1. AI Connect Proposed Member Business Loan Rule and Overview and updates to the Appraisal Rule Vincent Vieten, MBL, Program Officer Office of Examination and Insurance July 27, 2015 National Credit Union Administration

2. Member business loans have grown significantly over the last ten years Member Business Loan balance includes both member and nonmember business loans. Does not include unfunded commitments. Total MBLs including unfunded commitments is $51.7B. AI Connect

3. A growing percentage of credit unions have MBLs % of Credit Unions with MBLs AI Connect

4. Number of credit unions by MBL as % of total assets – All FICUs MBL as % of Total Assets AI Connect

5. Credit unions tend to make relatively small business loans Metrics Credit Unions with MBLs Additional Info # of CUs With MBLs2,23836% of Total CUs Total Assets (in billions) $975 87% of Total CU Assets Median Asset Size (in millions) $117 $24 All CUs MBLs as % of Total Loans 8.1%- # of CUs Originating MBLs in 2014 1,522- Total # of MBLs ( in thousands) 238- Credit Union MBL Activity (Dec. 2014) Total Asset Size Total MBL Balance (in billions) Average Loan Size (in thousands) <100MM$1.9$93 100MM – 250MM$4.4$141 250MM – 500MM$6.2$179 500MM – 1B$9.6$205 >1B$29.7$281 Total$51.7$217 Average MBL Size (Dec. 2014) AI Connect

6. Over 80% of MBLs are secured by real estate MBL Composition by Collateral Type (Dec. 2014) MBL Composition by Loan Type (Dec. 2014) % of Total MBLs Secured by Real Estate Secured by Non- Real Estate Unsecured * Nonfarm, residential includes investor 1-4 family residential real estates. AI Connect

7. Most credit unions with MBLs offer several business loan products AI Connect

8. Delinquency Rate (60+) by Loan Type* (Dec. 2014) * Please note that 1 st lien real estate loans, other real estate loans, and auto loans may also include MBLs. Credit union MBL delinquency rates were much higher than other loan types during the recession AI Connect

9. Net Charge-off Rate by Loan Type* (Dec. 2014) * Please note that 1 st lien real estate loans, other real estate loans, and auto loans also include MBLs. Credit union MBL net charge-off rates were manageable during the recession AI Connect

10. 30+ Delinquency Rate Comparison Credit Unions vs. Banks Credit union MBL delinquency compared to banks * Data Source: Bank data from SNL AI Connect

11. Net Charge-off Rate Comparison Credit Unions vs. Banks Credit union MBL net charge-offs compared to banks * Data Source: Bank data from SNL AI Connect

12. Total MBL related share insurance fund losses over the last five years are roughly $141MM, representing 25% of total losses Total Losses to Share Insurance Fund ($ in millions) Losses due to MBLs as contributing factor* ($ in millions) % of Total 2010$233.9$6.0 * 2.6% 2011$46.7$00% 2012$187.2$135.4 * 72.3% 2013$65.5$4.0 * 6.1% 2014$40.4$00% Total$573.7$141.424.7% AI Connect

13. 81% of credit unions with MBLs have a CAMEL rating of 1 or 2, compared to 69% for credit unions that do not offer MBLs CAMEL Distribution for Credit Unions with MBLs (Dec. 2014) CAMEL Distribution for Credit Unions without MBLs (Dec. 2014) AI Connect

14. The role of prudent business lending in credit unions CUs are well suited to serve small businesses, a vital and growing segment of their membership Improving access to financial services for small businesses helps create jobs Properly structured & priced, MBLs can have a positive impact on earnings and net worth MBLs can enhance portfolio diversification MBLs potentially offset IRR of long-term, fixed-rate residential real estate loans The key beneficiary of prudent business lending is the member who will receive financing that meet their needs and within their ability to repay AI Connect

15. Important fundamental questions about business lending QuestionAnswer Can business lending be done safely?Yes Is business lending more complex than consumer lending?Yes Is business lending more risky than other types of lending? It depends Should only institutions with the requisite expertise, policies, and procedures engage in business lending? Yes Are violations of the current prescriptive regulatory requirements the primary cause(s) for the credit unions that have gotten in trouble with business lending? No AI Connect

16. What are goals of modernizing Part 723? Replace overly prescriptive requirements with principles-based standards Reinforce risk management requirements needed to safely conduct commercial lending activities Improve the expertise and policy provisions of the regulation Change supervisory focus to sound commercial risk management practices from compliance with prescriptive regulatory requirements Eliminate NCUA involvement in day-to-day operations of CUs by eliminating need for waivers Eliminate need for NCUA approval of state rules Distinguish between commercial loans (align with RBC) and the statutory definition of MBL AI Connect

17. Comparison of MBL and Commercial Loan Definitions Type of LoanMBL Commercial Loan Loan fully secured by a 1- to 4- family residential property (borrower’s primary residence) No Member business loan secured by a 1- to 4- family residential property (not the borrower’s primary residence) Yes*No Member business loan secured by a vehicle manufactured for household use Yes*No Business loan with aggregate net member business loan balance less than $50,000 No Commercial loan fully secured by shares in the credit union making the extension of credit or deposits in other financial institutions No Commercial loan in which a federal or state agency (or its political subdivision) fully insures repayment, fully guarantees repayment, or provides an advance commitment to purchase the loan in full NoYes* Non-member commercial loan or non-member participation interest in a commercial loan made by another lender NoYes* * If the outstanding aggregate loan balance is greater than $50,000. AI Connect

18. What are the key changes and enhancements? (Page 1 of 4) AI Connect ProvisionCurrent RuleProposed Rule Construction and Development Loans 25% equity interest 15% of net worth Removed the limits Clearly defines collateral valuation method Requires CUs to value collateral appropriately and ensure risk sharing Requires CUs to set internal policy limit Stipulates loan administration requirements Loan Policy Requirements Limited coverage on risk management processes Requires underwriting commensurate with size, scope and complexity Requires a reliable credit risk rating system Stipulates sound risk management processes

19. AI Connect ProvisionCurrent RuleProposed Rule LTV 80% Removed the 80% limit Requires sufficient collateral commensurate with the level of risk Personal Guarantee Requires personal guarantee Removed the explicit requirement Requires credit unions to determine and document mitigating factors when personal guarantee is not required. Requires credit unions to set internal policy limits What are the key changes and enhancements? (Page 2 of 4)

20. AI Connect ProvisionCurrent RuleProposed Rule MBLs to a Single Member The greater of $100K or 15% of net worth Maintains the 15% limit with added flexibility to go up to 25% if certain conditions are met Modifies the definition of “associated borrower” Unsecured MBLs Lesser of $100,000 or 2.5% of CU Net Worth to one member (Well Capitalized CUs only) 10% of CU Net Worth Removed the limits Requires credit unions to set internal policy limits Experience Requirements 2 years of direct experience Removed the 2 year requirement Specifies the types of experience with emphasis on commercial credit risk management What are the key changes and enhancements? (Page 3 of 4)

21. AI Connect ProvisionCurrent RuleProposed Rule State Rule Requires NCUA approval for state rule 7 states have parallel state rules Principles-based rule obviates need for separate state rules Solicits SSA comments on the three options Non-member business loan participations Included in the cap unless waiver is granted Removed non-member business loans from the calculation against the cap No longer requires waivers Board Responsibilities Limited coverage (adopt and review policy) Clearly articulates that the CU Board is ultimately accountable for the safety and soundness of the commercial lending activities What are the key changes and enhancements? (Page 4 of 4)

22. List of waivers no longer required Aggregate C&D Loan Limit Minimum Borrower’s Equity for C&D Loans LTV Requirement Personal Guarantee Requirement Maximum Unsecured MBL to One Member or Group of Associated Members Maximum Aggregate Unsecured MBL Loan Limit Maximum Aggregate Net MBL to One Member or Group of Associated Members AI Connect

23. LTV requirement Only CU loans and superior lien included in the LTV (All debt and related payments to be considered in ability to repay) Sufficient to share risk (borrower investment) LTV should reflect the impact of Potential obsolesces Marketability Single use Condition Alternatives uses Overall risk of the transaction AI Connect

24. Construction and Development Valuation of the collateral Lesser of Cost or Market Market to be determined as Prospective Value (USPAP Statement 4) Land contribution lesser of cost or market first 12 months market value after 12 months Costs to be included are clarified All cost necessary to complete the project documented in an approved budget Interest reserve to be calculated based on projected completion/stabilization date (incl. in approved budget) Exclude preferential payments to equity holders, selling cost to be paid from sales. AI Connect

25. Construction and Development Requires approved budget Requisition process and schedule Disbursement of funds after an inspection documented in a written report stating work is completed along with certification the remaining budget amounts are sufficient to complete the project Certification that there are no intervening liens AI Connect

26. Appraisals Required Generally required with most real-estate related transactions >$250,000 Appraisals may also be required due to: – Higher-priced mortgage loan regulations (12 CFR 1026.35(c)) – NCUA safety and soundness concerns (12 CFR 722.3(e)) AI Connect

27. Appraisal Exemptions Transaction value is $250,000 or less Lien is taken as an abundance of caution Entrance into a lease of real estate (unless an economic equivalent of a sale/purchase) Existing extensions of credit, including advancement of new moneys, but only if the credit union can demonstrate there has been no obvious and material change which may affect the security interest (see section XIV of the 12/2/2010 Interagency Appraisal and Evaluation Guidelines) AI Connect

28. Appraisal Exemptions Existing loan(s) being sold, exchanged, traded, etc. Transaction wholly or partially insured, guaranteed by, or qualifying for sale to, a US government agency or US government sponsored agency(follow the guaranteeing agency requirements) NCUA has granted a waiver for a category of loans meeting the definition of a member business loan(proposed rule eliminates the waiver process) Note that NCUA regulations do not offer an exemption for business loans of $1 million or less AI Connect

29. Valuation Requirement For real-estate related transactions exempted, a written valuation must be performed by an individual qualified and experienced performing estimates of value for the property being considered and having no direct or indirect interest in the property. Refer to sections XII and XIII of the 12/2/2010 “Interagency Appraisal and Evaluation Guidelines” which sets forth the supervisory expectations for alternative valuation development and content. AI Connect

30. Minimum Appraisal Standards Conform with USPAP Written with sufficient information and analysis supporting the transaction decision Analyze and report deductions and discounts for proposed construction or renovation, partial leasing, non-market lease terms, and track developments with unsold units Based on the definition of market value Performed by licensed or certified appraiser as required by 12 CFR 722.3 AI Connect

31. Appraisal Review Ensures compliance with regulations, internal policy, and adherence to supervisory guidance. The review process should: Be performed by an independent, trained, and experienced reviewer Reflect a risk-focused approach in depth and scope Establish a process for resolving any deficiencies in appraisals or evaluations Set forth documentation standards for the review and the resolution of noted deficiencies AI Connect

32. Appraiser Independence Person(s) making the selection of appraisers should be independent from the loan production area. The fee appraiser must: – Be engaged directly by the credit union or agent – Have no direct or indirect interest in the property or the transaction An appraisal prepared by an appraiser directly engaged by another financial institution may be acceptable under certain conditions (see 2010 Interagency Appraisal and Evaluation Guidance). AI Connect

33. Discussion AI Connect