Midsize banks brace for loan defaults, more margin pressure

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Midsize banks are preparing for more credit losses, uneven loan demand and ongoing pressure on net interest margins, but is unclear just how long they will need to hunker down.

Simmons First National in Pine Bluff, Ark., F.N.B. Corp. in Pittsburgh and Old National Bancorp in Evansville, Ind. — among early reporters for banks with $20 billion to $40 billion in assets — all had similar forecasts for investors.

Margins are narrowing and each bank is paying close attention to credit, especially in the hospitality and retail sectors. The true pain of charge-offs at many midsize banks may not be felt until the first half of next year, and it anyone’s guess when loan demand will regain momentum.

Such uncertainty will likely hang over banks for some time, industry experts said.

“We’ve seen a lot of government stimulus, a lot of loan forbearances that have delayed” credit problems, said Jon Winick, CEO of Clark Street Capital. “Will they delay things long enough to get people to return to normal at some point next year? Obviously, nobody knows. I think there could be a lot of trouble ahead.”

“That uncertainty keeps pressure on bank stocks,” said Mike Matousek, a trader at U.S. Global Investors. “Investors are hungry for more clarity on what lies ahead.”

Elevated loan paydowns have exacerbated the shrinkage in Simmons’ loan portfolio, while pressuring its margin. Total loans, excluding Paycheck Protection Program balances, fell by 4.4% from a quarter earlier, to $13 billion. The margin compressed by 21 basis points, to 3.21%.

Banks need stronger volume to offset the yield pressure, but Simmons said it expects balances to keep declining.

“What we're seeing in the marketplace is our customers are deleveraging,” George Makris, Simmons’ chairman and CEO, said during the $21.5 billion-asset company’s earnings call.

"They're paying off their debt and … not taking on any new risk,” Makris added. “Until we see more certainty in the economy that gives our customers more encouragement to invest, we're a victim of that uncertainty."

F.N.B. executives shared a comparable story.

“I think there's been a little bit of caution in terms of capital investment,” CEO Vincent Delie said during the $37 billion-asset company’s quarterly call.

“Commercial borrowers have been a little more conservative,” Delie added. “We're in an election year. There's a lot of things that can potentially change relative to their businesses. We're still going through the pandemic. So that's not over yet.”

Excluding PPP originations, loans at F.N.B. fell by 2% from the second quarter, to $23.2 billion. Its margin compressed by 9 basis points, to 2.79%.

Old National was an outlier in terms of loan growth. Its portfolio, excluding PPP, increased by 2.5% from a quarter earlier, to $12.4 billion on Sept. 30. It reported pockets of momentum, including a surge in multifamily lending in the Minneapolis suburbs.

Loan pipelines remain healthy in the fourth quarter, Chairman and CEO Jim Ryan III said during Old National’s earnings call, though he emphasized that the $22.5 billion-asset company is cognizant of the pandemic’s potential to curb the number of creditworthy borrowers.

“We will continue to make new loans if we are comfortable with the underlying cash flow structure and pricing,” Ryan said. “The loans we’re booking today are generally with better structures than we would have accepted last year.”

Old National, like other midsize banks, felt the sting of lower loan yields. Its margin compressed by 11 basis points, to 3.03%.

And threats to credit quality remain.

At Simmons, the ratio of nonperforming loans to total loans increased to 1.20% in the third quarter from 0.91% a quarter earlier. The ratio was nearly double that of a year earlier.

Two large loans — one tied an under-construction hotel and the other connected to a student housing project — accounted for most of the increase, Makris said, though Simmons does not currently expect losses on those loans.

The credit outlook, Makris said, remains difficult to gauge given the unknown duration and ultimate impact of virus outbreaks.

“We're trying to err on the side of caution” while assessing the potential for future loan losses, Makris said.

Executives at F.N.B. said they anticipate more losses in deeply affected areas such as hospitality.

F.N.B. set aside nearly $23 million in the third quarter to cover potential losses in the hotel and restaurant sectors. The company has migrated a majority of its hotel portfolio and about 25% of its restaurant book to either classified or special mention status — indicating the potential for further stress.

Old National is also bracing for hits to credit quality, though the timing remains uncertain. Nonperforming loans and the loan-loss allowance at Old National, increased modestly during the third quarter.

"We still don't know when losses will meaningfully materialize, but we expect sometime in the first half of next year depending on additional government stimulus programs," Ryan said. While credit quality has held up so far, “we expect that credit metrics will ultimately worsen and losses will materialize once the stimulus and deferral programs run their course."

"We're only really less than two full quarters into this,” added Daryl Moore, Old National’s chief credit executive.

“As we see interim financial information from our clients, it's just really hard to try to understand what ultimate losses are going to come,” Moore added. "Further downgrades into the nonperforming category are certainly a strong possibility with the pace and magnitude dependent in some part on the continued impact of the pandemic.”

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Earnings Net interest margin Commercial lending Credit quality Coronavirus
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