It is never too early to stand watch for credit cracks, especially when one bears in mind the pains caused by the financial crisis.
Most community banks continue to report solid metrics when it comes to credit. Still, some industries, such as taxi medallions and energy, have caused headaches for lenders. And even some individual banks that don't lend to those sectors were forced to shore up reserves during the third quarter.
To that end, more industry observers note that when it comes to credit, it is a matter of when, not if, things will take a turn for the worse.
"I'm seeing what I would call a sound basis of concern across several asset categories and across the country," Walter Mix 3rd, a former state banking commissioner who leads the financial services practice at Berkley Research Group in Los Angeles, said. "I think asset quality will rear its ugly head in 2016."
Next year will represent at least the seventh year of economic recovery, even if it has been lackluster, Mix said, noting that most recoveries last about a decade. "We're getting kind of late in that cycle … so it's natural to see deterioration," he said.
Credit issues, by and large, seemed rather isolated — and mild — during the third quarter, and at least one chief executive said his bank would quickly address its biggest problem loan. Still, there was enough concern about credit to prompt Comptroller of the Currency Thomas Curry to issue a warning last month about the growth of banks' indirect automobile lending portfolios.
Some bankers feel the same way.
"All I'm saying … is that my credit trouble crystal ball is flashing warning signs and we're paying close attention," Mitchell Feiger, president and chief executive of the $15 billion-asset MB Financial of Rosemont, Ill., said during an Oct. 16 conference call to discuss quarterly results.
Any turn in credit would end a long-running positive trend. The percentage of nonaccrual loans to total loans industrywide fell from 4.9% at the end of 2010 to 1.7% as of June 30, according to data from the Federal Deposit Insurance Corp.
Credit is always something to watch, but some industry observers are more concerned with interest rate risk. "More than anything else, we see banks offering more fixed-rate products and extending maturity in order to compete," Bharpur Singh, president of credit risk management consultant T. Gschwender & Associates in Syracuse, N.Y, wrote Tuesday in an email.
"The majority of the community bank loan portfolios we review continue to perform well," Singh added. "Most banks have set reasonable limits on the highly volatile speculative construction loans which caused some of the bank failures during the last economic downturn."
Still, several institutions reported mixed result in their credit metrics during the third quarter.
While no one would confuse MB Financial as a troubled bank — nonaccrual loans totaled just 0.98% of total loans on Sept. 30 — the company reported that potential problem loans increased by $6.5 million during the third quarter.
The $3.2 billion-asset Peoples Bancorp was forced to add $5.8 million to its loan-loss allowance after a loan to a coal-related business was reclassified as nonperforming and four other credits were added to a list of criticized asset. The Marietta, Ohio, company recorded a meager $670,000 loan-loss provision in the second quarter.
There is optimism that Peoples can resolve the issue with the coal-related loan, Charles Sulerzyski, the company's president and chief executive, told analysts during an Oct. 29 conference call. Sulerzyski said he understood the concerns that analysts expressed about Peoples' loan book, but he insisted that the company's underwriting and overall credit quality remains solid.
"If you look at the last four years … we've really had top-quartile performance" with credit, Sulerzyski said. "There's nothing that has fundamentally changed in our portfolio. There is nothing has fundamentally changed in our underwriting, and nothing really changed in the discipline that has gotten us here. That is why I have the comfort I have."
It is important to note that isolated credit issues cropped up after years of steady overall improvement, said Kevin Fitzsimmons, a managing director at Hovde Group in Chicago. "We've kind of gone as low as we can go in terms of net chargeoffs and provisioning," he added.
For now, one delinquency can cause a major blip in a company's results — a lesson Peoples learned. The company's nonaccrual loans totaled $21.1 million at Sept. 30, compared to $8.4 million at the end of 2014. The third quarter total still represents just 1.2% of total loans.
For most market watchers, the biggest reason to expect a correction reflects a realization that all positives trends have to come to an eventual end.
"How long can you keep benefitting from zero provisions, negative provisions and drawing down the allowance for loan losses?" Fitzsimmons said. "We're building in a higher degree of credit costs, not in a dramatic spike, but more as a normalization."
"We're closer to the next downturn every day and further away from the last one," Sulerzyski said, noting that the banking industry can stave off the next downtown by staying disciplined. Bankers must be willing to walk away from applications that fail to meet standards, rather than "follow each other down the drain."
For now, most bankers and industry observers are pointing to specific industries — such as energy, taxi medallions and indirect auto lending — as areas of concern. MB Financial's Fieger added companies dealing in commodities to his list, while Fitzsimmons mentioned chatter about softness in hospitality lending.
Mix, who was California's banking commissioner in the late 1990s, has expressed broader fears, stating that his biggest worries are focused on strategic risks taken by banks in recent years in response to persistently low interest rates and subsequent margin compression.
"They've gone into new business lines to create increased returns," Mix said. "We'll find out in the next several months how well those loans were underwritten."