Navigating the changing risk landscape for credit unions

Recently, credit unions nationwide have been dealing with elevated credit risk in their loan portfolios. As economic pressures increase and consumer debt levels rise, credit unions face challenges in maintaining positive loan performance. The combination of persistent inflation, higher interest rates and increased regulatory scrutiny has created a complex landscape.

The National Credit Union Administration (NCUA) is expected to focus on credit risk monitoring in the coming year. As of the third quarter of 2024, delinquencies have been trending upward, with used auto and credit card portfolios being the most significant contributors.   

Understanding the risk factors

To effectively manage credit risk, it is crucial to identify the factors driving this trend. Some of the key contributors include:

• Consumer confidence: Post-pandemic consumer confidence was at an all-time high due to accumulated savings and paid-down debt, leading to increased discretionary spending. However, by March 2024, consumers had fully depleted any savings they built up during the pandemic years and are now saving at rates lower than before the pandemic.
• Inflation: Ongoing inflation has strained consumers, with the rising costs of essentials eating into accumulated savings and available lines of credit.
• Interest rates: Higher interest rates resulting in higher monthly loan payments have also contributed to household budget pressures.
• Buy now, pay later (BNPL) programs: BNPL programs have given consumers a false sense of affordability, with research showing a 10%-40% increase in spending when using these services.
• Digital banking shift: The move to digital banking has left members less engaged with their credit unions, leading to missed communication and less loyalty.
• Insurance costs: Insurance costs have risen, specifically in areas with high climate event risks like Florida and California.
• Vehicle shortages: Vehicle shortages have driven up prices, especially for used vehicles, which require more repairs and maintenance.

How to mitigate risk

Earlier in February, the NCUA held a webinar expanding on 2025 priorities. In that webinar, they indicated that their exam’s focus will be on evaluating credit unions’ underwriting policies and procedures, modification strategies, risk monitoring and response and oversight by management and the board of directors.

For credit unions concerned with monitoring and mitigating credit risks, some best practices include:

• Underwriting policy assessment: Continuous evaluation of underwriting policies and practices can address current risks and trends.
• Stress testing: Regularly conduct stress tests to monitor and control risks, including the impact of adverse economic scenarios such as rate changes, unemployment increases, recessions and property value declines. 
• Post-mortem loan reviews: Regularly conduct post-mortem loan reviews for identifiable issues, such as financial condition or collateral valuations, and adjust policies and procedures as necessary.
• Collections practices: Ensure collections departments are practicing appropriate collection and modification efforts, as well as proper treatment of GAAP for nonaccrual loans, charge-offs, repossessions and foreclosures. 
• Third-party reviews: Regularly review third parties involved in lending functions, such as underwriting, servicing and collections.
• Management and board oversight: Ensure proper oversight by management and the board. Oversight should include ongoing assessments and discussions on trends, such as excessive loan growth and delinquencies. Oversight should also feature a review of loan reports, to include concentrations by credit risk and loan policy limits.
• Diversification: Diversify the loan portfolio, using third parties and participations to tap into new markets and products. While beneficial for building loan growth and interest income, credit unions must diligently assess and monitor third-party service providers and lead lenders’ practices, such as underwriting standards. It is imperative the credit unions have the knowledge from within to understand the risks and challenges of the various loan pools.
• Risk appetite: Assess the level of risk the credit union is willing to accept and ensure the risk appetite is reflected in policies and practices, including pricing, regulatory compliance and operational resilience.

By understanding the risks and implementing the appropriate best practices, credit unions can better navigate the challenges of elevated credit risk and maintain the stability of their loan portfolios.

How Wipfli can help

If your credit union is concerned about elevated credit risk threatening your portfolio, Wipfli can help. Our dedicated team of financial services professionals can work with you to identify risk factors and proactively address them. In an uncertain environment, advisors you can trust make a big difference in staying ahead of volatility. Contact us today to get started.