One of the differences I had to get accustomed to when I came to credit union land were requirements for guarantors. On the banking side of the fence, guarantees were not a regulatory issue. Oh, we almost always got them and the only way we would look at a deal non-recourse would be if it went to the secondary market or if we received other concessions to entice us to not require a guarantor on a loan. Another time we would look at non-recourse lending was if we had a project that had very strong cash flow that would exceed the loan term or amortization.

At that time in my career, guarantees on a loan seemed more common loan sense than a matter of regulation. Credit union regulations have a clearly defined set of requirements for loan guarantees. These are required, unless you have other guarantee stipulations with certain government guaranteed loans. Section 723.7(b) states principals, other than those in a not-for-profit organization as defined by the IRS Code or where the Regional Director grants a waiver, must provide personal liability guarantees for the commercial loan. Some have read this to mean that any natural person with ownership in a company, no matter how small that ownership portion may be, must provide a personal guarantee.

But a reading of that one sentence in the regulation and guidance, without an understanding of the whole regulation is “lucky-dipping”. This is a Missouri term we used to use when someone picks out one sentence or item in a much larger document and bases an opinion on that one item, even though it may contradict the whole. Whatever you come up by sticking your hand at the bottom of the lake, no matter if it a catfish or a handful of mud, you cannot assume the entire lake consists of whatever you pull up.

A Supervisory Letter titled, Evaluation Credit Union Requests for Waivers of Provisions in NCUA Rules and Regulations Part 723, Member Busienss Loans (MBLs) provides further clarity on the subject. In reading on page 10 of that document the definition of who has to guarantee is outlined as “one or more natural persons who have a majority ownership interest in the business organization (borrower) receiving the loan. For a corporation, this will be one or more shareholders having a majority ownership of the organization. Natural person partners having a majority ownership in the partnership must each guarantee the full amount of a loan to a partnership.”

The next key is to define what is a majority? This is necessary to find out who will have to guarantee. Majority is a majority of all classes of ownership. This could be general and limited partners in a partnership, or common and preferred stockholders in a corporation. So you have to have at least 50.1% of the people in ownership provide a full guarantee on the loan. This can get more complicated if a part of your ownership group is a company or a series of nested entities. Then you need to drill down through the different layers of ownership in the company to determine exactly who will need to provide a personal guarantee. Also you should be getting corporate guarantees for each level of ownership as well. Page 11 of the document is a wonderful resource and provides an example in a chart of who and what entities need to sign.

I would add that as a practical matter, even if the controlling partner or stockholder has a minority ownership percentage, the officer should get the guarantee from that person. It only make sense to have guarantees from those that control the entity. Another idea is to get a guarantee from anyone who has 20%+ ownership; this follows rules found with the SBA and Rural Development. A final practical idea here I will advance is to get the guarantee of those strongest financially, even if they have a minority of ownership. At the end of the day, you want your loan to be paid.

What does a “guarantee” actually mean? The guarantor must provide a payment guarantee, meaning they will make the entire payment under the terms of the note. The guarantee should be full, meaning it applies to all the amount of the borrower’s indebtedness, past, present, and future, to the lender. It should be joint and several, so the lender can pursue one or all guarantors for the payment or full amount of the loan.

With some cases, it is my opinion that you should always require a guarantee on the loan. An example would be a construction loan. Construction loans typically have more risk. If you have a small company that wants to avoid guarantees on this type of loan and have you bear all the risk, you should be extremely careful. It would be as if the customer is expecting you to bear the risk as a general contractor.

If you want to deviate from the guidelines, you will need approval from the NCUA. The reasoning should represent sound credit underwriting and not just, “I have to do it to get the deal.” The guidance letter lists the following factors that should be in place for all guarantee waivers:

· Creditworthy borrower

· Superior DSCR

· Positive income and profit trends

· Strong balance sheet and conservative debt-to-worth ratio of borrower

· Easily marketable collateral

· Low LTV

· Long relationship with the customer (5+ years)

Note that often waiving a guarantee will require additional monitoring going forward. The minimum additional steps you must take are:

· Well defined financial loan covenants

· Increased regular financial reporting that include: annual tax returns, quarterly management-prepared financials, annual GAAP prepared financial. The frequency can increase if necessary

· Well defined reporting covenants that outline penalities if the financial reporting is not done promptly

· Site visits at least yearly and more often if needed

If you are considering waiving a guarantee, consider some alternatives like requiring limited guarantees. Some deals I have been a part of had pro-rata guarantees that were limited to a certain multiple of a percent of the ownership the individual had. An example would be with a 150% of ownership guarantee, an owner of 25% of a company would provide a guarantee of 37.5% of the debt. As an aggregate, you would have total guarantees equal to 150% of the debt, though you would not be able to collect that entire amount from any one guarantor.

Releasing guarantors should also be done with care. The lender should make sure that a release does not violate any terms of the loan type, like SBA, and that the release will not produce a violation to any regulations. In my career, I have only seen releases occur with two different circumstances. The first occurred to release a spouse of a deceased partner. The company had buy-sell agreements in place to take care of the estate and the wife transferred any ownership she had to the remaining partners. The second occurred after a property was built and stabilized that had a long-term credit tenant in the property with a lease term that exceeded the amortization on the loan.