Wary outlook for loan growth after PPP boost

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A word of caution about any second-quarter loan growth banks report: Take it with a grain of salt.

While some banks could hold more loans at midyear, much of the new volume will likely be tied to the Paycheck Protection Program, which was designed as short-term assistance for small businesses hurt by the coronavirus pandemic.

There is also a good chance many banks will report lower loan balances, even with the help of PPP originations. Total loans at banks fell by 1.5% during the first half of June, according to data compiled by the Federal Reserve.

“It’s just a very hard environment to see [what borrower] is going to be a good credit and who’s going to be a challenge,” said Jon Winick, CEO of Clark Street Capital in Chicago. “It’s going to be very difficult to develop new business.”

As a result, banks will be pressured to sharpen their focus on niche lending, businesses such as mortgage refinancing that bring in fees, and expense management. Those topics are expected to come up frequently as banks host their second-quarter conference calls.

To be sure, the Paycheck program will be a bright spot when banks report second-quarter results. Banks made more than $500 billion in PPP loans during the second quarter, based on Small Business Administration data.

But with the program winding down, those loans will start to roll off banks’ books. They will be hard to replace.

“We suspect organic loan growth … will remain muted,” the research team at Piper Sandler said in a recent note to clients. They pointed to “lower demand in general” tied to a sluggish economy hampered by the pandemic.

“While there are pockets of opportunistic growth within our coverage universe, we suspect material loan growth will be challenging in the quarters ahead,” the Piper Sandler team added.

“There is still a lot of uncertainty in the outlook,” said Scott Brown, Raymond James’ chief economist. While there was some recovery in May as states began to reopen their economies, the “improvement after the initial rebound will slow, barring a vaccine or effective treatment for COVID-19,” Brown said.

“Significant challenges” will exist for the rest of the year and “risks remain weighted predominantly to the downside,” Brown said. Since heavily populated states such as California, Florida and Texas have already paused their reopening plans, more economic contraction is possible, he said.

Those pauses could harm loan demand and shrink an already shallow pool of creditworthy borrowers, industry observers said.

Some banks hope to deepen ties to customers obtained through the PPP, while others are scouring for industries that may recover faster than others.

Dean Athanasia, president of Bank of America's consumer and small business segment, said that the Charlotte, N.C., company’s health care clients, such as dental practices and veterinary clinics, are building back up quickly after temporarily shutting their doors to comply with state lockdown orders.

"They're ready to get back in business” and address customer backlogs, Athanasia said at a June conference. While dental, medical and veterinary clients had accounted for a large share of BofA’s small-business loan deferral requests, more than 90% of those businesses have told the bank they do not need another deferral.

There may be lending opportunities tied to those businesses, including credit lines to bridge the gap from recession to recovery or, over time, loans to finance expansions as things normalize.

Still, BofA struck a generally cautious tone on loan growth overall. Most banks have done the same.

JPMorgan Chase in New York said it is still attracting new customers, but at a much slower pace.

“You're much more likely to see us be more on the conservative side," Gordon Smith, CEO of JPMorgan’s consumer and community banking business, said during a June conference.

Banks are actively refinancing mortgages and collecting fees as homeowners take advantage of historically low interest rates stemming from the Fed’s efforts to drive down rates and stimulate the economy.

Mortgage applications for the second week of June were 21% higher than a year earlier, according to the Mortgage Bankers Association. It was the highest volume in 11 years, with refinancing accounting for more than 60% of the applications.

Refinancings could exceed $1.3 trillion this year, which would be the highest total since 2012, said Joel Kan, the MBA's associate vice president of economic and industry forecasting.

But it could prove difficult for banks to increase overall fee income.

The Piper Sandler team said that they expect second-quarter fee income to decline and that they believe noninterest income could rise by just 1.5% in 2020 from a year earlier. That forecast hinges on some form of economic recovery over the second half of the year.

With that in mind, banks will likely outline more plans to cut costs. Some have already teased out plans to close branches and reduce headcount and office space ahead of reporting quarterly results.

“Consumers and businesses banked virtually throughout the lockdown with few issues, providing another data point that banks’ physical delivery systems can be significantly downsized and further digitized,” said Michael Perito, an analyst at Keefe, Bruyette & Woods.

“With investor focus beginning to shift towards pretax pre-provision earnings, occupancy cost reductions could play a critical role in protecting core profitability,” Perito added.

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Commercial lending Consumer lending Paycheck Protection Program Small business lending Coronavirus