ALEXANDRIA, Va. (3/12/12)--Member demand has sparked an increase in the number of credit unions offering member business loans (MBL) and by the end of 2011 federally insured credit unions had a combined MBL portfolio of $39.1 billion, the National Credit Union Administration (NCUA) noted in its monthly NCUA Report.
That total portfolio represents an MBL jump of more than 5% for the year, the agency monthly newsletter noted in an article that went on to outline areas that need specific attention when offering an MBL program. In part, the article said:
- 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.
- 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
- Third-Party Originator: Credit unions looking to boost loan volume often look to outside third-party underwriters to analyze loans. The credit union must 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
- 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. 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.
- 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.
- Financial Covenants: The purpose of financial covenants is to provide an expectation for commercial borrowers to operate within a financial framework that does not expose the lender to excessive risk. Breach of a financial covenant provides an early warning to the lender and the ability to call a loan into default. As credit unions bring in sophisticated commercial borrowers, they should look to protect themselves via cash flow, leverage and liquidity covenants.
- Due Diligence on Collateral: Credit unions need to complete adequate due diligence on collateral securing loans through inspection, commercial appraisal, environmental assessment, or other method to confirm valuation and salability of collateral should the need occur. The extent of due diligence is a function of credit exposure, collateral type, and likelihood that collateral will need to be relied upon. The advance rates on collateral should be a function of the secondary market for securing collateral.
- Cash Is King: A fundamental difference between a financial institution and an asset-based lender is the expectation and requirement that an MBL will be repaid with cash generated from operations, rather than secondary sources of repayment like collateral liquidation or a call on guarantors. With the possible exception of unencumbered guarantor liquidity and readily marketable securities serving as collateral, there are few alternatives to proven cash flow. Cash flow coverage (also known as debt-service coverage) is usually calculated as the annualized sum of net income, interest expense, and non-cash expenses divided by the sum of existing and proposed principal and interest payments for the applicable year.
- Portfolio Controls: Credit unions with new MBL departments are often pressured to generate sufficient volume to justify the initial investment in MBL personnel and infrastructure. However, absent experience in administrating these loans, a rapidly growing MBL portfolio has the potential to alter the credit risk profile of a credit union. Management needs to carefully choose the initial MBLs to build their portfolio while reasonable growth targets should be set.
Use the resource link below to click through to the NCUA Report and read what the article describes as "bad signs" in each program category.