Customer Due Diligence

By Claire White, Deposit Services Officer

On July 11th 2016, new FinCEN rules clarifying and strengthening customer due diligence requirements went into effect. Credit unions will have until May 11, 2018 to comply with the rules.

The new rules contain explicit customer due diligence requirements and include a new requirement to verify the identity of beneficial owners of legal entity customers (i.e. business entity members) with certain exclusions and exceptions.

Under the new rules, credit unions will use Customer Identification Program (CIP) procedures, similar to those used for individuals, to identify the beneficial owners of a legal entity. The credit union may rely on copies of the identification documents used to identify the beneficial owner and may rely on information provided by the entity, as long as it has no knowledge of facts that would call into question the reliability of the information.

Legal entity customers are defined in the final rules as a corporation, limited liability company, or other entity that is created by the filing of a public document with a Secretary of State or similar office, a general partnership, and any similar entity formed under the laws of a foreign jurisdiction that opens an account. Sole proprietorships and unincorporated associations are not included in the definition, even if those such businesses may file with the Secretary of State in order to, for example, register a trade name or establish a tax account.

The final rules also include a list of entities that are not included as legal entity customers under the rules. The exclusions begin on page 17 of the link included in this article.

The final rules define beneficial owners as each of the following:

  • Each individual who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25% or more of the equity interests of a legal entity customer; and
  • A single individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager (e.g. a CEO, CFO, COO, Managing Member, General Partner, President, Vice President, or Treasurer) or any other individual who regularly performs similar functions.
  • If a trust owns directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, 25% or more of the equity interests of a legal entity customer, the beneficial owner(s) for the purpose of the final rules is the trustee.

CU Business Group recommends credit unions review their Bank Secrecy Act (BSA) procedures and other procedures related to the opening and monitoring of business accounts to ensure compliance with the new Customer Due Diligence (CDD) rules before May 11, 2018.

We have created the following list of action steps to help you get started:

  1. Review your current account opening, monitoring, and any related BSA procedures for business accounts.
  2. Update the procedures if necessary.
  3. Contact your form vendor regarding a Certification of Beneficial Owner(s) or use the form provided in Appendix A of the Customer Due Diligence Requirements at account opening or when significant changes occur.
  4. Determine which areas of operations will be affected by the changes and provide training to staff.
  5. Inform internal and external auditors of the changes.

You can view the final rules on Customer Due Diligence Requirements for Financial Institutions online.

If you have questions about FinCEN’s final rules on CDD for legal entity customers, contact CUBG’s deposit team at 866-484-2876, or

Cowboys riding into the sunset

By Nick Reynolds, Vice President/Credit Services Manager

The risks associated with business lending differ significantly from those associated with traditional consumer lending.  While consumer information is still an important part of knowing your member, the types of risks associated with commercial loans tend to be more varied and wider in scope.  This article is one in a series to help credit unions more clearly understand some of the unique risks of business lending.

Standard practice in commercial loan underwriting requires that both the borrower and all guarantors qualify for the credit.  In some cases the borrower may not qualify for the loan and you must rely on the strength of one guarantor to approve the loan.  The assumption that one strong individual can support a weak credit is the basis for a combined analysis of all related parties, better known as “global analysis”.

It is generally believed that this is a valid method of analyzing a loan request, but there are a few reasons to think twice. Foremost among these reasons is that the success rate of having a guarantor service a loan that has gone bad is generally quite low.  Asset recovery experts will tell you that once a project fails, the typical guarantor will either have no assets left to service the loan, or will file bankruptcy to protect what they have left.  Either way, your chance of collecting from a guarantor is minimal.  One option is to make your guarantor a co-borrower, but this can actually be worse from the lender’s perspective because the individual waives some protections as a guarantor that are available to them as a co-borrower.

Despite these challenges, in practice you will need to use global analysis at times.  One of the great benefits of being a credit union is that you know your member.  If you know the business and its ownership, have worked with them for some time, and have a good feel for their integrity, you can avoid most of the problems associated with trying to collect from a guarantor.

Consider a couple of scenarios. One is an investment property that is not quite meeting an adequate debt service coverage ratio, but the borrower has a solid plan to increase rents to market rates over the next year. In this case, with a solid guarantor you can make a case for approval.

On the flip side, you have a borrower that has approached you for financing a large new project with highly uncertain outcomes, such as a new hotel. In this case, your guarantor had better be very strong, with the highest level of integrity.  Most deals will fall somewhere between those two extremes, and your assessment of the guarantor strength should correlate closely to the riskiness of the request.

Timeframe is an important factor as well.  For example, if you are financing a loan to purchase an underperforming property, and the principal has a solid business plan and the available capacity to support the project, it may be an approvable deal.  Today.  But it would be wise to set expectations with the guarantor about what happens if the deal does not perform as expected.  What is the exit plan?  Will you expect additional pay downs from other sources?  What is the timing of those pay downs and will they be tied to a specific measure like debt service coverage ratio?

As a general rule, you should not be locked into an under-performing property forever.  Any decision to lend on a property that does not cover its own debt service should be based on a reasonable expectation that the borrower will raise the property to an acceptable level of performance within a reasonable time.  A strong guarantor is one that has both the capacity and the willingness to ensure the property performs as advertised.  It is this assumption on which the validity of the global analysis method is based.

Question thought bubbles

By Mike Smith, CUBG VP/Senior Business Services Officer

In today’s challenging economic climate, credit unions are actively seeking new ways to achieve growth and profitability. For many this means taking a fresh look at promoting their business services program, with an eye toward building long-term relationships versus generating individual loan transactions.

At CU Business Group’s 2016 National Business Services Conference in Reston, VA, CUBG led a session aimed at helping credit unions develop a comprehensive marketing plan to target businesses right in their communities. Patrick Farrington, vice president of business services at Hiway Federal Credit Union ($1.1 billion, St. Paul, MN) attended the class.

“Each of the credit unions here seem to have similar issues,” Farrington said. “Whether it’s how to develop business or how to market their business, regardless of size everyone seems to be in the same boat.”

Here are some key steps to help get your credit union’s business services marketing strategy airborne:

Step 1: Establish a high-octane cross-selling program

Your existing membership base is a treasure trove. Most do their business banking at another institution, which means you have a great opportunity to gain member wallet share by offering specific, customized product and service recommendations.

“One thing to remember is that banks are concerned with competition from credit unions because they don’t want to give up a share of the business,” Farrington says. “There’s a goldmine of business and we just need to go after it.”

Key elements of a successful cross-selling system include defining your market, developing the right product mix, and providing your team with the tools they need.

Step 2: Communicate regularly with your members

According to a recent survey of business clients at the top 100 banks in the U.S., between 25 and 40% of business customers leave their bank within the first year, at an average cost to the institution of $400. A rigorous, consistent onboarding system can mean the difference between becoming your members’ primary financial institution and losing them to the competition.

CUBG recommends a multiple-step onboarding process, starting within three days of new account opening, simply to check in and make sure your member’s account is set up correctly. At one week following signup, have a senior executive, such as the vice president of lending, contact the new member. After six weeks, have another senior-level individual, perhaps even your CEO make a call.

At ninety days, it’s time for a face-to-face visit to your member’s business. This is a great opportunity to bring along a representative from another department such as wealth management or commercial lending, to demonstrate your credit union’s ability to meet all of the member’s financial needs. Make sure to celebrate your member’s one-year anniversary with a simple, handwritten card or a small gift.

Step 3: Engage with your community

In the business services arena, involvement in the local community is critically important. But don’t take a shotgun approach. Get involved in organizations and programs that are meaningful to your prospects.

For instance, if your strategy is focused on offering commercial real estate loans and deposit services to larger, more established businesses, it makes little sense to connect with the local Small Business Development Center, which primarily serves startups. Getting involved with organizations like the Commercial Brokers Association may pay greater dividends.

Step 4: Connect through social media and your website

In today’s business climate, engaging in social media is critical to reaching your target audience. According to a 2013 Gallup poll, prospects who research their buying decisions through social media platforms like Facebook or Twitter show a 17.6% greater chance of making the purchase than those who don’t.

In developing a social media program, focus on efficiency, authenticity, and consistency. Fewer than 20% of your posts should sell your credit union’s products and services. Instead, gain your audience’s trust by posting informational and educational articles. For efficiency, use services such as Hootsuite to schedule posts in advance and across multiple social platforms.

Even with the incredible growth of social media over the past few years, your website still serves as your credit union’s primary marketing and informational hub. Transform the business services page to a place where members can link to outside resources and additional services, then sit back and watch as it becomes a go-to destination for businesses in your community.

Step 5: Unleash your branch sales team

Lastly, don’t forget that your credit union already has a built-in, yet often underutilized sales machine: your branches! But in order to start generating referrals from the branches, you must establish clear goals, provide ample training and product information, and hold your branch team and management accountable. Just 20 minutes a day of consistent focus can result in immediate, quantifiable growth in qualified referrals from your branch network.

Follow the above action steps, and your business services program will reach cruising altitude in record time!

Q2 Logo

By Brad Johnson, Director of Solutions Consulting at Centrix Solutions, a Q2 Company

More and more credit unions (CUs) are exploring the idea of expanding their business services. Some are well on their way, with commercial bankers recruited and ready; other CUs are a little more cautious—having done little to adopt more complex business services. And caution is more than understandable. Credit unions’ historical focus on consumer offerings gives them unrivaled expertise in retail services, but it also makes the prospect of expanding into the complex realm of business services a bit unsettling.

At the very least, CUs find themselves facing a lot of questions when they start to seriously consider expanding their business services: Is their core equipped for commercial account processing? Will their online platform provide the entitlements control, reporting and other features necessary to serve larger businesses? What transaction channels should be supported—ACH origination, wire, RDC?

And, often, the  answer to one question simply generates more questions.

Take the subject of ACH origination services. A lot of CUs have limited ACH origination activity already, but if they intend to grow their business services, ACH origination volume will no doubt increase. To plan for this, the CU must take a hard look at their current processes and technology and find scalable ways to handle a bigger ACH lift, while simultaneously mitigating risk.

 Three of the biggest ACH considerations around expanded business services are:

 1. ACH monitoring and anomaly detection

New clients represent increased risk. As CUs expand services, they’ll see a sharp increase in the resource requirements necessary to underwrite and manage new commercial members—some of whom might be originating more activity on their own than the CU previously originated from all its members combined (assuming they did any at all).

It’s vital to be proactive, implementing technology before ACH activity begins to spike. CUs must find tools that can automatically monitor ACH activity to detect anomalies, manage exposure limits and provide general oversight of all origination activity.

Starting with a solid, proactive strategy around monitoring and general data management for ACH origination will prove well worth the investment as activity grows. On the other hand, a reactive strategy, and managing the process with a lot of manual intervention, substantially increases both your risk and the stress on your operations staff.

2. Accurate and regular reporting

CUs expanding their business offerings may face an exponential increase in workload, making it next to impossible to track and report ACH activity manually. CUs hoping to scale their business services should not depend on unwieldy Excel spreadsheets, but should instead invest in efficiency-boosting reporting tools.

Even if a credit union doesn’t have the originator volume to support a reporting platform at the start of their foray into business services, by investing in robust, intuitive technology early on—coupling ACH reporting with monitoring and data management functionality—they will ease growing pains and substantially reduce risk. A full-featured ACH reporting platform can save a lot of time and effort by quickly and easily generating reports for the CU’s board or for annual ACH audits.

3. Annual risk reviews: what you need to know

Regulations require a comprehensive risk assessment on each originator at least once per year. But, more than just a compliance box to check, these assessments—if done right—can greatly reduce risk by providing insight into originators’ business activities. CUs should keep in mind that the risk surrounding commercial accounts is made up of more than their ACH activity. A solid risk assessment process, powered by the right tools, will look beyond ACH activity to include the overall financial health of the originator. Assessments should be able to spot red flags in customers’ deposit accounts—like insufficient funds and overdraft activity—as well as their loan positions or past due history. A business that has no anomalous ACH activity may still present significant risk. Identifying the warning signs early can help manage that risk—and the relationship with that business—in ways that ultimately benefit both the CU and the business in the long run.

Expanded offerings doesn’t have to equal increased manpower

Increased services don’t necessarily equal an increase in payroll. With the right tools, credit unions can expand their business offerings, while reducing the ACH-related workload of their back-office employees. CUs on the fence about implementing more business services should remember—the right tools can make the prospect less frightening and the process more profitable.

Confused businessman

From Nick Reynolds, Vice President/Credit Services Manager

The risks associated with business lending differ significantly from those associated with traditional consumer lending. While consumer information is still an important part of knowing your member, the types of risks associated with commercial loans tend to be more varied and wider in scope. This article is one in a series to help credit unions more clearly understand some of the unique risks of business lending.


A K-1 is an important piece of analyzing a member business loan.

One important, but often overlooked area of risk is owner distributions. Excessive levels of distributions can have a significant and adverse impact on a business. If the owners withdraw all earnings as distributions rather than reinvesting in the business, then no income is left for equipment purchases, growth in working capital, or repayment of debt. Typical debt service coverage analysis appropriately includes a deduction from income for the amount of distributions.

One of the benefits of using business tax returns to analyze your borrowers is that it is often easy to determine salary paid to the principals. Some partnership and corporate returns have that amount listed on the front page. At other times officers’ salaries are itemized further back in the return.

An officer’s salary should reflect the “market rate” for the work she actually does. If she wasn’t there, she would have to hire someone to take her place. If her salary lines up with typical rates in the local marketplace, then no further analysis is necessary. However, if that salary is greater than you would normally consider reasonable, you should dig deeper to find out why.

Distributions are also typically fairly easy to discern. While you would normally obtain distribution information from the tax returns or K-1s, it is also possible to back into that number with a straight-forward calculation: by definition, a balance sheet should balance, with assets equaling liabilities plus owners’ equity. It should also balance from period to period. Ending retained earnings should equal beginning retained earnings, plus income, less distributions. So, if you know beginning retained earnings, ending retained earnings, and total income earned during the period, you can figure out total distributions.

But the relationship between distributions and salary is a little fuzzy. For example, many owners will elect to take distributions rather than salary to avoid payroll withholdings such as Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA). In addition, a certain level of distributions is normal to cover taxes paid by the individual on the income associated with an S-Corp. S-Corp income flows through to the personal tax return based on the income shown and may have no relation to the amount of distributions taken. That is why the K-1 is so important to the analysis, as it details those amounts.

Another important factor is notes due to the borrower from the shareholder. If the business pays money to the owner other than salary, it can be in the form of either a distribution of income or a note receivable. Both have the same impact on cash – it leaves! But on the balance sheet, the note shows as an asset, while the distribution reduces equity.

Similarly, the repayment of a note receivable or the contribution of paid in capital both have the same positive effect on cash but disparate effects on the balance sheet.

Most businesses are structured so that the principals own the operating company and also hold ownership in a separate LLC that owns the building the business occupies. Rents may be set at higher than market rates as a vehicle for transferring cash to the owners.

The result of all of these factors is a complex web of payments that can have a significant impact on the borrower’s ability to service its debt. With a little bit of prudent detective work, you can unearth some additional detail that will enable fuller underwriting and a more complete understanding of the borrower’s creditworthiness and true financial position.

Welcome to the team

CU Business Group is pleased to welcome two new members to the team.

Rich Muckey, VP/Senior Business Services Officer

Rich Muckey, VP/Senior Business Services Officer

Rich Muckey recently joined CUBG as VP/Senior Business Services Officer.  Rich brings 37 years of financial and commercial lending industry experience to the team. Prior to joining CUBG, Rich served as Chief Lending Officer at Rogue Credit Union where he and his team developed a successful business services program offering a wide array of commercial real estate and business loans, in addition to a full suite of deposit products. Rich’s lending experience spans many industries, including investor and owner occupied real estate, and commercial and industrial loans. Rich also has significant experience in commercial loan portfolio management and lending team program development.  At CUBG, Rich consults with credit unions in the U.S. on all aspects of business services planning, program development, account pricing, and education.

Justin Conrey, VP/Senior Commercial Loan Underwriter

Justin Conrey, VP/Senior Commercial Loan Underwriter

CUBG also welcomes Justin Conrey as VP/Senior Commercial Loan Underwriter.  Justin has more than 12 years of commercial lending experience working in both credit unions and community banks and has a background in all facets of commercial lending. Justin began his career with University Federal Credit Union in Austin, TX, helping to grow their commercial lending program and eventually managing the business lending department.  Most recently Justin served as Chief Credit Officer for a community bank, overseeing commercial, mortgage, and consumer lending.  At CUBG, Justin underwrites and performs credit analysis on all types of commercial loans and consults with credit unions on loan structure, pricing, and other aspects of lending and portfolio management.


Business Deposit - Business Owner

From Larry Middleman, CUBG President/CEO

When CUBG conducted a focus group with business owners near the top of the small business pyramid, the responses reinforced a long-held truism:

Not every business needs to borrow money, but every business needs a strong depository relationship.

The business account opportunity is one that is frequently overlooked by credit unions in favor of a focus on business loans, particularly CRE lending. In order for your credit union to move up the pyramid and capture a larger piece of the small business market pie, you must first shore up the product line to fit the needs of more sophisticated small businesses.

For example, according to a 2013 study by Raddon Financial Group, the majority of businesses with over $5 million in annual sales utilize services like a money market account and merchant services. Other popular services include: remote deposit capture, ACH origination, commercial insurance, and sweep accounts for cash management purposes.

To drill down further, basic consumer-type depository services that most credit unions offer to micro-businesses, such as a business checking account, a savings account, consumer online banking and bill pay platforms, and perhaps merchant Visa/Mastercard services, are not sufficient to be a player with more sophisticated businesses – those that keep six-figure deposit balances and generate significant fee income.

In order to reach this market, your credit union needs to offer a “next level” business deposits package, one that includes services such as: analyzed business checking, advanced-feature business online banking, remote deposit capture, and ACH origination capabilities. Online banking typically serves as the core, central point for businesses to manage the cash inflows and outflows of their accounts.

Do not underestimate the expertise needed to position your credit union as a knowledgeable resource in depository services. You will need to hire a dedicated expert well-versed in the needs of sophisticated small businesses, with a full understanding of the benefits and features of these specialized services. In other words, you will need to hire a Cash Management Officer.

Most credit unions intent on growing a strong and vibrant business loan portfolio will hire three to five commercial lending experts. Yet these same organizations won’t hire anyone to manage the deposit side of the equation. This is not a formula for long-term success.

By the way, did you know that maintaining your business borrower’s deposit accounts may be the best risk management tool that you have at your disposal? Instead of waiting to receive quarterly financial statements or worse yet – annual tax returns – before analyzing your member’s business conditions and ongoing performance, access to the member’s deposits will allow you to observe changes in cash flow in real time, providing you the tools to address issues quickly, before they become real headaches for you and your member.

The future could not be brighter for credit unions in the business lending marketplace. With recent, positive regulatory changes, credit unions’ outstanding reputation for trust and service, and an improving economic outlook, now is the time to take full advantage of this exciting opportunity. With some planning and a dedicated focus on serving business members’ specialized needs, credit unions can capture the full business relationship and become valued partners with larger, more sophisticated, and profitable member businesses.

Lending to Operating Companies vs. Investment Real Estate Graphic

Small business is growing once again in the U.S. Following the 2008-09 recession, the number of businesses in the U.S. with fewer than 500 employees fell precipitously. By 2013, small business had once again rebounded to 2009 levels.

This spells opportunity for credit unions. Credit unions have long gravitated toward investment real estate as a relatively simple way to do business lending, as the source of repayment on these loans is easy to understand and is generated primarily from rental income. However, lending to operational businesses can add diversity to your loan portfolio. These businesses, such as tire stores, restaurants, or clothing retailers, generate their income by selling goods and services or adding value to the manufacturing process chain.

Census bureau small business figures

By 2013, small business had once again rebounded to 2009 levels

The risks related to investor property income flows generally correlate closely with longer term trends in the local real estate market. Are vacancies going up? Are local population demographics changing? Is population on a rising or declining trend?

With an operating company, the long-term business risks are the same, but there are unique short-term risks as well, such as:

  • Can the owners hire adequate staff?
  • Can they sell their product at a profitable margin?
  • Are costs of labor and raw materials rising?
  • Are new competitors moving into the market?

The collateral risks between investment real estate and operating entities differ as well. For example, a line of credit secured by inventory and accounts receivable can be fully secured one month, and virtually unsecured the following month. The marketability of inventory is highly dependent on its current state in the process and may become stale or obsolete in a short period of time. Lenders need to liquidate receivables quickly; if you wait too long, they may have already been collected and spent by the borrower. Specialized equipment also has its own challenges as it has a limited market and may deteriorate and depreciate quickly.

Because of these differences, each type of lending demands a different approach toward credit analysis. Fundamentally, all loans rely on the good character of the business owners. The credit report and personal financial statement set the tone for the relationship. But a few additional items should be considered:

  • Debt service coverage: When analyzing an investment property non-owner occupied real estate loan, the focus of the analysis should be on the debt service coverage ratio, which reflects your best chance of being repaid on the loan. As long as the collateral is in good shape and market conditions are favorable, repayment is likely. Borrower leverage is not as important, as long as you have strong collateral coverage. Working capital is almost immaterial, and most of these entities can function just fine with a low-balance checking account.
  • Working capital: For owner-occupied real estate and operating company loans, the analysis of the loan, and your risk rating, should be based on a complete understanding of the operating company as your primary source of repayment.

Similarly, the analysis of an operating company line of credit facility should focus mainly on working capital. The purpose of such lines is to help support the company’s working capital needs, and the primary source of repayment will be the turnover of operational assets.

Stick to Your Knitting

For lenders, the bottom line is that the type of borrower and the type of credit facility should drive the analysis and the credit decision. As an organization, you may have expertise in certain types of loans or industries. If that is the case, you should minimize your exposure to those types of borrowers where you have little expertise, or consider outsourcing that analysis to a service provider with experience in that particular field.

Connecting With Business Members

One way to tackle the sophisticated small business market is to even the playing field with commercial banks by offering a richer portfolio of business loan products.

According to a 2013 Raddon Financial Group study, the majority of small businesses with annual sales of $5 million and over are active users of credit cards. Many also take advantage of lines of credit, vehicle and equipment loans and leases, as well as commercial real estate and Small Business Administration (SBA) loans. If your credit union doesn’t offer these common products, you have little hope of gaining traction with the top end of the small business market.

Yet most credit unions focus primarily on commercial real estate. In fact, 84% of all member business loan balances are real-estate secured, leaving only 16% for commercial & industrial, credit cards, vehicle and equipment loans, and the like. Credit unions are leaving a huge opportunity on the table.

What can your credit union do to capture more of the sophisticated business lending market? Consider focusing on one or two specific, discrete niches, such as:

  • Commercial & industrial lending: Following the Great Recession, most banks backed away from lending to small businesses, leaving many of these companies strapped for capital, particularly in the $50,000 to $250,000 loan range. This is a natural market for credit unions, and one they can serve very well.
  • SBA and government-guaranteed loan programs: There are a number of advantages to using SBA-guaranteed programs such as the flagship 7a and associated SBAExpress programs. Although a guarantee will never make a bad loan good, it does help to limit credit exposure in the cases of a collateral shortfall, a startup business, or riskier industry sectors. And to top it off, the guaranteed portion of any business loan does not count toward the statutory MBL cap!
  • Targeting specific industries: Many credit unions have found success by narrowing their focus to just a couple of industry segments. For instance, you may consider creating a special package of business loan and deposit services for the veterinarian market, or one specifically designed for medical practitioners. By doing this, you will establish your credit union as the “expert” in that industry, and over time become recognized through word of mouth referrals as the go-to resource—a lender that understands your target market’s unique needs.
Lines of Credit Evaluation

by Nick Reynolds, VP/Credit Services Manager

The risks associated with business lending differ significantly from those associated with traditional consumer lending. While consumer information is still an important part of knowing your member, the types of risks associated with MBLs tend to be more varied and wider in scope. The credit union industry is expanding further into relationship lending with business members. The next logical step is to gain capabilities in lines of credit, as these are often the lifeblood of a business’ cash flow. This article is one in a series to help credit unions more clearly understand some of the unique risks.

Lines of credit are an important product to offer your business members. However, they tend to be complex, and if they are not managed properly, your member can get into hot water.

One of the biggest questions surrounding business lines of credit is in determining how large of a line of credit should be offered to the member. The correct answer to that question is dependent on the member’s unique circumstances in regard to their sales and credit practices.

Consider a business that offers 30 day net terms to its customers, and sells 100% on account. In this scenario, monthly sales will equal the amount of accounts created each month. If the business’ customers pay an average of 30 days from invoice, accounts receivable will remain consistently at a 30 days of sales level. For example, if the business has sales of $1.2 million each year, and it collects all accounts at an average of 30 days, then accounts receivables will remain at an average of $100,000. But the average collection time for most businesses is about 45 days, and as the lender you should not advance much more than 70% against receivables. So in a typical business that sells all on account, a line of no more than 10% of gross sales is recommended (Ex. 1).

Ex. 1: 100% of Sales Account

  • $1,200,000 sales * (45 days/360 days) * 70% advance ratio = $105,000 line of creditTotal Non-Real Estate Secured MBLs

Now consider a retail business, in which half of sales are paid for in cash or credit card payments, and half is paid on account. How large of a line would this business need? The short answer is: half as much. They are now selling $50,000 per month on account, and receivables are running at an average of $75,000. At an advance rate of 70%, an appropriate line would be no more than 10% of annual receivables, or a maximum of $60,000 (Ex. 2).

Ex. 2: 50% on account/50% cash:

  • $1,200,000 sales * 50% on account * (45 days/360 days) * 70% advance ratio = $52,500 line of credit

Seasonality is another key decision factor. I once had a client in Alaska that worked only during the summer months, just three months out of the year. In his case, the normal receivables level was one third of his sales! Businesses with significant seasonal fluctuations in sales have a much greater need for a line of credit than those with little or no seasonality. The advantage to you as the lender in this scenario is that at the end of the season, sales go to zero, expenses go to zero, all accounts are collected, and the line is paid off in full.

Now, consider a business with no seasonality at all. How would your member pay off the line of credit? The aggregate level of receivables never goes down (a source of cash) nor does it ever increase (a use of cash). In a non-seasonal business, the only way to experience large swings in line of credit usage is with big swings in sales! So, while it is useful to have a cleanup or resting requirement in your loan covenants, you can create automatic covenant violations if the business does not experience large seasonal variations. A better course is to establish a line to fund only the seasonal variation in the accounts. The permanent, fixed portion of those accounts should be funded with capital, i.e. a working capital loan or equity in the business.

Lines of credit are complex products that require extensive due diligence up front, and regular monitoring going forward. Don’t make the mistake of providing your member with the wrong product for their needs, or “setting and forgetting” the line of credit after closing. This is a disservice to your member, and one that may result in many headaches down the road.

About CU Business Group
Established in 2002, CU Business Group, LLC, provides a wide array of business lending, deposit, and consulting services to credit unions nationwide. Based in Portland, Oregon, with offices in the West, Southwest and Eastern U.S., CU Business Group has a staff of 40 professionals and serves more than 500 credit unions in 46 states.