Low yields, a "back to the drawing board" rethinking of how income statements are managed and new challenges to the credit union business model have left some wondering how to navigate through it all.
One way may be through loan participations, according to a new white paper from the CUNA Lending Council. The research examined a variety of business models using this loan type: a sample policy, board questions, regulatory oversight and information on finding a partner. The loan provides a long list of benefits, including a source for selling loans to keep under the 12.25% member business lending cap, geographic and loan type diversification and an average loan yield that is three times the amount of the average investment.
The dangers, however, can have lasting effects. "Participations are more complex and when the loan goes south, the misery of hefty dollar losses is shared with all," said Jim Jerving, author of the white paper.
Jerving said a credit union's board, in its role as watchdog, also needs to decide whether management has a thorough understanding of the risks, underwriting, pricing and terms of each loan, whether it's member business, real estate or construction lending. According to Jerving, managing participation loans require a calculated approach from experienced lending staff, as well as constant oversight as market risk and credit risk change over the loan term.
Last year's decline in loan participations was brought on by tightened credit, the lingering effects of the recession, and some credit unions losing their appetite for a loan type that brings more risk than wanted, Jerving said. In 2005, there was $9.1 billion in all outstanding purchased participations. They reached a peak at $11.3 billion in 2008, but dropped 10.3% in 2009 to $10.1 billion. There was a slight recovery in the first quarter of 2010 as participations increased to $10.2 billion outstanding.
Jerving said the aftermath of a sluggish economy can also be seen in the drop on the average outstanding participation loan balance. From 2007 to 2008, there was a slight decline from $25,907 to $24,156. The balance descended even further in 2009 to $18,816. According to industry data, nonmember business loans (excluding construction and development) represented 37.7% of participation loan types made in 2009. Real estate loans followed at 25.8%, and MBLs at 14.8% and consumer loans at 10.9% rounded out the list.
Credit unions hesitant about testing the business lending waters may see loan participations as a way to cautiously wade in. While the transactions are typically done among larger credit unions, Jerving found that smaller ones can reap the advantages of risk pooling and shared expertise too. Like their larger peers, most tend to keep their investments conservative. Some partner with a CUSO and others have been successful in obtaining NCUA waivers to expand their lending authority beyond the 12.25% MBL cap.
"It's an anomaly," Jerving said of the current cap. "Credit unions have been around for 100 years and have been providing loans to businesses [since then]. There are a quite a few credit unions that have the expertise."
With increased regulatory scrutiny of loan participations, boards are under the spotlight even more to ensure that due diligence is paramount. Practices such as reporting the loans to the board on a monthly basis as a separate program within the overall loan portfolio-including trends in loan growth, charge-offs and delinquency-should be second nature, according to Jerving.
The events of the past several years have highlighted the effects of excessive risk taking and resulted in calls for more regulation even though credit unions have, for the most part, avoided unreasonable risk and dubious lending practices, he added.
"There is a necessary tension between regulator and credit union because their missions are dissimilar and inevitably collide. One is to regulate and help credit unions manage risk, the other is to serve the needs of members and earn income," Jerving said.
He recommends that those considering loan participations ask themselves the hard questions. Where is the opportunity coming from-a CUSO, a credit union or a third party? Is the loan participation a good fit and is it compatible with the organization's business plan? Loan growth and other key financial projections, including what parameters and ratios are needed to track the effectiveness of the program, are critical areas to address. Jerving said knowing the credit union's ability to underwrite and having the required expertise in place are just as important.
"One of the questions that comes up with lending professionals is how to find quality partners with similar risk appetites," Jerving said. "Risk appetite is an elusive metric to measure, especially in a potential lending partner. A meeting of the minds of what is considered acceptable risk among partners, however, is a vital ingredient in the mix for a successful life of the loan participation."