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The economic downturn fueled by the COVID-19 pandemic is keeping Wisconsin banks on their toes as they pad their loan loss provisions for a potential wave of bad loans.
Banks who stop bailiffs are yet to experience heavy losses, but Q2 earnings reports suggest Wisconsin banks and financial institutions across the country are bracing for the worst.
Wisconsin banks have doubled down on their loan loss provisions, adding $84 million more to their reserves than Q1 for a total of $163 million in Q2 of 2020, according to the Federal Deposit Insurance Corporation.
Loan loss provisions, which banks set aside as an allowance for uncollected loans and loan payments, are an income statement expense. These funds can be used to cover different types of loan losses such as non-performing loans, customer bankruptcy and renegotiated loans that incur lower than previously estimated payments.
Although higher rates of loan default among borrowers is not guaranteed, the length of the pandemic and its negative impact from both a loss of employment perspective and a business’s ability to remain open have banks taking precautionary measures.
“I do think there are many people who are concerned about the stability of borrowers and businesses, looking ahead over the next six to twelve months given the pandemic,” said Rose Oswald Poels, president and chief executive officer of the Wisconsin Bankers Association.
Wisconsin banks also saw a decrease in interest income, dropping by approximately $30 million in Q2 compared to Q1 of 2020, according to the FDIC. For many banks, a 1.5% drop in interest rates implemented by the Federal Reserve at the beginning of March was a driving factor for decreased interest income in Q2, said Dave Werner, First Midwest Bank’s southeast Wisconsin executive vice president and market president.
The dip in interest income, combined with an increase in COVID-19 related expenses, such as pay bumps for branch staff and extra cleaning measures, cut into banks’ earnings, said Werner.
With much of the country sheltered in place, consumers cut spending, which dropped credit card transactions and in turn reduced fee income for many banks, Werner added.
But even as financial institutions gear up for potential loan losses, a year-over-year look at earnings reports indicates that Wisconsin banks remain in a position of strength.
Total assets among Wisconsin banks increased 8.5% from $57.2 billion in the second quarter of 2019 to $62.1 billion as of June 30, 2020, according to the Wisconsin Department of Financial Institutions report measuring Wisconsin’s 139 state-chartered banks.
Net income also increased for Wisconsin banks year-over-year in the second quarter by 2.02% from $339.3 million as of June 30, 2019 to $346.2 million as of June 30, 2020.
“Wisconsin’s state-chartered banks are well positioned to continue supporting our communities, individuals, and businesses despite continued economic stress due to the COVID-19 pandemic,” DFI secretary Kathy Blumenfeld, who oversees state-chartered banks, said in a statement. “At the end of the second quarter, bank capital levels and asset quality were strong.”
Wisconsin banks also saw a substantial leap in net loans, which jumped from $42.7 billion as of June 30, 2019 to $44.6 billion as of June 30, 2020, according to the DFI.
“Lending overall has gone up, but it was largely tied to (Paycheck Protection Program) loans, which we expect of course will be forgiven,” Oswald Poels said. “That means banks will obviously be repaid, but the interest they’re going to earn (for PPP) will be very low.”
Although current earnings reports shed light on how the pandemic has impacted the industry, when loan losses will occur is still unknown. A modern day recession tied to a health crisis is without precedence.
One aspect of the industry not clearly illustrated by the data is the changing dynamic between lenders and borrowers. Banks and lenders are engaged in a more partnership-like relationship, which has benefited both parties throughout the pandemic, said Corey Vanderpoel, owner and managing director of the Taureau Group, a Milwaukee-based investment banking firm.
Because of the pandemic’s widespread economic impact, there has been a greater focus on how supply chains and markets are being disrupted, with both lenders and business owners paying closer attention to where raw materials are being sourced from and how end markets may be disturbed by the pandemic, said Vanderpoel, who sits on the board of directors for PSB Holdings, Inc., the holding company for Peoples State Bank.
“They really get a much deeper understanding of the business now, and that can be really helpful for the business owner to have someone in there to assess the business, give feedback and to understand and vocalize those risks in the business,” Vanderpoel said.
This deeper connection also laid the foundation for many businesses to pivot and survive the pandemic as banks helped business owners understand their capital structures, their immediate need for liquidity and their long-term ability to invest in the business.
“Those conversations coming to the forefront are really positive in the overall business community and for the business owners to get another person looking deep into their business,” Vanderpoel said.
The commercial lending environment is also changing as banks identify which sectors have been hit hardest by the pandemic. Commercial real estate as well as new loans tied to the hospitality industry, for example, are giving banks pause, Oswald Poels said.
“It depends on how exposed a bank already is to those sectors,” Oswald Poels said. “I certainly don’t mean to say no loans will be made to those types of borrowers. But it might be tougher to find a bank to lend in those sectors just because of the pandemic’s effect on those industries right now.”
Whether it’s mergers and acquisitions or commercial lending, there are two principles that provide some comfort: visibility and certainty, both of which were obscured during the outset of the pandemic, said Vanderpoel.
“But it’s come back generally since that timeframe,” he said. “Now…there’s still risk out there and unawareness. A lot of customers of mine and businesses in general are still seeing impact, some positive and some bad because of COVID. That being said, we’re regaining that certainty and visibility.”