NCUA’s new member business loan (MBL) rule became effective in January, and credit unions are still determining exactly how to implement the rule’s changes.
While the underlying policy behind the new rule reflects a shift from prescriptive regulatory limits to a more principle-based approach, credit unions now must determine their own limits—and often are left wondering if they’ve set those limits according to examiner expectations.
This past November, NCUA released more than 100 pages of guidance in a new online version of its Examiner’s Guide, providing credit unions with more insight into how examiners will apply the new rule.
Of particular interest is the guidance on the new collateral and security requirements in section 723.5 of the regulation.
In the former version of the rule, NCUA expressed strict loan-to-value (LTV) limits and personal guarantee requirements. The new rule has done away with those requirements, allowing credit unions to make their own risk-based decisions. Determining what exactly that means from an operational perspective requires a closer look at the guidance.
The new MBL rule states that credit unions granting commercial loans must require sufficient collateral to protect against the risk of loss, but collateral alone should never be the sole basis for granting a loan.
The creditworthiness of the borrower and the marketability of the collateral determine the amount of collateral needed for each loan, and credit unions must establish standards, policies, and procedures to confirm, value, manage, and control collateral.
Specifically, standards should set forth requirements for establishing an enforceable and protected lien position, whereas procedures should determine considerations such as whether contamination or hazardous material has affected the property offered as collateral.
Policies should factor in the size and complexity of the loan transaction and should also address:
NCUA also has taken a less prescriptive approach on LTV limits in the new rule. Rather than set specific ratios for each type of collateral, the agency now expects credit unions to set their own LTV ratio limits.
But you should base LTV limits on internal risk management analysis and accepted financial industry standards, because although NCUA doesn’t require credit unions to meet the bank regulatory standards for LTV guidelines for real estate, the agency still views them as reasonable benchmarks.
So, while the rule no longer specifically limits a credit union to an LTV of 80% in a real estate transaction, you should provide strong justification for instances that exceed the accepted limits.
One of the most highly publicized changes in the new rule is the removal of the personal guarantee waiver requirement, which became effective in May 2016.
As a result, credit unions now have the ability in some circumstances to make MBLs without requiring a personal guarantee.
But it’s very important to note that NCUA still expects a personal guarantee in most cases, because the most effective guarantee is still an unlimited, joint, and several personal guarantees from the principals who have controlling interest of a borrower’s operation.
Credit unions should waive the requirement for a personal guarantee only when the credit union has a strong credit risk management program, and the ability to properly mitigate the additional risk, to meet the needs of a “financially strong” borrower.
According to the Examiner’s Guide, “financially strong” borrowers demonstrate a preponderance of the following:
NCUA has stressed the importance of documenting the mitigating factors that justify the credit union’s decision to make a loan without requiring a personal guarantee.
When examining a credit union that grants commercial loans without personal guarantees, examiners will evaluate the strength of the credit union’s credit risk assessment process at inception and throughout the life of the loan.
A comprehensive risk assessment should support the decision to forego the personal guarantee, and credit unions should monitor the borrower’s financial condition by requiring frequent financial reporting and compliance with specific, well-defined financial covenants.
Examiners also will evaluate the credit union’s portfolio management process for sufficiency to determine how much risk the credit union can reasonably take on its books. Credit unions that forego the personal guarantee should limit their exposure to risk associated with these loans by establishing a concentration level appropriate for the credit union’s capital position and management ability.
The guidance directs examiners to determine whether a credit union adheres to its policy in granting unguaranteed commercial loans, giving particular attention to the institution’s ability to monitor the performance of these loans. Credit unions should report loans without a personal guarantee to their board of directors in the aggregate and clearly monitor for adverse changes in performance and risk.
While the new collateral and security requirements have technically provided credit unions with more flexibility to make risk-based decisions in setting LTV limits and extending credit in the absence of a personal guarantee, the Examiner’s Guidance indicates many of the examiner expectations haven’t changed.
The former version of the MBL rule contained prescriptive regulatory requirements because the industry lacked familiarity with commercial lending at that time.
Now, we’re operating in a different world, and to remain competitive in the financial marketplace, credit unions need more flexibility to make commercial loans.
As a result, NCUA has deformalized the waiver process and lifted some of the limits, allowing credit unions to make commercial loans more easily in situations where the credit union can identify, mitigate, and manage the risk.
NCUA examiners likely will approach the exam process as more of a “risk review” than a loan review. So, credit unions need to ensure they understand the risk they’re assuming in making each commercial lending decision, and document any deviation from accepted industry standards.
WHITNEY NICHOLAS is CUNA’s senior federal compliance counsel.