Community banks and credit unions are facing a dynamic and challenging operating environment as we approach 2025. The landscape remains shaped by the lingering effects of the COVID-19 pandemic, higher interest rates, inflationary pressures, and slower economic growth. As such, effective credit risk management is a top priority for community banks and credit unions to maintain financial stability.
For now, it appears the U.S. economy will likely have performed better than expected in 2024, with annual GDP growth estimated to end at 2.7%. However, in 2025, economic growth is expected to decline to a consensus forecasted range between 1.0–2.0%. The primary causes for slower growth are moderating consumer spending, rising unemployment rates, and weaker business investment. Uncertainty surrounding tariffs, hard-to-shake inflation, and fewer Fed rate cuts than previously forecast will add further nuance to a dynamic 2025 business environment.
Credit quality, broadly speaking, is expected to return to normal, with delinquencies and net charge-offs increasing modestly from 2024 levels. Commercial real estate (CRE) portfolios, particularly the office segment, continue to experience higher stress, while most other CRE sectors remain healthy, albeit down from peak valuations seen in early 2022. Recent trends in agricultural loan portfolios indicate higher nonperforming loans as a result of lower commodity prices combined with higher input costs creating a stressed working capital scenario. On the commercial and industrial loan front, industries which appear to be experiencing higher credit risk include retail (motor vehicle dealers, power equipment, and electronics); transportation (freight trucking); healthcare (skilled nursing facilities); and waste management services.
Effective credit risk monitoring remains as important as ever. Banks and credit unions should continually adapt their strategies to identify loans that have higher risk profiles as soon as possible. As was highlighted in the Office of the Comptroller of the Currency Bulletin 2024-29 in October 2024, banks and credit unions should evaluate credit risk during ongoing monitoring activities such as annual reviews or upon nearing loan maturities. A proactive analysis that monitors a borrower’s performance relative to expectations is highly encouraged. Multivariable stress testing at the loan level for vacancy rates, expenses, interest rates, and capitalization rates is a valuable risk management tool. On a portfolio level, effective credit risk management processes include monitoring of the volume and number of loans maturing within a specified time period, identification of portfolio sectors affected by external risk factors, and setting and adhering to sector concentration limits.
As community banks and credit unions navigate the complexities expected in 2025, addressing credit risk in the commercial, agricultural, and CRE portfolios will be paramount. Staying informed about economic trends and advancing your risk management strategies can solidify a better positioning for success in the year ahead.
