Business loans have “become a larger share of credit unions’ loans and assets.” Of those credit unions with between $100 million and $500 million in assets, over three quarters are making business loans. Of those with more than $500 million in assets, over 90% are making business loans.
The National Credit Union Administration (NCUA) recently updated its Member Business Lending and Commercial Lending rule to provide greater flexibility to credit unions in making Member Business Loans and commercial loans (yes, there’s a distinction).
In February 2016, the “NCUA Board unanimously approved a final member business lending rule that [amended] Part 723 of NCUA's Rules and Regulations regarding the ability of federally-insured credit unions to make Member Business Loans…The majority of the rule [became] effective January 1, 2017, while the personal guarantee requirement [was] eliminated 60 days after the rule's publication in the Federal Register...” (publication was in March 2016).
As a quick aside, for some specifics on nomenclature--and as a special note to those on the compliance side--when talking about “business loans” in the context of the new Member Business Lending rule, we should note the distinction between general “Commercial Loans” and statutorily defined “Member Business Loans.” The NCUA Examiner’s Guide provides that a general “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) …” whereas loans “recognized as member business loans must be reported as such and kept within the statutory limit of the Federal Credit Union Act.” In an effort to address some of the confusion resulting from this distinction, the NCUA Examiner’s Guide actually contains a table listing types of loans and clarifying whether they fall within the definition of a Member Business Loan or Commercial Loan. Let me add that—contributing to the confusion—one often sees “MBL” in articles and the media as a shorthand reference for both the “Member Business Lending and Commercial Lending” rule and a statutorily defined “Member Business Loan.” Yet we’re talking about two different things (even though the Member Business Lending and Commercial Lending rule controls Member Business Loans).
With the above “aside” out of the way, let’s narrow our focus on guarantees in general. In discussing the NCUA’s amendments to the Member Business Lending and Commercial Lending rule, the National Association of Federally-Insured Credit Unions, on its Legislative & Regulatory Issues Webpage, noted that the amended rule “removes the prescriptive underwriting criteria and personal guarantee requirements of the current regulation, thereby eliminating the current waiver process. Instead, the rule allows credit unions to implement a principle-based risk management policy related to its commercial and business lending activities. Addressed as part of NCUA's regulatory modernization initiative, the final rule: gives credit union loan officers the ability, under certain circumstances, to not require a personal guarantee…”
OK, so under the new Member Business Lending and Commercial Lending rule, credit unions in certain circumstances now have greater flexibility in determining whether to require personal guarantees. But when has obtaining personal guarantees been a bad idea (yes, we’ve heard that requiring guarantees can have a chilling effect in some circumstances)? We all know that when your borrower is an LLC or corporation whose assets have limited liquidation value outside of the operating entity, a guarantee from the owner can provide critical protection and leverage when problems arise.
Which brings up a still lingering issue in connection with personal guarantees: spousal guarantees. For starters, it’s understandable why any lender wants a spouse’s guarantee: Married couples own their residential real estate together (via tenancy by the entirety in North Carolina; also, in North Carolina, a spouse has a marital interest in other non-residential real estate titled solely in the name of the other spouse). If the lender has a guarantee from the owner only (and not the owner’s spouse), and “things go south,” oftentimes what turns out to be the owner/guarantor’s single largest asset—the owner’s residence—is beyond the lender’s reach because that asset is co-owned by a non-guarantor.
Here’s the wrinkle: Regulation B, which implemented the Equal Credit Opportunity Act (“ECOA”), provides in part, “a creditor shall not require the signature of an applicant's spouse or other person, other than a joint applicant, on any credit instrument if the applicant qualifies under the creditor's standards of creditworthiness for the amount and terms of the credit requested. A creditor shall not deem the submission of a joint financial statement or other evidence of jointly held assets as an application for joint credit.”
However, back in the 80s, the Board of Governors of the Federal Reserve System expanded the definition of “applicant” in Reg B to include “guarantors.” So, setting aside, for the moment, the argument that the interpretation of Reg B was stretched to apply to the commercial context when it was originally intended for the consumer context, it’s understandable why many, including examiners, take Reg B to mean that if an applicant (including the owner/guarantor of an entity borrower in a commercial loan transaction) is “creditworthy,” the lender should not also be looking to the applicant/owner/guarantor’s spouse for a spousal guarantee. If a lender nevertheless goes ahead and requires a spousal guarantee as a condition to a loan in circumstances in which the owner/guarantor is already creditworthy (and the spouse is not a co-owner of the entity/borrower), and the loan then goes into default, and the lender sues the spouse/guarantor along with the entity borrower and owner/guarantor, the lender may very well be looking at a counterclaim from the spouse/guarantor for an ECOA violation.
Up until March of 2016, many were seeing an Eighth Circuit Court of Appeals decision in Hawkins v. Community Bank of Raymore--which said that the ECOA marital status protections applied only to “applicants,” and that spouse/guarantors are not “applicants” within the purview of the ECOA--as potentially providing some relief from the historical application of Reg B as prohibiting spousal guarantees. The Supreme Court affirmed the Eighth Circuit’s ruling, but only per an evenly split vote (because of the death of Justice Scalia). So while the Supreme Court’s 4-4 split vote means the Eighth Circuit’s ruling in Hawkins stands as controlling authority in the seven states comprising the Eighth Circuit (Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, South Dakota), the lack of a majority opinion from the Supreme Court means the Hawkins decision has no precedential effect in the other 12 circuits. Which means that credit unions and other lenders in the other 12 circuits need to continue to carefully follow their policies with respect to the issue of spousal guarantees.
Let’s connect the dots and sum all of this up: The NCUA’s new Member Business Lending and Commercial Lending rule provides credit unions with greater discretion in determining whether to require personal guarantees for business loans. But we all know that, generally speaking, personal guarantees provide added protection and leverage, and credit unions should continue to seek personal guarantees when making business loans to entity borrowers. That said, unless your credit union is operating and making loans in the seven states comprising the Eighth Circuit Court of Appeals, you still have to be careful when it comes to consideration of the appropriateness of a spousal guarantee for a particular business loan. The due diligence process that would support the justification of a spousal guarantee in certain circumstances has not changed.