Banks aren’t done building credit reserves just yet

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Bankers are bracing for a wave of loan delinquencies and defaults as forbearances on loans granted at the start of the coronavirus pandemic are set to expire.

Just a few months after signaling that provisions for loan losses had peaked, many banks now say they will need to continue adding to reserves into 2021, according to a survey released Thursday by IntraFi Network.

Most banks have allowed borrowers to skip payments if their finances had been hit hard by lockdowns and other restrictions meant to slow the spread of the virus, but many of those grace periods have recently expired or will expire by the end of the year. In the survey of 512 bank CEOs, presidents and chief financial officers, two-thirds of respondents said that they expect loans will need to be restructured for borrowers who are unable to make payments when their deferral periods end.

The survey of executives at community banks, most with assets of less than $10 billion, took place during the first two weeks of October, before a rise in new COVID-19 cases threatened more lockdowns going into the Thanksgiving and Christmas holidays.

Reserve builds were thought to have peaked in the second quarter, when stay-at-home orders ground much of the nation’s economic activity to a halt.

By the third quarter, though, many banks were setting aside less for loan losses than previously anticipated, and some even began releasing reserves because many borrowers who had received forbearance were again making monthly payments.

IntraFi’s survey indicated that bankers now see the timeline for an economic recovery being pushed out further into 2021 and perhaps 2022.

“The longer [the pandemic] goes on there is more weariness and concern,” said Paul Weinstein, a senior policy adviser at IntraFi. “We’re at a point where people are settling in for the long haul."

According to the survey, only 17% of executives said that they expect reserve builds to peak this year while 72% predicted that the peak would come sometime in 2021. One in 10 even predicted that their banks would need to keep adding to loan-loss reserves into 2022.

There was some optimism in the survey around loan growth, which has been a source of heartburn for an industry that has seen its margins squeezed from low rates. Forty-six percent of respondents anticipated loan demand would improve over the next year, up 10 percentage points from second-quarter survey. Given how the dire economic conditions were at the start of the pandemic, Weinstein said he’s not surprised banks are somewhat more optimistic about loan demand.

“I think it’s just more banks..refining their outlook more so than anything else,” Weinstein said.

Executives were split on how long rates would remain compressed. While the Federal Reserve has indicated it would keep borrowing costs at record lows through 2023, executives were split on whether they believed the forecast. Forty-two percent of bankers said they think the Fed would move sooner and adjust rates before 2023, while 43% expect the central bank would keep them level through that time.

Banks also had different expectations on how they would handle branch networks that have emptied during the pandemic. Nearly all bankers said they have seen foot traffic at their branches fall while mobile app users have increased, but 74% of respondents said they had no plans to cut their number of branches.

This sentiment did vary based on size. Twenty-five percent of executives from banks with between $1 billion and $10 billion of assets said they had plans to reduce branches, while just 4% of those at banks with less than $1 billion of assets said they were anticipating closing some offices for good.

In recent weeks, a number of small regional banks, including the $19.9 billion Atlantic Union Bancshares in Richmond, Va. and the $21 billion-asset First Midwest Bancorp in Chicago have announced plans to shutter branches due to declining foot traffic and customers’ accelerated migration to digital channels.

Still, the survey results showed the banks still believe their physical locations are important for long-term marketing and cross-selling products, Weinstein said. He added that small banks in particular could be hesitant to close branches that also serve as main offices.

“Maybe it’s that banks believe their branches are central to their communities and once this pandemic is over they will be central again,” Weinstein said.

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