Banks in Indiana and elsewhere have recently begun to bolster their reserves against potential loan losses, though they also say they don’t yet see clear signs of trouble ahead.
Despite fears of an economy-wide recession and outright easing in the tech sector, banks are not reporting any signs of trouble in their loan portfolios. At the same time, many banks that reduced their reserves last year are rebuilding them.
“We’re at a very interesting point in the emergence of the credit cycle right now,” said Scott Siefers, New York-based senior research analyst and managing director of Minneapolis-based Piper Sandler Cos. “I think we all intuitively feel like tougher days are emerging, and they’ll probably be with us in several months and maybe next year, but we don’t see just no real deterioration now.
Siefers focuses on banking and follows companies such as Old National Bank, based in Evansville, and Merchants Bancorp, based in Muncie.
Each quarter, banks decide how much money they will set aside to cover possible loan losses. This amount, called the allowance for credit losses, can vary from quarter to quarter. If a bank feels that it could incur larger losses in the future, it can increase its quarterly provision. If a bank believes that its reserves are sufficient and the credit quality is good, it can also record a negative provision by releasing part of its reserves.
At the start of 2020, banks built up huge loan loss provisions because they feared the pandemic would trigger a wave of loan defaults. Those defaults did not happen and, in fact, credit quality has been much better than expected since then, with many banks reducing their reserves because their loans were performing so well.
Much of the reserve build in the last quarter, Siefers said, has to do with loan balances rising. As a bank’s loan portfolio grows, the amount needed to protect against potential losses also increases.
Nathan Stovall, an analyst at S&P Global Market Intelligence, said S&P “fully expects” banks to increase their loan loss provisions this year, partly because of overall loan growth and partly because credit losses are expected to return to more normal levels over the next year.
“You can’t have this abnormal [low] the level of loan losses continues,” Stovall said.
But he stressed that he does not foresee a sharp downturn ahead. “I just don’t think we’re in a situation where we’re going to see a serious short-term deterioration.”
Old National said loan growth and caution played a role in boosting the bank’s reserves last quarter.
During the second quarter, Old National added $9.25 million to its reserves for credit losses. That’s a notable change from the same period a year earlier, when the bank released $4.93 million from those reserves.
Old National chief financial officer Brendon Falconer said loan growth was a key reason for the shift. The bank ended the second quarter with $29.6 billion in loans, up from $13.8 billion a year earlier. (Old National acquired Chicago-based First Midwest Bank in February, which significantly increased Old National’s overall size and loan portfolio.)
And the bank’s credit quality remains solid: non-performing loans accounted for just 0.78% of Old National’s total loans last quarter.
“Credit quality has never been better,” Falconer said.
But economic uncertainty was also a factor in Old National’s decision to increase its reserves, he said.
The bank doesn’t see clear signs of trouble ahead, Falconer said, but “the [banking] the industry has had a track record of incredibly good credit quality for some time now…at some point it will just have to get back to normal.
Warsaw-based Lake City Bank recorded no provision for credit losses last quarter, having released $1.7 million from its reserves a year earlier.
Non-performing loans were just 0.2% of total loans last quarter at the bank; a year earlier, this figure was 0.19%.
But Lake City is also watching the economy carefully.
“We are closely monitoring the impact of current supply chain challenges, the impact of inflation and rising interest rates on our borrowers, and broader economic conditions,” the chairman said. and CEO David Findlay in Lake City’s second quarter financial announcement, released July 25. “While we are happy with our overall measures of loan quality, we will continue to look for any signs of a potential recession.”
At Fishers-based First Internet Bank, non-performing loans accounted for 0.15% of the bank’s total loans last quarter, which President and CEO David Becker said is “very close to a historic low for us”.
First Internet is focused on commercial banking, although it has consumer businesses, including a longstanding business in financing individual purchases of RVs and horse trailers. Despite inflation and high gas prices, Becker said, the bank has seen no increase in delinquencies in its RV loan portfolio.
First Internet added $1.19 million to its reserves last quarter, up from just $21,000 a year ago and $800,000 in the first quarter.
The quarter-over-quarter increase, Becker said, was “100% due to loan growth.”
JPMorgan Chase & Co. CEO Jamie Dimon made headlines in June when he advised investors to prepare for an economic “hurricane.”
Becker disagrees with this perspective, predicting that any future crisis will be more like a tornado – a targeted problem that causes problems for individual borrowers rather than a systemic problem that sweeps through and affects many people.
Becker also acknowledged the complexity of forecasting when so many factors are at play, including high employment numbers, but also high oil prices, troublesome inflation and the ongoing war in Ukraine.
“I don’t think there is an economist alive today who has tried to operate a crystal ball with all the factors in the world today,” he said. “The jury is still out on how this thing is going to end.”•