The National Credit Union Administration (NCUA) has proposed five new rules that, if enacted as written, have the potential to significantly change the commercial lending playing field for both credit unions and banks.
Credit unions would be able to compete with banks for more commercial loans under a proposed member business lending rule (Part 723) approved by the NCUA board. Following a public comment period that ended August 31, the board will issue its final ruling.
The current credit environment, with low interest rates and unusually thin margins on many commercial loan products, only adds pressure to the situation.
Credit unions’ historical lending portfolios
Historically, credit unions have existed to serve their members with a variety of credit and other products targeted to individuals. Commercial loans for most credit unions comprised a relatively small portion of their lending portfolios and were generally confined to loans to individuals, partners, and pass-through entities such as LLCs in which its members were involved.
The new rules, which include the ability for credit unions to offer 80% loan-to-value (LTV) loans with no personal guarantees, as well as other changes, will allow credit unions to move away from their historical core lending business of providing affordable credit solutions to its members. This change would place credit unions in the markets where banks, particularly community banks, have participated for the vast majority of lending.
Both credit unions and banks have competitive advantages in the commercial loan sector.
- Credit unions, because of their tax-exempt status, will probably find it easier to be profitable in an environment with low rates and thin margins, especially because banks will continue to struggle to offer loan products with higher costs and a broad range of services, such as cash management solutions. They also will benefit from having access to commercial customers who are non-members.
- Banks have far more experience in commercial loans, particularly commercial real estate loans. Their staff is already knowledgeable and trained on how to sell and service those products. Banks also provide significant commercial and industrial (C&I) lending, an area that credit unions aren’t likely to enter significantly even under the new, proposed rules.
For both groups, the competition will be a new experience.
Effect on community banks
Community banks and even mid-size regional banks are the most likely to be affected by the new regulations. With some credit unions approaching $15B-$20B in assets, banks as large as $8B-$10B could face new competition for commercial loans.
One exception is community banks whose portfolios are too heavily weighted with commercial real estate loans. Many of those banks have begun moving into more C&I loans, which, as previously noted, is an area much less likely to see significant credit union participation.
The differences caused by Basel III
One other factor that will affect banks, probably much more than credit unions, is the implementation of Basel III, the upcoming global, regulatory framework on bank capital adequacy, stress testing, and market liquidity risk.
Capital standards will be more rigorous for banks, especially the larger ones. The historic bank balance sheet is more capital-intensive than the credit union balance sheet, and those differences will become more pronounced between now and Basel III’s full implementation in 2019.
How credit unions can prepare
Credit unions that plan to become more involved in commercial lending, especially non-real estate credits, will have to closely evaluate their liquidity management, asset management, and other treasury functions to be sure these are responsive to the notable differences arising from cash flow dependent credit relationships. Increased discipline in treasury management will be crucial to successfully expanding into new credit categories.
Credit unions, for example, have historically not had to manage the type of cash flow inherent in commercial lines of credit. Credit exposures will also be different from their current types of lending. Credit unions will have to be able to do deeper and more frequent analyses of their lending portfolios and the dynamic credit worthiness of their commercial customers, which will require different people, processes, and technology than may be in place at many credit unions today.
How banks can prepare
Banks, particularly the board of directors, should be challenging their credit leadership as to their responses to the changes in the competitive landscape while making sure they’re not sacrificing a commitment to sound credit principles and applicable controls. Banks will have to take noted effort to not waver from their current underwriting and risk-management practices. Regularly challenging and reviewing credit risk management practices is always a solid business practice, and this is an ideal time to thoroughly review and assess.
Because the proposed regulations will most likely have effects tied to the normal credit and budget cycle, which tends to follow the calendar year, the landscape isn’t likely to change significantly until spring 2016. If Congress is slow to pass bills that include the new regulations, those changes could come later.
Regardless of the perceived and real advantages and disadvantages arising from expanded credit union presence in commercial lending, both banks and credit unions should be evaluating and preparing now for new commercial lending regulations. These evaluations should not be limited to the credit function, but should extend to those functions that directly support credit, such as treasury and information technology. Regardless of the extent of expansion of commercial lending powers for credit unions, strengthening risk-management practices on an enterprise-wide basis will support sustainable commercial credit operations and profitable portfolios.