Impending Credit Crisis: How Banks and Credit Unions Must Prepare

The COVID Slump is a very different recession. In some ways, it's nobody's fault. But an Accenture expert says that a careful balance is needed from lenders because it is possible for even a well-intentioned move to make the situation far worse. A key suggestion: Avoid any credit policy that looks like a 'blunt instrument.'

The challenges of the COVID-19 recession for lenders have not yet begun to bite in earnest, but banks and credit unions are going to start feeling it soon, according to an expert from Accenture.

The impact on credit of all kinds is going to be felt in different ways depending on the makeup of each financial institution’s portfolio and on the demographics of their consumer and small business borrowers. But as the summer of 2020 moved into fall, the Novocain was wearing off on the recession pain as certain credit relief efforts tailed off and as the impact of multiple stimulus programs ended.

Now lenders will begin feeling a nonperforming loan crisis that will differ from anything seen by most people in the industry today, with the exception perhaps of the oldest credit veterans. This recession’s impact on credit isn’t something that can be blamed on greed, bad credit modeling, overly aggressive marketing, the madness of crowds nor any of the villains of most crunches in memory. Shutdowns introduced to avert the spread of coronavirus slammed the emergency brake on a economy that still pointed to prosperity.

This overall view of where financial institutions stand comes from a report by Accenture and other sources. Chris Scislowicz, Managing Director of Accenture’s financial services practice, and Head of North American credit practice, told The Financial Brand that many lenders, with the exception of the very largest, are only now beginning to get a handle on where they stand on the credit side and what is likely to come.

Lenders Are in the Calm Before the Credit Storm

“The looming nonperforming loan crisis is going to manifest itself differently across consumer segments, across industry segments,” says Scislowicz. “It’s going to affect consumers, homeowners, small business owners and large companies.”

“The looming nonperforming loan crisis is going to manifest itself differently across consumer segments, across industry segments. It’s going to affect consumers, homeowners, small business owners and large companies.”
— Chris Scislowicz, Accenture

An Accenture report, “How Banks Can Prepare for the Looming Credit Crisis,” states that “We are in the calm before the storm, the moment in which payment holidays are not flowing through into consumer credit scores and where underlying business health is being masked by furlough and payroll protection schemes.”

That calm is ending, according to Scislowicz, and many financial institutions are figuring out where they stand. He explains that the drain of the Paycheck Protection Program and forbearance programs on lenders’ attentions and energies cannot be overestimated. In many organizations each stage of the PPP, the Main Street programs and more combined to divert staff and time away from more analytical tasks due to the nature of the health and economic emergency.

“The implications for the industry were pretty profound,” says Scislowicz, “in terms of pulling people off the line. But now the folks with key responsibility for portfolios are starting to take a hard look at things. They are asking, now that programs are winding down, what it means for their books of business.” While issues have already surfaced in commercial lending, that will be expanded as consumer credit forbearance begins to go away.

Matt Komos, Vice President of Research and Consulting at TransUnion, notes that two factors occurred in July 2020 that haven’t shown up in national credit statistics yet. First, credit relief offered to many consumers at the outset of the crisis began to end. Second, the $600 federal unemployment insurance payment boost went away.

57% of consumers reported that they have been economically hit by the COVID recession, according to TransUnion’s Financial Hardship Survey for July.

Here’s what to watch for: “I think the August numbers will give us a sense of what we might expect for the rest of the year,” says Komos. “That’s my preliminary assumption.”

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The Pain Begins Now For Lower-Income Consumers

“I was on the phone with a chief credit officer from a major superregional bank in mid-August,” says Accenture’s Scislowicz, “and he said that they were just starting to see delinquencies tick up.”

Accenture believes lenders will begin feeling more pain in late September to early October — the timing is approximate. From that point on, input from Accenture and other sources indicates, how well or how badly things go will hinge on the progress on COVID containment, Presidential election politics, regulatory attitudes, shareholder pressure on top management of banking companies, and the behavior and judgment of lenders themselves.

“The bottom 20% of the workforce has been hit hardest. People in many blue-collar jobs can’t work from home and have been hit harder by layoffs and closures.”

“Unlike the previous crisis, which was about speculation and overvaluation, what we have here is unemployment taking its toll,” says Scislowicz. Job losses keeps rising, with layoffs beginning to increase as companies reassess their near-term future.

“I think this could get pretty ugly on the delinquency front,” says Scislowicz.

In consumer and mortgage lending Scislowicz says patterns are shaping up differently than in the Great Recession. That crisis and its aftermath tended to vary around the country based on geographical factors that influenced market prices, he explains. The current crisis appears to depend on income level and the nature of the borrower’s employment.

Scislowicz says the bottom 20% of the workforce has been hit hardest. People in many blue-collar jobs can’t work from home and have been hit harder by layoffs and closures, overall.

At the same time that these consumers are suffering, those who still have jobs and who want homes have been bidding the prices of houses up as they pile into residential real estate in a time of extremely low rates, to the point where the housing supply is quite strained,.

“So you’ve got a strong dichotomy brewing between the haves and the have nots,” Scislowicz states.

A consumer survey conducted for Finicity in June 2020 found that people with household incomes of less than $50,000 appear to be getting hit harder by this recession. Some statistics from the firm’s research:

  • 50% have lost their job or had their income reduced, compared to only 31% of households with over $100,000 in income.
  • 73% are having trouble keeping up with bills and payments, versus 57% of those with income between $50,000 and $100,000 and 54% of those with household income over $100,000.
  • While 25% have tried to tap credit less often during COVID, 21% have had to use it more often. Another 23% have not attempted to use credit because they don’t think they would qualify.
  • 68% worry that the recession will damage their credit, while only 52% of people with over $100,000 in household income have that concern.

The TransUnion hardship study indicates that consumers are tending to not tap credit to meet income shortfalls, and those who have received some type of debt relief from lenders have been using that opportunity to pay down their debt more quickly than beforehand.

But the same research indicates that almost a third of renters surveyed said they will soon be unable to pay their rent. This will have ripple effects on landlords as well as on commercial real estate lenders financing multifamily housing.

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Be a Hero … for As Long As Possible

Something else that sets this recession and the credit impact of COVID-19 apart from past slumps is that there is comparatively little history on which to base planning.

“Lenders are going to have to make much faster decisions on credit risk than they have, historically,” says Scislowicz, “because they don’t have the luxury of time.”

Accenture believes that because this recession is not being placed at banks’ doorsteps this time around lenders have the opportunity to be heroes. Some of this has already been seen in early efforts to voluntarily offer credit relief, such as skip-a-pay programs. But this is a limited-time opportunity.

“It will last right up until the point where their shares start to suffer and their shareholders come after them,” says Scislowicz. “By that point they will have their own challenges.”

Initially, Scislowicz believes, regulators are likely to give lenders the leeway they need to continue to help consumer and business borrowers to make it through this rough period. He says that when the firm has spoken to its clients, which skew to the larger end of the banking industry, they are more concerned about shareholders than they are about regulators. “How long that leeway will last is anybody’s guess,” says Scislowicz.

“Accenture’s report warns against the possibility of using ‘blunt-instrument credit management based on short-term considerations rather than surgical intervention guided by forward-looking data and longer-term economics’.”

In early August 2020, recognizing that the first wave of voluntary assistance was winding down, federal regulators acting jointly through the interagency Federal Financial Institutions Examination Council, issued guidance on granting further relief while operating prudently.

“Well-designed and consistently applied accommodation options accompanied by prudent risk management practices can minimize losses to the financial institution, while helping its borrowers resume structured, affordable, and sustainable repayment,” the statement says.

Accenture’s report warns against the possibility of using “blunt-instrument credit management based on short-term considerations rather than surgical intervention guided by forward-looking data and longer-term economics.” Ideally, the report notes, thinking more broadly rather than focusing solely on asset recovery will lead to better outcomes for all.

“What we’re referring to is treating all borrowers the same,” says Scislowicz. He explains that the risk is that lenders will start putting consumers and small businesses into categories based on broad characteristics of their borrowings and making blanket decisions. “This includes such actions as deciding that anybody who has been delinquent for X number of days gets put into either foreclosure or special assets or what have you,” the analyst states.

Slice and Dice Your Portfolio to Find Best Solutions

“What we’re recommending is a more enhanced and segmented view of nonperforming loans than, frankly, many banks have used before,” says Scislowicz.

This suggestion applies particularly to small business lending, which represents so much of American employment and which has taken the COVID recession harder than other business categories. Scislowicz says the temptation to treat small firms identically won’t help lenders nor borrowers.

“Most banks serve niches of small business borrowers,” says Scislowicz. “They should be asking, ‘What do we think is going to happen to this segment and that segment?'”

One example he points to is dry cleaners. With work-from-home still continuing for many companies, he says, people aren’t getting business clothing cleaned very often.

“Do you think that segment will rebound? Or will working from home be the new normal and will dry cleaners suffer in the long term?” asks Scislowicz. The point is that another type of small business just down the street — a medical practice or a pet store — may face an entirely different future. Right now lenders should be assessing each type of business and each individual business as specifically as possible.

This will challenge many institutions because the situation goes beyond what traditional training accounts for. The same focused analysis will be required on other fronts as well. Commercial real estate, for example, in categories besides multifamily housing, will succeed or fail in this slump based on the industry affiliations reflected in the tenant mix.

Blunter Approaches Will Be Inevitable While the Recession Lasts

Scislowicz acknowledges that lenders won’t always be able to avoid wielding broad credit management policies. It will hinge on markets and the individual institution’s own financial health, no doubt.

He says the duration of the recession will also affect how much lenders can tailor their credit responses to each segment and each borrower.

“The longer the recession lasts, the more blunt I think things will get, which is unfortunate,” says Scislowicz. “You’d like to think that the longer it lasts, the more surgical lenders could be. But as time goes on there will be pressure from shareholders as well as from regulators to take blunter approaches.”

For an industry that took much of the heat for the Great Recession, and suffered resulting trust issues for years afterwards, this isn’t a great prospect.

“It will be at odds with public perception and there will be public outcry,” Scislowicz predicts. “The bottom line is that if this goes too long, banks are going to be in an untenable position.”

This is an area where, for a time, credit unions will have the advantage of being able to think in terms of members, not having to be concerned about shareholders, says Scislowicz. That said, they will face regulatory pressures should credit conditions deteriorate badly.

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A Worst-Case Scenario: Lenders Amplify the COVID Recession

An inevitable challenge is that every lender at some level is not only a participant in the economy, but an influence on that economy, whether the scope of that influence is national, at the state level or in a small town.

“If banks suddenly put a hold on funding, we could find ourselves quickly in a different crisis. Similarly, if banks started to suddenly start foreclosing on homes rapidly, they could create a real estate crisis.”

“Banks have to make clear-sighted decisions about how parts of the economy should be restructured,” the Accenture paper states. “Too indulgent, and the economy won’t adapt to serve a post-COVID world. Too harsh, and banks risk becoming pro-cyclical amplifiers of the crisis. That is the fine line between being a hero and a villain.”

Scislowicz says this could happen in the current recession if lenders found that conditions become shaky enough that they decide to turn off the credit tap.

“Liquidity nearly dried up in 2010,” recalls Scislowicz. “If banks suddenly put a hold on funding, we could find ourselves quickly in a different crisis. Similarly, if banks started to suddenly start foreclosing on homes rapidly, they could create a real estate crisis.”

The firm isn’t saying that this kind of development will come, only that it could come if lenders aren’t careful.

“There are levers that lenders can pull and certainly some of those levers could make this recession worse,” says Scislowicz. Another potential risk, for example, is institutions liquidating assets too quickly, flooding the market involved and driving down prices.

Even being helpful to troubled borrowers has be done carefully.

“There’s the concept of lending into a problem, giving someone with a strong business model the funds to get through six more months,” Scislowicz explains. “But the catch is that nobody’s got a crystal ball on how long this is going to last. If we’re still sitting in our homes wearing masks in August 2021, the U.S. will be a very different place, and some very different actions will have to be taken.”

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