The responsibilities of a credit union’s board of directors and management for its commercial lending activities is addressed in NCUA regulation § 723.3, Board of directors and management responsibilities. A credit union’s board is responsible for ensuring the institution’s commercial lending program is administered in a safe and sound manner and in compliance with applicable laws and regulations. The board of directors and senior management have crucial roles in maintaining a safe and sound commercial loan program.
A key principle in the member business loans and commercial lending rule (part 723, Member Business Loans; Commercial Lending) is that a credit union’s board of directors is ultimately accountable for the safety and soundness of the credit union’s commercial lending activities. The board must remain adequately informed about the level of risk in a credit union’s commercial loan portfolio. The rule reinforces the fiduciary responsibility of a credit union’s board for maintaining the safety and soundness of the institution, hiring competent staff, establishing appropriate policies and procedures, and for providing adequate oversight.
Adequate experience and expertise are essential to a safe and sound commercial lending program. Credit union personnel involved in commercial and member business lending must meet certain experience and expertise requirements (see §723.3(b)). Experience requirements are delineated between the qualifications required for a credit union’s senior executive officers and its staff. By having experienced and risk-management oriented senior management oversee commercial lending, credit unions are more likely to ensure that loans are granted safely, that staff possess necessary skills, and that loans are well structured to meet the needs and interests of members. Credit unions have options for how they may meet experience requirements. Subject to the provisions set forth in § 723.7(c), credit unions may rely on internal personnel, external personnel, or a combination of the two to satisfy their staffing needs. See § 723.3(b)(3).
Board of Directors
Per § 723.3, Board of directors and management responsibilities, a federally insured credit union’s board of directors must:
- Approve the commercial loan policy
- Ensure the credit union appropriately staffs its commercial lending program in compliance with § 723.3(b), and
- Understand and remain informed about the nature and level of risk in the commercial loan portfolio, including its potential impact on the credit union’s earnings and net worth
The board of directors must approve a commercial loan policy that complies with § 723.4, Commercial loan policy. The board should periodically reassess policies, because commercial loans are subject to business and economic changes that warrant frequent monitoring to ensure policy requirements remain effective. The policy must be reviewed at least annually, and more frequently if there is material change in a credit union’s portfolio performance or in economic conditions. The policy should be updated when warranted, and any policy updates must be approved by the board of directors.
To ensure effective governance, a credit union’s board of directors must understand the nature and level of risk associated with the institution’s commercial lending program and receive periodic updates from credit union management on the performance of the commercial loan portfolio. These updates should include, but are not limited to:
- Credit risk rating distribution and migration
- Loan growth
- Delinquencies
- Charge offs
- Workout activities
- Concentration by loan types, geographic areas, industries, etc.
- Policy exceptions
- Watch list loans
- Status of individual loan review and other risk monitoring, and
- Adherence to policy and regulations
It is also the board of directors’ responsibility to ensure that credit union management takes the necessary steps to identify, measure, monitor, and control these risks. This includes approving dollar thresholds for annual reviews, loan approvals, delegated approval authorities, exceptions, as well as exception thresholds.
The board of directors and senior management must also ensure their commercial lending program is staffed with personnel that have demonstrated appropriate expertise in managing the type of commercial lending in which the credit union is engaged. For example, if a credit union wants to engage in commercial lending activities to finance farm equipment, acquisition of farmland, or production expenses related to farming or ranching, it needs to ensure its staff has expertise in underwriting, servicing, identifying, and managing risks associated with agricultural loans.
Senior Management
Per § 723.3(b)(1), a federally insured credit union’s senior executive officers responsible for overseeing the commercial lending function must:
- Understand the credit union’s commercial lending activities
- Have a comprehensive understanding of the role of commercial lending in the credit union’s overall business model, and
- Establish risk management processes and controls necessary to safely conduct commercial lending activities
A credit union’s board of directors relies on senior management to directly oversee risk management activities and verify they are consistent with board policy. It is essential that senior executive officers have a comprehensive understanding of the credit union’s commercial lending activities and the ability to adequately oversee the management of the risks associated with those activities. Senior executive officers must ensure the credit union implements appropriate risk management processes to measure, monitor and control risks. Further, any staff involved in a credit union’s commercial loan program must have sufficient expertise in assessing and managing the risks associated with the type of commercial lending in which a credit union is engaged. Skills should be commensurate with each particular individual’s position and level of responsibility.
Managers responsible for a credit union’s commercial lending program should have demonstrated experience in:
- Overseeing commercial credit risk assessment and underwriting
- Managing and administering a credit risk rating system
- Managing a commercial loan portfolio and being held accountable for the risk in that portfolio, and,
- Managing commercial lenders and other risk managers
Qualified Lending Personnel
Per NCUA regulation § 723.3(b)(2), a federally insured credit union must employ qualified lending personnel with experience in the following areas:
- Underwriting and processing for the types of commercial lending in which the credit union is engaged
- Overseeing and evaluating the performance of a commercial loan portfolio, including rating and quantifying risk through a credit risk rating system, and
- Conducting collection and loss mitigation activities for the types of commercial lending in which the credit union is engaged
Maintaining appropriate staff expertise in the commercial lending area is a central pillar of a sound commercial lending program. Examiners should evaluate staff expertise when determining whether a credit union’s overall program is being managed in a safe and sound manner. When evaluating experience, examiners will primarily focus on the overall type and relevance of staff experience for those individuals involved in a credit union’s commercial loan program, with an emphasis on experience in commercial loan risk management. This includes experience requirements for any senior executive officers who oversee a credit union’s lending department and are otherwise accountable for the performance of the commercial loan portfolio.
More specifically, a credit union should have qualified lending personnel with:
- Experience directly related to the specific types of commercial lending in which the credit union is engaged
- Demonstrated experience in conducting commercial credit analysis and evaluating the risk of a borrowing relationship using a credit risk rating system
- Demonstrated experience in underwriting, processing, and conducting workout activities for the types of commercial lending in which the credit union is engaged, and
- Knowledge of the legal documentation necessary to protect the credit union from legal liability, and all relevant law and regulation impacting commercial lending activities
Meeting Experience Requirements
A credit union has multiple options to meet staff experience requirements. For example, it may meet the requirements by training and developing existing staff, hiring experienced professionals, or by using a third party such as a CUSO or an independent contractor. It is generally not prudent for a credit union that has newly adopted a commercial loan program to initially rely solely on training and developing existing staff, unless existing staff already possess the skills, competencies, and experience required.
Before using a third party, a credit union must ensure the third party meets the experience requirements outlined above. It is vital that a credit union possess sufficient in-house expertise to fully evaluate the reasonableness and accuracy of risk assessments and recommendations provided by any third party, and to effectively oversee the third-party relationship. Final responsibility for services provided by a third party, especially risk assessments, remains with a credit union because the risks associated with the transaction are borne by the credit union. While a credit union may use a third party for underwriting and assessing the credit risk, the credit union must ultimately make a credit decision. Before a credit union outsources key aspects of its credit risk management program to third parties, it should be satisfied it has internal staff that have a sufficient understanding of the key risks to comprehend and challenge the information they are getting from their third-party service providers. This is consistent with basic due diligence expectations and the NCUA’s guidance on evaluating third-party relationships. For more information, see NCUA Letter to Credit Unions 07-CU-13, Evaluating Third Party Relationships.
Lastly, as required by the conflict of interest provision in § 723.7(c), a credit union must ensure that there is no affiliation or contractual relationship between a third party and a borrower, or any associated borrowers, to avoid potential conflicts of interest. For example, if a third party is performing underwriting services for a credit union while also being compensated by a borrower for obtaining a loan, the conflict of interest provisions of the regulation have been violated. In addition, the risk assessment performed and provided by a third party must be based on a credit union’s underwriting criteria, as reflected in its commercial loan policy.
A strong risk management culture begins with good governance from the board of directors and management. By following the principles set forth in NCUA regulation § 723.4, Commercial loan policy, credit unions are more likely to have a successfully managed and controlled commercial lending program.
Last updated November 25, 2016
