Best Credit Risk Strategy

After more than a decade of continuous growth, the U.S. economy crashed into a crisis with the Covid-19 pandemic.

It’s a stark reminder that bad loans are made in good times.

“The time to worry about credit risk was probably 36 to 48 months ago,” says Patrick Gaughen, president and COO of Hingham Institution for Savings. With commercial real estate and some sectors of the economy remaining under pressure, we still don’t know how things will pan out for the banking industry.

It’s difficult to take a forward-looking view on credit risk, and the next few months will test many bank’s loan portfolios. To understand, from a historical perspective, which banks in our ranking have been most effective at managing credit risk, we measured improvement in net charge-offs (NCOs) and nonperforming loans (NPLs) from December 2014 to December 2019, and during the early stages of the coronavirus crisis, from December 2019 to June 2020.

To award consistency, we calculated average NCOs and NPLs, and average leverage and loan-to-deposit ratios. And we pulled in the institution’s Texas ratio, which divides nonperforming assets by tangible common equity and loan loss reserves, as of December 2019.

Finally, we further examined the effect of the Covid-19 downturn, based on exposure to impacted industries as well as deferral volume at June 30, 2020. When this report went to press, deferrals had been trending down from these levels.

Auburn National Bancorp. tops the ranking, with NCOs that declined 6 basis points to -0.03% over the initial Covid-19 period and declined 9 basis points overall from December 2014 to December 2019. NCOs were already low, averaging 0.01% during that period, and NPLs averaged 0.52%. Its Texas ratio is super low, at 0.18%.

Stock Yards Bancorp, ranking second, saw its NCOs decline by 19 basis points over the five-year period we examined; NCOs averaged 0.09% and NPLs 0.36%. Less than 10% of its portfolio included industries impacted by the pandemic, notably restaurants, shopping centers and hotels. Deferrals at their highest levels totaled around 17% of the loan portfolio.

In third place, Bank OZK features the highest average leverage ratio, at 14.06%. An estimated 15% of the portfolio included pandemic-affected industries. Deferrals as of June 30, 2020, totaled $982 million, 5.6% of the portfolio.

Hingham Institution for Savings ranks fourth. It features the lowest average NCOs at 0% and NPLs at 0.24%, and a low Texas ratio at 2.65%. At June 30, 2020, Hingham had modified just 3% of the bank’s total loan volume in response to Covid-19.

“The kinds of things that have been more challenged in this environment, particularly retail and hospitality, we stay away from,” says Gaughen. Hingham focuses on residential and commercial real estate, mostly apartment buildings, and he sees opportunities in that space today due to the bank’s countercyclical approach. “There are maybe fewer folks that are in the market to do things with strong borrowers, so that makes it an interesting time,” he explains. “I don’t think that now would be the time to get into the hotel lending business if you aren’t familiar with it but for a lot of the multi-family assets that we lend on, I think there are some interesting opportunities.”

Finally, Community Bank System ranks fifth. Almost 15% of its portfolio included industries impacted by the pandemic, particularly retail (around 5% of total loans) and hotels (around 4%). Around 10% of loans — totaling $704 million — were in forbearance as of June 30, 2020, but that number dropped to $150 million by July 24. NCOs improved 8 basis points during the early pandemic period.

“[The U.S. economy has seen] monetary and fiscal support of an unprecedented scale, so that’s helped provide some buoyancy to the business community and has helped keep credit pretty stable so far,” says Community Bank System CEO Mark Tryniski. But uncertainty looms. “I think heading into ‘21, we’re going to see what credit really looks like” in the banking sector.

It’s unknown how many banks stuck to their knitting on credit quality and how many eased their standards, says Crowe Partner Rick Childs. “When times are good, we tend to forget the institutional knowledge we should have learned,” he adds. “Exceptional banks know how to adapt, and they have a strong culture around credit, so they don’t wait for the problems to start — they get on top of them.”

How They Ranked: Best Credit Risk Strategy

SCORE NET CHARGE-OFFS (AVG.)
DEC. 2014 -DEC. 2019
TEXAS RATIO
DEC. 2019
CATEGORY WINNER: Auburn National Bancorp. 7.38 0.01% 0.18%
2 Stock Yards Bancorp 7.88 0.09% 3.00%
3 Bank OZK 8.00 0.15% 1.20%
4 Hingham Institution for Savings 8.50 0.00% 2.65%
5 Community Bank System 8.58 0.18% 2.71%
6 First Financial Bankshares 8.78 0.11% 2.33%
7 Eagle Bancorp Montana 9.03 0.08% 4.91%
7 Prosperity Bancshares 9.03 0.11% 2.29%
9 Glacier Bancorp 9.25 0.09% 4.42%
10 Lakeland Financial Corp. 9.55 0.06% 3.88%
11 Southern Missouri Bancorp 10.05 0.39% 2.84%
12 Greene County Bancorp 11.25 0.11% 4.03%
13 Meta Financial Group 11.33 0.61% 12.51%
14 City Holding Co. 11.43 0.14% 8.38%
15 Horizon Bancorp 11.43 0.13% 5.02%
16 Independent Bank Corp. 11.60 0.05% 5.39%
17 First Capital 11.75 0.20% 3.22%
18 The First Bancorp 12.68 0.15% 16.02%
19 Southside Bancshares 13.80 0.05% 16.10%
19 WSFS Financial Corp. 13.80 0.24% 4.26%

SOURCE: S&P Global Market Intelligence, bank websites, filings and other public information