5 MBL Details Examiners Are Watching
CU Business Group LLC, a Portland, Ore.-based business lending and services CUSO, said it has discovered several member business lending issues that have drawn increased examiner scrutiny. The CUSO discovered the trend after meeting with NCUA officials, including Vin Vieten, the agency’s member business lending program officer, and after speaking with some of its 460 credit union clients.
“It’s not filtering through one examiner’s opinion on how a MBL loan program should run or how a loan should be underwritten,” said Larry Middleman, CUBG president/CEO. “We focus on those trends rather than just the one-off, realizing the direction of NCUA in addressing the complexities of commercial lending.”
Middleman, along with several members of the CUBG team, recently shared five trending areas in the MBL space that examiners are looking at more closely.
1. Business owner living expenses
CUBG tackled the underwriting question of quantifying the ability of a borrower or guarantor 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, said Jim Clark, CUBG senior vice president and chief credit officer.
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 senior vice president and senior business services officer, said he 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.”
Middleman said as CUBG assessed the impact on credit unions the CUSO had underwritten, and the living expenses calculation did not change a loan decision from an approval to a decline.
“But is 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.
2. Global cash flow calculations
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 was being 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.
3. Taxi medallions
Based in New York, Mucilli said he is hearing examination feedback on taxi medallions.
“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, a common practice in which medallion owners 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 doesn’t know of any losses stemming from medallion lending.
“Of course, if you listen to certain people six or 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.”
4. Flood insurance coverage
There are 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.”
5. Loan Participations
Middleman said this is not necessarily a new thing, but the landscape has changed a bit due to new regulations that came out last September.
“Everybody was worried about them because it was a long time coming. Most credit unions were worried that if you’re buying participations, you might be limited to 25% if limited to a single originator. That 25% changed to 100% of your own net worth. Everybody kind of breathed a sigh of relief,” Clark said.
There is a new 10% retention requirement with variances for state-chartered credit unions. In many states, including California and Washington, only 1% is needed to be retained for the lead lender, Middleman said. With the new regulation, it was 5% when renewing a loan.
“The other thing that’s changed is language was always along the lines that you can’t participate in a loan that you are not set up to originate on your own. Now, you can,” Clark said. “This comes into place with things like agriculture loans and taxi medallions.”