The NCUA finalized its Member Business Loans Commercial Lending rule in March 2016. The amendments modernize the regulatory requirements that govern credit union commercial lending and allow greater flexibility to lenders.
Does an overhaul of the Commercial Lending Rule require an overhaul of your own commercial lending program? Here’s what you need to know:
The revisions to the Member Business Loans rule discuss policy and program responsibilities that a federally insured credit union must implement as part of a safe and sound commercial lending program. The revisions also specify the limit on the aggregate amount of member business loans that a federally insured credit union may make.
If you understand the following five key areas of the rule, you will be able to properly identify and implement any needed changes to your commercial lending program.
First, let’s look at the rule applicability. It is important to keep in mind that this rule only applies to federally insured, natural-person credit unions.
The rule does not apply to loans made by:
- Corporate credit unions;
- A federally insured credit union to a credit union service organization (CUSO); or
- A federally insured credit union to another federally insured credit union.
Second, for the sake of clarity, the rule modifies definitions for certain terms and adds new definitions for terms not currently defined in the member business rule. These definitions are an important part of the rule and need to be fully understood when making the necessary changes to the credit union’s member business/commercial lending program.
Some of the defined/redefined terms include:
- Associated borrower
- Commercial Loan
- Credit-risk rating system
- Loan-to-value ratio
- Readily marketable collateral
Third, the rule will influence certain exemptions. For smaller credit unions that meet certain criteria and are only occasionally granting loans that meet the regulatory commercial loan definition, there is an exemption in the new rule. These credit unions are relieved from the burden of having to develop a full commercial loan policy and commercial lending organizational infrastructure.
The NCUA considers a “smaller credit union” to be an institution that:
- “Has less than $250 million in assets;
- Has a commercial loan portfolio plus commercial loans sold but serviced less than 15 percent of its total net worth; and
- In any given calendar year has originated and sold and no longer services commercial loans that in aggregate are less than 15 percent of its net worth.”
Next, let’s look at how the rule will affect policy.
For credit unions that do not meet the exemption requirements, they will be expected to implement and adopt policies and procedures intended to provide for ongoing control, measurement, and management of the credit union’s commercial lending activities. Consequently, a CU’s board of directors and management need to be willing to potentially take on additional responsibilities to help them accomplish the oversight requirements. For example, CUs will be expected to adopt a formal credit risk rating system to identify and quantify the level of risk within their commercial loan portfolio.
The rule requires the commercial loan policy address a number of specified areas, which are detailed in the full text.
5. Personal Guarantees
Lastly, the rule will impact personal guarantees. The rule allows credit unions to grant loans without the personal guarantee of the principal(s), but only when there are strong mitigating factors to offset the additional risk created when the loan is not guaranteed by the primary beneficiary, which is generally the principal of the borrower.
A credit union’s decision to forego the use of a guarantee should only be approved when it meets the needs of a financially strong member, and when other credit-risk mitigations exist.
Having the principal of the borrower commit their personal liability to the repayment obligation is, in many cases, very important for commercial lending. The credit union will need to set prudent portfolio limits for loans that will not require the personal guarantees of the principal(s).
Clearly, the changes to the rule are significant. Timely supervisory guidance is important for effective implementation of this final rule. The NCUA plans to issue supervisory guidance to examiners before the final rule takes effect. Most of the requirements of the member business rule will be effective January 1, 2017, but the revisions pertaining to personal guarantees took effect on May 31, 2016.
So now is the time to make sure you understand the many aspects of the changes to the rule and help your financial institution adequately train staff to ensure compliance with the new requirements.
For more information, read the NCUA’s rule summary.