The NCUA has put forth a proposal of new regulations for business loans. This will totally change the existing regulations that are currently in place. In many ways, this will give CUs more flexibility in their business loan decisions. More freedom also requires more responsibility as CUs will be required to have stronger loan policies, underwriting standards, and credit management practices. I would encourage everyone to read the policy changes and provide comments which are due by August 31.
There are several items that I see in the new regs that raise questions for me. First, the regulation creates a new class of loans called “commercial loans”. Now some loans that are currently considered Member Business Loans for statutory purposes are not commercial loans and vice-versa. While I do think it is wise to extract some of the items currently carried in the MBL limits, the reg did not state what would be done with the commercial totals. Will these loans also be subject to an overall portfolio scrutiny? If so what are the levels? Who determines this, the CU or the NCUA?
The associated borrower and single borrower limits also cause me some concern. The reg seems to cast a broad net over what constitutes an associated borrower and seems to leave some vagueness in areas where one sponsor who has control over a certain amount of another’s company stock is counted or not. It also removes the guarantor criteria in calculating limits to one customer as now any associated borrower would count toward the limit. This is good, as it would encourage limited use of not requiring guarantors on credits.
But I contend that many times with good solid sponsors who may have multiple profitable companies, the associated borrower rule may prevent the CU from entering into a new transaction that would be profitable and a prudent credit. Perhaps using a proportion of the credit in calculating associated borrower limits may be applicable when dealing with companies where the owner has less than 20% ownership, where the company’s debt is not guarantor reliant, where the owner does not derive more than 20% of his personal income form the company, where the company has historic income to satisfy all expenses, debt, and dividends paid to owners, and where the debt is adequately collateralized.
The regulation outlines several different reporting requirements which need to be identified from the reg and then monitored by the board and credit management. Much of the reporting goes under the heading of tracking exceptions to your loan policy. I find this category too broad, since you can have an exception to policy for almost anything. It would be wiser to create categories within loan policy of what exceptions will be tracked. This forces the tracking into broad categories such as exceeding LTV, inadequate quality of financial statements per policy, guaranty not provided per policy, or DSCR below minimum threshold. Such tracking will be more meaningful in managing these credits and also it will not create a minutia of information that fails to track what are important risk factors.
The policy now requires a substantial commercial loan policy that is reviewed and updated at least annually. In the requirements for policy inclusion items, it seems that some of the items in the proposed regulation may fall under procedure rather than policy. In either case, these items should be present and forcing CUs to create a substantial commercial loan policy is needed. Once the regulation is in place, if you need help, contact us.
Another item in the regulation is the use of a risk rating system to gauge the risk of the credit. This should be established at closing and also tracked during the life of the loan. The risk rating model should help move a subjective guess of the credit’s risk into something that is more objective. I would add that multiple risk models should be utilized as the risk inherent in an ag loan is much different than what is found in a rental office building. Again, if you need help here, ask us.
The reg removes unsecured lending limits. While that opens up business possibilities, it is also quite risky. Each loan policy should have different measurements and thresholds of performance where an unsecured loan should meet before entering into one. These tests should be spelled out in loan policy. Some of these would be DSCR thresholds, current ratio minimum, debt/asset limits, etc.
The proposal removes the waiver process as most items that are currently waiver items, become issues of loan policy, underwriting, and credit structure. CUs will find less reasons to structure credits around regulatory constraints and more reasons to formulate loans around sound credit practices and policies. This feature is a positive change.
Once the regulation is in force, there will be an implementation period of 18 months. While the time may be good, sub-timeframes should be used to help CUs along the way. Some of these may be to establish a date when loan policies should be completed by, another date for the start of exception reporting, etc. This would ensure a smoother start up into the new policy.
The new regulation will require a lot more work to shops that are weaker on their current credit policy and management. For many, it will not be much of a change from their present operation. The proposed changes in the regulations is needed to improve the overall credit management in the industry. I suggest that everyone read the new regulation, ask questions, and prepare comment letters to outline what you like and what sections can be a hindrance to your CU.