Loan Participation Underwriting May Expose Exam Weakness
For some credit unions, being able to get in a car and drive to a piece of commercial real estate that a member is trying to secure financing for is a pivotal part of the lending process. Scoping out the area where that strip mall or office building is located may be more telling than a scanned image sent in an email attachment.
In the case of loan participations, one of the motivations for entering into this type of shared transaction helps to mitigate risk and offer lending opportunities that would otherwise not be available to a credit union if it were to go it alone. Still, the deal breaker may or may not come down to not having the wherewithal to see and touch a piece of property.
There are many banks and credit unions that successfully lend to members and customers throughout the country, said Henry Wirz, president/CEO of the $1.8 billion SAFE Credit Union in North Highlands, Calif. However, the risk may not lie with the borrower and the lender being separated by great distances.
“I agree that making loans in the credit union’s service area is the better option than buying participation loans all over the country. But, I would not automatically assume it is less risky,” Wirz said. “In fact, it is just as easy to argue that geographic concentration of loans in the credit union’s own immediate area also poses a concentration risk.”
A proposal from the NCUA to cap federally insured credit unions’ purchase of loan participations from a single originator in the aggregate to 25% of the credit union’s net worth has been criticized by trade groups and others. 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.
One problem with the NCUA’s proposal is its scant attention on the underwriting process, Wirz said.
“The problem is that credit unions are buying loans they haven’t adequately underwritten and probably in most cases, do not have the expertise to underwrite,” Wirz said. “Too many credit unions do not have the expertise, controls or process to buy participation loans.”
SAFE CU buys participation loans and also underwrites its own business loans, Wirz said. The process for underwriting the loan is the same whether the credit union buys the loan participation or whether it underwrites the loan for on its own, he pointed out.
Wirz said the credit union looked at loans being sold by Business Partners LLC and rejected them on the basis of the financial institution’s underwriting criteria and due diligence. Business Partners is a California business lending CUSO that services participation interest for approximately 180 credit unions. It was founded in 1995 by the $318 million Telesis Community Credit Union in Chatsworth, Calif. Telesis’s lending woes led to the cooperative’s recent conservatorship and is now being managed by the $1.3 billion Premier America Credit Union.
While Business Partners and its former parent, Telesis, has taken some heat for what some say was an overextension of their loan participations, one of the CUSO’s equity owners and board member said the firm has filled a void.
“I am from a small credit union that needs and requires the services of BP,” wrote Deborah, a Credit Union Times reader in a response to a CUTimes.com article about Telesis. “Without it, we could not meet our members’ needs–in all facets whether its business loans or participations.”
Deborah–who did not provide a last name–said her small credit union is located in an urban area where consumer loans have dried up as the financial institution continues to search for other ways to generate income.
“Ultimately, this is to ensure our members still receive the services they want and need. The income generated from loans are the only method I know of, other than investment income, that we can count on to provides services to our members,” Deborah wrote.
As of late, it’s likely that many credit unions can relate to having to seek out new channels of income. Wirz goes back to underwriting and what he said is the failure of the examination process to detect and prevent unsafe lending, whether it is the purchase of participation loans or the origination of loans that are later sold as participations.
“The real problem is that the very loans which now trouble Telesis and which have the potential to harm many other credit unions, may have been underwritten and sold by a credit union that did not have the expertise, controls or process to make those loans safely,” Wirz offered.
The NCUA has said Business Partners will continue to service and originate loans. The CUSO has not responded to calls for comment.
“I can tell you the balance sheet is pretty good,” Deborah said about Business Partners. “The income levels are good and overall, the CUSO is doing just fine.”
Wirz questioned how so many unsafe loans could be made and sold over such a long period of time without being prevented by internal controls or by regulatory action. He said the primary fault lies with the board and management of Telesis. But it also raises the question of whether NCUA examinations should have detected a problem, he noted, adding, he is looking forward to a review by the NCUA Inspector General.
“I suspect that the high default rate will be due to faulty underwriting rather than the bad economy,” Wirz said. “I believe it will become clear that these loans had a higher failure rate than the business loans made by other credit unions; that already appears to be the case.”
Wirz said beyond the NCUA’s loan participation proposal, he thinks it would better if the agency takes a harder look at the underwriting by the purchasing credit union, which is an area he feels is often lacking. While the buyer must have qualified business lending expertise or must use an independent third party consultant who has the necessary expertise to review and underwrite participations, he doesn’t think this is the norm.
“I think it would be far better for NCUA to examine how credit unions underwrite loan participations and the kind of due diligence they perform on CUSOs and credit unions that sell loan participations,” Wirz said.