The Sky Is Not the Limit

When Generations Federal Credit Union committed to offering member business loans three years ago, it hired a community banker with extensive knowledge to recruit a team and launch the program.

Over the next year, the $560 million/50,000-member San Antonio credit union hired experienced business loan underwriters and administrators and seasoned commercial lenders who knew the growing market well and brought extensive contacts and “centers of influence” with them. That recruitment strategy “enabled us to get traction fairly quickly,” says Chief Risk Officer Ken Raymie, a CUES member.

The credit union launched business lending in the fall of 2015, and its portfolio grew to $75 million in two years, largely in commercial real estate loans, working capital lines of credit, equipment financing and loans through U.S. Small Business Administration programs. Along the way, Raymie’s team began to develop action plans “to manage to the cap,” a limit on credit unions’ member business loan portfolios set by Congress and overseen by the National Credit Union Administration.

“In the coming months, we’ll have to start executing on those strategies sooner rather than later. I didn’t envision that we’d need to be managing to the cap quite so quickly, but I suppose it’s a nice problem to have,” he says.

The member business lending cap limits a credit union’s business loan holdings to the lesser of 1.75 times its actual net worth or 1.75 times minimum net worth. That standard was revised along with other changes to MBL regulations that took effect in January 2017. The rule changes offer greater flexibility and more autonomy for credit unions, says Joey Duckworth, VP/marketing with Member Business Lending, Draper, Utah.

Still, some thriving commercial loan programs may run up against the cap. Fortunately, those credit unions have several options to maintain compliance—and, in the bargain, continue to grow this vital product line.

Some strategies—like loan participations—are widely used, while others—like an exemption from the cap that can be granted when a CU is designated to serve low-income communities—are less well known, says Larry Middleman, CEO of CU Business Group, a credit union service organization based in Portland, Ore. Let’s look at some of these methods.

1. Do Loan Participations

Generations FCU’s primary strategy for managing to the cap will be to partner with banks and credit unions familiar with the booming South Texas market in buying and selling loan participations—an arrangement that puts parts of the loan on several credit unions’ books.

“We’re building a circle of friends and partners with a goal of developing familiarity with each other and trust in each other’s sound underwriting and structuring of loans so that we’re dealing with known entities,” Raymie says.

Middleman calls loan participations “the most tried-and-true method of managing the cap.”

“You only have to report the amount kept on your books under the cap. If you sell 50 percent of a loan, the amount sold does not count toward the cap,” he notes.

This strategy applies to buying portions of commercial loans as well. Because the cap only applies to member business loans, portions of non-member business loans purchased from other lenders do not push credit unions closer to the regulatory limits.

2. Keep Growing

The business loan portfolio of $5.1 billion/385,000-member Lake Michigan Credit Union has expanded to $290 million in outstanding loans in the eight years since this product line was introduced, says Jim Maskell, SVP/commercial lending with the Grand Rapids, Mich. credit union.

The business lending cap is a “moving target” for growing credit unions, because the limit rises in step with net worth, Maskell notes. Because Lake Michigan CU has expanded its net worth by $50 million to $60 million over the last few years, “as a rapidly growing credit union, we’re nowhere near our cap.”

3. Become an SBA Lender

Because the government-guaranteed portions of SBA loans don’t count toward the cap, these loans offer another means of navigating the regulation. This form of lending requires additional expertise, but credit unions can sign on with strategic partners that specialize in these programs to package and underwrite loans properly and ensure compliance with requirements to hold the guarantees over the life of the loans.

$830 million/79,000-member Ventura County Credit Union specializes in SBA lending, relying on the CUSO Member Business Lending to provide back-office technical expertise and servicing, explains VP/Business and Home Loan Services Ed Sahakian.

One of the most popular SBA loans is the 504 program, which offers business property and equipment loans. With a 504 program loan, the borrower puts down 10 percent, the credit union finances 50 percent, and the SBA covers the remaining 40 percent with a guarantee. The 10 percent down payment and favorable rate benefit borrowers, and the SBA-guaranteed portion does not count against the credit union’s business lending cap.

Ventura County CU also recently completed a loan deal through the 504 Green program, which helped a local business expand its headquarters and reduce energy costs. Financing through this program is available to businesses to finance renovations with projected 10 percent energy savings or generation of 10 percent of their energy needs, Sahakian explains.

As a CUSO that specializes in SBA lending, a major focus for Member Business Lending is educating credit unions about the benefits of these programs, both in terms of protecting their assets and opening up cap restrictions, Duckworth says.

“It would take a lot of loans to hit their cap if they were using these guaranteed loans, but credit unions are hesitant to use them because they’re viewed as being very complex, document- and labor-intensive,” he notes. “That can be a huge challenge if they don’t have commercial lenders on staff with experience in making these loans.”

Working with a partner can help credit unions navigate the complexities of SBA lending, including the maintenance of “audit-ready” loan files to ensure loan guarantees are enforceable.

Lake Michigan CU participates in the 504 program and hopes to complete back-office preparations this year to begin making 7A loans, designed for small businesses with insufficient collateral to meet standard underwriting criteria. Like many other credit unions and banks, it works with a business partner, the state Economic Development Foundation, to package 504 loan proposals to meet the SBA’s standards.

The credit union is scheduled to complete the acquisition of a community bank, Encore Bank in Naples, Fla., where the CU has a large membership base and several branches. The acquisition would bring personnel experienced in 7A lending on board. “That’s a nice complementary benefit to that acquisition for our commercial lending program,” Maskell says.

SBA loans aren’t the only government programs for small businesses. CU Business Group can take referrals from credit unions for certain types of loans, like apartment buildings or health care facilities, to firms that are lenders for Freddie Mac and U.S. Department of Housing and Urban Development programs designed to spur growth.

“A credit union can refer members to these programs for superior rates and loan structures for someone buying a 30-unit apartment building, for example,” Middleman says. “The credit union can still be involved in the transaction and receive a portion of the loan fee for the referral but not record the loan on its books.”

4. Manage the Portfolio by Sector

In addition to cap management, credit unions may need to consider their commercial loan portfolios with an eye toward examiners’ potential concerns about concentration risks in certain business sectors, says Alex Cohen, CEO of Liberty SBF, Philadelphia, a nationwide specialty loan originator, servicer and asset manager in commercial real estate lending.

This is another area where SBA loans offer an effective strategy for portfolio management. “There’s a healthy appetite for government-guaranteed properties in the secondary market,” Cohen notes.

SBA 504 loans offer borrowers more financing options for commercial real estate acquisition with potentially more favorable rates as longer, fixed-rate loans. The program offers loans for diverse industry and property types, each with its own underwriting standards, from distribution companies buying warehouses to hotels to assisted living facilities and daycare centers. A potential drawback is that these loans may require a larger capital hold for credit unions than other types of financing, which makes selling these assets or originating the loans in the secondary market more common.

Credit unions can provide a valuable service to small business members in making these loans or providing referrals. As part of the SBA loan process, borrowers need to demonstrate that they have not been able to secure credit elsewhere, Cohen notes. “In addition to being approved for the loan, they’re able to take advantage of favorable rates and terms subsidized by the SBA. These programs offer ways for small businesses to tap into much-needed financing.”

5. Make Small Loans Efficiently

A final way to manage cap requirements is by making small-dollar business loans, as MBL relationships with a total loan value under $50,000 are exempt from cap restrictions.

Many small-business owners are “classic credit union members”—sole proprietors and small operations that need loans of $25,000 to $100,000—Middleman says. Large commercial lenders often consider those loans too small to be profitable, but they’re a great size for credit unions, even those under $100 million in assets.

“The key is making these loans efficiently. You can’t afford to spend a lot of time on risk analysis for these fairly small-dollar loans,” he says. “Getting the right processes and turnaround time in place and making the process easy is necessary for member service and the ability to compete with online lenders.”

With fintech competitors entering this arena, small-business owners can apply for and receive loan approval in a day or two and have funds in their accounts by day three, Middleman notes. On the downside, the loan rate might be 12 to 18 percent, plus higher fees and an onerous loan structure, in some cases requiring weekly or even daily payments. Credit unions can compete on loan terms and pricing but still need to improve accessibility and efficiency.

Even larger credit unions with 10-person business lending staffs may not have the right resources to handle small loan requests efficiently, he adds. That’s why CU Business Group is rolling out new small-dollar business loan options, with the goal of supporting one- to two-day turnaround time on loan decisions, with documents completed in just a few days.

“Many credit unions would like to be able to offer this service to business members,” Middleman says. “Our goal is to do this at a low cost, in the range of a $200 to $300 fee to credit unions for these small loan requests, like a $75,000 truck loan in the business’s name.”

CU Business Group anticipates that this service will apply to secured loans under $100,000 and unsecured loans under $50,000, including business credit cards and lines of credit in the $10,000 to $20,000 range.

Worth the Extra Effort

At its current asset size, Ventura County CU’s business lending cap is about $100 million, so its $45 million portfolio is about halfway there. The credit union is already employing key strategies to manage to the cap: selling participations in large loans and making small-dollar and SBA business loans.

“We’ve got plenty of space in our cap right now, but if we have another year like we did last year, we’ll be starting to push up against it soon,” Sahakian notes. “We would love to see some regulatory relief that would allow us to continue to make these loans with fewer restrictions.

“We did a deal recently that generated 25 additional jobs,” he adds. “When we can help businesses grow and create new jobs in the community, that’s what commercial lending is all about.”

Member business lending offers advantages that make the added work of managing to the cap worthwhile, including portfolio diversification and being able to position the credit union as a full-service financial institution. Raymie notes that Generations FCU promotes its value proposition as being “easy to do business with.”

“That means a lot of different things to different people,” he says. “One of the things we would like it to mean is that you can come to Generations and get all your needs met, including business services, instead of having to fracture your relationship across multiple financial institutions.”

Credit unions that run up against the cap and have to slow their business lending can undo a lot of hard work in building their reputations as commercial lenders, Middleman cautions.

“If you don’t have a lot of capacity and have to be more judicious about which loans you can take on, you’re saying no more often,” he says. “There are market and perception risks in saying no to established business members. Cap management has to go on in the background, because the bottom line for members is, ‘Can you give me a loan or not?’”

Karen Bankston is a long-time contributor to Credit Union Management and writes about credit unions, membership growth, marketing, operations and technology. She is the proprietor of Precision Prose, Eugene, Ore.