Lax Due Diligence, Too Much Lead Lender Trust May Topple Participations
Larry Middleman, president/CEO of CU Business Group, shared that sentiment during a recent Webcast on NCUA's letter 08-CU-26, which provides guidance on running a successful business loan participation program. More than 75 credit unions tuned in to the session to hear how the new regulations affect them and the action steps for compliance.
Over the last five years, loan participations increased 262%, which was faster than the overall total for all loans during that period, according to CUBG, a Portland, Ore.-based business lending CUSO serving 300 credit unions. The disturbing trend is that 2008's loan participation charge-offs were twice the level of 2006 figures, Middleman said.
"All of this leads to a legitimate look at this whole area by examiners. Quite frankly, there can be some lax due diligence and too much trust in the lead lender," Middleman said. "There's a little bit too much trust out there. I'll leave it at that."
Loan participation borrowing has increased, a potentially troubling area of concern for buyers who can lose control of the lead lender, Middleman explained. The good news is at 2%, loan participation delinquencies are significantly lower than banks, Middleman noted. Historically, charge-offs have ranged between the 0.5% to 1% range, another "stellar number compared to the banking world."
NCUA examiners are now looking more closely at a number of risks including credit, compliance, interest rate, strategic, liquidity, reputation and transaction, and how all relate to the aggregate exposure to net worth. Middleman said another area on the watch list is where participation buyer's trade areas are geographically based. The standard now is to have a trade area for the business, but the participant can pick and choose where to buy and who to buy from.
"I see this potentially being changed by the regulation. I think it is open to interpretation as to how this is written," Middleman said.
CUBG is often asked how it assesses the market in a particular area, said Larry Robbins, senior vice president and chief credit officer at the CUSO. Examiners also want to know specific approaches, he added. Talking to lenders in the areas, getting and actually reading appraisals helps survey the landscape. "The appraisal will disclose if things are stable, growing and especially if the area is deteriorating, which can lead to lower property values," Robbins said.
Another area of scrutiny is how guarantors are treated. A NCUA legal opinion said individual owners have at least 51% ownership. Robbins said he has seen a couple of transactions where some sought partial guarantees, an obstacle that could cause problems later. Fair value accounting is on the radar as well. If loan participations are a significant chunk of the balance sheet, "it's good to talk about this now rather than wait regarding [asset-liability management]."
Scott Humphreys, vice president and senior business loan officer at CUBG, shared several real-life situations. One credit union executive asked whether he should be concerned that the borrower is suddenly requesting "interest only."
"In certain cases, there's no point in doing this," Humphreys said. "The loan that came in was a booked loan with 95% occupancy. It was booked with interest only, but when the rate changed and the principal and interest kicked in, the borrower could no longer meet the payments."
In another instance, a borrower wanted to cash out. Humphreys said that's not always a bad thing depending on the reason such as for property improvements. Great cash flow can also mask upside-down loans, he warned.
Middleman said he commends examiners for taking a harder look at the borrower relationship with a credit union. "We see quite a few deals that are shotgunned around by brokers trying to make them stick. Unfortunately, credit unions latch on. The [entity] doesn't have any idea who the credit union is. It's not a deal breaker. It's just a red flag to consider."