Proposed Rule2022-27607
Financial Innovation: Loan Participations, Eligible Obligations, and Notes of Liquidating Credit Unions
Primary source
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Published
December 30, 2022
Issuing agencies
National Credit Union Administration
Abstract
The NCUA Board (Board) is seeking comment on a proposed rule that would amend the NCUA's rules regarding the purchase of loan participations and the purchase, sale, and pledge of eligible obligations and other loans (including notes of liquidating credit unions). The proposed rule is intended to clarify the NCUA's current regulations and provide additional flexibility for federally insured credit unions (FICUs) to make use of advanced technologies and opportunities offered by the financial technology (fintech) sector. The proposal would also make conforming amendments to the NCUA's rule regarding loans to members and lines of credit to members by adding new provisions about indirect lending arrangements and indirect leasing arrangements. Finally, the proposal would make other conforming changes and technical amendments in other sections of the NCUA's regulations. The Board does not view these conforming and technical changes as substantive.
Full Text
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<title>Federal Register, Volume 87 Issue 250 (Friday, December 30, 2022)</title>
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[Federal Register Volume 87, Number 250 (Friday, December 30, 2022)]
[Proposed Rules]
[Pages 80479-80501]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-27607]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Parts 701 and 714
[NCUA-2022-0185]
RIN 3133-AF49, 3133-AE96
Financial Innovation: Loan Participations, Eligible Obligations,
and Notes of Liquidating Credit Unions
AGENCY: National Credit Union Administration (NCUA).
ACTION: Proposed rule.
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SUMMARY: The NCUA Board (Board) is seeking comment on a proposed rule
that would amend the NCUA's rules regarding the purchase of loan
participations and the purchase, sale, and pledge of eligible
obligations and other loans (including notes of liquidating credit
unions). The proposed rule is intended to clarify the NCUA's current
regulations and provide additional flexibility for federally insured
credit unions (FICUs) to make use of advanced technologies and
opportunities offered by the financial technology (fintech) sector. The
proposal would also make conforming amendments to the NCUA's rule
regarding loans to members and lines of credit to members by adding new
provisions about indirect lending arrangements and indirect leasing
arrangements. Finally, the proposal would make other conforming changes
and technical amendments in other sections of the NCUA's regulations.
The Board does not view these conforming and technical changes as
substantive.
DATES: Comments must be received by February 28, 2023.
ADDRESSES: You may submit comments by any of the following methods
(Please send comments by one method only):
<bullet> Federal eRulemaking Portal: <a href="https://www.regulations.gov">https://www.regulations.gov</a>.
The docket number for this notice of proposed rulemaking is NCUA-2022-
0185. Follow the instructions for submitting comments.
<bullet> Mail: Address to Melane Conyers-Ausbrooks, Secretary of
the Board, National Credit Union Administration, 1775 Duke Street,
Alexandria, Virginia 22314-3428.
<bullet> Hand Delivery/Courier: Same as mail address.
Public inspection: All public comments are available on the Federal
eRulemaking Portal at: <a href="https://www.regulations.gov">https://www.regulations.gov</a> as submitted, except
when impossible for technical reasons. Public comments will not be
edited to remove any identifying or contact information.
If you are unable to access public comments on the internet, you
may contact the NCUA for alternative access by calling (703) 518-6540
or emailing <a href="/cdn-cgi/l/email-protection#d8979f9b95b9b1b498b6bbadb9f6bfb7ae"><span class="__cf_email__" data-cfemail="6f20282c220e06032f010c1a0e41080019">[email protected]</span></a>.
FOR FURTHER INFORMATION CONTACT: For policy questions: Laura Smith,
Senior Credit Specialist, or Naghi Khaled, Director of Credit Markets,
Office of Examination and Insurance, at (703) 518-6360; for legal
questions: Frank Kressman, General Counsel, the Office of General
Counsel, at (703) 518-6540; or by mail at National Credit Union
Administration, 1775 Duke Street, Alexandria, VA 22314.
SUPPLEMENTARY INFORMATION:
I. Summary of the Proposed Rule
A. Background
The Board is proposing to amend Sec. Sec. 701.21, 701.22, 701.23,
and part 714 of the NCUA's regulations regarding the purchase of loan
participations and the purchase, sale, and pledge of eligible
obligations and other loans (including
[[Page 80480]]
notes of liquidating credit unions).\1\ The Board intends this proposal
provide FICUs with additional flexibility to make use of advanced
technologies and opportunities offered by the fintech sector. In
addition, the proposed amendments are intended to clarify ambiguities
related to loan participations and eligible obligations.
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\1\ Note that the terms credit union, federal credit union,
federally insured state-chartered credit union, corporate credit
union, and FICU are used throughout the document and are not
necessarily interchangeable. Specifically, while Sec. 701.23
applies to FCUs only, Sec. 701.22 applies to all federally insured
consumer credit unions, and Sec. 701.21 has provisions that apply
to all federally insured credit unions.
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Over the last several years, the NCUA has modernized and updated
several of its regulations to shift from a prescriptive to a
principles-based approach. As a result of this effort, many of the
agency's regulations are now principles-based, meaning the regulations
provide a framework for a credit union to determine how to structure
its operations. The NCUA's principles-based approach to rulemaking is
intended to apply a broad, well-defined, set of principles governing
the regulated activity. This principles-based approach enables a credit
union to establish and adjust its policies and procedures to reflect
its board-established risk-tolerance levels, provided those policies
and procedures continue to meet the principles outlined in the
regulation, including safety and soundness and compliance
considerations.
The Board believes shifting to a more principles-based approach
with respect to loan participations and eligible obligations is
appropriate and will be beneficial to FICUs. By removing certain
prescriptive limits and other qualifying conditions, and replacing them
with risk-focused, principles-based requirements, the Board believes
this proposal will advance the agency's efforts to strike an
appropriate balance between mitigating risk to the National Credit
Union Share Insurance Fund (Share Insurance Fund), protecting credit
union members and fostering growth and stability in the credit union
system. In addition, this shift would provide FICUs with flexibility to
innovate how they manage their balance sheets while offering new or
enhanced services to their members. The Board also believes the
proposed changes would increase FICUs' ability to engage in lending
arrangements with other financial institutions and third parties,
including fintech companies providing lending services, expanding their
access to diverse loan origination channels, new markets and potential
new services to their members. Finally, the Board notes that this
proposal would address part of one of the strategic objectives outlined
in the 2022 NCUA Annual Performance Plan, which is to ensure NCUA
policies and regulations appropriately address emerging and innovative
financial technologies.
B. Overview of Proposed Changes
The proposed rule would remove certain prescriptive limitations and
other qualifying requirements relating to eligible obligations and
provide credit unions with additional flexibility to purchase eligible
obligations of their members. Removing the current prescriptive
limitations and other qualifying requirements will allow federal credit
unions (FCUs) additional flexibility to engage with the advanced
technologies and other opportunities offered by the fintech sector. The
greater flexibility and individual autonomy will also allow FCUs to
establish their own risk tolerance limits and governance policies for
these activities, while codifying due diligence, risk assessment,
compliance and other management processes that are consistent with the
Board's long-standing expectations for safe, sound, fair and affordable
lending practices.
The proposed rule would also provide credit unions with additional
flexibility to participate in loans acquired through indirect lending
arrangements, allowing FICUs to utilize advanced technologies and
opportunities offered by the fintech sector.
As discussed in greater detail in the section-by-section analysis,
the Board is proposing to amend Sec. 701.21 of the NCUA's regulations
to add new paragraph (c)(9) regarding indirect lending and indirect
leasing arrangements. The new paragraph is intended to replace the
language defining indirect lending and indirect leasing arrangements
under current Sec. 701.23(b)(4)(iv), which would be removed under this
proposal for the reasons explained below.
The proposal would also amend Sec. 701.22 of the NCUA's
regulations. In particular, the proposal requests comment on certain
clarifying amendments to the introductory paragraph, and would codify
NCUA Legal Opinion 15-0813, Loan Participations in Indirect Loans--
Originating Lender.\2\ Through the codification of Legal Opinion 15-
0813, this proposed rule would clarify that a FICU engaged in an
indirect lending relationship can meet the definition of ``eligible
organization'' under Sec. 701.22 of the NCUA's regulations, provided
the FICU meets certain conditions. Specifically, under this proposal,
for purposes of Sec. 701.22, a FICU would be considered the
originating lender and meet the definition of an ``eligible
organization'' if the FICU makes the final underwriting decision
regarding the loan, and the loan is assigned to the purchaser very soon
after the inception of the obligation to extend credit.
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\2\ NCUA Legal Op. 15-0813 (Aug. 10, 2015) available at <a href="https://www.ncua.gov/regulation-supervision/legal-opinions/2015/loan-participations-indirect-loans-originating-lenders">https://www.ncua.gov/regulation-supervision/legal-opinions/2015/loan-participations-indirect-loans-originating-lenders</a>.
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The Board notes that it intends the codification of the
aforementioned legal opinion to clarify that a FICU can meet the
definition of ``originating lender'' in certain transactions where the
FICU is engaging in indirect lending arrangements with fintech
companies and other third-party loan acquisition channels, such as
Credit Union Service Organizations (CUSOs) and other loan-originating
retailers.
In addition, this proposed rule would amend Sec. 701.23 of the
NCUA's current regulations as follows:
<bullet> Proposing certain clarifying and conforming amendments to
the introductory paragraph to Sec. 701.23.
<bullet> Removing the CAMELS ratings and well-capitalized
requirements under Sec. 701.23(b)(2) for FCU purchases of certain non-
member loans from FICUs.
<bullet> Narrowing the application of the 5-percent limit on the
purchase of eligible obligations to notes of a liquidating credit
union.
<bullet> Adding safety and soundness requirements to section Sec.
701.23(b)(6)(i)-(vi) concerning the purchase of eligible obligations,
to offset risks associated with removing the CAMELS and well-
capitalized requirements from Sec. 701.23(b)(2), and narrowing the
application of the 5-percent limit to notes of liquidating credit
unions. Safety and soundness and compliance requirements would apply to
all FCUs engaged in the purchase of eligible obligations and notes from
a liquidating credit union. In particular, the proposed rule would
require an FCU purchasing eligible obligations or notes from a
liquidating credit union to:
[cir] establish written, board-approved policies, risk assessments,
and risk management process requirements that are commensurate with the
size, scope, type, complexity, and level of risk posed by the planned
purchase activities. These policies would include underwriting
standards for the loans, ongoing performance and risk monitoring,
including compliance risk, tailored to the types of loans purchased and
the sellers as applicable, and
[[Page 80481]]
portfolio concentration limits by loan types and risk categories in
relation to net worth;
[cir] conduct due diligence on a seller prior to the purchase; and
[cir] require the written loan purchase agreements to contain
certain contract language and provisions (similar to the standards
currently established for loan participation agreements under Sec.
701.22 of the NCUA's regulations);
[cir] provide for a legal review and assessment of applicable loan
purchase agreements or contracts to protect the FCU's legal and
business interests from undue risk.
<bullet> Revising the definition of an eligible obligation under
Sec. 701.23(a)(1) to clarify the distinction between transactions
treated as loan participations and those treated as eligible
obligations.
<bullet> Revising the applicability of the 5-percent limit,
discussed in more detail later in this document, from covering the
purchase of most eligible obligations to only ``notes'' purchased by an
FCU from a liquidating credit union.
<bullet> Revising the ``grandfathered purchases'' section of the
current rule to include eligible obligation purchases that were
executed before the effective date of this proposed rule (if adopted)
and complied with Sec. 701.23 at the time the transaction was
executed, subject to safety and soundness and compliance
considerations.
<bullet> Adding safety and soundness requirements to Sec.
701.23(c) concerning the sale of eligible obligations, requiring the
selling FCU to do the following:
[cir] obtain a legal review and assessment of all applicable loan
sale agreements or contracts to protect the FCU's legal and business
interests; and
[cir] identify the specific loan(s) being sold either directly in
the written loan sale agreement or through a document that is
incorporated by reference into the loan sale agreement.
The Board is also proposing to amend Sec. 714.9 of the NCUA's
regulations to make certain conforming amendments related to proposed
changes to Sec. 701.23(b)(4).
Finally, the proposal would make certain other conforming changes
and technical amendments in other sections of the NCUA's regulations.
The Board does not view these additional conforming technical changes
as substantive.
II. Legal Authority
Section 120(a) \3\ of the Federal Credit Union Act (FCU Act or Act)
authorizes the Board to prescribe rules and regulations for the
administration of the Act.\4\ Similarly, section 209 \5\ of the FCU Act
authorizes the Board to prescribe such rules and regulations as it may
deem necessary or appropriate to carry out the share insurance
provisions of subchapter II of the Act. In addition, section 206 of the
FCU Act provides the Board with broad authority to take enforcement
action against a FICU or an ``institution-affiliated party'' \6\ that
is engaging or has engaged, or the Board has reasonable cause to
believe that is about to engage, in an unsafe or unsound practice in
conducting the business of such credit union.\7\ Congress chose not to
define ``unsafe or unsound practices'' in the FCU Act, leaving
determinations regarding which actions are unsafe or unsound to the
Board.
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\3\ 12 U.S.C. 1766(a) (The Board may prescribe rules and
regulations for the administration of 12 U.S.C. chapter 14
(including, but not by way of limitation, the merger, consolidation,
and dissolution of corporations organized under the chapter). Any
central credit union chartered by the Board shall be subject to such
rules, regulations, and orders as the Board deems appropriate and,
except as otherwise specifically provided in such rules,
regulations, or orders, shall be vested with or subject to the same
rights, privileges, duties, restrictions, penalties, liabilities,
conditions, and limitations that would apply to all Federal credit
unions under the chapter.).
\4\ Sections 1751-1795k.
\5\ Section 1789(11) (providing in relevant part as follows:
``In carrying out the purposes of this subchapter, the Board may--[.
. .] prescribe such rules and regulations as it may deem necessary
or appropriate to carry out the provisions of [12 U.S.C. 1781-
1790e].'').
\6\ See section 1786(r) (providing that for purposes of the FCU
Act, the term ``institution-affiliated party'' means--(1) any
committee member, director, officer, or employee of, or agent for,
an insured credit union; (2) any consultant, joint venture partner,
and any other person as determined by the Board (by regulation or on
a case-by-case basis) who participates in the conduct of the affairs
of an insured credit union; and (3) any independent contractor
(including any attorney, appraiser, or accountant) who knowingly or
recklessly participates in--(A) any violation of any law or
regulation; (B) any breach of fiduciary duty; or (C) any unsafe or
unsound practice, which caused or is likely to cause more than a
minimal financial loss to, or a significant adverse effect on, the
insured credit union.).
\7\ Section 1786.
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Section 107(5)(E) of the FCU Act authorizes FCUs to engage in
participation lending with other credit unions, credit union
organizations, or financial organizations in accordance with written
policies of the board of directors.\8\ Section 107(5)(E) also provides
that a credit union that originates a loan for which participation
arrangements are made in accordance with this subsection shall retain
an interest of at least 10 per centum of the face amount of the
loan.\9\
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\8\ Section 1757(5)(e).
\9\ Id.
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Section 107(13) of the FCU Act authorizes FCUs, in accordance with
rules and regulations prescribed by the Board, to purchase, sell,
pledge, or discount or otherwise receive or dispose of, in whole or in
part, any eligible obligation (as defined by the Board) of its
members.\10\ In addition, section 107(13) authorizes FCUs, in
accordance with rules and regulations prescribed by the Board, to
purchase from any liquidating credit union notes made by individual
members of the liquidating credit union at such prices as may be agreed
upon by the board of directors of the liquidating credit union and the
board of directors of the purchasing credit union, but no purchase may
be made under authority of this paragraph if, upon the making of that
purchase, the aggregate of the unpaid balances of notes purchased under
authority of this paragraph would exceed 5 per centum of the unimpaired
capital and surplus of the credit union.\11\
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\10\ Section 1757(13).
\11\ Id.
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Section 107(14) of the FCU Act authorizes FCUs, subject to
regulations of the Board, to sell all or a part of its assets to
another credit union, to purchase all or part of the assets of another
credit union, and to assume the liabilities of the selling credit union
and those of its members.\12\
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\12\ Section 1757(14).
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III. Section-By-Section Analysis
A. Part 701 Organization and Operation of Federal Credit Unions
As discussed in more detail below, this proposal would make several
changes to sections in part 701 of the NCUA's regulations. The Board
requests comment on all aspects of the proposal and on specific
questions and issues mentioned below. These changes are intended to
clarify numerous provisions regarding loans to members and lines of
credit to members under Sec. 701.21; loan participations under Sec.
701.22; and the purchase, sale, and pledge of eligible obligations
under Sec. 701.23. In addition, the proposal would amend the NCUA's
current regulatory requirements under Sec. Sec. 701.22 and 701.23. The
amended requirements would provide FICUs authority and autonomy to
innovate and transact business with fintech companies and other
institutions that provide services associated with the origination and
sale of loans made to members of FICUs.
Section 701.21 Loans to Members and Lines of Credit to Members
As discussed in more detail below, this proposal would, as a
conforming amendment, add new provisions to Sec. 701.21 regarding
indirect lending
[[Page 80482]]
arrangements and indirect leasing arrangements. The new provisions are
intended to take the place of a provision in current Sec. 701.23,
which would be removed under the proposal. No other changes to Sec.
701.21 are proposed.
Section 701.21(c) General Rules
New Sec. 701.21(c)(9) Indirect Lending and Indirect Leasing Agreements
For reasons discussed in the preamble discussion on current Sec.
701.23(b)(4), the NCUA is proposing to delete paragraph (b)(4)(iv)
regarding indirect lending from Sec. 701.23. Current Sec.
701.23(b)(4)(iv) excludes certain loans acquired through indirect
lending arrangements and indirect leasing arrangements from the 5-
percent limit on the aggregate of the unpaid balance of certain loans
purchased under Sec. 701.23. While the language excluding loans and
leases acquired through indirect lending and indirect leasing
arrangements would no longer be needed in Sec. 701.23(b)(4), the
definition of such arrangements is still relevant for purposes of other
provisions in the NCUA's regulations. Under current paragraph (b)(4),
and NCUA's long-standing interpretation,\13\ loans acquired by an FCU
pursuant to an indirect lending arrangement are considered loans made
by the FCU under Sec. 701.21, rather than loans purchased under Sec.
701.23. Accordingly, the Board is proposing to add to Sec. 701.21 new
paragraph (c)(9) regarding indirect lending and indirect leasing
arrangements. The new paragraph is intended to replace the language
defining indirect lending and indirect leasing arrangements under
current Sec. 701.23(b)(4)(iv).
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\13\ See, e.g., NCUA Legal Op. 97-0546 (Aug. 6, 1997), available
at <a href="https://www.ncua.gov/regulation-supervision/legal-opinions/1997/indirect-lending">https://www.ncua.gov/regulation-supervision/legal-opinions/1997/indirect-lending</a>.
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New Sec. 701.21(c)(9)(i) Definitions
Proposed new Sec. 701.21(c)(9)(i) would define the terms
``indirect leasing arrangement'' and ``indirect lending arrangement''
for purposes of the NCUA's regulations. Current Sec. 701.23(b)(4)(iv)
provides that an indirect lending or indirect leasing arrangement that
is classified as a loan and not the purchase of an eligible obligation
because the FCU makes the final underwriting decision, and the sales or
lease contract is assigned to the FCU very soon after it is signed by
the member and the dealer or leasing company, is excluded in
calculating the 5-percent limit. The NCUA believes splitting the
provision in paragraph (b)(4)(iv) into two definitions will help
clarify the existing requirements. Accordingly, proposed new Sec.
701.21(c)(9)(i) would provide that the term indirect leasing
arrangement means a written agreement to purchase leases from the
leasing company where the purchaser makes the final underwriting
decision, and the lease agreement is assigned to the purchaser very
soon after it is signed by the member and the leasing company. Proposed
new paragraph (c)(9)(i) would provide further that the term indirect
lending arrangement means a written agreement to purchase loans from
the loan originator where the purchaser makes the final underwriting
decision regarding making the loan, and the loan is assigned to the
purchaser very soon after the inception of the obligation to extend
credit.
Both proposed new definitions would use language that is generally
similar, but not identical, to the language in current Sec.
701.23(b)(4)(iv). The NCUA is proposing to revise the language used in
current paragraph (b)(4)(iv) to clarify the different requirements that
apply to indirect leasing arrangements and indirect lending
arrangements. The proposed changes are intended to clarify but not
change the current meaning of both terms.
The Board specifically requests comment on whether proposed
paragraph (c)(9) would have a material impact on credit unions'
existing and future indirect lending arrangements, indirect leasing
arrangements, or both.
New Sec. 701.21(c)(9)(ii) Indirect Lending
Proposed new Sec. 701.21(c)(9)(ii), consistent with current Sec.
701.23(b)(4)(iv), would clarify the difference between loans made
pursuant to indirect lending arrangements under Sec. 701.21 and loans
purchased under Sec. 701.23. Current Sec. 701.23(b)(4)(iv) excludes
loans acquired pursuant to certain indirect lending arrangements from
the 5-percent limit under current paragraph (b)(4). Paragraph
(b)(4)(iv) provides that an indirect lending or indirect leasing
arrangement that is classified as a loan and not the purchase of an
eligible obligation because the FCU makes the final underwriting
decision, and the sales or lease contract is assigned to the FCU very
soon after it is signed by the member and the dealer or leasing
company, is excluded from calculating the 5-percent limit.\14\ As
previously mentioned, current Sec. 701.23(b)(4)(iv) would be removed
under this proposal. Accordingly, proposed new Sec. 701.21(c)(9)(ii)
would provide that a loan acquired pursuant to an indirect lending
arrangement, and that meets the requirements of Sec. 701.21, is
classified as a loan and not the purchase of a loan for purposes of the
NCUA's regulations, which are codified in chapter VII of title 12 of
the Code of Federal Regulations.
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\14\ (emphasis added); see also, e.g., NCUA Legal Op. 97-0546
(Aug. 6, 1997) (providing in relevant part: ``FCUs may participate
in indirect lending arrangements under the authority to make loans
to members, 12 U.S.C. 107(5); 12 CFR 701.21, rather than the
authority to purchase eligible obligations, 12 U.S.C. 107(13); 12
CFR 701.23, as long as two conditions are met. First, the FCU must
make the final underwriting decision. That is, before the retailer
and the member complete the loan or sales contract, the FCU must
review the application and determine that the transaction conforms
to its lending policies. This is because an FCU may not delegate its
lending authority to a third party. Second, the retailer must assign
the loan or sales contract to the FCU very soon after it is
completed. Assignment close in time to the making of the loan allows
the retailer to function as the facilitator of the loan while the
FCU remains the true lender. As the time between completion and
assignment of the loan lengthens, the FCU's payment to the retailer
becomes the purchase of the loan rather than part of the processing
of the loan.'').
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New Sec. 701.21(c)(9)(iii) Indirect Leasing
Proposed new Sec. 701.21(c)(9)(iii), consistent with current
Sec. Sec. 701.23(b)(4)(iv) and 714.9, would clarify the difference
between leases made pursuant to indirect leasing arrangements under
Sec. 714.2(b) \15\ and leases purchased under Sec. 701.23. Current
Sec. 701.23(b)(4)(iv) excludes leases acquired pursuant to certain
indirect leasing arrangements from the 5-percent limit under current
paragraph (b)(4). Paragraph (b)(4)(iv) provides that an indirect
lending or indirect leasing arrangement that is classified as a loan
and not the purchase of an eligible obligation because the FCU makes
the final underwriting decision, and the sales or lease contract is
assigned to the FCU very soon after it is signed by the member and the
dealer or leasing company, is excluded in calculating the 5-percent
limitation.\16\ Similarly,
[[Page 80483]]
current Sec. 714.9 provides that an FCU's indirect leasing
arrangements are not subject to the eligible obligation limit if they
satisfy the provisions of Sec. 701.23(b)(3)(iv) that require that an
FCU make the final underwriting decision and that the lease contract is
assigned to the FCU very soon after it is signed by the member and the
dealer or leasing company. Accordingly, proposed new Sec.
701.21(c)(9)(iii) would provide that a lease acquired pursuant to an
indirect leasing arrangement, and that meets the requirements of part
714 of the NCUA's regulations, is classified as a lease and not the
purchase of a lease for purposes of the NCUA's regulations, which are
codified in chapter VII of title 12 of the Code of Federal Regulations.
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\15\ (Providing: ``[An FCU] may engage in indirect leasing. In
indirect leasing, a third party leases property to [the FCU's]
member and [the FCU] then purchases that lease from the third party
for the purpose of leasing the property to [the FCU's] member. [The
FCU does] not have to purchase the leased property if [it complies]
with the requirements of Sec. 714.3.'').
\16\ Id. (emphasis added); see also 12 CFR 714.2(b) & 714.9; and
NCUA Legal Op. 00-0811 (Nov. 2000) (providing in part: ``NCUA's
leasing regulation recognizes that FCUs may engage in the leasing of
personal property and does not distinguish between consumer and
business leasing. 12 CFR part 714. The authority of FCUs to engage
in secured lending is the basis for their authority to engage in
leasing. Therefore, FCU leasing generally must comply with the
statutory and regulatory requirements applicable to secured lending,
including the member business loan rule. 12 CFR part 723. Our
leasing regulation, however, notes exceptions from certain
provisions of the lending rules that are not pertinent to leasing;
for example, the interest rate ceilings. 12 CFR 714.10,
701.21(c)(7). In a lease, the lessee's payments are periodic rental
payments, not the repayment of principal and interest as in a
loan.'').
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Section 701.22 Loan Participations
As discussed in more detail below, the proposal would make several
clarifying amendments to Sec. 701.22. These changes are primarily
intended to clarify FCUs' authority to purchase loan participations and
the requirements applicable to the purchase of loan participations by
federally insured, state-chartered credit unions (FISCUs).
701.22 Introductory Paragraph
The introductory paragraph to current Sec. 701.22 sets forth the
scope and limitations of the section. The NCUA Board added the
introductory paragraph to Sec. 701.22 as part of a final rule it
approved in 2013 (2013 Final Rule).\17\ The introductory paragraph was
intended to clarify several issues related to the scope and
applicability of Sec. 701.22. In particular, the 2013 Final Rule
explained as follows in the remainder of this paragraph. The
introductory text clarified the scope of the rule and helps distinguish
a loan participation under Sec. 701.22 from an eligible obligation
under Sec. 701.23. Further, it clarified that the rule applies to a
natural person FICU's purchase of a loan participation where the
borrower is not a member of that credit union. Generally, an FCU's
purchase, in whole or in part, of its member's loan is covered by
NCUA's eligible obligations rule at Sec. 701.23. Additionally, by a
cross-reference to Part 741 of NCUA's regulations, the rule also was
made applicable to natural person FISCUs. The Board noted that
corporate credit unions are subject to the loan participation
requirements set forth in Part 704 and, therefore, are not subject to
Sec. 701.22 of NCUA's regulations. \18\
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\17\ 78 FR 37946 (June 25, 2013) (footnote omitted).
\18\ Id. at 37948.
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The introductory paragraph has seven separate substantive
provisions. First, the paragraph provides that this section applies
only to loan participations as defined in the section. Second, it
provides that the section does not apply to the purchase of an
investment interest in a pool of loans. Third, it provides that the
section establishes the requirements a FICU must satisfy to purchase a
loan participation. Fourth, it provides that the section applies to a
FICU's purchase of a loan participation only where the borrower is not
a member of the purchasing FICU and where a continuing contractual
obligation between the seller and purchaser is contemplated. Fifth, it
provides that Sec. 701.23 generally applies to an FCU's purchase of
all or part of a loan made to one of its members. Sixth, it provides
that Sec. 741.225 requires FISCUs to comply with the requirements of
Sec. Sec. 701.22 through 741.225 provides that FISCUs are exempt from
the borrower membership requirement in current Sec. 701.22(b)(4).
Seventh, the paragraph provides that the section does not apply to
corporate credit unions as defined in part 704.
In the 2013 Final Rule, the Board added a similar introductory
paragraph to Sec. 701.23 regarding the purchase, sale, and pledge of
eligible obligations to clarify the scope of that section and
distinguish loan participations from eligible obligations. The
provisions included in that introductory paragraph are discussed in
detail later in the part of the preamble on the introductory paragraph
to Sec. 701.23.
Since adopting the prefatory language in both sections, the NCUA
has received inquiries from NCUA examiners, FICUs, fintech companies,
and other parties who have expressed confusion about how to interpret
many of these provisions. This confusion has led to inconsistent
reporting of loan interests by FICUs and uncertainty about which of the
two sections, Sec. 701.22 or Sec. 701.23, to apply to certain
transactions, particularly innovative programs that have been designed
by FICUs after 2013. In addition, the Board is concerned that continued
confusion about lines of authority in this area could discourage FICUs
from entering into certain safe, sound and compliant loan
participation, purchase, or sale agreements that are within their
statutory authority.
One significant issue with the current introductory paragraph to
Sec. 701.22 that parties have raised is when a FICU's partial loan
purchase is subject to that section. In particular, parties have cited
the continuing contractual obligation qualifier as a source of
confusion. The third sentence in the introductory paragraph to current
Sec. 701.22 provides that the section applies only to a FICU's
purchase of a loan participation where the borrower is not a member of
that credit union and where a continuing contractual obligation between
the seller and purchaser is contemplated.\19\ The fourth sentence in
the paragraph provides further that, generally, an FCU's purchase of
all or part of a loan made to one of its own members, subject to a
limited exception for certain well-capitalized FCUs in Sec.
701.23(b)(2), where no continuing contractual obligation between the
seller and purchaser is contemplated, is governed by Sec. 701.23 of
this part.\20\ Similarly, the introductory paragraph to Sec. 701.23
provides that Sec. 701.23 governs an FCU's purchase, sale, or pledge
of all or part of a loan to one of its own members, subject to a
limited exception for certain well-capitalized FCUs, where no
continuing contractual obligation between the seller and purchaser is
contemplated.\21\
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\19\ Emphasis added.
\20\ Emphasis added.
\21\ Emphasis added.
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In practice, however, purchase agreements, regardless of whether
the transactions involve the purchase of an eligible obligation or a
loan participation, frequently contain some form of continuing
contractual obligation between the buyer and the seller, including
representations and warranties regarding the loans and loan repurchase
agreements, servicing agreements, and other similar types of ongoing
obligations set forth under the agreements. The Board believes the
continuing contractual obligation clauses in the third and fourth
sentences in the introductory paragraphs to current Sec. 701.22 are
unnecessary when determining whether a loan purchase agreement
qualifies as either a loan participation or an eligible obligation.
In addition to the concerns explained above, the clause where the
borrower is not a member of that credit union in the first part of the
third sentence of the introductory paragraph conflicts with another
provision in Sec. 701.22. This language could be misinterpreted to
suggest that Sec. 701.22 does not apply to a partial loan purchase
where the borrower is a member of the purchasing credit union, even
when the transaction otherwise meets the definition of a loan
participation under Sec. 701.22. This clause directly conflicts with
the more specific requirement in Sec. 701.22(b)(4),
[[Page 80484]]
which provides that the borrower must become a member of one of the
participating credit unions before the purchasing FICU purchases a
participation interest in the loan. The NCUA has long interpreted the
more specific language in paragraph (b)(4) as controlling and has
applied the requirements of Sec. 701.22 to partial loan purchases
where the purchase meets the definition of a loan participation and the
borrower is a member of the purchasing FICU.
Accordingly, the NCUA believes the removal of this clause will
serve to clarify and reduce confusion when Sec. 701.22 applies to
certain transactions. As part of this proposal, the Board requests
comment on whether deleting the fourth and fifth sentences in the
introductory paragraph to current Sec. 701.22 would clarify when the
section applies to certain transactions. After considering any public
comments received on this issue, the Board may adopt these amendments
in a final rule based on this proposal.
The NCUA recognizes that whether the purchase of a partial loan is
a loan participation under Sec. 701.22 or a loan purchase under Sec.
701.23 may still be uncertain in some instances even if these sentences
are removed. The NCUA believes, however, that other provisions in Sec.
701.22, such as the definition of loan participation and the conditions
outlined in paragraph (b), make clear which transactions are subject to
the requirements of Sec. 701.22.
As discussed in more detail in the part of the preamble below
regarding Sec. 701.23, the Board is also considering deleting the
continuing contractual obligations sentence in current Sec. 701.23,
subject to comments received on this proposal. The Board intends this
change to work in conjunction with the proposed changes to the
introductory paragraph to current Sec. 701.22.
The Board is proposing no other changes to the introductory
paragraph to current Sec. 701.22. Another provision in the
introductory paragraph that is often misread, however, is the sentence
providing that Sec. 701.22 does not apply to the purchase of an
investment interest in a pool of loans. That sentence is intended to
clarify that the purchase of such investment interests, to the extent
they are permitted, are governed by part 703 of the NCUA's regulations
for FCUs (and under part 741 of the NCUA's regulations and as
authorized under state law for FISCUs) and not Sec. 701.22. This
continues to be the case under this proposal. The NCUA notes further
that this qualification to the section makes clear that Sec. 701.22
neither applies to nor authorizes FICU investments in either asset-
backed securities or the purchase of other similar investment interests
in pools of loans.\22\ The requirements of Sec. 701.22 apply to each
individual loan a FICU purchases a loan participation interest in.\23\
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\22\ Emphasis added.
\23\ See, e.g., NCUA Legal Op. 18-0133 (March 2018), available
at <a href="https://www.ncua.gov/regulation-supervision/legal-opinions/2018/loan-participations">https://www.ncua.gov/regulation-supervision/legal-opinions/2018/loan-participations</a>.
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If all the changes proposed above are adopted in a final rule, the
introductory text of Sec. 701.22 would provide the section applies
only to loan participations as defined in paragraph (a). It does not
apply to the purchase of an investment interest in a pool of loans. The
section establishes the requirements a federally insured credit union
must satisfy to purchase a participation in a loan. Federally insured
state-chartered credit unions are required by Sec. 741.225 to comply
with the loan participation requirements of the section. The section
does not apply to corporate credit unions, as that term is defined in
Sec. 704.2.
Section 701.22(a)
The proposed rule would add a second sentence to the current
definition of ``originating lender'' in Sec. 701.22(a) to codify and
further clarify a 2015 NCUA legal opinion (2015 Opinion) regarding loan
participations in indirect loans.\24\ The NCUA's 2013 Final Rule
amended the loan participation regulation to, among other things,
clarify that the originating lender must participate in the loan
throughout the life of the loan.\25\ In the 2013 Final Rule, the NCUA
explained that this requirement derives from sections 107(5) and (5)(E)
of the FCU Act.\26\ Section 107(5) provides in relevant part that an
FCU shall have power to participate with other credit unions, credit
union organizations, or financial organizations in making loans to
credit union members.\27\ Section 107(5)(E) requires further that
participation loans with other credit unions, credit union
organizations, or financial organizations shall be in accordance with
written policies of the credit union's board of directors, provided
that a credit union which originates a loan for which participation
arrangements are made in accordance with this subsection shall retain
an interest of at least 10 per centum of the face amount of the
loan.\28\ While the statutory requirements of section 107(5)(E)
primarily pertain to FCUs involved in loan participations, the Board
chose, for safety and soundness reasons, to extend most of the
requirements in Sec. 701.22 to cover all FICUs as part of the 2013
Final Rule.\29\
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\24\ NCUA Legal Op. 15-0813 (Aug. 10, 2015) available at <a href="https://www.ncua.gov/regulation-supervision/legal-opinions/2015/loan-participations-indirect-loans-originating-lenders">https://www.ncua.gov/regulation-supervision/legal-opinions/2015/loan-participations-indirect-loans-originating-lenders</a>.
\25\ 78 FR 37946, 37949 (June 25, 2013) (providing verbatim: The
proposed rule revised the definitions of ``originating lender'' and
``loan participation'' to clarify that the originating lender must
participate in the loan throughout the life of the loan.''); see
also Sec. 701.22(a) (providing in relevant part that: Loan
participation means a loan where one or more eligible organizations
participate pursuant to a written agreement with the originating
lender, and the written agreement requires the originating lender's
continuing participation throughout the life of the loan. (emphasis
added)).
\26\ See 76 FR 79548, 79549 (Dec. 22, 2011); and 78 FR 37946,
37949 (June 25, 2013) (providing that: The requirement that credit
unions only participate with the originating lender derives from the
FCU Act's requirement for originating FCUs to retain at least a 10
percent interest in the face amount of all loans they participate
out. Moreover, the Board interprets the authority in the FCU Act for
credit unions to participate in loans ``with'' other lenders to
contemplate a shared, continuing lending arrangement. Simply put,
the rule requires an originating lender to remain part of the
participation arrangement and to retain a continuing interest in the
loan in order to be a true participant. Otherwise, the transaction
is not a loan participation but more akin to the sale of an eligible
obligation.).
\27\ 12 U.S.C. 1757(5) (emphasis added).
\28\ Section 1757(5)(E) (emphasis added).
\29\ See 76 FR 79548, 79548 (Dec. 22, 2011) (Explaining in part
that: [L]oan participations [. . .] create more systemic risk to the
share insurance fund (NCUSIF) due to the resulting interconnection
between participants. For example, large volumes of participated
loans in the system tied to a single originator, borrower, or
industry or serviced by a single entity have the potential to impact
multiple credit unions if a problem arises. Additionally, as both
federal credit unions (FCUs) and federally insured state-chartered
credit unions (FISCUs) actively engage in loan participations, it is
important to the safety and soundness of the NCUSIF that all
federally insured credit unions (FICUs) adhere to the same minimum
standards for engaging in loan participations. The Board believes
such standards are necessary to ensure the NCUSIF consistently
recognizes and accounts for the risks associated with the purchase
of loan participations. Finally, during examinations and other FICU
contacts, the agency has encountered confusion concerning the
application of the current loan participation rule regarding the
entities and transactions subject to the rule.); and 78 FR 37946,
37947 & 37955 (June 25, 2013); and Sec. 741.225.
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In the 2013 Final Rule, the Board noted two specific safety and
soundness concerns as reasons for adopting the current definition of
``originating lender,'' explaining in relevant part as follows:
The 2013 Final Rule requires an originating lender to remain part
of the participation arrangement and to retain a continuing interest in
the loan in order to be a true participant. Otherwise, the transaction
is not a loan participation but more akin to the sale of an eligible
obligation. As the Board noted in 1991, permitting the sale of
participation interests in eligible obligations will blur the
distinction between loan participations and loan purchases and
[[Page 80485]]
sales, arguably circumventing the purpose of the loan participation and
eligible obligations rules. Additionally, the Board believes the
continued participation of the lender that initially originated the
loan is integral to a safe and sound participation arrangement. In
1991, the Board expressed its concern that a lender may have a
decreased interest in properly underwriting a loan if they know they
can later reduce their risk by selling participation interests in it.
The requirement for the originating lender's continued participation in
a loan participation arrangement is intended to address this safety and
soundness concern.\30\
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\30\ 78 FR 37946, 37948 & 37949 (emphasis added) (providing also
that: In granting [loan participation authority to FCUs], Congress
expressed its intent to enhance the ability of FCUs to serve their
members' loan demands. Congress also expressed, however, that
originating FCUs must maintain discipline in the origination
process. [. . . T]he loan participation authority must not be so
broad that loan participations may be originated from any source. [.
. .]); 56 FR 15034, 15034-15035 (April 15, 1991) (providing that:
NCUA has interpreted the term ``participation loan'' to mean
arrangements made prior to disbursements of the loan proceeds. In
the preamble to the proposed rule, the Board stated that this
interpretation may be too restrictive and proposed deleting it. [. .
.] One commenter noted that this change will blur the distinction
between loan participations and loan purchases and sales. [. . .]
There are two basic safety and soundness concerns with the proposed
change. FCUs may have a decreased interest in properly underwriting
a loan if they know they can later reduce their risk by selling
participation interests in it. Alternatively, FCUs interested in
obtaining a participation after the loan is made may not properly
investigate the loan and may instead rely on the original
participants to have properly underwritten the loan. FCUs may jump
in without a proper due diligence review. [. . .] Accordingly, the
NCUA Board declines to adopt the proposed change and will continue
to require a written commitment to participate in a loan precede
final disbursement.); see also 68 FR 39866, 39867 (July 3, 2003); 68
FR 75110 (Dec. 30, 2003); and H.R. Rep. No. 95-23, at 12 (1977),
reprinted in 1977 U.S.C.C.A.N. 115.
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As explained in more detail below, these concerns are fully
accounted for under the 2015 Opinion and this proposal by limiting the
interpretation to indirect loans and requiring that such loans meet the
same general requirements applicable to indirect loans made by FCUs
under current Sec. 701.23(b)(4)(iv).
The 2013 Final Rule responded to concerns raised by commenters
regarding the proposed definition of ``originating lender'' and its
application in situations where a CUSO underwrites and processes a
loan, but the FICU funds the loan. In response to this feedback the
Board provided the following explanation.
These commenters observed that a CUSO often serves as an originator
in name only and, thus, is not the most appropriate party to regard as
the originating lender for the purposes of the rule. For example, loans
may be underwritten and processed by a CUSO, but funded by its owner
credit union. The Board acknowledged that this CUSO model is not
uncommon within the industry and permissible under Sec. 712.5. For
purposes of this final rule, it was the Board's intent that the
originating lender is the entity with which the borrower initially or
originally contracts for the loan.\31\
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\31\ 78 FR 37949-37950 (emphasis added).
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As noted above, the Board's responses to commenters in the 2013
Final Rule regarding the definition of originating lender were limited
to situations in which a FICU purchased a loan from a CUSO that had
underwritten the loan. The Board did not discuss the application of the
definition of originating lender to CUSOs or other entities in the
context of indirect lending arrangements in which a purchasing FICU
underwrites the loan and makes the final underwriting decision.
Accordingly, the application of the definition of originating lender to
CUSOs or other entities in the context of indirect lending arrangements
was left unaddressed in the 2013 Final Rule and open to later
interpretation by the NCUA, which is what it did two years later in the
2015 Opinion discussed in more detail in the following paragraphs.
The NCUA has long used the act of underwriting a loan as a feature
to distinguish between transactions where a FICU makes a loan and
transactions where a FICU purchases a loan.\32\ In particular, in a
1997 legal opinion the NCUA explained:
---------------------------------------------------------------------------
\32\ See, e.g., NCUA Legal Op. 92-1203 (Jan. 5, 1993); NCUA
Legal Op. 92-1203 (May 11, 1993); NCUA Legal Op. 97-0546 (Aug. 6,
1997), available at <a href="https://ncua.gov/regulation-supervision/legal-opinions">https://ncua.gov/regulation-supervision/legal-opinions</a>; and Sec. 701.23(b)(4)(iv).
FCUs may participate in indirect lending arrangements under the
authority to make loans to members, 12 U.S.C. 107(5); 12 CFR 701.21,
rather than the authority to purchase eligible obligations, 12
U.S.C. 107(13); 12 CFR 701.23, as long as two conditions are met.
First, the FCU must make the final underwriting decision. That is,
before the retailer and the member complete the loan or sales
contract, the FCU must review the application and determine that the
transaction conforms to its lending policies. This is because an FCU
may not delegate its lending authority to a third party. Second, the
retailer must assign the loan or sales contract to the FCU very soon
after it is completed. Assignment close in time to the making of the
loan allows the retailer to function as the facilitator of the loan
while the FCU remains the true lender. As the time between
completion and assignment of the loan lengthens, the FCU's payment
to the retailer becomes the purchase of the loan rather than part of
the processing of the loan.\33\
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\33\ NCUA Legal Op. 97-0546 (emphasis added).
By requiring the purchasing credit union to make the final
underwriting decision in an indirect lending transaction, the NCUA
ensured that the purchasing credit union was not relying on the due
diligence of the loan seller who might otherwise have had a decreased
interest in properly underwriting the loan knowing it would later be
sold. Moreover, under the NCUA's loan participation regulation, the
originating lender is required to retain at least a 5-percent interest
in any participation interest for the life of the loan.\34\
Accordingly, where an eligible organization makes a loan through an
indirect lending arrangement there is no greater risk of incentives for
lax or improper underwriting for purposes of Sec. 701.22 than if the
eligible organization had processed and funded the loan itself.
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\34\ Sec. 701.22(d)(4)(ii) (``The interest that the originating
lender will retain in the loan to be participated. If the
originating lender is a federal credit union, the retained interest
must be at least 10 percent of the outstanding balance of the loan
through the life of the loan. If the originating lender is any other
type of eligible organization, the retained interest must be at
least 5 percent of the outstanding balance of the loan through the
life of the loan, unless a higher percentage is required under state
law.'').
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Furthermore, as discussed in the 1997 legal opinion quoted above,
the NCUA has long distinguished between indirect loans, made under
section 107(5) of the FCU Act and 12 CFR 701.21, and eligible
obligations purchased under section 107(13) of the FCU Act and 12 CFR
701.23.\35\ For over 25 years the NCUA has treated indirect loans--as
defined under current Sec. 701.23(b)(4)(iv)--made by a credit union to
be separate and distinct from eligible obligations. Accordingly, while
permitting the sale of participation interests in eligible obligations
might blur the distinction between loan participations and loan
purchases and sales and circumvent the purpose of the loan
participation and eligible obligations rules, allowing the sale of
participation interests in indirect loans presents no such risk.
---------------------------------------------------------------------------
\35\ NCUA Legal Op. 97-0546.
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Working within the regulatory and interpretative history discussed
above, the NCUA determined in the 2015 Opinion that an ``eligible
organization'' \36\ may be considered the ``originating lender'' for
purposes of Sec. 701.22 where the eligible organization generated the
loan through an ``indirect
[[Page 80486]]
lending arrangement'' \37\ with a retailer such as an auto dealer.\38\
Current Sec. 701.22(a) defines the term ``originating lender'' as
``the participant with which the borrower initially or originally
contracts for a loan and who, thereafter or concurrently with the
funding of the loan, sells participations to other lenders.'' \39\ The
2015 Opinion explained that, in indirect lending arrangements with a
retailer such as an auto dealer, the retailer is acting as an agent of
the eligible organization, and is simply performing as an
administrative functionary processing a loan for the eligible
organization, and the retailer's activities are part and parcel of, and
an extension of, the eligible organization's lending operations. In
this context, the 2015 Opinion concluded, the retailer is not acting as
a separate lender generating loans for itself and then selling those
loans to an eligible organization. Rather, the retailer is a
facilitator that is part of the eligible organization's loan processing
mechanism, and the eligible organization is the de facto originating
lender and, therefore, the originating lender for purposes of the
NCUA's loan participation rule.
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\36\ Id. (providing in relevant part as follows: ``Eligible
organization means a credit union, credit union organization, or
financial organization.'').
\37\ See Sec. 701.23(b)(4)(iv) (``An indirect lending or
indirect leasing arrangement that is classified as a loan and not
the purchase of an eligible obligation because the Federal credit
union makes the final underwriting decision and the sales or lease
contract is assigned to the Federal credit union very soon after it
is signed by the member and the dealer or leasing company.'')
(emphasis added).
\38\ NCUA Legal Op. 15-0813.
\39\ Id. (providing in relevant part: ``Originating lender means
the participant with which the borrower initially or originally
contracts for a loan and who, thereafter or concurrently with the
funding of the loan, sells participations to other lenders.'').
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The 2015 Opinion explained further that a loan purchased by an
eligible organization must satisfy two conditions to be classified as
an ``indirect loan'' and not the purchase of a loan.\40\ First, the
eligible organization must make the final underwriting decision
regarding the loan. In other words, a loan must be underwritten by the
purchasing eligible organization before completion of the loan or sales
contract.\41\ An eligible organization may use an automated credit
scoring system to make its final underwriting decision as long as the
``score'' obtained from the automated system is the sole determinant
for granting credit.\42\ When an eligible organization establishes the
qualifying criteria for the automated scoring system, it is effectively
making an advance decision on a particular application.\43\ So long as
the party entering the borrower's application information does not
exercise any judgment regarding that information, the score will be
deemed to reflect the FCU's lending policies.\44\
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\40\ See Sec. 701.22(b)(4)(iv); see also NCUA Legal Op. 15-
0813; and 78 FR 37946, 37949 (explaining that ``a lender `may have a
decreased interest in properly underwriting a loan if they know they
can later reduce their risk by selling participation interests in
it.' '').
\41\ See id.
\42\ See NCUA Legal Op. 97-0546.
\43\ See id.
\44\ See id.
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Second, the sales contract must be assigned to the eligible
organization very soon after it is signed by the borrower and the
dealer.\45\ As explained in a separate NCUA legal opinion, assignment
close in time to the making of the loan allows the retailer to function
as the facilitator of the loan while the eligible organization remains
the true lender.\46\ The length of time that satisfies ``very soon
after'' depends on the nature of the loan and the practical realities
of assigning certain kinds of loans in the current marketplace and in
accordance with prevailing industry standards.\47\ While ``very soon
after'' is generally determined on a case-by-case basis by loan type
and in accordance with commercial reasonableness, the longer the time
between the formation of the contract and its assignment, the more
likely the program will be viewed as involving the purchase of an
eligible obligation rather than the making of a loan.\48\
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\45\ Emphasis added.
\46\ See NCUA Legal Op. 97-0546.
\47\ The preamble to the 1998 proposal to amend the eligible
obligations rule requested public comment on whether the NCUA should
specify a certain number of days as constituting ``very soon.'' 63
FR 41976, 41977 (Aug. 6, 1998). After considering the comments,
however, the NCUA Board determined not to specifically define it
because it wanted to provide FCUs with flexibility under various
circumstances. The NCUA Board also clarified that assignment of the
loan means acceptance of the loan and not necessarily the physical
receipt of the loan documentation, recognizing that acceptance and
payment are often done electronically. However, physical receipt of
the loan documents by the FCU should occur within a reasonable time
following acceptance of the loan. 63 FR 70997, 70998 (Dec. 23,
1998); see also NCUA Legal Op. 97-0546 (Aug. 6, 1997) (Concluding
that an indirect lending arrangement where the retailer made a loan
and assigned it to the purchasing credit union within one business
day met the ``very soon after'' timing requirement.).
\48\ 63 FR 41976, 41977 (Aug. 6, 1998).
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The Board believes that codifying the 2015 Opinion will clarify the
loan participations rule and facilitate further growth in credit
unions' purchase and sale of indirect loan participations. Industry
data shows significant growth in credit unions engaging in indirect
lending programs, which have become an important channel for credit
unions to extend services to their members and provide a viable source
of income to support their growth.
Since 2015, FICUs have experienced large growth in indirect lending
programs as reflected in Table 1. The $299 billion outstanding balance
of indirect loans as of June 30, 2022, more than doubled the 2015 year-
end loan balance.\49\
---------------------------------------------------------------------------
\49\ NCUA call report data for all federal insured credit unions
from the 4th quarter of 2015 through the 2nd quarter of 2022.
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During the past seven years, FICUs' indirect lending activities had
double-digit increases (ranging from 14 percent to 21 percent) year
over year between 2016 and 2018, and a low single-digit increase in
2019 and 2020.\50\ The speed of growth went back to double digits in
2021, with FICUs reporting an aggregate 16.26 percent increase as of
June 30, 2022, from year-end 2021.\51\ The share of indirect loans
outstanding in FICUs' total loan portfolio increased from 17.35 percent
in 2015 to 21.22 percent in 2018, and reached 21.56 percent as of June
30, 2022, after maintaining at 20 percent for the past three years.\52\
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\50\ NCUA call report data for all federally insured credit
unions from the 4th quarter of 2015 through the 4th quarter of 2021.
\51\ NCUA Call Report data for all federally insured credit
unions from the 4th quarter of 2015 through the 2nd quarter of 2022.
\52\ Id.
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Furthermore, between December 31, 2015, and June 30, 2022, the
delinquency rate on the indirect lending program was relatively stable,
ranging from 0.77 percent to 0.47 percent, while the net charge-off
percent decreased from 0.7 percent in 2017 to 0.24 percent in 2021 and
0.21 percent in June 2022.\53\
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\53\ Id.
\54\ Id.
\55\ Period as of June 30, all other periods were as of December
31.
Table 1--FICU Indirect Lending Activities \54\
----------------------------------------------------------------------------------------------------------------
2022
(In $ million) 2015 2016 2017 2018 2019 2020 2021 \55\
----------------------------------------------------------------------------------------------------------------
Total Outstanding Indirect Loans 136,583 165,171 194,016 221,477 228,559 233,161 257,271 299,106
% Year over Year Growth......... ........ 20.93 17.46 14.15 3.20 2.01 10.34 16.26
[[Page 80487]]
% Indirect Loans Outstanding/ 17.35 19.00 20.27 21.22 20.63 20.05 20.50 21.56
Total Loans....................
Total Del. Indirect Loans (> = 988 1,264 1,391 1,494 1,513 1,291 1,198 1,537
60 Days).......................
% Loans Delinquent > = 60 Days/ 0.72 0.77 0.72 0.67 0.66 0.55 0.47 0.51
Total Indirect Loans...........
Net Indirect Loan Charge-Offs... 782 997 1,264 1,318 1,354 1,129 594 288
% Net Charge-Offs/Avg Indirect 0.63 0.66 0.70 0.63 0.60 0.49 0.24 0.21
Loans..........................
----------------------------------------------------------------------------------------------------------------
For the reasons discussed previously, and consistent with sections
107(5) and 107(5)(E) of the FCU Act and the 2015 Opinion, the Board is
proposing to codify into the NCUA's regulations its interpretation that
an eligible organization may be considered an ``originating lender''
for purposes of Sec. 701.22 where the eligible organization generates
a loan through an indirect lending arrangement. Moreover, the Board
proposes to further clarify in the regulation that any ``eligible
organization''--as that term is defined under Sec. 701.22(a)--that
acquires a loan through an indirect lending arrangement acts as the
originating lender for purposes of Sec. 701.22, provided the eligible
organization made the final underwriting decision regarding making the
loan and was assigned the loan or sales contract very soon after the
inception of the obligation to extend credit. In such cases, the Board
considers the third party processing the loan to be an agent of the
eligible organization that performs as an administrative functionary
processing the loan for the eligible organization, and the third
party's activities are part and parcel, and an extension, of the
eligible organization's lending operations.
Where an indirect loan is underwritten by the purchasing eligible
organization before the loan is made and the loan is transferred to the
eligible organization very soon after the inception of the obligation
to extend credit, the Board believes there is little risk the loan will
not be properly underwritten. Accordingly, proposed Sec. 701.22(a)
would add to the end of the definition of ``originating lender'' a
second clarifying sentence providing that originating lender includes a
participant that acquires a loan through an indirect lending
arrangement as defined under Sec. 701.21(c)(9). Proposed paragraph
(c)(9) provides, in part, that indirect lending arrangement means a
written agreement to purchase loans from the loan originator where the
purchaser makes the final underwriting decision regarding making the
loan, and the loan is assigned to the purchaser very soon after the
inception of the obligation to extend credit.
The Board specifically requests comment on whether there are
certain types of transactions that should be excluded from the
interpretation above. In particular, are there transactions in which
eligible organizations acquire loans through indirect lending
arrangements, but the third parties making the loans do not act as
administrative functionaries processing the loan on behalf of the
eligible organizations, and the third parties' activities are not part
and parcel, and an extension, of the eligible organizations' lending
operations? If there are transactions of this type, please explain why
they should be excluded and provide information about the transactions
and the specific activities undertaken by the parties.
In addition, the Board requests comment on whether there are other
factors, changes, safety and soundness, or compliance implications the
NCUA should consider related to the proposed amendments to the
definition of ``originating lender.'' If there are, please explain them
in detail and provide supporting data and information. Should the Board
consider providing additional clarity such as adding some parameters
around the meaning of ``very soon after'' for the assignment of the
loan or contract to the credit union? Examples could be within seven
days of the borrower executing the loan or contract, or assignment
prior to the first loan payment.
The Board also invites comments on what it means for the credit
union to make the final underwriting decision regarding making the loan
in an indirect lending arrangement. For example, should the Board
specify in the rule that a credit union in an indirect lending
arrangement must be involved or consulted at the time of the extension
of credit? Or, can the credit union simply provide its underwriting
standards to the other party in the indirect lending arrangement and
clarify in the indirect lending agreement that only those loans meeting
the credit union's underwriting standards will be accepted for funding?
Would a credit union still be making the final underwriting decision if
a third party includes significantly more underwriting criteria that
are more restrictive, for example, than the credit union requires?
Also, should the Board establish an indirect lending rule? And if
so, what specifically should the Board consider in any future indirect
lending rulemaking? Should a credit union be considered the originating
lender in cases where an intermediary is added to a loan transaction
between the initial party extending credit and a credit union,
including a third party facilitating the loan transaction? The NCUA
received several inquiries from the credit union system related to
CUSOs that work with other lenders to extend credit. The CUSOs in those
cases then either receive an immediate assignment of the loans and/or
act as a facilitator in immediately assigning loans further to credit
unions, where the loans meet the credit unions' underwriting criteria.
Are there structural, safety and soundness, or compliance concerns
that would warrant considering that the addition of intermediaries in
loan origination transactions, including CUSOs, precludes a credit
union assignee from being considered the originating lender under the
revised definition in the proposed rule?
Are there any additional safety and soundness or compliance
implications concerning the proposed definition of ``originating
lender'' that the Board should consider?
Should the Board consider defining the term ``an investment in a
pool of loans'' in a future rulemaking? If so, how should it be defined
and why?
Section 701.22(e) Temporary Regulatory Relief in Response to COVID-19
Current Sec. 701.22(e) provides that notwithstanding paragraph
(b)(5)(ii) of Sec. 701.22, during the period commencing on April 21,
2020, and concluding on December 31, 2022, the aggregate amount of loan
participations that may be purchased from any one originating lender
shall not exceed the greater of $5,000,000 or 200 percent of the FICU's
net worth.\56\ The Board approved Sec. 701.22(e) to help ensure that
FICUs remained operational and had sufficient
[[Page 80488]]
liquidity during the COVID-19 pandemic.\57\ The Board concluded, at the
time, that the amendments would provide FICUs with the necessary
flexibility in a manner consistent with the NCUA's responsibility to
maintain the safety and soundness of the credit union system.\58\ As
provided in current paragraph (e), the temporary regulatory relief
provided under the paragraph will expire on December 31, 2022.
Accordingly, the Board is proposing to remove this paragraph as part of
any final rule amending Sec. 701.22 issued after December 31, 2022.
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\56\ Emphasis added.
\57\ See 85 FR 22010 (April 21, 2020); 85 FR 83405 (Dec. 22,
2020) (extending paragraph (e) through Dec. 31, 2021); and 86 FR
72517 (Dec. 22, 2021) (extending paragraph (e) through Dec. 31,
2022).
\58\ 85 FR 22010, 22010 (April 21, 2020).
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The Board welcomes comments on the impact, if any, that was
experienced due to the flexibilities provided in the temporary rule.
Did the temporary rule have any effect on the participation markets?
Are there any safety and soundness or compliance implications related
to the expiration of the flexibilities?
Finally, the Board invites comment on what other recommendations it
should consider in the loan participation rule. For example, should the
Board consider replacing prescriptive limits with principles-based
requirements? Should the Board consider removing the limit on the
amount of loan participations that could be purchased from any one
originating lender under current Sec. 701.22(b)(5)(ii)?
Section 701.23 Purchase, Sale, and Pledge of Loans
As discussed in more detail in this portion of the preamble, this
proposal would make several changes to current Sec. 701.23 of the
NCUA's regulations. These changes are intended to clarify numerous
provisions regarding the purchase, sale, and pledge of eligible
obligations. The proposal would also amend the NCUA's current
regulatory requirements under current Sec. 701.23 to provide FCUs
expanded authority and autonomy to innovate and transact business with
fintech companies and other institutions that provide services
associated with the origination and sale of loans made to members of
FCUs.
Section 701.23 Introductory Paragraph
The introductory paragraph to current Sec. 701.23 sets forth the
scope and limitations of the section. The Board added the introductory
paragraph to Sec. 701.23 as part of the 2013 Final Rule.\59\ The
introductory paragraph was added to clarify several issues related to
the scope and applicability of Sec. 701.23. In particular, the 2013
Final Rule explained in five sentences as follows: The proposal added
introductory text to Sec. 701.23 to clarify the scope of Sec. 701.23
and to distinguish transactions under Sec. 701.23 from transactions
covered by Sec. 701.22. The final rule adopts the additional language
substantially as proposed, but with some amendments to conform it to a
2012 final rule promulgated by NCUA eliminating the Regulatory
Flexibility Program (RegFlex).\60\ The final rule regarding RegFlex
provides a limited exception to the general requirement that an FCU's
purchase, sale, or pledge of all or part of a loan must be to one of
its own members.\61\ Specifically, the exception permits FCUs that meet
the well capitalized standard to buy loans from other FICUs without
regard to whether the loans are eligible obligations of the purchasing
FCU's members or the members of a liquidating credit union. The final
rule also makes a parallel conforming amendment to the introductory
text to Sec. 701.22 in this regard.\62\
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\59\ 78 FR 37946 (June 25, 2013).
\60\ 77 FR 31981 (May 31, 2012).
\61\ 12 CFR 701.23(b)(2).
\62\ 78 FR 37954-37955.
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The introductory paragraph to current Sec. 701.23 has three
separate substantive provisions. First, the paragraph provides that the
section governs an FCU's purchase, sale, or pledge of all or part of a
loan to one of its own members where no continuing contractual
obligation is contemplated between the seller and the purchaser. The
first provision also notes that there is a limited exception to the
membership requirement for certain well-capitalized FCUs. Second, the
paragraph elaborates on the membership requirement by providing that
the borrower must be a member of the purchasing FCU before the purchase
is made, except as provided in current Sec. 701.23(b)(2). Third, the
paragraph provides broadly that an FCU may not purchase a non-member
loan to hold in its portfolio.
Since amending Sec. 701.23 as part of the 2013 Final Rule, the
NCUA has received numerous inquiries from NCUA examiners, FCUs, fintech
companies, and other parties who have expressed confusion about how to
interpret these provisions. This confusion has led to inconsistent
reporting of loan interests by FCUs and uncertainty regarding which of
the two sections, Sec. 701.22 or Sec. 701.23, applies to certain
transactions, particularly innovative programs that have been designed
by FICUs after 2013. In addition, the Board is concerned that continued
confusion about when a borrower is required to be a member under Sec.
701.23 could discourage FCUs from entering into certain safe and sound
loan purchase, sale, and pledge agreements that are within their
statutory authority.
The clause in the first sentence of the introductory paragraph to
current Sec. 701.23 that provides ``where no continuing contractual
obligation between the seller and purchaser is contemplated'' continues
to be a source of confusion for examiners and the credit union system.
As mentioned above, in practice loan purchase agreements, regardless of
whether the transactions involve the purchase of an eligible obligation
or a loan participation, frequently contain some form of continuing
contractual obligation between the buyer and the seller, including
representations and warranties regarding the loans and loan repurchase
agreements, servicing agreements, and other similar types of ongoing
obligations. Accordingly, the Board requests comments on deleting the
continuing contractual obligations clause in current Sec. 701.23. The
Board intends this potential change to work in conjunction with the
proposed changes to the introductory paragraph to current Sec. 701.22.
In the introductory paragraph to Sec. 701.23, the Board is
considering two other changes in conjunction with amendments made
elsewhere in this proposal, which are described in more detail below.
First, the Board requests comments on removing the clause referring to
the limited exception for well-capitalized FCUs. As discussed in more
detail below in the part of the preamble on Sec. 701.23(b)(2), the
Board is proposing to remove the well-capitalized requirements for FCU
purchases of certain non-member loans from FICUs. Accordingly, the
Board believes that deleting the clause referring to the limited
exception for well-capitalized FCUs is a necessary conforming
amendment.
Second, the Board is proposing to remove the third sentence in the
introductory paragraph to current Sec. 701.23 to clarify the broad
prohibition on holding non-member loans in the portfolio. This
prohibition appears to have originally been intended to address FCU
purchases of non-member loans to complete pools of loans for resale, as
authorized for real estate-secured loans and federally guaranteed
student loans under current Sec. 701.23(b)(1)(iii) and (iv). The
prohibition on retaining the non-member loans in portfolio goes
together with the authority in paragraphs (b)(1)(iii) and (iv) because
those provisions allow an FCU to buy such
[[Page 80489]]
non-member loans solely to complete a pool of loans for resale.
Moreover, the second sentence in current Sec. 701.23(b)(1)(iv)
further confirms this relationship by providing that a pool must
include a substantial portion of the credit union's members' loans and
must be sold promptly.\63\ For other purchases of non-member loans
under current Sec. 701.23, the authority is not tied to a plan or
requirement to resell the loans being purchased. Prohibiting the FCU
from retaining the loans in portfolio, as the current wording in the
undesignated introductory paragraph implies, unnecessarily restricts
FCUs' authority to purchase and hold non-member loans from FICUs under
current Sec. 701.23(b)(1)(ii) \64\ and (b)(2). Accordingly, the Board
requests comment on deleting the third sentence in the introductory
paragraph to Sec. 701.23, providing that an FCU may not purchase a
non-member loan to hold in its portfolio.
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\63\ Emphasis added.
\64\ Authorizing FCUs to purchase eligible obligations of a
liquidating credit union's individual members, from the liquidating
credit union.
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The Board is considering one other change to the introductory
paragraph. The second paragraph provides that for purchases of eligible
obligations, except as described in paragraph (b)(2) of the section,
the borrower must be a member of the purchasing FCU before the purchase
is made. As discussed above, there are express exceptions to the
membership requirement under paragraph (b)(1) as well as in paragraph
(b)(2). For example, paragraphs (b)(1)(iii) and (iv) authorize FCUs to
buy non-member loans to complete a pool of loans for resale.
Accordingly, the Board requests comment on amending the second sentence
in the introductory paragraph to current Sec. 701.23 to provide that
for purchases of eligible obligations, except as described under
paragraph (b) of the section, the borrower must be a member of the
purchasing FCU before the purchase is made.
If the changes proposed above are adopted in a final rule, the
introductory text of Sec. 701.23 would provide that the section
governs an FCU's purchase, sale, or pledge of all or part of a loan to
one of its own members, subject to certain exceptions. The introductory
paragraph would provide further that for purchases of eligible
obligations, except as otherwise described under paragraph (b) of Sec.
701.23, the borrower must be a member of the purchasing FCU before the
purchase is made.
Section 701.23(a) Definitions
The proposed rule would, among other changes discussed below, amend
current Sec. 701.23(a) to add the heading ``Definitions'' to the
paragraph and remove the numbering from the individual definitions
under paragraph (a). This change is intended to avoid errors and
confusion when definitions in paragraph (a), which may be cross
referenced elsewhere in the NCUA's regulations, are added or removed.
Accordingly, the individual definitions included under proposed Sec.
701.23(a) will be listed in alphabetic order but will not be numbered
individually.
Eligible obligation. Proposed Sec. 701.23(a) would amend the
definition of ``eligible obligation'' to clearly distinguish between an
eligible obligation and a note held by a liquidating credit union.
Current Sec. 701.23(a) defines the term eligible obligation broadly to
mean a loan or group of loans, which includes the notes of a
liquidating credit union.\65\ As explained in the part of the preamble
on Sec. 701.23(b)(4), under this proposal the statutory 5-percent
limitation on the aggregate of the unpaid balance of notes purchased
under Sec. 701.23 would apply to only notes of liquidating credit
unions and not to eligible obligations as that term is generally used
under section 107(13) \66\ of the FCU Act. Accordingly, the proposal
would amend the current definition of eligible obligation to clarify
that the term does not include a note held by a liquidating credit
union.
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\65\ See, e.g., Sec. Sec. 701.23(b)(1)(ii), (b)(2)(ii), and
(b)(4).
\66\ Section 1757(13) (authorizing FCUs by providing that: [I]n
accordance with rules and regulations prescribed by the Board, to
purchase, sell, pledge, or discount or otherwise receive or dispose
of, in whole or in part, any eligible obligations (as defined by the
Board) of its members and to purchase from any liquidating credit
union notes made by individual members of the liquidating credit
union at such prices as may be agreed upon by the board of directors
of the liquidating credit union and the board of directors of the
purchasing credit union, but no purchase may be made under authority
of this paragraph if, upon the making of that purchase, the
aggregate of the unpaid balances of notes purchased under authority
of this paragraph would exceed 5 per centum of the unimpaired
capital and surplus of the credit union[.]).
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The proposal would also amend the definition of ``eligible
obligation'' to clarify that the term includes a whole loan or part of
a loan. The NCUA has long held the position that the term eligible
obligation includes loans, in whole or in part, provided the loan does
not meet the definition of a loan participation under Sec.
701.22(a).\67\ The Board believes that the amended definition of an
eligible obligation would provide clarity and reduce confusion in the
credit union system concerning when a transaction involving a loan
purchased in part (partial loan) meets the regulatory definition of an
eligible obligation. It has come to the Board's attention that many
credit union officials find the eligible obligations rule unclear,
specifically when attempting to determine which rule applies to a loan
purchased in part. The amended definition will allow FCU officials to
differentiate between a transaction involving a partial loan that meets
the definition of an eligible obligation under Sec. 701.23 and a
transaction involving a partial loan that meets the definition of a
loan participation under Sec. 701.22.
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\67\ See 78 FR 37946, 37948 (June 25, 2013) (providing in part:
``[The introductory paragraph to Sec. 701.22] clarifies that the
[section] applies to a natural person FICU's purchase of a loan
participation where the borrower is not a member of that credit
union. Generally, an FCU's purchase, in whole or in part, of its
member's loan is covered by NCUA's eligible obligations rule at
Sec. 701.23.'' The 2013 final rule also notes in FN 2 that there is
also ``a limited exception for certain well capitalized federal
credit unions to purchase, subject to certain conditions, non-member
eligible obligations from a FICU. 12 CFR 701.23(b)(2).''); see also,
12 U.S.C. 1757(13) (providing in part: An FCU shall have power, ``in
accordance with rules and regulations prescribed by the Board, to
purchase, sell, pledge, or discount or otherwise receive or dispose
of, in whole or in part, any eligible obligations (as defined by the
Board) of its members.'' (emphasis added)).
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Current Sec. 701.22(a) provides that loan participation means a
loan where one or more eligible organizations participate pursuant to a
written agreement with the originating lender, and the written
agreement requires the originating lender's continuing participation
throughout the life of the loan. For example, if an FCU purchases a
partial loan that does not meet the definition of loan participation
under proposed Sec. 701.22(a), then the transaction may still be
permissible provided it meets the definition of an ``eligible
obligation'' under proposed Sec. 701.23(a) and meets the requirements
under that section.
Finally, the proposal would amend the definition of ``eligible
obligation'' to remove the words ``group of loans.'' The words are
redundant because the term eligible obligation is used in its plural
form, eligible obligations, throughout proposed and current Sec.
701.23 to indicate where the section authorizes or applies to the
purchase of one or more loans. The Board believes removing the phrase
``group of loans,'' in conjunction with the other changes discussed in
this proposal, will clarify the definition of eligible obligation.
Accordingly, for all the reasons discussed above, proposed Sec.
701.23(a) would provide that eligible
[[Page 80490]]
obligation means a whole loan or part of a loan (other than a note held
by a liquidating credit union) that does not meet the definition of a
loan participation under Sec. 701.22(a).
Liquidating credit union. Proposed Sec. 701.23(a) would define the
term ``liquidating credit union'' to specify the point in time when a
credit union meets the definition of a liquidating credit union for
purposes of applying the 5-percent limitation in proposed Sec.
701.23(b)(4). The term liquidating credit union is used but not defined
in current Sec. 701.23 because the section does not distinguish
between eligible obligations and notes of liquidating credit unions for
purposes of calculating the 5-percent limitation on the aggregate of
the unpaid balance of loans purchased under current Sec. 701.23(b)(1)
and (b)(2)(ii). As explained in more detail later in the part of the
preamble on proposed Sec. 701.23(b)(4), under this proposal, the 5-
percent limitation would apply only to notes purchased from liquidating
credit unions, making it necessary for the NCUA to specify the point in
time when a credit union meets the definition of a liquidating credit
union. Consistent with Congress' use of the broad term ``credit union''
in section 107(13) of the FCU Act, the definition of liquidating credit
union would include both liquidating FICUs and liquidating credit
unions not insured by the NCUA.\68\
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\68\ See Section 1757(13) (providing in relevant part: ``to
purchase from any liquidating credit union notes made by individual
members of the liquidating credit union at such prices as may be
agreed upon by the board of directors of the liquidating credit
union and the board of directors of the purchasing credit union, but
no purchase may be made under authority of this paragraph if, upon
the making of that purchase, the aggregate of the unpaid balances of
notes purchased under authority of this paragraph would exceed 5 per
centum of the unimpaired capital and surplus of the credit union;''
(emphasis added).).
---------------------------------------------------------------------------
Accordingly, the Board proposes to define the term liquidating
credit union as follows: Liquidating credit union means: (1) in the
case of a voluntary liquidation, a credit union is a liquidating credit
union as of the date the members vote to approve liquidation; and (2)
in the case of an involuntary liquidation, a credit union is a
liquidating credit union as of the date the board of directors is
served an order of liquidation issued by either the NCUA or the state
supervisory authority.
The Board specifically requests comment on whether the Board should
provide any additional clarity regarding the definitions of the terms
``eligible obligation'' and ``loan participation.'' If so, what further
clarification should be provided?
Also, should the Board consider defining the term ``empowered to
grant'' in a future rulemaking? Are there any other terms used in Sec.
701.23 that the Board should consider defining or further clarifying
through a future rulemaking?
Section 701.23(b) Purchase of Loans
Current Sec. 701.23(b) would be amended, as discussed in more
detail later in this preamble, to make certain substantive changes and
to implement clarifying and conforming changes. Proposed Sec.
701.23(b) would amend the current paragraph heading to current
paragraph (b) to clarify which transactions are covered under the
paragraph. The current heading for paragraph (b) is ``Purchase.'' The
Board believes that this would result in only a minor technical change
to current Sec. 701.23(b). The amended rule would only add the two
words ``of loans'' to the current rule text to better clarify the type
of eligible obligation transactions for which this section would apply,
that being the purchase of loans. Accordingly, the paragraph heading
for proposed Sec. 701.23(b) would be revised to read ``Purchase of
loans.''
Section 701.23(b)(1)
Section 701.23(b)(1)(ii)
Current Sec. 701.23(b)(1)(ii) authorizes FCUs to purchase certain
eligible obligations of a liquidating credit union's individual members
from the liquidating credit union. As explained previously in the part
of the preamble on Sec. 701.23(a) regarding the definition of eligible
obligation, under this proposal, notes of liquidating credit unions
would no longer be included within the definition of ``eligible
obligations.'' Accordingly, subject to the 5-percent limitation, this
proposal would amend current Sec. 701.23(b)(1)(ii) to remove the
references to eligible obligations and authorize FCUs to purchase notes
of a liquidating credit union's individual members from the liquidating
credit union.
Section 701.23(b)(1)(iv)
The word ``mortgage'' is misspelled in the first sentence of
current Sec. 701.23(b)(1)(iv). Proposed Sec. 701.23(b)(1)(iv) would
revise the current rule to correct that misspelling. No substantive
changes would be made to current paragraph (b)(1)(iv).
Section 701.23(b)(2) Purchase of Obligations From a FICU
Proposed Sec. 701.23(b)(2) would revise the current rule to remove
the CAMELS rating requirement and the capital classification
requirements in the introductory paragraph. Current Sec. 701.23(b)(2)
provides that an FCU that received a composite CAMELS rating of ``1''
or ``2'' for the last two (2) full examinations and maintained a
capital classification of ``well capitalized'' under part 702 of the
chapter for the six (6) immediately preceding quarters may purchase and
hold certain obligations, provided that it would be empowered to grant
them.
The Board is proposing to simplify the rule and provide FCUs
additional authority to purchase loans. This includes removing limits
on eligible obligations of a credit union's members and removing the
CAMELS rating and capital classification requirements.
The CAMELS rating and capital classification requirements were
added to the NCUA's regulations as part of a 2001 final rule regarding
the NCUA's RegFlex program.\69\ The 2001 final rule explained, in two
sentences responding to commenters suggestions that the requirements be
removed, as follows: The Board continues to believe that CAMEL ratings
and net worth ratios are the best measures of how well a credit union
is managed and how much risk it presents to the NCUSIF and the credit
union system. That is, consistent with safety and soundness concerns,
credit unions with advanced levels of net worth and consistently strong
supervisory examination ratings have earned exemptions from certain
NCUA Regulations.\70\
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\69\ 66 FR 58656 (Nov. 23, 2001).
\70\ 66 FR 58656.
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FCUs have generally managed their loan purchase, sale, and pledge
activity well since the addition of the CAMELS and capital requirements
and continue to do so. Approximately 10 percent of FCUs were engaged in
the purchase, sale, or pledge of loans during the first half of
2022.\71\
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\71\ NCUA Call Report data for all FCUs as of the 2nd quarter of
2022.
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Additionally, the Board notes that this purchase authority is
limited to only purchases from a FICU. Therefore, the loans able to be
purchased under this authority are already in the credit union system.
Moving the obligation from one FICU to another FICU generally is not
expected to result in a significant increase to the Share Insurance
Fund's risk exposure.
Further, the current CAMELS and net worth restrictions are only
applicable to a limited segment of the credit union system given that
the vast majority of FCUs have a CAMELS composite rating
[[Page 80491]]
of 1 or 2 and are well-capitalized.\72\ Expansion of this authority
would allow slightly more FCUs to purchase obligations from a FICU,
potentially creating additional revenue and capital for the purchaser
and providing an additional outlet for selling FICUs, creating
additional liquidity channels in the credit union system.
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\72\ As of June 30, 2022, 78 percent of FCUs were rated a CAMELS
composite 1 or 2 and were classified as ``well capitalized.'' These
FCUs account for 96 percent of total FCU assets. There were only 614
FCUs with a CAMELS composite rating of 3, 4, or 5, and only 166 FCUs
not classified as ``well capitalized.''
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Lastly, the NCUA believes any increased risk associated with
removing the CAMELS rating and capital classification requirements in
current Sec. 701.23 would also be minimized by the addition of the
proposed principles-based due diligence, risk assessment, and risk
management requirements.
Accordingly, the introductory paragraph to proposed Sec.
701.23(b)(2) would provide that an FCU may purchase and hold certain
obligations if it would be empowered to grant them.
Section 701.23(b)(2)(ii) Notes of a Liquidating Credit Union
Current Sec. 701.23(b)(2)(ii) authorizes FCUs to purchase certain
eligible obligations of a liquidating credit union without regard to
whether they are obligations of the liquidating credit union's
individual members. As explained earlier in the part of the preamble on
Sec. 701.23(a) regarding the definition of eligible obligation, under
this proposal notes of liquidating credit unions would no longer be
included within the definition of ``eligible obligation.'' Accordingly,
this proposal would amend current Sec. 701.23(b)(2)(ii) to remove the
words ``eligible obligations'' and ``obligations'' and authorize FCUs
to purchase notes of a liquidating credit union without regard to
whether they are notes of the liquidating credit union's individual
members.
Section 701.23(b)(3) Introductory Text and (b)(3)(ii)
Proposed Sec. 701.23(b)(3)(ii) would revise the current
requirement that written agreements and schedules of loans be retained
by the purchaser. Current Sec. 701.23(b)(3)(ii) provides that a
written agreement and a schedule of the eligible obligations covered by
the agreement are retained in the purchaser's office. Under the
proposed rule, the purchasing FCU would still be required to retain the
written loan purchase agreement and a schedule of the eligible
obligations covered by the agreement, but the proposal would eliminate
the requirement for it to be retained in the purchaser's office.
The Board acknowledges the requirement for the FCU to retain the
written loan purchase agreement and schedule of the eligible
obligations in the purchaser's office could imply that the written loan
purchase agreement and schedule be retained in a hard-copy format,
which is outdated given the current digital environment. An FCU might
choose to store its records in electronic format, in the cloud, or
housed in off-site servers or databases. The Board intends, with this
proposed change, that the FCU make the written loan purchase agreement
and schedule of the eligible obligations covered by the agreement
available upon request.\73\ Credit unions that have some or all of
their records maintained by an off-site data processor are considered
to be in compliance for the storage of those records if the service
agreement specifies the data processor safeguards against the
simultaneous destruction of production and back-up information.\74\
Accordingly, proposed Sec. 701.23(b)(3)(ii) would provide that a
written agreement and a schedule of the eligible obligations covered by
the agreement are retained by the purchaser.
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\73\ See Sec. 749.2.
\74\ See appendix A to part 749.
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This proposed change would align this requirement with the NCUA's
regulations and guidelines for FICUs on records preservation programs.
Under part 749, the NCUA does not require or recommend a particular
format for record retention. If the credit union stores records on
microfilm, microfiche, or in an electronic format, the stored records
must be accurate, reproducible, and accessible to an NCUA examiner.\75\
If records are stored on the credit union premises, they should be
immediately accessible upon the examiner's request; if records are
stored by a third party or off site, then they should be made available
to the examiner within a reasonable time after the examiner's request.
The credit union must maintain the necessary equipment or software to
permit an examiner to review and reproduce stored records upon request.
The credit union should also ensure that the reproduction is acceptable
for submission as evidence in a legal proceeding.\76\
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\75\ See 12 CFR 749.5.
\76\ See generally part 749; and NCUA Legal Op. 07-0812 (Jan.
2008), available at <a href="https://www.ncua.gov/regulation-supervision/legal-opinions/2008/electronic-retention-records">https://www.ncua.gov/regulation-supervision/legal-opinions/2008/electronic-retention-records</a>.
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Section 701.23(b)(4)
This proposal would amend current Sec. 701.23(b)(4), which limits
the aggregate unpaid balance of certain eligible obligations purchased
by an FCU to a maximum of 5 percent of the FCU's unimpaired capital and
surplus. Under this proposed rule, the 5-percent limitation would apply
solely to notes of a liquidating credit union's members purchased by an
FCU from the liquidating credit union. As discussed in the following
paragraphs, the Board has determined this change would remove a
regulatory limit to the purchase of eligible obligations that the FCU
Act does not require. The Board believes adequate safety and soundness
of eligible obligations purchases can be accomplished through
principles-based regulation rather than a once-size-fits-all
limitation.
Section 701.23 provides both the regulatory authority for purchases
of eligible obligations by an FCU and the limitations. Currently, the
5-percent limitation applies to eligible obligations purchased by an
FCU under Sec. 701.23(b)(1) and (b)(2)(ii). In general, paragraph
(b)(1) authorizes an FCU to purchase (1) eligible obligations of its
members; (2) eligible obligations of a liquidating credit union's
members from the liquidating credit union; and (3) student loans and
real estate-secured loans from any source to facilitate the purchasing
FCU's packaging of a pool of such loans to be sold or pledged on the
secondary market. Paragraph (b)(2)(ii), which is on purchases from
FICUs, authorizes an FCU to purchase the ``eligible obligations of a
liquidating credit union without regard to whether they are obligations
of the liquidating credit union's members.''
The statutory source of the 5-percent limitation is section 107(13)
of the FCU Act.\77\ Section 107 generally enumerates the powers of
FCUs, and paragraph (13) authorizes an FCU to make certain loan
purchases. Specifically, paragraph (13) provides verbatim as follows:
in accordance with rules and regulations prescribed by the Board, to
purchase, sell, pledge, or discount or otherwise receive or dispose of,
in whole or in part, any eligible obligations (as defined by the Board)
of its members and to purchase from any liquidating credit union notes
made by individual members of the liquidating credit union at such
prices as may be agreed upon by the board of directors of the
liquidating credit union and the board of directors of the purchasing
credit union, but no purchase may be made under authority
[[Page 80492]]
of this paragraph if, upon the making of that purchase, the aggregate
of the unpaid balances of notes purchased under authority of this
paragraph would exceed 5 per centum of the unimpaired capital and
surplus of the credit union.\78\
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\77\ 12 U.S.C. 1757(13).
\78\ Id. (emphasis added).
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Section 107(13) applies to the purchase of two mutually exclusive
categories of loans--``eligible obligations'' (as that term may be
defined by the Board) of the purchasing FCU's members and the ``notes''
of a liquidating credit union made to the liquidating credit union's
members. The 5-percent limitation, however, applies solely to the
second category of loans, that is, the notes of a liquidating credit
union to its members. The statutory language specifies that ``no
purchase may be made . . . if, upon the making of that purchase, the
aggregate of the unpaid balances of notes purchased under authority of
this paragraph would exceed 5 per centum of the unimpaired capital and
surplus of the credit union.'' \79\ The 5-percent limitation is
specific to the ``aggregate unpaid balances of notes'' \80\ purchased
``under authority of this paragraph'' (that is, paragraph (13) of
section 107). As italicized in the preceding quotes, the only notes
authorized to be purchased pursuant to section 107(13) are those of a
liquidating credit union to its members. Notwithstanding the ambiguity
introduced by the reference to the entire ``paragraph'' (13) in the
context of the 5-percent limitation, the following term ``notes''
narrows the required scope of its application to purchases from a
liquidating credit union.
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\79\ Emphasis added.
\80\ Emphasis added.
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Despite the statutory wording, the NCUA's implementing regulation
at 12 CFR 701.23 does not distinguish between eligible obligations and
notes. Section 107(13) of the FCU Act empowers the NCUA to define the
term ``eligible obligation.'' The NCUA has exercised this discretion by
opting to jointly treat notes and other eligible obligations as the
same type of instrument under its regulations. Both are encompassed in
the regulatory definition of the term ``eligible obligation,'' which is
defined to be ``a loan or group of loans.'' \81\ The proposed rule
would amend current Sec. 701.23 to more closely follow the statutory
language. Under the proposed rule, the 5-percent limitation would apply
solely to the purchase by an FCU of the notes made by a liquidating
credit union to the liquidating credit union's members. The limitation
would not apply to other loans purchased by an FCU under the authority
of section 107(13).
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\81\ 12 CFR 701.23(a).
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The proposed rule would also amend the definition of ``eligible
obligations'' to reflect the revised scope of the 5-percent limitation.
Under the proposed rule, the term ``eligible obligation'' would be
revised to mean ``a whole loan or part of a loan (other than a note
held by a liquidating credit union) that does not meet the definition
of a loan participation under Sec. 701.22(a).'' \82\
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\82\ Under the current definition of ``eligible obligation'',
there may be instances where the notes of the liquidating credit
union members are also eligible obligations of the members of the
purchasing FCU. The 5-percent limitation would apply to these loans
as they fall within the more specific category of ``eligible
obligations'' purchased from a liquidating credit union.
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The Board acknowledges that the current scope of the 5-percent
limitation reflects or implies an alternate legal reading of the
statutory language, which the Board recognizes as a plausible reading.
The alternate reading hinges on the language providing that ``no
purchase may be made under authority of this paragraph.'' The term
``this paragraph'' encompasses paragraph (13) of section 107 in its
entirety. This reading applies the 5-percent limitation to all
instruments (eligible obligations and notes) purchased pursuant to
paragraph (13). The current regulation reflects such an interpretation,
and the Board has made past statements in support of this reading.\83\
This proposed rule constitutes a reconsideration of the NCUA's prior
position. As noted, the NCUA has determined that the proposed
regulatory change is more consistent with the language of the FCU Act
and is more aligned with the different safety and soundness
considerations with respect to eligible obligations in general and
notes purchased from a liquidating credit union.
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\83\ For example, the preamble to the 1979 final rule
implementing the NCUA's eligible obligations authority contained the
following statement: ``The Administration feels that the language of
Section 107(13) is clear, and that the best interpretation is that
adopted in the proposed rule'' (that is, the currently codified
regulatory text). 44 FR 27068, 27070 (May 9, 1979).
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The proposed reading is better supported by accepted canons of
statutory construction. The statutory construction canon of
``consistent usage'' logically presumes that different words denote
different ideas.\84\ Accordingly, the use of the terms ``eligible
obligations'' and ``notes'' is intended to distinguish between two
mutually exclusive categories of loans. Further, the canon holds that
``a word or phrase is presumed to bear the same meaning throughout a
text.'' \85\ The use of the word ``notes'' in paragraph 107(13) is
appropriately interpreted consistently and exclusively to reference
only notes made by a liquidating credit union to its members.
---------------------------------------------------------------------------
\84\ Antonin Scalia & Bryan A. Garner, Reading Law: The
Interpretation of Legal Texts, 148 (2012).
\85\ Id.
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The proposed reading also aligns with the ``surplusage'' canon of
statutory interpretation. Under this canon, ``every word and every
provision is to be given effect if possible.'' \86\ ``No word should be
ignored. None should needlessly be given an interpretation that causes
it to duplicate another provision or have no consequence.'' \87\ The
proposed interpretation accounts for language subsequent to ``under
authority of this paragraph'' that modifies the clause's scope. This
subsequent language specifies that the prohibition applies only ``if,
upon the making of that purchase, the aggregate of the unpaid balances
of notes purchased under authority of this paragraph would exceed 5 per
centum of the unimpaired capital and surplus of the credit union.''
Thus, the limit's application is required only with respect to the
purchase of ``notes,'' which, as stated previously, is appropriately
narrowed to solely cover loans made by liquidating credit unions to
their members. Reading the statute to require application of the 5-
percent limitation to ``eligible obligations'' conflates the terms
``notes'' and ``eligible obligations,'' despite the different
terminology Congress enacted. The effect of treating the terms as
duplicative is to effectively ignore the use of the term ``notes,''
which should be separately considered under the surplusage canon.
---------------------------------------------------------------------------
\86\ Id. at 145.
\87\ Id.
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It also bears noting that the stated rationale for original
enactment of the 5-percent limitation does not apply to the purchase of
eligible obligations. The 5-percent limitation language in section
107(13) of the FCU Act was added by Congress in 1968 and referred
solely to notes of liquidating credit unions at that time because that
statute did not refer to purchases of eligible obligations.\88\ That
[[Page 80493]]
language is identical to the current version of the statutory text and
continues to refer solely to ``notes'' of liquidating credit unions.
Prior to the amendment, FCUs lacked express statutory authority to
purchase the loans of liquidating credit unions. As a result,
liquidating credit unions were hampered in their efforts to dispose of
their assets to repay their members. The Senate report accompanying the
legislation explained that the change would ``greatly increase the
market for the notes of liquidating credit unions and will prevent
liquidating credit unions from having to go outside the credit union
movement to liquidate their assets.'' \89\ However, Congress was also
mindful of the risks that might be posed in purchasing the loans of
credit unions compelled to liquidate due to poor management
decisions.\90\ As a result, it opted to limit the ability of an FCU to
purchase notes of liquidating credit unions to 5 percent of its
unimpaired capital and surplus.\91\
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\88\ Public Law 90-375 (approved July 5, 1968) (Providing that:
in accordance with rules and regulations prescribed by the Director,
to purchase from any liquidating credit union notes made by
individual members of the liquidating credit union at such prices as
may be agreed upon by the board of directors of the liquidating
credit union and the board of directors of the purchasing credit
union, but no purchase may be made under authority of this paragraph
if, upon the making of that purchase, the aggregate of the unpaid
balances of notes purchased under authority of this paragraph would
exceed 5 per centum of the unimpaired capital and surplus of the
credit union. (emphasis added)).
\89\ S. Rep. No. 1265, 90th Cong., 2d Sess., at 2 (June 18,
1968).
\90\ Statement of J. Deane Gannon, Director, Bureau of Federal
Credit Unions, Social Security Administration, Department of Health,
Education and Welfare, FCU Act Amendments, Subcommittee on Financial
Institutions of the Comm. on Banking and Currency, at 11-12 (May 24,
1968).
\91\ H.R. Rep. No. 1372 (May 9, 1968).
---------------------------------------------------------------------------
The express authority to purchase eligible obligations was later
added to the text of section 107(13) in 1977.\92\ The legislative
history from that time shows the amendment was intended to provide FCUs
with flexibility to use secondary market facilities to enhance
liquidity, especially in relation to real estate loans.\93\ The
purchase by an FCU of loans made to its own members is not analogous
to, and does not pose the same inherent risk that, purchasing the notes
of a liquidating credit union does. Accordingly, it is reasonable that
Congress would elect not to mandate a limit on the ability of an FCU to
make such purchases. This supposition is supported by Congress'
decision to use the new term ``eligible obligations'' (and in granting
the NCUA broad authority to define this term), rather than simply
revising the existing scope of the term ``notes'' to include member
loans. Further, the legislative history accompanying enactment of the
1977 amendments does not make any mention of the 5-percent limitation
being applicable to eligible obligations.
---------------------------------------------------------------------------
\92\ Public Law 95-22 (approved Apr. 19, 1977).
\93\ H.R. Rep. No. 95-23, at 16 (Feb. 22, 1977).
---------------------------------------------------------------------------
The 1977 legislative history in several instances also refers to
the amendment granting FCUs the ability to purchase the ``notes'' of
its members. One could infer from this that the term ``eligible
obligations'' was intended to be read synonymously with ``notes.'' \94\
This reading appears at least plausible because the broad category of
``notes'' could be seen to encompass various debt instruments,
including notes or written documents evidencing a member's eligible
obligations. Such a reading, however, is not required and is inferior
to the interpretation the Board is proposing in this rule for two
reasons. First, Congress ultimately opted to use the term ``eligible
obligations'' in the statutory amendment that was enacted. The codified
text supersedes non-binding statements in the legislative record.\95\
Secondly, and as discussed earlier, accepted canons of statutory
construction favor an interpretation that provides individual terms
with their own individual meaning.
---------------------------------------------------------------------------
\94\ See, for example, 123 Cong. Rec. H 1521-32, at H-1524
(Daily ed. March 1, 1977) (Describing the amendment as providing for
the ``Purchase and sale of notes of members.''); H.R. Rep. No. 95-
23, at 16 (Feb. 22, 1977) (also describing amendment as pertaining
to the ``Purchase and sale of notes''); and Statement of C. Austin
Montgomery, Administrator, National Credit Union Administration
Before the Subcommittee on Financial Institutions Supervision,
Regulation and Insurance Committee on Banking, Finance, and Urban
Affairs, House of Representatives, 95th Cong. 27 (1977) (``Temporary
liquidity problems experienced by credit unions might be resolved by
selling or pledging notes'').
\95\ Scalia & Garner, supra note 7 at 64 (``[T]he purpose must
be derived from the text, not from extrinsic sources such as
legislative history or an assumption about the legal drafter's
desires'').
---------------------------------------------------------------------------
For the preceding reasons, the NCUA has determined that the
proposed regulatory change is more consistent with the language of the
FCU Act. The NCUA also has determined that the amendment will not pose
a safety and soundness risk due to the addition of principles-based
risk management requirements. By amending the current rule to narrow
the application of the 5-percent limitation to the aggregate of the
unpaid balances of loans purchased from any source to instead apply to
only the ``notes'' of a liquidating credit union, the Board intends to
allow FCUs greater capacity, flexibility, and individual autonomy to
establish their own risk tolerance limits for the amount of the loans
of its members that can be purchased from any source other than a
liquidating credit union. This includes other financial institutions,
fintech companies, third-party loan acquisition channels such as CUSOs,
and other loan-originating retailers.
While the narrower interpretation of section 107(13) of the FCU Act
would remove the existing limit on the amount of eligible obligations
that an FCU could purchase, establishing risk management expectations
will minimize potential risk to the Share Insurance Fund while allowing
FCUs more flexibility in how they manage their eligible obligation
purchase activities. Proposed new Sec. 701.23(b)(6), which is
discussed in detail later in the part of the preamble on paragraph
(b)(6), would outline minimum risk management standards that must be
included in the written loan purchase policy for any FCU that plans to
purchase eligible obligations. The Board believes these risk management
standards should be part of the normal business practices at well-run
FCUs that engage in the purchase of eligible obligations, and as such,
should not represent an additional burden. It is the Board's view that
the proposed changes would allow well-run FCUs more autonomy and
flexibility in how they conduct their business. Provided the FCU can
demonstrate and document that its loan purchase activity does not
present a material risk to the viability or solvency of the FCU through
the standards established in Sec. 701.23(b)(6), the FCU should be able
to establish its own internal standards to meet its business needs and
the needs of its members.
The proposed rule would amend current Sec. 701.23(b)(4) to remove
the exclusions provided in paragraphs (b)(4)(i) through (iv) and revise
the current language to apply the 5-percent limit to only notes
purchased from liquidating credit unions. While the narrower
interpretation of section 107(13) of the FCU Act would remove the
existing restriction on the amount of eligible obligations an FCU could
purchase, the new risk management requirements will minimize the
potential increase in risk to the Share Insurance Fund, while allowing
FCUs more flexibility in how they manage their loan purchase
activities. Accordingly, proposed Sec. 701.23(b)(4) would provide that
the aggregate of the unpaid balance of notes purchased under paragraphs
(b)(1)(ii) and (b)(2)(ii) of Sec. 701.23 shall not exceed 5 percent of
the unimpaired capital and surplus of the purchaser.
The Board invites comments concerning the proposed rule narrowing
the application of the 5-percent limitation to only apply to the
aggregate amount of ``notes'' that can be purchased by an FCU from a
liquidating credit union. Should the Board consider defining the term
``notes'' as used to calculate the 5-percent limitation for the
aggregate of the unpaid balances of notes an FCU could purchase from a
liquidating credit union? If so, how should it be defined?
[[Page 80494]]
Are there additional changes to this rule that the Board should
consider in the future that would further facilitate credit union
engagement with fintech companies and other third parties in a safe and
sound manner?
Section 701.23(b)(5) Grandfathered Purchases
Proposed Sec. 701.23(b)(5) would amend the current rule to broaden
the grandfathering provision in current paragraph (b)(5). Current Sec.
701.23(b)(5) provides that, subject to safety and soundness
considerations, an FCU may hold any of the loans described in paragraph
(b)(2) of this section provided it was authorized to purchase the loan
and purchased the loan before July 2, 2012. The Board believes the
proposed revisions to the current grandfathering provision would avoid
placing undue burden on FCUs that were operating in compliance with the
existing rule and avoid disrupting the existing eligible obligations
market by forcing widespread divestments of the eligible obligations
currently held in FCU loan portfolios. While the proposed
grandfathering provision would allow FCUs to continue to hold eligible
obligations that were purchased prior to the effective date of this
rule, it does not exempt FCUs from conducting and updating risk
assessments, establishing concentration limits, or monitoring the
ongoing condition of the FCU's eligible obligation loan portfolio.
Accordingly, proposed Sec. 701.23(b)(5) would provide that,
subject to safety and soundness considerations, an FCU may hold any of
the loans described in paragraph (b) of this section that were acquired
before the effective date of the final rule approved by the Board;
provided the transaction was in compliance with Sec. 701.23 at the
time the transaction was executed.
New Sec. 701.23(b)(6)
The proposal would add a new paragraph (b)(6) to Sec. 701.23,
which would set forth basic due diligence, risk assessment, and
management requirements that must be addressed in an FCU's internal
written purchase policies.\96\ An FCU's board of directors is
responsible for planning, directing, and controlling the FCU's
activities. To fulfill these duties, the board of directors must
establish adequate policies. The introductory paragraph to proposed
Sec. 701.23(b)(6) would provide that the purchases of eligible
obligations and notes of liquidating credit unions must comply with the
purchasing FCU's internal written purchase policies, which must contain
certain provisions.
---------------------------------------------------------------------------
\96\ A credit union's written loan purchase policies may be
incorporated into the written lending policies required under Sec.
741.3(b)(2).
---------------------------------------------------------------------------
The specific policy requirements, which are discussed in detail
below, are part of the basic fiduciary responsibilities and duties
required of boards of directors.\97\ The requirements in the proposed
rule address the basic elements necessary to administer a safe and
sound loan purchase program.
---------------------------------------------------------------------------
\97\ See Sec. Sec. 701.4(b)(4), 701.21(c)(2), and 741.3(b)(2).
---------------------------------------------------------------------------
As discussed previously, the Board is proposing that these
requirements be added to mitigate the risk of removing certain
regulatory limits on the purchase of loans by FCUs. The new
requirements proposed under Sec. 701.23(b)(6) are crafted to encourage
credit discipline and promote safe and sound loan purchase programs,
which are intended to protect the Share Insurance Fund. These
requirements continue the Board's long-standing expectations for FCUs
that purchase loans to appropriately identify and mitigate undue risk,
while also providing FCUs greater flexibility to establish their own
risk tolerance limits. These principles eliminate some unintended
consequences of the prescriptive requirements in current Sec.
701.23(b)(2) that, in some cases, resulted in FCUs managing their
lending practices and balance sheets to regulatory restrictions instead
of broader considerations for safe and sound lending practices.
The proposed framework would provide credit unions with expanded
flexibility to develop loan purchase policies that are commensurate
with the size, scope, type, complexity, and level of risk posed by the
planned loan purchase activities. The proposed changes are intended to
provide principles-based requirements that are useful for credit unions
of any size or complexity to implement the appropriate level of due
diligence, risk assessment, and management.
When determining whether to start a loan purchase program and
developing related written policies, credit unions should consider
whether the proposed loan purchase activities are consistent with the
FCU's overall business strategy and risk tolerances, and financial and
operational capabilities. Loan purchase, sale, or pledge activities
that are inconsistent with the FCU's risk tolerance levels or beyond
management's ability to manage can pose material risks to an FCU's
financial or operational condition.
The risk management expectations that are outlined in this proposal
reflect the key components of long-standing supervisory expectations as
communicated to credit unions through NCUA Letters to Credit Unions
(LCU), Supervisory Letters, and the Examiner's Guide. The NCUA
specifically requests comment on the written purchase policy
requirements being proposed in paragraph (b)(6) of the rule. Are the
principles-based due diligence, risk assessment, and management
requirements proposed sufficient to offset the risk associated with
removing the CAMELS rating and ``well capitalized'' requirements for a
credit union to purchase and hold eligible obligations from a FICU? Are
there other principles-based safety and soundness or compliance
criteria the Board should consider that would mitigate the risk of
removing certain prescriptive requirements from the rule?
New Sec. 701.23(b)(6)(i)
Proposed new Sec. 701.23(b)(6)(i) would require FCUs to perform
due diligence on the seller, and any applicable counterparties, before
purchasing an eligible obligation. Conducting due diligence on third
parties is a long-standing expectation for credit unions engaging in
third-party relationships and when introducing new loan programs and
products, as noted in NCUA LCU 01-CU-20 (November 2001), NCUA LCU 08-
CU-26 (November 2008), and NCUA LCU 10-CU-03 (March 2010).\98\
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\98\ Available at <a href="https://ncua.gov/regulation-supervision/letters-credit-unions-other-guidance">https://ncua.gov/regulation-supervision/letters-credit-unions-other-guidance</a>.
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Third-party relationships with credit unions have resulted in
financial stress due to unexpected costs, legal disputes, and asset
losses on several occasions. Due diligence reviews are important
because they assist credit unions in risk identification and mitigation
when engaging in a new loan program and when partnering with outside
parties to enhance services to members. Failure to complete adequate
due diligence can result in the acquisition of loan volumes that exceed
the board's risk appetite, loan types that go beyond management's
ability to manage, or loan types or volume that exceed the capabilities
of current loan processing and management information systems. The use
of third parties can add complexity and additional risk to a credit
union's activities and may also expose the credit union to consumer
compliance and other legal risks. For example, failure to conduct
adequate due diligence could lead to an FCU entering into agreements
with a third party that may discontinue services in the future. This
could lead to disruptions in member service, uncollected payments on
loans, and potential losses if the third party fails to
[[Page 80495]]
remit funds that are due to the purchasing FCU.
The responsibility to perform appropriate due diligence remains
with the FCU's board of directors and management and cannot be
outsourced. Overreliance on the due diligence information provided by a
third party without independent review by the FCU's board and
management could result in unsafe and unsound practices.
The proposed rule allows FCUs the flexibility to determine the
level and depth of due diligence reviews that are necessary based on
the level of risk posed by the loans being purchased and the third-
party relationships. Several factors may be considered when determining
the appropriate nature of due diligence for third-party loan purchases
and programs, including:
<bullet> the transaction's complexity;
<bullet> the purchasing FCU's internal lending policies and
procedures;
<bullet> the transaction's size relative to the FCU's existing loan
portfolio, concentrations, and net worth level; and
<bullet> the purchasing FCU's management and staff expertise
regarding the types of loans being purchased.
Additionally, FCUs can take a tiered approach when establishing
their due diligence processes in their loan purchase policies. For
example, when conducting background checks the FCU can determine how
best to assess a third party's business reputation, potential conflicts
of interest, experience, and compliance with federal and state laws,
rules, and regulations based on the type of relationship with the third
party and its risk exposure.
Accordingly, proposed Sec. 701.23(b)(6)(i) would provide that the
purchasing FCU's written purchase policy must require that the
purchasing FCU conduct due diligence on the seller of the loans and
other counterparties to the transaction prior to the purchase.
New Sec. 701.23(b)(6)(ii)
Proposed new Sec. 701.23(b)(6)(ii) would require FCUs to establish
risk assessment and risk management processes for purchase activities.
Conducting risk assessments and implementing risk management processes
reflect the NCUA's long-standing expectation that credit unions
incorporate these activities in relationships with third parties as
outlined in NCUA LCU 07-CU-13 (April 2008), Evaluating Third-Party
Relationships; NCUA LCU 22-CU-05 (March 2022), CAMELS Rating System;
and NCUA Letter to FCUs 02-FCU-09 (March 2002), Risk-Focused
Examination Program.\99\ The purchase of loans can provide an FCU with
a wide range of benefits, including achieving strategic loan growth,
managing liquidity, adjusting risk exposures, and enhancing the
services provided to members. However, an FCU that starts a new lending
program, including the purchase or sale of loans, or engages with third
parties without fully understanding the associated risks, may expose
itself to credit, interest rate, liquidity, transaction, compliance,
strategic, or reputation risk. Risk assessments allow credit unions to
better understand the risk involved in new products and services to
ensure the board has effective processes in place to control the risk.
Not understanding these associated risks may result in the FCU
operating outside of the board's risk appetite and can result in
elevated risk to the Share Insurance Fund. FCUs are ultimately
responsible for safeguarding member assets and ensuring sound
operations.
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\99\ Available at <a href="https://ncua.gov/regulation-supervision/letters-credit-unions-other-guidance">https://ncua.gov/regulation-supervision/letters-credit-unions-other-guidance</a>.
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Adequate risk management processes include ongoing monitoring and
oversight of the loan purchase program. This includes formal reporting
to the board of directors and the FCU's senior management, which will
ensure the board is able to fulfill its duties. An FCU's management
reporting should be timely and commensurate with the size, complexity,
and risk exposure of the FCU. For example, the board of directors
should be informed when targets are met or exceeded, or limits
breached. Reports should also consist of appropriate information that
the board of directors and management could use to make informed
decisions and take timely corrective action when warranted. For
effective governance, an FCU's board of directors and management must
understand the nature and level of risk associated with the FCU's
purchased loan portfolio and program and receive periodic updates and
reports on the performance of the purchased loan portfolio.
The proposed rule provides FCUs the flexibility to tailor their
risk assessment and management processes to fit within their governance
framework and other operations, while providing a basic framework to
follow when developing their initial and ongoing risk assessment and
management processes. Accordingly, proposed Sec. 701.23(b)(6)(ii)
would provide that the purchasing FCU's internal written purchase
policies must establish risk assessment and risk management process
requirements that are commensurate with the size, scope, type,
complexity, and level of risk posed by the planned loan purchase
activities.
New Sec. 701.23(b)(6)(iii)
Proposed new Sec. 701.23(b)(6)(iii) would require FCUs to
establish certain internal underwriting and ongoing monitoring
standards for eligible obligation purchase activities. Underwriting is
the foundation of lending. Without ensuring that underwriting standards
are in place that adequately address how to analyze a borrower's
ability to repay their debt, the board will not be able to fulfill its
responsibilities for the safety and soundness of the FCU's lending
activities. By this same logic, the board must also monitor the level
of credit risk within the credit union's loan portfolio. Changing
economic conditions at the local, regional, or national level can
materially impact the likelihood that the credit union's outstanding
loans are repaid. For example, the closure of a local business that is
a large employer of the credit union's members could significantly
change the risk profile of the credit union's loan portfolio. Changing
levels of credit risk within the FCU's existing loan portfolio
(including eligible obligations) may necessitate strategic changes or
mitigating actions. If the level of credit risk begins to exceed the
board's risk appetite, then risk exposures may need to be adjusted.
Depending on the circumstances, this could include, but is not limited
to, restricting the purchase of new eligible obligations, implementing
more conservative underwriting standards, or potentially divesting
parts of the existing loan portfolio.
The FCU's internal policies must address the level of underwriting
to be performed for the purchase of loans. Underwriting should identify
all risks that could materially influence the purchasing FCU's decision
to proceed with a loan purchase. Appropriate underwriting standards
that adequately address how to analyze a borrower's ability to repay
their loan and the support provided by collateral are a basic tenet of
lending and help ensure that the FCU will be repaid, which protects its
members and the Share Insurance Fund. Without appropriate underwriting
standards, an FCU will not be able to accurately assess its risk of
credit loss. Originating or purchasing loans to high credit risk
borrowers without appropriately understanding and planning for that
risk can result in unexpectedly high loss rates that negatively impact
earnings and net worth, which may impair the viability of the credit
union and pose a risk to the Share Insurance Fund. A lack of
[[Page 80496]]
adequate underwriting standards can also result in adverse risk
selection, whereby high credit risk borrowers are only able to obtain
loans from institutions with lax underwriting, resulting in the FCU
attracting borrowers with a much higher risk of default.
An FCU engaging in loan purchases should conduct an independent
credit analysis and assessment of the borrower's creditworthiness and
ability-to-repay, the support provided by collateral if relied on as
part of the credit decision, and changes to the risk profile of the
purchased loans. A purchasing FCU should not rely on the underwriting
and analysis performed by the seller, or work performed by other third-
party underwriters on behalf of a seller. To do so is an unsafe and
unsound practice.
An FCU can leverage its current internal underwriting policies for
similar loan types when developing its loan purchase policies.
Performing credit and collateral analysis as if it were the originator
should result in purchased loans that are consistent with the board of
director's overall business strategy, risk tolerances, and credit
quality standards. To the extent a purchasing FCU relies on a third
party's credit models for credit decisions, the purchasing FCU should
perform due diligence on the credit model. An FCU is not prohibited
from relying on a qualified and independent third party to perform
model validation. However, the purchasing FCU should review the model
validation to determine if it is sufficient.
The purchasing FCU's internal loan purchase policies should outline
and identify the loan types that are acceptable for purchase. For
example, acceptable loan types could include residential real estate
(1-4 family or multi-family first lien and/or junior lien), solar
loans, automobile loans, student loans, unsecured loans, out-of-
territory loans, commercial loans, or government guaranteed loans
(guaranteed and/or unguaranteed portion).
The loan purchase policy should address the level and depth of the
underwriting and analysis that is required for each loan type permitted
to be purchased based on the specific loan category, type, size,
complexity, and risk profile of the borrower. The proposed rule allows
flexibility to establish those parameters, while providing a basic
framework for FCUs to follow when developing their policies.
Accordingly, proposed Sec. 701.23(b)(6)(iii) would provide that
the purchasing FCU's internal written purchase policies must establish
internal underwriting and ongoing monitoring standards that are
commensurate with the size, scope, type, complexity, and level of risk
posed by the loan purchase activities. Proposed paragraph (b)(6)(iii)
would provide further that underwriting and ongoing monitoring
standards must address the borrower's creditworthiness and ability to
repay, and the support provided by collateral if the collateral was
used as part of the credit decision.
New Sec. 701.23(b)(6)(iv)
Proposed new Sec. 701.23(b)(6)(iv) would provide that the
purchasing FCU's internal written purchase policy must require that the
written purchase agreements include certain language. A well-written
loan purchase agreement can minimize conflicts between the FCU and
other parties to the agreement. The Board believes that any written
loan purchase agreement must clearly delineate the roles, duties, and
obligations of the seller, the purchasing FCU, servicer, and any other
parties associated with the agreement, as applicable. The proposed rule
establishes minimum provisions that any well-written loan purchase
agreement must address.
The written loan purchase agreement is a critical component of any
third-party relationship. In addition to establishing the rights and
obligations of each party to the loan agreement, it should clearly
address how the relationship operates. The written loan purchase
agreement should fully describe the roles and responsibilities of all
parties to the agreement, including any subcontractors. A well-written
loan purchase agreement should address dispute resolution, requirements
for any ongoing credit information if necessary for the loan type,
remedies upon loan default and bankruptcy, identify which party bears
the costs of collateral disposition, whether there are recourse
arrangements for early pay-off, and if there is an obligation for the
purchasing FCU to make any additional purchases or credit advances.
The purchasing FCU's board of directors and management should
understand that it may have limited control over credit decisions for
loans purchased in part, including limitations on the ability of the
purchasing FCU to participate in loan modifications, act on defaulted
loans, or decline to make additional advances if the purchasing FCU
deems such advances are not prudent in relation to the loan quality.
The written loan agreement must address these circumstances, and other
conditions under which the parties to the agreement may replace the
servicer if services are not performed in accordance with the terms of
the written loan purchase agreement. The purchasing FCU must also know
the location and custodian for the original loan documents if the
original loan documents are not required to be transferred to the
purchasing FCU as part of the loan purchase transaction. The purchasing
FCU could be required to provide the original loan documents to various
parties involved in the administration and collection of the purchased
loans. The purchasing FCU would therefore need to know where the
original documents were located and which party to contact should the
purchasing FCU need to obtain the original loan documents.
The written loan purchase agreement must, prior to the loan
purchase transaction, identify the specific loan or loans being
purchased, and the interest being purchased. A loan purchase
transaction may involve a single loan or multiple loans, purchased in
whole or in part. The documentation, for example, can be as simple as
an addendum or schedule identifying each loan, provided the addendum or
schedule is incorporated by reference into the loan purchase agreement.
This provision clarifies in the existing rule that the loan purchase
transaction involves the purchase of individual loans, and it is not
the purchase of an investment interest in a pool of loans. Accordingly,
for all the reasons outlined above, proposed Sec. 701.23(b)(6)(iv)
would provide that the purchasing FCU's internal written purchase
policy must require that the written purchase agreement include: the
specific loans being purchased (either directly in the agreement or
through a document that is incorporated by reference into the
agreement); the location and custodian for the original loan documents;
an explanation of the duties and responsibilities of the seller,
servicer, and all parties with respect to all aspects of the loans
being purchased, including servicing, default, foreclosure, collection,
and other matters involving the ongoing administration of the loans, if
applicable; and the circumstances and conditions under which the
parties to the agreement may replace the servicer when the seller
retains the servicing rights for the loans being purchased, if
applicable.
New Sec. 701.23(b)(6)(v)
Proposed new Sec. 701.23(b)(6)(v) would require that FCUs
establish certain portfolio concentration limits. Excessive
concentration risk can severely impact the financial condition of an
FCU. High
[[Page 80497]]
concentrations in areas experiencing economic distress could result in
significant losses exceeding an FCU's net worth. An FCU's board of
directors and management have the responsibility to identify, manage,
monitor, and control the risks facing the FCU, including concentration
risk. FCU management must know what their concentration risks are and
be able to demonstrate appropriate risk management and mitigation
practices to minimize the risk of significant financial condition
decline. Accordingly, proposed Sec. 701.23(b)(6)(v) would provide that
a purchasing FCU's internal written purchase policies must establish
portfolio concentration limits by loan type and risk category in
relation to net worth that are commensurate with the size, scope, and
complexity of the credit union's loan purchases. Paragraph (b)(6)(v)
would provide further that the policy limits must take into account the
potential impact of loan concentrations on the purchasing credit
union's earnings, loan loss reserves, and net worth.
An FCU's loan purchase policy should establish credit underwriting
and administration requirements that address the risks and
characteristics unique to the loan types permitted for purchase. An
FCU's loan purchase policy concentration limits should be considered
for the aggregate amount of total purchased loans, for each loan type,
risk factor, or category permitted. For example, concentration limits
can be set by loan or collateral type but may also be set by associated
borrower, origination channel, geographic area, or other risk category
as applicable.
An FCU's board of directors should establish concentration risk
limits commensurate with its net worth levels and consider how the
limits fit into the overall strategic plan of the FCU. When credit
union loan portfolios are concentrated in a small number of loan
products that are significantly exposed to similar or correlated risk
factors, a single event can impact a large portion of the loan
portfolio and result in elevated losses that, if not managed
appropriately, can lead to the credit union's failure. Since the year
2000, more than 50 percent of the NCUA's postmortems and material loss
reviews have cited concentration risk as a central component of credit
union failures. An FCU's board of directors should use a comprehensive
perspective when developing loan purchase concentration policy limits,
including identifying outside forces (such as economic or housing price
uncertainty) that would affect the ability to manage concentration
risk. The parameters set by the board of directors should be specific
to each portfolio and should include limits on loan types and third-
party relationship exposure, at a minimum. The concentration risk
limits should correlate to the FCU's overall growth objectives,
financial targets, and net worth plan. The concentration risk limits
set forth in the FCU's policy should be closely linked to those
codified in related policies, including, but not limited to, real
estate loans, member business loans, asset/liability management (ALM),
and investment policies. Concentrations that exceed net worth must be
monitored carefully, and the board of directors should document an
adequate rationale for undertaking that level of risk.\100\
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\100\ See attachment to NCUA Letter to FICUs 10-CU-03 (March
2010) available at <a href="https://www.ncua.gov/files/letters-credit-unions/LCU2010-03Encl.pdf">https://www.ncua.gov/files/letters-credit-unions/LCU2010-03Encl.pdf</a>.
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New Sec. 701.23(b)(6)(vi)
Proposed new Sec. 701.23(b)(6)(vi) would address when a legal
review of agreements or contracts would be required. The written loan
purchase agreement is a critical component of any third-party
relationship and, as such, the requirement for a legal review is a key
element in the overall risk mitigation and management process. By
obtaining legal advice regarding third-party contracts, an FCU can
ensure its legal and business interests are appropriately protected,
and the board of directors and management understand the risks, rights,
and responsibilities of each party to the written loan purchase
agreement. Accordingly, proposed Sec. 701.23(b)(6)(vi) would provide
that an FCU's internal written purchase policy must address when a
legal review of agreements or contracts will be performed to ensure
that the legal and business interests of the credit union are protected
against undue risk.
A legal review of the written loan purchase agreements and
contracts will help an FCU ensure that the board of directors and
management understand the rights and responsibilities of each party.
For example, the review could identify which party bears the costs of
collateral disposition, whether there are recourse arrangements, or
whether the agreement includes a commitment for the purchasing FCU to
make additional loan purchases and describe the interest being
purchased. A legal review may also reduce a credit union's legal,
compliance, or reputation risk by ensuring that the written loan
purchase agreement complies with all applicable state and federal laws.
Further, an FCU should understand what actions it may take if the
contract is breached, or services are not performed as expected. For
example, the legal review could determine if the written loan purchase
agreements include recourse language that requires a seller to buy back
loans with missing documents, made outside of policy, or otherwise not
in conformance with representations and warranties. The written loan
purchase agreement is a critical component of any third-party
relationship and, as such, a legal review is a key element in the
overall risk mitigation and management process.
Section 701.23(c) Sale
The proposal would make a non-substantive conforming change to
current Sec. 701.23(c)(1). In addition, the proposal would make
certain substantive changes to paragraph (c)(2) and add new paragraphs
(c)(3) and (4), which are discussed in more detail in the following
paragraphs. No changes would be made in the introductory sentence to
current Sec. 701.23(c).
Section 701.23(c)(1)
As required by the changes discussed below, proposed Sec.
701.23(c)(1) would make a conforming amendment to current Sec.
701.23(c)(1). The conforming amendment would remove the ``and'' at the
end of the provision to allow for an additional provision to be added
under Sec. 701.23(c)(2). No substantive change to this provision is
intended.
Section 701.23(c)(2)
The proposal would amend current Sec. 701.23(c)(2) to change the
retention requirements for the written agreement and schedule of
eligible obligations sold by an FCU. The Board believes that this would
result in only a minor technical change to current Sec. 701.23(c)(2).
Under the proposed rule, the FCU selling the eligible obligations would
still be required to retain the written loan sales agreement and a
schedule of the eligible obligations covered by the agreement. The
Board acknowledges the requirement for the FCU to retain the written
loan sales agreement and schedule of the eligible obligations in the
seller's office could imply that the written loan sales agreement and
schedule be retained in a hard-copy format, which is outdated given the
current digital environment. An FCU might choose to store its records
in electronic format, in the cloud, or housed in off-site servers or
databases.
This proposed change would align this requirement with the NCUA's
regulations and guidelines for FICUs on records preservation programs.
Under
[[Page 80498]]
part 749, the NCUA does not require or recommend a particular format
for record retention. If the credit union stores records on microfilm,
microfiche, or in an electronic format, the stored records must be
accurate, reproducible, and accessible to an NCUA examiner.\101\ If
records are stored on the credit union premises, they should be
immediately accessible upon the examiner's request; if records are
stored by a third party or off site, then they should be made available
to the examiner within a reasonable time after the examiner's request.
The credit union must maintain the necessary equipment or software to
permit an examiner to review and reproduce stored records upon request.
The credit union should also ensure that the reproduction is acceptable
for submission as evidence in a legal proceeding.\102\ Accordingly,
proposed Sec. 701.23(c)(2) would provide that a written agreement, and
a schedule of the eligible obligations covered by the agreement, is
retained by the selling credit union that identifies the specific loans
being sold either directly in the agreement or through a document that
is incorporated by reference into the agreement.
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\101\ See 12 CFR 749.5.
\102\ See generally part 749; and NCUA Legal Op. 07-0812 (Jan.
2008), available at <a href="https://www.ncua.gov/regulation-supervision/legal-opinions/2008/electronic-retention-records">https://www.ncua.gov/regulation-supervision/legal-opinions/2008/electronic-retention-records</a>.
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New Sec. 701.23(c)(3)
The proposal would add new paragraph (c)(3) to Sec. 701.23 to
require a legal review of the written agreement to protect the legal
and business interests of the selling FCU. A legal review of the
written loan sales agreements and contracts will help an FCU ensure
that the board of directors and management understand the rights and
responsibilities of each party. For example, the legal review would
make clear which party bears the costs of collateral disposition,
whether there are recourse arrangements, whether the agreement includes
a commitment for the purchasing credit union to make additional loan
purchases, and whether it describes the interest being purchased. The
legal review would also ensure that the written loan sales agreement
complies with all applicable state and federal laws, helping to
minimize a credit union's legal, compliance, and reputation risk. The
legal review should address loan and collateral documentation and
information that the selling party is required to share with the
purchasing party, status reports on payments and interest accrual, exit
strategies, procedures for modifying loan terms, notification of
adverse loan events, and collection procedures if servicing rights are
retained by the seller. Further, an FCU should understand what actions
it may take if the contract is breached or services are not performed
as expected. The written loan sales agreement is a critical component
of any third-party relationship and, as such, the requirement for a
legal review is a key element in the overall risk mitigation and
management process.
Accordingly, proposed Sec. 701.23(c)(3) would require a legal
review of the written agreement is completed that includes the terms,
recourse, and risk-sharing arrangements, and, as applicable, loan
administration and controls, to ensure that the selling FCU's legal and
business interests are protected from undue risks.
Section 701.23(d) Pledge
The proposed rule would amend current Sec. 701.23(d)(1)(iii) to
amend the retention requirements for agreements covering eligible
obligations pledged by an FCU. The Board believes that this would
result in only a minor technical change to current Sec.
701.23(d)(1)(iii). Under the proposed rule, the FCU pledging the
eligible obligations would still be required to retain the written
agreement covering the pledging arrangement. The Board acknowledges the
requirement for the FCU that pledges the eligible obligations to retain
the written agreement in the office could imply that the written
agreement should be retained in a hard-copy format, which is outdated
given the current digital environment. An FCU might choose to store its
records in electronic format, in the cloud, or housed in off-site
servers or databases. The Board's intent is that the FCU that pledges
the eligible obligations make the written agreement covering the
pledging arrangement available upon request.\103\
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\103\ See Sec. 749.2.
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This proposed change would align this requirement with the NCUA's
regulations and guidelines for FICUs on records preservation programs.
Under part 749, the NCUA does not require or recommend a particular
format for record retention. If the credit union stores records on
microfilm, microfiche, or in an electronic format, the stored records
must be accurate, reproducible, and accessible to an NCUA
examiner.\104\ If records are stored on the credit union premises, they
should be immediately accessible upon the examiner's request; if
records are stored by a third party or off site, then they should be
made available to the examiner within a reasonable time after the
examiner's request. The credit union must maintain the necessary
equipment or software to permit an examiner to review and reproduce
stored records upon request. The credit union should also ensure that
the reproduction is acceptable for submission as evidence in a legal
proceeding.\105\
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\104\ See 12 CFR 749.5.
\105\ See generally part 749; and NCUA Legal Op. 07-0812 (Jan.
2008), available at <a href="https://www.ncua.gov/regulation-supervision/legal-opinions/2008/electronic-retention-records">https://www.ncua.gov/regulation-supervision/legal-opinions/2008/electronic-retention-records</a>.
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Accordingly, proposed Sec. 701.23(d)(1)(iii) would require that a
written agreement covering the pledging arrangement is retained by the
credit union that pledges the eligible obligations.
Section 701.23(g) Payments and Compensation
The proposed rule would amend current Sec. 701.23(g) by adding a
paragraph heading. The Board believes that this would result in only a
minor technical change to paragraph (g). The amended rule would add the
three-word descriptive heading ``payments and compensation'' for this
section of the rule, but does not add any additional requirements or
make any other changes to this section of this rule. Accordingly,
proposed Sec. 701.23(g) would have the paragraph heading ``payments
and compensation.''
Section 701.23(i) Temporary Regulatory Relief in Response to COVID-19
The proposed rule would not extend the regulatory relief in Sec.
701.23(i) that the Board approved in April of 2020 in response to
COVID-19. This temporary relief is set to sunset on December 31, 2022.
Current paragraph (i) provides that: notwithstanding Sec. 701.23(b),
during the period commencing on April 21, 2020, and concluding on
December 31, 2022, an FCU may: purchase, in whole or in part, and
within the limitations of the board of directors' written purchase
policies, any eligible obligations pursuant to paragraph (b)(1)(i) and
(b)(2)(i) without regard to whether they are loans the credit union is
empowered to grant or are refinancing to ensure the obligations are
ones the purchasing credit union is empowered to grant; and purchase
and hold the obligations described in Sec. 701.23(b)(2)(i) through
(iv) if the FCU's CAMELS composite rating is ``1,'' ``2,'' or
``3''.\106\
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\106\ Emphasis added.
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As provided in current paragraph (i), the temporary regulatory
relief provided under the paragraph expires on December 31, 2022. The
Board temporarily modified certain regulatory
[[Page 80499]]
requirements to help ensure that FICUs remained operational and liquid
during the COVID-19 pandemic. The Board concluded, at the time, that
the amendments would provide FICUs with the necessary flexibility in a
manner consistent with the NCUA's responsibility to maintain the safety
and soundness of the credit union system. The Board provided this
temporary regulatory relief to assist credit unions in navigating the
national emergency resulting from the COVID-19 pandemic.\107\ Since the
implementation of temporary regulatory relief, many credit unions have
generally resumed normal, pre-pandemic operations. The majority of the
COVID-19 pandemic health mitigation efforts imposed by states as well
as the federal government have been lifted (non-essential business
closures, social distancing requirements, and mask mandates).
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\107\ See 85 FR 22010 (April 21, 2020).
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The expiration date of the temporary final rule was initially
extended through the close of December 31, 2021, by publishing the
extension in the Federal Register on December 22, 2020.\108\ Due to the
continued impact of COVID-19, the Board decided it was necessary to
further extend the effective period of these temporary modifications
until December 31, 2022, by publishing the extension in the Federal
Register on December 22, 2021.\109\ The Board is proposing to remove
current paragraph (i) from Sec. 701.23 as part of any final rule
issued after December 31, 2022.
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\108\ See Id.
\109\ 85 FR 22010.
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B. Part 714--Leasing
Section 714.9 [Removed and Reserved]
Current Sec. 714.9 provides that the indirect leasing arrangements
of an FCU are not subject to the eligible obligation limit if they
satisfy the provisions of Sec. 701.23(b)(3)(iv) that require that FCUs
make the final underwriting decision and that the lease contract is
assigned to the FCU very soon after it is signed by the member and the
dealer or leasing company. The reference in current Sec. 714.9 cites
to Sec. 701.23(b)(3)(iv), but there is no paragraph (b)(3)(iv) in that
section. It is clear from the ``eligible obligations limit'' language
in current Sec. 714.9, however, that the cross citation is intended to
reference the exclusion from the 5-percent limitation in current Sec.
701.23(b)(4)(iv). Because this proposal would amend Sec. 701.23(b)(4)
to remove paragraph (b)(4)(iv) and would no longer apply the 5-percent
limitation to any purchases of eligible obligations, as explained
earlier in the preamble, current Sec. 714.9 would be rendered moot by
this proposal. Accordingly, this proposal would remove the language in
current Sec. 714.9 and reserve the blank section for future use.
The Board seeks comments specifically on the placement of the
definition of indirect leasing arrangement in the NCUA's regulations.
The proposed definition would apply throughout the NCUA's regulations
and is being proposed for inclusion in Sec. 701.21 alongside the
related definition of indirect lending arrangement that the Board is
proposing to add to new Sec. 701.21(c)(9)(i). The Board requests
comments on whether stakeholders would find it clearer or more user-
friendly to codify this definition in part 714.
IV. Regulatory Procedures
Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) generally requires that, in
connection with a notice of proposed rulemaking, an agency prepare and
make available for public comment an initial regulatory flexibility
analysis that describes the impact of a proposed rule on small
entities. A regulatory flexibility analysis is not required, however,
if the agency certifies that the rule will not have a significant
economic impact on a substantial number of small entities (defined for
purposes of the RFA to include credit unions with assets less than $100
million) \110\ and publishes its certification and a short, explanatory
statement in the Federal Register together with the rule.
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\110\ See 80 FR 57512 (Sept. 24, 2015).
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The Board fully considered the potential economic impact of the
proposed changes during the development of the proposed rule. As noted
in the preamble, the proposed rules would clarify the NCUA's current
regulations and provide additional flexibilities to FICUs, making it
easier to take advantage of advanced technologies and opportunities
offered by the fintech sector.
The proposed rule would not impose any new significant burden on
FICUs and may ease some existing requirements. Small FICUs are not
obligated to buy and sell eligible obligations and loan participations.
Additionally, while the proposed rule introduces risk management and
due diligence policy expectations, FICUs have the flexibility to tailor
required processes and policies to fit within their existing governance
framework and commensurate with their size and complexity. Accordingly,
the NCUA certifies that it would not have a significant economic impact
on a substantial number of small FICUs.
Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in
which an agency by rule creates a new paperwork burden on regulated
entities or modifies an existing burden.\111\ For purposes of the PRA,
a paperwork burden may take the form of a reporting, disclosure, or
recordkeeping requirement, each referred to as an information
collection. The NCUA may not conduct or sponsor, and the respondent is
not required to respond to, an information collection unless it
displays a currently valid Office of Management and Budget (OMB)
control number.
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\111\ 44 U.S.C. 3507(d).
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The rule as previously published contains an information collection
in the form of a written policy requirement and a transaction
documentation requirement, covered by OMB control numbers 3133-0127 and
3133-0141. The proposed changes to part 701 would not result in a
change in burden, and there are no new information collection
requirements associated with this proposed rule.
Executive Order 13132
Executive Order 13132 encourages independent regulatory agencies to
consider the impact of their actions on state and local interests. The
NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5),
voluntarily complies with the principles of the executive order to
adhere to fundamental federalism principles. This proposed rule would
reduce regulatory burdens on, and expand the authority of, federally
insured credit unions, including federally insured, state-chartered
natural-person credit unions to purchase certain loans and loan
participations. It may have, to some degree, a direct effect on the
states, on the relationship between the National Government and the
states, or on the distribution of power and responsibilities among the
various levels of government. It does not, however, rise to the level
of material impact for purposed of Executive Order 13132.
Assessment of Federal Regulations and Policies on Families
The NCUA has determined that this proposed rule will not affect
family well-being within the meaning of section 654 of the Treasury and
General Government Appropriations Act, 1999,
[[Page 80500]]
Public Law 105-277, 112 Stat. 2681 (1998).
List of Subjects
12 CFR Part 701
Advertising, Aged, Civil rights, Credit, Credit unions, Fair
housing, Individuals with disabilities, Insurance, Marital status
discrimination, Mortgages, Religious discrimination, Reporting and
recordkeeping requirements, Sex discrimination, Signs and symbols,
Surety bonds.
12 CFR Part 714
Credit unions, Leasing, Reporting and recording keeping
requirements.
By the National Credit Union Administration Board on December
15, 2022.
Melane Conyers-Ausbrooks,
Secretary of the Board.
For the reasons discussed above, the Board proposes to amend 12 CFR
parts 701 and 714 as follows:
PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS
0
1. The authority citation for part 701 continues to read as follows:
Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1758, 1759,
1761a, 1761b, 1766, 1767, 1782, 1784, 1785, 1786, 1787, 1788, 1789.
Section 701.6 is also authorized by 15 U.S.C. 3717. Section 701.31
is also authorized by 15 U.S.C. 1601 et seq.; 42 U.S.C. 1981 and
3601-3610. Section 701.35 is also authorized by 42 U.S.C. 4311-4312.
0
2. Amend Sec. 701.21 by adding paragraph (c)(9) to read as follows:
Sec. 701.21 Loans to members and lines of credit to members.
* * * * *
(c) * * *
(9) Indirect lending and indirect leasing arrangements--(i)
Definitions. For purposes of this chapter, the following definitions
apply:
Indirect leasing arrangement means a written agreement to purchase
leases from the leasing company where the purchaser makes the final
underwriting decision, and the lease agreement is assigned to the
purchaser very soon after it is signed by the member and the leasing
company.
Indirect lending arrangement means a written agreement to purchase
loans from the loan originator where the purchaser makes the final
underwriting decision regarding making the loan, and the loan is
assigned to the purchaser very soon after the inception of the
obligation to extend credit.
(ii) Indirect lending. A loan acquired pursuant to an indirect
lending arrangement, and that meets the requirements of this section,
is classified as a loan and not the purchase of a loan for purposes of
this chapter.
(iii) Indirect leasing. A lease acquired pursuant to an indirect
leasing arrangement, and that meets the requirements of part 714 of
this chapter, is classified as a lease and not the purchase of a lease
for purposes of this chapter.
* * * * *
0
3. Amend Sec. 701.22 by:
0
a. Revising the introductory text; and
0
b. Revising the definition of ``Originating lender'' in paragraph (a).
The revisions read as follows:
Sec. 701.22 Loan participations.
This section applies only to loan participations as defined in
paragraph (a) of this section. It does not apply to the purchase of an
investment interest in a pool of loans. This section establishes the
requirements a federally insured credit union must satisfy to purchase
a participation in a loan. Federally insured state-chartered credit
unions are required by Sec. 741.225 of this chapter to comply with the
loan participation requirements of this section. This section does not
apply to corporate credit unions, as that term is defined in Sec.
704.2 of this chapter.
(a) * * *
Originating lender means the participant with which the borrower
initially or originally contracts for a loan and who, thereafter or
concurrently with the funding of the loan, sells participations to
other lenders. Originating lender includes a participant that acquires
a loan through an indirect lending arrangement as defined under Sec.
701.21(c)(9).
* * * * *
0
4. Amend Sec. 701.23 by:
0
a. Revising the introductory text, paragraph (a), the heading to
paragraph (b), and paragraph (b)(1)(ii);
0
b. Removing the word ``mortage'' from the first sentence in paragraph
(b)(1)(iv) and adding in its place the word ``mortgage'';
0
c. Revising paragraphs (b)(2) introductory text, (b)(2)(ii),
(b)(3)(ii), and (b)(4) and (5);
0
d. Adding paragraph (b)(6);
0
e. Revising paragraphs (c)(1) and (2);
0
f. Adding paragraph (c)(3);
0
g. Revising paragraph (d)(1)(iii); and
0
h. Adding a heading to paragraph (g).
The revisions and additions read as follows:
Sec. 701.23 Purchase, sale, and pledge of loans.
This section governs a Federal credit union's purchase, sale, or
pledge of all or part of a loan to one of its own members, subject to
certain exceptions. For purchases of eligible obligations, except as
otherwise described under paragraph (b) of this section, the borrower
must be a member of the purchasing Federal credit union before the
purchase is made.
(a) Definitions. For purposes of this section:
Eligible obligation means a whole loan or part of a loan (other
than a note held by a liquidating credit union) that does not meet the
definition of a loan participation under Sec. 701.22(a).
Liquidating credit union means:
(i) In the case of a voluntary liquidation, a credit union is a
liquidating credit union as of the date the members vote to approve
liquidation.
(ii) In the case of an involuntary liquidation, a credit union is a
liquidating credit union as of the date the board of directors is
served an order of liquidation issued by either the NCUA or the state
supervisory authority.
Student loan means a loan granted to finance the borrower's
attendance at an institution of higher education or at a vocational
school, which is secured by and on which payment of the outstanding
principal and interest has been deferred in accordance with the
insurance or guarantee of the Federal Government, of a state
government, or any agency of either.
(b) Purchase of loans. (1) * * *
(ii) Notes of a liquidating credit union's individual members, from
the liquidating credit union;
* * * * *
(2) Purchases of obligations from a FICU. A Federal credit union
may purchase and hold the following obligations, provided that it would
be empowered to grant them:
* * * * *
(ii) Notes of a liquidating credit union. Notes of a liquidating
credit union, without regard to whether they are notes of the
liquidating credit union's members;
* * * * *
(3) * * *
(ii) A written agreement and a schedule of the eligible obligations
covered by the agreement are retained by the purchaser; and
* * * * *
(4) The aggregate of the unpaid balance of notes purchased under
paragraphs (b)(1)(ii) and (b)(2)(ii) of this section shall not exceed 5
percent of the unimpaired capital and surplus of the purchaser.
(5) Subject to safety and soundness considerations, a Federal
credit union
[[Page 80501]]
may hold any of the loans described in paragraph (b) of this section
that were acquired before [EFFECTIVE DATE OF THE FINAL RULE]; provided
the transaction was in compliance with this section at the time the
transaction was executed.
(6) Purchases of eligible obligations and notes of liquidating
credit unions must comply with the purchasing Federal credit union's
internal written purchase policies, which must:
(i) Require that the purchasing Federal credit union conduct due
diligence on the seller of the loans and other counterparties to the
transaction prior to the purchase.
(ii) Establish risk assessment and risk management process
requirements that are commensurate with the size, scope, type,
complexity, and level of risk posed by the planned loan purchase
activities.
(iii) Establish internal underwriting and ongoing monitoring
standards that are commensurate with the size, scope, type, complexity,
and level of risk posed by the loan purchase activities. Underwriting
and ongoing monitoring standards must address the borrower's
creditworthiness and ability to repay, and the support provided by
collateral if the collateral was used as part of the credit decision.
(iv) Require that the written purchase agreement include:
(A) The specific loans being purchased (either directly in the
agreement or through a document that is incorporated by reference into
the agreement);
(B) The location and custodian for the original loan documents;
(C) An explanation of the duties and responsibilities of the
seller, servicer, and all parties with respect to all aspects of the
loans being purchased, including servicing, default, foreclosure,
collection, and other matters involving the ongoing administration of
the loans, if applicable; and
(D) The circumstances and conditions under which the parties to the
agreement may replace the servicer when the seller retains the
servicing rights for the loans being purchased, if applicable.
(v) Establish portfolio concentration limits by loan type and risk
category in relation to net worth that are commensurate with the size,
scope, and complexity of the credit union's loan purchases. The policy
limits must take into account the potential impact of loan
concentrations on the purchasing credit union's earnings, loan loss
reserves, and net worth.
(vi) Address when a legal review of agreements or contracts will be
performed to ensure that the legal and business interests of the credit
union are protected against undue risk.
(c) * * *
(1) The board of directors or investment committee approves the
sale;
(2) A written agreement, and a schedule of the eligible obligations
covered by the agreement, is retained by the selling credit union that
identifies the specific loans being sold either directly in the
agreement or through a document that is incorporated by reference into
the agreement; and
(3) A legal review of the written agreement is completed that
includes the terms, recourse, and risk-sharing arrangements, and, as
applicable, loan administration and controls, to ensure that the
selling Federal credit union's legal and business interests are
protected from undue risks.
(d) * * *
(1) * * *
(iii) A written agreement covering the pledging arrangement is
retained by the credit union that pledges the eligible obligations.
* * * * *
(g) Payments and compensation-- * * *
* * * * *
PART 714--LEASING
0
5. The authority citation for part 714 continues to read as follows:
Authority: 12 U.S.C. 1756, 1757, 1766, 1785, 1789.
Sec. 714.9 [Removed and Reserved]
0
6. Remove and reserve Sec. 714.9.
[FR Doc. 2022-27607 Filed 12-29-22; 8:45 am]
BILLING CODE 7535-01-P
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</html>Indexed from Federal Register on December 30, 2022.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.