Subordination of Direct Loan Basic Security To Secure a Guaranteed Line of Credit

DEPARTMENT OF AGRICULTURE

Rural Housing Service

Rural Business--Cooperative Service

Rural Utilities Service

Farm Service Agency

7 CFR Parts 1962, 1965, and 1980

RIN 0560-AE92

Subordination of Direct Loan Basic Security To Secure a

Guaranteed Line of Credit

AGENCIES: Rural Housing Service, Rural Business--Cooperative Service,

Rural Utilities Service, Farm Service Agency, USDA.

ACTION: Final rule.

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SUMMARY: This rule revises Farm Service Agency (FSA) regulations

regarding loan security servicing in two ways that are intended to

increase the use of subordinations to move direct farm loan program

borrowers to the private sector. First, the Agency will allow

subordinations of direct loan basic chattel and real estate security if

necessary to secure a guaranteed operating line of credit. Second, this

rule revises FSA farm loan regulations to allow subordination of Agency

loan security so another lender may refinance a borrower's debt. This

change is needed because recent legislation places restrictions on the

uses of direct loans for refinancing.

EFFECTIVE DATE: The effective date of this rule is May 26, 1998.

FOR FURTHER INFORMATION CONTACT: Phillip Elder, Senior Loan Officer,

United States Department of Agriculture, Farm Service Agency, Farm Loan

Programs Loan Servicing Division, 1400 Independence Avenue, SW, STOP

0523, Washington, D.C. 20250-0523. Telephone (202) 690-4012. Electronic

mail: [email protected].

SUPPLEMENTARY INFORMATION:

Executive Order 12866

This rule has been reviewed under E.O. 12866 and was determined to

be not significant.

Executive Order 12372

1. For the reasons set forth in the Notice related to 7 CFR part

3015, subpart V (48 FR 29115, June 24, 1983), Farm Ownership Loans,

Farm Operating Loans, and Emergency Loans are excluded from the scope

of E.O. 12372, which requires intergovernmental consultation with state

and local officials.

2. The Soil and Water Loan Program is subject to and has met the

provisions of E.O. 12372.

Federal Assistance Program

These changes affect the following FSA programs as listed in the

Catalog of Federal Domestic Assistance:

10.404--Emergency Loans

10.406--Farm Operating Loans

10.407--Farm Ownership Loans

10.416--Soil and Water Loans

Environmental Impact Statement

It is the determination of the issuing agency that this action is

not a major Federal action significantly affecting the environment.

Therefore, in accordance with the National Environmental Policy Act of

1969, Pub. L. 91-190, and 7 CFR part 1940, subpart G, an Environmental

Impact Statement is not required.

Executive Order 12988

This final rule has been reviewed in accordance with E.O. 12988,

Civil Justice Reform. In accordance with this rule: (1) All State and

local laws and regulations that are in conflict with this rule will be

preempted; (2) no retroactive effect will be given to this rule; and

(3) administrative proceedings in accordance with 7 CFR parts 11 and

780 must be exhausted before bringing suit in court challenging action

taken under this rule unless those regulations specifically allow

bringing suit at an earlier time.

Regulatory Flexibility Act

In compliance with the Regulatory Flexibility Act (5 U.S.C. 601-

602), the undersigned has determined and certified by signature of this

document that this rule will not have a significant economic impact on

a substantial number of small entities. This rule does not involve a

new or expanded program and new provisions included in this rule will

not impact a substantial number of small entities to a greater extent

than large entities. Although it is the intent of this rule to move

direct loans to guaranteed loans, participation is voluntary and

requires no action on the part of small entities. Large entities are

subject to these rules to the same extent as small entities. Therefore,

a regulatory flexibility analysis was not performed.

Unfunded Mandates

Title II of the Unfunded Mandates Reform Act of 1995 (UMRA), Public

Law 104-4, requires Federal agencies to assess the effects of their

regulatory actions on State, local, and tribal governments or the

private sector. Agencies generally must prepare a written statement,

including a cost benefit analysis, for proposed and final rules with

``Federal mandates'' that may result in expenditures of $100 million or

more in any 1 year for State, local, or tribal governments, in the

aggregate, or to the private sector. UMRA generally requires agencies

to consider alternatives and adopt the more cost effective or least

burdensome alternative that achieves the objectives of the rule.

This rule contains no Federal mandates, as defined under Title II

of the UMRA, for State, local, and tribal governments or the private

sector. Thus, this rule is not subject to the requirements of sections

202 and 205 of UMRA.

Paperwork Reduction Act

The amendments to 7 CFR parts 1962, 1965 and 1980 set forth in this

final rule require no revisions to the information collection

requirements that were previously approved by OMB under the provisions

of 44 U.S.C. chapter 35. A proposed rule containing an estimate of the

burden impact of this rule was published on September 9, 1997 [62 FR

47384, 47385]. No comments on the burden estimate were received.

Discussion of Comments Received

The Agency received comments on the proposed rule (62 FR 47384-

47388) from five parties, including FSA employees, employee

organizations, a commercial bank, and the American Banker's

Association. All comments received were in support of the

[[Page 20296]]

proposed changes and recommended their adoption with a few

clarifications.

Two commenters suggested clarification of the excess security

requirement proposed for Sec. 1980.108(a)(1)(vi)(A) or removal of the

requirement entirely. This comment was seriously considered but not

adopted. The Agency proposed to change its regulations to allow a

combination guaranteed loan and subordination of direct loan security

because lenders in selected areas of the country were reluctant to

provide farmers with a line of credit secured only by planned crop

production, even when the loan was 90 percent guaranteed against loss

by the government. We understand from industry advocates that this

reluctance is due to the large annual fluctuations in crop income

experienced in those areas. Because the risk of loss on these lines of

credit is inordinately large, as evidenced by the policies of the local

lenders, the Agency felt it was necessary to restrict these combination

subordination and guarantees to those direct loan borrowers whose loans

are well secured in order to protect the Government's interest.

However, the Agency has clarified this paragraph to require that the

total unpaid balance of the direct loan be less than or equal to 75

percent of the value of the security for the direct loan, excluding the

value of growing crops and planned production at the time of the

subordination. The Agency also clarified that a lender making the

subject guaranteed loan is responsible for obtaining any appraisals

necessary to document compliance with this provision.

Two commenters also indicated confusion about proposed

Sec. 1962.30(a)(3) and questioned the need for a separate provision for

a subordination to purchase crop insurance. The Agency agrees. Since

Sec. 1962.30(a)(2) allows a subordination for any authorized direct

loan purpose and the payment of crop insurance premiums is an allowable

use of direct operating loan funds, the Agency agrees that paragraph

(a)(3) was redundant and has removed it accordingly.

Another commenter pointed out that proposed Sec. 1965.12 needed to

be clarified as to the allowable uses of Single Family Housing (SFH)

loan funds. Since the proposed rule was drafted, the Rural Housing

Service (RHS) promulgated new program regulations and is no longer

covered by part 1965, subpart A. Since FSA employees are not

responsible for servicing RHS loans, Sec. 1965.12(a)(9) has been

removed. This regulation still allows a subordination to be made for

the purpose of improving a farm residence in some instances under

Sec. 1965.12(a)(1) as an authorized direct loan purpose. FSA will

consider RHS debt with regard to subordinations as it would any other

lien.

The fourth comment received suggested that subordinations of direct

loan basic real estate security to secure a guaranteed line of credit

should be prohibited or very rare. This rule is being issued

specifically to allow subordinations of real estate to secure a

guaranteed loan. Regardless, the limitations included in

Sec. 1980.108(a) will allow subordinations of direct loan basic

security in only those cases where the likelihood of a Government loss

on the direct loan is small.

One commenter requested that the rule be revised to not require

that the Agency loan be secured after the subordination, but rather to

allow a subordination as long as the Agency's position is not damaged.

This comment was not adopted. The condition mentioned by the commenter

was not added as part of the proposed rule. Section 1965.12(a)(9)

provides that the Agency loan must still be adequately secured after

the subordination, or the value of the security will be increased by at

least the amount of advances made under the subordination. Also, this

requirement will not overly restrict the Agency's ability to make

subordinations under the authorities provided in this rule.

Another commenter suggested that the Agency require a formal

application for a subordination. The Agency currently requires

borrowers to submit a ``Request for Subordination, Release or

Consent,'' to be considered for a subordination. Therefore, this

comment was not adopted. However, the Agency agrees with the concerns

of the commenter that subordinations are not sufficiently recorded or

monitored. The Agency is exploring methods to improve its data on

subordinations and expects its internal records system to be revised

soon.

Finally, a commenter suggested that the county committee not be

required to make recommendations regarding subordinations. Proposed

Sec. 1965.12(a)(10) required, ``When the subordination will be used to

acquire land, the FSA county committee has made a favorable

recommendation.'' We agree with the commenter that county committee

concurrence with this loan servicing action is not necessary;

therefore, this provision has been removed.

In addition to these changes, the Agency has made several

administrative changes to the proposed rule. First, the Agency has

determined that in some instances an Agency subordination to allow the

borrower to obtain a loan from the Rural Housing Service or the

Commodity Credit Corporation may be prudent. Accordingly, the Agency

has removed proposed Sec. 1962.30(b)(6) which prohibited subordinations

to other USDA Agencies. The Agency will treat USDA agencies like other

Federal Agencies for subordination purposes.

Second, the Agency has removed proposed Sec. 1965.12(a)(3). This

section conditioned a subordination on it furthering the purpose of the

loan. A subordination is limited to eligible loan purposes; thus, this

provision was redundant. Taken together with the other conditions under

Sec. 1962.30 or 1965.12, any eligible loan purpose would further the

objectives of the loan.

Third, proposed Sec. 1965.12(a)(4) has been removed. The provision

required FSA to obtain as security an assignment of the beneficial

interest of any stock required in connection with a loan. This

requirement was included in previous versions of this regulation

because Farm Credit System (FCS) institutions required that a borrower

purchase stock in the local association. Agency experience indicates

that the assignment is unnecessary. The Farm Credit Administration

(FCA) requires a minimum purchase of $1,000 or 1 percent of the loan

amount. Local associations may require up to 5 percent of the loan

amount, but most associations are requiring only the minimum stock

purchase of $1,000. Consequently, the value of cooperative stock is

negligible and does not impact the Agency's decision to grant a

subordination. Besides, the treatment of the stock has no effect since

it is invariably applied to the FCS loan when it is paid in full.

Proceeds from the liquidation of a beneficial interest in a cooperative

generally have not been applied to an Agency loan as a result of this

requirement.

Fourth, proposed Sec. 1965.12(e) has been added to clarify the

appraisal requirements for a real estate security subordination.

Fifth, paragraphs (b)(6) and (7) and (e) and (f) were added to

section 1962.30 to make the chattel provisions consistent with the real

estate provisions in section 1965.12. Section 1962.20(f) requires a

chattel appraisal if the existing appraisal is more than 2 years old or

inadequate for the FSA official to make a subordination determination

under that section. The 2 year standard is consistent with current

chattel appraisal requirements under Sec. 1941.25. Paragraphs (a)(10)

and (11) were added

[[Page 20297]]

to section 1965.12 to make it consistent with section 1962.30.

Sixth, section 1962.30(b)(2) was clarified and 1965.12(a)(10) was

added to clarify that a subordination is provided to secure a specific

loan to be made and that the loan is to be made as soon as practical

after the subordination is granted. This change will clarify that a

subordination is approved only for a limited period. This limitation is

on the subordination form but is not currently contained in the

regulation.

Seventh, section 1980.108(a)(1)(iii) was revised to delete

subordination provisions now covered by paragraph (a)(1)(v) of that

section. The revision was inadvertently omitted from the proposed rule.

Finally, the Agency has revised proposed Sec. 1980.108(a)(1)(v) to

clarify that the conditions contained in Secs. 1962.30 and 1965.12 as

appropriate apply when the Agency subordinates its security interest in

direct loan security when a guaranteed loan is being made. This change

was made to allow removal of duplicative conditions under the

guaranteed loan provision. Proposed Sec. 1980.108 (a)(1)(vi)(K) has

been removed as unnecessary because the notification requirements of

Secs. 1980.145 and 1980.146 of the same subpart require specific lender

actions when a guaranteed loan becomes delinquent.

List of Subjects

7 CFR Part 1962

Crops, Government property, Livestock, Loan programs--Agriculture,

Rural areas.

7 CFR Part 1965

Real property--Foreclosure, Loan programs--Agriculture, Rural

areas.

7 CFR Part 1980

General--Agriculture, Loan programs--Agriculture, EM.

Accordingly, 7 CFR chapter XVIII is amended as follows:

PART 1962--PERSONAL PROPERTY

1. The authority citation for part 1962 continues to read as

follows:

Authority: 5 U.S.C. 301; 7 U.S.C. 1989; 42 U.S.C. 1480.

Subpart A--Servicing and Liquidation of Chattel Security

2. Section 1962.30 is revised to read as follows:

Sec. 1962.30 Subordination and waiver of liens on chattel security.

(a) Purposes. Subject to the limitations set out in paragraph (b)

of this section, the Agency chattel liens may be subordinated to a lien

of another creditor in either of the following situations:

(1) The prior lien will soon mature or has matured and the prior

lienholder desires to extend or renew the obligation, or the obligation

can be refinanced. The relative lien position of the Agency must be

maintained; and

(2) The subordination will permit another creditor to refinance

other debt or lend for an authorized direct loan purpose.

(b) Conditions. Agency chattel liens may be subordinated to a lien

of another creditor if all of the following conditions are met:

(1) If the lien is on basic chattel security, the amount of

subordination is necessary to provide the lender with the security it

requires to make the loan;

(2) Approval of a subordination is limited to a specific amount and

the loan to be secured by the subordination is closed within a

reasonable time;

(3) Only one subordination to one creditor may be outstanding at

any one time in connection with the same security;

(4) The borrower has not been convicted of planting, cultivating,

growing, producing, harvesting or storing a controlled substance under

Federal or state law. ``Borrower'' for purposes of this provision,

specifically includes an individual or entity borrower and any member

stockholder, partner, or joint operator, of an entity borrower and any

member, stockholder, partner, or joint operator of an entity borrower.

``Controlled substance'' is defined at 21 CFR part 1308. The borrower

will be ineligible for a subordination for the crop year in which the

conviction occurred and the four succeeding crop years. Applicants must

attest on the Agency application form that it and its members, if an

entity, have not been convicted of such a crime;

(5) The loan funds will not be used in such a way that will

contribute to erosion of highly erodible land or conversion of wetlands

for the production of an agricultural commodity according to subpart G

of part 1940 of this chapter;

(6) The borrower can document the ability to repay the total amount

due under the subordination and pay all other debt payments scheduled

for the subject operating cycle; and

(7) The Agency loan is still adequately secured after the

subordination, or the value of the loan security will be increased by

at least the amount of the advances to be made under the terms of the

subordination.

(c) Subordination to make a guaranteed loan. In addition to the

requirements of this section, subordinations on chattel security to

make a guaranteed loan will be approved in accordance with

Sec. 1980.108 of subpart B of part 1980 of this chapter.

(d) Forms. Subordinations will be requested and executed on Agency

forms available in any Agency office or on any other form approved by

the Agency.

(e) Rescheduling of existing Agency debts. The Agency may consent

to rescheduling of an existing Agency debt when a subordination is

granted to the debt of another lender. The rescheduling will be allowed

only when the borrower cannot reasonably be expected to meet all

currently scheduled installments when due and the conditions of subpart

S of part 1951 of this chapter are met.

(f) Appraisal. The Agency will prepare a chattel appraisal report

when the existing appraisal report is more than 2 years old or is

inadequate to make the determination in this section. The Agency may

use an appraisal submitted by the borrower if it is substantially

similar to Form RD 440-21, ``Appraisal of Chattel Property,'' and

prepared by a licensed appraiser.

PART 1965--REAL PROPERTY

3. The authority citation for part 1965 continues to read as

follows:

Authority: 5 U.S.C. 301; 7 U.S.C. 1989 and 42 U.S.C. 1480.

Subpart A--Servicing of Real Estate Security for Farmer Program

Loans and Certain Note-Only Cases

4. Section 1965.12 is revised to read as follows:

Sec. 1965.12 Subordination of an Agency mortgage.

(a) Conditions. A subordination may be granted if all of the

following conditions are met:

(1) The subordination is to refinance debt or for an authorized

direct loan purpose;

(2) The Agency debt cannot be refinanced without a subordination;

(3) The borrower can document the ability to repay the total amount

due under subordination and pay all other debt payments scheduled for

the subject operating cycle;

(4) The loan funds will not be used in such a way that will

contribute to erosion of highly erodible land or conversion of wetlands

for the production of an agricultural commodity according to subpart G

of part 1940 of this chapter;

[[Page 20298]]

(5) Any planned development is performed in a manner directed by

the creditor and agreed to by the Agency and reasonably attains the

objectives of subpart A of part 1924 of this chapter;

(6) Funds to be used to develop or to acquire land will be

deposited in a supervised bank account that is subject to signature by

the Agency and the borrower, or in a similar arrangement, to ensure

that funds will be spent for the planned purposes;

(7) In cases of land purchase or exchange of property, the Agency

will obtain a valid mortgage on the acquired land. Title clearance and

loan closing will be required as for an initial or subsequent FO loan,

as appropriate;

(8) The borrower has not been convicted of planting, cultivating,

growing, producing, harvesting or storing a controlled substance under

Federal or state law. ``Borrower'' for purposes of this provision,

specifically includes an individual or entity borrower and any member

stockholder, partner, or joint operator, of an entity borrower and any

member, stockholder, partner, or joint operator of an entity borrower.

``Controlled substance'' is defined at 21 CFR part 1308. The borrower

will be ineligible for a subordination for the crop year in which the

conviction occurred and the four succeeding crop years. An applicant

must attest on the Agency application form that it and its members, if

an entity, have not been convicted of such a crime;

(9) The Agency loan is still adequately secured after the

subordination, or the value of the loan security will be increased by

at least the amount of the advances to be made under the terms of the

subordination;

(10) The subordination is limited to a specific amount and the loan

to be secured by the subordination is closed within a reasonable time;

and

(11) Only one subordination to one creditor may be outstanding at

any one time in connection with the same security.

(b) Subordination on real estate owned by an entity member.

Notwithstanding the provisions of paragraph (a) of this section, when

the borrower is an entity and the Agency has taken real estate as

additional security on property owned by an entity member, a

subordination for any authorized Farm Loan Programs loan purpose may be

approved when it is needed for the entity member to finance a separate

operation. The subordination, however, may be approved only if it does

not cause the unpaid principal and accrued interest balance of the

Agency loan to exceed the value of the loan security or otherwise

adversely affect the security.

(c) Request for subordination. A borrower must complete an

application provided by the Agency to receive consideration for a

subordination.

(d) Notice of foreclosure. The lienholder requesting the

subordination will agree to give notice of foreclosure as required by

the Agency.

(e) Appraisal. The Agency will prepare a current appraisal report

in accordance with part 1922, subpart E, of this chapter when property

is to be purchased or exchanged, or when the existing appraisal report

is more than 1 year old or is inadequate to make the determination

required in this section. The Agency may use the appraisal report

prepared for another lender if it complies with the requirements of

subpart E of part 1922 of this chapter.

(f) Reamortizing existing Agency debts. The Agency may consent to a

reamortization of an existing Agency debt when a subordination is

granted to the debt of another lender. The reamortization will be

allowed only when the borrower cannot reasonably be expected to meet

all currently scheduled installments when due and the conditions of

subpart S of part 1951 of this chapter are met.

(g) Subordination to make a guaranteed loan. In addition to the

requirements of this section, subordinations of liens on real estate

security to make a guaranteed loan will be approved in accordance with

Sec. 1980.108 of this chapter.

PART 1980--GENERAL

5. The authority citation for part 1980 continues to read as

follows:

Authority: 5 U.S.C. 301; 7 U.S.C. 1989 and 42 U.S.C. 1480

Subpart B--Farmer Programs Loans

6. Section 1980.108 is amended to add paragraphs (a)(1)(v) and

(a)(1)(vi), and to revise paragraphs (a)(1)(iii) and (d) to read as

follows:

Sec. 1980.108 General provisions.

(a) * * *

(1) * * *

(iii) When the Agency and the lender are involved in separate loans

to the same borrower, separate collateral must be clearly identified

for both the Agency's loan and the lender's loan. Different lien

positions on real estate are considered separate collateral.

* * * * *

(v) The Agency may subordinate its security interest on a direct

loan when a guaranteed loan is being made if the requirements of

Sec. 1962.30 or Sec. 1965.12 of this chapter, as appropriate, are met

and only in any the following circumstances:

(A) To permit a guaranteed lender to advance funds and perfect a

security interest in crops, feeder livestock, or livestock products,

(milk, eggs, wool, etc.);

(B) When the lender requesting the guarantee needs the

subordination of the Agency's lien position to maintain its lien

position when servicing or restructuring;

(C) When the lender requesting the guarantee is refinancing the

debt of another lender, and the Agency's position on real estate

security will not be adversely affected; or

(D) To permit a Contract of Guarantee--Line of Credit to be

advanced for annual operating needs in accordance with

Sec. 1980.175(c)(2).

(vi) The Agency may subordinate its security in a direct loan under

paragraph (a)(1)(v)(D) of this section only when both of the following

additional conditions are met:

(A) The total unpaid balance of the direct loan is less than or

equal to 75 percent of the value of the security for the direct loan,

excluding the value of growing crops or planned production, at the time

of the subordination. This direct loan security value shall be

determined by an appraisal that complies with subpart E of part 1922 of

this chapter. This appraisal will be provided by the lender requesting

the guarantee. The lender may charge the applicant a reasonable fee for

the appraisal.

(B) The applicant cannot obtain sufficient credit through a

conventional guaranteed loan.

* * * * *

(d) Relationship between Agency loans, direct and guaranteed. A

guaranteed FO or OL loan may be made to an insured borrower with the

same type of direct loan provided:

(1) The outstanding combined direct and guaranteed FO or OL

principal balance owed by the loan applicant or owed by anyone who will

sign the note as cosigner may not exceed the authorized guaranteed loan

limit for that type of loan; and

(2) Chattel and real estate collateral must be separate and

identifiable so as to be discernible from the collateral pledged to the

Agency for a direct loan. Different lien positions on real estate are

considered separate and identifiable collateral.

7. Section 1980.175 is amended to add paragraph (h)(3) as follows:

Sec. 1980.175 Operating loans.

* * * * *

[[Page 20299]]

(h) * * *

(3) Subject to the requirements of this section, the Agency may

approve a Contract of Guarantee for a line of credit to be secured by

basic chattel or real estate security in which the Agency has

subordinated its lien position in accordance with Sec. 1980.108.

* * * * *

Signed in Washington, D.C., on April 10, 1998.

August Schumacher, Jr.,

Under Secretary, Farm and Foreign Agricultural Services.

Dated: April 10, 1998.

Jill Long Thompson,

Under Secretary, Rural Development.

[FR Doc. 98-10902 Filed 4-23-98; 8:45 am]

BILLING CODE 3410-05-U