Against a backdrop of a groundswell of support to expand business lending authority, one outcome is becoming an unfortunate black eye on those efforts.
Some credit unions that have succumbed to financial collapse have been linked to massive losses in commercial real estate and member business loans.
The latest to fall was the $122 million AM Community Credit Union in Kenosha, Wis., which was placed into liquidation Aug. 1 by the Wisconsin Office of Credit Unions after the NCUA put the struggling cooperative into conservatorship in February. All of AM Community’s members, deposits, core facilities and consumer loans were purchased and assumed by the $739 million TruStone Financial Federal Credit Union in Plymouth, Minn.
For nearly 13 years, AM Community offered business loans, initially for investment and rental properties, and financed loans to a more diverse group of entrepreneurs, such as restaurants and independent truck drivers to day-care centers.
In 2006 and 2007, the credit union was fast approaching its member business lending cap and opted to enter into participation loans to continue meeting what had become a growing demand from the community.
AM Community became one of the owners of Business Lending Services LLC in 2006, a separate, multi-owned limited liability company of the Business Lending Group Inc., said Linda Kennedy, BLG president/CEO.
In September 2009, BLS was dissolved and the commercial loan portfolios were transferred to the lead credit unions to service, Kennedy said.
“All of the loans that Business Lending Services LLC did service were approved by the credit unions that participated in them,” Kennedy wrote in a statement to Credit Union Times. “We do not have any information to determine why they were placed in receivership nor are we able to comment on the extent to which their business loan portfolio affected their being placed into receivership.”
A close look at AM Community’s June 2012 financials showed nearly $5 million of the credit union’s $9.65 million in delinquent loans were business loans. Delinquent modified real estate loans totaled $2 million. More than $1.3 million in charge-offs also hammered the portfolio.
Just how much of an impact business loan losses led to the AM’s demise is uncertain, but what is clear is that the credit union once sought to build its fledgling program to aid small businesses, including partnering with other peers in participation loan deals to keep the pipeline flowing.
So, what happened? Some of the experts Credit Union Times talked to did not want to point any fingers of blame, choosing instead to speak generally on the culprits that can slowly and methodically take credit unions down into the pit of loan losses.
“It’s kind of hard to talk about participations and not talk about MBLs,” said Harvey Johnson, senior manager and CPA with Witt Mares PLC, a Newport News, Va.-based accounting and business consulting firm that counts credit unions and community banks among its clients.
“They often go hand in hand. These are the larger ones that some credit unions don’t have the liquidity to fund themselves or don’t want to because of the risk.”
Johnson said while loan participations can be beneficial for credit unions, risk appetite is a key consideration before moving forward.
“The problem comes when a smaller credit union that typically may not have the business lending background on staff to go after loans, particularly as aggressively as AM did.”
One area that he feels is not getting the attention it deserves is the accounting treatment of sale versus secured borrowing, Johnson said. A participation loan is typically treated as a sale, but it must qualify for sale treatment under accounting rules. There could an element in the contractual agreement that doesn’t meet the criteria of a sale, in which case it becomes a secured borrowing, he explained.
To illustrate, Johnson said AB Credit Union has a great participation program with CD Credit Union, and AB originates 10 loans to 10 different borrowers. If the transactions fail to meet sale accounting treatment, then the credit unions (both AB and CD) have to account for the participations as secured borrowings. So, CD doesn’t have 10 loans to 10 different borrowers but 10 loans to just AB.
This significantly alters how the relationships are viewed from a legal lending limit standpoint, Johnson said. One of the big criteria that will prohibit the credit unions from accounting for the participations as a sale is recourse against the credit union. If the borrower defaults, and CD can go after AB to collect on the loan, then that is considered a secured borrowing, not a participation loan, according to accounting standards.
While the accounting requirements are not complex, they are tedious enough that credit unions should contact an attorney that specializes in these types of contracts and knows how to structure the deals, Johnson advised.
It’s very common for credit unions like the defunct AM Community to partner with other entities to build business loan programs especially if there is a hesitation on hiring an experienced commercial lending officer or putting the investment into the effort.
“Credit unions are very cost conscious,” said E. Mike Gudely, president/CEO of Innovative Business Solutions, a business lending CUSO in Fort Mill, S.C. “There may be a reluctance to spend the type of money to originate in their market. That goes past the business development side to loan administration.”
One dangerous outcome might be not having the experience to assess credit loan quality might suffer, Gudely said. For those credit unions that don’t have a senior credit officer, relying on outside sources becomes a likely alternative.
“While we’re looking for growth and income to minimize costs, we have to be sure we’re putting enough infrastructure in place,” Gudely said. “We owe it to the whole entire membership to have people and processes in place to be there for the members.”
Even though Gudely is a big advocate of CUSOs, he is a critic of loan broker originated loan participations because the arrangements have the potential for going after loans that may not be ideal for the credit union’s risk appetite.