When the National Credit Union Administration released its final member business lending rule in February 2016, it represented a sea change for the agency. The new rule forgoes most prior “prescriptive” limits in favor of a more flexible and business-friendly “principles-based” philosophy.
It introduces several important changes, including:
· Lifting most prescriptive limits: Nearly all loan limits and restrictions were eliminated, including collateral loan-to-value requirements and the aggregate portfolio limit on construction and development (C&D) loans. Credit unions may also raise their single borrower policy limit to 25% of net worth (with certain restrictions), and personal guarantees are no longer required (as of May 13, 2016).
· Distinguishing between commercial and member business loans: To ensure full compliance with the statutory business lending limits in the Federal Credit Union Act, while focusing on true commercial loan risk, the NCUA created distinct definitions for “commercial loan” and “member business loan.” Small, less-active credit unions are exempted from this provision.
· Expanding board and management responsibilities: The NCUA defines distinct roles and responsibilities for boards, senior management and commercial lending staff, and requires strict oversight of third-party firms, including CUSOs involved in commercial lending-related work.
· Exempting non-member participation loans: Credit unions engaging in non-member participation loan purchases may now exclude such loans from their MBL cap limit. This provision is automatically available to all eligible credit unions.
With all provisions now in effect, credit unions must meet the new requirements in preparation for their next safety and soundness exam.
On Nov. 29, 2016, the NCUA released long-awaited guidance to help examiners and credit unions interpret the MBL rule. We encourage credit unions to read both the guidance and final rule in their entirety, but can focus today on a few key areas:
1. Revisit commercial lending policies: Gone are the days of simply copying and pasting from NCUA regulations part 723 into an MBL policy. With the additional flexibility afforded by the new rules, credit union boards and managers are to fully understand the risks and set policy limits accordingly.
Specifically, NCUA examiners will look for credit unions to mitigate risk in several areas, including the types of loans offered, geographical trade areas, portfolio and concentration limits, single borrower limits, staff experience and qualifications, underwriting standards, and the loan approval process.
2. Understand and comply with board and management responsibilities: One of the most significant areas of change, credit union leaders would do well to spend time educating boards and senior management on their increased role.
Per the NCUA’s guidance, “A key principle in the member business loans and commercial lending rule (Part 723) is that a credit union’s board of directors is ultimately accountable for the safety and soundness of the credit union’s commercial lending activities.”
This means board members should have a basic understanding of the commercial lending processes and risks: underwriting and approval, loan monitoring, portfolio management and workout procedures. The board is responsible for reviewing and approving the commercial loan policy annually, and ensuring that the credit union hires and trains commercial lending staff fully competent to carry out their duties.
3. Develop a comprehensive risk rating system: Per the NCUA’s examiner guidance, a credit risk rating system “allows management to assess credit quality, identify problem loans, monitor risk performance, and manage risk levels.” The NCUA emphasizes that each credit union should develop a unique, customized system to address its own specific risk factors, and has attempted to clarify the minimum factors examiners will consider to ensure the institution is monitoring individual loan and portfolio risk appropriately.
Credit unions should involve both quantitative factors (such as credit scores and collateral valuations) and qualitative factors (including management experience and operational efficiency) in developing one or more well-defined risk rating matrices.
The NCUA also urges credit unions to employ technology to monitor the risk rating system’s performance in providing accessible, viable data to adequately track portfolio risk.
4. Implement technology for loan administration and reporting:
The NCUA recognizes technology’s importance in managing all aspects of commercial lending. In fact, its expectations for deployment of sophisticated MIS (management information systems) are explicitly laid out in the guidance:
"A credit union should have a loan information system that is able to handle the processing, servicing, monitoring, tracking, and reporting requirements for commercial lending. This can be challenging, as commercial loans have a wide variety of loan structures, repayment terms, schedules, and interest rate types (variable rates tied to an index that is subject to change daily). An inadequate system can result in the inaccurate calculation of interest income, billing errors, inaccurate amortization, and a credit union’s inability to process cash payments in non-accrual or collection loan situations. A credit union should have systems that can meet the needs of commercial borrowers, and can support the complexities associated with such loans."
With some direction, any credit union can actively manage business lending administration and operations effectively and efficiently.
Robby Knapp is regional president of credit union for nCino.
