Commercial Loans Spooking Some Banks

Commercial Loans Spooking Some Banks

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What could be more scary than high prices and even higher borrowing costs? Another 75 basis point increase in the Fed Funds rate on Wednesday, November 2nd. That’s what.

After having borrowing costs near zero for two years, the Federal Reserve has already raised interest rates by three percentage points this year (actually in the six months from March through September). Housing markets have responded in kind.

The U.S. Department of Commerce estimates that new home sales in September 2022 dropped 10.9% from August and 17.6% from September 2021. Home prices are also dropping as the interest rates to finance them rise.

The effect on the overall economy, though, tends to happen more slowly. There is a lag as consumers adjust their spending habits and businesses in turn, feel the impact. We took a look back to see what the result was the last time the Fed raised interest rates this quickly to see what we might expect this time.

Hold on to your broomsticks; we are expecting turbulence in the air.

After 9/11, a considerable amount of loosening was required to keep the country moving forward. The Fed Funds rate was lowered by 5.50% from January 2001-June 2003. A year later, a reversal was required and the rate was raised by 4.25%. These increases were all made in quarter point increments during a 2-year period June 2004-June 2006.

That’s not quite the same. Prior to that, in 1994/95 the Fed Funds rate was raised by 3.00% (like now) but it took an entire year to accomplish it. As was the case in the early  2000’s, this tightening occurred after a long stretch of loosening. Between 1991 and 1992, the Fed Funds rate dropped 3.75% - from 6.75% to 3%.

Neither of these examples compares well with what we have today. Deregulation in the 1980s fueled the highest Fed Funds target rate on record (between 19 and 20%), but that is still not an apples to apples comparison. This is virgin territory.

That’s why we expect to see more dissenters in this vote than usual. Already, Esther George wanted to decelerate with a 0.5% increase in June instead of 0.75%. We expect she’ll have company this time.

In any case, if (when) consumer spending starts to stall, community banks with high investments in business lending could find themselves in a vulnerable position. Those reporting that at least 50% of total loans was tied up in Commercial and Industrial loans and/or Commercial Real Estate (C&I &/or CRE) at June 30th, that also had at least 3% 90 days or more delinquent can be found on page 7.

In some instances (like 5-Star Fresno First Bank, CA, the remainder of the loan portfolio remains pristine so the risk is much less. In fact, Fresno First’s CRE portion is outstanding. However, delinquent C&I loans increased from less than $1 million at June 30, 2021 to $18.5 million at March 31, 2022. They did recede a bit during the second quarter, closing at $13.4 million.

Another caveat regarding this list is that, while we sometimes combine C&I and CRE together to get a sense of business loans as a whole, that can reflect negatively on a bank because you can’t see the bigger picture.

When we look more closely at Fresno First, we can see that it reduced its C&I loan exposure by 45% over the year. Those loans  plus another $50 million worth were instead invested in CRE and Multi-family Real Estate loans. And, even though the underwriting of its C&I loans leaves something to be desired, Fresno First reported no (none, zero, zilch) delinquent CRE or multi-family residence loans at June 30th.

With a combined delinquency rate of 3.59% on its C&I+CRE, Fresno First does belong on page 7. It would have also had we reported on just C&I with an 8.6% delinquency rate. However, had we reported solely on CRE or multi-family, Fresno First would have been sitting pretty with zero delinquencies in both.

All that being said, there are some banks that do have spooky numbers lurking in their business loans. 1-Star BancCentral, N.A., Alva, OK, has a delinquency rate of 11.2% on combined C&I & CRE. Separating them, delinquencies are 9.1% (C&I) and 15.1% (CRE).

Its other loans are not faring any better as evidenced by a Texas Ratio of 110% and Bauer’s Adjusted CR of 0.74%. BancCentral has been operating under an Enforcement Action since last November and, believe it or not, it has been making progress. But, an economic downturn could summon the grim reaper, regardless of that progress.

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