As Q2 call report data becomes available, analysts are looking for indications of how the pandemic may be impacting allowances and delinquencies in community bank balance sheets.  However, considering COVID-19’s severe economic impacts didn’t begin until mid-March, what may be more telling at this juncture may be what is occurring off balance sheet.

Community Banking Q2 Data: A Closer Look at What You’ll Find Outside of the Balance Sheet

Allowances

While it’s true that some banks have dramatically increased their allowances for credit losses, when the sector is split into “big banks” (assets > $3 Billion) and “community banks (assets < $3B), there is a marked difference in the change in allowances:

It’s hard to tell from these aggregated numbers, but there are likely several contributing factors at work here including:

  • the relatively conservative nature of community bank underwriting
  • a more personalized approach to community loan workouts
  • differences in loss accounting methodologies

The last point can’t be underestimated, as larger banks are more likely to have adopted CECL’s “expected loss” approach to allowances in lieu of most community banks’ “incurred loss” models.

Regardless of the driving factors related to the above chart, what is clear at this point is that allowances are not yet an indicator of COVID-19- related troubles at community banks.

Off-Balance Sheet Commitments

One area that may be more of a leading indicator for smaller banks is changes in “Unused Commitments,” which typically reside off the balance sheet.  These represent portions of credit lines that banks have previously committed to lending, but borrowers have not yet drawn. 

Consider, for example, a home equity line of credit (HELOC) with a $100,000 limit.  If the borrower has borrowed $25,000, the remaining $75,000 remains available to the borrower on demand and is accounted for off the balance sheet as an “unused” commitment.  Note, this is a particularly simple example, as HELOCs have some of the most straightforward mechanics pertaining to credit lines.  However, the analysis concept remains compelling:  when the economy is awash in trillions of dollars of fiscal and economic stimulus, signs of a credit crunch may be seen in the way borrowers tap into established credit lines at community banks.

In looking at the chart above, there is a marked downward trend in Total Unused Commitments.  While it’s difficult to draw a definitive conclusion about the underlying causes, it is reasonable to determine that several factors are driving this.  Chief among them, the data indicates that borrowers are using credit cards and HELOCs at increasing rates—to such as degree that some banks have temporarily stopped underwriting new HELOC accounts.

Given the significant amount of stimulus aid and other forms of relief currently being provided (e.g. loan deferrals and modifications), we are not yet likely to see “past dues” and” write-offs” reflected in bank data.  However, if unused commitments continue to ramp down and stimulus dries up, community banks could rapidly find themselves with a portfolio of troubled credit. Only time will tell, but given the fact that layoffs continue, and that the passage of further stimulus relief has stalled, Q3 and Q4 data may start to show more explicitly where borrowers are slipping through the cracks.