Bankers forced to guesswork as loan deferrals increase
Banks that rushed to grant forbearance to distressed borrowers are now trying to assess the underlying condition of the deferred loans.
Many lenders, especially those that have complied with the Current Expected Credit Losses standard, have experienced significant loan losses provisions in the first quarter, using their best estimates and models – as well as a heavy dose of guesswork – to assess their exposure to industries hard hit by the coronavirus outbreak.
The forbearance, although it can last for months, does not last forever, leaving bankers and industry watchers to speculate on how many deferred loans will be unrecoverable. The potential damage will depend heavily on the severity and duration of the pandemic and its consequences.
A cloudy view of credit quality also makes it more difficult for banks to assess risk and establish the terms and conditions of new loans, industry observers have said.
“The pandemic is forcing banks to forbear, which in turn creates a short-term muddy windshield on the actual credit quality of banks,” said Christopher Marinac, analyst at Janney Montgomery Scott.
Nearly 14% of commercial loans and 8% of mortgages were in arrears as of March 31, according to Keefe, Bruyette & Woods analysis of around 180 publicly traded banks with total loans of $ 5.5 trillion. About 5% of other consumer credit has been deferred.
Deferrals represent a much higher percentage of total loans than nonperforming assets, suggesting borrowers are struggling, but not to the point that their problems show up in credit quality metrics.
“There is an underreporting of the true credit image given that there are so many deferrals,” Marinac said.
At Amerant Bancorp in Coral Gables, Fla., Deferrals – granted and requested – accounted for nearly a fifth of total loans as of March 31, but only 0.59% of its loans were classified as non-performing.
Although it has strong collateral requirements and conservative loan-to-value ratios, around 30% of Amerant’s loans are related to industries such as retail, hospitality, foodservice, entertainment and childcare. of children. Bankers talk to clients while trying to gauge their long-term prospects.
“In view of the relief requests granted, the management team has stepped up its oversight and monitoring of credit and liquidity risk and is working hard to understand and quantify the potential extent of the current pandemic on our business,” said Amerant CEO Millar Wilson at the $ 8. call for profits from a billion-asset business.
Deferrals also account for nearly a fifth of all loans from First Defiance Financial in Defiance, Ohio, while non-performing only represent 0.79% of the overall portfolio. Most of the postponements are for six months, and executives have expressed hope that by the fall, the economy will recover, allowing borrowers to resume their payments.
“At the end of the tunnel, these loans will have the same quality rating as long as certain business activities that support these loans return,” CEO Donald Hileman said during the company’s quarterly appeal for $ 6.5 billion assets. .
Like Hileman, many bankers and investors are hopeful that the pressure on the economy will ease in the coming months and that the second quarter will mark a low for the current credit cycle. If this turns out to be true, loans that have been deferred could rebound and high allowances in the first quarter would largely cover the losses.
But that’s the optimistic point of view.
“What if it goes on for a lot longer – or if it stops for a while and then comes back?” [down] later? “said Mike Matousek, trader at US Global Investors. He noted that prolonged unease increases the likelihood of substantial loan losses despite lender mitigation efforts.
Historically, consumer losses start with credit cards and then spill over into auto loans and mortgages, in the order in which people prioritize debt payments, Matousek said.
Major credit card issuers are already pulling out as they try to control their exposure.
Nearly 50 million U.S. credit card customers said their credit limits had been reduced or their cards had been closed in recent weeks, according to a LendingTree survey. One in four Americans said their issuer had changed the terms of their card since the start of the pandemic.
Discover Financial said it has enrolled nearly 500,000 accounts in its automatic payment programs, although it has also warned that the postponements may prove insufficient to mitigate the impacts of the pandemic.
“Due to the nature and novelty of the crisis, our credit and economic models may not be able to adequately predict or forecast credit losses,” Discover warned in a statement to Bloomberg. “The pace of the recovery is uncertain and unpredictable. “
History may prove to be an unreliable guide to commercial loans, given the virus’s unprecedented impact on foot traffic. But concerns are growing that almost all sectors could struggle if an economic recovery stalls in the second half of 2020. Banks’ commercial loan portfolios could be under further strain.
In addition to opting out in areas such as credit cards, lenders will likely be reluctant to seek new arrangements – beyond federal programs such as the Paycheque Protection Program and the Main Street Loan Program – until they have a better understanding of their current exposure.
The last Federal Reserve investigation senior loan officers have also found that it has become more difficult to qualify for loans in all major categories.
“Overall, the survey gave us a picture of an industry in which standards have tightened at all levels,” Piper Sandler’s research team said in a recent note to clients.
The shock “came so quickly – there was no slow decline in liquidity or the normal measures used by banks to forecast credit problems,” said Dallas Wells, senior vice president of the strategic innovation at PrecisionLender, a division of Q2 Holdings that provides pricing and portfolio management. advice to banks and other lenders.
“A significant portion of the portfolio hit the wall at times,” Wells added. “Under these circumstances, it is almost impossible to assess the risk because there are no indicators on how to do this stuff.”