remains very data dependent.”
The Fed on Wednesday balked at a March rate reduction but hinted cuts are coming. The KBW Nasdaq Bank Index rose more than 2% on the day. Still, while the index is up more than 20% from the lows of March 2023, when Signature Bank and Silicon Valley Bank each failed, the index is ahead just about 4% year to date.
The regional bank downfalls — followed by the failure of First Republic Bank last May — intensified already heated competition for deposits, drove up funding costs and cast a long shadow over bank investor sentiment.
The challenges came atop simmering credit quality concerns following the Fed’s efforts over the course of 2022 and early 2023 to drive up rates and counter inflation that surged in the wake of the pandemic and Russia’s invasion of Ukraine. Analysts cautioned that, historically, rising interest rates tended to dampen new investments and tilt the economy into a recession. Banks often suffer higher loan losses during downturns.
Bank stocks last year hit their lowest levels since the immediate shocks of the pandemic in 2020.
In recent months, however, federal data showed that inflation, while choppy, has come down dramatically. At a 3.2% annual rate in February, it was barely a third of the 2022 peak of 9.1%. The Fed appeared to tackle the worst of the inflation challenge while avoiding a recession and has paused its rate-hike campaign since last summer.
Yet inflation remains above the Fed’s targeted 2% level and the job market, while strong, is not entirely rosy. Companies across technology, finance, media and other industries have announced layoffs early this year, and the unemployment rate ticked up to 3.9% in February from 3.7% the prior month. Job openings also declined.
Robert Bolton, president of Iron Bay Capital, further noted that sizable portions of recent job gains involved lower-paying positions and second jobs.
“There’s a lot of unknowns still,” said Bolton, explaining why many bank investors remain on the sidelines. “Inflation is not the one and only concern.”
On Wednesday, Fed policymakers reiterated prior suggestions that rate cuts were on the horizon, perhaps as soon as this summer. While Fed officials kept their target rate in the 5.25% to 5.50% range, a majority of policy officials projected in a report that three rate cuts were possible this year. They next meet in May and then again in June.
For the near term, however, “the path forward is uncertain,” Fed Chair Jerome Powell said during a press conference Wednesday. “We are strongly committed to returning inflation to our 2% objective.”
With a higher-for-longer rate policy, the Fed could further cool the job market and the economy. This would help to further drive down inflation, but it would not bode well for loan demand or, potentially, banks’ credit quality, Bolton said.
Employers collectively reported six-figure job gains every month last year — and again in January and February of this year. Employers added 275,000 jobs in February, according to the Labor Department. But the pace has slowed. The economy created 353,000 jobs during the first month of this year.
The pace of economic growth has also eased. Gross domestic product advanced at an annual rate of 3.2% in the fourth quarter, down from third-quarter growth of 4.9%, according to the Commerce Department.
“With the U.S. economy posting two consecutive quarters of 3%-plus GDP growth, recession calls have quieted down,” said Larry Adam, chief investment officer for Raymond James.
But, he added, “there have been some warning signs over the last few months that suggest growth could slow. … While the labor market is on solid footing, cracks are forming.”
The Atlanta Federal Reserve projected first-quarter GDP growth of just over 2%.
Piper Sandler analyst Scott Siefers said that the latest weekly Fed data, covering the week that ended March 8 for the banking industry, showed deposit stability but loan growth of just 2% from a year earlier. Lending, he said, “is simply bobbing around a very weak level.”
From an investor perspective, Siefers added, “as the year marches on, it becomes increasingly important for bank loan growth to inflect upward to meet existing expectations” for stronger interest income and profitability in 2024.
“But realistically,” he added, “lower rates and better macro clarity may be necessary to make this a reality, reinforcing the notion of how heavily tied this group’s fortunes are to factors outside banks’ direct control.”
New York Community Bancorp’s latest leadership revamp did little to quell investors’ worries about the Long Island-based bank, as its stock price fell nearly 26% after a flurry of announcements that started late Thursday.
The company said early Friday that it has filled gaps in its executive ranks by hiring a new chief risk officer and a head auditor. The appointments are part of the bank’s efforts to fix “material weaknesses” in its internal controls, which New York Community disclosed publicly the day before.
The hirings of George Buchanan as chief risk officer and Colleen McCullum as chief audit executive fill two vacancies that had been a source of concern for investors. But New York Community’s disclosures about internal control weaknesses and an announcement that it is delaying the release of its annual report sparked new worries.
On Friday, Fitch Ratings cut its rating of New York Community to BB+, moving it into “junk” or speculative territory.
Fitch analysts wrote in a note that the new hires are “constructive steps in building an executive team with depth of experience more in line” with a bank its size. But they stated that the material weaknesses prompted a “re-assessment of NYCB’s risk profile.” And they warned that the bank may see its profitability hampered if it further ramps up its reserves, which guard against losses in its real estate-heavy loan portfolio.
Moody’s Investors Service also cut the bank’s rating to B3, deeper into junk territory. In a note on Friday night, the ratings firm said the bank’s overhaul is coming during a “particularly challenging” environment and flagged “ongoing risks to its creditworthiness” as the bank’s changes take full effect.
Piper Sandler analyst Mark Fitzgibbon, who downgraded the bank’s stock rating late Thursday from “overweight” to “neutral,” said the leadership changes and delayed annual report imply that New York Community may not be past its woes.
Investors are “sniffing around trying to find bargains” in the banking sector and wondering whether the hard-hit New York Community is a good candidate, Fitzgibbon said.
The bank’s stock price is now hovering at levels last seen during the Clinton administration. But Fitzgibbon said its problems are “very opaque,” making it hard for investors to predict whether there’s more pain to come.
“Everybody thought they had ripped the Band-Aid off three or four weeks ago,” Fitzgibbon said in an interview. “Now it appears that’s not the case, and that there’s more to come.”
The bank’s disclosures late Thursday also raised new questions about New York Community’s auditor, KPMG. The accounting giant, which is the leading auditor of U.S. banks, has faced criticism following the failures last spring of Silicon Valley Bank, Signature Bank and First Republic Bank, all of which KPMG audited.
In an annual filing last year, New York Community said that KPMG had audited the effectiveness of its internal controls as of year-end 2022. The next year was a busy one for New York Community, as it folded in Flagstar Bancorp’s operations and also acquired much of Signature’s remains.
On Thursday, New York Community blamed the “material weaknesses” in its internal controls on “ineffective oversight, risk assessment and monitoring activities.” It said that the weakness related to how the bank reviews loans internally.
The bank also said that it has discussed the issues it disclosed Thursday with KPMG and that a full review of its internal controls is ongoing.
New York Community said that it expects to announce in its annual report that “its disclosure controls and procedures and internal control over financial reporting were not effective” at the end of 2023. It also said it would lay out a “remediation plan” to fix the weaknesses.
“There are a lot of questions that the auditors are going to have to answer,” said Dennis Kelleher, the co-founder and CEO of the advocacy group Better Markets.
A KPMG spokesperson declined to comment. New York Community did not respond to a request for comment on the issue.
The latest news from New York Community “will once again test customer loyalty and deposit stickiness given this new round of stock price pressure,” analysts at the ratings firm Morningstar DBRS wrote in a research note.
Shares in the bank fell 25.9% after Thursday’s disclosures and ended Friday at $3.52 per share, down sharply from roughly $10 per share at the start of the year.
“Unfortunately, these additional news items place further scrutiny on the company at a time when it needs to restore confidence,” the Morningstar DBRS analysts wrote.
A little over four weeks ago, New York Community announced a fourth-quarter earnings loss and dividend cut that shocked investors and sank the company’s stock price by nearly 40% in a single day.
A week later, Alessandro “Sandro” DiNello, the former Flagstar CEO who had been New York Community’s non-executive chairman, was named executive chairman. That appointment appeared to represent a demotion for New York Community CEO Thomas Cangemi. On Thursday, the bank said that Cangemi was out as CEO, with DiNello adding that title.
Buchanan, the new chief risk officer, previously led credit review and risk management at Regions Bank. McCullum, who was named chief audit executive, arrives from United Community Bank. Earlier in her career, she headed audit and risk teams at Capital One Financial, Wells Fargo and Bank of America.
Those additions were part of an 18-hour stretch of musical chairs in the bank’s executive ranks and on its board.
While Cangemi is remaining on the company’s board, New York Community also announced Thursday that board director Hanif “Wally” Dahya has left his position. Dahya wrote in his resignation letter that he “did not support the proposed appointment of Mr. DiNello as president and CEO of the company.”
Dahya’s departure came less than a month after the resignation of another director, Toan Huynh, who walked away on the same day that DiNello was named executive chairman.
Also on Thursday, Marshall Lux, who joined the board two years ago, was named “presiding director” of the board and chair of its nominating and corporate governance committee.
On Friday, DiNello touted the progress he’s made since taking a more hands-on role.
“Over the last three weeks since being appointed as executive chairman, the company has taken swift action to improve all aspects of our operations,” DiNello said Friday in a prepared statement. “The leadership team identified the material weaknesses disclosed yesterday and has been taking the necessary steps to address them, including appointing new executives.”
The $116.3 billion-asset company’s new leaders will have to steady an outsized commercial real estate portfolio, fix the newly disclosed weaknesses in the company’s controls and contend with its lowest stock price since 1997.
Wedbush analyst David Chiaverini, who downgraded New York Community twice back in November, landing at “underperform,” wrote in a Friday note that the bank’s internal review could lead to additional loan loss reserves. Such reserve building would be aimed at protecting against losses in the bank’s massive real estate portfolio, especially rent-regulated properties that have come under pressure due to high interest rates and new limitations on rent increases, Chiaverini said.
DiNello said in his statement Friday that the bank’s existing allowance for credit losses accounts for the weaknesses, and isn’t expected to change. The Morningstar analysts wrote that they didn’t view the company’s latest announcements as indicative of new issues.
During Cangemi’s tenure as CEO, New York Community made two acquisitions in quick succession that vaulted the bank to more than $100 billion of assets, which brought a higher level of regulatory scrutiny. The company bought Flagstar in late 2022 and acquired parts of Signature after the crypto-friendly institution failed last year.
The bank’s new leadership team is inheriting a challenging situation, Kelleher said.
“Hopefully, this new management and board will be able to stabilize the bank, but no matter how good they are, they still have to deal with an incredibly burdened balance sheet,” he said. “All the internal controls, the loan book, the CRE problems and on and on are still there.”
New York Community Bancorp, which had $116.3 billion of assets at the end of last year, grew substantially through its acquisitions of Flagstar Bancorp and the failed Signature Bank.
Bloomberg/Adobe Stock
Nearly a week after New York Community Bancorp’s fourth-quarter earnings report triggered a substantial decline in the company’s stock price and deepened a sense of wariness about its loan portfolio, industry observers are now watching for signs of deterioration in its deposit base.
They’re also wondering who’s overseeing the enterprise risk management function at the Hicksville, New York, company, which nearly doubled in size over the past 16 months.
A spokesperson for New York Community — which crossed the $100 billion-asset threshold in late March 2023 when it acquired large chunks of the failed Signature Bank — confirmed Monday night in an email that Nicholas Munson, the company’s chief risk officer since 2019, left “in early 2024.”
Munson’s departure, which was first reported by the Financial Times, leaves a significant leadership gap that may exist for a couple of months, said Clifford Rossi, former chief risk officer for Citigroup’s consumer lending division.
How long the chief risk officer job is open depends on how quickly New York Community can identify, interview and vet qualified candidates, and then ultimately hire someone, he said.
Finding the best candidate as quickly as possible is paramount, said Rossi, who is now a professor at the University of Maryland School of Business.
“This is not some officer buried in the hierarchy,” Rossi said Tuesday. “This is the most senior risk officer in the organization, so it’s important for the bank to put a person in that place, and it’s important for regulators to see that they are putting someone in place.”
Munson joined New York Community in 2018 as its chief audit executive, according to a biography that has since been removed from the company’s website. As the chief risk officer, he was responsible for “designing, implementing and maintaining an effective risk management program that aligns to applicable regulatory guidance and is commensurate with the company’s size, scope and complexity,” the biography read.
It’s unclear whether Munson left of his own accord, whether company executives were somehow dissatisfied and felt the need to seek someone more familiar with overseeing risks at a larger company or whether regulators pushed the bank to make a change.
It’s also unclear who is currently overseeing risk management operations at New York Community. The company’s spokesperson declined to say if someone has temporarily taken over the duties of the C-suite level role or how the organization plans to fill it on a more permanent basis.
Some analysts believe that the bank will move quickly to find someone new.
“They’re going to hire a chief risk officer in no time, there’s no doubt,” said Casey Haire, an analyst at Jefferies. “I don’t know why [Munson] left, but rest assured they’ll be looking.”
Haire pointed out that New York Community’s 2024 expense guidance calls for an estimated $80 million increase in spending earmarked for annual compensation and benefits. Altogether, the bank expects to hike spending by $265 million, including costs related to becoming a so-called Category IV bank, which has $100 billion to $250 billion of total consolidated assets.
Silicon Valley Bank left the chief risk officer position unfilled for eight months, during which time the bank and its parent company, SVB Financial Group, grappled with a host of risks, such as rising interest rates, insufficient liquidity and the impacts of a slowdown in the venture capital marketplace.
New York Community’s situation is different, since the risk chief position was only recently vacated.
“It’s not like they were flying blind,” said David Chiaverini, an analyst at Wedbush Securities.
New York Community, which had $116.3 billion of assets at the end of December, months after joining the more heavily regulated tier of banks with at least $100 billion of assets, has been on a roller-coaster ride for the past week.
Last Wednesday, it reported a quarterly net loss of $260 million, driven by a large reserve build to protect against souring loans. The company also surprised Wall Street by slashing its dividend by 70% — from 17 cents to five cents — a move that executives said was necessary in order to build capital.
Those unexpected moves came at a time when analysts were already on alert about New York Community’s exposure to both office loans and rent-controlled multifamily loans, and they contributed to a sharp decline in the bank’s stock price. Shares fell 37% last Wednesday, and they have fallen by double digits on four of the last five trading days.
The stock closed Tuesday down more than 22% from the prior day’s close, and down more than 59% from a week ago.
After the market closed, Moody’s Investors Service downgraded New York Community’s long-term issuer rating by two notches, citing myriad headwinds.
In the past week, Jefferies and Compass Point Research & Trading have both downgraded the bank’s shares. On Friday, Fitch Ratings also downgraded the stock, saying in a note that the “timing of the announced actions” to meet the prudential standards for Category IV banks, as well as the size of the credit provisions, were “outside of Fitch’s baseline expectations.”
The lower the stock price sinks, the greater the chances that depositors will get spooked, Chiaverini said. In November, he downgraded shares in New York Community on two occasions, citing ongoing concerns about its “outsized [commercial real estate] exposure in a higher-for-longer rate backdrop” as well as its “sizable exposure” to New York City’s rent-regulated multifamily lending market.
“Now that the stock has taken a dive … there’s fear, and the key concern now is retaining their deposits,” Chiaverini said Tuesday. Some 36% of New York Community’s deposits are uninsured, he noted. If those uninsured funds go elsewhere, the bank will have to make up for them with borrowings, which are expensive and have a negative impact on the bank’s net interest margin.
In the past week, New York Community has not provided an update to investors about its deposit volume. But analyst Ebrahim Poonawala of Bank of America Securities said in a research note Monday that “feedback from management indicates that the bank is not seeing any unusual deposit inflows or outflows.”
Poonawala also noted that New York Community, through its Flagstar Bank subsidiary, has a “significant retail branch footprint, aiding its ability to raise retail deposits.”
Mark Fitzgibbon, an analyst at Piper Sandler, wrote in a note to clients that New York Community described its deposits situation on Tuesday as “business as usual.”
“We interpret this to mean that there is no meaningful deposit pressure,” Fitzgibbon wrote. “While it would be natural for the company to see a few customers react to last week’s headlines and diversify some funds, we do not think the company wants to be in a position of discussing deposit flows each day; hence their comments. We have also been scouring social media for any hints of short sellers trying to exert deposit pressure on the company and have not found anything too worrisome.”
Deposits totaled $81.4 billion as of Dec. 31, 2023, a decline of 2% from the prior quarter.
Several banks that were experiencing deposit outflows last spring issued updates about their deposits, but Chiaverini said there’s reason to be cautious about that approach.
“There’s a debate as to whether putting out an interim update does more harm than good,” Chiaverini said. “Those banks that provided more frequent updates last year, it didn’t seem to help during the height of the chaos” that was sparked by Silicon Valley Bank’s failure.
Executives at Cullen/Frost Bankers, Bank OZK and BankUnited have all made favorable comments recently about credit quality in their banks’ commercial real estate portfolios.
Adobe Stock
As investors fret about how a downturn in commercial real estate could hurt the U.S. banking sector, several small and midsize lenders with substantial exposure to CRE say not to worry.
Banks whose commercial real estate portfolios have come under the microscope include Cullen/Frost Bankers in San Antonio, Florida-based BankUnited, Bank OZK in Arkansas, Seattle-based WaFd Inc. and Brookline Bancorp in Boston.
At all five of those banks, which range in size from roughly $10 billion-$50 billion of assets, executives sought during recent earnings calls to reassure analysts about their commercial real estate books, even as high interest rates and remote work stamp the sector with question marks.
The executives’ efforts were generally successful. The share prices of all five banks have risen over the last five trading days — though some increased only slightly.
The largest of the bunch, the $49 billion-asset Cullen/Frost, reported a rise in charge-offs during the fourth quarter. But CEO Phil Green said Thursday that commercial real estate loans, which make up 36% of the bank’s $18.8 billion book, weren’t the source.
“We saw an increase in problem loans this quarter,” he said during the company’s earnings call, “but it really wasn’t from commercial real estate at all.”
Nearly half of the Texas bank’s CRE transactions are classified as investor real estate — a category that includes office, multifamily and industrial properties — while the rest are mostly owner-operated properties. The biggest exposure risk on paper relates to multifamily construction, rather than office properties, which have been a sore spot for the industry, Green said in an interview.
He said that Cullen/Frost, the holding company for Frost Bank, actually had three paydowns of office properties that totaled $95 million.
During the fourth quarter at Cullen/Frost, credit quality remained above historical levels, but charge-offs still rose year over year to $11 million from $3.8 million. Green said he expects further normalization in 2024.
Cullen/Frost is hitching its wagon to the relationships it has built with borrowers, as well as the underwriting decisions it has made, Green said in the interview, which occurred after the company’s fourth-quarter earnings call.
“The reason I don’t worry about that is because of the types of properties, the locations, the quality of the projects and, most importantly, the quality of the relationships that we have,” Green said.
“It’s not something I’m really worried about. The reason is not because of anything we’re doing now. You can’t do very much now. It’s about what you’ve done over the last few years as you develop your portfolio.”
Analysts at Wedbush Securities, which have a neutral rating on Cullen/Frost’s stock, wrote in a research note that positive signs for the company include an elevated level of loan loss reserves. While Cullen/Frost’s stock price fell by 1.8% on Friday, it was still up by 0.4% for the week.
At Miami Lakes, Florida-based BankUnited, Chairman and CEO Rajinder Singh said Friday that the level of nonperforming loans, including CRE loans, is so low “it will be harder to drive them down further.”
Fourth-quarter net charge-offs were just 0.09% of average loans, which beat analysts’ expectations.
Some credit normalization appears headed BankUnited’s way, but the trend will start off a very low base. While criticized commercial loans rose by 15% quarter over quarter to $1.14 billion, nonperforming loans declined by $10 million during the three months ending Dec. 31, finishing last year at 0.52% of total loans.
“Overall on credit,” Singh said during the company’s quarterly earnings call, “I’m sleeping very well at night.”
BankUnited’s office building loans are anchored in growing South Florida markets, as well as in Manhattan. In its Manhattan portfolio, the $35.8 billion-asset company is reporting a 96% occupancy rate. “We don’t see much in the way of loss content,” Chief Operating Officer Tom Cornish said on the conference call.
Shares in BankUnited fell by 0.6% on Friday, but were up 0.5% for the week.
Similar to Bank United, the $11.4 billion-asset Brookline Bancorp reported linked-quarter declines in both total and CRE nonperforming loans. The latter category ended 2023 at $19.6 million, down 7% from Sept. 30. Net charge-offs of $7.1 million amounted to an annualized 0.30% of total loans, down from 0.47% on September 30.
Laurie Havener Hunsicker, an analyst who covers Brookline for Seaport Research Partners, raised her price target for the company’s shares by $2 to $14, largely on the strength of its credit quality performance.
“Credit costs continue to normalize, but have been better than our expectations,” Hunsicker wrote Friday in a research note.
Shares in Brookline, which reported its quarterly earnings on Wednesday, were up 5.5% this week.
At Bank OZK in Little Rock, Arkansas, nonperforming loans totaled $61 million, or 0.23% of total non-purchased loans on Dec. 31. Bank OZK’s national CRE lending unit reported full-year net charge-offs of $5 million, amounting to three basis points of its $16.9 billion portfolio.
Credit quality at the $34.2 billion-asset bank is “relatively benign and limited to a handful of transactions,” Chairman and CEO George Gleason said during a Jan. 19 earnings call.
Shares in Bank OZK are up 6.4% since it released its earnings report last week.
At the $22.6 billion-asset WaFd Inc., holding company for Washington Federal Bank, the ratio of nonperforming loans to total loans was 0.26% for the fourth quarter. Shares in WaFd are up by about 1.5% since it released its quarterly earnings report on Jan. 16.
At the time, CEO Brent Beardall sounded optimistic about prospects for continued strong credit performance in 2024. He cited a recent decline in long-term interest rates, which should make it easier for commercial real estate borrowers to make their payments.
“Much has been speculated about the potential downturn of the commercial real estate market, and we don’t know with certainty how or if that will occur, yet we do know that this decline in long-term rates narrows the refinance gap for borrowers and thus lowers credit risk for banks,” Beardall said in a press release earlier this month.
Executives at First Citizens BancShares pointed Friday to several positives following its March 2023 acquisition of the failed Silicon Valley Bank. At the same time, they warned of “headwinds” that could impact growth in that business segment, which serves startups and technology companies.
Bloomberg
Ten months after acquiring a significant portion of Silicon Valley Bank, First Citizens BancShares says it continues to retain and win back some of the failed bank’s former customers and also stabilize its deposit base, whose remarkably swift erosion last spring led to SVB’s collapse.
On Friday, executives at First Citizens — which doubled in size after the acquisition — ticked off several positives. For starters, the integration work should be finished this year, including a systems conversion of the acquired segment’s private bank that’s set to take place in the first quarter.
In addition, the loan pipeline for Silicon Valley Bank’s global fund banking unit, which serves private equity and venture capital funds, grew by about 40% during the fourth quarter, a result of attracting new and retaining existing customers, executives said. The SVB unit’s deposit base has been largely stable since April, it added 60-plus primary operating business clients between April and November, and deposits should see “modest growth” going forward, executives noted.
But there are still “headwinds” within the innovation economy that may prove to be challenging for the Silicon Valley Bank segment, they told analysts during First Citizens’ fourth-quarter earnings call.
Despite the “strong pipeline” in global fund banking, growth will continue to be “pressured” due to the ongoing slowdown in private equity and venture capital, Chief Financial Officer Craig Nix said. The company also expects “a modest decline” in technology and health care banking stemming from a reduction in venture capital fundraising and line draws as well as increased loan payoffs, he said.
While First Citizens is “very encouraged” about the coming year, there are challenges, acknowledged Marc Cadieux, president of Silicon Valley Bank’s commercial banking business.
“The innovation economy continues to go through … its own downturn,” Cadieux said on the call. We expect that’s going to continue in 2024. So our intention is to keep doing what we were doing in 2023 and hoping that 2025 and ahead [are] better.”
First Citizens, which now has $213.8 billion of assets, acquired substantially all Silicon Valley Bank’s loans and certain other assets from the Federal Deposit Insurance Corp., which acted as a receiver for Silicon Valley Bridge Bank. First Citizens decided last year to keep the Silicon Valley Bank name and brand, operating it as a division of the larger company.
In September, First Citizens launched a nationwide advertising campaign, calling it “Yes, SVB,” to raise awareness of Silicon Valley Bank’s presence and show that it is “open for business.”
The company reported fourth-quarter net income of $514 million, which was double its pre-merger total of a year earlier but fell 32% from the third quarter. Earnings per share of $34.33 fell short of the average estimate of $48.60 from analysts surveyed by FactSet Research Systems.
There were several notable items in the quarter, including $116 million of acquisition-related charges as well as a Federal Deposit Insurance Corp. special assessment of $64 million.
Noninterest expenses totaled nearly $1.5 billion, compared to $1.4 billion for the third quarter. Net charge-offs were $177 million, representing 0.53% of average loans, the same as the third quarter.
Net charge-offs are expected to be “elevated” this year in the innovation, general office and equipment finance portfolios, the company said.
The company has “taken proactive steps to help limit losses,” Nix said on the call.
First Citizens confirmed Friday that it plans to buy back shares in the second half of this year, pending regulatory approval. The company halted repurchases last year.
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Bank of America said Monday that it will need to “de-designate” interest-rate swaps and reclassify how it accounts for them. Though the bank will take a noncash, pretax charge of $1.6 billion in the fourth quarter, it expects to regain that money as interest income over time.
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Bank of America’s support for a short-lived interest rate index from Bloomberg L.P. will lead the bank to take a $1.6 billion hit in its earnings report on Friday, though it will earn that money back over time.
BofA was perhaps the leading backer of Bloomberg’s Short Term Bank Yield Index, or BSBY, rate, which was designed to play a major role in replacing the once-ubiquitous London Interbank Offered Rate. Libor was used in loans across the world before a rate-rigging scandal caused its demise. Bloomberg had foreseen a window in which it could come up with its own benchmark for banks to use in loans.
But regulators were either skeptical of BSBY or openly combative about its adoption. After the rate failed to gain much traction in the banking industry, Bloomberg said in November that it would permanently discontinue BSBY this year.
The rate’s demise is triggering an accounting shift at Charlotte, North Carolina-based BofA, since derivatives transactions the bank entered to hedge its exposure to BSBY no longer qualify for special treatment under accounting rules.
In a securities filing Monday, the $3.15 trillion-asset bank said it will need to “de-designate” those interest-rate swaps and reclassify how it accounts for them. BofA is taking a noncash, pretax charge of $1.6 billion in the fourth quarter due to that change. But the bank also said it expects to regain that $1.6 billion as interest income over time, with much of that occurring by the end of 2026.
The one-time charge will also cause a decline of eight basis points in the company’s common equity tier 1 ratio, Bank of America said.
Analysts described the change as a nonissue, even if it makes the bank’s quarterly earnings somewhat noisier than BofA might like. The bank reported $7.8 billion in earnings during the third quarter, so a $1.6 billion hit in the fourth quarter is not insignificant.
Jason Goldberg, a bank analyst at Barclays, said in an email that the change is “much more of an accounting nuisance” than anything. He noted that BofA will earn $1.6 billion over the next few years as it makes up the one-time charge.
Piper Sandler analyst Scott Siefers wrote in a note to clients that the “one-time accounting change” will “introduce some noise” into Bank of America’s quarterly earnings but will not have much impact beyond that.
Other banks that used BSBY in loans may also have to make moves to clean up from the index’s discontinuation. But few, if any, banks likely used BSBY as much as Bank of America, which made loans to several publicly traded companies that referred to the benchmark, according to securities filings that provide details of those loans.
The key feature that made BSBY attractive was that it was credit-sensitive. Like Libor, it moved up when financing conditions were tighter, which meant the interest payments banks received from borrowers reflected any stresses in real time.
By contrast, the Secured Overnight Financing Rate, which has replaced Libor in the United States, is seen as “risk-free” since it’s based on some of the safest transactions in the world. SOFR moves very little in times of financial stress, which bankers say does not reflect the fact that it’s more expensive for them to fund their operations when markets are tighter.
Bank of America, along with several regional banks, had participated in a series of virtual workshops in 2020 and 2021 that regulators set up to discuss the role of credit-sensitive rate options.
After those meetings, banking regulators said they were open to banks using non-SOFR rates as long as they understood and planned for any risks. But Securities and Exchange Commission Chairman Gary Gensler was openly critical of BSBY, which observers say contributed to its demise.
The developers of Ameribor, another credit-sensitive rate that some community banks have favored, said after Bloomberg decided to shut BSBY that their plans haven’t changed.
Despite a credit-quality issue vexing Bancorp 34, its $28 million merger with another Arizona banking company — CBOA Financial — is on track for completion in the first quarter, Bancorp 34 CEO Jim Crotty says.
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A deteriorating commercial real estate credit has forced Bancorp 34 in Scottsdale, Arizona, to restate third-quarter earnings and extend the deadline of its pending merger with CBOA Financial.
The $28 million, all-stock deal between Bank 34 and CBOA — the Tucson, Arizona-based holding company for the $411.3 million-asset Commerce Bank of Arizona — was announced April 27 and had to be completed within a year. Both companies agreed Friday to extend the completion deadline two months to June 28, according to a news release issued Friday by the $581 million-asset Bank 34.
The companies agreed further to adjust the exchange ratio upward, according to the release. Originally, CBOA investors were to receive 0.24 shares of Bank 34 stock for each of their shares. Under the new ratio, they would receive 0.2628 shares.
Attempts to reach officials at both companies Tuesday were unsuccessful.
Credit-quality matters notwithstanding, the deal is on track for completion in the first quarter, Bancorp 34 CEO Jim Crotty said in the release. “While we had to address a single isolated credit with a specific reserve in the third quarter, significant progress has been made towards completing the merger,” Crotty said.
Bancorp 34 restated third-quarter earnings to reserve an additional $2.28 million for a single CRE credit it had previously placed on nonaccrual status. As management worked to service the problem credit, it determined deterioration had been present on Sept. 30 and opted to revise its financial statements. The modest $3,000 profit Bancorp 34 previously reported for the third quarter flipped to a $2.275 million loss. Similarly, the $550,000 profit reported for the first nine months of 2023 changed to a loss of $1.73 million.
Bancorp 34 said previously its results included merger expenses of $1.3 million through Sept. 30.
CBOA earned $2.5 million through the first nine months of 2023, according to the Federal Deposit Insurance Corp.
Bancorp 34’s difficulties come as banks around the country have dramatically scaled back commercial real estate originations in the wake of rising delinquencies. According to a report issued earlier this month by Trepp, third-quarter CRE originations by banks totaled $2.5 billion, down 46% on a linked-quarter basis and nearly 70% year over year. A recent academic paper, moreover, concluded nearly half of banks’ office loans — one of the five CRE property types Trepp tracks — appear to be underwater, with loan balances in excess of an individual property’s value.
Bancorp 34 did not provide any details in Friday’s press release about the type of CRE property tied to the problem loan.
On Wednesday, the $14.1 billion-asset Provident Financial Services in Iselin, New Jersey, and the $11.2 billion-asset Lakeland Bancorp in Oak Ridge, New Jersey, extended the deadline to close their $1.3 billion, all-stock deal to March 31. Announced in Sept. 2022, it was initially scheduled for a second-quarter 2023 close. Two weeks earlier, the outside closing date for the $22.5 billion-asset, Seattle-based WaFd’s $654 million acquisition of the $8.1 billion-asset Luther Burbank Corp. in Santa Rosa, California, was extended through February. None of the companies involved in either merger provided a reason for the delays.
Huntington Bancshares’ entry into Native American financial services is an outgrowth of its 2021 acquisition of TCF Financial, which expanded the bank’s footprint into Minnesota and Colorado.
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Huntington Bancshares isn’t about to let a potential economic slowdown go to waste.
Huntington plans to expand commercial banking into North Carolina and South Carolina, and to create a unit that specializes in medical asset-based lending. The company also said it recently added a Native American financial services group.
“The ability at this stage — when other banks may be doing cost programs or reductions, or have a limited appetite for risk-weighted asset growth for capital or other reasons — this is a window,” said Huntington Chairman, President and CEO Steve Steinour. “We’ve been gearing the company for outperformance during a recession … and we’re going to deliver that.”
“It’s a bit of a contrarian play,” added Steinour, who was speaking at the Goldman Sachs U.S. Financial Services Conference in New York City. “With strong capital, excellent liquidity, the capabilities of the team, the credit performance, this is our time to move. We intend to do it throughout 2024, as well.”
In October, on a conference call to discuss third-quarter earnings, Steinour said that Huntington’s noninterest expenses, which totaled $1.1 billion for the three months ending Sept. 30, would increase by 4%-5% in the fourth quarter. He also said that the spending growth would carry over into 2024.
Huntington’s Carolinas expansion will be led by commercial banking, according to Steinour. The Columbus, Ohio-based bank plans to offer middle-market corporate specialty banking capabilities, along with treasury management and capital markets services, he said.
Banking teams in the Carolinas will be located in five regions: Charlotte; Raleigh-Durham; the Triad region of Greensboro, Winston-Salem and High Point; Upstate South Carolina; and Coastal South Carolina.
Huntington has already hired many of the bankers it needs to staff its teams, Steinour said, though he stopped short of disclosing precisely how many individuals it has recruited.
“We were able to be opportunistic in identifying teams of experienced bankers who know these markets well,” Steinour said. “I’m very enthusiastic about the teams who have recently joined the bank.”
While several Huntington specialty lending units, including Small Business Administration lending, have pursued nationwide expansions, commercial banking has heretofore been restricted largely to the company’s 10-state footprint in the Midwest and the West.
Huntington’s plans for a medical asset-based lending unit should dovetail with an existing health care specialty banking group, Steinour said. The new effort offers the opportunity to “extend the menu” with existing relationships and bring new ones into the company, he said: “It’s a natural fit, hand in glove.”
The entry into Native American financial services is an outgrowth of Huntington’s June 2021 acquisition of TCF Financial, which expanded the bank’s footprint into Minnesota and Colorado, according to Steinour.
“We’ve got a half dozen very experienced bankers [with] great reputations, and we’re prepared to invest,” he said.
Huntington joins a small group of companies, including Wells Fargo and the neobank Totem, that are seeking to expand the financial services options available to Native Americans. The move could have a positive impact on deposits, since loans to Native Americans are often part of relationships that feature high deposit-to-loan ratios, in many cases 100%, Steinour said.
“Done well, it’s a really good business, and it serves an underserved community. It’s in line with our purpose,” Steinour said.
Though he provided no details, Chief Financial Officer Zach Wasserman said the moves announced Wednesday will begin to have a positive impact on Huntington’s results in the second half of 2024 and into 2025.
“These are really exciting,” Wasserman said. “Each in and of themselves is additive and helpful. Cumulatively, they’ll be powerful. … We’re seeing the highest-caliber talent come to us. That’s what enables the fast payback.”
A Bloomberg spokesperson said the discontinuation of BSBY, which lagged in the race to succeed the defunct Libor rate, was the result of the “limited” commercial opportunities.
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Bloomberg L.P. says it’s shutting down its BSBY interest rate benchmark, marking a quiet end to the data provider’s attempt to offer a successor to the defunct London Interbank Offered Rate.
The end of Libor, which was once dominant in worldwide financial contracts but was phased out after a rate-rigging scandal, had brought about opportunities for new benchmarks. Bloomberg’s goal was to have some chunk of loans between banks and their borrowers refer to BSBY, an interest rate that would go up or down depending on broader financing conditions.
But the rate failed to gain much traction over the last couple of years, as the Secured Overnight Financing Rate was cemented as Libor’s successor in the United States. Another competitor called Ameribor says it’s pressing on, though its usage is more prominent at smaller banks than at larger institutions.
BSBY had the backing of some regional and national banks — most notably Bank of America — but U.S. banks and their borrowers didn’t rush to adopt the rate at the scale that it needed.
Few observers ever expected BSBY to be as widely used as SOFR, the benchmark that major market participants coalesced on through a Libor transition group convened by U.S. regulators. But some market watchers had foreseen a small role for BSBY, which would have given banks and borrowers another option.
Instead, Bloomberg announced this month the “permanent cessation” of the BSBY index starting on Nov. 15, 2024. Borrowers and the holders of other contracts that refer to BSBY have a year to prepare for its expiration.
In a statement, a Bloomberg spokesperson attributed the decision to the relatively low usage of BSBY.
“The scope of commercial opportunities for BSBY and its usage within financial products is limited, resulting in the decision to discontinue publication of the rate,” the company spokesperson said.
Bank of America, which used BSBY in loans to several publicly traded companies, declined to comment.
It didn’t help that at least some financial regulators weren’t thrilled about the use of BSBY as a benchmark.
Criticisms of BSBY added a feeling of “risk and grayness” over its usage, making it even tougher to gain momentum, said Edward Ivey, a lawyer and head of the derivative and swaps practice at Moore & Van Allen.
BSBY also faced other challenges, Ivey said.
Early in the transition away from Libor, the SOFR benchmark lacked a forward-looking term option that gave the borrower a clear number they’d pay for the next 30 days or another period. Borrowers seeking a forward-looking rate could find one in BSBY, which helped its proponents to make their case. But once a “term SOFR” option became available, the case for BSBY got a bit weaker, Ivey said.
Another difficulty was a BSBY-related derivatives market that never really took off.
In theory, borrowers whose loans referred to the Bloomberg-backed index could hedge the risk of BSBY rising or falling in the derivatives markets — essentially swapping out the risk of a change in interest rates with another party.
But since few loans used BSBY, there weren’t many market participants who made those bets. The lack of players in the market made it more expensive for potential BSBY borrowers who wanted to swap their risks, making it less attractive to take on a BSBY loan in the first place.
SOFR, by contrast, is based on roughly $1 trillion in daily transactions, and it is far easier to hedge risks related to the more popular benchmark. The SOFR index is based on the cost of borrowing cash overnight while putting up U.S. Treasury securities as collateral — a repurchase transaction, or “repo,” that’s critical to the global financial system.
The repo market is not immune to hiccups — rates shot up in 2019 during a brief period of volatility. But the transactions are generally viewed as exceedingly safe, and their interest rates don’t change much in times of stress.
Years ago, many regional banks pushed back on the adoption of SOFR, saying that the industry needed a rate that would reflect financial stresses in real time. When credit conditions are tight, interest rates go up, and the banks were seeking an option that reflected that relationship.
Libor was a credit-sensitive rate and thus spiked during times of financial market stress — such as in 2008 and 2020 — which gave banks more compensation to make up for larger risks. But the rate was merely an estimate developed by a handful of bankers in London, and its subjective nature opened it up to the rigging that led to its demise.
BSBY was based on actual transactions, not estimates, from more than 30 larger U.S. banks, though Gensler argued that the pool of transactions was too small, giving BSBY some Libor-like flaws.
The SEC chairman has not publicly said anything similar about Ameribor, another credit-sensitive rate that reflects the cost of bank-to-bank lending on a platform called the American Financial Exchange. The Ameribor rate, which is based on transactions made among hundreds of banks, has gained some traction among smaller banks and has sought to add more banks to its platform.
John Shay, CEO of the American Financial Exchange, said in a statement after BSBY’s announcement that the “AFX marketplace and supporters of AMERIBOR are undaunted.” The company’s website says “one size does not fit all” and argues that Ameribor gives banks a credit-sensitive choice that reflects their “own unique local conditions.”
“Things are changing rapidly, and our early adopters understand this and are responding to it,” Shay said. “Our hope is to draw in more liquidity providers while providing technological improvements that further streamline the trading process.”
During the third quarter, net charge-offs rose to 0.11% of average loans at the regional and community banks that Stephens Inc. covers, up from 0.04% a year earlier. Those numbers include both consumer and commercial charge-offs.
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Move over, deposit costs. The health of commercial borrowers is now a major source of hand-wringing among bank investors.
Problems in business loans have risen in recent months as companies that were in a weak financial position have started closing up shop. The environment remains relatively benign, and few analysts expect the credit worsening to get nearly as dire as it did after the 2008 financial crisis.
But it’s clear that the starting gun has gone off in what analysts call “credit normalization.” Bank loans were unusually healthy during the pandemic, but now more commercial borrowers are running into trouble, and bankers are starting to write off soured loans.
Some bankers have described the issues as “one-off” problems with specific borrowers, rather than anything indicating broader stresses in their loan portfolios. But investors worry those isolated events will start piling up next year. The difficulty in gauging which banks will face more trouble is prompting many stock buyers to stay away from the sector as a whole.
“The problem that a lot of these investors are facing right now is that it’s hard to get your arms around credit quality and how the banks are going to perform in a worse credit environment,” said Andrew Terrell, a bank analyst at Stephens.
During this year’s third quarter, net charge-offs rose to 0.11% of average loans at the regional and community banks that Stephens covers, up from 0.04% a year earlier. Those numbers include both commercial and consumer charge-offs.
U.S. consumers experienced stress earlier than businesses, as inflation, high interest rates and depleted savings caused some to fall behind on their credit card payments. At many credit card issuers, charge-offs are nearing or have already surpassed pre-pandemic levels.
Regional banks have been relatively insulated from consumer pressures since many of them have smaller consumer books. But worries over their commercial real estate portfolios persist, and their non-real-estate loans to commercial borrowers are starting to turn, even if problem loans remain at mild levels.
One recent corporate bankruptcy caused some tremors. Mountain Express Oil, a Georgia-based company that distributed oil to hundreds of gas stations, had gotten a $218.5 million loan from a group of banks. But the oil distributor filed for liquidation, and the banks involved in the loan now say they’re unlikely to recover any of the money they lent. That’s a tougher pill to swallow than a reorganization bankruptcy, where some recovery is likely.
The 100% loss rate was unexpected and added to investors’ usual wariness of banks’ participation in syndicated loans, said Chris McGratty, an analyst at Keefe, Bruyette & Woods. Unlike loans directly to businesses, syndicated loans leave banks at a distance from the borrower, which means they have less control when things go south. Losses tend to be larger and less predictable.
In their third-quarter earnings calls, the CEOs of affected banks said the Mountain Express Oil issue was a one-time event. And they expressed confidence in the rest of their syndicated loan exposures.
Other than that one loan, the balance sheet at First Horizon “continues to perform very well,” CEO Bryan Jordan told analysts last month. The Memphis, Tennessee-based bank led the Mountain Express Oil syndicated loan.
Concerns over the oil distributor’s bankruptcy were understandably “magnified,” since it followed a long period where investors didn’t have to worry much about the health of bank loans, KBW’s McGratty said.
“There’s going to be a normalization process — it’s well underway,” he said. “It’s still fairly good, but the trend is moving against us.”
Nowhere is that trendline clearer than in the trucking sector, which is in dire financial straits after booming during 2020. Consumers spent big on furniture, electronics and appliances as they stayed home during the pandemic. But they rapidly shifted toward travel, entertainment and restaurants as the world reopened, causing a crisis for trucking companies that suddenly had less inventory to ship.
The trucking giant Yellow Corp. filed for bankruptcy in August, part of a bloodbath that’s taken down decades-old companies.
A large concentration in trucking loans appears to have been behind the failure of a small community bank in Sac City, Iowa — the fifth bank failure this year. The bank was tiny, with just $66 million of assets, but regulators had previously dinged it for being too exposed to trucking and shut it down because of “significant loan losses.”
Trucking loans likely make up a far smaller share of total loans at many other banks, which can get in trouble with regulators for being too exposed to any one sector. But any loan losses in one area lower the cushion they’ve built up to absorb troubles elsewhere.
Other commercial sectors don’t appear to be undergoing that kind of pain, said Stephens’ Terrell. But within various industries, some companies that were already struggling are suffering as high interest rates take a toll.
“When times are really good, you’ve got air cover to restructure anything you want,” Terrell said. But as the cycle turns, the “weakest operators go first.”
Bankers say they’re keeping a close eye on their commercial real estate portfolios, particularly office loans. Occupancy rates in office buildings have fallen amid the rise of remote and hybrid work. Banks are stashing away reserves in case those loans go bad and are marking more CRE loans as “nonaccrual” credits, according to the ratings firm Fitch Ratings.
Any problems will likely “disproportionately weigh on regional banks, which have relatively higher CRE exposure,” Fitch analysts wrote in a note this week.
“However, banks are generally well positioned to absorb further ‘normalization,’” they wrote.
