Commercial lending governance starts at the top
Understand the policies and risks associated with creating or managing an existing MBL program.
Thanks to NCUA’s Member Business Lending (MBL) rule, it has never been easier for credit unions to enter the commercial lending market.
The rule forgoes most prior prescriptive limits in favor of a more flexible and business-friendly “principles-based” philosophy.
But commercial lending is not the same as consumer lending, and credit unions should approach this as an entirely separate business practice.
One of the main differences is that commercial lending requires considerable guidance from the board of directors. According to the MBL rule, “A credit union’s board of directors is ultimately accountable for the safety and soundness of the credit union’s commercial lending activities.”
As a director, you are expected to understand the processes and risks associated with your credit union’s commercial lending policies.
Use the following tips to maintain effective commercial lending oversight, whether implementing a new commercial lending program or managing an existing program.
Establishing a program
Are you new to commercial lending? Ask these questions to help you implement the basic components of a commercial lending program:
►Have you established and approved a commercial loan policy? Section §723.4 of the MBL rule requires credit unions to adopt a more robust commercial loan policy that incorporates broad commercial lending risk management practices. Credit unions are required to address these components within their commercial loan policy.
►Is your commercial lending program appropriately staffed? When starting a new program, finding an experienced commercial lender can pose a significant challenge for credit unions.
The ideal candidate has a broad understanding of the business, formal training in cash flow analysis, analytical skills, technical proficiency, and more.
It’s not enough to promote your best consumer or real estate lender to manage commercial lending. The commercial lender has to understand and be able to talk the language of the business in addition to overseeing and evaluating the performance of a commercial loan portfolio.
►Do you understand the nature and level of risk in the commercial loan portfolio? Directors should clearly understand the potential impact of commercial lending on earnings and net worth.
Determine your risk appetite and decide which types of loans you will provide based on where they fall on your preferred spectrum of risk.
Managing your existing program
If you’ve already established a commercial lending program, keep these tips in mind as you manage your program long-term:
►Mitigate risk. Establish a separation of duty ownership within the program to guard against internal risks. Ensure the same staffer doesn’t wholly manage loan approval, posting, and disbursement.
Perform annual audits to look for unauthorized activity, defalcation (misappropriation of funds), and noncompliance with regulations using an outside audit firm or your internal audit department.
►Conduct due diligence. Conduct due diligence on all third-party vendors in the commercial lending program to ensure they’re following processes and procedures, and not putting your credit union in harm’s way.
►Understand your portfolio. Perform a risk assessment of your commercial loan types to determine acceptable concentration levels relative to net worth.
Diversify loan types and amounts to avoid a financial disaster due to overexposure to a negative event, similar to what occurred with the recent commercial real estate market crash. Monitor the portfolio’s financial performance by regularly reviewing board minutes.
►Assess the program’s value annually. Effective oversight requires the board of directors to receive regular reports and opinions from management, counsel, auditors, and expert advisers.
Require management to hire a third-party vendor with sufficient experience in commercial lending to review the commercial loan portfolio.
Commission the review annually to determine compliance with loan policy, documentation compliance, and credit underwriting standards.
The vendor should evaluate loans of a specified size, nonperforming loans, loans with exceptions, and loans originated since the last review.
Remain vigilant in your approach to risk management, especially as it relates to commercial lending. You must continually evolve and monitor portfolio changes, and address new or evolving risks to stay on top of the ever-changing commercial lending landscape.