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Criticized loans at U.S. banks recede as pandemic deferrals dwindle

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Criticized loans at U.S. banks recede as pandemic deferrals dwindle

Two advance indicators of bank credit quality have continued to improve, even as another wave of coronavirus infections threatens to slow the economic recovery and lenders continue to evaluate their portfolios for long-term scars from the pandemic.

Criticized loans fell sequentially at 18 of the 25 U.S. banks with more than $50 billion of assets for which values are available for the second quarter, according to data from S&P Global Market Intelligence. Banks assess loans using internal risk ratings, and identify as criticized those that have higher chances of becoming delinquent or defaulting.

Pandemic payment deferrals also dwindled to a median 0.5% of net loans across the group, with a number of banks no longer giving updates on the special forbearances as they have diminished in importance.

The most recent figures represent the third quarter in a row in which a majority of large banks have reported declines in criticized loans. Nevertheless, criticized balances remain far above levels from the end of 2019, before the pandemic. Banks said they are continuing to scrutinize commercial real estate exposures in sectors heavily impacted by the health crisis, although they expect actual losses to remain low overall and have continued to aggressively reduce loss reserves.

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SNL ImageM&T Bank Corp. was among the banks that reported sequential growth in criticized loans, marking its fifth consecutive quarter-over-quarter increase. The company attributed the deterioration to investor-owned CRE loans backed by hotel, office and healthcare properties, but said such loans generally had healthy loan-to-value ratios in a range of roughly 55% to 65%.

During M&T's second-quarter earnings call in July, executives said cash flows at properties backing criticized loans were under pressure, but added that in some cases borrowers could support their obligations with other sources of money. The bank lowered its credit loss allowance by 3.7% to $1.58 billion.

New York Community Bancorp Inc., which posted a large quarter-over-quarter jump in criticized loans in the first quarter, said it believes migration into the criticized category peaked in February and it expects criticized balances to continue to decline as it reevaluates borrower cash flows. Its criticized balances fell $311.3 million, or 11.1% sequentially in the second quarter, to $2.48 billion.

New York Community specializes in rent-controlled and below market-rate multifamily loans, and has a multidecade record of exceptionally strong credit performance. Still, the bank's criticized pool also includes roughly $500 million of office loans, Chairman, President and CEO Thomas Cangemi said on its second-quarter earnings call. But despite the potential for long-term shifts in the office marketplace because of the pandemic, Cangemi said the bank does not extend high amounts of leverage to borrowers and does not envision any losses in the segment.

New York Community also reported that loans paying only interest under pandemic deferrals fell from $2.54 billion at March 31 to $1.01 billion, or 2.3% of net loans, at June 30. The bank has had no loans skipping principal payments under special deferrals since March 31. Cangemi said the bank believes "most all of our customers will be out of any form of relief" by the end of the year.

"There is some work to do on office and retail, but I think that will follow as the employees and the traffic start to pick up in Manhattan," Cangemi said.

At Signature Bank, another New York-based bank with high exposure to commercial real estate in the city, criticized loans increased $334.3 million from the first quarter to $4.58 billion, or 8.4% of net loans. Pandemic deferrals making no payments fell from $982.8 million at April 15 to $308.7 million at July 15, but other pandemic-related modifications remained relatively high at 7.0% of the loan portfolio.

Signature's net chargeoff rate remained low at 12 basis points in the second quarter, however, and it reduced its ratio of loss reserves to gross loans by eight basis points sequentially to 94 basis points.

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Most mortgages that have exited deferrals — roughly 89.2% — are either performing or have paid off, although the mortgage technology company Black Knight said the number exiting deferral and remaining delinquent has begun to edge upward. Roughly 6.8% of mortgages that exited deferral are now in post-deferral loss mitigation plans.

The population of single-family mortgages in active pandemic deferrals has continued to decline but remains substantial at about 1.9 million as of July 13, Black Knight said. That compares with roughly 2.2 million at May 18 and a cumulative total of 7.3 million mortgages that have ever been granted pandemic deferrals.

Black Knight warned that updated guidance on maximum pandemic deferral periods from government agencies backing the loans means that roughly 1.2 million forbearances will expire over the rest of 2021. Nearly 700,000 expirations in September will strain servicers that will have to evaluate borrowers for other accommodations, the firm said.

Some big banks reported an acceleration in the declines in their mortgage forbearance balances.

Wells Fargo & Co. said that deferrals on its mortgages, excluding government insured loans, fell 25.5% sequentially in the second quarter to $7.81 billion, a faster drop than the 11.9% decline in the first quarter. JPMorgan Chase & Co.'s mortgage deferrals dropped 36.2% in the second quarter to $5.78 billion, compared to a 10.4% decline in the first quarter.

Both banks said that more than 90% of the mortgages that have exited deferral so far were current at June 30.