In 2016, the NCUA revised commercial lending regulations to allow credit unions to set their own personal guaranty requirements. While credit unions can now choose whether to waive personal guaranties altogether or obtain limited, partial, or pro rata guaranties, it’s important to remember why personal guaranty requirements were established in the first place.
Conceptually, there are very few good reasons to ever waive a personal guaranty. As the lender, the only benefit you receive from a commercial loan is interest income. The owners of the business or commercial property are positioned to benefit from the upside potential when the enterprise succeeds, or when the collateral property appreciates in value. Since the upside benefit accrues to the ownership, they should accept the majority of the risk as well. This is the nature of entrepreneurial risk. The equity owners risk their capital to enjoy the profits. The lender should not be responsible for the risk of entrepreneurial failure.
Additionally, you should consider exactly why the owners would ask a lender to forego the guaranty. They are asking the credit union to invest its capital in the project, and they should have at least the same willingness to put their assets on the line. Owners are required to invest just 20% equity into the project, and in exchange they should provide reassurance of the lender’s 80% commitment via the guaranty. The question to ask the borrower is “Why should we invest if you don’t have this level of confidence in the project?”
These are just a few of the reasons why it makes sense to decline most requests for unguaranteed loans. However, you will get requests like this from time to time, and you should be prepared to deal with them.
One way to approach such requests is to consider the lack of a guarantor as a significant weakness that needs to be mitigated. This mitigation needs to be substantive, such as offering a smaller loan amount to lower the LTV on the collateral or requiring a larger down payment. The guarantor may also provide additional collateral in lieu of a guaranty. Covenants are good monitoring tools, but do not lower the actual risk of the deal.
There are several situations where it makes sense to pass on a request for the waiver of a guaranty. Such scenarios include those situations where a guarantor has taken substantial distributions or loans from the borrower, or has demonstrated in any way that his personal well-being comes before that of the business. A similar scenario is a request for a cash out refinance. In this case, the owners would directly benefit from the loan, while concurrently transferring risk from the ownership to the lender. There is no way to justify a waiver of personal guarantees in that scenario.
Let’s also consider an owner-occupied real estate loan. The operating company should always guarantee these types of transactions, in the form of a cross-corporate guaranty. The risk rating and assessment of the credit should be based largely on the health of the operating company, as that is where repayment will come from. This is another example where there is little justification for ever waiving a guaranty.
Unguaranteed credit facilities are usually the type of product offered by life insurance companies on very large real estate projects. These “non-recourse” facilities are usually approved based on the professional, experienced management of the property, very low LTVs, and a significant cushion in debt service coverage. This is very different from the types of requests most credit unions see as a matter of course. But you will on occasion receive requests to waive personal guaranties, and it is important to recognize when the best decision you can make is to decline the deal, or to structure it in a way that reduces the risk to a manageable level.