Credit Union Exam Solutions Presents With Flying Colors

This is Mark Rele with another
episode of With Flying Colors.

This is a short take on commercial
credit risks in 2025 in credit unions,

uh, and also as pointed out by the OCC.

And we have a short summary of just
this one topic, which came from a longer

one hour episode early last month.

In any event, I hope you enjoy
and uh, will listen again soon.

This is Mark Rele and next
up commercial credit risk.

Miller: The commercial credit risk,
it's been on the kind of a horizon

or in the bullseye, so to speak, of
all the regulators pretty much since

COVID started and you had this work
from home and vacancies appearing.

So I think the commercial credit
risk, it's been at the top of the

mind for all the regulators or
we're going on five years now.

There has been some rising
delinquency in that, in both the

credit unions and the banking
industry over the last couple years.

It's not.

What you would call a
severe level of delinquency.

It's still under 1%, but
it has been going up.

And I think that kind of
catches everyone's highlights.

You know, we had the low
interest rates during COVID.

A lot of people refinanced
their properties during that

time at low rates, two, 3%.

A lot of those are
variable rate type loans.

They're coming due for
resets in the coming years.

Of course, rates are up
in that six, 7% range now.

So some of these borrowers are looking at
three, 400 basis point stocks and there's

concerns are they gonna be able to pay.

And, um, you know, what's
gonna happen with, um.

Future losses and delinquencies.

So that's a, it's been the center of
the bullseye for all the regulators.

We've seen it at NCUA.

They some of our clients,
they've been asked to stress

test their commercial borrowers.

They've been asked to stress test
their ability to handle payment shocks.

And I think we'll continue
to see more of that.

It's somewhat interesting when
you read through that whole risk

report from the OCC, they almost
seem optimistic and surprised at

how well banks are performing.

But man, they are uncertain
and totally worried about which

direction things might go.

Treichel: Great points.

Uh, Steve or Talk, or Steve or Dennis,
anything you wanna add on this topic?

Bauer: Yeah, I think, you know, commercial
loans, it's a, it's a broad, right?

It's a broad category.

I mean, within commercial loans there's
different types of commercial loans.

Obviously.

I think what's getting the most press
is obviously real estate values,

particularly in like city center
types of locations, where I think,

as Todd mentioned, the whole remote
work, the high interest rates, right?

There's a lot of vacancies occurring
in, in those types of of properties.

You know, right.

Just in the, in the city of Minneapolis,
for example, I think real estate values

in the city center area, I think they're
down since last year, almost 22, 20 5%.

Um, so right.

That's where the concern or the
concern lies is in those, I think

in those types of more in those
types of, uh, commercial loans.

You know, and I know in our
credit we didn't, our, ours was.

Our commercial loans were fairly
small in nature for the, for the most

part spread out either residential
types of multifamily dwellings,

and those seem to be you know,
those seem to be handling economic

environment we're in, um, pretty good.

So I think where it gets challenging not
only for commercial loans but also retail

and consumer loans, is how do then, do you
forecast this as Todd mentioned, you know,

what, what's your forecast for the future?

Because Right, that all has to be somewhat
incorporated now into, into Cecil.

So particularly as it relates to
unemployment and, uh, real estate values.

So it'll be interesting to see going
forward, uh, with the current environment,

what type of impact, those Cecil types
of factors how that comes into play.

You know, based on what I've seen.

Trending for both commercial,
just overall loans.

It appears that Cecil
since was enacted in 2023.

It's increased, but probably not
at the same rate that we've seen

delinquency and charge offs increase.

So I know there's different
flavors of Cecil out there.

Not everyone treats Cecil the same, but
that could be a big, that could be a

big impact I think to, uh, the credit
union performance, uh, down the road.

Miller: You bring up an interesting
point with Cecil Dennis, 'cause

you would expect provision expense
to grow at about the same rate

that loan portfolios are growing.

Yeah.

And for the last couple years for
the credit industry, their provision

for loan losses has grown much
faster than their loan portfolios,

much faster than delinquency.

But for the first quarter here of
2025, Cecil charges, a provisioning

actually shrank when you still have
loan growth and rising delinquency.

And it's like you ask yourself, did
they get ahead by Overfunding in

the past or are they just getting
behind because of earnings pressure?

Like I said, just the way Cecil works,
you would expect provisioning to grow at

about the same pace that loan growth is.

And for the first quarter
anyway of 2025, it's behind.

Yep.

Treichel: And as you tell, it could
be behind because they're trying

to manage earnings a little bit.

It could be a little bit of, uh,
architecture of earnings there.

Miller: Yep.

Treichel: So a couple one other thing on
commercial loans not related necessarily

to the risk report, but the things we've
seen in our discussions with credit

unions is NCA being hyperfocused on the
annual review process that's required

in the commercial loan portfolios.

And oftentimes recently, uh, some credit
unions have not kept up with that.

And that's something that
definitely gets written up.

And then the, you know, the discussion
about office buildings being empty and

the return to, to the workplace and,
and how that might reinvigorate some of

these office spaces near where NCA is at.

Uh, patent and trade is right,
right across the street from NCA

and they used to rent three or four
buildings in addition to the one.

That they own.

And they've let leases go on two or three.

And then across the street from that,
there's a, another agency that was

renting the building right next to that.

And their lease is up in a year and
it's been vacant for four years.

And they have guards that walk around it
just like the patent and trade offices.

And they actually did a public notice
that they're trying to convert that

to either a condo or apartments.

And then when you, when
you think about, um.

When you think about, um, the
rate situation that, that, I

think you both mentioned that, and
that's mentioned in the report.

And there's the, a lot of those
loans are structured with five-year

balloons where those can get repriced.

So what happens when that
happens if you can't reprice it?

Reminds me of some or all of you may
have gone to the School of Banking of

the South for commercial lending class.

Yep.

I've seen, I'm seen some nods.

There was a guy there, professor Willie
Stotts, he looked like, uh, Groucho Marx.

And, uh, he coined the phrase, or
first time I heard the phrase, uh,

a rolling loan gathers no loss.

You know, so you get to that,
you get to that rewrite date.

You, you, you wanna rewrite to
a new, to the new rates, which

is why you put that in place.

But can they do it?

Can they not?

You might see some pressure
on delinquency in that regard.

Steve, did you wanted to add on,
on this topic before we move?

Farrar: Yeah.

You know, the commercial lenders you're
always dealing with you kind of new issues

that your borrowers are dealing with.

Whenever I am out talking with people who
own businesses and stuff, the conversation

anymore always goes to insurance.

They are really being surprised.

This is just in, in, uh, you know,
property and casualty insurance,

that they're, they're being very
surprised and some of 'em are even

being counseled by institutions
they've been with for 20 some years.

So I think that's kind of
gonna be a new problem.

And then you look at, you know, just
the state of some of the, you know,

the flooding and that kinda stuff.

Insurance is gonna continue to be
a, a new and more dramatic issue for

a lot of your commercial borrowers.

Within the

Miller: fine print of the report,
they actually mentioned that

rising insurance costs, that are
increasing expenses for these folks.

Just kind of turn this into credit
unions too, and something we're seeing

with some of our clients, as Dennis
mentioned earlier, there's different

types of commercial loans, but we're
seeing NCUA is asking credit unions that

are involved in the commercial lending
business to really set concentrations

on those different types of loans,
the different types of properties.

You know, before it was a concentration
limit on commercial loans.

Now they want concentration limits
on hotels, on office buildings,

on, you know, just a variety.

Go through the whole N-A-S-I-C codes
and want concentration limits, very

detailed for the different types of
commercial lending they're doing.

So, raising the bar on expectations for
credit risk management, for card unions

that are involved in commercial lending.

Treichel: Great.

Great point.

I that's a, a nice pivot.