ANALYSIS: The state’s amended member business loan (MBL) rules took effect on June 1. The amendments introduced a new MBL definition and significantly expanded the list of loan types that are exempt from that definition.
The amendments have prompted inquiries from credit unions. So, in recent weeks, The League has discussed various questions with the DFI’s Chief Legal Counsel. The League will update its ii Release No. B027, which summarizes both the state and federal MBL rules, to reflect his answers. In the meantime, this Courier will recap our conversations.
Background
This April Compliance Courier explained how the state MBL rules changed and why.
The OCU repealed and re-created the state’s definition of an MBL, which is found in DFI CU 72.02, so that it closely follows the NCUA’s definition in its MBL rules. The Wisconsin definition now reads as follows:
DFI-CU 72.02. Member business loan. (1) “Member business loan” means a loan, line of credit, letter of credit including unfunded commitments, and any interest a credit union obtains in such loans made by another lender to individuals, sole proprietorships, partnerships, corporations or other business enterprises for commercial, industrial, agricultural or professional purposes.
(2) “Member business loan” does not include any of the following:
(a) Loans for personal expenditure purposes.
(b) Loans made by a corporate credit union.
(c) Loans made by a federally insured credit union to another federally insured credit union.
(d) Loans made by a credit union to a credit union service organization.
(e) Loans secured by a one- to four-family residential property.
(f) Loans fully secured by shares in the credit union making the extension of credit or deposits in other financial institutions.
(g) Loans secured by a vehicle manufactured for household use, except that such loans will be considered member business loans if they will be used for a purpose set forth in sub. (1) and the outstanding aggregate net member business loan balance is $50,000 or greater.
(h) Business purpose loans that are equal to or less than $50,000 after calculating the aggregate outstanding balances plus unfunded commitments less any portion secured by shares in the credit union held by the borrower or an associated borrower.
(i) Loans for which a federal or state agency fully insures repayment, fully guarantees repayment, or provides an advance commitment to purchase the loan in full.
(j) Any non-member business purpose loan or non-member participation interest in a business purpose loan made by another lender, provided the credit union acquired the loan or interest in compliance with all relevant laws and regulations and the credit union is not, in conjunction with another credit union, trading member business loans to circumvent the aggregate limit.
Importantly for credit unions, two kinds of loans are no longer considered MBLs under the state’s new rules:
- Non-member participation loans, which were not exempt under previous versions of our MBL rules.
- Loans secured by a one- to four-family residential property – whether owner-occupied or not. Previously, these loans were only exempt from the MBL definition if they were the member’s primary residence.
Analysis
Participation loans
Because participation interests in business loans are exempt from the MBL definition, we asked the DFI attorney whether such loans are exempt from all the requirements of the MBL rules.
He confirmed that participation loans do not count toward MBL limits, but he stressed that they are still subject to two key MBL rule requirements. This is because of a provision in the Wisconsin’s credit union statutes (Wis. Stats. §186.098(9m)), which says: “A credit union may participate with other lenders in a loan of any type that the credit union may otherwise make.”
That provision means that credit unions wishing to participate in business loans may only do so if they could have made the loans themselves – and that means the participating credit union must comply with what he described as two “basic eligibility requirements to make loans of that ‘type’” under the state’s MBL rules:
- The participating credit union’s board of directors must “adopt a specific member business loan policy and review it at least annually.” DFI-CU 72.05(1). The credit union can tailor its policy to its activities, the DFI attorney said: “The scope of that policy could be limited to participation loans if that is the only business lending activity in which the credit union plans to engage.”
Several years ago, REACH Business Lenders, LLC, made a sample business lending policy available to the credit unions it works with. The League is working to update that policy.
- The participating credit union must “utilize the services of an individual with at least 2 years direct experience with the type of lending in which it will engage.” DFI-CU 72.05(2). The participating credit union need not have that person on staff. The rules allow them to rely on an originating credit union, CUSO, or other third party to provide the needed experience.
The DFI attorney explained: “A credit union that participates in a member business loan issued by a Wisconsin credit union in compliance with DFI-CU ch. 72 would presumably satisfy that requirement, because (1) the issuing Wisconsin credit union would necessarily have the expertise required under DFI-CU 72.05 (or else it couldn’t issue the loan); and (2) the participating credit union would be relying upon, and have access to, that expertise when opting to participate in the loan.”
Credit unions that work with REACH may be able to rely on their staff for the experience needed. “If Reach has the necessary expertise and makes it available to credit unions that participate in the loan, the expertise prong of DFI-CU 72.05 would be satisfied for the participating credit unions,” the DFI attorney wrote.
Participations in construction & development loans
As with other participation loans, credit unions participating in construction and development loans must have an appropriate policy in place. They must also rely on someone with at least five (not just two) years’ experience in this type of lending. Again, the DFI attorney said, they may rely on an originating credit union, CUSO, or another third party to provide the needed experience. He also confirmed that, like any loans which are exempt from the MBL definition, participation interests in construction and development loans do not count toward the state’s MBL caps.
Loans secured by multiple 1- to 4-family residential properties
However, a loan secured by multiple one- to four-family residential properties is an MBL – a position taken by both the DFI’s attorney and the NCUA. Such a loan does not fit the state’s (or the NCUA’s) exemption, which only applies to a loan secured by “a” (singular) one- to four-family residential property.
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 evaluate for and manage 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 borrowers 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.
Definition of “residential property”
The state’s revised rules do not define that term “residential property.” The DFI attorney confirmed that credit unions can look to the NCUA’s definition for the meaning:
Residential property means a house, condominium unit, cooperative unit, manufactured home (whether completed or under construction), or unimproved land zoned for 1- to 4-family residential use. A boat or motor home, even if used as a primary residence, or timeshare property is not residential property.
Note that a boat, motor home, or timeshare is not a “residential property,” and so business purpose loans secured by those assets do count toward the state MBL caps.
Periodic loan reviews
Wisconsin credit unions must monitor the MBLs they make. Our state MBL rules require a credit union’s MBL policy to address, among other things, “General loan procedures, including all of the following: (a) Loan monitoring. (b) Servicing and follow-up. (c) Collection.”
The DFI attorney helped answer several questions about this obligation:
- Does this monitoring requirement apply to a credit union participating in a business loan that another lender originated? Yes. Although participation interests are exempt from the definition of an MBL, participating credit unions must still have a business loan policy (as explained above), and it must address loan monitoring.
- How detailed should loan reviews be? Wisconsin’s rules do not offer specifics, but the DFI attorney confirmed for us that OCU examiners follow NCUA guidance on loan reviews.
The NCUA requires that a covered credit union’s commercial loan policy must address (among other things): “Risk management processes commensurate with the size, scope and complexity of the federally insured credit union’s commercial lending activities and borrowing relationships. These processes must, at a minimum, address the following: … Periodic loan review, consistent with loan covenants and sufficient to conduct portfolio risk management. This review must include a periodic reevaluation of the value and marketability of any collateral …”
The NCUA Examiner’s Guide materials on commercial loan policies expands on this requirement, saying: “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.”
This section of the Examiner’s Guide goes into much more detail on periodic reviews. Wisconsin credit unions should review this material and ensure that their business lending policies and procedures comply with it.
- Can participating credit unions rely on third parties to perform business loan reviews? Yes. The DFI attorney wrote: “Under the circumstances described in my prior emails (i.e., participations in MBLs issued by Wisconsin CUs in compliance with DFI-CU ch. 72, where the participating CU is relying upon – and has access to – the lending CU’s expertise), the participating CU could also rely on the lending CU’s monitoring, provided such reliance is reasonable under the circumstances.”
Presumably, participating credit unions might be able to rely on REACH to provide these reviews, as well, though the DFI attorney did not address this specifically.
- How often should reviews be done? The Wisconsin rules do not say, and the NCUA rules call for “periodic” reviews. However, the NCUA Examiner’s Guide explains that “It is a standard practice to review the commercial relationship at least annually (more frequently if there is a change in the risk).” The League cautions against explicitly requiring reviews every 12 months in your business loan policies. That’s because in some situations, such as where a business borrower has been given an extension, it might make sense to delay the review for a time.
If you have questions about the state’s new MBL rules (or any other compliance issues), please reach out to The League’s Compliance Hotline at (608) 640-4050 or compliance@theleague.coop.