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Clark Street Capital in American Banker: The Two Ways to Read into Lenders’ Low Chargeoffs-8/8/17

American Banker Story 8/7/17

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Net chargeoffs are at a 10-year low. That’s a good thing … right?

Well, as a wise grandma might reflect, the answer to such questions depends on where you are at in life, or in the case of lenders, where they are at in the business cycle.

Look at the numbers over the past decade: Net chargeoffs peaked at 3.14% in the fourth quarter of 2009, according to data from the Federal Reserve Bank of St. Louis. Then they began to plummet, and since the first quarter of 2014 the chargeoff ratio has hovered around a half of a percentage point, which is right where it stood in the first half of 2007, before the financial crisis began.

A chargeoff rate of 0.47% — the reading for the first quarter of this year — would have seemed like a gift from the heavens for most banks in the immediate years after the crisis, but now, in an era when lenders are scrounging for growth and the tepid economic recovery persists, the low figure raises questions about whether bankers are being too cautious for their own good and everyone else’s.

One reason that chargeoffs are low is that the value of assets has increased “so that you’re not taking a loss when these deals go bad,” said Jon Winick, CEO of the banking advisory firm Clark Street Capital in Chicago.

Banks, too, perhaps have learned from the past and improved their risk management skills.

“Certainly chargeoffs are at a level where bank lending is very profitable,” Winick said.

At the same time, it could be argued that several years of such low chargeoffs means banks are not taking enough risk, he said.

What is the optimal rate, the right balance between systemic risk and macroeconomic reward? Winick said his estimate “is probably somewhere between where we are and 1%.” When the rate tops 1%, it typically means real estate prices have fallen or the economy is in a recession, Winick said.

Eventually the ratios have to rise, but bank executives recently have sounded content with the status quo. In fact, some seemed to relish it.

Thomas Reddish, the chief financial officer for TriCo Bancshares in Chico, Calif., said the $4.5 billion-asset company’s current loan-loss allowance is 1%.

“It’s hard to establish an allowance when you don’t have any losses,” Reddish said at the Keefe, Bruyette & Woods Community Bank Investor Conference last week. “I don’t think we’ve had any net chargeoffs in the last five years.”

Susan Cullen, CFO at Flushing Financial in Uniondale, N.Y., said the $6.3 billion-asset company has not recorded a loan-loss provision for the past 18 months and charged off only $54,000 of credits in the second quarter.

“Those are very low numbers that we’ve had for a long time,” Cullen said at the KBW conference. “We have not taken a charge in quite a while.”

Michael Scudder, CEO of the $14 billion-asset First Midwest Bancorp in Itasca, Ill., said its chargeoff rates are lower than normal.

“Our credit performance in the quarter was also favorable again, reflective of the current benign credit environment, as chargeoffs of 16 basis points were well below what we would call our normalized range of 25 to 40 basis points,” he said during a July 26conference call on second-quarter results.

Andy Schornack, president and CEO of Flagship Bank Minnesota in Wayzata, said there is some speculation that marketplace lenders are possibly “taking some of the high-risk borrowers out of the banking market.” While banks are doing well, the online lenders are seeing higher chargeoff rates, he said.

“You’re looking at two models that are seeing diverging paths, and you’ve got one with the banks that are really performing really well on a credit-quality standpoint,” Schornack said in an interview.

As much as ever, the numbers and the satisfaction that bankers are expressing about them can be alternatively viewed as signs of success, underachievement or a calm before the storm.

The current environment is good in that it means portfolio performance is safe, Winick said, but the problem is now things can only get worse.

“What comes next I think is harder to predict,” Winick said.

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