Examiners Eye MBLs
Member business lending has been an area of contention between the regulator and the regulated for some time. One business lending CUSO explained how it is helping its members read the examiners’ tea leaves.
In recent meetings with the NCUA and talking with some of its 460 credit union clients, CU Business Group LLC, a Portland, Ore.-based business lending and services CUSO, discovered several trending areas that may be on the radar of examiners.
“It's not filtering through one examiner's opinion on how an MBL loan program should run or how a loan should be underwritten,” said Larry Middleman, CUBG president/CEO, adding the CUSO invited the regulator to come review its operations. “We focus on those trends rather than just the one-off, realizing the direction of the NCUA in addressing the complexities of commercial lending.
“In summary, we came through with flying colors,” Middleman said during a May webinar on staying ahead of the examiners. “We did learn some things and had some very positive experiences.”
One of the topics that came up was global cash flow calculations. It wasn't that CUBG's model was flawed but the NCUA wanted something more robust, said Jim Clark, CUBG SVP and chief credit officer. The CUSO was set to provide an updated credit policy for its credit union clients in May.
For instance, the 1.25% debt service coverage ratio can't be used to look at an individual's business investment, income and salary and interest income on the same scales, said Jeff Stone, CUBG vice president and senior business services officer.
The ratio doesn't really cut it in terms of a business owner's personal debt to income, he suggested. If the inversion is attempted, the 43% maximum debt expense figure from the Dodd-Frank Act established by regulators for things such as qualified mortgage residential lending, is equivalent to two and a half times the debt coverage ratio, Stone said. As a result, an adjustment was needed between the two types of cash flow: Business to investment side and personal side.
Another area of emphasis from examiners had to do with how living expenses are calculated, Middleman said. Looking at the starting point of the federal poverty level, CUBG asked what a borrower or guarantor should have in terms of the ability to make payments on personal obligations. The CUSO came up with a method using the federal poverty line, which is adjusted on an annual basis by the federal government, Clark explained.
From there, in order to get it to work with global cash flow, the CUSO turned to Dodd-Frank which said for qualified mortgages, one could use the 43% adjusted gross income for housing, living and debt expenses. Income brackets were created as a further guide.
“The calculation is easy for examiners to follow,” Clark said. “Some examiners have already seen (the model) as they’re examining credit unions.”
Michael Mucilli, CUBG SVP and senior business services officer, has seen firsthand how credit unions are accounting for living expenses when he conducts audits for shops on both coasts.
“I think it's 50-50. In the past, relatively few credit unions accounted for living expenses,” Mucilli said. “These days, they’re seeing more and more but I still run into credit unions that don't account for anything for living expenses.”
Clark went back to the 1.25% debt service coverage ratio, saying examiners questioned whether it allowed a realistic calculation for the borrower to live on.
“So, they came up with the $750 for the first person and then X amount for each person after that. That was good about a decade ago,” Clark said. “Examiners came up with different methods for calculating living expenses tied to inflation.”
The sticking point here is an individual used to earning large amounts of adjusted gross income will have a totally different concept of minimal living expenses compared to someone who has $33,000 in AGI, Clark noted.
Ken Imse, CUBG vice president and senior business loan officer, said federal government figures are used, the calculation process is palatable and that it can be independently verified. Middleman said as CUBG has assessed the impact on credit unions the CUSO has underwritten, the living expenses calculation has not changed a loan decision from an approval to a decline.
“But it has perhaps changed the risk rating from one category to another because dollar figures are relative to specific situations rather than one average across the board,” Middleman observed.
Examiners are also putting taxi medallions under the microscope, according to Middleman.
Based in New York, where they are very prevalent, Mucilli is hearing the feedback.
“Examiners are now looking at several areas,” he said. “I’ve been fortunate to do some audits and I’m seeing some credit unions doing really well with taxi medallions and others, not so much.”
One area of scrutiny is cash-out refinances, which is a common practice where medallion owners will refinance when the value of their medallion goes up, Mucilli said. The medallion value is a market value that is published or advertised in metropolitan areas such as New York and Chicago.
Per an April NCUA supervisory letter, the regulator said examiners want to see that credit unions have documented the reason why a borrower wants to cash out as well as controls and tracking in place to verify that cashed-out funds were actually used for that approved reason. In the past, these areas weren't being strongly monitored, Mucilli said.
Typically, income tax forms were enough when a borrower wanted financing for a taxi medallion, Mucilli said. Now, especially for those who have a fleet of medallions, higher-level financial statements are requested.
Examiners may also want to see a debt coverage ratio at 1.25% – some lenders were using a lower percentage, according to Mucilli. Other requests include projections prepared by the borrowers so they actually know what's going into their calculations and global analysis, again prepared by the borrowers. He pointed out that most credit unions are exercising due diligence with global analysis.
“It's not a change but more scrutiny is on interest-only loans with originating lenders – 20- to 25-year amortization with three-year terms,” Mucilli said. “Going forward, as the (NCUA) supervisory letter says, they should only be done on an exception basis. The reasons are obvious because interest-only loans generate more risk and there's not a pay down on principal.”
Middleman said in his 34-year credit union and commercial banking career, he knows of no losses from medallion lending.
“Of course, if you listen to certain people six of seven years ago, they would have said the same thing about church lending,” Middleman noted. “I’m not trying to draw a parallel but facts are facts.”
Finally, examiners have issued new rules when it comes to flood insurance coverage, Clark said. In October 2013, the NCUA and other regulatory agencies issued a statement tied to the Biggert-Waters Flood Insurance Reform Act of 2012. Essentially, the federal government said it can no longer totally subsidize flood insurance for people across the country. Rather, coverage will need to operate at market level.
Property owners who were currently enjoying subsidized insurance were going to find themselves facing a 25% year-over-year increase, Clark explained. Last fall, CUBG issued a memo advising credit unions to work with their insurance carriers to ensure they have the most current maps.
“Over time, there have been changes in flood maps as weather patterns have changed,” Clark said. “People who didn't think they were in flood areas, now are.”