National Credit Union Administration Regulations (May 2008)
Member Business Loans
Member Business Loans (granted and serviced by a credit union) are covered under Part 723 of National Credit Union
Administration, Rules and Regulations, Revised April 2004 (as Revised November 2001).
As per § 723.1, a member business loan is defined as "any loan, line of credit, or letter of credit
(including any unfunded commitments) where the borrower uses the proceeds for the following purposes:
(1) Commercial;
(2) Corporate;
(3) Other business investment property or
venture; or
(4) Agricultural."
As per § 723.16, "The aggregate limit on a credit union’s net member business loan balances is the
lesser of 1.75 times the credit union’s net worth or 12.25% of the credit union’s total assets."
As per § 723.8, Unless a "Regional Director grants a waiver for a higher amount, the aggregate amount of net
member business loan balances to any one member or group of associated members must not exceed
the greater of:
(a) 15% of the credit union’s net worth; or
(b) $100,000.
As per § 723.7 (a) (1), all loans must be secured by collateral and "The maximum loan-to-value ratio for all liens
must not exceed 80%", however as per § 723.7 (c) (2), a credit union may "make unsecured member business
loans" as long as "The aggregate of the unsecured outstanding member business loans to any one
member or group of associated members does not exceed the lesser of $100,000 or 2.5% of" net worth.
As per § 701.21(c)(4), for federally-chartered credit unions, the maturity of MBLs is limited to 12 years, except
“lines of credit are not subject to a statutory or regulatory maturity limit.”
As per § 723.7 (b), "Principals, other than a not for profit organization as defined by the Internal Revenue Service
Code (26 U.S.C. 501) or those where the Regional Director grants a waiver, must provide their personal liability and
guarantee."
In most cases, the maximum LTV on any member business loan is 80.0%. However, as per § 723.7 (e), a cfederal credit union "may make vehicle loans under this part without complying with the loan-to-value ratios
in this section, provided that the vehicle is a car, van, pick-up truck, or sports utility vehicle and
not part of a fleet of vehicles."
As per § 723.10, a credit union may apply to its Regional Director to obtain a waiver of the above
requirements, for instance if a loan is 100% collateralized with a deposit and/or securities, then perhaps the personal
guarantee may be waived. Similarly, as per § 723.17 there are exceptions to the aggregate loan limit indicated in
§ 723.16 above
Member Business Loan Credit Analysis (12 C.F.R. 723)
As per § 723.5, the Credit Analyst performing the due diligence, credit application preparation, presentation and recommendation
must be "an individual with at least two years direct experience with the type of lending the credit
union will be engaging in."
Most credit union underwriting packages include:
Loan Application
Personal Financial Statement (of business owners as a personal guarantee is usually required)
Last two to three years business Federal Income Tax returns for the corporation or partnership
Last two to three years financial statements for the corporation or the partnership
Interim financial statement for the corporation or the partnership (current / year-to-date)
Last two years personal tax returns
Personal financial statement (year-to-date as prepared by a CPA)
Copies of lease with the landlord (if renting where the business is located)
Contract of Sale to purchase the business or real estate
Many of these companies are small, privately held entities thus the Borrower also needs to indicate:
When established
Major products and services
Method of operation
Explain any significant changes in earnings (both positive and negative)
Largest customers
Major Suppliers
List of affiliated businesses
Tax delinquencies
Lawsuits or pending litigation
Business location
Banking relationship summary
Assets
Cash: end of period cash, demand deposits with banks, share deposit(s) in corporate credit union(s); as cash on
hand earns the
lowest return so we are just looking to make sure it approximates a percentage of current liabilities.
Certificates of Deposit (less than one year in maturity)
Marketable securities (Available for Sale and Held to Maturity): short-term investment of excess cash timed to be available with maturing liabilities.
U.S. government obligations and federal agencies securities, Mortgage-backed securities (agency and private-label),
Municipal bonds.
Available-for-sale (carried at fair value).
Corporate credit union Membership Capital Shares are sometimes purchased to allow the credit union to access to services of the corporate
credit union at preferable prices. The Membership Capital Shares are considered restricted, as they may only be
resold to the corporate credit union at cost.
Money market account investments are usually required by Visa USA, Inc., who
provides credit card service to a credit union’s members. The account is held as
collateral and the required balance is based on the outstanding credit card balances.
Member Loans / Loan Receivables (net of Allowance for Loan Loss)
The assets in this category will reflect what the company really is focused on: loans to consumers such as
mortgages
or home equity loans, credit cards, automobile financing (new and used), etc.; or if the focus is more on commercial
customers then it may have commercial mortgages, equipment financing or leasing, term loans, lines of credit, etc.
Owned, on-blance sheet
receivables are loans owned by the credit union and they assume the full credit risk for the performance of the receivable.
Managed is the performance of both on-balance sheet loans and off-balance sheet loans
owned by other credit union participants as a single portfolio.
Fixed Assets (Building / Branch network; includes owned branches and leasehold improvements, furniture and fixtures),
less accumulated depreciation and amortization. Buildings, furniture and equipment and data processing are depreciated
using the straight-line method over the estimated useful lives of the assets. The cost of leasehold
improvements is amortized using the straight-line method over the terms of the related leases.
Accrued interest receivable
National Credit Union Share Insurance Fund (NCUSIF) deposit is in accordance with National Credit Union Administration
(NCUA) regulations, which require the maintenance of a deposit by each federally insured credit union in
an amount equal to 1.0% of its insured members shares.
Other Assets and Prepaid
Goodwill
Liabilities
Current Liabilities
Members Shares Deposits (individual and corporate member savings and checking accounts referred to as Regular
shares, Share draft accounts, Money market accounts, Individual retirement accounts, Certificates)
Other Deposits
Short-term borrowings
Accounts Payable
Accrued expenses and other liabilities
Loans from affiliates
Long-term Liabilities
A credit union may have a credit agreement with a Federal Home Loan Bank under from which it may borrow funds, which will
be collateralized by specific credit union assets.
Medium-term notes
Long-term debt
Affiliate debt
Member Shares
Credit unions are owned by its membership and it does not report "Equity" as other financial institutions.
Share ownership entitles the members to vote in the annual elections of the Board of Directors
and on other corporate matters. Irrespective of the amount of shares owned, no member has more
than one vote. Members’ shares are subordinated to all other liabilities of a credit union upon
liquidation.
Preferred shares
Retained Earnings
Common share
Retained Earnings
Income Statement
Interest Income
Interest on loans to Members
Interest on Deposits / Other Deposits
Interest Expense
Interest on Members's shares deposits
Interest on Other Deposits
Interest on Short-term borrowings / Bank loans<
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Net Interest Income
Provision for loan losses
Other Income
Fees and service charges
Gain (Loss) on sale of investments available for sale
Gain (Loss) on sale of Fixed Assets (property and equipment)
Operating Expenses
Compensation and Employee Expenses
Occupancy (lease expense, maintenence)
Real estate taxes
Depreciation Expense
Extraordinary / Non-recurring Items
Material events and transactions that are unusual and infrequent.
Profit (gains) or loss on sale of fixed assets.
Net Income
As not-for-profit organizations, credit unions are required to channel any profit to its members in the form of
Competitive dividend rates paid on savings and investment accounts, lower fees, competitive interest rates on loans,
and expanded, low-cost products and services. Credit unions are exempt from state and federal corporate income tax,
however are required to pay other state and local sales and real estate taxes.
Credit unions primarily borrow money in the retail market from its membership deposits and lends to, finances or leases assets or
asset purchases to/by customers (creating receivables) and/or purchasing loan/financial receivables originated by others (participations).
These receivables are usually held on balance sheet with the company earning the interest spread between what the
receivables pay and what the company pays on borrowed funds. The credit union can hold the receivables at the CUSO subsidiary-level,
receiving a one-time payment at par or discounted from the face value of the receivables (with some recourse provision)
and continue servicing the portfolio for the parent or other participant(s) earning a management and/or servicing fee.
The credit union's source of funding may also come from the wholesale market
cash flow from operations
Issuance of additional regulatory shares
In a changing interest rate environment, is the credit union asset sensitive or liability sensitive? For instance, if
interest rate rates are declining, and the credit is liability sensitive, that means that borrowed funds mature or
reprice at a faster rate than finance receivables, thus it can maintain a positive interest spread.
Are the receivables concentrated in any single industries or geographic location? Credit union's are required to lend
to its local membership, which results in a concentration of credit exposure to a single, local market.
Are the assets, as collateral to the receivables (if secured):
Does the credit union utilize credit scoring methodology or is creditworthiness decided on a case-by-case basis by
credit personnel and management?
Does the company service and collect its own receivables or is there a third party?
Liquidity refers to a CU's ability to convert an asset into cash. The faster the conversion the more
liquid the asset. Illiquidity is a risk in that a CU might not be able to convert the asset to cash when most needed.
Moreover, having to wait for the sale of an asset can pose an additional risk if the price of the asset decreases
while waiting to liquidate. CUs are required to maintain a 10% ownership of any loan offered for sale / participation
thus it never really can eliminate all exposure to a counterparty or have full liquidity.
Capital Adequacy
Capital Adequacy
is a measurement of a credit union to determine if solvency can be maintained due to risks that have been incurred as a
course of business. Capital allows a credit union to grow, establish and maintain both public and regulatory confidence,
and provide a cushion (reserves) to be able to absorb potential loan losses above and beyond identified problems. A credit
union must be able to generate capital internally, through earnings retention, as a test of capital strength.
Federal credit unions are subject to various regulatory capital requirements administered by the NCUA. In addition, the
NCUA has also established Risked Based Net Worth (RBNW) requirements for complex credit unions based on risk weighting
formulas on specific assets, liabilities, and off-balance sheet items which qualify under the regulations.
On August 7, 1998, Congress enacted the Credit Union Membership Access Act,
Pub. L. No. 105-219, 112 State. 913 (1998). Section 301 of the statute added a new
section 216 to the Federal Credit Union Act, 12 U.S.C. 1790d (hereinafter referred to
as “CUMAA” or “the statute” and cited as “§1790d”). Section 1790d requires the
NCUA Board to adopt by regulation a system of “prompt corrective action” (sometimes
referred to as “PCA”) to commence when a federally-insured “natural person” credit
union becomes undercapitalized.
Equity Capital / Total Assets
Ratio required to be classified as "Complex" / "Adequately Capitalized" - 6.0% to 6.99%
Ratio required to be classified as "Well Capitalized" - 7.0% or greater
A credit union is considered complex if:
Long-term real estate loans equal or exceed 25.0% of month-end total assets.
Combined portfolios of either a). MBLs outstanding and b). Unused MBL commitments equal or exceed 12.25% of month-end total assets.
Long-term investments equal or exceed 15.0% of month-end total assets.
Loans sold with recourse equal or exceed 5.0% of month-end total assets.
Asset Quality
Asset Quality evaluates risk (and there must be some risk to earn a return), controllability, adequacy of loan loss
reserves, and acceptable earnings; and the affect of off-balance sheet earnings and loss. The quality of a credit union's
assets hinges
on their ability to be collected during and at maturity. Thus, one must examine the portfolio quality, the portfolio classification
system (aging schedule and the methodology to classifying a receivable) and the fixed assets (the productivity of the
long-term assets, for instance the branch network). It is also necessary to determine the liquidity and the maturity structure
of various Assets. Investing in earning assets is how a credit primarily earns a return. How well are these assets going to perform?
It is also important to understand the credit union's methodology for setting reserves as a percentage of non-performing
receivables (60 days or longer overdue) and net charge-offs. Every product category Loan receivable has a different
inherent loss characteristic. Specific portfolio issues are:
growth of the number of loan receivables
product mix
bankruptcy trends
geographic concentration
economic conditions
portfolio seasoning
current level of charge-offs and delinquencies
What percentage of loans (either separate portfolios of consumer loans and commercial loans and/or combined) are
delinquent 30 day? What percentage of total loans are delinquent 90 days? What percentage of total loans are non-performing
(over 90-day, non-accrual and restructured).
What is the percentage of charge-offs to total loans (consumer and commercial receivbles)? What is the percentage change
of charge-offs from the previous fiscal period?
Loan Loss Reserves / Total Loans
This is a primary measurement for judging capital strength.
Traditionally the amount is a minimum 1.0% but it is not sure if it is adequate unless it is compared to
Provisions/Total loans: percentage of provisions from fiscal income statement as a percentage of the portfolio.
Loan Loss Reserves / Non-Performing or Non-current Loans and leases
Non-performing or Non-current loans consist of loans that are 90 days or more overdue and still accruing and nonaccrual loans.
Also sometimes known as the coverage ratio, should be in excess of 1.5x
Total Loans 90-Days Past Due / Total Loans
Indicates that the loan portfolio may be experiencing some deterioration through either poor underwriting and/or
collections.
Profitability
Earnings determine the ability of a credit union to increase capital (through retained earnings), absorb loan losses, support the future growth of assets
The largest source of income for a credit union is net interest revenue (interest income from lending
activity less interest paid on deposits and debt). The second most important source is from investing activity. A substantial
source of income also comes commissions / transaction fees (sometimes through a CUSO subsidiary).
Key Ratios for Examining Profitability
Net Interest Income (annualized) / Average Interest Earning Assets
This is net interest income expressed as a percentage of average earning assets.
Net interest income is derived by subtracting interest expense from interest income.
Indicates how well management employed the earning asset base (the denominator focuses strictly on assets that generate income).
May come under pressure from offering
preferential rates to customer base, a low level of growth in savings and the higher percentage of more expensive
wholesale funds available. The lower the net interest margin, approximately 3.0% or lower, generally it is reflective of a
credit union with a large volume of non-earning or low-yielding assets.
Conversely, are high or increasing margins the result of a favorable interest rate environment, or are they the result
of the credit union moving out of safe but low-yielding, low-return securities into higher-risk, higher yielding and less liquid
loans or investment securities?
Net operating income (annualized) after taxes (including realized gain or loss on investment securities) / Total Average Assets (assets at the previous fiscal year plus assets
at this current fiscal year divided by 2) for a given fiscal year
Actual net income should be examined for the inclusion of extraordinary earnings (which may be excluded).
This measures how the assets are utilized by indicating
the profitability of the assets base or asset mix.
For comparison purposes, it usually ranges from approximately 0.60% to under 2.0% for U.S. Banks. Historically in the U.S. the benchmark was 1.0% or
better for the bank to be considered to be doing well.
Net operating income after taxes (including realized gain or loss on investment securities) / Total (average) equity (member's shares) for a given fiscal year
This ratio is affected by the level of capitalization of the credit union.
Measures the ability to augment capital internally (increase net worth).
Measures the return on the member's share investment (not considered an effective measure of earnings performance from
the credit union's standpoint).
In the long run, a return of around 15% to 17% is
regarded as necessary to maintain capital strengths.
Adjusted ROE or ROAE: Net income / Total equity plus loan loss reserves in excess of 10% of equity (member's shares).
Revenue from loans, securities, cash equivalents and earning assets (including non-interest) before
interest expense / Earning Assets
Measures the results of operations prior to funding costs and as if the operations were totally
funded by equity.
Operating profits (before the loan loss provision and excluding gains or losses from asset
sales and amortization expense of intangibles) / Net operating revenues (interest income less interest expense plus
noninterest income)
This ratio measures the percent of net operating revenues consumed by operating expenses,
providing the remaining operating profit (the higher the margin the more efficient the credit union).
Inverse of the efficiency ratio.
Non-Interest Income (annualized) / Total Average Assets
Non-interest income is income derived from fee-based services such as service charges on deposit accounts,
consulting and advisory fees, rental of safe deposit boxes and other fee income, fiduciary, brokerage and insurance
activities.
Realized gains on the sale of securities is excluded.
It is important that a credit union devlop non-interest income sources but it should become a major portion of the credit union's total
revenue unless it really is an annual core business operation.
Accrued Interest Receivable / Interest Income x 365
This is
a measurement of the number of days interest on earning assets remains uncollected and indicates that volume of overdue
loans is increasing or repayment terms are being extended to accommodate a borrower's inability to properly service debt.
Total Non-Interest Expenses (annualized) / Total Average Assets
Non-interest expenses (annualized), which are the normal operating expense associated with the daily operation of a bank
such as salaries and employee benefits plus occupancy / fixed asset costs plus depreciation and amortization.
These costs tend to rise faster than income in a time of inflation or if the credit union is expanding by the purchase or construction of a new branches.
Provisions for loan and lease losses, realized losses on securities and income taxes should not be included in non-interest expense.
Total Non-interest expenses / Total Net Interest Income (before provisions) plus Total Non-Interest Income
Efficiency improves as the ratio decreases, which is obtained by either increasing net interest income, increasing
non-interest revenues and/or reducing operating expenses.
Non-interest expenses (expenses other
than interest expense and loan loss provisions, such as salaries and employee benefits plus occupancy plus depreciation
and amortization) tend to rise faster than income in a time of inflation.
This is a measure of productivity of the credit union, and is targeted at the middle to low 50% range. This may seem like
break-even but it is not; what this is saying is that for every dollar the credit union is earning it gets to keep 50 cents and it has to
spend 50 cents to earn that dollar. The ratio can be as low as the mid to low 40% range, which means that for every dollar
the bank earns it
gets to keep 60 cents and spends 40 cents, a very efficient bank.
Ratios in excess of 75% mean the credit union is very expensive to operate.
Funding & Liquidity
Funding and Liquidity are related, however they are separate situations. Funding is what a credit union relies upon to
grow its business and the asset side of the balance sheet above and beyond what could be accomplished with just
equity. Funding is provided by deposits, short-term debt and longer-term debt. Funding means access to capital.
Liquidity is what a credit union
requires if Funding is interrupted and the credit union must still be able to meet certain obligations (credit union's ability to repay
depositors and other creditors without incurring excessive costs). What is the liability
structure / composition of the credit union’s liabilities, including their tenor, interest rate, payment terms,
sensitivity to changes in the macroeconomic environment, types of guarantees required on credit facilities, sources of
credit available to the institution and the extent of resource diversification.
A credit union's least expensive means of funding loan growth is through deposit accounts. When this is not available, credit unions
must rely on more expensive funding sources such as borrowing funds at wholesale rates or liquidating investment securities
portfolios. The best type of deposits are "core" deposits, which are balances that are left at the credit union due to convenience
(the depositor resides in the area) or through loayalty. Non-core deposits / funding are sources that can be very
sensitive to changes in interest rates such as brokered deposits, CDs greater than $100,000, and borrowed money.
The Deposit Growth Rate, which is computed by subtracting prior-period total deposits from current-period total deposits,
then dividing the difference by prior-period total deposits, indicates how a bank is funding the asset side of its balance sheet.
Liquidity refers to reserves of cash, securities, a credit union's ability to convert an asset into cash,
and unused lines of credit. The faster the conversion the more
liquid the asset. Illiquidity is a risk in that a credit union might not be able to convert the asset to cash when most
needed. Moreover, having to wait for the sale of an asset can pose an additional risk if the price of the asset
decreases while waiting to liquidate. Thus, if loans or assets are illiquid then liquidity is also limited, especially
if the loans exceed stable deposits and available lines of credit. Liquidity must be sufficient to meet all maturing unsecured debt obligations due
within a one-year time horizon without incremental access to the unsecured markets.
Loans (gross) / Total Deposits
Indicates the percentage of a credit union's loans funded through deposits (measures funding by borrowing as opposed to
equity)
The higher the ratio the more the credit union is relying on borrowed funds.
However, cannot also be too low as loans are considered the highest and best use of bank funds (indicates excess liquidity).
A high loan-to-deposit ratio indicates that a credit union has fewer funds invested in readily marketable assets, which provide
a greater margin of liquidity to the credit union.
Book Value
If the credit union had to be shut down immediately, the book value of the credit union is equal to the Total Assets
minus Liabilities, Preferred Member's Shares, and Intangible Assets. However, this is a straight arithmetic exercise. The reality is
that a distressed credit union has impaired or hard to sell assets and it is not likely that another credit union or investor is going to
purchase them at par. Thus, the assets must be examined to determine whether there are any secured lenders who have a
claim on assets, what type of securities is the credit union holding in its portfolio and what is the present performance
of the loan portfolio. The fixed assets are not going to be readily marketable and the fixtures and furniture will either
disappear with employees or be of salvage value only. Liabilities usually tend to be definite in value while assets tend to have fluctuating or questionable value.
National Credit Union Administration Regulations (May 2008)
