Credit Union Business Lending Trends: Times Are Shifting

This year in business lending could be equated to something that college football fans like myself find easy to understand. This is the first year that neither Alabama nor Clemson made the college football playoffs. Did they have a bad year? No. Did they slow down a little from record setting prosperous times? Yes. Credit unions experienced boom times during 2021 and the first half of 2022, which will not be replicated for quite some time. Even with the recent softening of loan originations, the pace is still very strong historically and portfolios are growing at a solid pace. With the NCUA Call Report data released for September 2022, let’s dig deep to see if credit unions are playing for the national championship, for a New Year’s Day Bowl or are barely bowl eligible.

Slower, but Not Slow

Does it feel like you are ahead of budget for the year? It should. The first half of 2022 featured unprecedented loan originations for business loans. However, if we carve out just third quarter data, it reveals a slowdown in the pace of originations. A total of $12.8 billion in business loans were originated in the third quarter of 2022. This pace of loans would eclipse 2021’s record year of business loan originations. However, Q3 did mark a 9.5% reduction in the amount of loans funded on average versus in the first half of 2022. Total business loan units funded declined in a nearly identical pattern of 10.1%. The average size of a business loan funded also remained virtually the same at slightly over $600,000. The pace of loans funded in the first half of 2022 represented an astronomical increase over the two previous years and the pace of growth was simply unsustainable. I’ve spoken with many credit analysts and other support staff for business lending programs who have enjoyed finally having some breathing room to get their work completed at a more normal pace recently.

Liquidity Issues Hit Participation Loans

Lender: “We have a great borrower with a new loan request. We are at our limit with them, so can we send it out for participations?”

Management: “Well …”

This conversation has happened thousands of times in recent months and the third quarter data proved out what many of us already knew. If you take a deep dive into the 20 largest purchasers of commercial participation loans in the first half of 2022, 15 of those credit unions reduced their purchases by at least 50%. In fact, eight of the 20 largest purchasers reduced their third quarter purchases by 80% or more. Overall, $1.401 billion of commercial loan participations were purchased during the third quarter industrywide, which equates to a 19.5% reduction over the average quarter in the first half of the year. Those credit unions with the liquidity and capacity to purchase can be more selective when it comes to rates and terms.

Credit unions are a cooperative industry with a key principle of ongoing collaboration. If you begin “dialing for dollars” when you need a participation partner, you will find it may be difficult to get a loan placed. Take the time to establish good working relationships and understand everyone’s liquidity position before you need to identify participation partners. We also recommend becoming part of a CUSO or marketplace with a roster of buyers and sellers. The easiest thing to do now is to retrench by halting loan participation purchases and remaining a seller only, but this approach may not take the broader picture into account. A frozen loan marketplace can create reputational risk for everyone. It is easy to be a participation partner in times of free-flowing liquidity, but the current environment is when we truly look to build on the cooperative spirit our industry was founded upon.

Portfolios Grow at Credit Unions Even as Rates Rise

Even with a slowdown in the pace of business loans funded, overall portfolios grew 5.6% in the third quarter alone. Credit unions will easily grow their overall business loan portfolio by more than 20% this year, which is nearly identical to the growth rate over the past five years. During that time, rates have increased, plunged and increased again, but the business loan portfolio continues to see steady growth. Why is that? Credit union business lending has grown dramatically over the past 20 years, but we still hold less than 1% of the overall commercial loan portfolio in the United States.

There is still a tremendous upside for cooperatives as more and more businesses learn about credit unions as an option. Business lending is also a big, big world, so different sectors in the marketplace are hot and cold at various times. Worried about office space? There are plenty of other asset classes such as warehouses and multi-family that have plenty of upside in most markets. The structure of most business loans also helps keep loan originations steady. With many loans having rates that reset every five years, there is always a plentiful supply of prospects with financing needs coming up.

Credit Quality Is Showing Signs of Stress

I’ve talked with many credit union leaders who have told me, “We’ve had a business loan program for (fill in the blank) years and never had a loan go bad.” Please, go to your executive team and tell them business loans will go bad and the credit union should prepare for a business loan loss. It is not realistic to prepare and manage toward a zero loss and risk portfolio. Since the Great Recession, credit unions have enjoyed very low delinquency and charge-off rates. In nine months, the industry’s business loan delinquency has increased from $399 million to $556 million. With past increases in delinquency, much of the total could be attributed to a particular asset class or credit union. This increase in delinquency is a steady, across-the-board increase. There has been an increase of almost 40 credit unions that are reporting approximately $1 million or more in delinquent business loans.

What can your credit union do to prepare for your inevitable business loan delinquency or charge-off? First, don’t point fingers. Delinquency is a normal part of any business loan portfolio and business cycles, and sound loan decisions sometimes do not turn out the way we expected. Proactive management is key to minimizing losses. If you wait until you see a loan in the delinquency queue, it is often too late. Closely monitor NSF checks and taxes but remember that there is no replacement for an old-fashioned conversation with your member or an on-site visit. Finally, managing business loan workouts and collections takes expertise. It can be difficult at times for the same people who made the loan to separate themselves from the collections process, so make sure you have proper checks and balances in the program.

Times Are Good, but Let’s Be Diligent

Times are good for credit unions in their business lending programs. With these numbers, credit unions wouldn’t be playing for a national championship, but a, still impressive, Rose Bowl bid. Loan originations continue to be strong, but now it is time to focus on ensuring we have a strong back office to manage the portfolio and the inevitable hiccups along the way. 2023 is a great opportunity to ensure you are diversifying your portfolio with various industries, loan types and geography to help manage risk well into the future. There is no need to fire the coach at your first loss and rebuild everything. However, our current environment is a great time to review your program and make sure you are built for success in 2023 and beyond.

Mark Ritter is CEO of the CUSO Member Business Financial Services and its subsidiary, Nu Direction Lending, in Philadelphia, Pa.