This blog was authored by my colleague Erica Crain, Managing Principal of Value & Risk Services.

If something is repeated it’s likely a message that carries some weight. I think we can officially say that more than a “friendly reminder” has been provided by the regulatory agencies regarding increasing credit risk for both banks and credit unions. In November 2023, the Office of the Comptroller of Currency (OCC) provided their examination priorities for 2024. Coming in at number two on the list is assessing how banks are identifying and responding to credit risk. In January 2024, the National Credit Union Administration (NCUA) also announced their supervisory focus for the year with credit risk topping the list. During the last week of February 2024, news headlines about New York Community Bank and a lacking loan review program and deteriorating credit quality trends for credit unions has come to the forefront.

It’s not news that credit risk is receiving additional attention. In May 2020, the federal regulatory bodies came together and issued guidance about the significance of credit risk review systems. In 2021 and 2022, financial institutions got a heavy dose of guidance on the Allowance for Credit Losses, which included key principles around credit risk identification and management. Last year, the federal regulatory agencies issued guidance on loan accommodations and workouts in anticipation of a commercial real estate meltdown. The messaging has been quite strong. So, how is a weak loan review program a critical matter in 2024 for one of the largest financial institutions in the United States? Working with financial institutions across the nation, a consistent question asked circles around the re-evaluation of credit risk appetite, culture, risk mitigation strategies, concentration management, and credit review functions given current economic changes and consistent regulatory emphasis. However, a typical response is that not much change has been made or deemed warranted as the financial institution has never received any criticism from regulators in the past.

Financial institutions have significant experience in navigating evolving credit cycles and this is one of those times to consider if strategies need to be adjusted. Credit stresses are growing, and borrowers have to adjust to a new environment in which financing conditions have become even tighter. Cash flow stress, lower income, and higher costs are realities an increasing number of borrowers (consumer and commercial) are facing which impact their repayment performance. For example, in Q4 2023, credit union data shows that problem loans rose again and that the net charge off ratio continued to climb, reaching its highest point in over a decade. Largely the increase was attributed to credit card and used vehicle loan performance, indicating consumers are feeling the effects of the current economic pressure. For your financial institution, take another look at the evolving credit risk exposure and consider some simple steps like the following:

1. Assess your current loan portfolio by key segments and document the risk exposure. Although commercial real estate has been making headlines, there are signs of weakness in other lending categories, like consumer. Stay informed and consider the ripple effect of softening conditions throughout the entire portfolio.
2. Evaluate your independent loan review process. Consider if your internal team is adequately staffed or providing the expertise needed. Challenge third-party providers results and go deeper in areas demonstrating increased risk for your financial institution. Your loan review process shouldn’t just be a validation of your assigned risk ratings. If your third-party provider is not providing you the insights you need in the current environment, consider other options.
3. Engage, proactively, with your borrowers who appear to be at risk to identify opportunities to help. The time investment today could help offset potential significant losses in the future.

At CLA, we can help you navigate the risks in your portfolio with a credit risk review that provides management with insights and opportunities in the loan portfolio. Please reach out to Erica Crain, Dustin Morris, or Susan Sabo today to see how we can help.