Credit unions may be turning to member business loans as a source of growth, especially in light of this year’s principle-based MBL rulings. On Tuesday, Nov. 29, the NCUA provided additional clarity around the definition of MBL loans versus commercial loans, and expectations for how credit unions will effectively manage the increased and different risk that comes with business lending compared to consumer lending.
Whether the institution has an MBL concentration to grow or will be starting a new lending segment, credit unions can begin gearing up today for the Jan. 1 commercial lending rule. This includes procuring the right staff and technology as well as developing sound policies and controls that reduce risk.
Here are four ways credit unions can gear up for commercial lending growth.
Prepare the Board of Directors
Ultimately, it is the responsibility of the credit union board to protect the institution and its members, so it is important for directors to outline up front the goals behind increasing business lending and the related risks. This includes strategy around niche or geographic targets of commercial lending and how the risks created by MBL will be mitigated to ensure sufficient capital coverage. This also extends to due diligence in the selection and oversight of outside parties used in the commercial lending process, including software vendors, loan review firms, etc.
In addition to the loan policy for commercial lending, the board is also tasked with understanding the institution’s portfolio risk through regular reporting from senior executives who understand MBL.
Build Out MBL Policy
Once strategic decisions are made, they can be translated into the institution’s commercial lending policy, which requires annual review with the board of directors at the credit union. Policy should outline but not be limited to concentration limits, trade areas, staffing requirements, procedures for analyzing and approving these loans, collateral requirements, requirements around the use of CUSOs, if applicable, and procedures for the administration of the loans and the portfolio.
The November updates in the NCUA examiner handbook clearly outline a number of commercial industry sectors and recommend using NAICS codes to more granularly define the institution’s area of focus. NAICS can also be used to ensure benchmark data is appropriately leveraged for business comparisons and is required by the institution’s MBL policy.
In the event that loan policy undergoes material change in the credit union or there is a significant change in the credit union’s market, the policy must be re-approved by the board.
The new MBL policies could seem like a big departure from the norm for some credit unions. As one example, if the institution has focused on consumer lending to date, loan administration for MBL can require significant change management. For consumer loans, the institution may primarily rely on delinquency metrics and credit scores. However, business lending requires regular review, and many credit unions’ systems aren’t necessarily designed to monitor lien filings, update cash flow estimates regularly and track compliance with loan covenants.
Train the Staff
As another preparatory step for the Jan. 1 guidance, institutions can grow staff-development programs to more comprehensively cover member business loan analysis. Some principle areas to cover include:
- Understanding business financial statements and tax forms;
- Global cash flow analysis and double counting adjustments;
- Data gathering for commercial loans;
- Loan documentation;
- Using business credit scores or probability of default;
- Commercial risk ratings ;
- Business valuations and collateral appraisal management; and
- Industry resources for the niches the credit union will serve (check with industry associations, which often produce benchmarking studies and newsletters).
Consider Technology for Efficiency and Consistency
For the origination of new business loans, institutions may consider expanding loan decisioning technology – which many credit unions leverage in consumer loans already – to commercial portfolios.
Loan decisioning software allows credit unions to prescribe specific templates for different loan types, so data-entry screens, calculations and decisioning rules are streamlined and customized to the credit union’s policy. This technology allows the institution to quickly screen loans and identify applications that should be approved, rejected or reviewed further through a comprehensive spread and global analysis.
The automation and consistency of loan decisioning technology also reduces the risk of manual error, which can be higher at institutions new to MBL. With clear instructions on the data to enter and automation for calculations, loan decisioning technology becomes business process management and can be a training tool that helps allocate experienced credit analysts’ time to the credits that need more attention.
Business lending is not an area in which all credit unions should enter, as the risks and requirements are different. Yet, in reading through the regulatory expectations and tackling the above four preparatory steps, institutions can begin to gear up for the Jan. 1 MBL rules.
Libby Bierman is an analyst at Sageworks. She can be reached at 866-603-7029 or libby.bierman@sageworks.com.
