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Credit Unions: Member Business Loans Seeing Substantial Growth

Credit Unions: Member Business Loans Seeing Substantial Growth
Posted: Jul 13, 2017
Categories: Regulations, Consulting
Comments: 0

Thanks to recent NCUA changes to open up and simplify member business lending.

In Callahan & Associates’ most recent credit union Trendwatch, record high loan originations was one of the highlights of the growth of credit unions’ portfolios, placing the total loan portfolio held by credit unions in the U.S. at close to $900 billion. While auto loans led the growth in percentage terms at 16.8%, a surprising category emerged in second place at 15.5% growth – Member Business Loans. The driver of this come-from-behind category of lending is the recent changes made by the NCUA to open up and simplify member business lending. While some credit unions have jumped on the opportunity created by the changes, many credit unions still have not dove back into granting the type of loans that first created credit unions – member business loans.

History

According to NCUA’s history of credit unions, a court reporter in Quebec, Alphonse Desjardins, in 1900 became aware of loan sharks charging outrageous interest. In response, he organized the first credit union in North America to provide affordable credit to working class families. That credit union was La Caisse Populaire de Levis. A decade later, he helped a group of Franco-American Catholics in Manchester, New Hampshire, organize St. Mary’s Cooperative Credit Association, in part, to provide loans to farmers to purchase livestock, equipment, seeds and other farming needs. These were the first member business loans in the U.S.

In the first 90 years of credit unions’ existence, there was no cap on business lending. In 1998 a cap was imposed by Congress in the Credit Union Membership Access Act of 1998 (CUMAA), which limited most credit unions to lending no more than 12.25% of their assets to small businesses. This limit was set without any justification in terms of economic, safety and soundness or historical rationale.

More recently, it was proposed to the NCUA that credit unions could help grow the economy. If this cap was lifted, it was believed that credit unions could lend an additional $16 billion to small businesses, with the resulting potential to create nearly 150,000 new jobs in the first year after enactment. In comparison to government stimulus programs, this job creation could be accomplished without costing the taxpayers a dime and without increasing the size of government.

In 2016, the NCUA Board approved an overhaul of the section of rules that governs member business loans. The new rules became effective in January 2017 and allow credit unions to greatly expand their loan portfolios, but also bring some additional responsibilities for credit unions.

 What’s New?

The changes are extensive; the NCUA has a summary document that lists 27 changes and their implications. Some are minor or primarily clarifications, and some are true game changers. The one that has garnered the most attention is the new definition, “commercial loans”, distinct from member business loans.

The significance of this additional loan category is the existing 12.25% cap. Previously, credit unions had their total loans capped at 12.25% of their assets. Now non-member loans, re-categorized as commercial loans, do not count toward the cap. To help clarify, the NAFCU Compliance Blog provided a Venn diagram to help explain that only the loan activity in the blue circle counts toward the cap.

Furthermore, the definition of the cap, itself changed. The 12.25% is now to be calculated based on net worth, not percentage of assets. This means that credit unions with a higher net worth would have a higher MBL cap under the revised risk-based standard rather than the net worth ratio requirement.

Another big change is the elimination of the need for waivers. Previously, the following items were requirements, but could be bypassed if a waiver was submitted and accepted.

  • Personal guarantee requirement
  • Aggregate construction & development (C&D) loan limit
  • Minimum borrower’s equity for C&D loans
  • Explicit LTV requirements
  • Maximum unsecured MBL to one member or group of associated members
  • Maximum aggregate unsecured MBL loan limit
  • Maximum aggregate net MBL to one member or group of associated members

These requirements have been lifted, and in some cases replaced with rules that provide credit unions with flexibility in setting their own underwriting criteria. For example, the need for a waiver for a Personal Guarantee -  whereby the borrower promises to repay their loan regardless of whether the business succeeds or fails which ensures that credit union members do not suffer a loss for the faith they placed in the borrower's business – is replaced with a requirement for the credit union to document the mitigating factors which offset the additional risk of not having the personal guarantee.

Other major changes address exemptions, mandatory experience, collateral and loan-to-value limitations.

Exemption: Credit unions with assets less than $250 million and total commercial loans less than 15 percent of net worth that are not regularly originating and selling or participating in commercial loans are exempt from MBL rules that define Board of directors and management responsibilities and commercial loan policy requirements.

Experience: The previous explicit requirement that a credit union have on staff “personnel with a minimum of 2 years in making and administering MBLs” is replaced with a more flexible approach that considers the overall experience of the staff involved in the credit union’s commercial lending program.

Collateral: The new rule replaces the limit of 15% of net worth with a policy that states that while 15% is still the upper limit, a credit union can go as high as 25% of net worth if the loan is supported by readily marketable collateral. Sufficient capital is required, but the new rule states that collateral alone shouldn’t be the sole basis for granting a loan.

LTV limits: The new rule replaces specific loan-to-value requirements and unsecured lending limits with a requirement that each credit union set their own limits based on internal risk management analysis and accepted financial industry standards.

“With Great Power Comes Great Responsibility”

Most of the changes in the rule are guided by the desire to more closely align member business lending with that of other banking agency standards. But along with the loosening of restrictive requirements, some of the changes impose additional responsibilities on credit unions and their board of directors if the credit union wishes to engage in MBL.

Credit unions are now required to adopt a board-approved commercial loan policy, and create policies which specify types of commercial loans permitted, required experience of lending staff, loan limits, approval process, and risk management processes. The risk management process must include a formal credit risk rating system to identify and assign a credit risk rating to each commercial loan in the portfolio. The credit risk rating for each loan must be assigned at loan inception and reviewed periodically. There must be different risk rating levels to take into account the various types of loans. And the data required in quarterly NCUA call reports has been modified, effective September 2017, for credit unions engaged in commercial lending.

The loan policy must also specifically address underwriting standards, including the borrower’s ability to repay, the type of collateral acceptable, and the method(s) used to valuate collateral.

As the NCUA states in it's FAQ section of the NCUA Report on Implementing New MBL Rules:

"The best preparation is to adhere to active risk-management principles for sound lending. A well-developed program with appropriate monitoring and controls, and appropriate audit and oversight, should best prepare credit union management for the next examination."

Summary

Credit unions initially set out with a mission to help members of their community accumulate wealth. Member business lending is one of the more significant ways to meet this mission. In every community, there are potential small business owners who need the capital to start or grow their business. Whereas in the early days the capital was needed for farming equipment, now it is needed for computer servers or restaurant equipment. Commercial loans for most credit unions still comprise a relatively small portion of their lending portfolios; according to Entrepreneur Magazine, the average loan size granted by credit unions for business purposes is $212,000. But with the new rules in place, and some careful planning, credit unions can be the single biggest force in growing jobs and enabling small businesses.

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Dean Knudtson

Dean KnudtsonDean Knudtson

Dean has been in the financial services business for close to 30 years, after starting his career at Seattle Trust and Savings and then Western States Bankcard Association where he was regional vice president for the Pacific Northwest and Northern California.

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