In a recent nationwide survey of small businesses, nearlytwo-thirds said it has become significantly harder to get loanstoday than just a few years ago. Similarly, a National Federationof Independent Business survey found a nearly 10% increase in thenumber of small businesses trying to borrow but no change in thenumber of small businesses actually obtaining credit. 

As a result small businesses across the country are turning tocredit unions for loans as banks continue to tighten creditstandards. And credit unions have answered the call, experiencing a45% increase in business lending nationally since the financialcrisis began in December 2007. During that same period, largenational banks reduced small business lending by 15% due to thetough economy, new government regulations and the decision to limitsmall business lending. 

While this represents an area of potential growth for manycredit unions, business lending is still relatively unfamiliarterritory for most credit unions and many smaller credit unionsjust don't have the expertise in house to support a significantbusiness loan portfolio. For those credit unions with little to noexperience in member business lending, a good way to get started isthrough loan participations.  A loan participation occurswhen an originating credit union sells off a portion of a loan toone or more participating credit unions.  Loanparticipations are also a good way for any credit union coming upagainst the current MBL cap (12.25% of total assets) to continuingserving members while remaining compliant with regulatorylimitations. 

For credit unions looking to grow their business lendingprograms, partnering with larger, more experienced credit unions isa good way to gain experience in member business lending whileminimizing risk.  Some larger credit unions are now evencreating formalized programs. For example, in July, a large,Washington, D.C.-based credit union launched a new commercialparticipation loan program, which will create partnerships withother credit unions nationwide. 

Loan participations can be beneficial for both institutions. Thelead (experienced) credit union is able to reduce its risk byparticipating out a portion, which also allows them the ability tocontinue to fund new loans if it is too close to the currentlending cap.  For the participating credit union, it cancreate a mentoring relationship, allowing them to gain valuableexperience in underwriting and servicing business loans while alsolimiting its risk exposure.    

Credit unions considering loan participations should be aware ofa few important items.  First and foremost is riskappetite.  Risk appetite and management are an integralpart of any credit union's plan, but risk management becomes evenmore important when entering into member business lending or a loanparticipation agreement.  Business loans are typicallymuch larger in dollar value than consumer loans and inherently aremore risky due to the different underwriting standards.   

And while it is imperative the credit union's board determineits risk appetite in advance, that may be a challenge as the boardmay not have the experience in business lending to fully understandall the associated risks.  Consider having thoroughtraining for the board and management prior to engaging in businesslending or loan participations so that an appropriate risk appetiteand guidelines can be established.

In addition, several key areas of risk should be consideredbefore entering into business lending and loan participationagreements.   

Concentration risk. The types of loans that thecredit union is willing to enter into including dollarexposure.  Don't forget the lessons learned from banksthat were too concentrated in real estate.  Inadequatediversification of the loan portfolio in terms of differentindustries, loan products, terms of loan products or the number ofborrowers may result in significant losses.  

Collateral risk. As with any loan ensuring thesecurity interest is perfected and that adequate loan to valueratios are maintained are instrumental in protecting the creditunion from potential losses.

Interest rate risk.  Maturity andre-pricing characteristics of loans can have a significant impacton the credit union's interest rate risk profile.  Theterms of the participations as well as the interest rates thatcredit union is willing to accept are vital to controlling interestrate risk.

Management and operational risk.  Asstated earlier, it's key to enter into participation agreementswith credit unions who are experienced in businesslending.  Failure of the institution to properly evaluateand monitor business loans could expose both institutions tosignificant financial and reputational losses if the loan becomestroubled or uncollectible. 

Legal/compliance risk.  Have anattorney with experience in credit unions and loan participationsreview the agreement before execution.  A well-draftedparticipation agreement that spells out each institution's rightsand obligations can help both institutions avoid–and resolve–anyconflicts that may arise down the road

By providing available credit to businesses in need, creditunions can be a vital resource to small businesses.  Loanparticipations can be a great way for credit unions to be a majorcontributor in helping our ailing economy while mitigating theirrisk exposure. 

Harvey L. Johnson, CPA, is a senior manager at Witt Mares,PLC.
Contact 757-627-4644 or hjohnson@ wittmares.com