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Are We Out Of The Woods Yet?

Posted on April 22, 2021 Published by

Are we out of the woods yet? Have we turned the economic corner on the COVID pandemic? Is that a light at the end of the tunnel? Or is it an oncoming freight train about to run us over? Do I really need to wear two masks if I have had the COVID vaccine? We will tackle these and other burning questions this month! And you thought this was going to be boring!

Are we out of the woods yet?

Whether we are talking individual health impacts or the economic impacts on specific businesses after 12 months of dealing with a highly infectious respiratory disease, Captain Obvious has made it clear that in both instances, the impacts have not been the same for everyone. While nearly 99% of the people who test positive for the COVID virus will survive, the health impacts can range from asymptomatic or minor sniffles to hospitalization and death depending on such factors as age and existing medical conditions. The same is true in the business environment. While many businesses have survived and some have even prospered, other businesses and whole industries have been more seriously compromised.

Tom Cronin gave a presentation to Risk Management Association members on March 25, 2021. Using loan quality data compiled by Risk Analysis Service through February 28, 2021 from reporting banks, it is apparent that certain industries were extremely hard-hit while others, having stumbled, are nearly back to pre-pandemic loan quality levels.

(Note that this is not a measure of revenue, profitability, or balance sheet strength of a given industry or business, but rather a measure of how credit quality fared through the pandemic. Undoubtedly, this may be more a measurement of management’s ability to adapt to the changing business environment than overall economic health.)

Loan Perspective

From a C&I perspective, non-accrual loans currently stand at 0.93% which is certainly up from 2020 but has remained relatively flat over the last several months. Although non-accrual loan balances increased across nearly all industry sectors, the largest increases occurred in 1) Mining, Oil and Gas; 2) Arts, Entertainment and Recreation; 3) Accommodations and Food Services; and 4) Retail Trade. As will be discussed later, not all segments of these industries were equally impacted.

Of particular interest in the presentation was a “stacked” analysis of total non-accruing and criticized accruing loans (special mention and classified). This analysis was interesting from a couple of perspectives. First, the relative mix of non-accrual loans to criticized accruing loans may give some insight into future problem loans. Second, not all business types within a given industry class were impacted equally. The top three industry groups as measured by the greatest percentage of loans in this portfolio “stack” were Mining, Oil and Gas at over 23%, followed by Arts, Entertainment and Recreation, and Accommodations and Food Services at nearly 20% each.

However, the level of non-accrual loans in the Mining, Oil and Gas group were 8.9%. This was more than the top six industry groups combined. There were also significant differences within industry groups; for example, Fitness was the hardest hit in Arts, Entertainment and Recreation, while restaurants exhibited the worst numbers within Accommodations and Food Service.

Top Five Industry Groups

Also, in the top five industry groups were based upon total percentage of non-accrual, special mention and criticized loans were Transportation (air, water, and truck) at approximately 17% and Retail Trade at approximately 13.5%. Within Transportation, airlines and cruise ships made up the majority of problem loans. In the Retail segment, non-store direct sellers including “lunch wagons” were the most significant non-accrual totals. But, the lowest overall totals, whereas general merchandise retailers had the highest percentage of total outstandings in this “stack” but lowest level of non-accruals. Given that this group has the highest total of loans outstanding, it may be a leading indicator for where the highest potential for problems exists.

CRE is exhibiting similar trends but seems to be lagging a bit to the C&I portfolio. Overall, non-accruals were at 0.29% in May 2020 but reached 1.28% by January 2021. As one might expect based upon C&I results, the lodging sector is exhibiting the largest negative non-accrual trend. After being flat through May of 2020 at 0.5%, non-accruals rose to nearly 9% by year end 2020. The bad news does not stop there. 45% of the lodging portfolio outstandings is made up of non-accrual, classified, and special mention loans. This is likely an indication of more issues on the horizon.

Retail and healthcare show similar characteristics as non-accrual represents 1.8% and 1.5% of their respective group. Total non-accrual, classified and special mention at 7% and 6%, respectively. CRE trends overall have shown a relatively flat percentage of special mention and classified loans. However, the trend has been a shift away from special mention into classified suggesting an ongoing deterioration.

Conclusions

So, what conclusions might we draw from these numbers? I suppose the glass may be half full as the negative trends in the C&I portfolio appear to have moderated or stabilized. The glass may be half empty for the CRE world as the sectors with the largest totals of non-accrual, special mention, and criticized loans are seeing a deteriorating quality trend. Surprisingly, the Office segment has not seen a significant increase in nonaccruals to date. However, special mention is the largest portion of the adversely rated portfolio which may be a crystal ball if it follows the pattern of other industry segments.

So, what about our original questions?

No, it does not appear that the light you see is a freight train about to run us over. From a credit quality standpoint, we may have turned the corner as it relates to the C&I portfolio (not to say we will not see some future deterioration). However, there are industries within the CRE portfolio showing migration to higher risk profiles. They will require a long-term recovery (if at all). So, while we may not be out of the woods, we can certainly see the edge of the field.

 

Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape. We lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.

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“By questioning some of our methodologies, Enlighten has helped us say, ‘Okay, this is where we need to train staff better and focus on so that they understand what they're doing better.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“The organization of the communication — before, during, and after the reporting process — was certainly better with Enlighten than what I've experienced with a lot of auditors.”
— Bill Beardsley, President, Michigan Business Connection
“The staff at Enlighten have been available for questions, in addition to the engaged work that they do. They've been very helpful as a resource beyond the major audit.”
— Meghann Kasper, Chief Credit Officer, Bank First
“Enlighten gives us a very good second set of eyes on our transactions. They're not afraid to challenge us on some of the work that we've done, which is what is needed. I don't need to pay somebody to tell me I'm good, I need to pay somebody to tell me where I've made mistakes.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“Enlighten provided industry best practices that weren’t going to show up in an audit report. They would say, ‘Hey, I noticed you do this. This is really unique, you do a really great job of it.’ And then they might add, ‘Some other clients that I have are doing something like this.’”
— Bill Beardsley, President, Michigan Business Connection
“By questioning some of our methodologies, Enlighten has helped us say, ‘Okay, this is where we need to train staff better and focus on so that they understand what they're doing better.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“The organization of the communication — before, during, and after the reporting process — was certainly better with Enlighten than what I've experienced with a lot of auditors."
— Bill Beardsley, President, Michigan Business Connection