2021 Will Put Credit Quality to the Test for CUs

Last year tested credit unions’ ability to preserve income, and this year will test their ability to manage their loan risks, according to Nathan Powell, who analyzes banks and credit unions for Kroll Bond Rating Agency of New York.

Powell, a managing director at KBRA, said the fourth quarter marked a transition from the peak of the pandemic as returns on average assets began to improve and provision expenses fell to more normal levels.

“2020 was all about the income statement as forbearance activity was pervasive across all financial institutions,” he said. “As you transition into the vaccine phase in 2021, now it’s going to become a credit risk story. We’ll have to judge institutions going forward on how well they’ve managed risk in their loan portfolios.”

Powell works with KBRA Financial Intelligence, a paid subscription service that provides data and analysis for the roughly 10,000 banks and credit unions in the United States. His unit found annualized returns on average assets (ROA) were just over 0.80% for the three months ending Dec. 31 for all credit unions.

The estimate was in line with Callahan & Associates’ “Trendwatch” report issued Feb. 11 that showed fourth-quarter ROA was 0.83% for the three months ending Dec. 31, down from 0.93% in the pre-pandemic fourth quarter of 2019, but up from 0.79% in the third quarter.

KBRA found the usual pattern of ROA rising with asset sizes for the three months ending Dec. 31:

• 0.99% for those with assets greater than $10 billion, up 6 bps from a year earlier and up 41 bps from the third quarter.
• 0.9% for those with assets of $1 billion to $10 billion, up 4 bps from a year earlier and up 1 bps from the third quarter.
• 0.77% for those with assets of $500 million to $1 billion, up 7 bps from a year earlier and up 7 bps from the third quarter.
• 0.59% for those with assets of $100 million to $500 million, down 1 bps from a year earlier and unchanged from the third quarter.
• 0.28% for those with assets of less than $100 million, down 13 bps from a year earlier and down 19 bps from the third quarter.

KBRA studied NCUA fourth-quarter Call Reports and found 736 credit unions, representing about 14% of assets, had net releases of $57.3 million from their loan loss reserves during the quarter, representing about 6% of pre-provision net income. In 2019’s fourth quarter they had loan loss provisions of $103.2 million.

Credit unions, and especially this group, took heavy provisions in early 2020. The same pattern occurred among banks, and many of them have also released funds from their loan loss reserves. “If things don’t turn out as badly as you thought they were going to be 12 months ago, you would be justified in releasing some of your reserves,” Powell said.

The credit unions with releases also had lower gains in delinquencies from Sept. 30 to Dec. 31 than credit unions that had no releases.

For credit unions without reserve releases, their delinquencies fell 18% from Dec. 31, 2019 to Sept. 30, 2020, and then rose 12% to $6.6 billion as of Dec. 31.

For credit unions with reserve releases, their delinquencies fell 21% from Dec. 31, 2019, and then rose 3% to $432.3 million as of Dec. 31.

“The story was these guys could release reserves because their delinquencies were holding steady, whereas the remaining credit unions they had not released them because their delinquency numbers were picking up,” Powell said.

Powell said widespread forbearances and other accommodations have been encouraged by regulators and have helped many consumers, as intended. At the same time, he said the practices might be obscuring some credit risks.

“It’s safe to say the inherent credit risk in the loan portfolios is definitely not fully reflected in the delinquency numbers as of today.

“We’re going to find out in 2021 how accurate that is,” he said. “The trajectory of the economy is going to tell us how this shakes out.”

Economic growth will allow credit unions to make more loans and lower the amount of assets in low-yielding investments. That will improve net interest margins (NIMs), but the gains will be slow.

“They might stabilize, but we’re not going to see them rocket back up. NIMs just don’t do that,” Powell said. “The only thing that would cause that is if the economy were to rocket off. That doesn’t seem likely at the moment.”