AI ConnectProposed Member Business Loan

Ruleand

Overview and updates to the Appraisal Rule

Vincent Vieten, MBL, Program OfficerOffice of Examination and Insurance

July 27, 2015

National Credit Union Administration

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Member business loans have grown significantly over the last ten years

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 $-

$10

$20

$30

$40

$50

$60

0%

2%

4%

6%

8%

10%

12%

14%

16%

$2.2

$12.3

$48.7

1.2%

3.0%

6.8%

MBL Balance* and as % of Total Loans

MBL Balance MBL as % of Total Loans

Year

Mem

ber

Busi

ness

Loa

n Ba

lanc

e (in

bill

ions

)

MBL

as

% o

f Tot

al L

oans

• Member Business Loan balance includes both member and nonmember business loans. Does not include unfunded commitments. Total MBLs including unfunded commitments is $51.7B.

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Total Assets Less than 100MM

Total Assets 100MM - 500MM

Total Assets Greater than 500MM

All 0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

13%

53%

72%

19%21%

77%

93%

36%

2004 2014

A growing percentage of credit unions have MBLs

% of Credit Unions with MBLs

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Number of credit unions by MBL as % of total assets

– All FICUs

No MBL

0-1% 1-2% 2-3% 3-4% 4-5% 5-6% 6-7% 7-8% 8-9% 9-10% 10-11%

11-12.25

%

12.25-15%

15-25%

25-35%

35-50%

50-100%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,5004035

656342

179 172 129 117 89 96 82 78 73 76 43 62 9 16 19

# of Credit Unions(Dec. 2014)

MBL as % of Total Assets

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Credit unions tend to make relatively small business loans

Metrics Credit Unions with MBLs Additional Info

# of CUs With MBLs 2,238 36% of Total CUs

Total Assets (in billions) $975 87% of Total CU

Assets

Median Asset Size (in millions) $117 $24

All CUs

MBLs as % of Total Loans 8.1% -

# of CUs Originating MBLs in 2014 1,522 -

Total # of MBLs ( in thousands) 238 -

Credit Union MBL Activity (Dec. 2014)

Total Asset SizeTotal MBL

Balance (in billions)

Average Loan Size (in thousands)

<100MM $1.9 $93

100MM – 250MM $4.4 $141

250MM – 500MM $6.2 $179

500MM – 1B $9.6 $205

>1B $29.7 $281

Total $51.7 $217

Average MBL Size (Dec. 2014)

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Over 80% of MBLs are secured by real estate

MBL Composition by Collateral Type(Dec. 2014)

11 12 13 140%

20%

40%

60%

80%

100%

84% 83% 83% 83%

15% 16% 16% 16%

1% 1% 1% 1%

Year

% o

f Tot

al M

BLs

Non owner-occupied Nonfarm and Non-

residential; 30%

Nonfarm Res-idential*, 21%

Owner-occupied Nonfarm and Non-

residential; 23%

Commerical and Industrial; 14%

C&D Loan; 4% Ag Loan; 4% Unsecured and other; 1%

MBL Composition by Loan Type(Dec. 2014)

% of Total MBLs

Secured by Real Estate

Secured by Non-Real Estate

Unsecured

* Nonfarm, residential includes investor 1-4 family residential real estates.

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Most credit unions with MBLs offer several business loan products

With 1 MBL Product; 722

With 2 MBL Products; 397

With 3 or more MBL Products; 1,119

# of Credit Unions with MBLs (Dec. 2014)

(32% of Total)

(18% of Total)

(50% of Total)

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04 05 06 07 08 09 10 11 12 13 140.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

0.4%

4.1%

0.9%

0.3%

2.3%

0.9%

0.2%

1.6%

0.8%0.00665715241071165

1.3%

2.1%

0.9%

0.011618995325431

MBL 1st Lien RE loans Other RE loansAuto Loans Credit Cards Student Loans

Year

Delinquency Rate (60+) by Loan Type*(Dec. 2014)

* Please note that 1st lien real estate loans, other real estate loans, and auto loans may also include MBLs.

Credit union MBL delinquency rates were much higher than other loan types during the recession

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05 06 07 08 09 10 11 12 13 140.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

0.1%

1.0%

0.3%0.0%

0.4%

0.1%0.1%

1.3%

0.3%0.00506209279137622

2.2%

4.3%

1.9%

0.00232249941824973

MBL 1st Lien RE loans Other RE loansAuto Loans Credit Cards Student Loans

Year

Net Charge-off Rate by Loan Type*(Dec. 2014)

* Please note that 1st lien real estate loans, other real estate loans, and auto loans also include MBLs.

Credit union MBL net charge-off rates were manageable during the recession

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30+ Delinquency Rate ComparisonCredit Unions vs. Banks

Credit union MBL delinquency compared to banks

* Data Source: Bank data from SNL

05 06 07 08 09 10 11 12 13 140.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

5.7%

1.8%

5.1%

1.2%

Credit Unions Banks with Total Assets <$50B

Year

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Net Charge-off Rate ComparisonCredit Unions vs. Banks

Credit union MBL net charge-offs compared to banks

* Data Source: Bank data from SNL

05 06 07 08 09 10 11 12 13 140.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.0%

0.3%

1.5%

0.1%

Credit Unions Banks with Total Assets <$50B

Year

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Total MBL related share insurance fund losses over the last five years are roughly $141MM , representing 25% of total losses

Total Losses to Share Insurance Fund

($ in millions)

Losses due to MBLs as contributing factor*

($ in millions)% of Total

2010 $233.9 $6.0* 2.6%

2011 $46.7 $0 0%

2012 $187.2 $135.4* 72.3%

2013 $65.5 $4.0* 6.1%

2014 $40.4 $0 0%

Total $573.7 $141.4 24.7%

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81% of credit unions with MBLs have a CAMEL rating of 1 or 2, compared to 69% for credit unions that do not offer MBLs

CAMEL Distribution for Credit Unions with MBLs (Dec. 2014)

17%

64%

17%3%

0%

1 2 3 4 5CAMEL

CAMEL Distribution for Credit Unions without MBLs (Dec. 2014)

11%

58%

27%

5%

0%

1 2 3 4 5CAMEL

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The role of prudent business lending in credit unions

• CUs are well suited to serve small businesses, a vital and growing segment of their membership

• Improving access to financial services for small businesses helps create jobs

• Properly structured & priced, MBLs can have a positive impact on earnings and net worth

• MBLs can enhance portfolio diversification

• MBLs potentially offset IRR of long-term, fixed-rate residential real estate loans

• The key beneficiary of prudent business lending is the member who will receive financing that meet their needs and within their ability to repay

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Important fundamental questions about business lending

Question Answer

Can business lending be done safely? Yes

Is business lending more complex than consumer lending? Yes

Is business lending more risky than other types of lending? It depends

Should only institutions with the requisite expertise, policies, and procedures engage in business lending? Yes

Are violations of the current prescriptive regulatory requirements the primary cause(s) for the credit unions that have gotten in trouble with business lending?

No

What are goals of modernizing Part 723?

• Replace overly prescriptive requirements with principles-based standards

• Reinforce risk management requirements needed to safely conduct commercial lending activities

• Improve the expertise and policy provisions of the regulation

• Change supervisory focus to sound commercial risk management practices from compliance with prescriptive regulatory requirements

• Eliminate NCUA involvement in day-to-day operations of CUs by eliminating need for waivers

• Eliminate need for NCUA approval of state rules

• Distinguish between commercial loans (align with RBC) and the statutory definition of MBL

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Comparison of MBL and Commercial Loan Definitions

Type of Loan MBL Commercial Loan

Loan fully secured by a 1- to 4- family residential property (borrower’s primary residence) No No

Member business loan secured by a 1- to 4- family residential property (not the borrower’s primary residence) Yes* No

Member business loan secured by a vehicle manufactured for household use Yes* No

Business loan with aggregate net member business loan balance less than $50,000 No No

Commercial loan fully secured by shares in the credit union making the extension of credit or deposits in other financial institutions No No

Commercial loan in which a federal or state agency (or its political subdivision) fully insures repayment, fully guarantees repayment, or provides an advance commitment to purchase the loan in full

No Yes*

Non-member commercial loan or non-member participation interest in a commercial loan made by another lender No Yes*

* If the outstanding aggregate loan balance is greater than $50,000.

What are the key changes and enhancements? (Page 1 of 4)

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Provision Current Rule Proposed Rule

Construction and Development Loans

• 25% equity interest• 15% of net worth

• Removed the limits• Clearly defines collateral valuation

method• Requires CUs to value collateral

appropriately and ensure risk sharing • Requires CUs to set internal policy

limit• Stipulates loan administration

requirements

Loan Policy Requirements

• Limited coverage on risk management processes

• Requires underwriting commensurate with size, scope and complexity

• Requires a reliable credit risk rating system

• Stipulates sound risk management processes

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Provision Current Rule Proposed Rule

LTV • 80% • Removed the 80% limit• Requires sufficient collateral

commensurate with the level of risk

Personal Guarantee • Requires personal guarantee

• Removed the explicit requirement• Requires credit unions to determine

and document mitigating factors when personal guarantee is not required.

• Requires credit unions to set internal policy limits

What are the key changes and enhancements? (Page 2 of 4)

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Provision Current Rule Proposed Rule

MBLs to a Single Member

• The greater of $100K or 15% of net worth

• Maintains the 15% limit with added flexibility to go up to 25% if certain conditions are met

• Modifies the definition of “associated borrower”

Unsecured MBLs • Lesser of $100,000 or 2.5% of CU Net Worth to one member (Well Capitalized CUs only)

• 10% of CU Net Worth

• Removed the limits• Requires credit unions to set internal

policy limits

Experience Requirements

• 2 years of direct experience

• Removed the 2 year requirement• Specifies the types of experience

with emphasis on commercial credit risk management

What are the key changes and enhancements? (Page 3 of 4)

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Provision Current Rule Proposed Rule

State Rule • Requires NCUA approval for state rule

• 7 states have parallel state rules

• Principles-based rule obviates need for separate state rules

• Solicits SSA comments on the three options

Non-member business loan participations

• Included in the cap unless waiver is granted

• Removed non-member business loans from the calculation against the cap

• No longer requires waivers

Board Responsibilities • Limited coverage (adopt and review policy)

• Clearly articulates that the CU Board is ultimately accountable for the safety and soundness of the commercial lending activities

What are the key changes and enhancements? (Page 4 of 4)

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List of waivers no longer required

• Aggregate C&D Loan Limit

• Minimum Borrower’s Equity for C&D Loans

• LTV Requirement

• Personal Guarantee Requirement

• Maximum Unsecured MBL to One Member or Group of Associated Members

• Maximum Aggregate Unsecured MBL Loan Limit

• Maximum Aggregate Net MBL to One Member or Group of Associated Members

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LTV requirement

• Only CU loans and superior lien included in the LTV(All debt and related payments to be considered in ability to repay)

• Sufficient to share risk (borrower investment)

• LTV should reflect the impact of • Potential obsolesces• Marketability

• Single use• Condition• Alternatives uses

• Overall risk of the transaction

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Construction and Development

• Valuation of the collateral• Lesser of Cost or Market• Market to be determined as Prospective Value (USPAP

Statement 4)• Land contribution lesser of cost or market first 12 months market value after 12 months

• Costs to be included are clarified• All cost necessary to complete the project documented in an

approved budget• Interest reserve to be calculated based on projected

completion/stabilization date (incl. in approved budget)• Exclude preferential payments to equity holders, selling

cost to be paid from sales.

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Construction and Development

• Requires approved budget

• Requisition process and schedule

• Disbursement of funds after an inspection documented in a written report stating work is completed along with certification the remaining budget amounts are sufficient to complete the project

• Certification that there are no intervening liens

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Appraisals Required

• Generally required with most real-estate related transactions >$250,000

• Appraisals may also be required due to:– Higher-priced mortgage loan regulations (12 CFR

1026.35(c)) – NCUA safety and soundness concerns (12 CFR

722.3(e))

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Appraisal Exemptions

• Transaction value is $250,000 or less• Lien is taken as an abundance of caution• Entrance into a lease of real estate (unless an

economic equivalent of a sale/purchase) • Existing extensions of credit, including

advancement of new moneys, but only if the credit union can demonstrate there has been no obvious and material change which may affect the security interest (see section XIV of the 12/2/2010 Interagency Appraisal and Evaluation Guidelines)

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Appraisal Exemptions

• Existing loan(s) being sold, exchanged, traded, etc.• Transaction wholly or partially insured, guaranteed

by, or qualifying for sale to, a US government agency or US government sponsored agency(follow the guaranteeing agency requirements)

• NCUA has granted a waiver for a category of loans meeting the definition of a member business loan(proposed rule eliminates the waiver process)

• Note that NCUA regulations do not offer an exemption for business loans of $1 million or less

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Valuation Requirement

• For real-estate related transactions exempted, a written valuation must be performed by an individual qualified and experienced performing estimates of value for the property being considered and having no direct or indirect interest in the property.

• Refer to sections XII and XIII of the 12/2/2010 “Interagency Appraisal and Evaluation Guidelines” which sets forth the supervisory expectations for alternative valuation development and content.

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Minimum Appraisal Standards• Conform with USPAP • Written with sufficient information and analysis

supporting the transaction decision• Analyze and report deductions and discounts for

proposed construction or renovation, partial leasing, non-market lease terms, and track developments with unsold units

• Based on the definition of market value• Performed by licensed or certified appraiser as

required by 12 CFR 722.3

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Appraisal Review

Ensures compliance with regulations, internal policy, and adherence to supervisory guidance. The review process should: • Be performed by an independent, trained, and

experienced reviewer • Reflect a risk-focused approach in depth and scope• Establish a process for resolving any deficiencies in

appraisals or evaluations• Set forth documentation standards for the review

and the resolution of noted deficiencies

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Appraiser Independence

Person(s) making the selection of appraisers should be independent from the loan production area. The fee appraiser must:– Be engaged directly by the credit union or agent– Have no direct or indirect interest in the property

or the transaction

An appraisal prepared by an appraiser directly engaged by another financial institution may be acceptable under certain conditions (see 2010 Interagency Appraisal and Evaluation Guidance).

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Discussion