Well . . . at least not in real time. I recently heard a senior lending officer proclaim, with obvious relief, “Looks like we’ve dodged the recession bullet. We’re refocusing on loan growth opportunities.” The Fed-orchestrated “soft landing” is, of course, what our industry desires, but history clearly warns that it can take years before the effects of macro events such as pandemics, rate shocks and rampant inflation actually show up in lower credit quality. Even as these triggering events subside or abate, the lesson is clear: We shouldn’t let our guard down yet. The Good Despite weaknesses in specific sectors of the economy, overall job growth and unemployment have remained resilient in the face of perceived economic pressures. The inflation rate in December fell to 3.4% vs. 6.5% a year earlier, and the Federal Reserve has hinted at lowering interest rates soon in response. While current rates are moderate compared to standards set in the ‘70s and ‘80s, cutting interest rates will certainly be a boon for the nearly-decimated mortgage industry and other lenders. The Bad Despite those promising economic indicators, other data signals potential challenges ahead: • A December 2023 study by renowned academics for the National Bureau of Economic Research indicated that about 44% of banks’ office loans are underwater (equity-to-loan value), with vacancies soaring. The study noted that a 10% default rate on broader commercial real estate (CRE) loans would result in about $80B in bank losses. Some fear that the drag of higher rates on the 1-4 family housing sector has created a multifamily housing bubble. • The research group “MSCI Real Capital Analytics” reported last summer that the community and regional bank share of the U.S. CRE market had exploded from 17% to 27% just since the pandemic. While the smaller banks have increased their CRE loans, investors and larger institutions have shed CRE exposures due to credit quality concerns and heightened regulatory scrutiny. • Weaknesses in the trucking sector were at the heart of a recent Midwest bank failure — the first credit quality focused closure in quite a while. • There’s a growing dichotomy between consumers living paycheck-to-paycheck (and running up credit card levels to historic heights) and those with strong balance sheets and investment resources. While this issue may be primarily affecting the credit union industry, it could impact bank performance as well. • The chart below of historical data from the “QwickAnalytics® National Performance Trends Report” (based on the proprietary QwickAnalytics Community Bank Index (QCBI) of true community banks) clearly indicates an approximate two-year lag between the end of rate hikes and the peak of non-performing loans (NPLs). This may be the most telling data supporting the continuing need for credit risk management vigilance! 11 The CommunityBanker
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