Business Lending Can Be Rough Business
Credit unions frequently are urged to offer (or expand) business lending products and services for their members. But are credit unions truly prepared to take on what can be a bruising market?
Three experts-one of whom cautioned that the level of fraud in commercial lending is far higher than statistics may indicate-had advice, insights and warnings in answering that question before the National Association of CUSOs (NACUSO).
Those experts included Scott Smits, risk management executive for the financial institutions group of consulting and accounting firm Crowe Chizek and Co., who, detailed the intricacies of construction and commercial real estate lending; Matthew Biliouris, program officer for NCUA, who discussed member business lending from a regulator's perspective, and David Dunn, director of operations for CU BizSource, whose company, among other things, provides "certification" for credit unions' and CUSOs' MBL programs-which he described as akin to a "Good Housekeeping Seal of Approval."
Before any credit union gets into construction or commercial lending, Crowe Chizek's Smits emphasized the need for having expertise on staff, cautioning that the level of fraud reported in such loans is less than what actually goes on. The reason: financial institutions will work with the borrowers rather than turn the case over to the FBI because they believe they have a better chance of recovery.
"Appraisals are a big issue right now," Smits continued. "Appraisers make errors that impact the value of the property. For larger, more complex projects, get a feasibility study to see if it makes sense, including a third-party examination of the budget. The cost of materials is rising, so make sure there are sufficient funds to complete the project."
Smits said red flags for construction loans include delays, a significant increase in the number of projects a borrower is involved with at one time, cost overruns, changes to the original budget, changes in sub-contractors, mechanics liens, multiple extensions, and a significant decline in the sales or lease price.
CUs should be aware of larger economic factors impacting their local market, he added. "There are many areas in the country whose median income households cannot afford the median-priced house. This is a big concern to me."
Commercial real estate lending has its own set of guidelines and warnings, said Smits. He advised credit unions to obtain three years' historical operating information from the potential borrower, a current rent roll for existing buildings, including the financial information for large anchor tenants.
"Be sure the appraiser has experience appraising similar properties, and avoid going outside your own market," he counseled. "Credit unions want to grow their business, but they must make sure they have the skills and ability to manage a commercial project. Again, know the market and factors that impact the specific community, such as a new business moving in that might put a key tenant out of business in a short time."
The main difference between commercial and residential lending is the rent roll for commercial buildings must be monitored annually, he said. CUs should obtain copies of all new leases, and a loan officer should review occupancy, debt service coverage and any other significant issues each year.
Other red flags for commercial lending: deterioration in the property and/or a sharp change in occupancy.
What The Regulators Think
The NCUA's Biliouris said construction and development loans tend to be the most speculative, and added NCUA has "some concerns" in this area.
"As a regulator, I am always concerned about risk," he said. "Examiners are always looking at written policies. For a credit union to implement a member business lending program, it must have written policies approved by the board."
NCUA statistics show member business lending activity for the 1,848 federally insured credit unions making such loans increased significantly during the six-year period of 2000 to 2005, including a 30% increase from 2004 to 2005. As of Dec. 31, 2005, these CUs had 102,558 outstanding member business loans with an average amount of $159,022. Only 2.4% of assets are in MBLs, which Biliouris said includes commercial, corporate, business investment property and agricultural loans.
Seal of Approval
CU BizSource is a "unique" organization, Dunn said. He founded it in 2001 as a division of the Pennsylvania CU Association, and the league later spun it off as a stand-alone company. He said CU BizSource helps credit unions police themselves, and it provides them access to secondary markets.
"Certification is an unobtrusive process, and it is a way to help protect the industry," he said. "We do not tell people how to run their credit union or CUSO. We see if policies are in place, what the underwriting process is, and we make sure credit unions don't approach member business lending like consumer lending."
Certification has not been done elsewhere, Dunn continued. He said it is not appropriate for all CUs, nor is it associated with NCUA.
"We are not trying to become a second regulator," he declared. "We want to protect this opportunity for all of us. We don't use a shotgun approach to fit all credit unions, and we are learning as we go."
Certification costs $2,500, which is down from the $10,000 fee when the program started, Dunn said. The fee covers only the costs to CU BizSource, he explained.