The recent failure of a small credit union in the San Fernando Valley barely caused a ripple in the world of finance. But it could become Exhibit A in the banking industry’s case against expanding the power of credit unions to make business loans.

Telesis Community Credit Union, a Chatsworth institution that became a prominent national commercial lender despite its small size, was shuttered by regulators March 23 because of heavy losses, particularly in its business loan portfolio.

The move came as the U.S. Senate is preparing to vote on legislation that would dramatically raise the ceiling on credit unions’ business lending. The higher limit, according to one projection, could generate hundreds of millions of dollars in small-business loans in Los Angeles County. The Senate is expected to vote as early as this month.

The banking industry, which has fought for years against the proposed change, has already seized on the failure of Telesis to lobby against what it calls unfair legislation that could lead to heavy loan losses.

“It would be obscene to advance expanded member business lending after the example we’ve had with Telesis,” said Paul Merski, chief economist for the Independent Community Bankers of America trade group in Washington, D.C. “You’re already seeing what could happen if member business lending is expanded.”

The organization has collected more than 12,000 signatures in an online petition opposing the effort to raise the cap.

The proposed legislation would allow credit unions to lend as much as 27.5 percent of their assets to small businesses, up from the current limit of 12.25 percent. Though most credit unions do little if any commercial lending, industry leaders argue that the existing cap limits the ability of some institutions to adequately serve their members, particularly at a time when many small-business owners are complaining about the difficulty of securing credit.

According to an analysis by the California Credit Union League, an industry trade group, raising the cap could generate $642 million in small-business loans in the county in the next year, creating as many as 7,000 jobs. Several of L.A.’s largest credit unions, including Kinecta Federal Credit Union in Manhattan Beach, have indicated that they want the opportunity to do more business lending.

“America’s small businesses continue to struggle to find the capital they need in order to start or expand their businesses,” said Bob Arnould, senior vice president of government affairs for the Ontario-based league. “Credit unions can play a critical role.”

Competitive advantage

In the past, credit unions could lend as much as they wanted to businesses, though few made many such loans. The business-lending cap has been in place since 1998, when the banking industry successfully lobbied Congress to restrict credit unions’ loans. Banks argued that credit unions, which are tax exempt, enjoyed an unfair competitive advantage.

Regulators objected to the change back then, saying it reduced the ability of credit unions to diversify their lending portfolios, making them more susceptible to market downturns, said John Zimmerman, public affairs specialist for the National Credit Union Administration.

“There was no real basis for having a cap on member business lending,” Zimmerman said. “We believe that the cap does more harm than good (and) the failure of Telesis does not change NCUA’s perspective.”

A number of credit unions began fighting to raise the cap and Telesis had emerged as a leader of the effort. Grace Mayo, the institution’s vocal chief executive, had testified in Washington about the importance of business lending, commented frequently in the press and was head of an industry task force specializing in small-business lending by credit unions. Mayo could not be reached for comment for this article.

With assets of about $625 million at its peak, Telesis was not particularly large, but it was a prominent business lender. Its business loan portfolio exceeded $200 million, and in recent months commercial loans constituted nearly half of its total portfolio.

Telesis, founded in 1965, had branches in the L.A. area, but was active nationally through participation loans. It was one of just a handful of credit unions nationwide allowed to exceed the cap because it had a history of business lending prior to 1998, Zimmerman said. About 120 of the nation’s more than 7,000 credit unions received such exemptions.

That has fueled the fire for critics, who say that credit unions do not have sufficient experience to safely lend to businesses without repeating the debacle of the savings and loan crisis of the late 1980s.

“It works as a case study of raising the member business lending cap because Telesis was allowed to operate above the cap,” said the banking trade group’s Merski. “They had done commercial lending all around the country very aggressively and that blew up on them.”

Rapid decline

Telesis suffered a range of problems, including high operating expenses due to its nationwide activity, but business loans weighed heavily on the institution. It lost $50 million over the last five years as a number of business borrowers went bankrupt.

By the time it was seized last month, its assets had shrunk to $318 million. Regulators said last week that Premier America Credit Union in Chatsworth would take over Telesis’ assets.

Tom Glatt, a credit union consultant, said he isn’t surprised the banking industry has seized on the failure, but he believes the argument is shortsighted.

“It’s certainly a compelling argument that the bankers are making,” said Glatt, founder of Glatt Consulting LLC in Wilmington, N.C. “But when I look at the details, Telesis was more of an isolated case. I think their challenges are not necessarily indicative of problems with credit unions doing business lending.”

He noted that its home market of Southern California was hit particularly hard in recent years, which would have had a disproportionate impact on the institution.

Advocates of raising the cap say they do not expect the failure to scuttle talks. Arnould, of the California Credit Union League, called the Telesis situation “a bit of a blip” and noted that Sen. Harry Reid, D-Nev., indicated that he will call for a vote on the bill shortly after the Senate returns from recess next week. A specific date for the vote on raising the cap has not been set.

“It’s supported by Treasury, it’s supported by the White House, it has strong bipartisan support,” Arnould said. “One failure of one institution in California is not going to make a difference.”