KBRA Downgrades Ratings for VyStar Credit Union

KBRA downgrades the deposit and senior unsecured debt ratings to BBB from BBB+, downgrades the subordinated debt rating to BBB- from BBB, and downgrades the short-term deposit and debt ratings to K3 from K2 for Jacksonville, Florida based VyStar Credit Union (“VyStar” or “VCU”) (“the credit union”). The Outlook for all long-term ratings is Negative.

Key Credit Considerations

The rating downgrade and Negative Outlook are largely predicated on the credit union’s weakened earnings profile, reflected by a 0.15% ROA for 9M24, partially driven by significant loss of interchange fee income that began in 3Q23 due to the Durbin Amendment as well as higher provision expense to offset incremental increases in net charge-offs and NPAs since 2022. Due to the inherent nature of the credit union and exposure to consumer-oriented loans in the portfolio, NCOs and NPAs typically run higher than that of similarly rated banks. In recent quarters, asset quality metrics have weakened as NCOs and NPAs were 0.90% and 0.68% of loans, respectively, as of 3Q24. Moreover, loan loss reserve coverage is weak when compared to similarly sized peers, narrowly covering NPAs by 1.2x at 3Q24, while the increase in provision expense covers NCOs by 1.1x. Historically, VCU’s earnings profile has been supported by solid fee revenue income with noninterest income representing ~40% of total revenue; however, following the impact of the Durbin Amendment, in conjunction with reduced mortgage originations, noninterest income has declined to 28% of revenue, weighing on overall earnings. Moreover, VyStar displays a relatively more expensive operating structure as operating expenses represent 3.4% of average assets, driven by an internal restructuring to improve core infrastructure and a 2022 M&A transaction that did not occur due to regulatory hurdles. That said, the ratings are supported by VCU’s solid net interest margin, as management has been focused on holding NIM steady, supported by the shorter-duration auto loan portfolio (representing 34% of loans) driving the increase in average earning asset yields. We note that increased deposit competition has caused VCU to grow its utilization of wholesale funding, which accounted for 28% of the funding base at 3Q24. That said, VyStar maintains a solid level of NIB and low yielding deposits at 23% of total deposits, helping to offset funding costs related to the increased use of non-core funding and to support the margin. Capital metrics improved following VyStar’s $200 million subordinated debt offering in 2022, though metrics have declined due to modest loan growth in 9M24 (8% annualized) combined with constrained earnings, reflected by the net worth ratio and total risk-based capital ratio falling to 9.0% and 12.6%, respectively, though this still maintains an adequate buffer above the minimum for well capitalized thresholds.

Rating Sensitivities

A return to Stable Outlook could occur from a stabilized credit environment and improved credit quality metrics, combined with improvement in profitability to more normalized levels, and regulatory capital metrics that are in line with peer averages. Given the Negative Outlook, a rating downgrade is possible should credit quality metrics continue to worsen, therefore, further weakening the profitability of the credit union. Moreover, if capital metrics deteriorate, combined with a substantial increase in wholesale funding, negative rating movement could occur.

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Methodologies