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Proposed Legislation Could Boost Credit Unions' Role in Small-Balance CRE Finance

With commercial conduits and even many banks still sidelined with respect to small-balance commercial real estate lending, another type of lender has been picking up the liquidity slack.

It's the credit unions (we'll refer to the depositor-owned co-operatives as CUs for brevity's sake).

Indeed, as commercial lending (including CRE-secured) by banks was off some 15 percent last year, CU member business lending (MBL in industry parlance) actually grew at a double-digit pace, according to trade group Credit Union National Association.

And if federal legislation now under Congressional consideration passes as proposed, CRE lending by CUs would presumably soar further.

Current rules cap portfolio MBLs at 12.25 percent of a given CU’s assets. The proposal would more than double the cap to 25 percent, while quintupling the minimum principal amount of CU loans classified as MBL, from $50,000 to $250,000.

CUNA estimates the proposed changes would generate as much as an additional $10 billion in new MBL activity by CUs during the first year.

The higher cap wouldn’t necessarily mean every one of the nation’s roughly 7,800 state and federally chartered credit unions will immediately target more CRE lending. After all, a lot of them are relatively small institutions that do little if any business lending.

But many larger credit unions with active commercial lending operations are currently hindered by the MBL cap – and are itching to take advantage of additional opportunities under the proposed higher limit, says Aharon Friedman, a New York-based partner at Wildwood Capital Group that advises CUs on CRE-secured MBL matters.

One such institution is the approximately $2 billion-in-assets Coastal Federal CU in Raleigh, NC. With many traditional small-balance CRE lenders still idled, Coastal management would like to continue taking advantage of solid opportunities to grow its CRE portfolio, says business loan officer Evans Lackey.

However, that 12.25 percent cap is clearly crimping Coastal’s ambitions. Lackey estimates Coastal’s MBL activity dropped by one-half in 2009 as the portfolio approached the cap – after two very active years at about $100 million per annum.

"We were able to cherry pick some very good deals and get money to people that needed commercial real estate financing, but now we’re having to slow down" because of the cap issue, Lackey laments. In fact, a primary reason the CU industry's MBL growth isn’t even stronger is that so many institutions that have become active in CRE lending are "capped out," as Lackey put it.

Logically, he and other senior managers at Coastal would enthusiastically welcome a doubling of the cap, which would "alleviate the current restraint" on the lender's portfolio growth.

And even some of the smaller co-ops that don't have the in-house expertise to originate business and CRE loans would presumably look to participate more in credit union lending syndications if the cap is raised, adds Friedman.

Of course, CUs with their roughly $750 billion in deposits have a long way to go before approaching the heft of the nation’s hard-hit banking sector (with more like $9 trillion). But they have come to compete effectively in the small-balance CRE arena.

Under prevailing CU regulations, MBLs above $50,000 are full recourse and must be collateralized. Friedman estimates three-fourths of them are secured by CRE, adding that some larger CUs will on occasion make loans (some as syndicate participants) as large as $5 million or more.

Some offer construction loans as well as permanent financing. Along with owner-occupied businesses, multifamily properties tend to attract the most attention from CU loan officers.

Since most credit unions active in small-balance CRE finance underwrite and originate loans to hold within their investment portfolios, rates and terms tend to be comparable to what community banks quote, Friedman notes.

For its part, Coastal frequently originates MBLs in the range of $750,000 to $1 million, but it has regularly funded CRE-backed mortgages from $2 million up to its internal cap of $3 million. Lackey describes Coastal's CRE lending strategy as "extremely conservative," sticking with permanent financing secured by primary property types, and avoiding hotels or any special-purpose categories. As a result none of its larger CRE loans are in default.

The cap-doubling legislation was introduced in the House of Representatives as HR 3380, and referred to the House Committee on Financial Services. The companion Senate bill, S 2019, was referred to the Committee on Banking, Housing, and Urban Affairs.

The bills appear to have considerable bipartisan support, but their fate remains uncertain as Congress continues to debate various measures to boost employment. Predictably, the banking lobby claims the legislation would give CUs an unfair advantage, given that bank have to pay income taxes and distribute profits to investors.

Further down the road, Friedman sees a potentially even larger role for CUs in small-balance CRE finance if their current prohibitions against charging pre-payment penalties are eliminated. That would boost CUs’ ability to sell loans into the secondary market, allowing for higher origination volumes, the consultant concludes.