Credit Unions Help Businesses as Economy Heals

When the pandemic first began, credit unions with commercial loans on their books braced themselves for major trouble.

Thankfully, the kind of trouble they feared never came. Many borrowers were given a deferral in the early months of COVID-19, but the majority of them have not asked for extensions and returned to making regular payments, according to CU Business Group, the largest business services CUSO.

NCUA data reflects what CUBG has seen – as of June 30, 2021, out of all the outstanding commercial loans at credit unions, only 0.81% were 30-60 days delinquent, 0.65% were more than 60 days delinquent and 0.07% were charged off (on June 30, 2020, those percentages were at 1.20%, 0.69% and 0.20%, respectively.

And the pandemic has not appeared to slow credit unions’ willingness to go all in with business members. From Q2 2020 to Q2 2021, real-estate backed commercial loan originations grew by 57.9% for all credit unions (for credit unions with $4 billion or more in assets, they grew by a whopping 95%), NCUA data showed. Commercial share deposits at all credit unions also shot up from $59.06 billion to $69.15 billion from June 30, 2020 to June 30, 2021.

Looking back further, NCUA numbers tell a story of steadily increasing interest in business services industry-wide. Commercial share deposits totaled $16.24 billion in 2013 and rose every subsequent year, and in 2007, commercial loans made up 4.9% of credit unions’ total outstanding loans; by 2020, they made up 8.2%.

Reasons for the Rosiness

The current state of commercial borrowers and business owners, and best practices for the credit unions that serve them, was the focus of CUBG’s virtual National Business Services Conference held Sept. 29-30. CUBG, which acquired the CUSO Member Business Lending in March, leading to the addition of SBA lending and loan servicing to its offerings, is based in Portland, Ore., and serves 640 credit unions.

“There’s all this upheaval in the economic world and lots of troubled real estate, but the space that credit unions play in really doesn’t touch those areas like restaurants, hospitality, events, all the things that made headlines for being cancelled or in bad shape over the last year and a half,” CUBG President/CEO Larry Middleman said in an interview with CU Times ahead of the conference. “Credit unions have really stuck to their commercial real estate and stable businesses, not so much the working capital kinds of loans that rely on the business opening its doors every day to make payments.”

Rachel Snyder, CUBG’s SVP/COO, noted that credit unions’ growing experience level with commercial lending helped lead them to recent success. “They’re now truly experienced commercial lenders, so when they apply those prudent commercial lending practices, they still can make a lot of deals,” she said. “Credit unions are looking to make more loans, and real estate investors are in the game and haven’t shied away either. So with real estate investors looking to buy properties and credit unions looking to lend, it’s created a volume of activity that we’re seeing at CUBG and we’re hearing it from other CUSOs as well.”

The flurry of refinances resulting from the low interest rate environment has helped, too. “When a commercial loan is available at a rate that starts with a 3, that’s just amazingly low,” Middleman said. “It fosters that lending environment for new loans, refinances and packaging deals, where the borrower may have three different loans on three different properties and we pool them together into one larger loan, which is better economically for the financial institution and the borrower.”

The commercial real estate market showed strong signs of a rebound in the second quarter of this year, with Real Capital Analytics reporting that U.S. commercial real estate sales returned to their pre-pandemic activity levels in Q2 2021, Dianne Crocker, principal analyst for real estate investment technology company LightBox and a speaker at CUBG’s conference, pointed out. She also noted 51% of the commercial real estate investment projects during the early stages of pandemic recovery were refinances.

“The fearfulness in the market has really abated in a big way,” Crocker said. “There’s a lot of pent up demand and there certainly are a lot of dollars looking for a home in the U.S. commercial real estate market, so there’s this frenetic sense of getting back to business, making up for lost time and taking advantage of deals while the market is still in really great shape.”

Proactive Credit Risk Management

That said, it hasn’t been unusual for some loans to turn problematic in the past year and a half. In one CUBG conference session, Michael Downey of M Downey Consulting in Santa Rosa, Calif., and CUBG SVP/Credit Administration Justin Conrey recommended that credit unions analyze the financial performance of their current business borrowers – using only post-March 2020 data – in order to get ahead of potential issues and better prepare for NCUA exams.

Downey and Conrey discussed how they recently assisted credit unions with evaluating their existing business loans and compiling reports of high-risk loans – mostly loans for business types that were highly impacted by the pandemic. Their next step was to create a “criticized asset action plan” for each high-risk loan, which includes a description of the property, the status of the loan, corrective actions for the borrower to take, a risk rating recommendation and how the credit union will monitor the loan going forward.

In one example, a $5 million loan on a retail strip mall with one vacancy raised concerns because five of the tenants were restaurants. But the credit union discovered the vacant spot had been split into two units, one that would soon be occupied by a new tenant, and that the borrower had paid all of their deferred interest from 2020. Taking the new tenant into consideration, the credit union projected the borrower’s debt service coverage ratio at 1.29, and made plans to reevaluate the loan once the new tenant began paying rent.

Downey advised credit unions pursuing a similar loan review process to also request updated financial information from borrowers on a scheduled basis, including their monthly cash burn rates and liquidity; review their commercial concentrations, especially for hard-hit businesses such as hotels and restaurants; stress test loan-to-value ratios and cash flow data; and perform onsite visits to businesses.

“The effort here is to really be able to drill down, understand the issues, build a plan and articulate how you’re going to approach those issues, and then get to some very realistic assessment of what that risk is,” he said. “You really need to have a process to identify, measure, manage and mitigate credits that are potentially problems.”

Leaning Into SBA Loans

The Small Business Administration’s Paycheck Protection Program (PPP) gave many credit unions the opportunity to originate SBA loans for the first time, raising their awareness of the government agency’s various loan programs.

David Doria, SBA lending manager for America First Credit Union ($15.8 billion, Riverdale, Utah), which has been making SBA loans for about 20 years, shared his top tips with CUBG conference attendees looking to enter the space.

First, he emphasized, it’s important to hire business development officers with specific experience in SBA lending as opposed to appointing someone on staff to handle the area. He noted that an experienced SBA lender will expect an incentive program in addition to a base salary, but that credit unions shouldn’t expect to compensate the person much more than they would a commercial lender. If a credit union fails to make this upfront talent investment, “the learning curve will be big and the road to profitability will be a steeper decline,” Doria said.

Second, Doria recommended steering clear of SBA Express loans, which are appealing to credit unions looking to help businesses with smaller loan amounts but carry the highest delinquency rates out of all the SBA loans and are usually only guaranteed up to 50%. America First mostly does 7(a) loans, which come with a 75% guarantee.

Facing Competition

One downside to credit unions’ exceptional business share deposit growth is it tasks them with lending out that money to keep their loan-to-share ratio from falling too low, and this has been a challenge due to growing competition in the marketplace.

“There are a lot of competitors out there, with a lot of banks and financiers that are playing in the marketplace, and what we’re finding too in some of the larger real estate deals is that certain lenders are willing to offer terms and loan structures that credit unions tend to not be real favorable on, such as a 10-year or even longer maturity,” Middleman said. “That’s great for the borrower to lock in a low rate, but it can expose the credit union on the asset liability side.”

Despite these challenges and lingering economic uncertainty, relationships between credit unions and businesses appear to be blossoming. Middleman noted the 2021 virtual conference drew around 700 attendees, speaking to credit unions’ growing interest in business services. “It’s much more widespread in our industry now than it has ever been,” he said. “And I don’t see us going backwards, if anything, it’s going to continue to expand.”