Criticized loans pile up at US banks as credit weakens

Weakening credit quality and persistent pressure in the commercial real estate sector are pushing US banks' criticized loans higher.

As of June 30, US public banks' median ratio of criticized loans to Tier 1 capital was 18.60%, up from 15.06% at year-end 2023 and the highest level since reaching 23.18% at year-end 2020, according to S&P Global Market Intelligence data. Criticized loans at public US banks totaled $264.32 billion, compared to $240.32 billion at the end of 2023.

At the 100 largest US public banks, the median ratio of criticized loans to Tier 1 capital rose to 21.95% as of June 30 from 19.24% at year-end 2023. The banks' criticized loans jumped to $246.64 billion from $219.83 billion.

Banks move loans to the criticized bucket if some sign of weakness emerges, but that migration does not necessarily suggest a future loss. As credit quality slipped from pristine levels, criticized loans have been trending upward, and one particular sector — commercial real estate (CRE) — has been facing persistent stress given the effects of the higher-for-longer interest rate environment on borrowers.

"In our view, criticized assets are increasing due to a combination of normalization from pandemic-era lows, as well as more visible deterioration in known pressure points such as office CRE, which are undergoing structural shifts likely to take time to resolve," Piper Sandler analyst R. Scott Siefers told S&P Global Market Intelligence in an email.

Credit trends continue to be negative, but negative migration slowed down in the second quarter, Wedbush Securities analyst David Chiaverini said.

"[W]e observed some pockets of positive performance after several quarters of consistent degradation," Chiaverini wrote in an Aug. 1 note. "CRE remains a major driver, but as was the case last quarter, [the commercial and industrial sector] is showing incremental deterioration."

Of the 27 US public banks with at least $50 billion in total assets as of June 30 that reported criticized loans, 18 logged sequential increases in criticized loans and all but one recorded higher criticized loans year over year. The ratio of criticized loans to Tier 1 capital climbed year over year at 25 banks.

Regional banks with outsized exposure to CRE posted the largest sequential increases in criticized loans, led by Webster Financial Corp., where criticized loans jumped 39.8% quarter over quarter to $1.97 billion. The company does not anticipate significant CRE loan growth beyond the second quarter and sees opportunities to get to its CRE concentration target of about 250% in the next three to five quarters, executives said on an earnings call.

New York Community Bancorp Inc., which did an 18-month "look forward" on its CRE portfolio, booked a 28.6% quarter-over-quarter jump in its criticized loans in the second quarter to $10.46 billion. The company's ongoing credit quality struggles might affect its ability to grow C&I loans in the short term, analysts recently told Market Intelligence.

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Valley National Bancorp's criticized loans soared 26.1% sequentially to $3.15 billion. The company made additional loan downgrades to criticized and classified statuses in the second quarter because of its "conservative decision to place less value on personal guarantees as a mitigating factor in our internal loan risk ratings," Chairman and CEO Ira Robbins said on an earnings call.

Given the high interest rate environment, Valley will likely report a continued modest migration of CRE loans to the criticized bucket, Valley National Bank Chief Credit Officer Mark Saeger said.

New York Community's ratio of criticized loans to Tier 1 capital was the highest among the banks on the list at 116.9%, up 87.0 percentage points year over year, followed by Valley National at 64.4%, up 34.7 percentage points.

Wells Fargo & Co. booked the most criticized loans in the second quarter at $35.47 billion, up 3.0% from the prior quarter and 22.3% from the year-ago period. JPMorgan Chase & Co. followed with $25.46 billion in criticized loans, an increase of 0.5% sequentially and 39.2% year over year.

M&T Bank Corp.'s criticized loans fell 6.9% quarter over quarter to $12.05 billion, making it one of the nine banks that posted quarter-over-quarter declines in such loans. On Sept. 3, J.P. Morgan analyst Steven Alexopoulos upgraded M&T to "overweight" from "neutral," expecting several overhangs on the company's stock — including credit fears fueled by criticized loans — to "erode considerably" over the next few quarters.