Commercial Loan Policy

A federally insured credit union engaged in commercial lending that is not exempt from NCUA regulations §§ 723.3, Board of directors and management responsibilities and 723.4, Commercial loan policy, must adopt and implement a comprehensive written commercial loan policy and establish procedures for commercial lending. The policies and procedures must provide for ongoing control, measurement, and management of the credit union’s commercial lending activities.

All credit unions must have a board-approved loan policy covering their lending activity in general, including those credit unions that qualify for the exemption. Exempt credit unions must ensure their general loan policy (required by part 701, Organization and Operation of Federal credit unions) covers the types of commercial loans the institution makes, including satisfying all other applicable commercial lending requirements in part 723, Member Business Loans; Commercial Lending.

The commercial loan policy must be approved by the board of directors. While a credit union’s board of directors can delegate the responsibility to its committee, the board is ultimately accountable for the safety and soundness of a credit union’s commercial lending activities.

The board-approved commercial loan policy must be reviewed at least once a year and updated when warranted. The policy should be reviewed more frequently if there is a material change in the commercial lending program or related organizational structure, and in response to any material change in portfolio performance or economic conditions (see § 723.3(a)(1)).

NCUA regulation § 723.4, Commercial loan policy, specifies that a commercial loan policy must address each of the following, at a minimum:

The policy should also include the pertinent requirements under Section 107(5) of the Act that contains limitations on loan maturity not to exceed 15 years and a prohibition on prepayment penalties. In certain states, there are exceptions (based on state law) to these restrictions for FISCUs.

Types of Commercial Loans Permitted

A credit union should analyze its membership and ensure its commercial lending staff has the necessary expertise, gained through experience and training, to understand the needs of the membership and the types of loans offered.

Trade Area

A credit union must be certain it is capable of serving its identified trade area. Trade areas are influenced by local demographics, economics, and industries. Credit unions should be familiar with the influences on the trade area and develop policies to ensure they monitor and react to changes in the trade area. Because effective risk management requires that a credit union have the ability to make periodic site visits to evaluate a borrower’s operations and inspect collateral, the trade area should be reasonably accessible to a credit union.1

Portfolio Concentration Limits

A credit union must set portfolio concentration limits, as a percentage of net worth, for all types of commercial loans, unsecured commercial loans and commercial loans without a personal guarantee. It should also set portfolio concentration limits by types of commercial loans, such as C&D loans, commercial and industrial loans by industry type, income-producing or owner-occupied commercial real estate loans, agricultural loans, etc.

NCUA Letter to Credit Unions 10-CU-03, Concentration Risk , states the board of directors must establish a policy which addresses its philosophy on concentration risk, limits commensurate with net worth levels, and the rationale as to how the limits fit into the overall strategic plan of the credit union.

The board should use a global perspective when developing this policy, including identifying outside forces (such as economic or housing price uncertainty) which will affect the ability to manage concentration risk. The parameters set by the board should be specific to each portfolio and should include limits on loan types, share types, third-party relationship exposure, etc. The risk limits should correlate to the overall growth objectives, financial targets, and net worth plan. The risk limits set forth in the concentration risk policy should be closely linked to those codified in related policies, including, but not limited to, real estate loan, member business loan, loan participation, asset/liability management (ALM), and investment policies. Concentrations that exceed 100 percent of net worth must be monitored carefully, and the board of directors should document an adequate rationale for undertaking that level of risk.

Single Borrower Limits

A credit union’s commercial lending policy must specify the aggregate dollar amount of commercial loans to any one borrower or group of associated borrowers. A single-borrower limit based on a percentage of the lender’s net worth is essential to prevent imprudent concentrations in any single borrower. This limit applies at the time a loan is granted.

The aggregate dollar amount of commercial loans to any one borrower or group of associated borrowers may not exceed the greater of:

  • 15 percent of a federally insured credit union's net worth, or $100,000, plus
  • An additional 10 percent of a credit union's net worth, if the amount that exceeds the credit union's 15 percent general limit is fully secured at all times with a perfected security interest by readily marketable collateral.

Consistent with banking regulations, the NCUA defines readily marketable collateral as financial instruments or bullion that are salable under ordinary market conditions with reasonable promptness at a fair market value determined by quotations based upon actual transactions on an auction or similarly available daily bid and ask price market. Inherent in the definition is that readily marketable collateral is liquid, saleable, and actively bought and sold in a normally-functioning marketplace. Such collateral will generally be in the form of bullion, currency, certain financial institution accounts (savings, checking, share, and some money market accounts), and high-quality securities. Securities may either be marketable equity or marketable debt instruments.

For a security to be marketable, it must be readily saleable for cash on short notice and in large quantities. Importantly, cash convertibility with little risk of principal loss is a key characteristic for highly-liquid instruments. As such, marketable-security collateral is generally limited to the most liquid assets, and their maturities tend to be less than one year. These shorter maturities (and lower effective durations) mean they can be bought or sold in any quantity with little effect on their prices. Typical examples of marketable securities include U.S. Treasury Bills, commercial paper and other money market instruments with maturities less than one year.

The favorable liquidity and price stability of readily marketable collateral make it a strong and stable form of credit enhancement. In cases where a credit union wants to increase its single obligor exposure to one borrower (or a group of associated borrowers) above fifteen percent and in an amount up to but not exceeding twenty five percent, it must fully secure the amount above fifteen percent with true readily marketable collateral that meets the quality, liquidity, and maturity distinctions that make it highly safe at all times. A credit union should not use assets that are price volatile, illiquid, or less marketable for this purpose. Examiners should solicit the assistance of a Regional Capital Markets Specialist if they are unsure if the collateral meets the requirements.

A key element of measuring single-borrower exposure is to determine the associated individuals and entities that comprise the borrower’s business relationships. The identification of associated borrowers captures those parties who are interdependent and have operational influence with the borrower due to shared ownership and management. (See Associated Borrowers.)

Qualifications and Experience Requirements for Lending Staff

A credit union should, in developing staffing requirements, consider relevant factors specific to the credit union and to the needs of its commercial borrowing members. Staffing should be determined based on loan volume, projected loan growth, trade area, complexity of the borrowing relationships, types of loans permitted, and any other unique influences on the credit union’s commercial loan portfolio.

In determining staffing levels, a credit union should consider appropriate levels of management, relationship managers, and support staff as may be required to ensure member’s needs are responsibly serviced in a safe and sound manner. (See the experience section in Board and Management Responsibilities).

A credit union should also consider an appropriate separation of duties to prevent potential conflicts of interest and other problems in the loan underwriting, collection, and portfolio monitoring functions. An appropriate separation of duties provides for a strong internal control to prevent fraud and error. A credit union should strive to achieve separation of duties wherever possible.

Loan Approval Processes

A credit union’s commercial loan policy must establish lending authority for approving credit decisions. A credit union must establish a process that assigns credit approval authority to individuals or to committees that make such decisions commensurate with the individual’s or committee’s experience evaluating and understanding commercial loan risk.

In addition, the approval process should ensure an adequate level of review and approval by senior management before loan decisions are made for complex or large loans or credit relationships. All lending authority limits should be assigned based on a borrower’s (and associated borrower’s) aggregate loan relationship. The MIS should capture sufficient data to allow adequate oversight and review of the loan approval process. The data should include, but is not limited to, all loan approvals or denials tracked by the loan department and officers. It should be periodically reported to senior management.

Underwriting Standards

The level and depth of credit analysis and risk assessment should be commensurate with the overall risk the borrowing relationship poses to a credit union based on its size, risk and complexity. A credit union’s commercial loan policy must address the required analysis and depth of the financial review performed to support a credit decision. It should establish the approval process, including the lending authorities and the documentation of the credit decision. It should also outline the required components of a credit approval document.

The approval process and documentation should provide sufficient information to allow the approving body to make a fully informed credit decision. A commercial loan policy should also set the requirements for the financial reporting to support a credit decision. It should address the minimum criteria for historic reporting at the inception of the loan, as well as regular reporting after the loan is closed, and the required quality of financial information to establish an accurate and reliable assessment of financial trends. Risks should be monitored throughout the life of a loan based on periodic review of the financial position of the borrower and site visits to detect any operational changes.

A credit union’s borrower analysis should focus on the borrower’s financial condition and ability to repay. The analysis should include income and expense trends, debt service ability, balance sheet changes, and the impact of those changes on the borrower’s ability to service debt. The analysis should discuss the required evaluation of related parties and the influence those parties have on a borrower’s ability to repay a loan. (See Financial Analysis and Credit Approval Document.)

The policy must establish due diligence requirements to evaluate the other sources of income or losses that affect the guarantors or principals to determine the global financial condition and the debt service ability of a borrower and any associated borrowers.

The policy should establish requirements for financial projections, which will ensure a borrower is actually planning and managing operations to achieve future goals. Financial statement projections should be required when a borrower’s historic performance does not support the proposed debt repayment, or when a credit union anticipates structural change in the borrower’s future operations, and repayment depends on the success of the changes. A borrower or principal must prepare such a projection, because they are responsible for executing and achieving the projected plan.

A credit union’s underwriting standards must address the quality of the financial information used to make a credit decision and ensure that the degree of verification reflected in the financial information is sufficient to support the financial analysis and the risk assessment of a credit decision. A credit union can determine the quality of a financial statement using the level of assurance provided by a preparer and the required professional standards supporting the preparer’s opinion.

In many cases, borrower-signed tax returns or financial statements professionally prepared in accordance with GAAP are sufficient for less complex borrowing relationships, such as those that are limited to a single operation of the borrower and principal with relatively low debt. For more complex and larger borrowing relationships, such as those involving borrowers or principals with significant loans outstanding or multiple or interrelated operations, a credit union should require borrowers and principals to provide either:

  • An auditor’s review of the financial statements prepared consistent with GAAP to obtain limited assurance (a “review quality” financial statement), or
  • An independent financial statement audit under GAAS for the expression of an opinion on the financial statements prepared in accordance with GAAP (an “audit quality” financial statement)

A credit union’s underwriting standards must also include the type of collateral allowed, LTV ratio limits, personal guarantees of the principals, and methods for valuing all types of authorized collateral. For real estate valuation, the valuation methods must comply with part 722, Appraisals of NCUA’s regulations. The standards should set minimum collateral requirements based on the characteristics of the collateral and risk associated with the borrowing relationships. The standards should also set forth the requirements for establishing an enforceable and perfected lien position for different types of collateral. (See Collateral.)

Risk Management Processes

The risk associated with commercial lending is dynamic due to changing influences on the market, as well as a borrower’s operational and financial condition. Credit unions must establish policies and procedures to identify and manage risk at the inception of the loan and throughout the life of the loan. Specific components to be addressed by the credit union include:

Use of Loan Covenants (when warranted)

A change in risk is generally reflected in an adverse change in the financial condition of a borrower or associated borrowers. A credit union’s policy should establish requirements for financial covenants, financial reporting, and regular site visits. Early detection of adverse changes in a borrower’s operation provides a credit union with the best opportunity to assist the member and protect itself from losses.

Periodic Review

The credit union loan policy must set forth the requirements for periodic loan relationship review. The periodic review requirements should include frequency of site visits, periodic financial reporting, and comprehensive review of the relationship. It is a standard practice to review the commercial relationship at least annually (more frequently if there is a change in the risk).

Credit Risk Rating System

A credit union must incorporate a credit risk rating system to quantify and manage the credit risk of each loan. (See Credit Risk Rating Systems.)

Loan Policy and Documentation Exceptions

A credit union’s commercial loan policy may allow for exceptions to the policy, when necessary, to meet the unique circumstances of a borrowing relationship and when doing so would not create undue risk to the credit union. The policy must establish the process for approval and documentation of an exception to loan policy. All exceptions to the loan policy should be tracked and periodically reported to senior management and to the board.

Last updated November 25, 2016