Written by Benjamin M. Litchfield, Regulatory Compliance Counsel
Greetings to all of you out there in regulatory compliance land. On Tuesday, November 29, 2016, NCUA issued Letter to Credit Unions 16-CU-11 notifying credit unions that long-awaited guidance on the revised member business lending rule has been added to the NCUA Examiner’s Guide with just over a month before the effective date of the rule. The agency originally promised that guidance would be shared with credit unions in the preamble to the final rule published in the Federal Register on March 14, 2016. See 81 Fed. Reg. 13530, 13533 (Mar. 14, 2016).
Since the final rule was released, the NAFCU compliance team has received numerous questions regarding revised section 723.4, which mandates federally insured credit unions adopt and implement commercial lending policies and procedures that address topics such as the types of commercial loans offered by the credit union, trade area, qualifications of credit union employees involved in the origination process and commercial loan underwriting standards. The updated Examiner’s Guide finally provides some much-needed guidance for credit unions drafting commercial lending policies. Here is what the guidance has to say about some specific areas of concern.
Types of Commercial Loans and Trade Areas
The guidance notes that a “credit union should analyze its membership and ensure its commercial lending staff has the necessary expertise, gained through experience and training, to understand the needs of the membership and the types of loans offered.” For example, if a credit union predominantly serves fishermen in Gloucester, Massachusetts, the guidance seems to suggest that the credit union should have staff that have the requisite experience and training to understand the needs of commercial fishermen and the types of loans they may need for their businesses to thrive.
Similarly, a “credit union must be certain it is capable of serving its identified trade area.” This means understanding local demographics, economics and industries as well as being familiar with what influences those aspects of the trade area. Returning to our Gloucester example, the economy on the North Shore of Massachusetts is largely based on commercial fishing and tourism. The guidance seems to suggest that a credit union serving this area may want to have an understanding of what factors influence the local economy (e.g., overfishing or lack of tourism). Furthermore, such a credit union may want to make sure that it has the capacity to serve businesses that may have infrequent payment streams since both commercial fishing and tourism are largely seasonal and highly depend on the weather.
Qualifications and Experience Requirements for Lending Staff
When it comes to policies addressing the qualifications and experience of commercial lending staff, the guidance recommends that credit unions “consider relevant factors specific to the credit union and to the needs of its commercial borrowing members” such as “loan volume, projected loan growth, trade area, complexity of the borrowing relationships, types of loans permitted” and any other unique factors that could influence the commercial loan portfolio of the credit union. This seems to indicate that NCUA expects credit unions with higher loan volumes, higher projected loan growth or with greater complexity in borrowing relationships to have more experienced staff but that is not explicitly stated in the guidance or preamble.
In addition, the guidance notes that when determining staffing levels “a credit union should consider appropriate levels of management, relationship managers, and support staff as may be required to ensure member’s [sic] needs are responsibly serviced in a safe and sound manner.” Likewise, a “credit union should also consider an appropriate separation of duties to prevent potential conflicts of interest and other problems in loan underwriting, collection, and portfolio monitoring functions.” In other words, the guidance suggests that credit unions developing policies regarding staffing levels in commercial lending departments consider what staffing level is sufficient to ensure adequate separation of duties and how many additional resources, in the form of managers or support staff, are needed to maintain that staffing level.
The Examiner’s Guide also states that a policy outlining credit union commercial underwriting standards “must address the required analysis and depth of the financial review performed to support a credit decision.” For example, a “credit union’s borrower analysis should focus on the borrower’s financial condition and ability to repay. The guidance indicates that this includes income and expense trends, debt service ability, balance sheet changes, and the impact of those changes on the borrower’s ability to service debt. NCUA also expects the guidance to discuss the required evaluation of related parties and the influence those parties have on a borrower’s ability to repay a loan.”
In addition, “the policy must establish due diligence requirements to evaluate the other sources of income or losses that affect the guarantors or principals to determine the global financial condition and the debt service ability of a borrower and any associated borrowers.” Moreover, a “credit union’s underwriting standards must address the quality of the financial information used to make a credit decision and ensure that the degree of verification reflected in the financial information is sufficient to support the financial analysis and the risk assessment of a credit decision. A credit union can determine the quality of a financial statement using the level of assurance provided by a preparer and the required professional standards supporting the preparer’s opinion.”
The guidance also addresses additional aspects of a credit union commercial underwriting policy including the use of tax returns or financial statements, the types of collateral allowed, LTV ratio limits, personal guarantees, and valuation methods.
But Wait! There’s More…
These are just some areas where credit unions have expressed concerns or sought additional clarification regarding the requirements of section 723.4. Other aspects of the commercial lending policy requirement are also discussed in the guidance. The Examiner’s Guide also addresses other aspects of the revised member business lending rule including commercial loan workouts and construction and development lending. As we continue to digest the guidance, we may provide periodic updates either on the NAFCU Compliance Blog or in other publications. As always, members are encouraged to reach out to the Compliance Team with any questions.
Have a great week!