Some Ideas for Underwriting Business Loan Applications for Credit Union Owner-Members in the UK

(some of the disciplines apply everywhere)  

Importance

1.  The economic recovery in the USA in the 1980s and 2010s (different political regimes) was assisted by credit unions lending to their owner-members for business purposes.
2. In the UK a credit union loan can be given for a “prudent and provident purpose” regardless of the interpretation.

In the USA, there is a ceiling on the percentage of balance sheet assets that can be held in business loans that our American credit union cousins are fighting to raise!

My background

1. Well known as an advocate for business lending.
2. With 35 experience and 22 years specifically in credit union business lending:-

1. assisting prospective borrowers prepare their businesses (a most vital exercise dispensing business education when the applicant is most susceptible to it) and
2. underwriting business loan applications for credit unions. 

      Of course like any good barrister, I don’t do both simultaneously!

Facts

1. Largely, in the UK credit union movement, business lending doesn’t happen.  Why?
2. League leaders largely have never had a business background, have specifically always enjoyed paid positions or are in receipt of another form of guaranteed income.  They have never enjoyed the insecurity of self employment (1), with no entitlement to any form of State benefit whilst in a self-employed state.  (Admittedly the self employed don’t subscribe to them, primarily to preserve cash flow and for taxation purposes.)
3. Recently a league leader that most look up to declared in writing “we (the leading associational body concerned) know nothing about business lending”.  So the subject is never taught!
4. So credit unions mostly don’t have the attitude or skillsets.
5. How many loan underwriters in a credit union are self employed themselves, know how to appraise the necessary declared/undeclared data, read accounts (if they exist), have any sharp end knowledge of many different trades and professions, understand the mentality of the self employed and can judge by instinct the necessary characteristics required to be displayed by a dedicated loan applicant?
6. “Getting this” will squeeze much of the risk out of underwriting loan applications. 
7. Credit checks should be made when necessary as the self employed person joins the credit union – early warnings – and again at loan application.  This will replace most automated lending decisions - point scoring should be ignored.  The banks swore blind the veracity of this until June 2008!

Understanding Business

1. Not by attending “chalk and talk” courses.
2. But by daily inertia study, listening to the radio/watching television business programmes; reading and collecting the right reference books and magazines; asking questions.
3. Being very inquisitive of the applicant by asking soft questions.  A house wife/husband should be good at this as they run a small business – “the house”.
4. Over the last 35 years banks have largely surrendered this territory and even the new challenger ones don’t get it – using their algorithmic formulaic point scoring techniques and distance underwriting.
5. Why?  They don’t “know your customer”, his/her life style (you can’t audit that!)
6. What a wonderful opportunity for credit unions as owner-members will require two or more accounts – personal, business, investment – for control and for taxation purposes.

Understanding the Self Employed

1.  A good loan prospect should show signs of being:
2. Selfish and self-centred by speech and actions
3. Self centred – self absorbed and driven
4. Independent of any aid at all other than the absolutely necessary (lenders are often too inquisitive!)
5.  The self employed
6. work far longer hours, more days than others.
7.  take far fewer pure holidays than others.
8. go sick on far fewer occasions than others.
9. show behavioural traits of a “24 hour” work life style, not necessarily at work but their mind always working “on business”.
10. All of these traits should come out on the application form and interview (written or conversational) stage.
11. Most self employed are the sons/daughters of self employed people.
12. Accusations of racial profiling are aimed at many self employed people at outset, particularly those from minority communities.
13. There is an increasing trend for the “sparky” long term unemployed from all socio-economic groups to turn to self employment (750,000 since 2010) and for many University undergraduates to start businesses whilst at University or immediately upon graduation.  This has led to the recent decline of gross domestic product as the self employed pay themselves very little (just enough to get by) during the initial trading period.  Underwriters must understand and interpret this “lack of income”.
14. Underwriters should be prepared to carry out site visits to see the business in operation.
15. The rate of loan interest charged and any security taken, penalties that could be incurred should reflect the risk exposure of the credit union.

Understanding draft or actual Trading Accounts

1.  Some interpretation can be placed on these, in the case of the former some mentoring (not advice – dangerous for legal reasons and possible debt pursuit) is required delivered by rhetorical questioning “have you considered that?”
2. With the latter, underwriters must obtain an understanding of the legitimate expenditure allowances and tax breaks allowed to the self employed.  Underwriters must ignore any personal moral values they have and replace those with legal ones.
3. A declared profit sum and its interpretation must be considered.
4. The Auditor to the credit union is professionally indemnified to give the correct advice to credit union underwriters.
5. Remember that in the UK credit unions can charge the cost price for delivering ancillary service, but for reasons noted above, this must be confined to making the correct information available.  The “customers must be educated to make the decisions”, they own the business.  Credit unions must keep their distance.

Assets of a Loan Applicant

1. Be careful that the applicant has full unencumbered title to them under UK law and ensure that all with any interests in them are informed of the loan application and agree to it.
2. Beware of taking a charge on a wasting asset, one with a declining real value less than the insured one, like a mink coat!
3. In the UK it is not possible to take a charge on “personal tools of trade”, take a first charge over residential property without regulatory consent and likewise, from 21.3.2016, take a second charge on a residential property.
4. But there are many types of asset that are not subject to regulatory constraint at present over which a charge can be taken. Study should occur, facts ascertained and necessary legal advice taken.

Credit Control

1.  All businesses are dependent upon positive cash flow daily regardless of how big or small the business.
2.  So loan repayment performance should be monitored daily, using good software to achieve this.
3. Any breaches of this, remedial action should ensure from the friendly telephone call to Court action and beyond.
4. I know of a very successful credit union that makes certain delinquent borrowers repay by daily instalments, using all the techniques available.
5. Warnings of these possible penalties and their costs should be noted on the Loan Application and Agreement.  The self employed know how to “smell the coffee”!

Reserves

1. Work like stink to build these up!
2. Educate owner-member savers and borrowers not to expect dividends and Boards of Directors not to offer one until the reserves are at the regulatory ceiling.
3. This is easier where the majority of owner-members are self employed for various reasons not set out here.
4. Mobilise and galvanise into action the “Friends” of the credit union to undertake activities to raise money with net proceeds donated to the credit union to be used to strengthen it.  It’s a business?

Warnings

1.  Only lend to named individuals, never to incorporated bodies or partnerships of any type for very sound legal reasons.
2. Individuals can be part of an incorporated body of some type (including marriage, civil partnerships, limited company, limited liability partnership or co-operative) but a credit union should never set itself up to deal with dispute resolution.
3. A loan can be issued to two individuals for £5,000 each to buy a £10,000 car, subject to separate underwriting.  Make each one “separately and together” for the entire debt ensuring that the credit union can pursue one or both of them if delinquency can occur regardless of any accord or discord between them.
4. Guarantors should be underwritten in the same way as owner-members and provided with the information “Obtain good legal advice” and “None of the information (not advice) given here is legally binding”  

Finally - All readers in Great Britain and Ireland should encourage their mother credit unions to enter for the “Edward Filene Credit Union Awards for Performance Excellence” for the category “Lending to Owner-Members, running their own business”.  No Award was made in 2014.  What does that tell you?