Risks in member business lending
U.S. credit unions experienced solid growth in traditional lending areas last year, but a large number of credit unions are focusing attention on either starting a member business lending (MBL) program or expanding their current efforts to provide loans to member businesses. When considering the development or expansion of a MBL program, industry experts point to several areas of risk to evaluate. In part 1 of this post, an overview of how to assess creditworthiness will be discussed.
By Mary Ellen Biery, Research Specialist, Sageworks
Regulations say a credit union’s member business loan policy must address a requirement “to analyze and document the ability of the borrower to repay the loan consistent with appropriate underwriting and due diligence standards.” This aspect, the regulations say, must also address “the need for periodic financial statements, credit reports, and other data when necessary to analyze future loans and lines of credit, such as, borrower’s history and experience, balance sheet, cash flow analysis, income statements, tax data, environmental impact assessment, and comparison with industry averages, depending upon the loan purpose.”
For credit unions accustomed to underwriting auto loans and consumer lines of credit, assessing creditworthiness of a manufacturing firm or other business is a major change. In addition to lacking the staff experience, credit unions may also find they don’t have the proper systems or analytics to evaluate a more complex borrower relationship.
Consumer credit reviews often involve verifying income through W-2s and evaluating personal credit scores provided through one of the major credit bureaus. For business lending, a credit union could be evaluating a cyclical business or one that has working capital needs that are far more complex, such as equipment financing. “Even a basic cash flow analysis is inherently more complicated in business lending than for the standard consumer loan,” according to Tim McPeak, a director in the Financial Markets Group at Sageworks. Consumer lending operations are often geared for volume, with centralized underwriting.
In business lending, it often happens that information gathered in one piece of the application process raises new questions that require additional data gathering. For example, an analyst reviewing a business’s balance sheet that shows a large accounts receivable balance might request to see a more detailed aging report on the receivables to complete the credit analysis.
A global cash flow analysis provides the most complete picture of a borrower’s ability to service debt. While owners and guarantors may be sources of capital, they can also be a drain on cash in downturns, depending on their personal and other business obligations. But global cash flow analysis can be a difficult and error-prone process. In a recent survey of more than 150 financial institutions, almost 40 percent indicated difficulty combining personal and business incomes is their biggest challenge while performing global cash flow analysis. Another 28 percent specifically cited double-counting income from the business and the individual as their biggest challenge. It’s important for credit unions to put in place standards for when to conduct a global cash flow analysis, what information to collect from borrowers and how to analyze that information.
Some credit analysis solutions that perform global cash flow analysis on borrowers can help credit unions standardize the process and make it more efficient. A simplified global cash flow analysis can also be performed using worksheets.
For information on some of the other common areas of risk associated with member business lending, download the whitepaper, Member Business Lending Landscape: Managing Risk & Opportunity.