Written by André B. Cotten, Regulatory Compliance Counsel
February is for lovers, and we are loving the new MBL guidance from NCUA. Previously, my colleague gave an overview of some of the changes to the rule beginning January 1, 2017. Today, I would like to take a closer look at collateral for commercial lending, and also the new suggested LTV ratios for real estate.
Collateral is essential to commercial lending transactions. The credit union should ensure that the collateral is sufficient to offset inherent risks in the commercial lending transaction. According to the MBL guidance, “a credit union should make credit decisions based on the adequacy and reliability of a borrower’s source of repayment, the net earnings stream generated from a borrower’s business operations.” (See, section 723.5).
In general, commercial loans provide funding for members businesses to purchase an asset or to provide working capital that either fund the member’s inventory or accounts receivable during the business cycle. NCUA suggests that credit unions at least require member businesses to pledge the assets being financed as collateral. NCUA also warns that additional collateral may be needed if a member’s assets are less marketable or possess a higher degree of risk. The credit union should closely consider a member business’ creditworthiness and the marketability of their inventory or accounts receivable.
As a result, NCUA advises that less marketable, less stable, and less valuable collateral should be monitored more closely than highly marketable, highly stable, and highly valuable collateral. Credit unions should establish policies and procedures to monitor less marketable collateral. These policies and procedures should include systems and process to respond to changes in asset values and the condition of the pledged collateral.
Simply put, the more marketable an asset, the more easily it can be converted to cash. The age and condition of the collateral, as well as possible alternative uses for the collateral, impact its marketability. For instance depreciating assets, such as newer equipment or vehicles, warrant a relatively higher LTV ratio. Alternatively, single-purpose real estate, like a car wash, has limited alternative uses, which warrants a lower LTV ratio.
Moreover, the amortization of a loan should reflect how long the credit union anticipates the collateral will be useful. This is determined by the type and expected use of the collateral being pledged. To mitigate this risk, the credit union should offset the potential volatility of an asset with the LTV. NCUA advises that credit unions use a reasonableness standard and align its policies with prudent lending practices to establish commercial LTV limits.
Real Estate Loan to Value Ratios
Section 723.2 defines the term, loan-to-value ratio, as the aggregate amount of all sums borrowed including outstanding balances plus any unfunded commitment or line of credit from all sources on an item of collateral divided by market value of the collateral used to secure the loan.
Prior to the implementation of the new MBL Rule, section 723.7(a)(1) read:
“The maximum loan-to-value ratio for all liens must not exceed 80% unless the value in excess of 80% is covered through private mortgage insurance or equivalent type of insurance, or insured, guaranteed, or subject to advance commitment to purchase by any agency of the federal government, an agency of a state or any of its political subdivisions, but in no case may the ratio exceed 95%”
(referring to loans for real estate). This version of the rule had a couple exceptions for construction loans or if the Regional Director granted a waiver. Otherwise, real estate loans had a loan-to-value cap.
The new MBL rule does away with the 80% cap for real estate and introduces loan to value ratio limits based on accepted industry and bank regulatory standards. NCUA also notes pursuant to section 723.4(f)(5) that credit unions should establish internal LTV ratio limits, which should be based on an internal risk management analysis and accepted financial institution industry standards.
The new LTV guidelines for real estate include:
- Loan Type (LTV Ratio Guidance)
- Raw Land (65%)
- Land development or improved lots (75%)
- Construction-Commercial, non-owner occupied multifamily, and other nonresidential (80%)
- Improved property-commercial, non-owner occupied multifamily, and other nonresidential (85%)
NCUA does not require credit unions to strictly follow these guidelines. However, NCUA does view this guidance as a reasonable benchmark. The agency believes this guidance is in line with industry practice and is appropriately tailored to the risk associated with the various types of collateral.
NCUA also notes that when credit unions calculate the LTV ratio for an acquisition transaction, the credit union should establish the collateral value as the lesser of:
- Acquisition cost (purchase price) plus improvements; or
- Appraised value
This method ensures the risk is distributed between the credit union and the member business. NCUA wants to see the member with “skin in the game” or their own capital invested in the success of business.
NCUA warns that if a credit union seeks to approve any loans as an exception to the recommended loan to value policy highlighted above, then the credit union must implement prudent internal limits and set procedures to track and monitor these high risk loans.
As credit unions continue to adjust to the new MBL guidance, the NAFCU compliance team will continue to provide updates in future publications. As always, feel free to email us at Compliance@nafcu.org if you have any specific questions.
Upcoming Training and Webcasts. The Spring session of our Regulatory Compliance School is coming up April 10-14 in Arlington, VA. If you’re thinking about joining us, be sure to register with code SPRINGSAVINGS by Friday, 2/10 to save $200. If you want to challenge yourself to earn the bragging-rights title of NAFCU Certified Compliance Officer (NCCO), this is the place to do it. Already an NCCO? You’ll earn the full 24 CEUs needed to recertify, without having to retake the exams.
Also, we have two webcasts this week that may be of interest:
Live Webcast: Tuesday, February 7 | 2:00-3:30 p.m. ET
Live Webcast: Wednesday, February 8 | 2:00-3:30 p.m. ET