Commercial loans are potentially complex transactions that can involve a number of parties on both the borrower and lender sides. NCUA regulation part 723, Member Business Loans; Commercial Lending prohibits certain commercial lending activities to maintain safeguards against insider abuse and conflicts of interest.
The rule explicitly prohibits involvement by certain transaction parties, as well as certain compensation features. These prohibitions help avoid unsafe incentives, conflicts, and risks that can undermine the integrity of a sound and prudential commercial loan program and expose a credit union to insider abuse. Such prohibitions have long been a part of bank supervision, including credit unions.
Examiners should determine if a credit union has appropriate policies and controls in its commercial lending processes to reasonably prevent conflicts of interest, as well as an audit or review program to identify any violations.
The explicit prohibitions contained in NCUA regulation § 723.7, Prohibited activities, are as follows:
(a) Ineligible borrowers. A federally insured credit union may not grant a commercial loan to:
(1) Any senior management employee directly or indirectly involved in the credit union’s commercial loan underwriting, servicing, and collection process, and any of their immediate family members (a spouse or other family member living in the same household);
(2) Any person meeting the definition of an associated borrower as set forth in NCUA regulation § 723.2, Definitions, with respect to any senior management employee directly or indirectly involved in the credit union’s commercial loan underwriting, servicing, and collection process, and any of their immediate family members; or
(3) Any compensated director, unless the credit union’s board of directors approves granting the loan and the compensated director was recused from the board’s decision making process.
(b) Equity agreements/joint ventures. A federally insured credit union may not grant a commercial loan if any additional income received by the credit union or its senior management employees is tied to the profit or sale of any business or commercial endeavor that benefits from the proceeds of the loan.
(c) Conflicts of interest. Any third party used by a federally insured credit union to meet the requirements of part 723, Member Business Loans; Commercial Lending, must be independent from the commercial loan transaction and may not have a participation interest in a loan or an interest in any collateral securing a loan that the third party is responsible for reviewing, or an expectation of receiving compensation of any sort that is contingent on the closing of the loan, with the following exceptions:
(1) A third party may provide a service to the credit union that is related to the transaction, such as loan servicing.
(2) The third party may provide the requisite experience to a credit union and purchase a loan or a participation interest in a loan originated by the credit union that the third party reviewed.
(3) A federally insured credit union may use the services of a CUSO that otherwise meets the requirements of § 723.3(b)(3) even if the CUSO is not independent from the transaction, provided the credit union has a controlling financial interest in the CUSO as determined under GAAP.
If a credit union insider who is not ineligible under NCUA regulation § 723.7, Prohibited activities obtains a commercial loan, it is incumbent upon a credit union to ensure it has the appropriate due diligence, reporting, and policy requirements to prevent the lending activity from violating the spirit and intent of the NCUA’s prohibitions. (That is, the credit union must ensure the credit union insider is truly independent from influencing the transaction.)
While a credit union must ensure that involving a CUSO in its commercial lending activities does not create a conflict of interest, there is some flexibility regarding CUSO involvement. For example, a credit union may engage a CUSO, subject to certain conditions, to help meet the credit union’s regulatory requirements for commercial lending experience as set forth in § 723.3(b)(3).
The authority to hire a CUSO to meet required experience levels may be a prohibited activity because the CUSO is not always independent of the loan transaction. As set forth in § 723.7(c)(3), flexibility can be granted if a federally insured credit union has a controlling financial interest in the CUSO as determined under GAAP. A credit union with a controlling interest in a CUSO can ensure that the CUSO aligns its legal and business interests with the credit union. Conversely, a less-than-controlling interest in a CUSO means there is an increasing risk these interests may diverge.
Last updated November 25, 2016
