As the Federal Reserve continues to raise interest rates to combat inflation, credit unions face challenges in the demand for mortgages and auto loans. The decline in mortgages, in particular, has prompted credit unions to explore alternative avenues for growth, and one such avenue is the development and expansion of member business lending (MBL) programs. In this blog post, we will delve into the strategies and policies credit unions can adopt to ensure the success and profitability of their MBL programs.
Member business lending: How to leverage MBL for credit union growth
Develop an MBL program while mitigating risk
Credit unions looking for alternate paths to growth in today's rising rate environment may be primed to leverage member business lending.
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Why member business lending might be right for your credit union
Where to begin
Develop a member business lending strategy
Developing a sound MBL strategy, or tightening an existing one, can help credit unions achieve long-term success in managing member business lending risks. Since the responsibility to protect the credit union and its members falls to the board of directors, the board should begin this process by outlining the goals and risks of introducing and increasing loans to business members. The board can lay this foundation by:
- Deciding how the credit union’s business lending approach fits into its existing strategy
- Designating resources and expertise available for the project
- Ensuring adequate capital levels
- Determining an appropriate rate of safe and sound growth
- Settling on the specific focus of the member business lending program (for example, an industry niche)
- Implementing credit risk management software and stress testing software to monitor the portfolio
- Preparing to adapt strategy to market fluctuations and threats based on credit risk management findings
Take it slow
A measured MBL approach is best
According to NCUA guidance, the amount and expertise of resources available for business lending should drive the complexity and options available for each portfolio. A common mistake is underestimating the manpower and funding required to maintain a successful program without exceeding risk appetite. The NCUA has emphasized the importance of considering the industries and loans the credit union plans to fund. It also recommends including projections related to loan pricing, operating expenses, and delinquency. In developing an appropriate strategy, credit unions should analyze the various plausible approaches they may take given their personnel, operational, and financial resources. Credit unions should not be afraid to start small and expand their MBL exposure in a measured way. Remember, it’s often the “slow and steady that wins the race.” A measured approach allows management to incrementally assemble the resources and expertise to implement a comprehensive program without subjecting the credit union to unnecessary risks. It enables the credit union’s directors to make sure its loans to businesses meet strategic goals while also meeting financial goals, such as using limited liquidity to generate maximum return or balancing cash flows and risks.
Establish business lending policies
Once an acceptable and sound strategy has been developed, the next step in mitigating member business lending risk is to craft policies tailored to the credit union's needs. Identifying and recording board-approved lending policies satisfies regulatory requirements and alleviates unnecessary pressure on the institution. Well-defined policies reduce subjectivity and promote consistency by clarifying goals and practices. The following specific policy areas are recommended for careful consideration and attention by all credit unions engaged in member business lending.
Cash flow analysis:
- Draft policies focused on consistent and accurate cash flow analyses.
- Address how cash flow will be used to determine business borrowers’ debt service coverage ratio and approve credits.
- Consider that global cash flow analysis will be necessary for complex borrowers and outline cases in which analysis is encouraged.
On-site inspections, appraisals, and appraisal reviews:
- Ensure knowledge of projects through on-site inspections.
- Use well-supported appraisals for credit decisions.
- Perform satisfactory appraisal reviews with appropriate assumptions, methodology, and market comparisons.
- If loans outside the credit union's market area aren't restricted, draft policies outlining criteria for granting them.
- Remember, examiners will look critically at loans made outside the credit union’s normal market area and expect mitigations to compensate for added distance.
Limits and restrictions:
- Create sufficient limits and restrictions to control commercial lending risks, including overall MBL portfolio limits, loan type limits, geographic restrictions, debt service coverage ratio (DSCR), loan-to-value (LTV), and other appropriate ratio limits.
Corporate entity, licensing, and signing authority verification:
- Verify the standing and licensing of corporate entities.
- Confirm the signing authority of corporate officials representing the entity.
Credit risk rating system:
- Establish an FAS-compliant credit risk rating system that staff can understand and carry out.
- Provide guidance on when credit ratings will be updated and how risk ratings will be used to monitor overall portfolio risk.
Audit review and control:
- Use internal and external audits to verify adequate internal controls.
- Consider an independent third-party loan review to validate in-house audits and confirm that underwriting quality is satisfactory.
- Involve your board of directors in approving policies, providing continual oversight, and engaging in annual reviews.
Planning for a successful program
Developing or expanding an MBL program offers credit unions a pathway to capitalize on their strengths and support small businesses. However, with opportunities come inherent risks. Credit unions must craft a formal strategy, establish robust policies, and engage in ongoing reviews to identify and mitigate potential risks. Board involvement is not only a regulatory requirement but also a means to ensure safety, soundness, and adaptability to changes in lending regulations or institution-specific strategies. By navigating these challenges with a well-thought-out approach, credit unions can successfully contribute to individual and national economic growth.