NCUA Report - March 2012

ELEMENTS OF AN EFFECTIVE MEMBER
BUSINESS LENDING PROGRAM

More and more credit unions have started to offer Member Business Loans (MBLs) because of member demand. At the end of 2011, federally insured credits unions’ business lending portfolios hit $39.1 billion, a more than 5 percent jump for the year. In light of recent growth, Region V examiners review some of the common commercial lending deficiencies in new MBL programs.

Mission Statement

The mission statement of new MBL programs should reflect a desire for a well-diversified portfolio of borrowers with proven cash flows, in low-risk industries. Bad Sign: The portfolio is comprised of higher-risk industry loans such as gas stations, swimming pools, and some church loans.

Personnel and Compensation

Credit union personnel with approval authority over MBLs should have adequate credit administration and underwriting experience. Relationships, sales, and business development experience does not count. Incentives should be tied to credit quality as much as it is to volume. Bad Sign: When the MBL managers inform their examiner that borrower losses have not exceeded revenues yet.

Third-Party Originator

Credit unions looking to boost loan volume often look to outside third-party underwriters to analyze loans. In the process they outsource the due diligence associated with the underwriting to the third-party vendor who does not always have the same incentive as the credit union. The credit union does need to review the third-party underwriting, confirm all analyses, and reach an independent conclusion about whether the proposed loans match credit union policy and risk appetite. Bad Sign: The comment, “They have an excellent reputation.”

Underwriting

The underwriting document or credit presentation should capture all pertinent aspects of an MBL. The credit presentation for a commercial loan should include the following analysis:

; Sources and uses of funds,

; Existing and projected cash flow,

; Leverage and liquidity, and

; Secondary sources of repayment to include collateral and guarantor support.

Other elements include:

; Financial reporting and credit monitoring requirements,

; Required adherence with financial covenants,

; Risks and mitigating factors, and

; A risk-rating justification for the proposed credit structure.

The credit presentation provides a global review of the commercial credit relationship that allows for an informed credit decision, quantification of risk, and subsequent pricing determination. Some credit unions make a habit of approving and disbursing loans on the fly and without underwriting. Once the cart is out of the MBL barn, then a manufactured credit presentation is produced to appease the examiner. Bad Sign: Credit presentations lack conditions of approval and are dated after loan dispersal.

Risk Rating Justification

While many credit unions earn high marks for properly analyzing borrowers, there are also many who assign risk ratings by using a subjective or arbitrary methodology. The outcome is a mismatch between the assigned risk ratings and concerns identified within the credit presentation. The credit union’s MBL policy should clearly articulate credit characteristics specific to each risk rating category, and include tangible metrics (cash flow coverage, leverage and liquidity) and corresponding thresholds for these categories. Bad Sign: An insolvent borrower with no history of cash flow gets an “acceptable” rating.

Financial Reporting and Portfolio

Monitoring the underwriting, approval, and disbursement processes represent the first steps for administrating an MBL loan. Credit unions need to clearly identify within the credit presentation (and loan documentation) the frequency and quality of financial reporting as a function of risk rating, credit exposure, and borrower sophistication. Employees need to follow through with obtaining and analyzing updated financial information on a timely basis and maintain a tickler system for following up on outstanding financials. This is particularly critical with purchased participations where the credit union does not have ready access to the borrower. Bad Sign: The originating lender is cooperating in obtaining outdated financial information.