Organization and Operation of Federal Credit Unions; Appraisals; Member Business Loans; and Requirements for Insurance

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701, 722, 723 and 741

RIN 3133-AB91

Organization and Operation of Federal Credit Unions; Appraisals;

Member Business Loans; and Requirements for Insurance

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: The NCUA is updating, clarifying and streamlining its existing

rules concerning member business loans and appraisals for federally

insured credit unions, as well as implementing recent statutory

limitations regarding member business loans.

The intended effect of this rule is to reduce regulatory burden,

maintain safety and soundness, implement statutory limits and provide

guidance on the statutory exception for qualifying credit unions from

the statutory aggregate limit on a credit union's outstanding member

business loans.

DATES: This rule is effective June 28, 1999.

ADDRESSES: National Credit Union Administration, 1775 Duke Street,

Alexandria, Virginia 22314-3428.

FOR FURTHER INFORMATION CONTACT: Michael J. McKenna, Senior Staff

Attorney, Division of Operations, Office of General Counsel, at the

above address or telephone: (703) 518-6540; or David M. Marquis,

Director, Office of Examination and Insurance, at the above address or

telephone: (703) 518-6360.

SUPPLEMENTARY INFORMATION:

A. Background

On July 23, 1997, the Board issued proposed amendments to the

regulation governing member business loans (Previous Section 701.21(h)

and Proposed Part 723 of NCUA's Regulations) and appraisals (Part 722

of NCUA's Regulations) with a sixty-day comment period. 62 FR 41313

(August 1, 1997). The Credit Union Membership Access Act (the Act) was

enacted into law on August 7, 1998. Public Law 105-219, 112 Stat. 913

(1998). Among other things, the Act imposed a new aggregate limit on a

federally-insured credit union's outstanding member business loans.

However, the Act also provided for three circumstances where a credit

union could qualify for an exception from the aggregate limit. On

September 23, 1998, the NCUA Board issued an interim final member

business loan rule with a sixty-day comment period. 63 FR 51793

(September 29, 1998). The comment period was extended November 19,

1998, for an additional sixty days. 63 FR 65532 (November 27, 1998).

B. Comments

Eighty-seven comments were received. Comments were received from

twenty-five federal credit unions, ten state-chartered credit unions,

eleven state leagues, three national credit union trade associations,

one association of state supervisors, one appraisal trade association,

fifteen banks, eighteen bank trade associations, two law firms, and one

government agency. Except for the bank and bank trade associations, the

commenters were generally supportive of the interim final rule,

although most commenters suggested ways they would modify the final

rule. The bank and bank trade association comments are summarized in a

separate section.

Section-by-Section Analysis and NCUA Board Decisions

Section 723.1(a)--What is a Member Business Loan?

This section provides a definition of a member business loan. The

Act sets forth the definition of a member business loan, so NCUA can no

longer define the term.

Therefore, a member business loan means any loan, line of credit,

or letter of credit, the proceeds of which will be used for a

commercial, corporate or other business investment property or venture,

or agricultural purposes. Section 107A(c)(1)(a) of the Act. The final

rule clarifies that unfunded commitments are included in determining

whether a loan is a member business loan.

Three commenters requested that loans made to churches or other

religious organizations be exempt from the definition of a member

business loan. These commenters stated that while churches may be

organized as corporations, any loan to such a corporation would not be

for a ``commercial'' purpose. These commenters stated that the term

``business'' implies for-profit activity. The NCUA Board disagrees with

these commenters. In general, a loan to a non-

[[Page 28722]]

natural person will qualify as a member business loan. Although a loan

to a church is not for a profit making purpose, it does have a

``corporate'' purpose as that term is generally understood. If the

purpose of the loan is to benefit the institution, even a non-profit

unincorporated association, then it has a corporate purpose. For

example, a loan to build a new church has the same corporate purpose as

a loan to a non-profit association to acquire a new headquarters

building. Even though the purpose (functions) of the institutions

differ, the purpose for the loan does not.

Section 723.1(b)--Exceptions to the General Rule

This section sets forth five exceptions to the general definition

of a member business loan. The exceptions are established by the Act

and are virtually identical to the exceptions in the previous member

business loan rule. The following loans are excepted from the member

business loan definition: (1) an extension of credit fully secured by a

lien on a 1-to-4 family dwelling that is the primary residence of a

member; (2) an extension of credit fully secured by shares in the

credit union making the extension of credit or deposits in financial

institutions; (3) an extension of credit that meets the member business

loan definition made to a borrower or an associated member that has a

total of all such extensions of credit in an amount equal to or less

than $50,000; (4) an extension of credit where the repayment is fully

insured or fully guaranteed by, or where there is an advance commitment

to purchase in full by, an agency of the federal government or of a

state, or any political subdivision thereof; or (5) an extension of

credit that is granted by a corporate credit union (as that term is

defined by the Board) to another credit union.

Three commenters requested that the $50,000 limit be increased to

$100,000. Another commenter also suggested an increase in the limit.

The NCUA Board cannot increase the dollar threshold because the Act

sets the dollar limit.

Two commenters recognized that NCUA does not have the authority to

adopt a definition of a member business loan that is different from the

one provided by the Act, but encouraged the agency to provide some

guidance on the meaning of ``commercial'' loan or ``investment

property.'' The NCUA Board believes that the interpretation given to

these terms will depend on the facts of a particular case. However, in

general, the NCUA Board interprets ``commercial'' as any loan that does

not fit in the standard category of consumer lending. The NCUA Board

interprets ``investment property'' as a property that is intended to

produce income.

Two commenters stated that NCUA should specifically exclude

vacation homes and other residences related to a member's professional

mobility that are not for investment purposes from the definition of

``commercial.'' One commenter requested that a loan fully secured by a

lien on a dwelling that is the member's secondary or vacation home

should be added to the loans specifically excluded from the definition

of member business loans. Two commenters requested that a second 1-to-4

family home should also be excluded from the definition. The NCUA Board

believes that since Congress used the term ``primary residence,'' the

exemption cannot be expanded to include other types of homes a member

may use as collateral in obtaining a loan. However, a loan to purchase

or refinance a vacation home or other residence that is not generally

used for investment purposes does not meet the definition of a member

business loan.

One commenter suggested that NCUA exempt retirement homes from the

member business loan definition because such homes will eventually be a

primary residence. This commenter also suggested defining ``primary

residence'' in the definition section. Although the Board does not

believe the term ``primary residence'' needs to be defined, to avoid

any misunderstanding, the Board is once again reiterating that a

federal credit union may finance a future retirement home under the

long-term mortgage authority. If at the time the loan is made, the

member's intent is to establish a new principal residence, either

immediately or some time in the future, the federal credit union may

grant a long-term mortgage secured by the second home. Under this

analysis, since the member intends to occupy this residence as his or

her primary residence, the credit union may grant a second home loan

under the long-term mortgage authority and the loan is exempt from the

definition of a member business loan as long as the source of repayment

is not dependent on rental income involving the residence.

One commenter suggested that the final rule clarify that an advance

commitment to purchase a loan by a federally chartered financial

institution would be considered a commitment from a federal agency and

be excluded from the definition of a business loan. The NCUA Board does

not believe such an exemption is permissible under the Act and thus is

not adopting this commenter's suggestion in the final rule. Of course,

loans to credit unions by a corporate credit union are exempt from the

definition of a member business loan.

One commenter requested that NCUA clarify that the amount of any

loan fully guaranteed by the federal, state or local government is not

included in determining whether the $50,000 threshold has been reached.

The reason is that small business administration loan programs do not

guarantee full repayment, only the amount of the loan that is not

guaranteed should be considered in determining whether the threshold

has been reached. The NCUA Board agrees and a credit union need not

include that portion of a loan that is guaranteed toward the $50,000

threshold.

One commenter questioned whether the final rule applies to

corporate credit unions, and specifically to corporate credit union

loans to non-credit union members. The Act does not distinguish between

corporate and natural person credit unions. Since the NCUA Board has

not been provided any compelling reason on why this rule should not

apply to corporate credit unions granting member business loans to

entities other than credit unions, the final rule applies to all types

of federally insured credit unions.

Section 723.2--What Are the Prohibited Activities?

This section sets forth who is ineligible to receive a member

business loan. The interim final rule identified as ineligible the

following persons: (1) Any member of the board of directors who is

compensated as such; (2) the chief executive officer; (3) any assistant

chief executive officers; (4) the chief financial officer; or (5) any

associated member or immediate family member of anyone listed in 1-4.

The interim final rule also added senior management employees to the

provision prohibiting equity agreements or joint ventures.

Four commenters supported the prohibition on member business loans

as set forth in this section. Six commenters requested that senior

management officials, compensated directors, and immediate family

members thereof, be able to receive member business loans. One

commenter stated that associated members or immediate family members of

anyone specifically prohibited should be eligible to receive a member

business loan. One commenter stated that ten states allow compensation

for the board of directors and the prohibition on compensated directors

obtaining member business loans should not apply to state chartered

credit unions.

[[Page 28723]]

The agency has historically included compensated directors as

persons who were prohibited from receiving member business loans. In

the past, the agency has believed that the compensated director might

unduly influence the other directors to have the credit union grant

questionable and/or risky member business loans to the compensated

director and/or their family members. Recent agency experience in other

lending areas has led the NCUA Board to believe that such influence

would probably be minimal or non existent. Therefore, the NCUA Board is

eliminating the prohibition on member business loans to the compensated

director. However, to maintain proper internal controls, the board of

directors must approve the loan to the compensated director and the

compensated director must be recused from the decision to grant or deny

the loan.

Section 723.3--What Are the Requirements for Construction and

Development Lending?

This section sets forth the requirements for construction and

development lending. NCUA clarified in the preamble to the interim

final rule that construction and development loans below the dollar

limits, individually and/or in the aggregate, are not considered to be

member business loans for the purpose of this rule. Thus, if a member

has a construction loan for $40,000, and no other outstanding business

type loans, including unfunded business type lines of credit, then the

construction loan is not a member business loan. No substantive

comments were received on this section. The Board is adopting this

section in final as set forth in the interim final rule, except the

term ``reserves'' has been replaced by the term ``net worth'' and the

word ``independent'' has been eliminated from paragraph (c) since most

financial institutions use qualified employees to conduct draw

inspections.

Section 723.4--What Are the Other Applicable Regulations?

This section merely describes the other NCUA lending rules credit

unions must follow when granting member business loans to the extent

they are consistent with this regulation. One commenter supported this

section. Six commenters opposed applying these standards to federally

insured credit unions. These commenters requested that NCUA, instead,

clearly state that this section does not apply to federally insured

state chartered credit unions except as may be specified in Part 741 of

NCUA's Regulations. The NCUA Board agrees and the final rule

incorporates this change.

Section 723.5--How Do You Implement a Member Business Loan Program?

This section sets forth the requirement that the board of directors

adopt business loan policies and review them at least annually. This

section also requires the board to use the services of an individual

with at least two years direct experience in the type of lending in

which the credit union will be engaging. The preamble to the interim

final rule also clarified that NCUA does not necessarily require

experience with business loans in general but, rather, the experience

could also be with the type of loans the credit union intends to grant.

The preamble also clarified that credit unions need not hire staff to

meet the requirements of this section; however, credit unions must

ensure that the expertise is available. Credit unions can meet the

experience requirement through various approaches. For example, a

credit union can use the services of a CUSO, an employee of another

credit union or other financial institution, an independent contractor,

or other third parties. However, the actual decision to grant a loan

must reside with the credit union.

Nine commenters believe the two-year experience requirement is

reasonable. Three commenters objected to the two-year experience

requirement. One commenter stated that the employee should only be

required to have general business lending experience and not direct

experience with a certain type of loan or collateral. One commenter

believed this section should be clarified to state that a credit union

need only have at least two years experience in making loans secured by

a particular class of collateral and not necessarily two years

experience in making business loans.

The NCUA Board believes it crucial for a credit union to have

experienced personnel involved in making decisions regarding business

lending. Member business loans require special expertise in virtually

all phases of origination and administration. 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. Therefore, the NCUA Board is adopting this

section in the final rule as set forth in the interim final rule.

Section 723.6--What Must Your Member Business Loan Policy Address?

This section set forth those items that credit unions must address

in their written business loan policies. The interim final rule used

the term ``determination of value'' instead of ``appraisal'' in the

discussion of written loan policies. One commenter stated that NCUA

should use the term ``appraisal.'' The Board believes that the term

``determination of value'' is more appropriate since the term

``appraisal'' unduly emphasizes member business loans as real estate

loans. The term ``determination of value'' clarifies that, whether a

member business loan is collateralized by real estate or other types of

collateral, credit unions must address the value of the collateral.

Two commenters requested that NCUA state that the maturity limit

for member business loans applies only to federal credit unions and not

state chartered credit unions. As stated in the preamble to the interim

final rule, federally insured state-chartered credit unions can grant

business loans with a maturity limit consistent with state law. The

final rule does not impose any maturity limits for state-chartered

credit unions.

One commenter stated that all the documentation listed in this

section is not necessary for every member business loan. The NCUA Board

agrees. The interim final rule, as well as the final rule, provides the

board of directors with significant discretion to determine the

documentation necessary to make the decision whether a member business

loan should be granted.

One commenter stated that credit unions should be required to

conduct a periodic review of financial statements. Agency experience

has demonstrated that, in most cases, a credit union will ordinarily

review the financial statements of its open-end business loans. The

NCUA Board is not requiring in the final rule, a review of financial

statements on all member business loans.

The NCUA Board is adopting this section in final as set forth in

the interim final rule except the term ``reserves'' has been replaced

by the term ``net worth.''

Section 723.7--What Are the Collateral and Security Requirements?

This section sets forth the remaining issues that written loan

policies must address, including loan-to-value ratios and the

requirement for the personal liability and guarantee of the member. As

is the current practice, loan-to-value ratios apply to the entire loan

that is in excess of $50,000.

Questions have been raised on loan-to-value ratios for multiple

member business loans to the same borrower. If multiple loans are on

the same

[[Page 28724]]

collateral, the loan-to-value limitation will apply to any loan where

the aggregate amount of the loans exceed $50,000. For example, if a

credit union makes a loan on a piece of real estate for $40,000 and

subsequently makes another $40,000 loan on the same collateral, the

loan-to-value limitation applies to the second loan. The NCUA will not

allow a credit union to circumvent the loan-to-value ratios simply be

making numerous loans for less than $50,000 on the same collateral. If

the first member business loan to a borrower is unsecured and the

second loan is secured the loan-to-value ratios apply to the second

loan if the aggregate amount of both loans exceeds $50,000.

Three commenters supported including unfunded commitments when

calculating the loan-to-value ratios. Two commenters objected to

including unfunded commitments. The NCUA Board believes it is

reasonable to include unfunded commitments when calculating the loan-

to-value ratios because, if they were excluded, the loan-to-value

ratios could be exceeded when the entire loan is funded.

Four commenters supported the second lien limitation at 80%. One

commenter requested the number be raised. One commenter requested NCUA

eliminate regulatory loan-to-value ratio requirements. One commenter

stated that the regulation should allow for selected loans to exceed

the proposed loan-to value ratios and/or occassionally be undersecured

or unsecured. Five commenters stated that NCUA should be more flexible

with respect to loan-to-value ratios for loans on personal property,

vehicles and equipment. One commenter requested that the loan-to-value

limitation be increased to 95%. The NCUA Board believes the specified

loan-to-value ratios are appropriate for member business loans and

although the exact wording has been modified, the same loan-to-value

ratios are incorporated into the final rule. However, the NCUA Board is

reiterating that, if there is a category of loans that a credit union

believes should be allowed to exceed these ratios, the credit union can

request a waiver from the appropriate Regional Director. For example,

if a credit union regularly grants vehicle loans in excess of $50,000

that meet the definition of member business loans, the credit union

would likely be a good candidate to receive a waiver from the loan-to-

value ratio requirements for that category of loans.

One commenter requested that NCUA allow borrowers that are

corporations and other business entities, such as limited liability

companies, to borrow in the name of the corporation whereby the

guarantor is the corporation. The NCUA Board does not agree with such a

change because it would allow a corporation to be liable instead of the

individual. Past experience with credit union losses with this type of

loan structure indicates that such a change would not be in the best

interest of credit unions or the National Credit Union Share Insurance

Fund (NCUSIF).

One commenter recommended NCUA use the term ``principals'' instead

of ``borrowers'' to avoid confusion when addressing the requirement for

a personal guarantee since a borrower could be a non-natural person.

The NCUA Board agrees this change would provide greater clarity and has

incorporated it into the final rule.

Section 723.8--How Much May One Member or a Group of Associated Members

Borrow?

This section sets forth the aggregate amount of outstanding member

business loans credit unions may grant to one member or a group of

associated members. Unless NCUA grants a waiver, the interim final rule

limited the aggregate amount of outstanding business loans to any one

member or group of associated members to 15% of the credit union's

reserves (less the Allowance for Loan Losses account) or $100,000,

whichever is higher. The NCUA Board, in the final rule, is replacing

the term ``reserves'' with the term ``net worth.'' This change will not

make the 15% limit more restrictive in gross dollar terms.

In the preamble to the interim final rule, the Board clarified how

loan participations are treated in regard to business loan limits. In

those situations where the credit union sold the participation without

recourse, the amount sold would not be included when calculating the

15% limit for a single borrower. However, if the credit union sold the

participation with recourse (that is, the selling credit union retains

a contingent liability), it would include the amount sold when

calculating the 15% limit.

Four commenters specifically approved of the aggregate loan limit

to one member or group of associated members. One commenter stated that

the restrictions on loan to one borrower should be deleted. One

commenter supported the 15% limit but would eliminate the $100,000

limitation. One commenter stated that unfunded commitments should be

included in the aggregate loan limit. One commenter stated that

unfunded commitments should not be included in the aggregate loan

limit. The NCUA Board has not been provided with a convincing rationale

for changing the loan limits to one borrower or for excluding unfunded

commitments from the loan limits. Therefore, the NCUA Board is adopting

the limitations in the interim final rule in the final rule.

Section 723.9--How Do You Calculate the Aggregate 15% Limit?

This section sets forth how a credit union calculates the aggregate

15% limit. The interim final rule stated that, if any portion of a

member business loan is secured by shares in the credit union or a

deposit in another financial institution, or fully or partially insured

or guaranteed by, or subject to an advance commitment to purchase by

any agency of the federal government or of a state or any of its

political subdivisions, such portion is not used in calculating the 15%

limit. No substantive comments were received on this section. Except

for inserting the term ``net worth'' for the term ``reserves'' the NCUA

Board is adopting in final this section as it was set forth in the

interim final rule.

Section 723.10--What Loan Limit Waivers Are Available?

The interim final rule provided for a waiver from: (1) the maximum

loan amount to one borrower or associated group of members; (2) loan-

to-value ratios; and (3) construction and development lending. The

interim final rule stated that the waiver is for a category of loans.

Two commenters supported the loan limit waiver provisions. In the

interest of making this section more informative, the NCUA Board is

also referencing the waivers that are available for appraisals under

Part 722 and the requirement for the personal liability in Section

723.7. Hence, this section is now retitled: ``What waivers are

available?'' The NCUA Board has not made any other substantive changes

to this section from the interim final rule.

Section 723.11--How Do You Obtain an Available Waiver?

This section described the information that a federal credit union

must submit to the Regional Director with a waiver request. This

section also provided a mechanism for state chartered federally insured

credit unions to have the waiver request processed through the state

supervisory authority. If the state supervisory authority approves the

request, the state regulator forwards the request to the Regional

Director. A waiver is not effective until it is approved by the

Regional Director.

[[Page 28725]]

One commenter requested that NCUA specify that the state

supervisory authority makes the decision whether or not to grant a

waiver for a federally insured state chartered credit union and that

state regulators may allow self-implementing waivers for categories of

loans. The NCUA Board has not been provided any convincing rationale

for not being part of the waiver process. Being part of the process

allows NCUA, as the insurer of credit unions, to ensure that all waiver

requests are properly reviewed.

Furthermore, permitting self-implementing waivers would result in

NCUA abdicating its regulatory responsibility and potentially

threatening the NCUSIF. Except for some minor editing changes,

including a reference for corporate federal credit unions, the NCUA

Board has not made any substantive changes to this section from the

interim final rule.

Section 723.12--What Will NCUA Do With My Waiver Request?

This section sets forth what the Regional Director must consider in

reviewing the waiver request and how the waiver is processed. The

interim final rule stated that a Regional Director must act on a waiver

request within 45 days (from receipt from the federal credit union or

the state supervisory authority) and set forth an automatic waiver

approval if a region does not take action on a request within the

specified time frame.

Any waiver is revocable at NCUA's sole discretion. If a waiver is

revoked, loans granted under the waiver authority are grandfathered.

Two commenters stated that NCUA should make the decision in 30

days. One commenter stated that NCUA should make a decision in less

than 45 days if the waiver was processed first through the state

regulator. The NCUA Board is maintaining 45 days as the time frame the

agency has to approve or deny the waiver because of the increase in the

number of available waivers for credit unions.

Section 723.13--What Options Are Available if the Regional Director

Denies My Waiver Request or a Portion of It?

This section describes how a credit union may appeal the denial of

its waiver request by the Regional Director to the NCUA Board. No

substantive comments were received on this section. The NCUA Board is

adopting this section in final as it was set forth in the interim final

rule.

Section 723.14--How Do I Reserve for Potential Losses?

This section addresses the criteria for determining the

classification of loans. One commenter stated that the title of this

section should be modified to address the classification of loans. The

NCUA Board agrees with this commenter and has changed the title of this

section accordingly.

Section 723.15--How Much Must I Reserve for Potential Losses?

This section provides a schedule a credit union must use to reserve

for classified loans. NCUA clarified the meaning of this section by

stating that this is the minimum amount when establishing the reserve

percentage. No substantive comments were received on this section.

Except for a minor editing change, the Board is adopting this section

in final as it was set forth in the interim final rule.

Section 723.16--What is the Aggregate Member Business Loan Limit for a

Credit Union?

The Act imposes a new aggregate limit on a credit union's

outstanding member business loans (including any unfunded commitments)

of 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. The definition of net worth should be determined

under Generally Accepted Accounting Principles which includes retained

earnings. Retained earnings normally includes undivided earnings,

regular reserves and any other appropriations designated by management

or regulatory authority. The final rule has been modified to reflect

this definition accurately.

If a credit union currently has business loans exceeding the

aggregate loan limit and does not qualify for an exception, it has

until August 7, 2001, to reduce the total amount of outstanding member

business loans to below the aggregate loan limit. Furthermore, once the

prompt corrective action provisions are implemented in a final

regulation, an insured credit union that is undercapitalized may not

make any increase in the total amount of member business loans until

such time as the credit union becomes adequately capitalized as

required by the prompt corrective action provisions of the Act. 12

U.S.C. 216(g)(2).

Four commenters opposed the statutory limitation. Two commenters

objected to including unfunded commitments in determining the aggregate

loan limit. Unfunded commitments are included in calculating the

aggregate loan limit because to do otherwise could inadvertently place

a credit union over the aggregate loan limit when the loan was fully

funded. Such a result would violate the Act.

One commenter requested guidance on how loan participations are

treated for purpose of the aggregate loan limit. Unless otherwise

exempt, loan participations that are made without recourse are not part

of the loan limit for the originating credit union. However, such loans

are to be counted against the aggregate loan limit for the

participating credit union, unless otherwise exempt.

Section 723.17--Are There Any Exceptions to the Aggregate Loan Limit?

The interim final rule set forth three exceptions to the aggregate

loan limit: (1) credit unions that have a low-income designation or

participate in the Community Development Financial Institutions

program; (2) credit unions that have a ``a history of primarily making

member business loans;'' or (3) credit unions that were chartered for

the purpose of primarily making member business loans. A credit union

that does not qualify for an exception must immediately stop making

business loans that will exceed the aggregate loan limit.

Five commenters stated that the exceptions for credit unions should

be self-certifying and the examiners could review whether the exception

is justified during the examination. The NCUA Board believes it would

be abandoning its regulatory responsibility if it were to allow credit

unions to self-certify. This could result in a credit union making

member business loans in excess of the amount permitted under the Act.

The NCUA Board believes that the process has worked properly since it

was adopted in September, and therefore, it is retained in the final

rule. In fact, of the eighty-three credit unions that exceeded the

aggregate loan limit as of August 7, 1998, sixty-five have been granted

exceptions, six requests were denied, and twelve have not sought an

exception. If a credit union is eligible for an exception but chooses

not to seek one, the credit union has until August 7, 2001 to reduce

the total amount of business loans to below the aggregate loan limit.

If an exception is revoked, current loans are grandfathered but the

credit union cannot make any new member business loan until the credit

union's total amount of business loans is below the aggregate loan

limit.

[[Page 28726]]

History of Primarily Making Member Business Loans

The NCUA Board defined ``a history of primarily making member

business loans'' as either: (1) member business loans comprise at least

25% of the credit union's outstanding loans; or (2) member business

loans comprise the largest portion of the credit union's loan

portfolio.

Six commenters supported NCUA's definition of ``a history of

primarily making member business loans.'' Two commenters stated that

the 25% level was too high. One commenter recommended a percentage

between 18-20% for determining whether a credit union has ``a history

of primarily making member business loans.'' Another commenter

suggested 17.5%. Four commenters suggested 15%. Two commenters stated

that any credit union currently above the aggregate loan limit should

be able to receive an exception. Two commenters requested a third

category under this exception. These commenters believe an exception

should also be granted to credit unions whose business loans have

averaged 20% of total loans over a ten-year period. One commenter

stated that NCUA should permit an exception if member business loans

are the second largest category in the credit union's portfolio. One

commenter stated that the Board should add a third criterion where

loans are an integral part of the credit union's loan portfolio.

The language of the statute is ambiguous and leaves to NCUA's

discretion the responsibility for defining when a credit union has a

``history of primarily making member business loan[s].'' The Board

recognizes that only a limited number of credit unions will be eligible

for this exception because the aggregate loan limit will prevent credit

unions in the future from exceeding the cap. While the legislative

history provides no definitive guidance, it does make clear that

Congress intended that exceptions be crafted in a way that would allow

those credit unions with a history of beneficial business lending to

continue that practice. The Senate Report stated that the NCUA Board

should

interpret the exceptions under new section 107A(b), to permit

worthy projects access to affordable credit union financing. Loans

for such purposes as agriculture, self-employment, small business

establishment, large up-front investments or maintenance of

equipment such as fishing or shrimp boats, taxi cab medallions,

tractor trailers, or church construction should not be unduly

constricted as a result of the Board's actions.

S. Rep. No. 105-193, p. 9 (1998). Report of the Committee on

Banking, Housing, and Urban Affairs.

The NCUA Board, believes that establishing the level at 25% of

assets is consistent with congressional intent and permits credit

unions with history and experience with member business loans to

continue to engage in that activity. NCUA arrived at this number after

reviewing the legislative history and other federal regulations and

interpretations, including the ``principally engaged'' language in the

Revenue Limit on Bank-Ineligible Activities of Subsidiaries of Bank

Holding Companies Engaged in Underwriting and Dealing in Securities. 61

FR 68750 (December 30, 1996).

The second part of the Board's exception would apply when member

business loans comprise the largest portion of a credit unions loan

portfolio. For example, a credit union would meet this standard if it

makes 23% member business loans, 22% first mortgage loans, 22% new

automobile loans, 20% credit card loans and 13% other real estate

loans.

This approach is consistent with the definition of primarily as

``being or standing first in a list [or] series.'' See Webster's II,

New Riverside University Dictionary, 1994 Houghton Mifflin Company. It

recognizes the primacy or state of being first when business loans form

the largest type of lending in a credit union's portfolio. See Id.

(Primacy defined as the state of being first or foremost) The Board

also believes it is faithful to the intent of the legislative history,

e.g., that those credit unions with a history of beneficial member

business lending may continue that practice.

The NCUA Board is requiring that, for determining the categories of

loans, a credit union must use loan categories that are similar to

those set forth in the call report such as: unsecured credit card

loans/lines of credit; all other unsecured loans/lines of credit; new

vehicle loans; used vehicle loans; total first mortgage loans; total

other real estate loans; and total member business loans. In no case

could a credit union have more than seven categories of loans for the

purpose of qualifying for this exception. The NCUA Board believes that

the largest book exception is consistent with congressional intent and

is not subject to manipulation since only seven categories of loans can

be used to calculate the largest book of loans.

The NCUA Board believes that the two definitions of a ``history of

primarily making member business loans'' are limited and carefully

crafted. In fact, this exception is so narrowly tailored that less than

ninety credit unions are even eligible for the exception.

The NCUA Board is also clarifying in the final rule what is

acceptable evidence to demonstrate a ``history of primarily making

member business loans.'' Call reports and financial statements from

January 1995 to September 1998 are acceptable evidence to demonstrate

the primacy of business lending in a credit union's portfolio. Three

commenters stated that credit union should be able to use call report

data after September 1998 to demonstrate that the credit union has a

``history of primarily making member business loans.'' The NCUA Board

disagrees with these commenters. Under the Act, if a credit union

exceeded the aggregate loan limit on September 30, 1998, and did not

receive an exception, the credit union should not have granted any new

member business loans, unless the credit union was pursuing an appeal.

Some have suggested that reliance on the call report is not a

history of lending but simply a snapshot in time. The NCUA Board

disagrees. Credit union loan portfolios fluctuate over time based on

such things as economic cycles, changes in membership and the needs and

desires of members. By allowing call reports and financial statements

from 1995 to September 1998 to support qualification for an exception,

the NCUA Board has adopted an approach which addresses these issues by

establishing a reasonable time period during which a credit union may

establish it qualifies for an exception. The period is in the recent

past and is of limited duration. This will assure that the exception is

available only to those credit unions with a demonstrated recent

history of primacy in the area of business lending.

One commenter stated that NCUA should include unfunded commitments

for purposes of calculating the amount of loans for the exception just

as NCUA counts unfunded commitments in determining the number for the

aggregate loan limit. The NCUA Board agrees and, therefore, unfunded

commitments are included in calculating whether the credit union has a

``history of primarily making member business loans.''

Three commenters stated that credit unions should be allowed to

count loans less than $50,000, as well as otherwise exempt loans, for

purposes of qualifying for the ``history of primarily making member

business loans'' exception. The NCUA Board disagrees. By definition,

these loans are not member business

[[Page 28727]]

loans under the Act and therefore are not counted for either the

aggregate loan limit or the exception from the limit. The final rule

incorporates this interpretation in Sections 723.16 and 723.17.

Loan Participations

Six commenters stated that loan participations should be excluded

from the calculation of a credit union's aggregate member business loan

limit, except for the originating credit union. Most of these

commenters stated that the Act refers to loans ``made'' by federally

insured credit unions and since the originating credit union ``makes''

the loan, purchasing credit unions would not be ``making'' the loan,

and therefore, it should not count toward the statutory limits. The

NCUA Board is not adopting this recommendation since it would promote

form over substance and result in a large block of member business

loans suddenly vanishing from the books of credit unions for purposes

of calculating the aggregate loan limit.

Eight commenters stated that NCUA should permit a credit union

participating in a member business loan to classify the participation

as an investment, rather than a member business loan. The NCUA Board

disagrees since the authority for loan participations is located in the

Federal Credit Union Act under the lending powers of credit unions and

not the investment powers. 12 U.S.C. 1757(5) and 1757(7). In addition,

NCUA, as well as credit unions, historically have classified loan

participations as loans and not as investments. In certain limited

circumstances the NCUA Board recognizes that a credit union can

purchase a loan participation that is properly structured as a

security. However, this does not mean that credit unions participating

in a member business loan can classify the transaction as an

investment.

Seven commenters recommended that NCUA should permit a credit union

participating in a loan to exclude it from its total member business

loan amount if it was originated by a credit union that is exempt under

the Act from the member business loan regulation limits. The exception

would, in effect, travel with the loan. The NCUA Board is not adopting

this recommendation. The Act exempts credit unions and not loans from

the aggregate loan limit. If NCUA adopted this recommendation, it could

lead to absurd results. For example, a credit union could have half of

its assets in member business loan participations without falling

within the aggregate loan limit and without receiving an exception.

Clearly, such a result was not intended by Congress and does not make

sense within the statutory scheme.

One commenter stated that only the amount of the loan held by the

originating credit union should be counted against the aggregate loan

limit. The NCUA Board agrees as long as the loan participations are

without recourse. One commenter stated that NCUA should exclude all

loans to non-profits purchased through participation agreements, the

proceeds of which are not used for commercial purpose. The NCUA Board

does not believe there is any statutory authority to support such a

position. Two commenters stated that a credit union that originates

sufficient loans to meet NCUA's threshold requirements should qualify

for the exception even if the credit union does not hold onto the

loans. The NCUA Board is not sure that such an expansion of the

exception is consistent with congressional intent.

Chartered for the Purpose of Making Member Business Loans

The NCUA Board also stated that an exception may also be granted

for credit unions that were chartered for the purpose of primarily

making member business loans. It is up to the credit union to provide

sufficient documentation to demonstrate it meets this exception. Due to

the nature of federal chartering, the NCUA Board believed it would be

unlikely that many federal credit unions would qualify for this type of

exception. However, the NCUA Board sought comment on how it could more

fully define credit unions that were ``chartered for the purpose of

primarily making member business loans'' for the purpose of this

exception.

Four commenters stated that the interim final rule is more

restrictive than the legislation by adding the word ``primarily'' to

this exception. These commenters stated that the fact that Congress did

not include the word ``primarily'' in the exception based on a credit

union's charter but did add it to the exception regarding member

business loan history is a strong indication that Congress did not

intend for the NCUA Board to include the additional standard. After

further review, the NCUA Board agrees with these commenters and the

final rule has been changed accordingly.

One commenter stated that, for this exception, NCUA should define

the exception as a product of the credit union's field of membership

and its lending history. For example, this commenter stated that this

would allow NCUA to exempt credit unions that serve farm cooperatives

or groups of self-employed individuals, such as taxi drivers; or

community credit unions with a history or providing small business

loans, and others. The NCUA Board generally agrees with this commenter

and has incorporated this suggestion into the final rule.

Two commenters stated that federal credit unions should be afforded

the opportunity to prove, if they can, that they were chartered for the

purpose of making member business loans. Two commenters suggested NCUA

allow a broad range of evidence including historical documents such as

original bylaws, articles of incorporation and the credit union's

mission statement. One commenter recommended that NCUA state what the

agency will consider as acceptable documentation to support such a

showing. NCUA will consider any documentation from original charters,

original bylaws, early business plans, mission statements, board

minutes, original field of membership, early loan portfolios and any

other appropriate evidence a credit union may submit to demonstrate

that the credit union was chartered for the purpose of making a member

business loan. The list of documentation that NCUA will consider in

making this determination has been incorporated into the final rule.

One commenter stated that NCUA should review a credit union's

service area and, if the service area is rural or agricultural, the

credit union should qualify for the exception. Simply because a credit

union is located in a rural or agricultural area does not demonstrate

that a credit union was chartered for the purpose of making member

business loans. Additional evidence would be necessary to permit a

credit union to obtain this exception.

Nine commenters stated that this exception should be broadened so

that an existing credit union can amend its charter to state that it is

chartered for the purpose of making member business loans and thus

qualify for the exception. The NCUA Board believes such a change would

not generally be consistent with congressional intent. If any credit

union simply could update its charter to state its purpose was to make

business loans, and thereby be exempt, from the statutory limits, the

result would be inconsistent with the entire statutory scheme. However,

there may be certain circumstances, including safety and soundness

reasons, that would require NCUA or the state supervisory authority to

recommend to the credit union to amend its charter.

[[Page 28728]]

Section 723.18--How Do I Obtain an Exception?

To obtain the exception, a federal credit union must submit

documentation to the Regional Director, demonstrating that it meets the

criteria of one of the exceptions. A state chartered federally insured

credit union must submit documentation to its state regulator to

receive the exception. Although effective when granted by the state

regulator, the state regulator should forward its decision to NCUA. The

exception does not expire unless revoked by the Regional Director for a

federal credit union or by the state regulator for a federally insured

state chartered credit union. If an exception is revoked, loans granted

under the exception authority are grandfathered.

One commenter stated that the preamble to the final rule should

clarify that if a state regulator has approved an exception, NCUA

cannot overturn the state regulator's decision. NCUA has no intention

of overturning a state regulator's decision regarding the exception.

The process simply requires the state regulator to notify NCUA that the

exception has been granted.

Section 723.19--What Are the Recordkeeping Requirements?

This section required a credit union to identify member business

loans separately in its records and financial reports. No substantive

comments were received on this section. The Board is adopting this

section in final as it was set forth in the interim final rule.

Section 723.20--How Can a State Supervisory Authority Develop and

Implement a Member Business Loan Regulation?

The interim final rule allowed a federally-insured state-chartered

credit union to obtain an exemption from NCUA's member business loan

rule so that a state supervisory authority can enforce the state's rule

instead of NCUA's rule. The NCUA Board must approve the state's rule

before a federally-insured state-chartered credit union is exempt from

NCUA's member business loan rule. The interim final rule identified the

minimum requirements that a state regulation must address for a rule to

be approved by the NCUA Board. Because of the new statutory

requirements of the Act, no state rule is currently approved for use by

federally-insured state-chartered credit unions. Therefore, states must

seek a new determination from NCUA. In addition, the NCUA Board is

reemphasizing that any state's rule must follow the new definitions and

the statutory limits in the Act. That is, the definition of a member

business loan, the exemptions from the definition of a member business

loan, the aggregate loan limit, and the state's interpretation of the

exceptions from the aggregate loan limit must mirror NCUA's Regulation.

One commenter specifically approved of this section. Three

commenters requested that NCUA eliminate the words ``substantial

equivalency determination'' from this section. Two commenters did not

agree in eliminating the words ``substantial equivalency

determination'' from this section. The final rule does not contain the

term ``substantial equivalency'' because of the continuing objections

expressed by some state supervisory authorities. The Board acknowledges

the concerns of the state supervisory authorities, and the final rule

recognizes that, in deciding whether to allow a state to implement its

own rule, the NCUA Board is concerned, as insurer, with safety and

soundness issues and not whether the language of the rule is virtually

identical to NCUA's rule.

One commenter requested that the rule specify the time frame NCUA

has to render a determination on a state's rule. Although no time frame

is specified in the final rule, the NCUA Board has a goal of making a

decision within 90 days of receiving a complete request for a

determination.

Section 723.21--Definitions

NCUA proposed a general definition section at the end of the rule.

One commenter did not object to NCUA's definition of ``associated

member'' but did question how NCUA applies it. This commenter

specifically requested that, in cases where there are related parties,

loans will be aggregated only when assets of the related parties

provide the income for the repayment of the loan. This commenter states

that the proper test for determining the status of an associated member

is the existence of a nexus between the success of the endeavor and the

ability to repay the loan. The NCUA Board agrees and the agency will

apply the definition accordingly.

In an attempt to make the regulation easier to understand, the NCUA

Board has slightly modified the definition of ``construction or

development loan'' and ``loan-to-value ratio'' and added a definition

for ``net worth'' and deleted the definition of ``reserves.''

Miscellaneous

Six commenters requested that NCUA develop two distinct classes of

member business loans--one for real estate and one for other types of

member business loans. At this time, the NCUA Board believes it is not

necessary to have separate rules because this final rule provides

sufficient flexibility and guidance.

The interim final rule was written in a plain English, question and

answer format. Two commenters approved of the plain English, question

and answer format. Two commenters preferred the traditional regulatory

style. The NCUA Board has not noted any problems with the plain

English, question and answer format and believes the question and

answer format is comprehensive and easy to understand. Therefore, the

final rule is written in the plain English, question and answer format.

A few commenters requested that NCUA's Chartering Manual be amended

to describe how a credit union can be chartered for the purpose of

making member business loans. The NCUA Board will review this issue the

next time it amends the Chartering Manual. In the meantime, a new

charter can simply incorporate into its charter or bylaws a statement

that its purpose is to make member business loans. Obviously, the

credit union must incorporate this statement in good faith and the

credit union's business plan will be reviewed to ensure that it

reflects this stated purpose.

Part 722--Appraisals

Certain loans as specified in Section 722.3(a) do not require an

appraisal. In addition, the interim final rule contains a waiver

process from the appraisal requirement where the appraisal requirement

is an unnecessary burden. Three commenters specifically approved of the

waiver provision for appraisals. Two commenters requested more guidance

on when a waiver would be granted for a category of loans. The NCUA

Board believes a waiver on a category of loans should be granted

whenever an appraisal would be virtually meaningless. For example, an

appraisal on loans to construct churches is often unnecessary. Another

example where an appraisal may be unnecessary is when the loan-to-value

ratio is extremely low due to property ownership interests, such as

borrowing a small amount to improve property that is already completely

owned by the member.

C. Other Reductions In Regulatory Burden

Under the previous member business loan rule, all loans, lines of

credit, or letters of credit that met the definition of a member

business loan had to be separately identified in the records of

[[Page 28729]]

the credit union and be reported as such in financial and statistical

reports required by the NCUA. NCUA believes that this information is

already collected, and readily available, through the 5300 Call Report.

The previous requirement imposed an unnecessary burden on credit unions

and, therefore, the NCUA Board deleted this monitoring requirement in

the interim final rule.

The previous member business loan rule required credit unions to

provide periodic disclosures to credit union members on the number and

aggregate dollar amount of member business loans. NCUA believed the

language was ambiguous and did not serve any true safety or soundness

issue purpose. Therefore, the NCUA Board deleted this requirement in

the interim final rule.

Two commenters supported the elimination of these reporting

requirements. The Board has not been provided any convincing rationale

for reimposing these reporting requirements on credit unions,

therefore, the final rule, like the interim rule, does not contain

these reporting requirements.

D. Comments From Banks and Bank Trade Organizations

Briefly summarized, the bank commenters argued that NCUA did not

interpret CUMAA correctly and some stated that federal credit unions

should be subject to taxation like banks. In general, these commenters

opposed: (1) NCUA's definition of a ``history of primarily making

member business loans'' exception; (2) NCUA's addition of the word

``primarily'' to the exception regarding the chartering of the credit

union for the purpose of making business loans; (3) NCUA's attempt to

reduce regulatory burden, including revisions regarding loans-to-one

borrower, employee lending experience, loan-to-value ratios, appraisal

rules, review of financial statements, and state waiver authority; and

(4) NCUA's elimination of some burdensome reporting requirements.

The Board has considered all issues raised by these commenters and

has previously addressed the major issues in this preamble since other

commenters also addressed many of the same provisions. As to the

question of taxation, this issue was legislatively addressed in CUMAA

at Section 2.(4), which states that ``[c]redit unions, unlike many

other participants in the financial services market, are exempt from

Federal and most State taxes because they are member-owned,

democratically operated, not-for-profit organizations generally managed

by volunteer board of directors and because they have the specified

mission of meeting the credit and savings needs of consumers,

especially persons of modest means.''

E. 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 (primarily those under

$1 million in assets). Aside from provisions mandated by the Act, the

final member business loan rule would reduce existing regulatory

burdens. In addition, most small credit unions do not grant member

business loans. Therefore, the NCUA Board has determined and certifies

that the final rule will not have a significant economic impact on a

substantial number of small credit unions.

Accordingly, the NCUA Board has determined that a Regulatory

Flexibility Analysis is not required.

Paperwork Reduction Act

The reporting requirements in part 723 have been submitted to and

approved by the Office of Management and Budget under OMB control

number 3133-0101. Under the Paperwork Reduction Act of 1995, no persons

are required to respond to a collection of information unless it

displays a valid OMB control number. The control number will be

displayed in the table at 12 CFR part 795.

Executive Order 12612

Executive Order 12612 requires NCUA to consider the effect of its

actions on state interests. The final rule, as does the current rule,

applies to all federally insured credit unions, including federally

insured state chartered credit unions. However, since the final rule

reduces regulatory burden, NCUA has determined that the final rule does

not constitute a ``significant regulatory action'' for purposes of the

Executive Order.

Congressional Review

The Small Business Regulatory Enforcement Fairness Regulatory

Enforcement Fairness Act of 1996 (Public Law 104-221) provides for

Congressional review of agency rules.

The reporting requirements is triggered in instances where NCUA

issues a final rule as defined by section 551 of the Administrative

Procedures Act, 5 U.S.C. 551.

The Office of Management and Budget has determined this is not a

major rule. A major rule is defined as being any final rule that the

Office of Management and Budget finds has resulted in or is likely to

result in: (1) an annual effect on the economy of $100 million or more;

(2) a major increase in costs or prices for consumers, individual

industries, Federal, State, or local government agencies, or geographic

regions; or (3) significant adverse effects on competition, employment,

investment, productivity, innovation, or on the ability of United

States based enterprises to compete with foreign-based enterprises in

domestic and export markets.

List of Subjects

12 CFR Part 701

Credit, Credit unions, Insurance, Mortgages, Reporting and

recordkeeping requirements, Surety bonds.

12 CFR Part 722

Appraisals, Credit, Credit unions, Reporting and recordkeeping

requirements.

12 CFR Part 723

Credit, Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 741

Bank deposit insurance, Credit unions, Reporting and recordkeeping

requirements.

By the National Credit Union Administration Board on May 19,

1999.

Becky Baker,

Secretary of the Board.

Accordingly, the interim rule amending 12 CFR parts 701, 722, 723

and 741 which was published at 63 FR 51793, September 29, 1998, is

adopted as a final rule with the following changes:

1. Part 723 is revised to read as follows:

PART 723--MEMBER BUSINESS LOANS

Sec.

723.1 What is a member business loan?

723.2 What are the prohibited activities?

723.3 What are the requirements for construction and development

lending?

723.4 What are the other applicable regulations?

723.5 How do you implement a member business loan program?

723.6 What must your member business loan policy address?

723.7 What are the collateral and security requirements?

723.8 How much may one member, or a group of associated members,

borrow?

723.9 How do you calculate the aggregate 15% limit?

723.10 What waivers are available?

723.11 How do you obtain a waiver?

[[Page 28730]]

723.12 What will NCUA do with my waiver request?

723.13 What options are available if the NCUA Regional Director

denies my waiver request, or a portion of it?

723.14 How do I classify loans so as to reserve for potential

losses?

723.15 How much must I reserve for potential losses?

723.16 What is the aggregate member business loan limit for a

credit union?

723.17 Are there any exceptions to the aggregate loan limit?

723.18 How do I obtain an exception?

723.19 What are the recordkeeping requirements?

723.20 How can a state supervisory authority develop and enforce a

member business loan regulation?

723.21 Definitions.

Authority: 12 U.S.C. 1756, 1757, 1757A, 1766, 1785, 1789.

Sec. 723.1 What is a member business loan?

(a) General rule. A member business loan includes any loan, line of

credit, or letter of credit (including any unfunded commitments) where

the borrower uses the proceeds for the following purposes:

(1) Commercial;

(2) Corporate;

(3) Other business investment property or venture; or

(4) Agricultural.

(b) Exceptions to the general rule. The following are not member

business loans:

(1) A loan fully secured by a lien on a 1 to 4 family dwelling that

is the member's primary residence;

(2) A loan fully secured by shares in the credit union making the

extension of credit or deposits in other financial institutions;

(3) Loan(s) to a member or an associated member which, when added

together, are equal to or less than $50,000;

(4) A loan where a federal or state agency (or its political

subdivision) fully insures repayment, or fully guarantees repayment, or

provides an advance commitment to purchase in full; or

(5) A loan granted by a corporate credit union to another credit

union.

Sec. 723.2 What are the prohibited activities?

(a) Who is ineligible to receive a member business loan? You may

not grant a member business loan to the following:

(1) Your chief executive officer (typically this individual holds

the title of President or Treasurer/Manager);

(2) Any assistant chief executive officers (e.g., Assistant

President, Vice President, or Assistant Treasurer/Manager);

(3) Your chief financial officer (Comptroller); or

(4) Any associated member or immediate family member of anyone

listed in paragraphs (a) (1) through (3) of this section.

(b) Equity agreements/joint ventures. You may not grant a member

business loan if any additional income received by the credit union or

senior management employees is tied to the profit or sale of the

business or commercial endeavor for which the loan is made.

(c) Loans to compensated directors. A credit union may not grant a

member business loan to a compensated director unless the board of

directors approves granting the loan and the compensated director is

recused from the decision making process.

Sec. 723.3 What are the requirements for construction and development

lending?

Unless the Regional Director grants a waiver, loans granted for the

construction or development of commercial or residential property are

subject to the following additional requirements.

(a) The aggregate of all construction and development loans must

not exceed 15% of net worth. To determine the aggregate, you may

exclude any portion of a loan:

(1) Secured by shares in the credit union;

(2) Secured by deposits in another financial institution;

(3) Fully or partially insured or guaranteed by any agency of the

federal government, state, or its political subdivisions; or

(4) Subject to an advance commitment to purchase by any agency of

the federal government, state, or its political subdivisions;

(b) The borrower must have a minimum of 35% equity interest in the

project being financed; and

(c) The funds may be released only after on-site, written

inspections by qualified personnel and according to a preapproved draw

schedule and any other conditions as set forth in the loan

documentation.

Sec. 723.4 What are the other applicable regulations?

The provisions of Sec. 701.21(a) through (g) of this chapter apply

to member business loans granted by federal credit unions to the extent

they are consistent with this part. Except as required by part 741 of

NCUA's regulations, federally insured credit unions are not required to

comply with the provisions of Sec. 701.21(a) through (g).

Sec. 723.5 How do you implement a member business loan program?

The board of directors must adopt specific business loan policies

and review them at least annually. The board must also utilize the

services of an individual with at least two years direct experience

with the type of lending the credit union will be engaging in.

Credit unions do not have to hire staff to meet the requirements of

this section; however, credit unions 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, 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.

Sec. 723.6 What must your member business loan policy address?

At a minimum, your policy must address the following:

(a) The types of business loans you will make;

(b) Your trade area;

(c) The maximum amount of your assets, in relation to net worth,

that you will invest in business loans;

(d) The maximum amount of your assets, in relation to net worth,

that you will invest in a given category or type of business loan;

(e) The maximum amount of your assets, in relation to net worth,

that you will loan to any one member or group of associated members,

subject to Sec. 723.8;

(f) The qualifications and experience of personnel (minimum of 2

years) involved in making and administering business loans;

(g) A requirement to analyze and document the ability of the

borrower to repay the loan;

(h) Receipt and periodic updating of financial statements and other

documentation, including tax returns;

(i) A requirement for sufficient documentation supporting each

request to extend credit, or increase an existing loan or line of

credit (except where the board of directors finds that the

documentation requirements are not generally available for a particular

type of business loan and states the reasons for those findings in the

credit union's written policies). At a minimum, your documentation must

include the following:

(1) Balance sheet;

(2) Cash flow analysis;

(3) Income statement;

(4) Tax data;

(5) Analysis of leveraging; and

(6) Comparison with industry average or similar analysis;

(j) The collateral requirements must include:

[[Page 28731]]

(1) Loan-to-value ratios;

(2) Determination of value;

(3) Determination of ownership;

(4) Steps to secure various types of collateral; and

(5) How often the credit union will reevaluate the value and

marketability of collateral;

(k) The interest rates and maturities of business loans;

(l) General loan procedures which include:

(1) Loan monitoring;

(2) Servicing and follow-up; and

(3) Collection;

(m) Identification of those individuals prohibited from receiving

member business loans.

Sec. 723.7 What are the collateral and security requirements?

(a) Unless your Regional Director grants a waiver, all member

business loans must be secured by collateral as follows:

------------------------------------------------------------------------

Minimum loan to value

Lien requirements

------------------------------------------------------------------------

All....................................... LTV ratios for all liens

cannot exceed 80% unless

the value in excess of 80%

is covered through private

mortgage or equivalent

insurance but in no case

can it exceed 95%.

First with PMI or similar type of insurer. You may grant a LTV ratio in

excess of 80% only where

the value in excess of 80%

is covered through:

acquisition of private

mortgage or equivalent type

insurance provided by an

insurer acceptable to the

credit union (where

available); insurance or

guarantees by, or subject

to advance commitment to

purchase by, an agency of

the federal government; or

insurance or guarantees by,

or subject to advance

commitment to purchase by,

an agency of a state or any

of its political

subdivisions.

First..................................... LTV ratios up to 80%.

Second.................................... LTV ratios up to 80%.

------------------------------------------------------------------------

(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.

(c) Federally insured credit unions are exempt from the provisions

of paragraphs (a) and (b) 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.

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 outstanding member business loans (including

any unfunded commitments) 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.

Sec. 723.9 How do you calculate the aggregate 15% limit?

(a) Step 1. Calculate the numerator by adding together the total

outstanding balance of member business loans to any one member, or

group of associated members. From this amount, subtract any portion:

(1) Secured by shares in the credit union;

(2) Secured by deposits in another financial institution;

(3) Fully or partially insured or guaranteed by any agency of the

Federal government, state, or its political subdivisions;

(4) Subject to an advance commitment to purchase by any agency of

the Federal government, state, or its political subdivisions.

(b) Step 2. Divide the numerator by net worth.

Sec. 723.10 What waivers are available?

You may seek a waiver for a category of loans in the following

areas:

(a) Loan-to-value ratios under Sec. 723.7;

(b) Maximum loan amount to one borrower or associated group of

borrowers under Sec. 723.8;

(c) Construction and development loan limits under Sec. 723.3;

(d) Requirement for personal liability and guarantee under

Sec. 723.7; and

(e) Appraisal requirements under Sec. 722.3.

Sec. 723.11 How do you obtain a waiver?

To obtain a waiver, a federal credit union must submit a request to

the Regional Director (a corporate federal credit union submits the

waiver 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 request to the Regional Director (or if appropriate the

Director of the Office of Corporate Credit Unions). A waiver 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 waiver request must contain the

following:

(a) A copy of your business lending policy;

(b) The higher limit sought (if applicable);

(c) An explanation of the need to raise the limit (if applicable);

(d) Documentation supporting your ability to manage this activity;

and

(e) An analysis of the credit union's prior experience making

member business loans, including as a minimum:

(1) The history of loan losses and loan delinquency;

(2) Volume and cyclical or seasonal patterns;

(3) Diversification;

(4) Concentrations of credit to one borrower or group of associated

borrowers in excess of 15% of net worth;

(5) Underwriting standards and practices;

(6) Types of loans grouped by purpose and collateral; and

(7) The qualifications of personnel responsible for underwriting

and administering member business loans.

Sec. 723.12 What will NCUA do with my waiver request?

Your Regional Director (or the Director of the Office of Corporate

Credit Unions) will:

(a) Review the information you provided in your request;

(b) Evaluate the level of risk to your credit union;

(c) Consider your credit union's historical CAMEL composite and

component ratings when evaluating your request; and

(d) Notify you whenever your waiver request is deemed complete.

Notify you of the action taken within 45 calendar days of receiving a

complete request from the federal credit union or the state supervisory

authority. If you do not receive notification within 45 calendar days

of the date the complete request was received by the regional office,

the credit union may assume approval of the waiver request.

Sec. 723.13 What options are available if the NCUA Regional Director

denies my waiver request or a portion of it?

You may appeal the Regional Director's (or the Director of the

Office

[[Page 28732]]

of Corporate Credit Unions) decision in writing to the NCUA Board. Your

appeal must include all information requested in Sec. 723.11 and why

you disagree with your Regional Director's (or the Office of Corporate

Credit Union Director's) decision.

Sec. 723.14 How do I classify loans so as to reserve for potential

losses?

Non-delinquent member business loans may be classified based on

factors such as the adequacy of analysis and supporting documentation.

You must classify potential loss loans as either substandard, doubtful,

or loss. The criteria for determining the classification of loans are:

(a) Substandard. Loan is inadequately protected by the current

sound worth and paying capacity of the obligor or of the collateral

pledged, if any. Loans classified must have a well-defined weakness or

weaknesses that jeopardize the liquidation of debt. They are

characterized by the distinct possibility that the credit union will

sustain some loss if the deficiencies are not corrected. Loss

potential, while existing in the aggregate amount of substandard loans,

does not have to exist in individual loans classified substandard.

(b) Doubtful. A loan classified doubtful has all the weaknesses

inherent in one classified substandard, with the added characteristic

that the weaknesses make collection or liquidation in full, on the

basis of currently existing facts, conditions, and values, highly

questionable and improbable. The possibility of loss is extremely high,

but because of certain important and reasonably specific pending

factors which may work to the advantage and strengthening of the loan,

its classification as an estimated loss is deferred until its more

exact status may be determined. Pending factors include: proposed

merger, acquisition, or liquidation actions; capital injection;

perfecting liens on collateral; and refinancing plans.

(c) Loss. Loans classified loss are considered uncollectible and of

such little value that their continuance as loans is not warranted.

This classification does not necessarily mean that the loan has

absolutely no recovery or salvage value, but rather, it is not

practical or desirable to defer writing off this basically worthless

asset even though partial recovery may occur in the future.

Sec. 723.15 How much must I reserve for potential losses?

The following schedule sets the minimum amount you must reserve for

classified loans:

------------------------------------------------------------------------

Classification Amount Required

------------------------------------------------------------------------

Substandard............................... 10% of outstanding amount

unless other factors (for

example, history of such

loans at the credit union)

indicate a greater or

lesser amount is

appropriate.

Doubtful.................................. 50% of the outstanding

amount.

Loss...................................... 100% of the outstanding

amount.

------------------------------------------------------------------------

Sec. 723.16 What is the aggregate member business loan limit for a

credit union?

The aggregate limit on a credit union's outstanding member business

loans (including any unfunded commitments) 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.

Sec. 723.17 Are there any exceptions to the aggregate loan limit?

There are three circumstances where a credit union qualifies for an

exception from the aggregate limit. Loans that are excepted from the

definition of member business loans are not counted for the purpose of

the exceptions. The three exceptions are:

(a) Credit unions that have a low-income designation or participate

in the Community Development Financial Institutions program;

(b) Credit unions that were chartered for the purpose of making

member business loans and can provide documentary evidence (such

evidence includes but is not limited to the original charter, original

bylaws, original business plan, original field of membership, board

minutes and loan portfolio);

(c) Credit unions that have a history of primarily making member

business loans, meaning that either member business loans comprise at

least 25% of the credit union's outstanding loans (as evidenced in any

call report filed between January 1995 and September 1998 or any

equivalent documentation including financial statements) or member

business loans comprise the largest portion of the credit union's loan

portfolio (as evidenced in any call report filed between January 1995

and September 1998 or any equivalent documentation including financial

statements). For example, if a credit union makes 23% member business

loans, 22% first mortgage loans, 22% new automobile loans, 20% credit

card loans, and 13% total other real estate loans, then the credit

union meets this exception.

Sec. 723.18 How do I obtain an exception?

To obtain the exception, a federal credit union must submit

documentation to the Regional Director, demonstrating that it meets the

criteria of one of the exceptions. A state chartered federally insured

credit union must submit documentation to its state supervisory

authority. The state supervisory authority will forward its decision to

NCUA. The exception does not expire unless revoked by the state

supervisory authority for a state chartered federally insured credit

union or the Regional Director for a federal credit union. If an

exception request is denied for a federal credit union, it may be

appealed to the NCUA Board within 60 days of the denial by the Regional

Director. Until the NCUA Board acts on the appeal, the credit union can

continue to make new member business loans.

Sec. 723.19 What are the recordkeeping requirements?

You must separately identify member business loans in your records

and in the aggregate on your financial reports.

Sec. 723.20 How can a state supervisory authority develop and enforce

a member business loan regulation?

(a) The NCUA Board may exempt federally insured state chartered

credit unions in a given state from NCUA's member business loan rule if

NCUA approves the state's rule for use for state chartered federally

insured credit unions. In making this determination, the Board is

guided by safety and soundness considerations and reviews whether the

state regulation minimizes the risk and accomplishes the overall

objectives of NCUA's member business loan rule in this part.

Specifically, the Board will focus its review on:

(1) The definition of a member business loan;

(2) Loan to one borrower limits;

(3) Written loan policies;

(4) Collateral and security requirements;

(5) Construction and development lending; and

(6) Loans to senior management.

(b) To receive NCUA's approval of a state's members business loan

rule, the state supervisory authority must submit its rule to the NCUA

regional office. After reviewing the rule, the region will

[[Page 28733]]

forward the request to the NCUA Board for a final determination.

Sec. 723.21 Definitions.

For purposes of this part, the following definitions apply:

Associated member is any member with a shared ownership,

investment, or other pecuniary interest in a business or commercial

endeavor with the borrower.

Construction or development loan is a financing arrangement for

acquiring property or rights to property, including land or structures,

with the intent to convert it to income-producing property such as

residential housing for rental or sale; commercial use; industrial use;

or similar uses.

Immediate family member is a spouse or other family member living

in the same household.

Loan-to-value ratio is the aggregate amount of all sums borrowed

including outstanding balances plus any unfunded commitment or line of

credit from all sources on an item of collateral divided by the market

value of the collateral used to secure the loan.

Net worth is retained earnings as defined under Generally Accepted

Accounting Principles. Retained earnings normally includes undivided

earnings, regular reserves and any other appropriations designated by

management or regulatory authorities.

PART 741--REQUIREMENTS FOR INSURANCE

2. The authority citation for part 741 continues to read as

follows:

Authority: 12 U.S.C. 1757, 1766 and 1781-1790. Section 741.4 is

also authorized by 31 U.S.C. 3717.

Sec. 741.203 [Amended]

3. Section 741.203 is amended in paragraph (a) by removing the

second sentence and adding in its place a new sentence to read as

follows: ``State-chartered, NCUSIF-insured credit unions in a given

state are exempt from these requirements if the state supervisory

authority for that state adopts substantially equivalent regulations as

determined by the NCUA Board or, in the case of the member business

loan requirements, if the state supervisory authority adopts member

business loan regulations that are approved by the NCUA Board pursuant

to Sec. 723.20.''

[FR Doc. 99-13310 Filed 5-26-99; 8:45 am]

BILLING CODE 7535-01-P