NCUA's Amended MBL Regs Expand CUSOs Options in Business Lending Loan Participations
The passage of the amendments to the NCUA's Member Business Lending Regulation in September is evidence of a healthy and vibrant regulatory environment. The Credit Union Membership Access Act ("Act") put restrictions on the ability of credit unions to meet the business lending needs of their members. These restrictions were part of the political price that credit unions paid for the passage of the Act. NCUA and the state credit union regulators have been examining ways to expand the options that CUs have in providing member business loans within the perimeters established by the Act. Seven state CU regulators (Washington, Maryland, Missouri, Wisconsin, Oregon, Texas and Connecticut) have persuaded NCUA to approve state business lending regulations that have extended the powers of their state chartered CUs. In light of changes at the state level, NCUA has made many changes which apply to federally chartered CUs and state chartered, federally insured CUs in the other forty-two states. I will focus here on the use of CUSOs and Loan Participations in providing business services. CUSOs have been used for several years as a means to aggregate the expertise to provide business loans. Examples of this CUSO type are Telesis Partnerships, Inc. of Chatsworth, California and the Business Lending Group of New London, Wisconsin. These CUSOs have internal and external resources that are able to solicit, underwrite and service business loans, principally loans that are secured by commercial real estate. Their CU clients are able to originate loans to their respective members and participation interests in loans originated by other CUs in a more efficient and economical manner than if each CU accumulated it's own resources. Now, CUSOs and Business Services CUSOs are beginning to flourish. There's no doubt that business loans will provide a boost to CUs searching for lending opportunities, but loans are just a start to servicing the micro and small business market. Experts agree that a financial institution has to have both depository and loan services in order to compete successfully. Service and fee income opportunities for business depository services are much larger than the loan market. Since most CU information technology providers do not have viable solutions for serving the business market, CUSOs are being considered to obtain a collective IT solution for them. (The Act places no limitations on CUs providing business depository services.) The amendments permit CUSOs to make business loans. The question is why would a credit union run a loan through its CUSO and not the CU? Some answers: a. CUSOs can grant loans to non-members. CUSOs still have to primarily serve members of the affiliated CUs but they can have a minority of its business loans with non-members. b. CUSOs are not confined by the limitations in the CUMAA or the NCUA R&R, thus have no restrictions on the types and number of loans they make. If the CU is in danger of exceeding its limit, the CUSO can be the lender. c. Managing risk. If a credit union had a non-conforming loan or a loan with a higher risk factor than the CU is comfortable with, it could place that loan in its CUSO. Say a loan is secured by real property and the CU belatedly learns of environmental problems that it does not want to deal with on a default, the loan could be sold to the CUSO. Or, a loan might have financial ratios that are not within policies, but the risk is reasonable. d. Raising Outside Capital. There are practical limitations as to how much capital is available to a CUSO for lending. A CU can not invest more than 1% of its paid-in capital and surplus in all its CUSOs. A solution to this regulatory restriction is to raise capital outside of the CU. A CUSO can do so by selling a portion of the CUSO to other CUs or to investors. If there is strong demand for loans, more members will be served at a lower cost of funds than if the funds were borrowed by the CU. The CUSO can grow in order to serve the member and non-member marketplace. e. Create Marketable Value. A successful lending CUSO will create value for the investors that can be sold and realized at a later time. Loan Participations Loan participations are valuable tools. They can allocate risk among two or more CUs. Originating CUs use them to generate liquidity; purchasing CUs use them in lieu of purchasing investments with excess cash. In business lending, they are also used to manage the Act's aggregate business loan cap (12.25% of total assets.) In the Reg's final version, loan participations in business loans are counted toward the purchasing CU's aggregate loan cap. As for the originating credit union, the amount of the loan participation sold is removed from the amount counted toward the originating CU's aggregate loan cap- as long as the participation interest is sold without recourse- (risk of repayment is shared by all participants in proportion). If a CU has a $100,000 business loan and sells 50% of it to another CU, each one counts $50,000 toward their respective aggregate. This amount is reduced as the loan is paid down. A Reg-Flex CU can buy the business loan for another credit union outright. Yes, they can buy the whole loan made by another CU to its member. A CU can not exceed its aggregate loan cap for loans made to its members. However, if a CU's aggregate loan cap would be exceeded by the sum of the outstanding balances of Member Loans, participation interests purchased and non-member loans purchased (for Reg Flex Credit unions), the CU can apply to the NCUA Regional Director for permission to exceed the cap. NCUA is drawing a distinction between Member Loans on one-hand and participation interests and non-member loans on the other hand, as the language of the Act only restricts the credit union's ability to lend to its members. NCUA understands that credit unions could play games to avoid the aggregate loan cap for Member Loans by trading loans back and forth. This is the reason why the application for Regional Director approval to exceed the cap includes a certification that the non-member loans and loan participations are not being used in conjunction with one or more other credit unions that are trading loans solely for the purpose of avoiding the cap. Credit unions were originally formed in Germany to help the farmers and merchants who could not get credit at the banks for a reasonable cost. Credit unions have now come full circle to again serve the small business market. CUSOs and loan participations are two powerful tools to help credit unions be responsive to member need and demand, while providing for a successful expansion of business.