On Jan. 1, NCUA’s revised member business lending rule went into effect. Since then, we have received a number of questions from credit unions about the rule and its implementation. To help, we have put together the following frequently asked questions about the rule and our expectations.
Additional information about NCUA’s supervisory expectations can also be found in the latest update to the Examiner’s Guide released in the fourth quarter of 2016.
What Are NCUA’s Expectations Under the New MBL and Commercial Loan Rule?
NCUA expects credit unions to offer commercial loans in a safe and sound manner and structured appropriately for the member’s needs and within the member’s financial abilities. The new rule requires active oversight by senior managers and the board. But, the new rule also extends flexibility to credit unions to establish policies and program controls instead of prescriptive regulatory requirements. As a result, the rule now takes a more principles-based approach to managing a commercial loan program and allows management to tailor appropriate risk-management practices to suit their individual circumstances.
We expect credit union practices to be safe and sound and in line with accepted and proven methods for managing commercial loan risk. In addition to knowing the levels of risk at all times, we require credit unions to have sufficient and qualified staff, comprehensive policies, and appropriate procedures and processes for identifying and tracking changes in risk, including an appropriate risk-rating system.
How Should My Credit Union Prepare?
The best preparation is to adhere to active risk-management principles for sound lending. A well-developed program with appropriate monitoring and controls, and appropriate audit and oversight, should best prepare credit union management for the next examination.
For example, at a loan’s inception, a credit union should perform a comprehensive risk assessment and assign an initial credit risk rating. The risk assessment and risk rating justification should be documented in the credit approval document.
After the loan closes, a credit union should reevaluate the risk level of the borrower relationship through regular contact with the borrower and regular reviews of the borrower’s financial condition. A change in risk should be addressed immediately and be reflected appropriately in the risk rating. Senior management and the board can verify the practices are appropriate by requiring regular independent loan reviews that evaluate the adequacy of the policy and procedures and the accuracy of the assigned risk grades.
Additionally, putting an action plan in place to address any issues identified in the loan review will demonstrate proactive risk management to the exam team.
Where Can I Find Background Information on NCUA’s Intent and Goals for the Rule?
An excellent resource is the rule’s preamble as it is published in the Federal Register. The preamble contains important information about NCUA’s policy objectives, the disposition of the public comments received and other factors that influenced the agency’s rulemaking. The preamble is an important aid in gaining an understanding of the intent and expectations for a rule. Copies of the proposed and final preambles and rules can be found on the NCUA.gov.
What Guidance has NCUA Issued and Are Credit Unions Expected to Follow it?
We recently completed a comprehensive update to the Examiner’s Guide relating to the supervision of commercial loans. This update is available on NCUA.gov.
The commercial and MBL section of the Examiner’s Guide sets forth a clear framework for supervisory expectations for managing a commercial lending program. While the guidance outlines the expectations for examiners, credit unions will benefit from reviewing it because it gives definitive information about what NCUA considers to be safe and sound practices. The guidance on commercial-loan risk management is consistent with the other bank supervisors and is based on conventional principles for sound management. Examiners will use this guidance as the basis for their assessments of a credit union’s commercial lending activities.
We urge credit unions to review the Commercial and MBL section of the Examiner’s Guide and understand how their commercial lending programs may differ from the supervisory expectations set forth in the preambles and the guide. Credit unions should be able to provide documentation that their policies and procedures appropriately manage the risk associated with their commercial loans, especially when a credit union’s practices differ from practices outlined in the Examiner’s Guide.
Does NCUA Require Loans be Guaranteed by the Principals of the Borrower, and Who Should Guarantee the Loans?
Personal guaranties of the principals of the borrower are an important and expected part of lending transactions to small businesses. However, in those cases where there are strong mitigating factors, such as superior debt service coverage, positive earnings trends, the abundance of collateral and low leverage to name a few, a credit union can elect to not require the guarantee. When a guarantee is not required, credit unions should detail in the approval document the justification and mitigating factors that offset the additional risk associated with an unguaranteed loan.
Waiving the guarantee should be considered an exception because personal guarantees provide an important element of financial integrity to commercial loan transactions. As the principals of a business have the most to gain from its success, it is appropriate that they shoulder the majority of the risk by personally guaranteeing the debt. The most effective guarantee will be from those individuals who have financial resources at risk and have control of the borrower. They will have the authority to manage operations and a financial incentive to maximize borrower value and retained assets and reduce debt in the borrowing entity. A firm commitment by sharing the risk through a guarantee by the principals is vital to preserving the value of the borrower’s business.
For additional information, please see the personal guarantee section in the Examiner’s Guide at https://go.usa.gov/x5NmY.
Are Credit Unions Required to Follow the Regulatory Adverse Loan Classifications of Substandard, Doubtful and Loss?
No, but the approach is consistent with the regulatory standard. Part 723 requires credit unions to monitor the levels and changes in risk in individual loans and in the overall commercial loan portfolio by administering an accurate credit-risk rating system. The rule does not specify any particular risk ratings or definitions.
However, the supervisory expectations for what constitutes an effective credit-risk rating system includes sufficient granularity in risk ratings to adequately describe the degree of weakness in troubled loans. Because the regulatory adverse classifications of substandard, doubtful and loss are an accepted, proven method, assigning these designations appropriately in the risk ratings is acceptable.
Additionally for pass or acceptable credits, risk ratings should again allow for sufficient granularity for early identification of adverse trends in the portfolio. A change in the pass rating can be an early sign of distress for the borrower and it should be addressed immediately by the credit union.
What Is the Process if a Credit Union Disagrees with the Findings of an Examiner?
We encourage immediate dialogue with the individuals most closely associated with your credit union. First, you should approach your examiner. This is the most effective method to resolve any issue. You have a right to question the conclusions and receive supporting information. Be sure you have support for your position that is reasonable and consistent with accepted risk-management practices.
Second, if you cannot arrive at an agreement with the examiner, the next step is to contact and express your concerns to the supervisory examiner. They are required to provide an objective review of the facts. They can review your examination in context with the standards applied to other examinations.
Finally, you may appeal formally in writing to the regional director and follow through with NCUA’s appeal process.