Don’t Bank On It: A Specialty-Finance Lender

Don’t Bank On It: A Specialty-Finance Lender

With this article, we continue our new series, “Don’t Bank On It,” which we intend to write for the foreseeable future.

Those of you who have been following our public banking articles know that we have been highlighting the major existential issues currently sitting on many bank balance sheets. In this series, we focus on the existential issues found on one specific bank’s balance sheet. We also challenge readers to figure out which bank we are covering in each article.

Our next highlighted bank is a publicly listed US bank with roughly $7B in assets. Unlike a traditional community bank, its balance sheet is heavily dominated by specialty and commercial finance. During the good part of the credit cycle, this has historically generated very strong returns; however, it becomes extremely risky when the credit cycle turns negative, and importantly, credit problems are already emerging at this bank.

Extremely high exposure to specialty finance

Commercial finance accounts for roughly 85% of the bank’s entire loan portfolio, or more than 600% of CET1 capital. Importantly, this exposure is heavily concentrated in one particular segment - renewable-energy financing, which is more than 2.5x the bank’s equity. As said earlier, this type of lending is highly profitable in good economic conditions but can quickly become highly loss-making.

Asset quality is already deteriorating

Even in this relatively benign credit environment, the bank is already facing major credit-quality issues. Nonperforming loans increased to 5.3% of gross loans at June 30, compared with just 2.4% three months earlier and around 1.5% a year ago. Importantly, according to the bank’s own disclosure, several renewable-energy construction projects tied to a common developer became nonperforming. Hence, this is where the high concentration in specialty finance, and particularly renewable-energy financing, is starting to become problematic despite previously high returns. Additionally, classified loans - substandard and doubtful - amount to roughly 8% of the portfolio.

Loan loss reserves are quite thin 

Total loan-loss reserves are about 2% of gross loans, implying that NPL coverage is about 40%. More importantly, the commercial-finance loan-loss reserve is less than 2% of the commercial-finance book, despite commercial finance now accounting for virtually all of the bank's serious credit problems.

Capital may not be enough if problems continue

The bank is not undercapitalized, with CET1 of roughly 11.5%. But classified loans already equal more than half of CET1 capital, while renewable-energy exposure alone is more than 2.5x the bank’s equity. As such, the bank does not need a major crisis to see a meaningful erosion of capital.

Can you recognize this bank? If not, come to StockWaves at ElliottWaveTrader.net to identify it and view not only the fundamentals report but the Elliott Wave analysis to assist in making investing decisions.