Delinquencies improve, but credit unions 'haven't seen the bottom yet'

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Credit unions got some surprising news with second-quarter results — problem loans actually declined from a year earlier despite significant economic turmoil.

The delinquency rate stood at 0.58% in the second quarter, a 5 basis point drop from the same period 12 months prior, according to data from the National Credit Union Administration. Delinquent loans totaled $6.6 billion in the second quarter, down about 1% year over year and 7% from the first quarter.

But it’s likely that these numbers are artificially low right now as lenders took steps to help those who were financially impacted by the fallout from the pandemic, and institutions should prepare for credit quality to worsen in the months ahead, experts said.

“We are continuing to live in a bit of an artificial environment,” said Leslie Parrish, a senior analyst at Aite Group, a research and consulting firm. She noted that many consumers got by in the early months of the pandemic thanks to things such as tax returns and various government benefits.

“The question is what will happen when there are no accommodations and the economy is still continuing to wane,” she added.

There are a few reasons loan delinquencies are down despite the elevated unemployment rate, experts said.

For one, there is usually some seasonality to problem loans, with the first quarter typically seeing a drop as consumers get their tax refunds and catch up on bills, said Steve Rick, chief economist at CUNA Mutual Group.

In addition to that, once the coronavirus became widespread and businesses started laying off workers, lenders were quick to provide struggling borrowers with accommodations, such as loan forbearances. That’s also contributing to the downward trend.

“You have a lot of people who asked for a loan extension just in case — even some people who were still working,” Rick said.

Stimulus checks and enhanced unemployment benefits provided by the government in an attempt to keep the economy from sputtering have also helped.

Perhaps one of the more surprising results has been how unsecured personal loans are holding up, Parrish said. Usually this lending category would be one of the first to show signs of weakness during an economic downturn, but that hasn't happened yet.

The percentage of consumers with unsecured personal loans that were 60 days past due stood at 2.5% in August, down from 2.8% in July and 3.1% in August 2019, according to data from TransUnion, the consumer credit reporting agency.

“People will pay their car loan first and then their cell phones [and] then maybe their housing payment,” Parrish added. “But we are seeing that people are paying their personal loan first. It’s the smallest balance, so maybe it’s a psychological decision over a rational one.”

But these trends probably won’t continue and credit quality is likely to worsen, experts said. A more accurate picture should start to emerge in the fourth quarter as the accommodations provided by lenders come to an end and borrowers are required to start making payments, said Sam Taft, associate vice president of analytics at Callahan & Associates. Delinquencies and charge-offs should rise throughout next year and even into 2022, he added.

However, many credit unions will be able to weather these challenges. Overall, the industry has aggressively set aside funds for loans potentially souring. Provisions for loan losses were up dramatically in the second quarter, surging more than 51%, to $9.7 billion, according to NCUA data.

The coverage ratio, which compares what credit unions have set aside for bad loans with total delinquencies, was 173%, Taft said. That means credit unions have reserved $1.73 for every dollar of delinquent loans. In June 2008, the coverage ratio stood at 86%.

“I think they learned from 2008,” said Taft, though he noted that the coverage ratio has been trending upward over the last five years and was 138% in 2019. “In the conversations we’ve had with a lot of these larger credit unions, they are taking this seriously and saying, ‘Let’s reserve now, take the earnings hit while we can and we still have the interest income.’”

Financial Center First Credit Union in Indianapolis is one institution that has been provisioning in case loans begin to sour, said Cameron Minges, executive vice president. The credit union’s provision for the first six months of the year was roughly $1.6 million, up about 16% from the same period a year earlier, according to call report data from NCUA.

Management has been proactive in trying to help members through this difficult time. The institution empowered employees to make decision about allowing members to skip loan payments if they were hurting financially because of the coronavirus and then had them actively reach out.

The $632 million-asset Financial Center First has averaged about 9,000 calls a month, Minges said. This has allowed the credit union to work with borrowers early on if they were facing a financial hardship, Minges said.

However, even though credit quality has held up so far, Minge said, the management team was still bracing for that to change.

“When will it drop off? No one knows,” he added. “We dusted off what happened in 2008 and we looked at that and the losses we experienced, and modeled it around that kind of approach. But we haven’t seen the bottom yet.”

Credit unions can track and manage potential credit issues by looking at their internal data, such as whether a member is no longer having a paycheck deposited or if a borrower is using their credit card differently now, said Eileen Iles, a partner at Crowe, an accounting and consulting firm.

There could also be long-term consequences to the economic fallout related to COVID-19. For instance, many employers have moved at least some of their staff members to work remotely. If that continues even after the pandemic has ended, then commercial office space could become less valuable. The hospitality industry has been particularly hard hit as consumers curbed travel.

Any lender holding a significant amount of loans in those areas could face problems, though credit unions could be somewhat spared given that they tend to be more concentrated in consumer loans.

“The loans for commercial real estate properties, how are they performing? How well are companies doing and what are the companies’ management thinking about?” Iles said. “It’s all connected and there are a lot of things that are going on simultaneously.”

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