The timing of criticism toward a regulatory proposal to limit loan participations to a certain percentage of a credit union’s net worth with the takeover of a California cooperative heavily steeped in the transactions may have created an ironic overlap.
Over a two-week span, the $318 million Telesis Community Credit Union’s financial woes led to the Chatsworth, Calif.-based financial institution being conserved by the NCUA to the $1.3 billion Premier America Credit Union, which was appointed to manage its assets.
Some in the industry said Telesis was a ticking time bomb mainly because its commercial lending reach spanned too far beyond its California borders. In 2011 alone, its business loan portfolio experienced hit after hit. However, its loan participation arrangements are getting much of the scrutiny.
As of December 2011, the total balance of loan participation sold or serviced by Telesis neared the $427 million mark. Telesis retained $120.5 million in participation loans at the end of the year, down from $147.4 million in December 2010, according to Telesis’ December 2011 Call Report.
Meanwhile, it was also at a December 2011 board meeting that the NCUA proposed a rule that would cap a federally insured credit union’s purchase of loan participations from a single originator in the aggregate to 25% of the credit union’s net worth.
Purchases of loan participations involving one borrower or a group of associated borrowers would be capped at 15% of the credit union’s net worth, the NCUA said. A waiver can only be sought from the limit on the purchase of loan participations from one borrower or group of associated borrowers.
NCUA Chairman Debbie Matz has said that while loan participations are a valuable tool for credit unions to diversify loan portfolios, improve earnings and manage balance sheets, they do have the potential to create systemic risk.
“Large volumes of participated loans tied to a single originator, borrower or industry–or serviced by a single entity–have the potential to impact multiple credit unions if problems occur,” Matz said at the time of the proposed loan participation amendment.
Indeed, credit unions looking to share the risk and build a layer of protection around its financials, often turn to loan participations. The snags may stem from the starting point of the transaction.
“The problem is not loan participations, it’s how they are originated,” 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 too big for its risk tolerance, a loan participation is a logical vehicle to close the loan and reduce risk,” he explained.
“If the loan is offered by a loan broker, after it’s been declined by most if not all the local lenders, only to be offered to an out of state credit union, that’s a very high risk situation,” Gudely said. “These borrowers are desperate and are willing to pay fees that are twice, three times what a credit union would normally charge.”
Gudely stressed that loan participations, when conducted in a sound manner and are based on a local borrower request that is approved by a local lender can benefit credit unions.
“To sell participations in loan broker deals, from who knows where, is presenting a material risk to the credit union industry and the NCUSIF,” he said.
As of June 2011, 1,401 federally insured credit unions held over $12.4 billion worth of outstanding loan participations, according to NCUA Call Report data. The agency said since 2007, loan participation balances have grown significantly– up 28% over the last four years–in an environment of extreme economic volatility. Federally insured state-chartered credit unions represent 68% of all participations sold and 55% of participations bought.
“FISCUs have consistently reported higher rates of delinquencies and charge-offs on loan participations–which is one reason why the proposal would extend loan participation protections to federally insured state-chartered credit unions,” the NCUA board said.
CUNA and NAFCU, as well as several state leagues and CUSOs, have said the loan participation proposal would restrict credit union growth. Both trade groups have called on the NCUA to withdraw the proposal.
In the thick of the scrutiny is Telesis, the founder and a co-owner of Business Partners LP, a California business lending CUSO that services participation interest for approximately 180 credit unions. Calls from Credit Union Times to several of the credit union clients were not returned. The NCUA said the CUSO will continue to originate and service loans.
“Unfortunately, sourcing from loan brokers was exactly what Telesis/Business Partners LLC did and then sold them to smaller, less sophisticated and unsuspecting CUs,” wrote a visitor on Credit Union Times website. “I would like to see what the BP LLC portfolio looks like at this point and how it is performing but suspect we won’t get that view until the portfolio implodes. CUs should really stay within their own FOM and stick to what they know best…”
Gudely urged credit unions to ask hard questions about who they’re doing business with when it comes to loan participations. Among them, asking how a member business lending CUSO CEO is compensated–salary or based on incentives. He stressed that neither option is wrong but at very least credit unions should be aware. Gudely said he is on salary at Innovative Business Solutions, a CUSO that serves 10 credit unions.
“There are really good and talented people at member business lending CUSOs, but sometimes the money in it may color their view of what they’re doing,” Gudely said.
He also suggested knowing if a CUSO closes a loan in its name or the credit union’s name when they sell off the loan. Getting a roster of participants and making sure the list added up to 100% is also critical, he advised. All these proactive moves may help to uncover any hidden fees that are being collected without the credit union’s knowledge.
A purchasing credit union should always get a copy of the closing statement especially if the loan is closed in the name of the CUSO because this is a good way to identify any borrower or loan broker fees that may not have been disclosed, Gudely said.
A lack of disclosures may lead to financial trouble down the road that same Credit Union Times reader implied.
As the fight in Washington continues to raise the 12.25% of assets member business lending cap, Gudely said he believes loan participation scrutiny is a much bigger issue.
“As an industry, we have to look at ourselves. We need to represent the 95% of the clean CUSOs and be the standard,” he offered. “These large, loan broker participations–they’re not the way to do member business loans.”