Banks brace for bad loans by shelling out millions – Indianapolis Business Journal

Indiana-based banks say they have not suffered any major loan losses so far thanks to the various government COVID-19 stimulus and relief programs that are helping to support the US economy.

But amid the economic uncertainty – and although some banks have expressed cause for optimism – they are now preparing for the likely losses to come.


“I believe we still have a long way to go before we know or understand the implications of the economic shutdown,” said John Martin, First Merchants Corp’s chief credit officer. “The economy is currently being fueled by stimulus that will eventually end.”

Over the past two quarters, Muncie-based First Merchants, like other Indiana-based banks, have significantly increased the amount they set aside for possible loan losses. The banks are repeating actions taken by the country’s largest financial institutions, including JPMorgan Chase & Co., Fifth Third Bancorp and Bank of America Corp.

Every quarter, banks create a loan loss reserve — a certain amount of money to cover potential bad loans. Banks can vary the amount they set aside each quarter based on factors such as the size of their loan portfolio, the expected performance of those loans, and the amount of reserves they already have.

If a bank increases its provisioning drastically, it can mean that it is in for trouble.

In the second quarter, First Merchants accrued $21.9 million, compared to an accrual of $19.8 million in the first quarter. In comparison, the bank set aside just $500,000 in the second quarter of 2019.


The increased provision, the bank said in its earnings announcement, “primarily reflects our view of increased credit risk related to the COVID-19 pandemic.”

Other Indiana-based banks have taken similar action.

Evansville-based Old National Bancorp, the largest Indiana-based financial institution, provided $22.6 million in Q2 2019 compared to $17 million in Q1 and $1 million in Q2 2019 2020 results reflecting a Jan. 1 change in how Old National calculates its expected credit losses.)

“Our credit quality metrics improved during the quarter, but we expect the losses to materialize eventually once the stimulus and forbearance programs have run their course,” Old National CEO Jim Ryan told analysts during a conference call the results on July 20th.

Warsaw-based Lakeland Financial Corp., parent company of Lake City Bank, committed $5.5 million in the second quarter — down from $6.6 million in the first quarter but a dramatic increase from $785,000 dollars provided in the second quarter of 2019.

Fisher-based First Internet Bancorp provided $2.5 million last quarter, up from $1.5 million in the first quarter and $1.4 million in the second quarter of 2019.


Still, First Internet CEO David Becker told IBJ he sees reasons for optimism. “Knock on wood, we think we’re actually in pretty solid shape.”

According to Becker, it is gratifying that fewer bank loans have been deferred than a few months ago.

As of mid-May, $633.6 million in loans –– 22% of the bank’s loan portfolio — was deferred. Becker said many of those stays went to dental practices whose revenue stream dried up as they were forced to temporarily close their offices to all but emergencies during the shutdown.

By June 19, deferrals had fallen to 18.6% of the bank’s portfolio. And as of July 17 — early in the third quarter — forbearance accounted for just 12.6% of the bank’s portfolio. Since July 1, the bank has only granted a handful of new forbearances, Becker said, and all borrowers who ended the forbearance have resumed their regular payments.

At the end of the quarter, First Merchants had made some form of loan modification for $1.1 billion, or 12.1% of its loan portfolio. Commercial real estate loans, which account for about a quarter of the bank’s portfolio, were most frequently modified: 29.1% of owner-occupied commercial property loans had modifications, in addition to 25.9% of non-owner-occupied commercial property loans.

As of June, 11% of Old National’s loan portfolio, or $1.3 billion, was pending. This includes 14% of the bank’s commercial loans and 3% of consumer and mortgage loans.

Learn how Indiana’s public banks are preparing for expected credit losses.

Lake City Bank had $653 million, or 15% of the bank’s loan portfolio, outstanding as of June 30. By July 22, that had fallen to $425 million in loans, or 9% of the total portfolio.

Federal regulators in late April gave banks leeway to grant deferrals instead of playing hard and forcing loans into default.

Under the then-announced policy, lenders could grant deferrals of up to six months without having to classify loans as past due if borrowers would otherwise have been up to date with payments.

The deferrals have helped shore up banks’ loan portfolios amid the economic downturn, said Nathan Stovall, senior banking analyst at S&P Global Market Intelligence. “No doubt it has masked what is probably a fairly large spike in problem loans.”

The deferrals will not be enough to keep all of those loans from forfeiting, Stovall said.

According to S&P’s analysis, “Broadly speaking, we expect 30% of loans forborne will ultimately go unaccrued,” Stovall said. “They postponed for a reason. There was a problem or stress.”

Another factor keeping loan defaults in check right now: the various forms of federal COVID-19 relief, including small business loans from the Wage Protection Program, improved unemployment benefits, and individual stimulus payments.

Congress has discussed possible additional relief measures, and starting August 10, PPP borrowers can begin filing documentation to determine if they are eligible for full or partial forgiveness.

Once the stimulus measures run their course, Stovall says banks will have a better idea of ​​what kind of loan losses they are facing. “Proof is going to come really late this year or maybe even next year,” he said.

Stovall forecast that loan losses will peak in 2021, although that rests on a few key assumptions: that a COVID-19 vaccine will be available next year and that the economy will have picked up by then. “If that hadn’t happened, things would have been very different.”•

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