With markets concerned about a potential turn in the economy, one-off credit issues could weigh on U.S. regional banks' third-quarter earnings season, according to a new briefing paper by analysts from S&P Global Market Intelligence.
Margin pressure will be the top issue for analysts across the entire banking space, from community banks to money-center institutions. While margin will be a primary focus for regional bank earnings, the group also has to worry about potential contagion from credit concerns as "one-off" issues appear to be on the rise.
Since regional banks tend to have higher sector concentrations, on a relative basis, than large national banks, they are more vulnerable to a sell-off out of their control. For example, if one bank reports a credit loss from energy, the market immediately looks for other lenders with exposure to the energy sector.
"And then everyone gets thrown under the bus, no matter if the risk is real," said Collyn Gilbert, an analyst for Keefe Bruyette & Woods. She cited franchise lending and energy loans as two potential areas of concern.
Other analysts also tabbed energy as a top candidate for third-quarter issues. Bankruptcies are on the rise for oil-and-gas drilling companies, and credit ratings agencies see financial distress increasing for both drilling and pipeline companies as oversupply drives down the price of gas.
Texas-based banks were behind several credit-related headlines in the second quarter. Texas Capital Bancshares Inc. charged off two energy loans in the second quarter and downgraded a third to "special mention" classification. Cadence Bancorp. also reported a spike in charge-offs and nonperforming loans, including an energy loan alongside restaurant and other credits. Other banks have also tabbed restaurant loans as a source of stress.
David Feaster, an analyst for Raymond James, said that while he expects actual losses to remain low, the market could sell off energy-focused banks as a result of loan downgrades — a designation that a credit has deteriorated, typically made before a charge-off. Even if a bank has zero credit issues, a downgrade of an energy loan at a peer bank could be enough to weigh on the whole sector, he said. For long-term investors interested in fundamentals, banks' pain could be their gain.
"In 2016, some of these banks lost more in market cap than they had in their entire energy portfolio," Feaster said in an interview. "That's the kind of irrationality that can happen — and that could create a buying opportunity."