Breaking Out Of The Cap Conundrum

These three far-sighted strategies can help remove roadblocks and provide a path to increased member business lending.
Catherine Siskos

It’s a cruel irony that for credit unions, one of the best potential sources of future growth also comes with a steep, built-in deterrent. Member business loans offer a higher revenue stream than consumer loans, are in demand among borrowers in many communities, and offer a chance at greater portfolio diversification. Yet under federal law, each credit union’s business lending capacity is limited to the lesser of either 1.75 times its net worth or 12.25% of assets.

For many credit unions, that cap presents a conundrum. Why invest in the special expertise and additional personnel that commercial loans require if there’s little incentive to succeed? After all, no credit union wants to risk turning away qualified borrowers because its portfolio is closing in on the cap.

Offering commercial loans automatically puts a credit union in an elite group, as only about one in three cooperatives lend to businesses as of 3Q 2013, according to Callahan Associates’ Peer-to-Peer analytics.

Although the three credit unions profiled here each took a different path to build their commercial lending business, these strategies all share one thing in common a way out of the cap conundrum if and when the institution needs it.

It’s a big issue whether credit unions do business lending today, says Brett Martinez, CEO of Redwood Credit Union ($2.26B, Santa Rosa, CA), who believes the sector is critical to the industry’s survival. Whatever people’s opinions are, we need the ability to grow this way because nobody knows what the future looks like, and this just gives us another arrow in our quiver.

Strategy #1 Spread The Risks With Loan Participations

The MBL arrow mentioned by Redwood Credit Union has struck the bull’s eye at United States Senate Federal Credit Union ($569M, Alexandria, VA).

In 2010, the credit union formed a wholly owned credit union service organization (CUSO) called CU Strategic Services that only does business loan participations. Unlike most CUSOs specializing in this area, CU Strategic Services doesn’t buy or sell the loans itself but matches credit unions wanting to get into the sector with those pushing their cap.


  • Redwood Credit Union
  • HQ: Santa Rosa, CA
  • Assets: $2.26B
  • Members: 189,138
  • 12-MO Share Growth: 7.06%
  • 12-MO Loan Growth: 9.08%
  • ROA: 2.15%

John Hayes, a former commercial lender at a bank and now president and CEO of CU Strategic Services, started this CUSO when he was USSFCU’s chief operations officer because it wasn’t cost effective for the credit union to originate loans itself. Established for a select employee group, the credit union had a limited field of membership and only a small demand for commercial loans.

We knew that only 10% of our members had a business, and that’s not enough to go out and build a commercial loan department, Hayes says.

The beauty of setting up a CUSO, which cost USSFCU a mere $1,000 or so, was that the credit union could acquire quality commercial loans with none of the legwork associated with origination.

I don’t have to physically sit down with a member for three hours and take an application, Hayes says. Instead, I’m leveraging the expertise from another credit union with 15 people on staff originating loans.

Hayes does, however, review and monitor the loans closely both for his own credit union as well as for other loan-purchasing clients who pay for that service. He visits each property before recommending any loan to either USSFCU or another buyer and at least once a year thereafter.

In all, the CUSO approach has helped USSFCU purchase nearly $60 million in business loans over three years without having to hire a single additional employee. The loans, which are for commercial properties, have an average balance of $927,000 and an average return of 4.74%, generating $1.3 million per year in interest income for USSFCU.


  • Listerhill Credit Union
  • HQ: Sheffield, AL
  • Assets: $629M
  • Members: 78,174
  • 12-MO Share Growth: 8.92%
  • 12-MO Loan Growth: 7.47%
  • ROA: 0.63%

Hayes finds sellers by using data from Callahan Associate’s Peer-to-Peer analytics to see which credit unions are pushing their cap. Buyers come mostly through referrals, and because his clients are spread out along the East Coast, the loan risk is too.

I spread the risk among lead lenders, states, and types of properties so if one area has a problem, I’m diversified, Hayes says.

The properties in this portfolio include medical and office buildings, apartment complexes, student housing, and retail in eight different states loans the credit union could never have acquired any other way except through a CUSO. Because the loans reprice every five years, interest rate risk is also reduced.

With business lending now at around 10% of assets, USSFCU is considering applying for a member business-lending waiver from the National Credit Union Administration (NCUA). Hayes believes the credit union stands a good chance of getting the waiver, which NCUA grants to institutions that can demonstrate solid risk management. And thanks to its CUSO, USSFCU already has the kind of diversification regulators like to see.

Strategy #2 Get a Low-Income Waiver

A $61 million business loan portfolio puts Listerhill Credit Union ($629M, Sheffield, AL) at 93% of the federal cap or roughly 11% of its assets. Luckily, the credit union already has a plan in place that will allow it to exceed that federal limit if necessary.

Listerhill is among the 1,961 credit unions that NCUA has designated low income, a classification that permits unlimited business lending to underserved communities with little access to credit.


  • Whatcom Educational Credit Union
  • HQ: Bellingham, WA
  • Assets: $962M
  • Members: 71,211
  • 12-MO Share Growth: 12.12%
  • 12-MO Loan Growth: 13.26%
  • ROA: 1.47%

Credit unions are eligible for the annually determined designation if 50% of their members qualify as low income. Cooperatives that fail to meet the standard at a later date have five years to unwind the portfolio. In Listerhill’s northern Alabama community, the median household income was $33,205 based on 2011 U.S. Census data.

Still, liberation from the federal cap hasn’t gone to Listerhill’s head.

Although the credit union aims for 10% annual growth in business lending, Listerhill is more interested in how that growth happens than in meeting a preconceived goal, says Fred Lindsey, vice president of business service operations.

Lindsey is also keenly aware of NCUA guidelines, which emphasize a go-slow approach for credit unions getting into the sector and he doesn’t want to jeopardize the waiver, which is renewed based in part on an annual risk assessment.

We don’t see this as a waiver to just go out and make loans, Lindsey says. We want to do things the right way with the right deals.

So far the right deals have been mostly commercial real estate loans, which is where the credit union plans to concentrate its future growth. Of the 273 business loans currently in Listerhill’s portfolio, 86% were for commercial real estate with the rest scattered among unimproved real estate, commercial development, and equipment. The average loan size is $223,254.

Staffing will also determine how fast Listerhill’s business lending grows. The credit union currently has five employees dedicated to these activities, including two commercial loan officers. If the portfolio grows suddenly, those employees could be stretched too thin to support that business adequately. And finding people with commercial lending expertise in a small, rural community is a tall order at the best of times, let alone in a crunch.

Strategy #3 Qualify For A State Exemption

Whatcom Educational Credit Union ($962M, Bellingham, WA) has been involved in member business lending for more than a decade. Yet its decision to switch to a state charter a few years back proved an especially prescient move for this business line.

The credit union has become so successful originating business loans that the federal cap would almost certainly have been a concern had its new charter not offered a way around that limitation.

Washington is one of six states including Connecticut, Maryland, Oregon, Texas, and Wisconsin where state-chartered credit unions may be eligible for a higher cutoff than the federal limit. In Washington, that waiver allowed Whatcom to raise the cap to 25% of assets as long as the credit union could demonstrate safe lending practices, sufficient liquidity, and a need for the loans in the community.

It took quite a while to qualify because there’s a pretty significant checklist of documents and reports that you have to submit, says Kent Bouma, Whatcom’s vice president of business services. During this application process, state and NCUA examiners jointly conduct evaluations of the credit union’s lending abilities.

They need to feel comfortable that you know what you’re doing before they’ll grant the waiver, he says.

Approved credit unions are also re-examined annually, a process Whatcom has successfully managed every year since it first applied for the exemption in 2009.

Today, the institution’s $157 million business loan portfolio equals 16.35% of its assets. Smaller business loans of $50,000 or less, which aren’t applied toward the cap, account for another $5.6 million.

Whatcom is also on track to increase business lending by 16% in 2013 and is considering a 20% annual target in the future. Despite this growth, Whatcom’s experience with MBL does dispel the common myth that credit unions automatically enjoy greater economies of scale the more business lending they do.

Economies of scale are hard to achieve because as you grow you need to keep adding expertise, says Jennifer Kutcher, Whatcom’s executive vice president and chief lending officer. Examiners are afraid your loan officers will get spread too thin so that quality suffers.

Besides adding staff to its 10-person MBL team, Whatcom will also need to consider investing in new technology that will better support these activities. For example, the credit union’s business lending segment still operates off of the same core processor used for consumer loans. But with its current track record of zero delinquencies for MBL, satisfying regulators shouldn’t be hard to do.

Buying Time for a Looming Cap

Last year, Redwood Credit Union’s ($2.26B, Santa Rosa, CA) MBL portfolio was fast approaching the 12.25% of assets that marks the federal cutoff. Estimating that the credit union had just 18 months before it hit the cap, Redwood’s CEO Brett Martinez swung into action to buy his institution some time until a more permanent solution could be found.

Interestingly enough, it’s almost a year and a half later, and we still have 18 months left, says Martinez, whose $186 million business loan portfolio is now just 6.5% of its assets.

Redwood may have successfully pulled a rabbit out of its hat, but the win required making some painful choices along the way. In August 2012, Redwood sold about $20 million in business loans to the federal government under the Small Business Administration (SBA) First Mortgage Loan Pool program, which was just about to expire. The sale still galls Martinez.

They were good performing loans that we would not have sold if it wasn’t for the cap, he says. Even with that extra breathing space, Redwood’s pain didn’t stop there.

We’re turning away some of the larger loans, which is a shame, because we got into commercial lending to help businesses in our community, Martinez says.

As an alternative, the credit union has begun targeting more SBA loans. Because the federal government guarantees 75% of SBA 7(a) loans and 50% of 504 loans, only the remaining 25% and 50% of those loan balances apply to Redwood’s cap. Likewise, the credit union’s 5.69% asset growth over the past year has also helped ease some of this pressure.

None of these options have provided exactly the type of long-term relief from the cap’s crippling effect on growth that Redwood is seeking, but a more comprehensive solution is on the way.

The credit union did receive a low-income designation from the National Credit Union Administration, enabling the cooperative to make unlimited business loans because more than 50% of its membership is considered low income. Now the state-chartered credit union is currently working with California’s Department of Business Oversight to qualify for this designation under state law.

Although the low-income standard must be met each year alongside proof of solid risk management, Martinez is confident Redwood can pass those tests. For one thing, its business loans have a 0.22% charge-off ratio, which is lower than other areas of the portfolio.

I think we’ve shown that we know what we’re doing, Martinez says. We can create our own caps.

January 13, 2014

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