Criticized Loans Are Stabilizing at Many of the Large Banks

While banks have not had to reckon with charge-offs and non-performing loans this year to the extent they would in a normal recession, criticized commercial loans have been steadily increasing. A criticized loan is one that is in danger of defaulting but may not necessarily be past due, and therefore may not show up as a write-off or even a delinquent loan. When they rise, it's another indicator of deteriorating credit and can be a hint of what's to come.

In the third quarter, some of the big banks saw their criticized commercial loans come down from the elevated levels in the second quarter, although not all. Let's take a look.

Image source: Getty Images. 

Criticized asset levels

It's no secret that many commercial sectors have struggled as people dial back their activity to prevent the spread of the coronavirus. Three of the nation's largest banks, JPMorgan Chase (JPM 0.01%), Bank of America (BAC 0.08%), and Citigroup (C 0.80%), more than doubled their criticized commercial loans in the first six months of the year. Wells Fargo (WFC -0.24%) also saw a significant increase in its criticized commercial loans, although less than double.

JPMorgan Chase, which broke down its criticized assets by industry, saw large increases in the consumer and retail, oil and gas, automotive, and media and telecom sectors. Citigroup saw high criticized loan levels in the transportation and industrials, consumer retail, media and telecom, and power, chemical, metals, and mining sectors.

Source: Regulatory filings. 

In the third quarter, JPMorgan Chase and Wells Fargo both saw their criticized commercial loan levels decline and move in the right direction. Total wholesale loans at JPMorgan and total commercial loans at Wells Fargo were also down from the second quarter, but this is still a positive development. 

Wells Fargo saw criticized loans decline in its commercial and industrial loan portfolio in the quarter, but then saw them grow by $2.2 billion in commercial real estate in the quarter. The bank said that 92% of that increase came from the hotel/motel, shopping center, and retail sectors.

Bank of America saw a significant rise of nearly $10 billion in its criticized loans in the quarter. While he didn't specify the industries with the elevated criticized asset levels, Bank of America CEO Brian Moynihan on the company's third-quarter earnings call said the increase is mostly related to the industries that are still not fully open. There's also likely a good chance that hotel loans make up a significant part of the increase because CFO Paul Donofrio said 60% of the bank's hotel loans are classified as criticized loans. Still, with $35.7 billion total criticized commercial loans at the end of the third quarter, Bank of America had less than any of the other three major banks, if only slightly. Hotel loans also comprise less than 1% of Bank of America's total loan book.

What does it mean?

It's a good sign to see criticized commercial loans stabilizing at some of the country's biggest banks. Remember, criticized loans are those that management has reason to believe are trending toward delinquency or default, so if they are on the rise it could hint at trouble in the future. That's why even though charge-offs (debt unlikely to be collected) and non-performing loans haven't materialized like they normally would in a recession, it has been hard to feel good about credit quality.

While actions by the Federal Reserve and federal government are still likely masking the true credit picture in banks' loan portfolios, the tapering of criticized loans at some of these big banks provides some confidence that management has at least thoroughly reviewed its loan book and feels good about its reserve levels, given the information it has.