The new member business lending (MBL) rules being implemented by the National Credit Union Administration (NCUA) could usher in a whole new era of commercial lending by the credit union industry. But will credit unions make full use of the amended rules, and should they?
For many years, NCUA regulations required member business loans (MBLs) to include a full recourse guarantee from principals that control the borrower and hold at least 51 percent of all equity interests in the borrower. Supervisory guidance prescribed in detail how to select the proper guarantor, and any relaxation of the requirement required a formal waiver from the NCUA. The rules prevented credit unions from making or participating in nonrecourse commercial real estate loans, which are widely available from banks and other commercial real estate lenders.
The NCUA decided to liberalize the old prescriptive rules governing MBLs, which include commercial real estate loans. Early this year, the NCUA issued new 12 CFR Part 723 — Member Business Loans; Commercial Lending, effective Jan. 1, 2017, subject to an important transitional rule. Its primary impact gives credit unions greater flexibility and autonomy to make nonrecourse commercial real estate loans as long as certain conditions are satisfied.
The regulation responds to the urgent need to loosen the full recourse personal guarantee requirement by including a transitional rule that became effective May 13, 2016, permitting credit unions to make nonrecourse MBLs even before the regulation becomes fully effective in January.
Under the new regulation, any credit union making a loan without a full recourse personal guarantee from the principals having a controlling interest in the borrower must determine and document the factors that offset the risk of waiving the standard full recourse personal guarantee. The new regulation removes the equity requirement, familiar to many as the "51 percent rule," that has required guarantees from principals holding at least 51 percent of all equity interests in the borrower. It also eliminates the cumbersome and rarely used NCUA waiver required when a credit union wished to vary from the guarantee rules. With the regulation's focus on guarantors who are control parties in the borrower, "control" is specifically defined and generally means a person or entity who owns, controls or has a controlling influence over the management or policies of the borrower. So the lending standard remains full recourse, but now the credit union is empowered to make a credit decision to lend on less than a full recourse basis when the risk of doing so is sufficiently mitigated. The new regulation does not provide specific guidance on what mitigating factors offset relevant risk, although these may be detailed in future supervisory guidance.
NCUA delayed full implementation to give CUs and regulators adequate time to adapt. Some credit unions have embraced the changes and are revising their underwriting policies to provide guidelines unique to a nonrecourse loan product. Credit unions also must overcome any internal restrictions. For example, nonrecourse member business lending may be prohibited by CU board policy, requiring board action to authorize making and participating in nonrecourse loans. Lead lenders and participants in loan participation programs must adapt their programs to take advantage of the new regulation.
Many are electing to implement the new regulation by making commercial real estate loans on a nonrecourse basis but with "carve-outs," a format commonly used in banking. The CU promises to foreclose on the real estate collateral as its sole remedy, but with specific exceptions giving the CU a right to recover directly from the borrower and guarantor on two levels: there will be (1) personal recourse liability to the extent of losses incurred by the lender resulting from certain "bad acts" by the borrower; and (2) springing full recourse liability for the entire loan amount for more serious events such as a borrower bankruptcy or fraud. The guarantors provide a nonrecourse carveout guarantee of the borrower's nonrecourse carveout liabilities, often called a "bad boy" guarantee. To our knowledge, credit unions are not electing to make commercial real estate loans without any recourse altogether, although the new regulation does not appear to specifically prohibit it.
We understand that additional supervisory guidance will be issued before Jan. 1, 2017, and regulators are indicating that new guidance is coming soon. In the absence of further guidance at this time, some credit unions are taking a wait-and-see approach. It is too early to know how regulators will treat loans made without full personal recourse under the new regulation. Some may be concerned that loans made during the transition period will retroactively run afoul of new guidance issued later.
In addition to those changes to the personal guarantee requirements, the final regulation generally eliminated most prescriptive lending limits and their corresponding waiver requirements. Another key change was the inclusion of a definition to distinguish between MBLs subject to the statutory cap on member business lending required under the Federal Credit Union Act and commercial loans that invoke the safety-and-soundness provisions established under the new regulation. Although the final regulation included these and other changes, the liberalized rules regarding personal guarantees have attracted the most attention to date.
The new regulation is a potential game-changer for credit unions, effectively leveling the playing field with other lenders in the commercial real estate lending market. The new regulation suggests that the credit union industry has earned the new regulatory relief by successfully navigating the recession and accumulating valuable lending experience over years under the old regulations. Business lending by credit unions remains small compared to banks, but the NCUA recognizes the "important role" credit unions play in the overall lending market, highlighting the more than $52 billion in outstanding member business loans held by credit unions. Credit union commercial real estate lending may be poised to grow more under the new regulation.
Gregg Loubier is a partner in Alston & Bird's Finance Practice, and Kayla R. Mehring is an associate in the group. Both work in the firm's Los Angeles office.
