For some credit unions, being able to get in a car and drive toa piece of commercial real estate that a member is trying to securefinancing for is a pivotal part of the lending process. Scoping outthe area where that strip mall or office building is located may bemore telling than a scanned image sent in an email attachment.

In the case of loan participations, one of the motivations forentering into this type of shared transaction helps to mitigaterisk and offer lending opportunities that would otherwise not beavailable to a credit union if it were to go it alone. Still, thedeal breaker may or may not come down to not having the wherewithalto see and touch a piece of property.

There are many banks and credit unions that successfully lend tomembers and customers throughout the country, said Henry Wirz,president/CEO of the $1.8 billion SAFE Credit Union in NorthHighlands, Calif. However, the risk may not lie with the borrowerand the lender being separated by great distances.

“I agree that making loans in the credit union's service area isthe better option than buying participation loans all over thecountry. But, I would not automatically assume it is less risky,”Wirz said. “In fact, it is just as easy to argue that geographicconcentration of loans in the credit union's own immediate areaalso poses a concentration risk.”

A proposal from the NCUA to cap federally insured credit unions'purchase of loan participations from a single originator in theaggregate to 25% of the credit union's net worth has beencriticized by trade groups and others. Purchases of loanparticipations involving one borrower or a group of associatedborrowers 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 thepurchase of loan participations from one borrower or group ofassociated borrowers.

One problem with the NCUA's proposal is its scant attention onthe underwriting process, Wirz said.

“The problem is that credit unions are buying loans they haven'tadequately underwritten and probably in most cases, do not have theexpertise to underwrite,” Wirz said. “Too many credit unions do nothave the expertise, controls or process to buy participationloans.”

SAFE CU buys participation loans and also underwrites its ownbusiness loans, Wirz said. The process for underwriting the loan isthe same whether the credit union buys the loan participation orwhether it underwrites the loan for on its own, he pointed out.

Wirz said the credit union looked at loans being sold byBusiness Partners LLC and rejected them on the basis of thefinancial institution's underwriting criteria and due diligence.Business Partners is a California business lending CUSO thatservices participation interest for approximately 180 creditunions. It was founded in 1995 by the $318 million TelesisCommunity Credit Union in Chatsworth, Calif. Telesis's lending woes led to the cooperative's recentconservatorship and is now being managed by the $1.3 billionPremier America Credit Union.

While Business Partners and its former parent, Telesis, hastaken some heat for what some say was an overextension of theirloan participations, one of the CUSO's equity owners and boardmember said the firm has filled a void.

“I am from a small credit union that needs and requires theservices of BP,” wrote Deborah, a Credit Union Timesreader in a response to a CUTimes.com article about Telesis.“Without it, we could not meet our members' needs–in all facetswhether its business loans or participations.”

Deborah–who did not provide a last name–said her small creditunion is located in an urban area where consumer loans have driedup as the financial institution continues to search for other waysto generate income.

“Ultimately, this is to ensure our members still receive theservices they want and need. The income generated from loans arethe only method I know of, other than investment income, that wecan count on to provides services to our members,” Deborahwrote.

As of late, it's likely that many credit unions can relate tohaving to seek out new channels of income. Wirz goes back tounderwriting and what he said is the failure of the examinationprocess to detect and prevent unsafe lending, whether it is thepurchase of participation loans or the origination of loans thatare later sold as participations.

“The real problem is that the very loans which now troubleTelesis and which have the potential to harm many other creditunions, may have been underwritten and sold by a credit union thatdid not have the expertise, controls or process to make those loanssafely,” 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 saidabout 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 soldover such a long period of time without being prevented by internalcontrols or by regulatory action. He said the primary fault lieswith the board and management of Telesis. But it also raises thequestion of whether NCUA examinations should have detected aproblem, he noted, adding, he is looking forward to a review by theNCUA Inspector General.

“I suspect that the high default rate will be due to faultyunderwriting rather than the bad economy,” Wirz said. “I believe itwill become clear that these loans had a higher failure rate thanthe business loans made by other credit unions; that alreadyappears to be the case.”

Wirz said beyond the NCUA's loan participation proposal, hethinks it would better if the agency takes a harder look at theunderwriting by the purchasing credit union, which is an area hefeels is often lacking. While the buyer must have qualifiedbusiness lending expertise or must use an independent third partyconsultant who has the necessary expertise to review and underwriteparticipations, he doesn't think this is the norm.

“I think it would be far better for NCUA to examine how creditunions underwrite loan participations and the kind of due diligencethey perform on CUSOs and credit unions that sell loanparticipations,” Wirz said.