ALEXANDRIA, Va. — Credit unions looking to build a commercial lending program should start small and grow their portfolios gradually.
"You have to do it right, you have to know what you're getting into and you have to go slowly," NCUA Board Member Gigi Hyland said during a webinar. "You have to make sure that you do your research, do your homework and you understand the risks associated with the commercial lending portfolio, which are very different from consumer lending."
The regulator hosted the 90-minute session to help credit unions understand best practices in member business lending and see regulators' perspective of this complicated field. Member business lending has exploded over the last decade, growing by an annualized rate of nearly 73%, to $32.5 billion-about 6% of all credit union loans. While credit unions are becoming more adept at commercial lending, a rough economic environment can severely damage institutions that moved too quickly into this realm or tried to adapt consumer-lending strategies to a very different marketplace.
"Sensible commercial loans typically represent a much greater degree of risk than consumer loans. Credit unions must ensure the return matches the risk," said Linda Vick, a former commercial lending specialist and current problem case officer for NCUA Region IV. She explained that competitive pricing is usually not an appropriate strategy for the commercial lending market. "A credit union may have to forgo commercial loans they want to make simply because they cannot price that loan as low or lower than a competitor when all factors are considered."
Risk rating systems, while not required by federal regulation, are "undoubtedly the best practice" to ensure solid business loan performance according to Linda Jekel, Washington state's director of CUs. "In my experience, the key is tailoring that risk-rating system to the complexity of the credit union's commercial loan portfolio," she said. "It must be consistently applied throughout the portfolio and it is critical that credit unions not adopt a particular risk rating system just to appease examiners."
Above all else, a competent management team and relationships with good third-party vendors is vital to successful and safe commercial lending. Examiners get the best handle on business loan programs through conversations with department heads and key staff members, Vick explained.
"The MBL VP or equivalent should be able to explain to an examiner how the department is structured, why the department is structured the way it is, as well as the experience level of all of the staff people within the department," she continued. "In most cases where a credit union has a well-run commercial loan program, staff is able to discuss approved policies and procedures with the examiner. We are looking to see that [they] have a general understanding an applying the principles of [their] policies while monitoring and carrying out the program."
As CUs turn to CUSOs and others for expertise, it is vital that every CU "perform adequate risk assessment and proper due diligence of each relationship," said Erika Eastep, NCUA's MBL program officer. "Poorly managed and monitored third-party relationships can result in unanticipated costs, legal disputes and financial losses." Board members with business experience can also be vital assets. Jekel suggested recruiting local business leaders as they'll understand cash flows, personal guarantees and the importance of performance history.
