Commercial lending was once unfamiliar territory for most credit unions. No more. Now many CUs have established member business commercial lending units. This member benefit can be very profitable if the basic fundamentals are established early-and very costly if not.
That’s why it’s important to put best practices, including loan portfolio management fundamentals, in place and use them to maximize asset quality. This will result in stronger revenue and better regulatory examinations. But first, now is a great time to review and assess how the commercial lending program is working.
Two factors are leading credit unions to consider moving into or expanding MBLs: the bank credit shortage brought on by the recent recession, and pending legislation in Congress. The latter is the “Promoting Lending to America’s Small Businesses Act,” which would increase the business lending cap to 25% of total assets from 12.5% and would exempt business loans under $250,000 from the cap (vs. the current $25,000 limit). The Obama administration also recently weighed in with its support for opening up more commercial lending to credit unions. The White House proposal calls for increasing the lending cap even higher than the House bill (to 27.5%), but calls for credit unions who go to the higher cap to be well-capitalized (7% net worth ratio).
It is important CUs not to jump blindly into commercial lending. First, staff expertise is essential. Hiring leadership with previous commercial lending experience can mean the difference between a successful portfolio and a file full of bad loans. Veteran commercial lenders can eliminate the learning curve for a new division and help to establish MBLs as a cornerstone for future business success.
Second, the creation of a strong and well-grounded “credit culture” is of the utmost importance. Many of the problems in today’s financial industry are the result of a misguided focus on growth at all costs, relaxed lending standards and being overweight in areas such as commercial real estate. Loan officers may have been paid commissions to grow their portfolio without the proper focus on loan quality. A strong credit culture is defined by a long-term view toward growth and profit that is grounded in the institution’s policy on risk tolerance, a disciplined approach to risk, and the necessary resources to manage the risk.
Along with strong leadership and a robust credit culture are clear, measurable loan portfolio objectives grounded in the CU’s credit culture and addressing the following items as part of your commercial loan policy: loan quality, portfolio diversification, loan product mix, product specialization, targeted industries, and geographic markets.
Building Blocks of Portfolio Management
There are five basic building blocks of commercial loan portfolio management:
1. Risk identification. Accurately determining credit risk at the borrower or loan level using a comprehensive approach that is reviewed on a regular basis is essential.
2. Documentation and policy exception management. Don’t allow gaps in the loan documentation or large numbers of atypical loans prevent you from enforcing the terms. Put policies in place to rapidly address missing paperwork and minimize exceptions.
3. Concentration of risk. Install procedures to identify loan concentrations with one borrower or group of borrowers, industry concentrations and concentrations by loan types. If loan policy specifies or allows such concentrations, put additional procedures into place to ID and mitigate risk.
4. Collections and workouts. ID problems loans early on and work out solutions with the borrower early to save the loan. A foreclosure benefits neither party.
5. Credit management systems. A comprehensive credit management system should be able to analyze and underwrite, risk rate, handle loan approval communication, track document and policy exceptions, manage collections and provide reporting necessary to understand risks and trends.
Shrewd politicians say “never waste a good crisis.” Savvy CUs shouldn’t either. There is a prime opportunity for you to expand market share and succeed where traditional business credit sources have stumbled-providing you understand the differences between commercial lending and more traditional CU services.