While several community banks have seen earnings rise during the second quarter, executives will have to figure out how to manage cash positions carefully in the coming months.

Some of the same initiatives that banks used to help customers affected by the pandemic – from loan modifications to Paycheck Protection Program loans – could also affect banks’ balance sheets in the coming months.  

Community banks for the most part entered the pandemic well-capitalized, and some have seen positive earnings in the second quarter amid the slowing economy. But the second half of 2020 could start to shed more light on how the pandemic will affect the banking industry.  

“There are a lot of the decisions or choices that banks are going to have as they relate to managing their balance sheet and driving their earnings position, none of them are going to be super comfortable,” said Jeffrey Reynolds, a managing director at the Newburyport-based Darling Consulting Group. “Particularly as this year goes on, and it looks less and less likely that we’re going to get a vaccine that can be rolled out in mass production [before the end of 2020].” 

Positive Earnings Reported 

Several Massachusetts stock banks in July reported positive earnings for the second quarter, including some, like Century Bank and East Boston Savings Bank, that have had more net income so far in 2020 than they had during the same period last year. East Boston Savings Bank even reported record earnings for both the second quarter and the first six months of 2020. 

Despite positive earnings, banks still saw the effects of the pandemic. Reynolds said a key variable affecting banks has been their provisions for loan losses, the amount each sets aside to cover loans that could default. Banks have had to consider not just the pandemic’s potential impact on loans, but also new requirements established by the current expected credit loss standard, or CECL, that went into effect for many publicly traded banks this year. 

After increasing provisions for loan losses at the start of the year, Massachusetts community banks at the end of the first quarter started adding more funds to these stockpiles, continuing those moves in the second quarter.  

Banks could, under the CARES Act, postpone implementing CECL, and Century Bank and East Boston Savings Bank are among those that decided not to adopt it this year. Nonetheless, they still increased their provisions due to the pandemic. 

Other banks did adopt CECL, including Boston Private, which had a net loss in the second quarter of $3.3 million after net income of $19.4 million during the same quarter last year. Boston Private’s provision for loan losses in the second quarter was $25.4 million, which the bank in its earnings statement attributed to “the macroeconomic outlook as a result of the COVID-19 pandemic and increased weightings of more severe scenarios in the CECL model.” 

Even as the provisions have affected bank income, loan losses themselves have not yet become an issue.  

“Generally speaking, you’re not seeing banks – at least thus far – exhibiting true credit stress,” Reynolds said.  

Flexibility offered by bank regulators and the Financial Accounting Standards Board meant banks could take a generous approach to offering forbearance options to business customers, Reynolds said. He added that overall credit quality would have looked worse if banks had to classify these concessions as troubled debt restructurings. 

Reynolds, whose firm works with banks across the U.S., said he has seen about 20 to 40 percent of commercial loan portfolios at each institution receive some type of forbearance, often interest-only payments, though sometimes full forbearance. 

With banks offering forbearance for 90 days, they are at the point where they will see whether customers need to extend forbearance for another three months. Reynolds expects banks to be more deliberate about determining whether customers do need to receive additional forbearance. 

With the potential for another three months of deferred payments for some portion of those that received modifications near the start of the pandemic, Reynolds said banks still need more time to see what problems could arise from these loans. 

‘Slow Burn-Off’ of PPP Cash 

The Paycheck Protection Program has also grown banks’ balance sheets. 

In a nationwide analysis, investment bank Keefe, Bruyette & Woods found that PPP lending had increased the size of the median bank’s balance sheet by 10 percent, with some community banks exceeding 20 percent of their existing loan balances. 

An unusual aspect of the PPP is that it has affected both sides of the balance sheet: PPP loans count as loans, but many businesses parked the proceeds at the same banks as deposits.  

“The expectation was that those deposits would be used to cover expenses in short order,” Reynolds said. “That burn–off has been very, very slow.” 

Diane McLauglin

Banks estimate that 70 to 75 percent of loans could be forgiven and paid back to the banks by the U.S. Small Business Administration, Reynolds said. Although that will allow the banks to start recognizing more fee income for participating in the PPP, it may also result in another spike in cash liquidity if the deposit balances continue to prove to be sticky.  

With fewer opportunities for loan growth during the pandemic and recessionary environment, as well as low yields, banks will need to consider how to handle cash positions. 

“Banks are going to have to be more active in the investment market than maybe they have been,” Reynolds said.