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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   January 2017

Regulatory Launch

Finding sound comparisons is key to estimating prices accurately

Regulatory Launch

The National Credit Union Administration (NCUA) has hatched new rules affecting how credit unions operate in the commercial mortgage market. Recognizing credit unions’ growing stake in business loans, the NCUA eliminated barriers to help them continue to grow in the commercial lending market. Personal guarantees, loan-to-value requirements and aggregate portfolio limits are all gone under the NCUA’s new rules.

Mortgage brokers are in a prime position to help their credit-union partners navigate the NCUA’s new rules. By fully evaluating the opportunities and risks that come with them, brokers and credit unions can work together to help their clients reach new heights.

A decade from now, experts may well mark 2017 as a watershed year for commercial lending by the nation’s credit unions. The NCUA, an independent federal agency that charters and oversees credit unions nationwide, this past February released broad and substantive changes to its member business lending (MBL) rules.

These changes, the bulk of which are slated to be implemented in January 2017, remove most prescriptive limits (collateral and security requirements, equity requirements and loans limits) in favor of a more “principles-based” regulatory approach intended to promote commercial lending by credit unions that is safe and sound.

As a broker, you are in a unique position to help educate and support your credit-union partners as they transition to this new era of regulatory oversight in the commercial mortgage market. In that light, there are some key steps that credit unions need to take now to successfully prepare for and capitalize on this historic opportunity.

Flexibility and autonomy

Total credit-union business loans grew from $15.1 billion in 2006 to $54.5 billion as of March 2016, according to data from Callahan & Associates. NCUA’s revamped MBL rules are designed to address credit unions’ success and growing experience in commercial lending. Following are some of the major highlights of the new rules.

Nearly all loan limits and restrictions that previously required a waiver application have been eliminated from NCUA Regulations Part 723. This includes the removal of all loan-to-value (LTV) requirements — formerly 80 percent maximum LTV on most loan types and 75 percent LTV for construction and development (C&D) lending. Also eliminated is the aggregate portfolio limit on C&D loans — previously set at 15 percent of net worth. The new rule also clarifies the definition of a C&D loan, clarifies how collateral values are determined, and adds additional requirements for monitoring and releasing loan disbursements during the construction period. Additionally, credit unions now have the option to raise their single-borrower policy limit from 15 percent of net worth to 25 percent under certain circumstances, and the personal-guarantee requirement has been removed.

To ensure full compliance with the statutory business-lending limits contained in the Federal Credit Union Act, while focusing board oversight on true commercial loan risk, the NCUA created separate and distinct definitions for a “commercial loan” and a “member business loan.” Small and less-active credit unions are exempted from this provision. The new rules, for example, define a loan secured by a one- to four-family residence, which is not the member’s primary residence, as an MBL. Such a loan still counts against a credit union’s MBL cap limit, but will not have to be monitored as a commercial loan. Credit unions may include the definitions and criteria for both MBLs and commercial loans in a single overarching business-lending policy.

The NCUA also has eliminated the explicit two-year commercial lending experience requirement, but now requires credit-union boards to have “qualified personnel to manage the commercial risk and adequate reporting to understand the level of commercial risk.” In addition, the rules define distinct roles and responsibilities for boards, senior management and commercial lending staff, and require strict oversight of third-party companies involved in any aspect of commercial lending.

Finally, credit unions that engage in non-member participation-loan purchases may now exclude such loans from their MBL cap limit. This provision was previously available as a limited waiver, but will now be automatically available to all eligible credit unions.

It should be noted that the Independent Community Bankers of America has filed a lawsuit against the NCUA challenging its new MBL rules — specifically the provision allowing nonmember participation loans to be excluded from the MBL cap. Although the NCUA filed a brief in November 2016 seeking to dismiss the lawsuit, the outcome of this litigation remains uncertain as of the time of this writing.

Preparing for change

Credit unions are busy preparing for full implementation of the new rules starting this month. As part of that process, commercial mortgage brokers who partner regularly with credit unions should encourage them to take some steps immediately.

  • Determine and refine the appetite for risk: Ideally, the credit union’s board and management conducted a full-market risk assessment well before it granted its first commercial real estate loan. Such an assessment should include: target industries, defined associated-borrower loan limits, property types, geographic areas served, and maximum loan-to-values. The major change with the new MBL rules is that virtually all prescriptive requirements have been removed, so credit unions can no longer simply insert the NCUA’s defined limits into their policies. It is important for credit unions to take their time, consider hiring a third-party consultant to help analyze members’ needs, and openly discuss the organization’s appetite and capacity for risk.
  • Update lending policies: If the credit union already has a business-lending policy, it needs to be updated with the new provisions and presented to its board of directors for approval. The policy must contain very specific definitions, underwriting standards, loan-to-value and portfolio limits, and defined roles and responsibilities for the board, senior management and commercial lending staff. Also, unless the credit union is exempt based on its asset size and commercial lending activity, the new criteria for “commercial loans” must be referenced in the policy.
  • Revisit all current policies and procedures: While the above step is non-negotiable, credit unions should not stop at simply updating their commercial lending policy with the bare-minimum requirements. All commercial lending policies, processes and procedures must be compliant with the latest regulatory guidance, yet tailored for the institution’s specific needs. Credit unions should consider policies and procedures for appraisals and environmental due diligence to be at the top of the list.
    Real estate appraisal regulations have evolved substantially in recent years, and it is worth revisiting internal appraisal policies and procedures if they haven’t been updated in a while. According to the Interagency Appraisal and Evaluation Guidelines published in the Federal Register (Vol. 75, No. 237) on Dec. 10, 2010, financial institutions (with certain exceptions for small or rural institutions) must maintain independence of functions within their real estate appraisal and evaluation programs. The guidelines also contain detailed instructions pertaining to establishing and maintaining an approved-appraiser list, sending out engagement letters to third-party appraisal companies and adhering to Uniform Standards of Professional Appraisal Practice.
    On another front, there are few aspects of pre-loan due diligence that can derail a deal as quickly as the discovery of a surprise environmental hazard on the collateral property. Worse yet are the post-closing impacts such as: lender liability, risk of default and effects on the credit union’s reputation. As with appraisals, credit unions should document clear and specific criteria for what types of environmental due diligence will be done based on collateral and deal size. Roles and responsibilities should be well-defined in policies and procedures, due diligence should be completed early in the deal, and borrower exceptions and negotiations should be kept to a minimum.
    Appraisal and environmental due diligence are two key but often-overlooked areas of risk for financial institutions. As a mortgage broker, you have a unique opportunity to add value to your relationship with your credit-union partner by recommending they review and revise their processes and procedures in these important functions.
  • Begin preparing now for the next safety and soundness exam: The NCUA has signaled it will ramp up its examiner training and even hire former commercial bankers and bank examiners to ensure a focused examination process. This is important, because the new guidance offers credit unions much greater flexibility to manage their programs the way they see fit. But whatever level of flexibility a credit union’s board decides to inject into its commercial lending policies, the institution must be able to justify it to their examination team. Just as critically, all production staff must fully understand policy and be held accountable.
  • Partner with a third-party risk-management consultant: Regardless of a credit union’s stage of growth in commercial lending, an experienced, specialized risk-management consulting practice can offer guidance in meeting the new compliance requirements while taking advantage of the additional flexibility available in the new rules. Suggest to your credit-union partners that they retain a company with a track record of working with banks as well as credit unions, and one that has engaged with regulatory examiners in the past.

Some third-party vendors also offer a wide range of services to support commercial lending operations, from underwriting and document preparation, to annual reviews and portfolio risk management. By leveraging the focused expertise of an experienced third-party service provider, credit unions can unshackle their staff to source and close more deals without devoting valuable internal resources to specialized support functions. 

•  •  •

With the NCUA’s recent implementation of broad changes to its MBL rules, credit unions are now able to craft a commercial real estate lending program focused on their specific needs. Along with this opportunity, however, comes the responsibility to fully evaluate market risks, implement secure and efficient lending processes, and monitor the health and compliance of the overall portfolio.

By taking certain key and necessary action steps now, credit unions can ensure a long-term and successful foray into commercial real estate lending.

 


 


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