The State of Credit Union Commercial Banking: A Q&A With Justin Conrey

Justin Conrey, a seasoned commercial banking executive who has spent time in both the credit union and community bank spaces, was named president/CEO of the Portland, Ore.-based CUSO CU Business Group last fall, taking the reins from the retiring Larry Middleman. We recently asked him for his insights into the state of credit union commercial lending today.

CU Times: How would you assess overall commercial lending growth trends over the past year for credit unions, and where do you think they’re headed?

Conrey: It’s not unique to credit unions by any means, but there are significant headwinds in the commercial real estate and lending space. A lot of that has to do with the rate environment. Naturally, when you have a rising rate environment, that’s going to make certain commercial loans harder to do. So the number of commercial loan opportunities out there is going to decrease, and credit unions and other financial institutions are going to become more selective. Their rates and cost of funds are higher, so overall it creates downward pressure and a downward trend on volume and opportunity. And there’s less out there for all the financial institutions that are trying to make loans. So that is an industry-wide thing that’s happened that isn’t specific to credit unions, but credit unions are definitely feeling the pinch it.

2022 was a record year for loan funding in the commercial lending space. I don’t know that we’ll ever see rates as low as they were in 2022, so credit unions and other financial institutions were doing record volume. That changed significantly when the Fed raised the rates, and especially when they raised them as steeply and quickly as they did. Commercial loan volume just fell. It was down 57% year over year, and the first quarter of this year was the largest commercial loan volume decrease since 2014. That’s not just affecting credit unions, that’s affecting everyone in the commercial space.

At the height of the pandemic when the government shut everything down and businesses weren’t operating, commercial loan volume tanked significantly because no one knew what was going on or what to expect. We were almost at that same level [this year], just naturally from the rising rate environment.

Credit unions also had a bigger challenge with liquidity than commercial banks did. They were a little slow to adjust to the rising rate environment, and as an industry we saw a lot of capital go out the door because we continue to have the lowest mortgage, commercial and auto rate in town. We became a favorite for consumers for all those loans and liquidity flowed out. There was also the artificial influx of liquidity through stimulus that has continued to erode, and that’s hampered liquidity for all financial institutions. So banks were challenged with liquidity, but I think credit unions more so. I felt like credit unions were hit with a one-two punch – we were hit with the general punch of high rates and low volumes, but then we also had to manage the liquidity challenges, and that I think is what’s affecting us the most.

We have a Capital Markets team that originates loans for credit unions and sees loan opportunities everywhere, and I use that as a barometer for the opportunities that are out there. As rates have started to somewhat stabilize – though they’re much higher than they’ve ever been, there is some stability, which does get some volume moving because investors can now project what the cost of funds is going to be – we started to see some volume come back and our capital markets pipelines continue to grow. But we were still struggling with finding opportunities and homes for them in the credit union space, because credit unions didn’t have the liquidity to make $5 or $10 million loans. So I feel like the credit union industry has been impacted more than the banking industry.

Of course there was Silicon Valley Bank and those other situations that created challenges in the banking space, and credit unions are not in any way going down that path, but we are struggling with the ability to be there when commercial loan volume recovers. I worry a little bit about credit unions’ ability when that does happen, if the Fed starts to cut rates sometime next year. If the volume comes back, will credit unions be able to jump back into the space the way they did in 2022? A lot of that is based on liquidity challenges, and to me it’s a little bit concerning.

There are also a couple of other trouble spots. The disparity between commercial loans and deposits on credit unions’ books is a challenge, and that speaks a lot to the liquidity challenge. If that ratio was much closer to 1:1, the liquidity situation wouldn’t be as challenging. But because of technology and other limitations, credit unions haven’t really pursued the commercial deposit offerings. They can now and technology has caught up, and that’s a big part of what [CUBG does]. We do a lot of deposit consulting and try to help credit unions grow and develop products that will be effective in that market.

There are also commercial real estate challenges in general – office is a big one. The nature of office leases are long-term, usually 10-year, compared to retail and residential leases, which are much shorter. So office is that one sector where we haven’t really seen that true impact of the pandemic. Something like hospitality … you know hotels were shut down and travel was shut off so you saw that go way down, but once travel was back, it was a quick recovery. So we sort of know what the full impact of the pandemic was on that industry. But with office, for example if you look at the building where we have our office, if you walk in there today it would look like a 100% vacant office, but technically it’s 100% occupied. There is a tenant paying rent in every space in that office, but nobody’s using it. So what’s going to happen when those leases come due? That office space could go from being 100% occupied to 100% vacant. So for credit unions holding office assets, that’s going to be something to watch. The values on those are going to deteriorate a little bit. Now a lot of that is going to be regional in impact – return-to-office is much stronger in other regions than it is, say, in our region [the Pacific Northwest]. So it depends on where the credit union is and what market they have office space in.

Another issue that I see potentially on the horizon is with the number of commercial loans that are maturing in the next two to three years. Refinances have always made up a large portion of the commercial loan volume that we do – investors taking cash out of one property to develop another or they’re refinancing because of rates – and when rates are really low, that activity is really high. But nobody’s in a hurry to give up a 3, 4% rate to get to a 7 or 8% rate today. So there really isn’t much of a refinance market, aside from loans that are going to mature. Commercial loans are usually set up on balloons – five- or seven-year balloons – so a lot of those are going to come due. And it’s not just credit unions, this is an industry-wide concern, but credit unions that funded those loans three, four or five years ago at the maximum LTV and the lowest possible debt service coverage, basically the limits of their acceptable policy, when you take that property today and turn that rate from 3% to 8%, is that still going to work? Because those loans are going to mature and they’ll either have to be refinanced or the borrowers are going to have to sell, and there could be some distress.

CU Times: Going back to the office space issue, is that an area that a lot of credit unions play in?

Conrey: There are aren’t many credit unions, especially that we see coming through CUBG, that are financing these large, high-rise office buildings in downtown areas. If they’re getting office space, it’s more in the secondary and tertiary markets. It’s in the suburbs and they’re smaller. I do think there will be impacts because I know there are credit unions that get into that space, but as far as the number of banks versus credit unions that are susceptible to that, it’s heavily weighted toward banks.

For credit unions, that could mean a potential opportunity. As those properties potentially sell at a lower rate, are short sold or foreclosed on because of challenges with vacancy, there’s an opportunity for repurpose. And there’s always the opportunity, because there’s a consistent housing shortage, out there of repurposing properties into multifamily or apartments. So if you’re on the side of the distressed asset, that’s not a good position to be in, but if you’re on the side of a potential developer that sees the ability to acquire that property at a significant discount and repurpose it into something else, that can be an opportunity for credit unions to step in and help with that.

CU Times: CUBG recently expanded into SBA lending through its acquisition of another CUSO. How would you characterize credit unions’ relationship with SBA lending today?

Conrey: Credit unions as a whole do about 3-5% of all the SBA loans that are made in a given year. It’s not much, and it’s largely because of resources. To effectively do SBA lending, you almost need to take your conventional commercial loan department and recreate all of those roles all over again with SBA experts, because there’s such a distinct difference in the rules and expertise needed for SBA. That’s an investment that a lot of credit unions just can’t make. It’s not that credit unions don’t want to help the community, to do that community-based lending or be part of SBA, it just simply comes down to resources.

It was a major goal for us, that if we wanted to help credit unions get in that space and improve, that we build a program that would allow them to get into that space with as little resource investment as possible. So we can help them do everything from origination of that loan through closing and liquidation. We felt that if we could do that, we could solve the resource equation.

And we encourage credit unions to get into the space because there’s a cultural alignment between SBA and credit unions. If you explained what a credit union and what a bank was to somebody and then asked them which one does SBA lending, they would say the credit union 10 times out of 10 because it just aligns with serving the underserved, it aligns with the [National] Credit Union Foundation’s cooperative principles. Concern for community and diversity, equity and inclusion are two of those eight principles, and those really align with what institutions use SBA lending to do. Credit unions also aren’t forced to do community reinvestment like banks are, so it’s incumbent upon credit unions to consciously make those efforts to reinvest in the community.

So we’re hoping that when we solve that resource issue, we can talk to credit unions and encourage them to align with the SBA’s principles, and be able to do more of that community-based lending. For me personally, it’s some of the most rewarding lending that I’ve ever done in a commercial space. It’s one thing to go and build a high-rise building or hotel, it’s really cool and fun and there are a lot of complexities to it, but to watch a member open their dream store in a downtown community, be able to achieve that dream of theirs, serve that community, provide local ownership and reinvest in the community, and for the credit union to be able to be a partner with the business owner, is tremendous. It’s way more rewarding to do that than to make a millionaire a multimillionaire from a commercial real estate prospective, and that’s what credit unions are all about. I think we have a responsibility as an industry to do that more, we just needed a way to do it effectively, and our hope is that CUBG’s program is that key.

CU Times: Has CUBG’s SBA program launched, and how is it being received so far?

Conrey: We’re about a year and a half into it. There’s been significant interest, but it takes a while for a credit union to [launch] SBA. We help them develop all their policies and procedures, they have to get approved with SBA and we have a really effective and diligent training process that we put all their employees through to understand it. It’s about a six- or seven-month lead time from when they decide they’re going to sign with CUBG and launch SBA to when they’re ready to go. We’ve had a handful sign on in the first few months, and we’ve almost tripled that this year.

I think what’s really helped us more than anything is what credit unions did with PPP [the Paycheck Protection Program]. Credit unions like I said only do 3% of SBA loans in a given year, but when their members really needed it, credit unions in true credit union fashion stepped up tremendously. They did over 300,000 PPP loans, and they were challenging – credit unions probably never want to do it again, it was a big, messy situation, but they stuck it out. They had employees working 24/7 trying to get those applications in because they saw the importance of helping that business member, not only to support their business, but that business is that member’s livelihood so they were helping to sustain lives too. I think they saw the opportunity there and how exceptional that was to help those businesses, and it opened their eyes a little bit to SBA. So SBA lending is supposed to be a lot of that, without the messiness and urgency of the PPP situation.

CU Times:  How are you advising credit unions to balance the need to beat out their competitors in the commercial lending market with the need to mitigate risks?

Conrey: At CUBG we’re fairly conservative because we want credit unions to operate in a safe and sound manner. We work very closely with the NCUA to ensure that’s possible, and we have a reputation with them, they like what we do and the advice that we provide. So we don’t want to encourage credit unions to go do risky things for the sake of generating volume. But their ability to compete has grown significantly. The talent level of individuals at credit unions in the commercial space has increased significantly. There have been a lot of credit union-bank acquisitions. There’s a lot of consolidation in the community banking space. Unfortunately for them, they’re getting folded into either super regionals or getting acquired by credit unions. That’s worked to our advantage in the credit union space, not just from a competitive standpoint, but there are fewer competitors out there.

Credit unions over the last 10 years have gained a 200-plus percent market share from community banks and continue to do so. And a lot of that is because of the evolving nature of credit union internal operations and supplementing it with places like CUBG. We’ve been really cognizant from an education and product offering perspective to creatively allow credit unions to compete on things like prepayment penalties on interest rate swaps. We’ve partnered with other organizations to help educate credit unions on the complexities of the different product offerings that are out there, and allowed them to develop product offerings that are consistent with the risk tolerance that they have as a credit union but allow them to be more competitive.

A big part of what I consider my job to be is to be a good listener to credit unions. I’ll go to a lot of conferences, not to promote CUBG but just to listen to the challenges credit unions are having, and take that back internally and figure out a way to help create products to help them solve them. We have a laundry list of products, and each one of those is the result of a credit union having a problem. So we’re continuing to do that in areas where credit unions are less competitive with community banks. Because there’s contraction in that market, there’s significant opportunity for credit unions to seize, but we want to make sure they have the tools to do that conservatively, effectively and safely.