NCUA Issues Proposal to Allow Capitalization of Interest
The National Credit Union Administration (NCUA) Board recently issued a proposed rule that would remove the prohibition on capitalization of interest in connection with loan workouts and modifications. NAFCU’s Regulatory Alert on the proposed rule provides all the details you need to better understand the rule and help us provide useful feedback to NCUA as to whether this rule strikes the correct balance of helpful but not too burdensome. The capitalization of interest is the addition of unpaid interest to the principal balance of a loan. This practice is particularly useful in managing loans in deferment or forbearance, which has been regularly offered during the COVID-19 pandemic. Borrowers are still facing financial hardships as a result of the pandemic that has stretched almost ten months in the United States. Access to viable solutions to address deferred interest will help borrowers and credit unions navigate the uncertain new year ahead.
NAFCU has advocated for a capitalization of interest allowance several times this year, including two letters written to NCUA in March and September. The letters, as well as NCUA’s rule release, mention operational concerns and the overly burdensome nature of the restriction. This relief will help credit unions and their members to meet loan obligations during the pandemic and beyond.
Current Structure
Under the current loan modification structure, the options for borrowers are limited. Many borrowers may have already been delinquent when their deferment period began under the CARES Act or similar hardship modification. A credit union can seek to recapture the deferred interest in a few ways, each of which has its own flaws for both the borrow and the credit union.
In one scenario, a credit union might recapture the deferred interest first as the borrower resumes making payments, thus lowering the amount of principal balance reduction and creating a balloon payment at maturity. Alternatively, a credit union could extend the loan by roughly the number of payments deferred, but the additional interest added would not result in a benefit for the borrower and they spend a longer time repaying the loan. NCUA examiners often recommend bifurcating the loan to create a separate non-interest-bearing loan for the deferred interest with the same term as the original or modified loan. This often presents confusion to members and operational challenges for credit unions.
The Proposed Structure
The proposed rule makes necessary and helpful changes, while the NCUA Board also maintains several requirements from the existing rule that apply to loan workout policies. Some of the new requirements include: consideration and balancing of the best interest of the credit union and the borrower, creating limits on the amount of modifications allowed on an individual loan, and ensuring workout decisions are made based on the borrower’s renewed willingness and ability to repay. It also establishes documentation requirements for determining a borrowers’ ability to repay the loan.
However, there a few changes that may present unique challenges. Under the proposed rule, if a credit union permits the capitalization of interest in its written loan policy, the policy must require compliance with all state consumer protection laws. It is therefore important to consider NCUA’s authority to preempt state laws affecting the terms and conditions of loans offered by credit unions. Because NCUA’s rules regulate the terms of loan repayment, credit unions are not required to follow many state mortgage laws. However, the proposed requirement to follow state consumer protection laws may potentially result in additional compliance requirements.
NCUA appears to have taken some of these concerns into account and addressed the need for regulatory reform in the proposed rule. Under the new approach, credit unions and their members will have access to a safe, sound solution to address concerns during loan modifications. Additionally, permitting credit unions to capitalize interest would create consistency with other banking regulators and facilitate operational ease. Many credit unions use loan systems that are generally modeled to work based on standardized practices of assuming a re-amortization includes capitalized interest. Failing to capitalize interest when re-amortizing a loan thus becomes an operational challenge and often forces the credit union to bifurcate the loan or suspend the entire deferred interest until the ultimate retirement of the loan.
The proposed rule’s allowance to capitalize interest will provide credit unions and members with a safe option for meeting loan obligations. With a 60-day comment period, NAFCU is hopeful that this rule can be finalized quickly to provide credit unions with much needed relief. Please contact Ann Kossachev, NAFCU’s Director of Regulatory Affairs, with questions or comments at akossachev@nafcu.org or (703) 842-2212.