A recent wave of elevated charge-off announcements is a sign that credit normalization is on the horizon.
The bankruptcy of an oil company is expected to drive up net charge-offs (NCOs) at First Horizon Corp., United Community Banks Inc., Synovus Financial Corp. and Hancock Whitney Corp., which already disclosed their expectations, and several other banks that participated in
Credit quality metrics have remained largely pristine since government stimulus helped shield banks from losses during the COVID-19 pandemic in 2020, but now the Street is wondering if the recent wave of elevated charge-off announcements is idiosyncratic or indicative of a widespread normalization of credit quality.
"I just don't buy the argument that it's a one-off and don't worry about it," Christopher Marinac, director of research at Janney Montgomery Scott, said in an interview. "It's the question of how much we see. How bad is the storm? Are we going to get several inches of snow as we go through this?"
Normalization forthcoming
Speaking at Janney's Community Bank Forum last week, analysts agreed that charge-offs are likely to increase over the next few quarters, but the upticks might not be cause for concern.
"Are they starting to build up or pick up in charge-offs? Yes," Janney analyst Dan Cardenas said during the conference. "Is it substantial? Not necessarily."
In a Sept. 22 note, Hovde analysts predicted that criticized assets levels will rise, but given the current historically low levels of problem assets, "it will initially be hard to discern if things are returning to some level of normal or weakening materially," they wrote.
As credit quality metrics begin to normalize, banks will be better prepared than they have been in the past thanks to the current expected credit loss model (CECL). Under CECL, banks are more proactive about building provisions and intervening early when credit issues come up, Marinac said.
"There is a steady increase of reserves and higher provisions," Marinac said. "There's a flexibility that companies have to take a charge off, write something down or perhaps sell that out."
US banks' provisions have steadily climbed for the most part since the beginning of 2022 and reached their highest level in three years during the second quarter, according to an analysis by S&P Global Market Intelligence.
Regulators are also being proactive with credit quality, urging banks to identify credit issues as soon as they become aware of them and to take immediate action.
"[Regulators are] really looking to see how banks are managing that," Citizens Community Bancorp Inc. Chairman, President and CEO Steve Bianchi said during the Janney conference. "Are you observing them and are you charging fees or raising the interest rate or getting more collateral?"
Commercial real estate concerns
Commercial real estate (CRE) will be a particular pain point for banks as credit quality normalizes. Those cracks have already started to show as the industry's overall CRE NCOs surged in the second quarter.
However, not all CRE exposure is the same, Janney analyst Feddie Strickland said during the conference. For example, office CRE loans in urban markets can present more risk than office loans in more suburban and rural markets, he said.
"There's a big difference between an office in Portland, Maine, versus San Francisco or Manhattan," Strickland said. "It's unfair to paint with a broad brush."
OceanFirst, for example, operates in metropolitan markets such as Philadelphia, Atlantic City and New York. The credit that OceanFirst recently announced it is charging off represents 13% of OceanFirst's $130 million portfolio of loans secured by office buildings as of Aug. 31, and the company expects the charge-off will be 45% to 50% of its total exposure.
In contrast, Eau Claire, Wis.-based Citizens Community Bancorp has not seen significant changes in credit quality because its midwestern markets do not experience the same "peaks and valleys" that take place in large metro markets, the company's CEO said during the Janney conference. More employees work from the office in Citizens Community Bancorp's markets than in major metropolitan areas, Bianchi said.
"We really don't have that exposure and to the extent that we have office buildings taller than two stories in our markets, it's pretty tough to find," Bianchi said.
