Credit unions, mark your calendars for Friday, May 13.
That's when, under a new NCUA rule, member business loans will not require a personal guarantee under certain circumstances. That's the biggest change in the final rule approved by the agency last month, according to industry insiders and experts.
The final rule allows CUs to tailor their MBL program to fit their strategic goals and the needs of their members, NCUA said.
Brian Lauer, partner in the Philadelphia-based law firm of Messick & Lauer, said the removal of the personal guarantee requirement allows CUs to truly evaluate a loan's risk, and draw their own conclusion if that requires a personal guarantee.
"It will allow credit unions to be more flexible in evaluating risk," Lauer said. "They will be able to look at loans on a case-by-case basis, and mitigate that risk as they see fit."
While the majority of the final rule will be implemented on Jan. 1, 2017, the ability to lift the personal guarantee requirement will go into effect 60 days after its publication in the Federal Register on March 14.
In a NAFCU webinar earlier this month, Larry Fazio, director of NCUA's Office of Examination and Insurance, said the new rule will provide much-needed flexibility in business lending—flexibility CUs have earned by virtue of strong performance.
Fazio said 98% of CUs that offer MBLs are well-capitalized, and almost 90% of those are rated CAMEL 1 or 2. "When you compare those credit unions to the universe of federally insured credit unions, they are better-performing than credit unions that don't do member business lending," he said. "They tend to be healthier than other financial institutions.
Fazio detailed a number of provisions that will change from the current rule to the final rule, starting with instances in which CUs no longer need to apply to NCUA for waivers. Those cases are:
- Aggregate construction and development (C&D) loan limit.
- Minimum borrower's equity for C&D loans.
- Loan-to-value (LTV) requirement.
- Personal guarantee requirement.
- Maximum unsecured MBL to one member or a group of associated members.
- Maximum aggregate MBL loan limit.
- Maximum aggregate net MBL to one member or a group of associated members.
"It did not make sense for NCUA to be in the waiver business, so one of our goals was to have a final rule that allowed credit unions to operate safely and soundly, but give them the flexibility they needed," Fazio said. "We will hold credit unions accountable for exercising that flexibility through the examination process instead of doing it on a 'Mother may I?' basis, through waivers."
Other key changes in the final rule are:
- Exemption provided to smaller CUs from maintaining separate policy and personnel requirements in cases of limited commercial loan exposures and activities.
- Distinguished the policies and program responsibilities for commercial loans from the statutory limit on MBLs.
- Modified the associated borrower definition to narrow its scope (with a parallel change proposed to the loan participation rule).
- Replaced the two-year experience requirement with more flexible governance and experience standards.
- Removed the requirement for personal guarantees (CUs can grant loans without a personal guarantee when there are mitigating factors that offset the additional risk).
- Removed LTV and portfolio concentration limits (except the statutory cap).
- Established policy requirements on the use of credit risk rating systems and provided additional details on how CUs must address commercial lending risk management processes.
- Allowed the single obligor limit to go up to 25% of net worth if the amount above 15% of net worth is collateralized by readily marketable collateral.
- Clarified non-member business loan participations do not count toward the cap, with no waiver required.
- Clarified policy requirements, LTV calculations, and C&D collateral value determination/disbursement processes.
The upshot of all these changes is, "Credit unions will set policies, and examiners will want to see reasonable practices," Fazio said.
"NCUA expects to see some form of a credit risk rating system for commercial loans," he noted. "We did not specify exactly how that had to work, but there has to be an understanding of risk in the portfolio, and how it relates back to capital. We believe this will change the conversation at exam time from looking loan-by-loan to looking at the forest. We want a mature business lending model."
Carrie Hunt, EVP of government affairs and general counsel for NAFCU noted the rule change means that many MBL dictates are now in the hands of credit unions. "On the flip side, that means on the exam side there is more subjectivity instead of objectivity. We will have to track how that works out."
Larry Middleman, president and CEO of business services CUSO CU Business Group LLC in Portland, Ore., advises credit unions to spend the next nine months "shoring up" their credit policies and procedures.
"They need to understand their risk-rating systems, because NCUA is going to focus on those," Middleman said. "Some credit unions do a good job of risk rating, while others do not. NCUA will put a much heavier impact in risk-rating systems. It needs to be well-defined and well-supported for every business loan a credit union makes."
Middleman said the biggest change in the variable will be seen in the future actions of NCUA and its examiners.
"We are keeping a close eye on how credit parameters will be defined going forward," Middleman said. "How will exams be different starting Jan. 2? We will be looking at the guidance NCUA gives to examiners. I do not think it will be a radical departure, but it is an unknown right now. It is easier for NCUA to perform examinations today because the rules and cut-and-dried, compared to how they will be."
Bill Hampel, chief policy officer for CUNA, noted there are "quite a few positives" in the final MBL rule, "Primarily, the fact specific details are up to credit unions rather than being hard coded."
"It is a principles-based approach, but credit unions can design their own policies based on their situation, which is always best," Hampel asserted. "Of course, credit unions will have to do a little more work to develop their own policy rather than adopting one passed down by NCUA, but I do not see that as a negative. They have a while, as the rule does not come into effect until Jan. 1, but they should start writing policies now so they can be ready."
There are two aspects of business lending from a policy perspective: the first is safety and soundness, to the CU and to the share insurance fund. Hampel said this issue is dealt with by NCUA addressing the commercial lending policy requirement.
"No longer do all credit unions have to follow the same policy," he noted, adding NCUA has defined loans as MBLs, commercial loans or both. "Some loans no longer have to be treated as commercial loans, including non-owner-occupied, one-to-four family residences, or an automobile owned by a business."
Previously, there was no distinction between commercial loans and MBLs.
The second aspect of business lending policy (addressed by the new MBL rule) is the requirement that member business lending not exceed 1.75 times a credit union's net worth, up to the amount needed to be well-capitalized. Hampel said when bankers submitted their comment letters to NCUA denoning the rule, they "had their arithmetic wrong"—as they thought this would raise the member business lending cap from 12.25% to 17.5% of assets, 1.75 times the 10% risk-based capital requirement to be well capitalized.
"What they missed is that for the vast majority of credit unions, 10% of risk assets is less than 7% of total assets. So this change, brought on by the new RBC rule, would only raise the MBL cap for a small number of credit unions, and even then by just a few percentage points above 12.25% of assets."
Hampel praised NCUA for clarifying an ambiguity regarding loan participations. He said under the current rule, if a credit union bought a loan participation in another credit union's MBL, it counted against both CUs' MBL cap. With the new rule, participations are not counted against the purchasing credit union's cap, which will give many credit unions some additional breathing room, he explained.
"This does not solve the problem of the 12.25% cap, but it makes it easier to operate with that cap," Hampel said.
Hampel pointed to provisions stating CUs with less than $250 million in assets that only do a small amount of commercial loans outstanding (less than 15% of net worth), no longer have to have a commercial lending policy in place. "This helps smaller credit unions, who no longer have to hire a business lending expert. This is a good sign, as NCUA is allowing credit unions to dip their toe in the water."
Existing business lending CUs will need to work on their policies, Hampel said, and for those that have avoided business lending due to the strict requirements, they can start to "experiment."
