Written by Elizabeth M. Young LaBerge, Regulatory Compliance Counsel
If you were able to attend NAFCU’s Annual Conference and Solutions Expo in Nashville two weeks ago, I hope you caught Friday morning’s presentation by NCUA’s Myra Toeppe, Regional Director for Region III. She spoke about the MBL final rule and its impact on examinations.
During that presentation, she gave attendees a peek into NCUA’s upcoming supervisory guidance regarding MBLs made without personal guarantees. As most of you know, the strict requirement for a personal guarantee was eliminated on May 13th as part of the new MBL final rule. As we mentioned previously, NCUA has promised further guidance on implementing the new, risk-based commercial lending requirements. Guidance is generally expected in September. However, as the personal guarantee was implemented before the rest of the final rule, it appears guidance has already been issued internally at NCUA in Bulletin 4650B, Supervisory Expectations for Credit Unions When Loans Are Granted Without the Personal Guarantee of the Principal.
Expectations for Commercial Loans Without Personal Guarantees
Under the transitional provision in current section 723.7(f), credit unions can write MBLs without a personal guarantee where they determine and document that mitigating factors sufficiently offset the relevant risk posed by not obtaining the personal guarantee. On January 1, 2017, new section 723.5(b) will require this determination and documentation of the loan file for any commercial loan where a personal guarantee is not required.
NCUA expects federally insured credit unions that write MBLs (or certain commercial loans in 2017 and beyond) without a personal guarantee from the principal to have sufficient protections in three areas: risk management practices, underwriting and assessment of the borrower’s financial condition, and ongoing monitoring.
Risk Management Practices. NCUA expects that a federally insured credit union would only grant an MBL/commercial loan without requiring a full, unconditional personal guarantee from the principals when the borrower is in strong condition financially. This strength, and the credit union’s decision to forego the guarantee, should be supported by a comprehensive risk assessment.
Underwriting and Assessment of the Borrower’s Financial Condition. In order to establish the borrower’s financial strength, a federally insured credit union should have the processes and practices in place to accurately determine the borrower’s financial condition. The quality of the financial information used in the financial analysis should be commensurate with the level of risk and complexity of the borrower and the principals' operations.
A “financially strong borrower” should be able to demonstrate a preponderance of the following qualities:
- Superior debt service coverage;
- Positive income and profit trends;
- Strong balance sheet with a conservative debt-to-net worth ratio;
- Historical track record of meeting lending and trade obligations;
- Readily salable collateral supporting the loan;
- Low LTV ratio; and
- Documentation evidencing sufficient due diligence to verify the borrower’s creditworthiness.
Ongoing Monitoring. NCUA requires that federally insured credit unions be diligent in ongoing monitoring and detection of any changes in the risk associated with the borrower’s operations. The credit union should have risk monitoring practices in place for early detection of deteriorating creditworthiness. The credit union should not only be risk grading the loan at origination, but also throughout the life of the loan.
Examination Focus on MBLs/Commercial Loans
Ms. Toeppe also discussed that examinations will focus on portfolio controls and management. NCUA field staff will evaluate the credit union’s portfolio management processes for sufficiency. This will include assessing the reasonableness of the credit union’s internal limits, the adequacy of its internal tracking and monitoring, and compliance with the credit union’s internal policies and NCUA’s guidance.
For more details, we will have to wait until September for the promised guidance. In the meantime, credit unions looking for more help can look to NCUA’s Letter to Credit Unions 13-CU-02 and the attached Supervisory Letter 13-01. These letters were issued in February, 2013 regarding expectations for MBL waivers, and they served as the basis for NCUA’s guidance.