When do credit problems move from one-off to trend?

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As new signs of deteriorating credit quality crop up at small and midsize banks, industry observers watch to see if a series of isolated incidents will become a trend.

A number of community banks reported credit issues that most characterized as episodic while touting solid overall underwriting practices. Suspected borrower fraud was also cited by a number of lenders.

Credit issues involved a wide variety of sectors, including a health care facility and a refinery at WSFS Financial in Wilmington, Del.; a mortgage warehouse firm at Customers Bancorp in Wyomissing, Pa.; and agricultural borrowers at Great Western Bancorp in Sioux Falls, S.D.

Still, there were enough issues to causee investors and analysts to take notice.

“There’s at least reason for caution,” said Mike Matousek, a trader at U.S. Global Investors. Commercial borrowers, on the whole, are highly leveraged and could struggle to make loan payments if their earnings take a hit.

“It doesn’t mean anything is imminent, but investors don’t want to get caught behind the curve,” Matousek warned.

Bankers made it clear during second-quarter earnings calls that they believe their teams have credit under control.

“While reporting credit losses stings, we still are fundamentally confident in our team, our discipline,” Paul Murphy, chairman and CEO of Cadence Bancorp., said during the Houston company’s call. “We don’t view this as systemic.”

Net charge-offs at the $17.5 billion-asset Cadence spiked in the second quarter — rising to $18.6 million from $600,000 a quarter earlier — as four loans soured. The credits spanned three states and borrowers in the energy, restaurant and supply management sectors.

Several more banks reported issues in the second quarter.

The $3.5 billion-asset HomeTrust Bancshares in Asheville, N.C., recorded a $5.7 million loan-loss provision after charging off $6 million loan to a heavy equipment contractor that unexpectedly shut down. Franklin Financial Network in Franklin, Tenn., charged off $7.5 million tied to a shared national credit.

Franklin hired an outside firm to perform a “top-to-bottom review” of its corporate and health care portfolios, including shared national credits, J. Myers Jones III, the $4.1 billion-asset company’s interim CEO, said during its quarterly call.

There were no “material risk rate changes,” Jones said. “This is effectively a clean bill of health at this given point in time. Aside from the single event, our credit metrics and asset quality remained strong.”

Wintrust Financial in Rosemont, Ill., had $22.3 million in net charge-offs in the second quarter, or quadruple what it recorded in the prior quarter. The biggest charge-off, totaling about $8 million, was tied to a loan participation with another bank and a private equity-owned construction company.

“You're probably asking yourselves whether these increased credit losses represent a trend,” Ed Wehmer, Wintrust’s CEO, said during the $33.6 billion-asset company’s earnings call. “We do not believe that the second quarter represents a trend, but as we all know credit cannot be this good forever.”

Wintrust will “continue to look through the portfolio for any and all cracks and exit relationships where cracks are found,” Wehmer added. “We don't try to kick the can down the road.”

To be sure, U.S. banks entered the second quarter on sound footing. At March 31, net charge-offs totaled just 0.14% of total loans at banks with less than $10 billion in assets, according to the Federal Deposit Insurance Corp. Noncurrent loans represented just 0.81% of loans at those banks.

“But when you start seeing more loan losses happening, you do get more people asking, is this just noise or is it the beginning of a trend?” said Lawrence White, an economist and professor at New York University’s Stern School of Business.


“I don’t think we can answer that yet, but the longer this cycle stretches, I think the more likely it becomes that we could see a trend form,” White added. “At some point, a downturn is inevitable.”

There is concern among bankers that lower interest rates and a slowing economy could convince some lenders to become more competitive with rates or loosen underwriting standards.

Wehmer said Wintrust is already seeing some loosening, adding that his company could tap the brakes on lending to stay disciplined.

“We'll not be afraid to stop the boat, as we have in the past,” Wehmer said.

Murphy said the economy remains strong heading into the second half of the year, and that Cadence’s customers, overall, are growing and profitable.

“I know that the longer we’re in a cycle, the possibility of a recession is something that we have to look at,” Murphy said. “Moving towards a more conservative place on the portfolio risk level, with leverage, is the direction we have chosen to go.”

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