Prompt Corrective Action; Corporate Credit Unions; Credit Union
Service Organizations; Member Business Loans; Regulatory Flexibility
Program
[Federal Register: October 1, 2003 (Volume 68, Number 190)]
[Rules and Regulations]
[Page 56537-56553]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr01oc03-5]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 702, 704, 712, 723, 742
Prompt Corrective Action; Corporate Credit Unions; Credit Union
Service Organizations; Member Business Loans; Regulatory Flexibility
Program
AGENCY: National Credit Union Administration (NCUA).
ACTION: Final rule.
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SUMMARY: NCUA is amending its member business loan (MBL) regulations to
provide greater flexibility to credit unions to meet the business loan
needs of their members within statutory limits and appropriate safety
and soundness parameters. Major changes include: (1) Reducing
construction and development loan equity requirements; (2) allowing
RegFlex credit unions to make their own decisions whether to require
personal guarantees by principals; (3) allowing well-capitalized credit
unions to make unsecured MBLs within certain limits; (4) providing that
purchases of nonmember loans and nonmember participation interests do
not count against a credit union's aggregate MBL limit, subject to an
application and approval process; (5) allowing 100% financing on
certain business purpose loans secured by vehicles; (6) providing that
loans to credit unions and credit union service organizations (CUSOs)
are not MBLs for purposes of the rule; and (7) simplifying MBL
documentation requirements. Other provisions in the MBL regulation are
simplified and unnecessary provisions are removed. In addition, NCUA is
amending the prompt corrective action (PCA) rule regarding the risk
weighting of MBLs and the CUSO rule to permit CUSOs to originate
business loans.
DATES: This rule is effective October 31, 2003.
ADDRESSES: National Credit Union Administration, 1775 Duke Street,
Alexandria, Virginia 22314-3428.
FOR FURTHER INFORMATION CONTACT: David M. Marquis, Director, Office of
Examination and Insurance, at the above address or telephone (703) 518-
6360; Robert M. Fenner, General Counsel, or Chrisanthy J. Loizos, Staff
Attorney, Office of General Counsel, at the above address or telephone
(703) 518-6540.
SUPPLEMENTARY INFORMATION:
A. Background
On March 27, 2003, the NCUA Board issued a Notice of Proposed
Rulemaking to amend the MBL rule and other rules as they relate to
business lending. 68 FR 16450, Apr. 4, 2003. In the proposed rule, the
Board provided some parity for federal credit unions (FCUs) with
federally insured, state-chartered credit unions (FISCUs) that are
exempt from NCUA's MBL rule because the Board had determined that their
chartering states had developed MBL rules that minimize risk and
accomplish the overall objectives of NCUA's rule. The parity provisions
in the proposed rule addressed construction and development loan equity
requirements, personal guarantees by principals, and unsecured MBLs.
The proposed rule also revised certain provisions that have created
unnecessary regulatory burden and clarified certain provisions that
have caused confusion. These proposed amendments related to: the dollar
amount that triggers compliance with the rule, the loans to one
borrower limit, the aggregate MBL limit, loan-to-value (LTV)
requirements, MBL documentation requirements, and the loan loss reserve
requirements. The Board also proposed that credit unions that purchase
participation interests in MBLs made to credit union members need not
count the purchase against the credit union's own limit. Finally, the
proposed rule expanded the current standard risk-based net worth (RBNW)
component for MBLs in the PCA rule and authorized CUSOs to originate
business loans.
In the preamble to the proposed rule, the Board noted that the
proposed amendments to the MBL rule would allow credit unions greater
opportunities to meet the small business loan needs of their members
without creating undue risk to the National Credit Union Share
Insurance Fund. The Board cautions, however, that MBLs are not suitable
for all credit unions. Credit union management must demonstrate a
higher standard in planning, policies, procedures, controls,
monitoring, credit risk, and diversification to safely establish a
long-term strategy in member business lending.
B. Comments
General
NCUA received three hundred and ninety timely comment letters on
the proposed rule. NCUA staff, however,
[[Page 56538]]
credited multiple comment letters from the same commenting organization
as one comment letter for a total of three hundred and fifty-one
letters. NCUA received comments from two hundred and seventy-six credit
unions, twenty-five credit union trade organizations, one CUSO, two
corporate credit unions, one corporate CUSO, one CUSO trade
organization, two law firms, two consultants, one journalist, fourteen
bank trade organizations, twenty banks, one federal agency, one
association of state supervisors, three credit union members, and one
letter from two members of the U.S. House of Representatives.
Two hundred and ninety-two commenters generally supported the
Board's proposal. Many of these commenters stated the changes would
improve the ability of credit unions to meet the small business loan
needs of their members. Others noted that credit union members need an
affordable source of funds to finance and grow their small businesses.
They said the proposed rule allows credit unions the ability to serve
all of their members' financial needs. Some commenters stated small
business owners need every available resource to continue to operate in
a competitive economy and that low cost MBLs would allow many
businesses to continue their efforts at economic success. They also
noted small businesses are the backbone of our nation's economy and are
often owned and operated by credit union members. One commenter stated
that, as an ex-banker, he felt strongly that many small businesses face
unmet credit needs today due to minimum loan amount requirements by
large banks and bank holding companies.
Commenters also found that the proposed rules reduce some of the
expense burden associated with the current regulations and provide a
more manageable solution to business lending. These commenters stated
credit unions, their members, and small businesses will benefit from
these changes. Several commenters said the current rules are overly
restrictive vis-[agrave]-vis the competitive marketplace and that the
restrictions have forced members to take their small business loan
needs to other financial institutions, although they would prefer to do
business with the credit union. One commenter stated that the need for
small business capital is a niche that credit unions should be allowed
and encouraged to fill. This commenter also noted that as not-for-
profit cooperatives, credit unions exist to fulfill the legitimate
demands of their members, including their demand for MBLs.
NCUA also received a letter from two members of Congress on the
House Financial Services Committee stating that, as authors of the
Credit Union Membership Access Act (CUMAA), they were pleased to see
that the NCUA Board used the latitude that was appropriately conferred
upon the agency by law in preparing these beneficial changes. 12 U.S.C.
1757a, Public Law 105-219, 112 Stat. 913 (1998). The congressional
representatives urged the Board to fully utilize the discretionary
authority conferred on it by Congress to facilitate credit union
lending in this important and oftentimes underserved area, and to
refrain from imposing any limitations upon credit union member business
lending not explicitly called for by Congress when it enacted CUMAA.
Thirty-three bank-affiliated commenters strongly opposed the
proposed changes to NCUA's MBL rule, stating the proposed amendments
are contrary to congressional intent to limit business lending by
credit unions. These commenters stated the proposed amendments
significantly erode congressional intent when it adopted CUMAA and that
Congress made it perfectly clear that credit unions should be focused
on consumer lending, not commercial lending. These commenters also
stated the proposed rule will divert credit union resources to
financing commercial enterprises, while relaxing safety and soundness
regulations associated with MBLs.
Three bank commenters stated it is a tremendous mistake to
encourage the growth of tax-exempt businesses, particularly when that
growth comes at the expense of tax-paying businesses. One commenter
stated its organization does not oppose the liberalization of the
current MBL rule but does oppose continued tax exempt status for credit
unions engaged in commercial lending. Three bank commenters stated the
rule creates additional unfair competition with America's small
community banks because small business loans are an essential part of
their loan portfolio and are what they call their ``bread and butter''
loans. They noted that, without business loans, their existence is
jeopardized. Two bank commenters stated credit unions should not be in
commercial lending at all.
The U.S. Department of Treasury submitted a comment letter
supporting the commitment of credit unions to their members through MBL
programs, but objecting to certain provisions of the proposed rule. The
Treasury Department objected to the proposed treatment of participation
interests, suggesting that the proposal would undermine the intent of
Congress with respect to limitations on credit union business lending.
The Treasury Department also commented that the proposed removal of the
personal guarantee requirement and the proposed authority to make
unsecured MBLs may raise safety and soundness concerns by eliminating
key provisions that have limited credit risk on MBLs.
Other Suggestions
Commenters offered numerous suggestions to amend the MBL rule that
are outside the scope of the issues on which the Board sought comment.
The most significant comments dealt with altering the MBL rule so that
it could be better aligned with lending programs offered by the Small
Business Administration (SBA); changing the LTV definition; and
clarifying other provisions in the current MBL rule. NCUA is reviewing
these comments and will assess whether to amend the MBL rule further at
a future date, in compliance with its responsibilities under the
Administrative Procedure Act, 5 U.S.C. 553, to offer the public the
opportunity to review and comment on any proposed amendments.
C. Section-by-Section Analysis
Loans to Credit Unions and CUSOs, Sections 723.1(c), 704.11(b)
Paragraph (c) of Sec. 723.1 clarifies that loans made by federal,
natural person credit unions to other natural person credit unions and
CUSOs are not MBLs because the Federal Credit Union Act grants FCUs
express authority to lend to credit unions and CUSOs, in addition to
their authority to make MBLs. 12 U.S.C. 1757(5)(C), (D). It also
permits FISCUs to exclude loans to credit unions and CUSOs in
calculating their aggregate MBL limit if the state supervisory
authority determines that FISCUs have authority to lend to credit
unions and CUSOs separately from the general authority to grant loans
to members. In the absence of authority similar to that in the Federal
Credit Union Act, a FISCU's loans to credit unions and CUSOs are
subject to the MBL rule.
The final rule includes a corresponding amendment to NCUA's
corporate credit union rule to conform to the MBL rule regarding loans
to corporate CUSOs by removing the requirement that a corporate credit
union's loans to corporate CUSOs be included in the MBL rule's
aggregate loan limit, 12 CFR 704.11(b)(4).
Forty-six commenters specifically supported the clarification that
loans to credit unions and CUSOs are not MBLs. Two of these commenters
supported
[[Page 56539]]
this exclusion from the MBL limit because they stated a credit union
should be allowed to use the entire percentage of its MBL cap to make
MBLs, as intended. Many of the commenters stated the clarification
eliminates confusion when calculating MBL caps. They noted credit
unions are already restricted in the aggregate amount they can lend to
a CUSO by law or regulation and are permitted by law to make loans to
other credit unions. One commenter noted many smaller credit unions
receive deposits from larger credit unions and many credit unions make
loans to each other. This commenter stated these loans represent the
cooperative spirit of credit unions and are not MBLs. Three commenters
stated credit unions may lend to other credit unions or CUSOs for
investment purposes; excluding such loans from the MBL rule preserves
those investment options while affording a credit union more
opportunity to grow a business loan portfolio aimed at the commercial
or agricultural needs of the membership.
Two commenters stated the language in the proposed rule wrongly
provided for FISCUs to exclude loans to credit unions and CUSOs only if
there is independent authority for such loans under state law. They
noted the state's authority may be statutorily specific, statutorily
implied, by regulation, or by agency interpretation and that the
provision should be revised accordingly. The Board agrees and revised
the language in the final rule to address this concern by removing the
requirement that there be independent authority in state law.
Ten commenters agreed that corporate credit union loans to
corporate CUSOs should not be subject to the aggregate MBL limits. Some
of these commenters supported the change because these loans serve as
investments for corporate credit unions and corporate credit unions are
the liquidity providers for the credit union movement. The Board notes
that, while they need not include loans to corporate CUSOs in
calculating their aggregate MBL loan limit, corporate credit unions
remain subject to Sec. 704.11(c), which specifically requires them to
comply with certain due diligence requirements in the MBL rule for
loans to corporate CUSOs.
Loan Participations, Section 723.1(d), (e)
Paragraph (d) of Sec. 723.1 requires a credit union to subject
purchased business loans or participation interests in business loans
that another lender made to members of the purchasing credit union to
parts 723 and 702 as if the credit union had originated the loans to
its members. Paragraph (e) of Sec. 723.1 permits a credit union to
exclude purchased business loans or participation interests in business
loans that another lender made to nonmembers of the purchasing credit
union from the MBL aggregate limit under the conditions set forth in
Sec. 723.16.
Section 723.1(d) of the proposed rule provided that any interest
obtained in a participation loan would be excluded in determining the
purchasing credit union's aggregate MBL limit but that the
participation interest would otherwise be treated the same as a
business loan made by the credit union. The effect of this proposal was
to subject purchased participation interests in business loans to all
of the safety and soundness requirements of NCUA's rules, without
requiring the purchasing credit union to count participation interests
in loans originated by other lenders against its aggregate MBL limit.
While the proposal did not specifically address purchases of whole
loans, authorized for RegFlex credit unions pursuant to 12 CFR part
742, the same logic would apply to those purchases.
Credit union commenters were largely supportive of the proposal,
although some questioned the basis for distinguishing between loans
originated by a credit union and those purchased from another lender.
Banks and their representatives argued that the proposal was
inconsistent with congressional intent to limit business lending by
credit unions, and that it presented unfair competition to community
bankers. The U.S. Treasury Department commented that the proposed
treatment of participation interests would create a ``loophole'' to
escape the aggregate limit on individual credit unions established by
Congress. On the other hand, two congressional sponsors of the CUMAA
urged NCUA to use its maximum flexibility to enable credit unions to
meet their members' business loan needs.
The Board has made two changes from the proposed rule to address
the concerns raised by the commenters and ensure that the treatment of
loan purchases and participation interests does not result in
circumvention of the aggregate limit. First, the final rule provides
that, if a credit union holds an interest in a business purpose loan of
its member, the interest will be treated the same irrespective of
whether it was made by the credit union or purchased from another
lender. If a loan is to a credit union's own member for more than
$50,000, and not otherwise excluded from the definition of an MBL, the
credit union must treat it as an MBL for all purposes, including the
aggregate limit. This change is accomplished by adding a new subsection
(d) to Sec. 723.1, ``What is a Member Business Loan?'' The new
subsection clarifies that purchased member loans and member
participation interests are MBLs for all purposes under the final
rule.\1\ Second, with respect to nonmember loans and nonmember
participation interests, the final rule provides that they will be
treated the same as an MBL for all purposes except the aggregate MBL
limit. The total of such nonmember loans, when added to member loans,
may exceed the aggregate limit on member loans only if approved by the
NCUA Regional Director pursuant to an application and review process.
Section 723.1(e) reflects this change and contains a cross reference to
new Sec. 723.16(b) that establishes the application process. The
reasons for this treatment of nonmember loans are addressed in detail
in the discussion of Sec. 723.16 below.
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\1\ In addition to the provisions of part 723, credit unions may
also be subject to the requirements or authorities granted in other
applicable regulations governing loan participations, eligible
obligations, and loan purchases by RegFlex designated credit unions.
12 CFR 701.22, 701.23, 742.5.
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Construction and Development Lending, Section 723.3
Section 723.3 sets a new borrower equity requirement and
establishes exceptions to the limits imposed on construction and
development MBLs. This section requires a borrower to have a minimum of
a 25%, rather than a 35%, equity interest in any construction or land
development project. It also creates specialized standards for
financing the construction of single-family residential properties by
professional homebuilders by excluding these MBLs from the aggregate
construction and development MBL aggregate limit and the borrower
equity requirement under certain circumstances.
Ninety-four commenters welcomed the reduced borrower equity
requirement of 25%. Many of these commenters stated this minimum equity
interest requirement should provide sufficient collateral for a credit
union and adequate incentive for a borrower to complete a project. Some
commenters stated the lowered equity interest requirement will help
credit unions assist more small business owners and put credit unions
on equal footing with other financial institutions. Twenty-two
commenters said the revision will provide flexibility for both the
borrower and the credit union without negatively impacting safety and
soundness. One
[[Page 56540]]
commenter noted that lowering the equity requirement reduces the
additional burden on credit unions to secure a waiver from the 35%
equity interest requirement.
Eight commenters recommended an even lower percentage for the
mandatory equity requirement to be competitive with the market. One
stated the requirement should be set at 20% and another suggested that
the rule permit waivers to 20%. One commenter asked that the rule allow
for a lower percentage when a government agency has provided a
guarantee or advance commitment on the loan. Another stated that the
proposal was a step in the right direction but would prefer if the
minimum equity requirement was lowered to 10% if principals give their
personal liability and guarantee. A few commenters raised concerns
about the equity requirement in relation to the current rule's
definition of LTV. They suggested that the agency adopt the FFIEC
Interagency Guidelines for Real Estate Lending that establish
supervisory limits on LTV ratios on construction and development MBLs.
12 CFR part 34, subpart D, appendix A.
The final rule retains the equity requirement as proposed. The
Board continues to regard the borrower equity interest in construction
and development projects and the MBL rule's LTV section, Sec. 723.6,
as important tools for safe and sound business lending, just as it did
when the Board first adopted these requirements in 1991. ``Collateral
requirements are imposed as a hedge against the potential for borrower
default. Additionally, LTV ratios implicitly produce powerful
incentives to encourage borrowers to repay, e.g., to protect the
borrower's equity interest in the property. These incentives do not
exist with high LTV ratios, where the borrower has little, if any,
equity at risk. Accordingly it is critical that sufficient equity be
available to protect the lender's interest.'' 56 FR 48421, 48423, Sep.
25, 1991. The Board also continues to view construction and development
loans as containing the largest overall risks to business lending. See
id. at 48424. It believes, therefore, that the requirement for a
borrower to have a 25% equity interest in a construction or land
development project is appropriate. A credit union, however, may apply
for a waiver of this requirement. 12 CFR 723.10.
The FFIEC Interagency Guidelines for Real Estate may provide more
flexibility for other financial institutions because, for example, the
Guidelines do not require any equity interest but establish LTV limits
for certain transactions. Some of the relevant FFIEC supervisory limits
are set as follows: 65% LTV for raw land; 75% LTV for land development;
and 80% LTV for commercial construction loans. 12 CFR part 34, subpart
D, appendix A. As noted above, however, comments directed at the rule's
LTV definition are not relevant to this current rulemaking because the
Board did not seek public comment on any changes to that definition.
These comments, as well as the suggestion to review the FFIEC
Interagency Guidelines for Real Estate Lending, remain under
consideration and may be addressed by future rulemaking.
Finally, commenters asked for clarification about the borrower's
equity requirement and whether it is based on the cost amount of the
project or the appraised value of the project upon completion. In NCUA
legal opinion 01-0422, dated June 7, 2001, the Office of the General
Counsel stated that a borrower's equity interest in a project may
include down-payment money and the value of land owned by the borrower
on which the project is to be built, less any liens. The legal opinion
letter also states that, because construction and development projects
are typically very speculative in nature, appraisals that attempt to
determine the future market value of the completed project tend to be
unreliable. Accordingly, NCUA believes it is more prudent to use the
market value of the project at the time the loan is made to determine
the value of the financed project. This includes the appraised value of
land owned by the borrower on which the project is to be built, less
any liens, plus the cost to build the project. To adopt the agency's
position and clarify this issue for commenters, the final rule states
that credit unions must use the current market value of the project in
determining its value.
Section 723.3 reduces the regulatory burden for members engaged in
the business of constructing single-family residential properties.
First, in the case of a loan to finance the construction of a single-
family residence where a contract already exists between the builder,
who is a member-borrower, and a prospective homeowner, the final rule
provides that such a loan is not subject to the aggregate 15% of net
worth limit of Sec. 723.3(a) or the 25% equity interest requirement.
These loans need only comply with the LTV requirements of Sec. 723.7.
Second, the final rule grants this same relief from the aggregate net
worth limit and the equity interest requirement for one construction or
development loan per member-borrower or group of associated member-
borrowers for a single-family residence, irrespective of the existence
of a contract with a prospective homeowner.
When making construction and development loans that are exempt from
the equity requirements in Sec. 723.3 but subject to the LTV
requirements of Sec. 723.7, credit unions must use the market value of
the project at the time the loan is made, as discussed above, when
determining the appropriate LTV limits.
Eleven commenters supported the exemptions for the financing of
single-family residential properties. Several of these commenters
stated that the Federal Credit Union Act charges credit unions to
extend credit for provident purposes. They found the exclusions for the
construction of single family residences enable credit unions to assist
their members in achieving home ownership because increased credit
union construction financing will enhance the marketplace for readily
saleable homes in every community. In short, they stated this
regulation opens a door for credit unions to increase the types of
service they can offer to their communities.
Two commenters asked for clarification on these provisions because
they were unclear as to the number of loans a member homebuilder may
have with the credit union under these exclusions. The final rule
allows the homebuilder to have as many loans as it has sales contracts
with future homeowners, plus one loan for a home for which the
homebuilder does not yet have a sales contract, subject to the loans to
one borrower limit in Sec. 723.8. When the credit union applies the
rule's exceptions to its first speculative-type loan made to a
homebuilder, that loan remains exempt from the 25% equity requirements
and excluded from the 15% net worth limit of Sec. 723.3 until the
builder pays off the loan. Once it is fully paid, the credit union may
exclude a new speculative loan made to the builder from the 15% net
worth limitation and subject the loan to the LTV requirements of Sec.
723.7. This is contrasted with an outstanding speculative loan to the
builder. The credit union cannot exclude an outstanding speculative
loan it made during the time the builder was repaying the first exempt
loan because any additional speculative loans to the builder during
that time must have been made under all of the conditions of Sec.
723.3.
Three commenters noted that the proposed Sec. 723.3(b) excluded
certain construction loans if the prospective homeowner contracted to
purchase and reside in the property, but that typically
[[Page 56541]]
prospective homeowners do not contract to reside in a property. They
asked, therefore, that this wording be removed. The Board agrees and
amended the final rule accordingly. These commenters also asked the
Board to expand the exclusion to one-to-four family dwellings. The
final rule maintains the more restrictive provision as proposed,
limiting the exclusions to single-family residences. The Board has
determined not to extend the exclusion to multi-family dwellings as
these dwellings have an investment component for the purchaser.
Direct Experience Requirement, Section 723.5
The final rule amends this section by requiring that the person
meeting the rule's mandatory two years of direct experience requirement
have sufficient experience given the complexity and risk exposure of
the credit union's MBLs. It also requires that a third party meeting
the experience requirement be independent from the transaction, but
establishes three exceptions from this standard.
Seventy-four commenters supported the agency's intent for this
proposal. Most of these commenters stated that the rule would make it
easier to find individuals qualified to act as an MBL officer by
allowing credit unions to engage the services of a third party with
direct experience in MBLs under certain conditions so as to avoid
potential conflict of interest. They also stated that it allows credit
unions to make MBLs without creating a costly infrastructure to meet
the experience requirement. The Board wants to clarify that credit
unions have been able to use third parties to meet the experience
requirement since the 1991 final MBL rule. 56 FR 48421, Sept. 25, 1991.
This rulemaking bolsters the experience requirement by ensuring that
the individual's experience is relevant to the types of MBLs the credit
union makes and that the individual does not have interests that
conflict with the credit union's interests.
Six commenters asked for clarification regarding the agency's
standard for the requisite lending experience. In 1999, the Board
stated that the ``experience requirement can be met by either general
business lending experience or experience with granting loans for a
particular purpose or secured by a particular collateral.'' 64 FR
28721, 28723, May 27, 1999. The final rule has a more specific standard
requiring a credit union to obtain the services of someone with
experience tailored to the credit union's needs. Individuals who meet
the requirements of this section must have lending experience directly
related to the type of MBLs the credit union intends to offer. These
individuals must be familiar with the proper underwriting, analysis,
and origination of loans of a particular type in order to understand
their complexity and risk exposure. For example, an individual with
experience solely in taxi cab loans does not have the requisite
experience necessary to underwrite a loan to the taxi company for a gas
station, because the individual will be unfamiliar with related issues
that may impact the loan, such as environmental laws applicable to
underground storage tanks. Likewise, an individual who only has
experience with financing residential real estate for homebuilders does
not have sufficient lending experience for the land development and
construction, or purchase, of a commercial strip center.
Thirty-three commenters found the prohibition against a third party
having an interest or involvement in the transaction too restrictive.
Most of these commenters stated that the proposal limited a credit
union's ability to use third-party service providers and should not be
adopted in the final rule. They stated that, while improper personal
financial gain cannot be tolerated, a paid third party's interest and
involvement is necessary to provide the assistance many credit unions
need to make MBLs. One commenter opposed the requirement stating that
it would preclude smaller credit unions from having agreements with
larger credit unions that have experience underwriting MBLs and then
selling participations to that credit union. Two commenters suggested
that, in any transaction in which a third party is retained, a credit
union should obtain written disclosures of actual or potential
relationships and fee arrangements the third party may have in the
transaction. Another commenter stated that the proposal was worded too
broadly. The Board agrees that the proposal required some revision. The
final rule amends the proposed language to more accurately reflect the
Board's concerns by establishing a general conflicts of interest
standard and exceptions to the standard.
In order for a credit union to engage in business lending in a safe
and sound manner, it is crucial for the credit union to maintain strong
internal controls and to have independent, experienced personnel
involved in making lending decisions that are in the best interests of
the credit union. The credit union must perform its own due diligence,
both when the credit union makes MBLs and when it purchases MBLs or MBL
participation interests, through the services of an individual who
meets the requirements in Sec. 723.5. The final rule does not prevent
a third party who has the direct experience necessary for a credit
union to make MBLs from providing services to the credit union such as
document preparation, annual reviews, or loan servicing.
The final rule generally prevents a credit union from relying on a
seller's due diligence and experience when the credit union is
purchasing MBLs or participation interests in MBLs from the seller.
Regardless of whether the seller is, for instance, another credit union
or CUSO, the purchasing credit union cannot meet the direct experience
requirements of Sec. 723.5 by depending on the advice of the
experienced individual(s) who performed the underwriting for the
originating lender unless: (1) Staff for the purchasing credit union
performed the loan analysis for the originating credit union; or (2)
the CUSO exception in Sec. 723.5(b)(3) applies. The final rule bars a
credit union from using a third party who has an interest in either the
sale of the loan or the collateral securing the loan. It does not bar a
smaller credit union from subsequently selling participations to a
larger credit union that had advised the credit union when it
originated the MBL.
Under the CUSO exception in paragraph (b)(3), a credit union may
comply with Sec. 723.5 when purchasing a participation interest or
eligible obligation from a CUSO, if the experienced individual is
employed by a CUSO in which the credit union has a ``controlling
financial interest'' as determined under the Generally Accepted
Accounting Principles, even though the CUSO is both the originator and
underwriter of the loan.
Member Business Loan Policy, Section 723.6
This section is amended to require credit unions to adopt analysis
and documentation requirements within their MBL policies that are
consistent with appropriate underwriting and due diligence standards
for the types of MBLs the credit union makes, without detailing
required documents. Documentation and underwriting criteria for an MBL
may vary depending on the type of business requesting the loan and type
of loan requested. The final rule also makes a technical amendment to
12 CFR 704.11(c) to reflect the redesignation of paragraphs in Sec.
723.6.
One hundred and twelve commenters supported the proposal. The vast
majority of these commenters noted it would greatly expedite the MBL
process
[[Page 56542]]
by eliminating unnecessary documentation and reducing staff time spent
on MBL documentation. Many commenters stated it is appropriate for a
credit union to adopt documentation requirements in its own policy
relative to the types of loans being made. They said that simpler
transactions should be subject to fewer documentation requirements than
more complex ones, as long as reasonable standards of safety and
soundness are met. The final rule adopts the revisions to Sec. 723.6
as proposed.
Loan-to-Value Ratio, Section 723.7
The final rule makes several amendments to this section. First, the
final rule uses plain English to describe the LTV requirements instead
of a chart. Second, the final rule retains the personal liability and
guarantee requirement but no longer requires RegFlex credit unions to
obtain these guarantees from principals. Third, the final rule permits
credit unions to make unsecured MBLs, in addition to credit card line
of credit programs offered to nonnatural person members, if: (1) The
credit union is ``well-capitalized'' as defined in 12 CFR
702.102(a)(1); (2) the aggregate of unsecured MBLs to one borrower does
not exceed the lesser of $100,000 or 2.5% of the credit union's net
worth; (3) the aggregate of all of the credit union's unsecured MBLs
does not exceed 10% of the credit union's net worth; and (4) the credit
union addresses unsecured loans in its written MBL policy. The final
rule reorganizes the waiver provisions of Sec. 723.10 and permits
credit unions to apply for waivers from the unsecured MBLs to one
borrower limitation and the aggregate unsecured loan limitation under
this section. Finally, Sec. 723.7 excludes MBLs made for the purchase
of consumer-type vehicles from the rule's LTV requirements if the
vehicle is a car, van, pick-up truck, or sports utility vehicle (SUV)
that is used for commercial purposes.
A few commenters favored removing the LTV chart for a plain English
description of the LTV requirements. One commenter stated, however,
that credit unions may misunderstand the rule's clarification that
government guarantees may not be used in place of the collateral
requirements of Sec. 723.7. While the Board recognizes the distinction
between the rule's collateral requirements and advance commitments or
loan guarantees issued by government agencies, the Board believes it is
helpful to maintain this clarification in the final rule. As stated in
Sec. 723.7(a)(2), the MBL rule does not permit guarantees as
replacements for collateral requirements. Borrowers must meet the LTV
requirements on the total loan amount from the credit union even if a
portion of the loan amount is guaranteed by a government agency. This
measure provides the credit union the necessary security in the event
the borrower fails to meet the terms of the government guarantee or
commitment. The Board notes this provision does not introduce a new
requirement but merely clarifies the existing rule. The final rule also
contains a correction by replacing ``minimum'' with ``maximum'' to
describe the LTV ratio limits prescribed in Sec. 723.3(a) that are
unchanged from the 1999 version of the rule.
Section 723.7(b) requires the personal guarantee of all principals
in the case of an MBL to a corporate or other organizational member.
The only exception is for certain not-for-profit organizations. The
proposed rule would have deleted this requirement and allowed the board
of directors of each credit union to determine whether to require
personal guarantees through its business loan policies. The proposal
noted that states that have received exemptions from the NCUA rule have
not required personal guarantees and that there is no indication of
increased losses or other safety and soundness problems in those
states.
While most commenters supported this proposal, a number of
commenters, including some credit unions, objected. The views expressed
by these commenters included: (1) That the personal guarantee
requirement is one of the key reasons that credit union MBLs have been
less risky than those of other lenders; (2) that if the principals are
not willing to stand behind an MBL, the credit union should not grant
it; (3) that without the guarantee requirement future loss experience
will be greater; and (4) increased loss experience will be to the
detriment of credit unions generally, not just those comparatively few
credit unions that choose to make MBLs. Commenters also noted that the
exemptions granted to individual states are relatively new and
suggested additional monitoring of those states is warranted before
eliminating the requirement altogether.
In response to the comments, and after further consideration of the
safety and soundness implications of the proposal, the Board has
determined to remove the personal guarantee requirement only for those
credit unions having RegFlex status under 12 CFR part 742. The personal
guarantee requirement is removed for both federal and federally insured
state-chartered credit unions meeting the standards of Part 742.
RegFlex credit unions generally have a net worth ratio of 9% or more
and a high supervisory rating. The Board believes there is little
additional safety and soundness risk to the credit union system in
allowing RegFlex credit unions that have MBL programs to make their own
decisions about requiring personal guarantees. This change is reflected
by amending Sec. 723.7(b), the personal guarantee requirement, to
state that it does not apply to RegFlex credit unions, and by amending
NCUA's RegFlex rule, at Sec. 742.4, to add Sec. 723.7(b) to the list
of regulatory requirements from which RegFlex are exempt. Credit unions
that do not have RegFlex status may apply for a waiver from the
personal guarantee requirement, as permitted in Sec. 723.10(e).
The Board notes the Office of the Comptroller of the Currency and
the Office of Thrift Supervision do not impose a legal requirement on
national banks and savings associations to obtain principals' personal
guarantees before extending credit to a business, but that personal
guarantees are nonetheless an industry practice. The Board also notes
that the SBA requires personal guarantees under its microloan, 7(a),
and 504 loan programs. The Board, therefore, encourages RegFlex credit
unions to consider personal guarantees as a risk mitigation tool.
Thirty-seven commenters supported the provision on unsecured MBLs
as proposed. Some of these commenters thought the proposal would enable
credit unions to expand the potential number of MBL borrowers they
could serve and allow them to be competitive with other financial
institutions. One commenter stressed how valuable the increase in the
unsecured lending authority is to credit unions that partner with the
SBA because SBA guidelines allow lenders to make an SBA loan to a
business with sufficient ability to repay the loan, even when there is
not enough collateral to cover the whole request. Accordingly, the
commenter stated, SBA lenders could often be faced with a loan amount
in excess of the value of the collateral, so credit unions need
sufficient unsecured lending limits to fund this uncollateralized gap.
Sixty-nine commenters stated that the provisions on unsecured MBLs
are too restrictive. These commenters offered various suggestions to
relax the limits placed on unsecured loans to one borrower and the
aggregate amount of unsecured loans a credit union is permitted to
make. Three commenters opposed allowing credit unions to make unsecured
MBLs.
Section 723.7(c) of the final rule adopts the provisions on
unsecured lending as proposed. While many credit
[[Page 56543]]
unions have requested that the final rule provide greater latitude, the
Board finds it prudent to maintain the proposed limits in order to
monitor the manner in which credit unions engage in unsecured business
lending. The Board also believes that, until it has the opportunity to
evaluate the progress of credit unions with unsecured MBLs, the waiver
process is sufficient for those credit unions seeking to exceed the
rule's current limitations. The waiver process affords NCUA Regional
Directors the opportunity to review the safety and soundness
considerations of each applicant's lending program on a case-by-case
basis.
Ninety-four commenters supported the exemption from the LTV
requirements for consumer-type vehicle MBLs. Many of the commenters
stated the change is long overdue because the distinctions between a
car loan for business purposes and a car loan for consumer purposes are
slim. One commenter stated it supported the proposal because the
exclusion includes leases of these vehicles and more than one vehicle
to an individual, association, organization or business entity. Eleven
commenters asked for clarifications on the vehicles covered under the
exemption or an expansion of the exemption. Nine of these commenters
asked that the Board extend the exemption to any titled vehicle.
Section Sec. 723.7(e) retains the standard proposed by the Board
because it believes that the vehicles covered present little or only
minimally greater risk than a comparable consumer loan. The Board
opposes extending this exemption to all titled vehicles because there
is not a readily available market for all types of titled vehicles as
there is for consumer-type cars, vans, pick-up trucks, and SUVs. In
taking advantage of this rule exception for certain vehicle MBLs,
credit unions should establish lending terms, including collateral
requirements, for these loans that reflect best industry practices. The
Board notes that sound lending practices require that LTV ratios and
the term of the loan be consistent with the depreciation schedule of
any vehicle used for a particular type of business.
As stated in the proposed rule's preamble, the Board intends this
exclusion to be used to finance business use or combined personal/
business use vehicles and not, for example, to finance fleet purchases.
One commenter asked the Board to clarify the concept of a fleet of
cars. A fleet is defined as ``a group of vehicles, as taxicabs * * *,
owned or operated as a unit.'' Webster's II New Riverside University
Dictionary (1994) at 486. The final rule clarifies that a fleet of
vehicles is not included in the vehicle exception to the LTV
requirements because, when a business requires the use of a fleet of
vehicles, it is likely these vehicles will depreciate far more quickly
than vehicles used for personal use or a combined personal/business
use.
Reserves for Classified Loans, Sections 723.14 and 723.15
The final rule deletes and reserves Sec. Sec. 723.14 and 723.15,
which addressed the classification of MBLs for losses and reserving
requirements, because NCUA's Interpretive Ruling and Policy Statement
on Allowance for Loan and Lease Losses Methodologies and Documentation
for Federally-Insured Credit Unions (FICUs) No. 02-3 provides FICUs the
appropriate guidance. 67 FR 37445, May 29, 2002. Six commenters
specifically supported the deletion of these provisions.
Effect of Purchased Loans and Purchased Participation Interests,
Section 723.16
In the CUMAA, Congress established an aggregate limit on MBLs made
by individual FICUs. A credit union is exempt from the aggregate limit
if it: (1) Was chartered for the purpose of making MBLs; (2) has a
history of primarily making MBLs; (3) serves predominantly low income
members; or (4) is a community development financial institution. For
credit unions that are not exempt, the amount of the aggregate limit is
the lesser of 1.75 times the credit union's net worth or 12.25% of the
credit union's assets. Thus, for credit unions with a net worth ratio
of 7% or more, the limit is 12.25% of assets. Also, certain loans, such
as those below $50,000 in amount and those covered by a government
guarantee, are excluded from the MBL definition. 12 U.S.C. 1757A.
The statutory language establishing the aggregate limit provides
that ``no insured credit union may make any member business loan that
would result in the total amount of such loans outstanding'' in excess
of the limit. 12 U.S.C. 1757a(a) (emphasis added). The Board believes
that this language lends itself to several possible interpretations.
The narrowest interpretation would apply the limit only to loans made
by a credit union to its members and not to loans and loan interests
purchased from another lender. A second interpretation would apply the
limit to all business loans to a credit union's members, whether made
by the credit union or purchased from another lender, but not to
purchases of loans or loan interests where the borrower is not a
member. The most inclusive interpretation would apply the limit to all
business loans, whether made or purchased, and irrespective of whether
the borrower is a member.
All FCUs are authorized to purchase participation interests in
loans made by other lenders to credit union members. 12 U.S.C.
1757(5)(E); 12 CFR 701.22. The borrower need not be a member of the
purchasing credit union, only a member of a participating credit union.
12 CFR 701.22(d)(2). In addition, an FCU generally may purchase
eligible obligations of its members from any source if the loans are
those the FCU is empowered to grant. 12 U.S.C. 1757(13); 12 CFR
701.23(b). Also, although not specifically addressed in the proposed
MBL rule, credit unions eligible for NCUA's regulatory flexibility
program are authorized to purchase whole loans from other FICUs,
including business purpose loans, irrespective of whether the borrower
is a member of the purchasing credit union. 12 CFR 742.5.
In the proposed rule, the Board requested comment on the least
constraining interpretation of the aggregate limit on MBLs, that is,
only business loans made by a credit union to its members would have
counted against the aggregate limit. The Board believes this proposal
is consistent with the plain language of the Federal Credit Union Act
establishing a limit on member business loans made by a FICU. The Board
also believes the proposal is consistent with the congressional intent
that credit unions not make business loans at the expense of the
consumer loan needs of members and that the credit union system not
take on undue risk as a result of over-concentration of MBLs. See
Senate Report 105-193 for a discussion of congressional intent.
In the proposal, the Board addressed the concern that purchasing
MBLs might divert a credit union from its responsibility to extend
consumer loans and minimize risk related to concentration of MBLs. The
Board noted that a credit union's member-elected board of directors
would meet its own members' loan demands first and purchase loans made
by other lenders only as a means of placing excess funds to maximize
returns to their member shareholders. The proposed rule addressed the
safety and soundness concerns both by requiring that the purchasing
credit union perform its own due diligence on all purchased loans and
loan interests and by treating a purchase as a business loan asset for
all other purposes, such as loan-to-one-borrower limits and risk-based
net worth requirements.
[[Page 56544]]
As previously stated, credit unions and credit union related
commenters were supportive of the proposal, but some questioned the
basis for distinguishing between originations and purchases. Banks and
their representatives argued that the proposal was inconsistent with a
congressional intent to limit business lending by credit unions. The
U.S. Treasury Department suggested that the proposed treatment of
participation interests would create a ``loophole'' to escape the
aggregate limit on individual credit unions established by Congress. On
the other hand, two congressional sponsors of CUMAA urged NCUA to use
its maximum flexibility to enable credit unions to meet their members'
business loan needs.
As explained in the discussion of Sec. 723.1(d) and (e) above, the
Board has addressed the commenters concerns by making certain changes
to the proposed rule. First, the Board has determined that business
purpose loans to members should be included in the aggregate limit
whether the loan was made by the credit union or purchased from another
lender. Thus, for example, if a credit union forms a CUSO to originate
business loans to the credit union's members and then purchases those
loans from the CUSO, the purchased loans will count against the credit
union's limit. This change is addressed in Sec. 723.1(d) of the final
rule.
On the other hand, purchases of nonmember loans and participation
interests, as authorized under certain conditions in NCUA's rules and
some state laws and rules, do not involve the provision of member loan
services, and the acquired loan assets are not MBLs. The Board
continues to believe that these purchases will be made only as a
productive method of placing excess funds after member loan demands are
met, and that they need not count against the purchasing credit union's
aggregate MBL limit. The Board believes it is important to avoid
unnecessary interference with the ability of credit unions to place
their excess funds in the manner that best serves the credit union, its
members, and the credit union system. A credit union that has, for
example, 10% of its assets in MBLs and no further current business loan
demand, should be able to place excess funds in participation interests
of loans made by another credit union without being concerned that it
will bar the purchasing credit union from meeting its own members'
future loan needs. Purchasing participation interests, or whole loans
in the case of a RegFlex credit union, provides a better rate of return
for the credit union and its members as compared to a typical
investment asset, provides for risk diversification within the credit
union system, and fosters the cooperative spirit that has traditionally
existed and continues to exist among credit unions. Purchased nonmember
participation interests, however, remain as loans on the credit union's
balance sheet even though, under this regulatory standard, they are not
MBLs for purposes of the aggregate MBL cap.
Recognizing that a purchased business loan or participation
interest of a nonmember is a business loan asset with all of the
attendant risks, the final rule does adopt the proposed rule's
treatment of these assets as MBLs for purposes of the safety and
soundness requirements of NCUA's regulations. A participating credit
union, therefore, must otherwise comply with Part 723 and subject these
loans to the PCA risk-weighting standards under Part 702 for MBLs as
though the credit union had originated the loans. Thus, for example,
the purchasing credit union will be required to do its own independent
underwriting review and treat the loan the same as an MBL for purposes
such as loan-to-one-borrower limits and construction and development
loan limits. This change is accomplished, as previously discussed, by
adding a new subsection (e) to Sec. 723.1, ``What is a Member Business
Loan? '' This subsection provides that purchased nonmember loans and
participation interests are treated the same as MBLs for all purposes
under the rule except the aggregate limit.
With respect to the aggregate limit on MBLs for individual credit
unions and to address concerns that the proposed rule would have
created a loophole enabling credit unions to escape the limit, the
final rule requires Regional Director approval of any transaction that
would cause the total of purchased nonmember business loans and
nonmember participation interests, when added to the credit union's
MBLs, to result in an amount in excess of the credit union's aggregate
limit on MBLs. If the credit union is a FISCU, the request must be
submitted to the state supervisory authority for approval. If the state
supervisory authority approves the request, the state supervisor will
forward it to the regional director for approval. This is consistent
with the treatment of waiver requests for FISCUs under the MBL rule. An
application submitted pursuant to this requirement must include a copy
of the credit union's business loan policies. The application must
confirm that the credit union adheres to all aspects of NCUA's MBL
rules with respect to purchases of nonmember business loans and
participation interests, except the aggregate MBL limit. The
application must include the credit union's proposed loan limit on
nonmember loans and nonmember participation interests. Finally, the
application must attest that the purchase is not being used, in
conjunction with one or more other credit unions, in a manner that has
the effect of trading MBLs that would otherwise exceed the aggregate
limit. Upon receipt of a completed application, the Regional Director
will issue a decision within thirty days. In the case of a FISCU, the
regional director will issue a decision within 30 days of receipt of a
completed application and the state supervisory authority's approval.
The application requirement responds to commenter concerns that
some credit unions may use the authority to purchase nonmember loans as
a device to swap loans and evade the aggregate limit. This process will
enable NCUA and the state supervisors to ensure that the authority to
purchase nonmember loans and participation interests is not used to
trade loans and circumvent the aggregate limit. Further, it will ensure
that purchasing credit unions have conducted their own independent
review and otherwise complied with the safety and soundness
requirements of the regulations. The Board notes that the final rule
does not permit a credit union to seek approval to exceed the aggregate
limit on MBLs for member loans or member participation interests made
by the credit union or purchased from another lender. The application
requirement regarding nonmember business loans and participation
interests is set forth in Sec. 723.16(b) of the final rule.
Net Member Business Loan Balance (NMBLB), Section 723.21
The final rule adopts the phrase ``net member business loan
balance'' as a new definition in Sec. 723.21 and uses it in various
sections in the rule, including Sec. Sec. 723.1, 723.3, 723.8, and
723.16. The NMBLB definition is:
[T]he outstanding loan balance plus any unfunded commitments,
reduced by any portion of the loan that is secured by shares in the
credit union, or by shares or deposits in other financial
institutions, or by a lien on the member's primary residence, or
insured or guaranteed by any agency of the federal government, a
state or any political subdivision of such state, or subject to an
advance commitment to purchase by any agency of the federal
government, a state or any political subdivision of such state, or
sold as a participation interest without recourse and qualifying for
true sales
[[Page 56545]]
accounting under generally accepted accounting principles.
The NMBLB definition reflects NCUA's interpretation of various
provisions in the MBL rule since the 1999 MBL rule was issued and
incorporates several exclusions derived from CUMAA. This definition is
key to determining: whether a loan qualifies as an MBL; which portion
of an MBL is included in the calculation of the loans to one borrower
limit; and which portion of an MBL is included in the calculation of a
credit union's total aggregate MBL limit. The Board notes that, because
the NMBLB definition excludes participation interests sold without
recourse from the selling credit union's MBL limits, neither the
originating credit union nor a participating credit union count
participations against their MBL aggregate cap provided, as discussed
above, the loan participation is not in a loan made to a member of the
participating credit union and the participating credit union has
obtained a waiver, if required under the circumstances. The Board also
notes the final rule includes language clarifying that participations
sold without recourse must qualify for true sales accounting under GAAP
so that the rule accurately reflects the agency's interpretation over
the last several years.
The proposed rule contained a substantially similar definition
using a different term, ``outstanding member business loan balance.''
Several commenters found the definition confusing because the term's
use of the word ``outstanding'' did not accurately reflect the
calculations required as part of the definition. In effect, the
proposed definition required a netting of the various exclusions in the
definition. The Board has changed the term to ``net member business
loan balance'' and simplified the definition to make it easier to
understand.
Seventy-four commenters approved of the proposed definition. Most
of these commenters stated it will enable credit unions to easily
ascertain the factors involved in calculating the MBL threshold and
various limit calculations, as well as providing more flexibility in
making MBLs. Three stated the new term recognizes the balances that
represent true risk to a credit union. Two bank commenters opposed the
new term.
One commenter asked the Board to provide examples to assist credit
unions in calculating multiple business purpose loans to one borrower.
This commenter asked how much a credit union reports as an MBL when it
has $35,000 in business purpose loans to a member and makes a $40,000
business purpose loan to the same member--$40,000, $25,000 or $75,000?
The credit union would count the $40,000 loan as an MBL and would
comply with all of the requirements of Part 723 in making this loan
because the loan caused the aggregate amount of business purpose loans
to the member to exceed the $50,000 threshold in Sec. 723.1(b)(3). The
credit union, therefore, must comply, for example, with the rule's
direct experience requirements and the LTV standards when making the
loan, as well as count the MBL against the credit union's aggregate MBL
limit in Sec. 723.16. When the member pays down the amount of the
total business purpose loans owed to the credit union so that the
aggregate amount falls below the $50,000 threshold, the credit union is
no longer required to report the $40,000 loan as an MBL.
For purposes of the loans-to-one borrower limitation under Sec.
723.8, the same calculation applies. The $40,000 MBL applies towards
the member's one borrower limit of the greater of 15% of the credit
union's net worth or $100,000, until the aggregate amount of business
purpose loans held by the member is less than $50,000. The member,
however, is still subject to the Federal Credit Union Act's limitation
on the total amount of loans made to one borrower of no more than 10%
of the credit union's unimpaired capital and surplus. 12 U.S.C.
1757(5)(A)(x).
Another commenter asked for clarification on the manner in which a
loan that has a partial guarantee from the SBA is analyzed with the
NMBLB definition. As discussed in the 1999 final rule's preamble, a
credit union only counts the amount of the loan that is not guaranteed
by the SBA towards the $50,000 threshold in Sec. 723.1(b)(3) to
determine if a business purpose loan is an MBL. 64 FR 28721, 28722, May
27, 1999. Consistent with this interpretation, a credit union that
makes a $100,000 business purpose loan, of which 75% of the loan amount
is guaranteed by a government agency, counts only $25,000 towards the
MBL threshold. 12 CFR 723.1(b)(3). Because this amount of $25,000 is
less than $50,000, the loan is not an MBL and is not subject to Part
723.
This example demonstrates loan analysis for purposes of Part 723:
Loan 1 to Company in January 2003: $40,000.
Loan 2 to Company in February 2003: $80,000 with a 75% government
guarantee.
? Loan 1 is not an MBL because it is under the $50,000
threshold.
? Loan 2 has an NMBLB of $20,000 (25% of $80,000) but when
added to Loan 1, the amount of business purpose loans to the member
exceeds $50,000, so Loan 2 is an MBL and must comply with all of the
requirements of Part 723.
? FCU must obtain a lien on Company's collateral valued at
$100,000 in order to make Loan 2.
? FCU counts $20,000 against its aggregate MBL limit and
$20,000 towards Company's limit on loans to one borrower.
? FCU must factor the entire loan amount of Loan 2, $80,000,
as an MBL into the standard RBNW calculation of the PCA rule until the
loan is fully paid.
Loan 1 is paid down to $15,000 in April 2003.
? Loan 2 is no longer an MBL for purposes of Part 723 because
the total amount of business purpose loans to Company is $35,000.
Loan 3 is a participation purchased in a loan made to Company on
May 2003: $25,000
? Loan 3 is an MBL because combined with the NMBLBs of Loans
1 and 2, Company's aggregate NMBLBs is $60,000.
Loan 4 Unsecured Line of Credit to Company in June 2003: $15,000.
? Loan 4 is an MBL because Company's aggregate NMBLBs for all
four loans totals $75,000, which exceeds the $50,000 threshold.
? As of June 2003, FCU counts Loan 3's NMBLB of $25,000 and
Loan 4's NMBLB of $15,000 against its aggregate MBL cap and against
Company's loans-to-one borrower limit.
? For PCA purposes, FCU calculates the standard RBNW based on
the outstanding balances on Loans 2, 3, and 4 in accordance with Sec.
702.106(b).
One commenter asked that NCUA amend its Form 5300 call report
instructions to reflect the changes in the final rule. NCUA will amend
the call report after the agency gives the public notice and an
opportunity to comment on any proposed changes in accordance with the
Administrative Procedure Act and the Paperwork Reduction Act of 1995.
The Board anticipates that this process will take several months.
The final rule deletes and reserves Sec. 723.9, which addressed
calculation of the limit on loans to one borrower, because the NMBLB
definition contains all of the rule's exclusions from this calculation,
making Sec. 723.9 unnecessary.
Effect of Final Rule on Approved State Rules
State supervisory authorities may continue to seek exemptions for
their FISCUs from NCUA's MBL rule as set
[[Page 56546]]
forth in Sec. 723.20. The seven states that have already received an
exemption from the Board will now have three options after the
effective date of this rulemaking: (1) State supervisors may rescind
their current MBL rules and require their charters to comply with
NCUA's new rule; (2) they may maintain their rules as the Board had
approved them; or (3) they may seek approval from the Board to adopt
any variances from those rules the Board previously approved, in
accordance with the process outlined in Sec. 723.20. Commenters asked
that the Board adopt a process for NCUA staff approval for any of the
seven states that want to update their rules to the new NCUA rule. As
noted in the 1999 final rule's preamble, the Board must approve a
state's rule before a FISCU is exempt from NCUA's MBL rule. 64 FR
28721, 28728, May 27, 1999. The Board, therefore, is responsible for
reviewing any state rule amendments to make a determination as to
whether the state regulation, as a whole, minimizes the risk and
accomplishes the overall objectives of NCUA's rule. The Board's intent
is that any revisions to exempted state rules that simply update those
rules to parallel changes in NCUA's rule will be approved on an
expedited basis.
Section 702.106, Standard Risk-Based Net Worth Component for MBLs
The final rule expands the standard risk-based net worth (RBNW)
component for MBLs to three tiers, from the current two. The bottom
tier is risk-weighted at 6% and consists of the amount of MBLs less
than or equal to 15% of total assets. The middle tier is risk-weighted
at 8% and consists of the amount of MBLs greater than 15%, but less
than or equal to 25%, of total assets. The top tier is risk-weighted at
14% and consists of the amount of MBLs in excess of 25% of total
assets.
Twenty-six commenters stated the expansion of the standard PCA RBNW
component dividing the portfolio of MBLs into three tiers is justified
by the consistently low loss history of MBLs since 1998 as well as
their unique characteristics. Commenters stated the proposal is a
reasonable way to protect the safety and soundness of a credit union
and accurately reflects the true underlying risk of MBLs. Several of
these commenters noted that this measure offers appropriate relief with
regard to RBNW requirements. First, they noted that, those credit
unions that were chartered primarily to extend business loans or that
have history of primarily extending business loans will benefit from
the 3-tiered risk weights by assisting such credit unions in managing
the business loan portfolio and RBNW. Additionally, they stated
purchased participations will be subject to PCA. Credit unions that
plan to engage in significant participation activity will benefit from
the new risk portfolios and may better manage participations and
maintain adequate net worth. Fifty-two commenters stated the change is
not useful as it could be because it overstates the risk. They offered
alternatives to the proposed standards. The Board disagrees that the
proposal overstates risks and incorporates the rationale articulated in
the proposed rule's preamble regarding the appropriateness of the final
rule's standard RBNW component into this rulemaking. 68 FR 16450,
16453, Apr. 4, 2003.
Five commenters stated that NCUA should allow for further risk
reduction under PCA for MBLs that provide balloon or call provisions
under which a loan matures within five years. They also asked that NCUA
permit credit unions to include loans with five years or less in
maturity in the lowest risk-weighted tier when calculating PCA. The
suggestions of these commenters fail to take into account the credit
risk of MBLs as well as their interest rate risk; regardless of a
loan's maturity, credit risk still exists. The final rule, therefore,
retains the provisions the Board proposed.
One commenter noted that the NMBLB definition may cause some
confusion for credit unions when calculating the standard RBNW
requirement under Sec. 702.106(b) because the PCA rule requires risk-
weighting of ``member business loans outstanding.'' For purposes of
Part 702, when a credit union classifies a loan as an MBL under Part
723 at the time it makes or purchases a loan or participation interest,
that loan remains an MBL for calculating the RBNW requirement until the
loan is paid off. This is another issue that the Board will clarify in
its future amendments to the Form 5300 call report.
CUSO Business Loan Origination, Section 712.5
The final rule adds business loan origination to the CUSO
regulation's list of permissible activities in paragraph (c) of Sec.
712.5.
Seventy-five commenters supported the amendment to the CUSO rule.
Many of these commenters stated that by authorizing CUSOs to originate
business loans, credit unions will be able to benefit from economies of
scale by pooling their investments in a business lending CUSO, thus
permitting them to offer MBLs to members that may otherwise be
unavailable through the credit union or other lenders. Eight bank
commenters opposed the proposal and stated NCUA should reject it
because it circumvents the statutory aggregate MBL limit placed on
credit unions.
Four commenters asked that the final rule elaborate on the word
``originate.'' They stated it is arguably appropriate that a CUSO
conduct functions such as taking business loans applications,
conducting analysis, preparing documentation, arranging for title
searches or similar services, loan servicing, and review and related
services. They also stated that it may also be appropriate for a CUSO
to fund loans. Accordingly, they asked that the Board define the term
``originate'' to establish what activity is permissible through a CUSO.
The final rule allows CUSOs to make business purpose loans, just as
CUSOs are permitted to engage in consumer mortgage loan origination,
meaning to fund or make consumer mortgage loans under Sec. 712.5(d).
This is separate from the already recognized authority of CUSOs to
engage in loan support services that include loan processing and
servicing under Sec. 712.5(j).
The U.S. Treasury Department stated in its comment that it did not
object to allowing CUSO business loan origination in itself but
expressed concern that the proposed rule excluded participation
interests in CUSO-originated MBLs purchased by credit unions from
counting towards the MBL cap. As detailed in the discussion regarding
Sec. 723.16 above, the final rule does not permit a credit union to
exclude any participation interest it has purchased in a loan made to
one of the credit union's members. This includes loan participations
originated by a CUSO.
Four commenters noted that a revision to the loan participation
rule, 12 CFR 701.22, was necessary to make it clear that FCUs may
purchase MBL participations from their CUSOs. On June 26, 2003, the
Board proposed an amendment to Sec. 701.22(a)(4) which will clarify
that CUSOs, as credit union organizations, are eligible organizations
in which credit unions may enter into participation agreements. 68 FR
39866, Jul. 3, 2003. FISCUs are subject to applicable state law on this
issue.
Two commenters asked the Board to clarify that CUSOs are not
subject to the MBL limitations in Part 723. These commenters are
correct in that CUSOs are not required to comply with the various
requirements and limitations in Part 723 when originating business
loans. The Board reminds FCUs that, when entering into eligible
obligation or
[[Page 56547]]
participation agreements with CUSOs or other eligible organizations,
FCUs must comply with all applicable regulations, including the MBL
rule. See 12 CFR 701.22, 701.23.
Regulatory Procedures
Regulatory Flexibility Act
The Regulatory Flexibility Act requires NCUA to prepare an analysis
to describe any significant economic impact any proposed regulation may
have on a substantial number of small entities (those under $10 million
in assets). The final member business loan relaxes some of the rule's
existing standards or clarifies current requirements. In addition, less
than 5% of small credit unions grant member business loans. The NCUA
Board, therefore, has determined and certifies that the final rule will
not have a significant economic impact on a substantial number of small
credit unions. Accordingly, a regulatory flexibility analysis is not
required.
Executive Order 13132
Executive Order 13132 encourages independent regulatory agencies to
consider the impact of their regulatory actions on state and local
interests. In adherence to fundamental federalism principles, NCUA, an
independent regulatory agency as defined in 44 U.S.C. 3502(5),
voluntarily complies with the executive order. This final rule
liberalizes current requirements and standards applicable to all
federally insured credit unions and will not have substantial direct
effects on the states, on the relationship between the national
government and the states, or on the distribution of power and
responsibilities among the various levels of government. NCUA has
determined that the final rule does not constitute a policy that has
federalism implications for purposes of the executive order.
The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families
The NCUA has determined that this final rule will not affect family
well-being within the meaning of section 654 of the Treasury and
General Government Appropriations Act, 1999, Public Law 105-277, 112
Stat. 2681 (1998).
Small Business Regulatory Enforcement Fairness Act
The Small Business Regulatory Enforcement Fairness Act of 1996
(Pub. L. 104-121) provides generally for congressional review of agency
rules. A reporting requirement is triggered in instances where NCUA
issues a final rule as defined by Section 551 of the Administrative
Procedure Act. 5 U.S.C. 551. The Office of Management and Budget has
determined that this rule is not a major rule for purposes of the Small
Business Regulatory Enforcement Fairness Act of 1996.
List of Subjects
12 CFR Part 702
Credit unions, Reporting and recordkeeping requirements.
12 CFR Part 704
Credit unions, Reporting and recordkeeping requirements.
12 CFR Part 712
Credit, Credit unions.
12 CFR Part 723
Credit, Credit unions, Reporting and recordkeeping requirements.
12 CFR Part 742
Credit unions.
By the National Credit Union Administration Board on September
24, 2003.
Becky Baker,
Secretary of the Board.
? For the reasons stated in the preamble, NCUA revises 12 CFR chapter VII
as set forth below:
PART 702--PROMPT CORRECTIVE ACTION
? 1. The authority citation for part 702 continues to read as follows:
Authority: 12 U.S.C. 1766(a), 1790d.
? 2. Amend Sec. 702.106 as follows:
? a. Revise paragraph (b) to read as set forth below; and
? b. Revise Table 4 following paragraph (h) to read as set forth below:
Sec. 702.106 Standard calculation of risk-based net worth
requirement.
* * * * *
(a) * * *
(b) Member business loans outstanding. The sum of:
(1) Six percent (6%) of the amount of member business loans
outstanding less than or equal to fifteen percent (15%) of total
assets;
(2) Eight percent (8%) of the amount of member business loans
outstanding greater than fifteen percent (15%), but less than or equal
to twenty-five percent (25%), of total assets; and
(3) Fourteen percent (14%) of the amount in excess of twenty-five
percent (25%) of total assets;
* * * * *
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? 3. Revise Appendix A to Subpart A of Part 702 to read as follows:
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? 4. Revise Appendix D to Subpart A of Part 702 to read as follows:
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? 5. Revise Appendix H to Subpart A of Part 702 to read as follows:
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PART 704--CORPORATE CREDIT UNIONS
? 6. The authority citation for part 704 is revised to read as follows:
Authority: 12 U.S.C. 1766(a), 1781, 1789.
? 7. Amend Sec. 704.7 paragraph (e)(2) by revising the sentence as
follows:
Sec. 704.7 Lending.
* * * * *
(e) * * *
(2) Corporate CUSOs are not subject to part 723 of this chapter.
* * * * *
? 8. Amend Sec. 704.11 by removing paragraph (b)(4).
? 9. Amend Sec. 704.11(c) by revising the letter (l) to the letter (j).
[[Page 56551]]
PART 712--CREDIT UNION SERVICE ORGANIZATIONS (CUSOs)
? 10. The authority citation for part 712 continues to read as follows:
Authority: 12 U.S.C. 1756, 1757(5)(D) and (7)(I), 1766, 1782,
1784, 1785, and 1786.
? 11. In Sec. 712.5, redesignate paragraphs (c) to (q) as paragraphs (d)
to (r) and add new paragraph (c) to read as follows:
* * * * *
(c) Business loan origination;
* * * * *
PART 723--MEMBER BUSINESS LOANS
? 12. The authority citation for part 723 continues to read as follows:
Authority: 12 U.S.C. 1756, 1757, 1757A, 1766, 1785, 1789.
? 13. Amend Sec. 723.1 as follows:
? a. Add the phrase ``the net member business loan balances are'' after
the word ``when'' in paragraph (b)(3);
? b. Add paragraphs (c), (d), and (e).
Sec. 723.1 What is a member business loan?
* * * * *
(c) Loans to credit unions and credit union service organizations.
This part does not apply to loans made by federal credit unions to
credit unions and credit union service organizations. This part does
not apply to loans made by a federally insured, state-chartered credit
union to credit unions and credit union service organizations if the
credit union's supervisory authority determines that state law grants
authority to lend to these entities other than the general authority to
grant loans to members.
(d) Purchase of member loans and member loan participations. Any
interest a credit union obtains in a loan that was made by another
lender to the credit union's member is a member business loan, for
purposes of this rule and the risk weighting standards of part 702 of
this chapter to the same extent as if made directly by the credit union
to its member.
(e) Purchases of nonmember loans and nonmember loan participations.
Any interest a credit union obtains in a nonmember loan, pursuant to
Sec. 701.22 or part 742 of this chapter or other authority, is treated
the same as a member business loan for purposes of this rule and the
risk weighting standards under part 702 of this chapter, except that
the effect of such interest on a credit union's aggregate member
business loan limit will be as set forth in Sec. 723.16(b) of this
part.
? 14. Amend Sec. 723.3 by revising paragraph (a) and paragraph (b) to
read as follows:
Sec. 723.3 What are the requirements for construction and development
lending?
* * * * *
(a) The aggregate of the net member business loan balances for all
construction and development loans must not exceed 15% of net worth. In
determining the aggregate balances for purposes of this limitation, a
credit union may exclude any loan made to finance the construction of a
single-family residence if a prospective homeowner has contracted to
purchase the property and may also exclude a loan to finance the
construction of one single-family residence per member-borrower or
group of associated member-borrowers, irrespective of the existence of
a contractual commitment from a prospective homeowner to purchase the
property.
(b) The borrower must have a minimum of 25% equity interest in the
project being financed, the value of which is determined by the market
value of the project at the time the loan is made, except that this
requirement will not apply in the case of a loan made to finance the
construction of a single-family residence if a prospective homeowner
has contracted to purchase the property and in the case of one loan to
a member-borrower or group of associated member-borrowers to finance
the construction of a single-family residence, irrespective of the
existence of a contractual commitment from a prospective homeowner to
purchase the property. Instead, the collateral requirements of Sec.
723.7 will apply; and
* * * * *
? 15. Revise Sec. 723.5 as follows:
Sec. 723.5 How do you implement a member business loan program?
(a) Generally. The board of directors must adopt specific business
loan policies and review them at least annually. The board must also
use the services of an individual with at least two years direct
experience with the type of lending the credit union will be engaging
in. The experience must provide the credit union sufficient expertise
given the complexity and risk exposure of the loans in which the credit
union intends to engage. Credit unions do not have to hire staff to
meet the requirements of this section but must ensure that the
expertise is available. A credit union can meet the experience
requirement through various approaches. For example, a credit union can
use the services of a credit union service organization (CUSO), an
employee of another credit union, an independent contractor, or other
third parties. However, the actual decision to grant a loan must reside
with the credit union.
(b) Conflicts of Interest. Any third party used by a credit union
to meet the requirements of paragraph (a) of this section must be
independent from the transaction and is prohibited from having a
participation in the loan or an interest in the collateral securing the
loan that the third party is responsible for reviewing, with the
following exceptions:
(1) The third party may provide a service to the credit union
related to the transaction, such as loan servicing;
(2) The third party may provide the requisite experience to the
credit union and purchase a loan or a participation interest in a loan
originated by the credit union that the third party reviewed; or
(3) A credit union may use the services of a CUSO that otherwise
meets the requirements of paragraph (a) of this section even though the
CUSO is not independent from the transaction, provided the credit union
has a controlling financial interest in the CUSO as determined under
Generally Accepted Accounting Principles.
Sec. 723.6 [Amended]
? 16. Amend Sec. 723.6 as follows:
? a. Add the phrase ``secured and unsecured'' before the word
``business'' in paragraph (c);
? b. Add ``Sec. 723.7(c)(2) and'' after the words ``subject to'' in
paragraph (e);
? c. Add the phrase ``consistent with appropriate underwriting and due
diligence standards, which also addresses the need for periodic
financial statements, credit reports, and other data when necessary to
analyze future loans and lines of credit, such as, borrower's history
and experience, balance sheet, cash flow analysis, income statements,
tax data, environmental impact assessment, and comparison with industry
averages, depending upon the loan purpose'' after the word ``loan'' in
paragraph (g);
? d. Remove paragraphs (h) and (i) and redesignate paragraphs (j) to (m)
as (h) to (k).
? 17. Revise Sec. 723.7 to read as follows:
Sec. 723.7 What are the collateral and security requirements?
(a) Unless your Regional Director grants a waiver, all member
business loans, except those made under paragraphs (c), (d), and (e),
must be secured by collateral as follows:
(1) The maximum loan-to-value ratio for all liens must not exceed
80% unless
[[Page 56552]]
the value in excess of 80% is covered through private mortgage
insurance or equivalent type of insurance, or insured, guaranteed, or
subject to advance commitment to purchase by an agency of the federal
government, an agency of a state or any of its political subdivisions,
but in no case may the ratio exceed 95%;
(2) A borrower may not substitute any insurance, guarantee, or
advance commitment to purchase by any agency of the federal government,
a state or any political subdivision of such state for the collateral
requirements of this paragraph.
(b) Principals, other than a not for profit organization as defined
by the Internal Revenue Service Code (26 U.S.C. 501) or those where the
Regional Director grants a waiver, must provide their personal
liability and guarantee. Federal credit unions and federally insured
state-chartered credit unions that meet RegFlex standards, as
determined pursuant to Part 742 of this Chapter, are exempt from this
requirement and may make their own determination whether to require the
personal liability and guarantee of principals.
(c) You may make unsecured member business loans under the
following conditions:
(1) You are well capitalized as defined by Sec. 702.102(a)(1) of
this chapter;
(2) The aggregate of the unsecured outstanding member business
loans to any one member or group of associated members does not exceed
the lesser of $100,000 or 2.5% of your net worth; and
(3) The aggregate of all unsecured outstanding member business
loans does not exceed 10% of your net worth.
(d) You are exempt from the provisions of paragraphs (a), (b), and
(c) of this section with respect to credit card line of credit programs
offered to nonnatural person members that are limited to routine
purposes normally made available under those programs.
(e) You may make vehicle loans under this part without complying
with the loan-to-value ratios in this section, provided that the
vehicle is a car, van, pick-up truck, or sports utility vehicle and not
part of a fleet of vehicles.
? 18. Revise Sec. 723.8 to read as follows:
Sec. 723.8 How much may one member or a group of associated members
borrow?
Unless your Regional Director grants a waiver for a higher amount,
the aggregate amount of net member business loan balances to any one
member or group of associated members must not exceed the greater of:
(a) 15% of the credit union's net worth; or
(b) $100,000.
? 19. Remove and reserve Sec. 723.9.
? 20. Revise Sec. 723.10 to read as follows:
Sec. 723.10 What waivers are available?
You may seek a waiver for a category of loans in any of the
following areas:
(a) Appraisal requirements under Sec. 722.3;
(b) Aggregate construction and development loans limits under Sec.
723.3(a);
(c) Minimum borrower equity requirements for construction and
development loans under Sec. 723.3(b);
(d) Loan-to-value ratio requirements for business loans under Sec.
723.7(a);
(e) Requirement for personal liability and guarantee under Sec.
723.7(b);
(f) Maximum unsecured business loans to one member or group of
associated members under Sec. 723.7(c)(2);
(g) Maximum aggregate unsecured member business loan limit under
Sec. 723.7(c)(3); and
(h) Maximum aggregate outstanding member business loan balance to
any one member or group of associated members under Sec. 723.8.
? 21. Remove and reserve Sec. 723.14.
? 22. Remove and reserve Sec. 723.15.
? 23. Revise Sec. 723.16 to read as follows:
Sec. 723.16 What is the aggregate member business loan limit for a
credit union?
(a) General. The aggregate limit on a credit union's net member
business loan balances is the lesser of 1.75 times the credit union's
net worth or 12.25% of the credit union's total assets. Net worth is
all of the credit union's retained earnings. Retained earnings normally
includes undivided earnings, regular reserves and any other
appropriations designated by management or regulatory authorities.
Loans that are exempt from the definition of member business loans are
not counted for the purpose of the aggregate loan limit.
(b) Effect of nonmember loans and nonmember participations. If a
credit union holds any nonmember loans or nonmember loan participation
interests that would constitute a member business loan if made to a
member, those loans will affect the credit union's aggregate limit on
net member business loan balances as follows:
(1) The total of the credit union's net member business loan
balances and the nonmember loan balances must not exceed the lesser of
1.75 times the credit union's net worth or 12.25% of the credit union's
total assets, unless the credit union has first received approval from
the NCUA regional director.
(2) To request approval from the NCUA regional director, a credit
union must submit an application that:
(i) Includes a current copy of the credit union's member business
loan policies;
(ii) Confirms that the credit union is in compliance with all other
aspects of this rule;
(iii) States the credit union's proposed limit on the total amount
of nonmember loans and participation interests that the credit union
may acquire if the application is granted; and
(iv) Attests that the acquisition of nonmember loans and
participations is not being used, in conjunction with one or more other
credit unions, to have the effect of trading member business loans that
would otherwise exceed the aggregate limit.
(3) A federal credit union must submit its request for approval to
the regional director (a corporate federal credit union submits its
request to the Director of the Office of Corporate Credit Unions). A
state chartered federally insured credit union must submit the request
to its state supervisory authority. If the state supervisory authority
approves the request, the state regulator will forward the application
and its decision to the regional director (or if appropriate, the
Director of the Office of Corporate Credit Unions). An approved
application is not effective until it is approved by the regional
director (or in the case of a corporate federal credit union the
Director of the Office of Corporate Credit Unions). The regional
director will issue a decision within 30 days of receipt of a federal
credit union's completed application or within 30 days of receipt of a
completed application and the state supervisory authority's approval
for a state chartered federally insured credit union.
? 24. Add the following definition to Sec. 723.21:
Sec. 723.21 Definitions.
* * * * *
Net Member Business Loan Balance means the outstanding loan balance
plus any unfunded commitments, reduced by any portion of the loan that
is secured by shares in the credit union, or by shares or deposits in
other financial institutions, or by a lien in the member's primary
residence, or insured or guaranteed by any agency of the federal
government, a state or any political subdivision of such state, or
subject to an advance commitment to purchase by any agency of the
federal government, a state or any political subdivision of such state,
or sold as a participation interest without recourse and qualifying for
true sales accounting under generally accepted accounting principles.
[[Page 56553]]
PART 742--REGULATORY FLEXIBILITY PROGRAM
? 25. The authority citation for part 742 continues to read as follows:
Authority: 12 U.S.C. 1756 and 1766.
? 26. Amend Sec. 742.4(a) by removing the words ``Sec. 703.12(c); and
Sec. 703.16(b) of this chapter'' and replacing them with ``Sec.
703.12(c), Sec. 703.16(b), and Sec. 723.7(b) of this chapter.''
[FR Doc. 03-24760 Filed 9-30-03; 8:45 am]
BILLING CODE 7535-01-P
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