LOANLINER Business Lending and Deposit Compliance Overview

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1 LOANLINER Business Lending and Deposit Compliance Overview Credit union member business lending (MBL) is heavily regulated by the Federal Credit Union Act and NCUA MBL rules. These laws impose a number of restrictions and limitations on MBL activity. One of the most significant limitations is the cap that limits the total amount of all outstanding MBLs to no more than 12.25% of the credit union s total assets or 1.75 times the credit union s net worth, whichever is less. A few states have applied for and received approval of special state member business loan rules that apply only to state chartered credit unions. These rules for the most part, are substantially similar to the NCUA rule. The Federal Credit Union Act Limitations on Powers The limitations on powers, Federal Credit Act section 1757a, apply to all federally insured credit unions, not just credit unions with a federal charter. Although the Act limits credit union business lending activity, there is no limitation on credit unions ability to offer business services such as cash management, coin services, night depository, and merchant credit card acceptance services. Limitations on Membership The Act limits credit union membership to people or organizations with a specific geographic community or to groups of individuals related by a common bond. Credit unions may only serve people and organizations within the field of membership they are chartered to serve; therefore FCUs business lending activities are limited to their field of membership. In the case of FCUs chartered to serve a community, the Act clearly states that organizations, may become members of a community chartered FCU. For closed chartered FCUs only serving members of select common bonds, a business may become a member if: 1) The organization is specifically listed in the federal credit union s charter as a member; or 2) If the FCUs charter includes in its field of membership organization of such persons and the organization is composed exclusively of persons currently within the FCUs field of membership. 1 NCUA Rules and Regulations Part MBL Definition of a MBL The MBL Rule defines a member business loan as any loan, line of credit or letter of credit made for a commercial, corporate, agricultural or business property investment or venture purpose. Excluded from the definition are the following types of loans: a) Loans fully secured by a lien on owner occupied 1-4 family dwellings that are the member s primary residence; b) Loans fully secured by shares in the credit union or deposits in other financial institutions; c) Total loans to one member or associated members of less than $50,000;

2 d) Loans fully insured or guaranteed for repayment by a federal or state agency or that are subject to an advance commitment to repurchase by a federal or state agency. It is important to recognize that it is the purpose for which the loan is made not the collateral with which the loan is secured that determines whether the loan must be classified as a business loan. Limitations on Amount of MBLs Credit unions may grant no more than $100,000 or 15% of the credit union s net worth, whichever is greater, in business loans (including unfunded commitments such as letters of credit) to one member or group of associated members. Waivers from this limitation are available by applying to the credit union s regional NCUA director. The aggregate amount of business loans made for the construction or development of commercial or residential property may not exceed 15% of the credit union s net worth. Waivers from this limitation are also available by applying to the credit union s regional NCUA director. The aggregate total of all business loans, including loans to one member and loans for construction or development purposes is limited to the lesser of 1.75 times the credit union s net worth, or 12.25% of the credit union s total assets. Net worth consists of all of the credit union s retained earnings, including: undivided earnings, regular reserves, and any other appropriations made by management or required by regulatory authorities. Certain credit unions may qualify for an exemption from the aggregate business loan limits. The following credit unions are not subject to any maximum cap on business lending: Credit unions with a low-income designation or that participate in the Community Development Financial Institutions program; Credits unions that can provide documentary evidence of being chartered for the purpose of making MBLs; and Credit unions that have a history of primarily making member business. (To qualify as having a history of primarily making business loans, at least one call report filed between January 1995 and September 1998, or equivalent documentation, including financial statements, must show that MBLs comprised at least 25% of the credit union s outstanding loans or that MBLs comprised the largest single portion of the credit union s loan portfolio). MBL Lending Requirements Credit unions cannot grant MBLs unless the credit granting decision is made utilizing the services of a person with at least two years direct experience in the type of lending in which the credit union is engaging. The rule allows the credit union to satisfy the two-year experience requirement by obtaining the required business lending expertise from CUSOs, other credit unions, independent contractors, or other third parties. However, the rule points out that the final decision to grant the loan must lie with the credit union. Before a credit union may begin making MBLs, the credit union must adopt a specific MBL policy. See MBL Policies Must Include. Generally, MBLs must be secured by collateral. However some exceptions exist for credit cards and certain vehicle loans. Loan Type Business loans excluding construction or development of commercial or residential property Business loans excluding construction or development of commercial or residential property with private mortgage or equivalent insurance Maximum LTV 80% 95% 2

3 For business loans granted for the construction or development of commercial or residential property, the principal must have at least a 25% equity interest in the project being financed. However, credit unions may finance the construction of one single family home that is under a contract to purchase upon completion and one additional single family home even if the principal does not satisfy the 25% equity requirement. In addition, principals of the business must provide their personal guarantee for the loan, unless the loan is made to a not-for-profit organization as defined by the Internal Revenue Service Code (26 U.S.C. 501) or the credit union meets the RegFlex standards of Part 742 of the NCUA rules and regulations. Credit unions may obtain a waiver from these collateral or guarantee requirements by applying to their regional NCUA director. Prohibited MBLs The MBL rule forbids credit unions from granting loans to the credit union s chief executive officer (the rules indicate this includes persons holding the title President, Treasurer or Manager), any assistant chief executive officers (including Assistant President, Vice President or Assistant Treasurer/Manager), the chief financial officer (Comptroller) or any associated member or immediate family member of any of the preceding individuals. The risk based net worth calculation requires credit unions to apply a 6% risk weighting factor to the standard risk based net worth requirement calculation to MBLs comprising less than 15% of the credit union s total assets. Credit unions must apply an 8% risk weighting to the portion of MBLs that comprise more than 15% but less than 25% of total assets. A 14% risk weighting factor must be applied to the portion of MBLs that comprise more than 25% of total assets. Some credit unions may not be sufficiently capitalized to satisfy the risk based net worth ratio. These credit unions may voluntarily or by order of the NCUA be required to curtail member business lending activity as a means of reducing and bringing risk based net worth ratios in line with the credit union s actual net worth ratios. Part 722 Appraisals On March 1, 2002 the NCUA amended the requirement for appraisals on MBLs. The NCUA no longer requires appraisals for business loans where the transaction is $250,000 or less. While appraisals are not required for these transactions, the credit union must document that it performed a valuation of the collateral. Appraisals are required for transactions greater than $250,000 secured by real estate. However waivers from this requirement are available by applying to the credit union s regional NCUA director. Part Prompt Corrective Action The prompt corrective action rule may act as a constraint on business lending activity. This rule requires certain credit unions meeting the definition of complex to maintain a net worth ratio that is not less than a risk based net worth ratio calculated according to the requirements of the regulation. The risk based net worth ratio applies a risk factor to the percentage of certain assets in a credit union s investment and loan portfolio. 3

4 MBL Policies Must Include 1) The types of business loans the credit union will make. 2) The credit union s trade area. 3) The maximum amount of the credit union s assets, in relation to net worth, that the credit union will invest in business loans. 4) The maximum amount of the credit union s assets, in relation to net worth, that the credit union will invest in a given category or type of business loan. 5) The maximum amount of the credit union s assets, in relation to net worth, that the credit union will loan to any one member or group of associated members. 6) The qualifications and experience of personnel involved in making and administering business loans. 7) A requirement to analyze and document the ability of the borrower to repay the loan. 8) Receipt and periodic updating of financial statements and other documentation, including tax returns. 9) A requirement for sufficient documentation supporting each request to extend credit, or increase an existing loan or line of credit (except where the board of directors finds that the documentation requirements are not generally available for a particular type of business loan and states the reasons for those findings in the credit union s written policies). Depending on the nature of the loan, the credit union should consider including and reviewing the following information in each business loan file. Some loans may require more detailed analysis than others. a) Balance sheet b) Cash flow analysis c) Income statement d) Tax data e) Analysis of leveraging f) Comparison with industry average or similar analysis 10) The collateral requirements must include: a) Loan-to-value ratios b) Determination of value c) Determination of ownership d) Steps to secure various types of collateral e) How often the credit union will reevaluate the value and marketability of collateral 11) The interest rates and maturities of business loans 12) General loan procedures which include: a) Loan monitoring b) Servicing and follow-up c) Collection 13) Identification of those individuals prohibited from receiving MBLs. 4

5 Federal Regulations Equal Credit Opportunity Act/Federal Reserve Regulation B Business loans are subject to the Equal Credit Opportunity Act and its implementing regulation, Regulation B with the same applicability as for loans to consumers. Differences exist with regard to notice requirements. Home Mortgage Disclosure Act/ Federal Reserve Regulation C The Home Mortgage Disclosure Act imposes detailed data collection and reporting requirements on certain credit unions with respect to home purchase and home improvement loans. Loans to purchase or improve a home are subject to HMDA, even if the loan must be classified as a business loan because it is for investment purposes and will not be occupied by the purchaser. Credit unions subject to HMDA should already be familiar with the requirements of this regulation. Depository Institution Deregulation and Monetary Control Act Regulation D The special account category for non-personal time deposit has a higher reserve requirement than natural person deposits. Electronic Funds Transfer Act Regulation E Not applicable to business accounts. However credit unions may choose to provide their consumer Reg E disclosure to business members. Collection of Checks and Other Items Regulation J Same applicability as consumer transactions. Truth-in-Lending Act Regulation Z Regulation Z specifically excludes loans made primarily for a business, commercial, agricultural or purpose or to a non-natural person or government entity. Consequently properly documented business loans are not subject to the complex disclosure requirements of Regulation Z. However, Reg. Z credit card protections relating to issuance and to a limited extent unauthorized use apply even in the case of business credit cards. Expanded Funds Availability Act Regulation CC Same applicability as consumer accounts. Fair Credit Reporting Act While the Fair Credit Reporting Act does not apply to credit reports concerning a loan to a business, credit unions will often have to comply with this statute even where a business loan is involved. The MBL Rule requires credit unions to obtain the personal guarantee of all principals. Because of this requirement credit union will likely be taking into consideration the credit history of the principal(s) of the business to determine whether to grant a loan to the business. In addition, because the principal has personally guaranteed the loan, credit unions may use the business loan performance to report on the principal(s) to the credit bureaus. Credit unions are required to comply with the act both in obtaining a credit report on a principal and in reporting on that principal s credit performance. Consumer Leasing Regulation M Same applicability as consumer transactions. Credit by Banks for the Purpose of Purchasing or Carrying Margin Stock Regulation U Same applicability as consumer transactions. 5

6 Bank Secrecy Act USA Patriot Act The Currency Transaction Reporting is applicable to business accounts. Certain businesses who regularly handle a large volume of cash can obtain exemptions. The Customer Identification Requirements require identification and verification of the business identity. Small Business Administration The Small Business Administration has programs available providing for federal guarantees of certain small business loans. Credit unions may exclude from the 12.25% cap on MBLs any loan that is guaranteed by a state or federal agency. The business loans guaranteed by the SBA are excluded from the cap. Although there is sufficient flexibility in the MBL rule to allow the NCUA to approve state MBL rules with fewer restrictions, the NCUA does not have the power to approve a state rule that deviates from requirements or limitations specified in Credit Union Membership Access Act (CUMAA). Because the 12.25% of assets limitation on MBLs is a part of the statue, the NCUA could not approve a state MBL rule that would allow credit unions to exceed this limitation. Please refer to the LOANLINER Business Documents Users Guide for document usage instructions to comply with the regulations in your state. State MBL Rules for State Chartered Credit Unions There is no requirement that states MBL rules be identical to the NCUA rule. In fact six states, Connecticut, Maryland, Missouri,Texas,Washington and Wisconsin have separate MBL rules for state chartered credit unions. However, significant differences that once existed between state and federal regulations have been largely eliminated due to recent changes to the NCUA MBL rule. 6