Credit Unions: It’s Time to Implement NCUA’s Commercial Lending Rule
Effective January 1, 2017, the final National Credit Union Administration’s (NCUA) member business loan (MBL) rule shifted business lending from the NCUA’s prescriptive approach (i.e., collateral and security requirements, equity requirements, loan limits, and MBL waiver process) to a more modernized, principles-based methodology. The new rule permits credit unions to internally govern safe and sound commercial lending activities.
The NCUA first published the rule in March 2016, and credit unions should be in the process of re-examining and implementing the rule’s requirements as they work toward compliance.
New rule introduces flexible lending limits
The final MBL rule eliminates many prescriptive lending limits and the corresponding waiver provisions under NCUA 12 CFR Part 723. The rule also separates a credit union’s commercial loan policy and program responsibilities from the statutory limit on MBLs. Under the new principles, credit unions must maintain prudent risk management practices and sufficient capital proportionate to the risk associated with their commercial lending activities.
Credit unions must develop their own commercial loan policies
Under Section 723.4, robust loan policy development relative to commercial lending activities is required, including:
- Types of loans to be offered and identification of trade areas • Underwriting, documentation, and monitoring guidelines for various types of commercial lending offerings
- Caps on loan amounts to aggregate borrowing relationships (generally 15 percent of the credit union’s net worth)
- The required qualifications and experience of personnel involved in the administration of the commercial lending program
- A formalized commercial loan approval process
- A formalized commercial risk grading system
- A formal commercial loan risk management process (including independent monitoring and reporting)
- A process for approval of policy exceptions
Small credit union exemption
A small credit union exemption was retained under Sections 723.3 and 723.4 that permits credit unions with assets of less than $250 million to be exempt from key board and management responsibility and policy requirements. The exemption also includes credit unions with total commercial loans less than 15 percent of net worth, so long as they are not regularly originating and/or actively selling commercial loan participations.
Increased responsibilities for boards and management teams
Under Section 723.3, the board of a federally insured credit union must approve the credit union’s commercial loan policy. Further, the board must review the commercial loan policy annually, if not more frequently, in response to material changes in portfolio performance or economic conditions, or prior to material changes in the commercial lending program or organizational structure. The board must also ensure that the credit union appropriately staffs its commercial lending program with senior executives and qualified lending staff who have the experience and competencies to manage and oversee commercial lending.
Examiner’s Guide updated to match final rule
On November 25, 2016, the NCUA updated the commercial and MBL sections of its Examiner’s Guide to match the changes contained in the final MBL rule. The updated Examiner’s Guide addresses the following topics:
- Commercial loan definition
- Commercial loan versus MBLs
- Types of commercial loans
- Major commercial industry sectors
Other notable changes to lending practices
The final MBL rule contains numerous other definitional and underwriting and administrative requirements relative to commercial lending, including the following:
- Collateral and security — The final rule replaces the prescriptive loan-to-value requirements and unsecured lending limit, with the principle that sufficient collateral should be obtained as warranted and in relation to risk. The final rule also replaces the requirement for a personal guarantee or waiver with the requirement that the credit union document the mitigating factors that offset the additional risk of not having a personal guarantee. (This provision became effective 60 days after publication of the final rule.)
- Construction and development (C&D) loans — The final rule eliminates the prescriptive portfolio limit of 15 percent of net worth for C&D loans. The final rule also clarifies the definition of a C&D loan and how collateral values for these loans are determined. Loan policy requirements relative to approval and fund disbursements for C&D loans are included in the final rule.
- Aggregate limits — The final rule incorporates the statutory limits on the aggregate amount of MBLs of the lesser of 1.75 times the net worth of the credit union or 1.75 times minimum net worth to be well capitalized under section 1790d(c)(1)(A) of the Federal Credit Union Act, but omits the prior reference to 12.25 percent of assets.
Examiner training will incorporate new MBL requirements
In addition to the Examiner’s Guide updates, NCUA examiner training on the new MBL rule will focus on:
- Overarching principles for managing commercial loan risk
- Critical components of commercial loan policies
- The credit approval process
- Credit risk-rating systems
- Structuring of credit packages to properly align members’ needs with their financial capacity to repay
- Credit risk management processes for underwriting, ongoing loan administration, and risk monitoring
How we can help
Boards and management should conduct a comprehensive review of their credit union’s commercial loan policy to help establish effective commercial risk management practices. Our credit risk management professionals understand the commercial lending market and are familiar with the regulatory and risk management challenges facing credit unions. We can help:
- Evaluate and assess risk related to commercial lending in your credit union in light of the new regulations
- Complete a comprehensive review of your commercial lending policy
- Establish strong credit risk management controls, processes and procedures, monitoring programs and reporting practices relative to your commercial lending activities