The Rundown

• Critics blame deals involving loan brokers.
• NCUA said proposal aims to shelter CUs from systemicrisk.
• CUs need to ask harder questions, CUSO CEO urges.

The timing of criticism toward a regulatory proposal to limitloan participations to a certain percentage of a credit union's networth with the takeover of a California cooperative heavily steepedin the transactions may have created an ironic overlap.

Over a two-week span, the $318 million Telesis Community CreditUnion's financial woes led to the Chatsworth, Calif.-basedfinancial institution being conserved by the NCUA to the $1.3billion Premier America Credit Union, which was appointed to manage itsassets.

Some in the industry said Telesis was a ticking time bomb mainlybecause its commercial lending reach spanned too far beyond itsCalifornia borders. In 2011 alone, its business loan portfolioexperienced hit after hit. However, its loan participationarrangements are getting much of the scrutiny.

As of December 2011, the total balance of loan participationsold or serviced by Telesis neared the $427 million mark. Telesisretained $120.5 million in participation loans at the end of theyear, down from $147.4 million in December 2010, according toTelesis' December 2011 Call Report.

Meanwhile, it was also at a December 2011 board meeting that theNCUA proposed a rule that would cap a federally insured creditunion's purchase of loan participations from a single originator inthe aggregate to 25% of the credit union's net worth.

Purchases of loan participations involving one borrower or agroup of associated borrowers would be capped at 15% of the creditunion's net worth, the NCUA said. A waiver can only be sought fromthe limit on the purchase of loan participations from one borroweror group of associated borrowers.

NCUA Chairman Debbie Matz has said that while loanparticipations are a valuable tool for credit unions to diversifyloan portfolios, improve earnings and manage balance sheets, theydo have the potential to create systemic risk.

“Large volumes of participated loans tied to a singleoriginator, borrower or industry–or serviced by a singleentity–have the potential to impact multiple credit unions ifproblems occur,” Matz said at the time of the proposed loanparticipation amendment.

Indeed, credit unions looking to share the risk and build alayer of protection around its financials, often turn to loanparticipations. The snags may stem from the starting point of thetransaction.

“The problem is not loan participations, it's how they areoriginated,” said Michael Gudely, president/CEO of Innovative Business Solutions,a business lending CUSO in Fort Mill, S.C.

“If a credit union originates a loan in its market that is toobig for its risk tolerance, a loan participation is a logicalvehicle to close the loan and reduce risk,” he explained.

“If the loan is offered by a loan broker, after it's beendeclined by most if not all the local lenders, only to be offeredto an out of state credit union, that's a very high risksituation,” Gudely said. “These borrowers are desperate and arewilling to pay fees that are twice, three times what a credit unionwould normally charge.”

Gudely stressed that loan participations, when conducted in asound manner and are based on a local borrower request that isapproved by a local lender can benefit credit unions.

“To sell participations in loan broker deals, from who knowswhere, is presenting a material risk to the credit union industryand the NCUSIF,” he said.

As of June 2011, 1,401 federally insured credit unions held over$12.4 billion worth of outstanding loan participations, accordingto NCUA Call Report data. The agency said since 2007, loanparticipation balances have grown significantly– up 28% over thelast four years–in an environment of extreme economic volatility.Federally insured state-chartered credit unions represent 68% ofall participations sold and 55% of participations bought.

“FISCUs have consistently reported higher rates of delinquenciesand charge-offs on loan participations–which is one reason why theproposal would extend loan participation protections to federallyinsured state-chartered credit unions,” the NCUA board said.

CUNA and NAFCU, as well as several state leagues and CUSOs, havesaid the loan participation proposal would restrict credit uniongrowth. Both trade groups have called on the NCUA to withdraw theproposal.

In the thick of the scrutiny is Telesis, the founder and aco-owner of Business Partners LP, a California business lendingCUSO that services participation interest for approximately 180credit unions. Calls from Credit Union Times to several ofthe credit union clients were not returned. The NCUA said the CUSOwill continue to originate and service loans.

“Unfortunately, sourcing from loan brokers was exactly whatTelesis/Business Partners LLC did and then sold them to smaller,less sophisticated and unsuspecting CUs,” wrote a visitor onCredit Union Times website. “I would like to see what theBP LLC portfolio looks like at this point and how it is performingbut suspect we won't get that view until the portfolio implodes.CUs should really stay within their own FOM and stick to what theyknow best…”

Gudely urged credit unions to ask hard questions about whothey're doing business with when it comes to loan participations.Among them, asking how a member business lending CUSO CEO iscompensated–salary or based on incentives. He stressed that neitheroption is wrong but at very least credit unions should be aware.Gudely said he is on salary at Innovative Business Solutions, aCUSO that serves 10 credit unions.

“There are really good and talented people at member businesslending CUSOs, but sometimes the money in it may color their viewof what they're doing,” Gudely said.

He also suggested knowing if a CUSO closes a loan in its name orthe credit union's name when they sell off the loan. Getting aroster of participants and making sure the list added up to 100% isalso critical, he advised. All these proactive moves may help touncover any hidden fees that are being collected without the creditunion's knowledge.

A purchasing credit union should always get a copy of theclosing statement especially if the loan is closed in the name ofthe CUSO because this is a good way to identify any borrower orloan broker fees that may not have been disclosed, Gudely said.

A lack of disclosures may lead to financial trouble down theroad that same Credit Union Times reader implied.

“Greed and ego got in the way of prudent investing of membershard earned money,” the reader wrote, responding to Telesis'conservatorship. “They had no concept of risk management andportfolio diversification nor much talent when it came to businesslending and relied on loan brokers to source high risk transactionat below market rates.”

As the fight in Washington continues to raise the 12.25% ofassets member business lending cap, Gudely said he believes loanparticipation scrutiny is a much bigger issue.

“As an industry, we have to look at ourselves. We need torepresent the 95% of the clean CUSOs and be the standard,” heoffered. “These large, loan broker participations–they're not theway to do member business loans.”

NEXT STEPS:
READ more on loanparticipations at CUTimes.com/loan-participation

READ more on Telesis atCUTimes.com/telesis