Commercial and Member Business Loans

This section of the Examiner's Guide addresses the following topics:

In this introductory section, you will find:

A commercial loan is a loan, line of credit, or letter of credit that a credit union extends to a borrower for a commercial, industrial, agricultural, or professional purpose. (See commercial loan definition.) These loans may be secured or unsecured, and may have a short or long-term maturity. Such loans include commercial real estate loans, as well as commercial and industrial loans (examples include term business loans, working capital lines of credit, and others).

Commercial lending is not appropriate for all credit unions. This type of lending is complex, and involves different risks than consumer lending. Managing commercial lending generally involves a greater cost to a credit union than consumer lending. If a credit union’s leadership (board and management team) does not have the experience, skills, and resources to manage commercial lending, the institution should refrain from making such loans.

To properly manage the risk associated with commercial lending, a credit union should have staff with expertise and more specialized risk management experience. A credit union that offers commercial loans should maintain prudent risk management practices and sufficient capital that is commensurate with the risks associated with its commercial lending activities at all times.

The primary focus of a commercial lending examination is on the effectiveness of a credit union’s risk management process and the aggregate risk profile of a credit union’s loan portfolio. Examiners should assess whether a credit union’s:

  • Board of directors understand the risks and provide sufficient oversight
  • Management and staff have appropriate experience, expertise, and resources
  • Commercial loan policy is adequate and complies with NCUA regulations
  • Credit risk ratings are consistent and reliable, and
  • Commercial loan risk management is comprehensive and ongoing

Part 723, Member Business Loans; Commercial Lending, is effective January 1, 2017 except for amendatory instruction number 4 adding § 723.7(f), which became effective May 13, 2016.

Purpose and Scope of Part 723

NCUA regulation part 723, Member Business Loans; Commercial Lending establishes policy and program responsibilities that a credit union must adopt and implement as part of a safe and sound commercial lending program. It also incorporates the statutory constraints in § 107A of the FCU Act, which limits the aggregate amount of MBLs that a credit union has on its balance sheet to the lesser of 1.75 times the actual net worth of the credit union or 1.75 times the minimum net worth required under the Act for a credit union to be well capitalized.

Exemption for Small Credit Unions with Limited Commercial Lending Activities

NCUA regulation part 723, Member Business Loans; Commercial Lending applies to all federally insured credit unions. However, a small credit union that holds a relatively small amount of commercial loans compared to its net worth and infrequently originates and sells commercial loans is exempt from §§ 723.3, Board of directors and management responsibilities, and 723.4, Commercial loan policy, of the regulation. In order to qualify for the exemption, a credit union must satisfy all of the following conditions as established in § 723.1(b)(1):

  • Less than $250 million in total assets

  • Aggregate amount of outstanding commercial loan balances and unfunded commitments, plus any outstanding commercial loan balances and unfunded commitments of participations sold, plus any outstanding commercial loan balances and unfunded commitments sold and serviced by the credit union total less than 15 percent of the credit union's net worth1

    • This threshold is measured against all commercial loans in a credit union’s portfolio, as well as whole commercial loans or commercial loan participations a credit union has sold but continues to service. For example, a credit union has $20 million commercial loans including unfunded commitments. In addition, the credit union has sold $10 million commercial loan participations, including unfunded commitments, and $5 million whole commercial loans, including unfunded commitments with servicing retained. In this example, the aggregate amount of commercial loans that need to be measured against the 15 percent of net worth threshold would be $35 million.
  • Amount of commercial loans originated and sold (which the credit union does not continue to service) total less than 15 percent of the credit union’s net worth in a given calendar year

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. A credit union that meets the criteria outlined above is only exempt from the specific policy and infrastructure requirements of NCUA regulations §§ 723.3, Board of directors and management responsibilities, and 723.4, Commercial loan policy. 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 the rule.

Commercial Loan Definition

A commercial loan is any loan, line of credit, or letter of credit (including any unfunded commitments) made to an individual, sole proprietorship, partnership, corporation, or other business enterprise for commercial, industrial, agricultural, or professional purposes (but not for personal expenditure purposes). This includes any interest a credit union obtains in a commercial loan made by another lender (such as a participation) as outlined in § 723.2, Definitions.

Excluded from this definition are loans:

  • Made by a corporate credit union
  • Made by a federally insured credit union to another federally insured credit union
  • Made by a federally insured credit union to a CUSO
  • Secured by a single 1- to 4- family residential property
    • A loan secured by more than one 1-4 family property is not excluded from the definition.
  • Fully secured by shares in the credit union making the loan or deposits in other financial institutions
  • Secured by a vehicle manufactured for household use
  • That would otherwise meet the definition of commercial loan and which, when the aggregate outstanding balances plus unfunded commitments less any portion secured by shares in the credit union to a borrower or an associated borrower, are equal to less than $50,000

Commercial loans include loans made to members, as well as purchased nonmember loans and participations.

The commercial loan definition excludes loans secured by a vehicle manufactured for personal, family, and household use. However, loans primarily secured by fleet vehicles or vehicles to carry fare-paying passengers are considered commercial loans. In addition, a loan to a vehicle dealership or seller to replenish inventory of vehicles for sale (a so-called “floor plan loan” or “vehicle inventory loan”) secured by those vehicles is a commercial loan.

The Economic Growth, Regulatory Relief, and Consumer Protection Act removed certain loans secured by a 1-4 family property from the definition of a member business loan. As such, a loan secured by a single 1- to 4- family residential property, whether or not it is the borrower’s primary residence (that is, owner or non-owner occupied), is not a commercial loan or member business loan. These loans are residential real estate loans.

A loan secured by multiple 1-4 family properties is a commercial loan and an MBL because the repayment of such loans relies on the successful operation of a commercial enterprise (rental revenue or the sale of units). The risk characteristics of owners of multiple 1-4 family residential properties are more similar to commercial real estate operators than those of owner-occupied 1- to 4- family residential loans.

An owner’s personal income usually offers additional support to the repayment of a loan secured by an owner-occupied 1-4 family property. In general, owners of multiple 1-4 family properties rely on rental operations or the sale of property units to repay the loan. In this way, the owners are similar to commercial real estate operators, and credit unions should evaluated for and managed them appropriately.

Credit unions should have credit risk management policies and processes commensurate with the risks specific to borrowers that operate multiple 1-4 family properties. Their underwriting standards and the complexity of their risk analysis should increase as the number of properties financed for, or owned by, the borrower or associated group of borrower’s increases. When a borrower finances multiple properties and the repayment of a loan depends on the successful operation of the multiple residential properties, a comprehensive global cash-flow analysis of the borrower and principal is generally necessary to properly underwrite and administer the credit relationship. In such cases, a credit union should analyze and administer the relationship based on the overall risk associated with the relationship.

Commercial Loans versus MBLs

There are several distinctions between a commercial loan and a statutorily defined member business loan. These apply whether a credit union directly offers a loan or purchases a loan or participation. It is important to understand the differences, as loans recognized as commercial loans must be evaluated based on the risk management principles outlined in part 723, Member Business Loans; Commercial Lending. Loans recognized as member business loans must be reported as such and kept within the statutory limit of the FCU Act. In all cases, a credit union should perform appropriate risk assessment to ensure a loan is supported by a reliable and adequate repayment source.

The following table outlines the distinction between commercial and member business loans as defined in part 723, Member Business Loans; Commercial Lending. These include any loan, line of credit, or letter of credit (including any unfunded commitments) a credit union makes to an individual, sole proprietorship, partnership, corporation, or other business enterprise for commercial, industrial, agricultural, or professional purposes (but not for personal expenditure purposes). However, a loan to a borrower or associated group of borrowers where the aggregate commercial loan balance, as defined in NCUA regulation § 723.2, Definitions, is less than $50,000 is excluded from both the commercial loan and MBL classification.

 

Type of Loan MBL Commercial Loan
Loan secured by a 1 to 4 family residential property No No
Loan secured by more than one 1 to 4 family residential properties Yes Yes
Loan secured by a vehicle manufactured for household use Yes No
Loan secured by a vehicle used in a fleet or to carry fare-paying passengers Yes Yes
Loan fully secured by shares in the credit union making the extension of credit or deposits in other financial institutions No No
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 business loan or non-member participation interest in a commercial loan made by another lender No Yes

Types of Commercial Loans

A credit union should structure a commercial loan consistent with the borrowing need of a borrower. It is critical that a credit union’s loan term and structure match the anticipated cash-flows and repayment sources with the purpose of the loan (see § 701.21(c)(4)). Typical types of commercial loans include:

  • Seasonal Line of Credit – Short-term loan to finance a seasonal increase in trading assets (receivables and inventory) and usually repaid by the conversion of trading assets to cash at the end of the operating cycle. Businesses engaged in manufacturing, distribution, retail, and service use short-term working capital loans as well as seasonal lines of credit. If a seasonal line of credit is not paid to zero at the end of the operating cycle, it may indicate an operating problem of the borrower that should be addressed by the credit union.
  • Revolving Line of Credit – Short-or long-term loan to finance permanent working capital as well as the seasonal build-up of trading assets. These loans are usually repaid by the conversion of trading assets to cash or refinanced to a term loan. Businesses engaged in manufacturing, distribution, retail, agriculture, and service use short-term working capital loans as well as seasonal lines of credit.
  • Bridge Loans – Usually a short-term loan (but can include long-term loans) to finance a specific event. This loan is repaid from the cash flow generated by the specific event.
  • Term Loan – A loan with fixed payment schedule, typically used to finance the acquisition of fixed assets (property, plant and equipment). Loan terms should match the useful life of the asset being financed (amortization period with periodic principal and interest installments) with the repayment source being cash flow from operations and profits retained in the business. Businesses engaged in manufacturing and distribution, and some retailers, will require a greater investment in property, plant and equipment than a service business.
  • Demand or Single-Pay Loans - Short or long-term loan based on the purpose or project. These include, but are not limited to, acquisition and development loans and construction rehab loans for unimproved land. These loans are usually repaid from the sale of an asset, or refinanced to a term loan.
  • Letters of Credit – Serve as an irrevocable guarantee for payment by the credit union to a beneficiary under specified conditions. There are two types of letters of credit, a Commercial Letter of Credit and a Standby Letter of Credit. Letters of credit must be supported with a letter of credit agreement, a demand promissory note to fund any advance, and a security agreement. Additionally, the letters of credit are governed by requirements of the International Chamber of Commerce, which should be represented in the documentation. No funds are disbursed at the time a letter of credit is approved and issued, only when a letter is drafted or drawn. However, as a letter of credit is an irrevocable guarantee for payment, it is treated like an unfunded loan commitment and should only be offered to financially strong borrowers. A credit union that offers letters of credit must have expertise on staff that not only understand the unique associated risks, but also the skills to administer and document this credit commitment safely.

A loan approved by a credit union should be limited to an amount that is necessary to support a borrower’s identified need, while remaining within the borrower’s financial capacity to repay.

Major Commercial Industry Sectors

Each industry has a distinct business model and risk characteristics. The major industry sectors are:

  • Service
  • Retail
  • Wholesale/distributors trades
  • Manufacturing
  • Construction
  • Agricultural

  • Commercial real estate

    • Income-producing Commercial Real Estate
    • C&D
    • Owner-occupied Commercial Real Estate
  • Other specialized industries or sectors such as taxi medallions, hospitality, church or religious organization, non-profits, governmental, mining, and energy production.

Each major industry sectors includes numerous sub-sectors. The North American Industry Classification System (NAICS) has 20 primary, broad sector codes and thousands of sub-sector codes. Lenders use industry codes to compare a borrower’s business characteristics (financial data) to other businesses in the same industry and to set risk management concentration limits.

Last updated March 12, 2019