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Rule2023-20950

Financial Innovation: Loan Participations, Eligible Obligations, and Notes of Liquidating Credit Unions

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Published

September 29, 2023

Effective

October 30, 2023

Issuing agencies

National Credit Union Administration

Abstract

The NCUA Board (Board) is amending the NCUA's regulations 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 final rule clarifies the NCUA's current regulations and provides additional flexibility for federally insured credit unions (FICUs) to make use of advanced technologies and opportunities offered by the financial technology (fintech) sector. The final rule also amends 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 final rule makes certain conforming changes and technical amendments to the NCUA's regulations. The Board does not view the conforming changes and technical amendments as substantive.

Full Text

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<title>Federal Register, Volume 88 Issue 188 (Friday, September 29, 2023)</title>
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[Federal Register Volume 88, Number 188 (Friday, September 29, 2023)]
[Rules and Regulations]
[Pages 67570-67601]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-20950]

[[Page 67569]]

Vol. 88

Friday,

No. 188

September 29, 2023

Part IV

National Credit Union Administration

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12 CFR Parts 701 and 714

Financial Innovation: Loan Participations, Eligible Obligations, and
Notes of Liquidating Credit Unions; Final Rule

Federal Register / Vol. 88, No. 188 / Friday, September 29, 2023 /
Rules and Regulations

[[Page 67570]]

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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: Final rule.

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SUMMARY: The NCUA Board (Board) is amending the NCUA's regulations
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 final rule clarifies the NCUA's current
regulations and provides additional flexibility for federally insured
credit unions (FICUs) to make use of advanced technologies and
opportunities offered by the financial technology (fintech) sector. The
final rule also amends 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
final rule makes certain conforming changes and technical amendments to
the NCUA's regulations. The Board does not view the conforming changes
and technical amendments as substantive.

DATES: This final rule is effective October 30, 2023.

FOR FURTHER INFORMATION CONTACT: For policy questions: Naghi Khaled,
Director of Credit Markets, the 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. Background

A. Introduction

On December 30, 2022, the Board issued a proposed rule 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 notes of liquidating credit unions).\1\ The Board intended
the proposal to provide FICUs with additional flexibility to make use
of advanced technologies and opportunities offered by the fintech
sector. In addition, the proposed amendments were intended to clarify
ambiguities related to loan participations and eligible obligations and
shift from a prescriptive to a more principles-based approach in
certain areas.
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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 federal credit unions (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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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. The intent behind the
final rule is to advance the NCUA'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 by
removing certain prescriptive limits and other qualifying conditions,
and replacing them with risk-focused, principles-based requirements.
The proposed shift to more principles-based requirements is intended to
provide FICUs with additional flexibility to innovate in terms of how
they manage their balance sheets while offering new or enhanced
services to their members. The Board believes the proposed changes will
increase FICUs' ability to engage in lending arrangements with other
financial institutions and third parties, including fintech companies
providing lending services, and expand their access to diverse loan
origination channels, new markets, including the underserved, and
potential new services for their members.

B. Summary of the Final Rule

The Board is now amending the NCUA's regulations 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 final rule adopts the amendments largely as
proposed with a few changes, which are discussed in the section-by-
section analysis of the preamble below. The final rule relocates and
clarifies the NCUA's provisions regarding indirect lending and indirect
leasing. The final rule also provides credit unions with additional
flexibility to participate in loans acquired through indirect lending
arrangements, allowing FICUs to use advanced technologies and
opportunities offered by the fintech sector. In addition, the final
rule removes certain prescriptive limitations and other qualifying
requirements relating to eligible obligations and provides credit
unions with additional flexibility to purchase eligible obligations of
their members.
Removing the prescriptive limitations and other qualifying
requirements is intended to allow 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 provided they are safe and
sound given the FCU's financial and operational capabilities, 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.
As discussed in greater detail in the section-by-section analysis
of the preamble, the final rule amends Sec. 701.21 of the NCUA's
regulations to add new paragraph (c)(9) regarding indirect lending and
indirect leasing arrangements. The new paragraph replaces the language
defining indirect lending and indirect leasing arrangements under
current Sec. 701.23(b)(4)(iv).
The final rule also amends Sec. 701.22 of the NCUA's regulations.
In particular, the final rule makes certain clarifying amendments to
the introductory paragraph, and codifies NCUA Legal Opinion 15-0813,
Loan Participations in Indirect Loans--Originating Lender.\2\ The
codification of Legal Opinion 15-0813 clarifies that a FICU engaged in
an indirect lending relationship can meet the definition of
``originating lender'' under Sec. 701.22 of the NCUA's regulations,
provided the FICU meets certain conditions. For purposes of Sec.
701.22, a FICU is considered the originating lender 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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In addition, the final rule amends Sec. 701.23 of the NCUA's
current regulations as follows:
<bullet> Makes clarifying and conforming amendments to the
introductory paragraph.
<bullet> Removes the CAMELS ratings and well-capitalized
requirements under

[[Page 67571]]

paragraph (b)(2) for FCU purchases of certain non-member loans from
FICUs.
<bullet> Narrows the application of the 5-percent limit on the
purchase of eligible obligations to cover only purchases of notes of
liquidating credit unions.
<bullet> Adds safety and soundness requirements to paragraph
(b)(6)(i)-(vi) concerning the purchase of eligible obligations, to
offset risks associated with removing the CAMELS ratings and well-
capitalized requirements from paragraph (b)(2). Safety and soundness
requirements would apply to all FCUs engaged in the purchase of
eligible obligations and notes from a liquidating credit union. In
particular, the final rule requires an FCU purchasing eligible
obligations or notes from a liquidating credit union to comply with the
following:
[cir] Establish written, board-approved policies, risk assessments,
and risk management processes 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 portfolio concentration limits by loan
types and risk categories in relation to net worth;
[cir] Conduct due diligence on a seller prior to a purchase;
[cir] Include certain contract language and provisions in the
written loan purchase agreements (similar to the standards currently
established for loan participation agreements under Sec. 701.22 of the
NCUA's regulations); and
[cir] Address in internal written purchase policies 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.
<bullet> Revises the definition of ``eligible obligation'' under
paragraph (a)(1) to clarify the distinction between transactions
treated as loan participations and those treated as eligible
obligations.
<bullet> Revises the applicability of the 5-percent limitation
under current paragraph (b)(4) to cover only ``notes'' purchased by an
FCU from a liquidating credit union.
<bullet> Revises the ``grandfathered purchases'' section to include
eligible obligation purchases that were executed before the effective
date of this final rule, provided the purchases complied with the
version of the rule that was effective at the time the transaction was
executed, and subject to safety and soundness and other compliance
considerations.
<bullet> Adds safety and soundness requirements to paragraph (c)
concerning the sale of eligible obligations, requiring the selling FCU
to do the following:
[cir] Obtain a 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 incorporated by
reference into the loan sale agreement.
The final rule also amends Sec. 714.9 of the NCUA's regulations to
make certain non-substantive amendments related to changes to current
Sec. 701.23(b)(4)(iv).
Finally, the final rule also makes certain 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.

C. Effective Date

Under the Administrative Procedure Act, the NCUA is generally
required to provide a minimum of 30 days from the date of publication
in the Federal Register before a final rule becomes effective.\3\ The
final rule will become effective 30 days after the date of publication
in the Federal Register so it can go into effect as quickly as possible
to give credit unions prompt access to the numerous beneficial changes
it makes.
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\3\ 5 U.S.C. 553(d).
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II. Legal Authority

Section 120(a) \4\ of the Federal Credit Union Act (Act) authorizes
the Board to prescribe rules and regulations for the administration of
the Act.\5\ Similarly, section 209 \6\ of the 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 Act provides the Board
with broad authority to take enforcement action against a FICU or an
``institution-affiliated party'' \7\ that is engaging or has engaged,
or the Board has reasonable cause to believe is about to engage, in an
unsafe or unsound practice in conducting the business of such credit
union.\8\ Congress chose not to define ``unsafe or unsound practices''
in the Act, leaving determinations regarding which actions are unsafe
or unsound to the Board.
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\4\ 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.).
\5\ Sections 1751[dash]1795k.
\6\ 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].'').
\7\ 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.).
\8\ Section 1786.
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Section 107(5)(E) of the 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 credit union's board of directors.\9\ Section 107(5)(E)
also provides that an FCU 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.\10\
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\9\ Section 1757(5)(e).
\10\ Id.
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Section 107(13) of the 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.\11\ 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

[[Page 67572]]

under authority of this paragraph would exceed 5 per centum of the
unimpaired capital and surplus of the credit union.\12\
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\11\ Section 1757(13).
\12\ Id.
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Section 107(14) of the Act authorizes FCUs, subject to regulations
of the Board, to sell all or a part of their 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.\13\
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\13\ Section 1757(14).
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III. Section-by-Section Analysis of the Final Rule and Comments on the
Proposal

The NCUA received 42 unique comment letters on the proposed rule.
In general, the overwhelming majority of commenters strongly supported
the proposed rule and agreed with the NCUA regarding the need for and
the rationale supporting the proposed changes. The commenters also
agreed with the proposal's shift toward more principles-based
regulations and suggested the proposed changes would allow credit
unions to be nimble in the future. Accordingly, the Board is now
issuing this final rule to adopt the amendments proposed with certain
changes that are discussed in more detail in the parts of the preamble
below corresponding with the amended sections.
The NCUA has summarized the comments received that were within the
scope of this rulemaking under the parts of the preamble below
corresponding with the amended sections and subsections. The NCUA
received many comments that were outside the scope of this rulemaking.
The NCUA has read and is considering the comments beyond the scope of
this rule for future rulemakings. Most of the comments received that go
beyond the scope of the proposal, even if summarized, are not
specifically responded to by the NCUA in the preamble to this final
rule.

A. Part 701 Organization and Operation of Federal Credit Unions

As discussed in more detail below, this final rule makes several
changes to sections in part 701 of the NCUA's regulations. These
changes 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 final rule amends the
NCUA's current regulatory requirements under Sec. Sec. 701.22 and
701.23. The amended requirements would provide FICUs 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 FICUs.
Public Comments
Several commenters noted that the proposed changes would clarify
credit unions' loan participation and eligible obligation authorities,
benefiting not only credit unions but also NCUA examiners and various
other stakeholders. In addition, many commenters expressly offered
support for the proposal's general shift toward a more principles-based
approach with respect to the NCUA's loan participation and eligible
obligation regulations. One commenter suggested that prescriptive
regulations, with fixed limits and rules, prevent credit unions from
evolving with shifting market forces (e.g., the rise of fintechs). The
commenter explained further that a principles-based approach to risk
tolerance and appetite will provide the opportunity for credit union
service organizations (CUSOs) to create comprehensive underwriting
guidelines acceptable to all participating credit unions, which will
allow credit unions to collectively compete against banks and other
financial institutions and be more attractive to lending platform
providers, original automotive equipment manufacturers, and point of
sale retailers. Another commenter specifically asked that the Board not
adopt new prescriptive definitions and regulations. The commenter
requested further that all safety and soundness standards imposed in
the final rule should be sufficiently flexible to permit credit unions
to adopt internal written purchase policy provisions commensurate with
the size, scope, type, complexity, and level of risk posed by their
individual activities. Several commenters requested, generally, that
the NCUA do more to clarify the rules, expand credit unions' authority
in this area, or both.
Discussion
Consistent with the strong support received from commenters, the
Board is adopting the rule largely as proposed, for the reasons set
forth in the notice of proposed rulemaking, with certain changes
discussed in the section-by-section analysis below. In addition,
several commenters requested additional clarification on certain
aspects of the proposal. The NCUA has provided further clarifying
guidance to credit unions where appropriate.

Section 701.21 Loans to Members and Lines of Credit to Members

Section 701.21(c) General Rules

As discussed in more detail below, this final rule, as a conforming
amendment, adds new provisions to Sec. 701.21 regarding indirect
lending arrangements and indirect leasing arrangements. The new
provisions take the place of a provision in current Sec. 701.23, which
will be removed as part of this final rule.
Public Comments
Most commenters offered support for the proposed changes to the
NCUA's regulations regarding indirect lending and indirect leasing
arrangements, agreed the proposed changes would provide additional
clarification to affected parties, and supported moving the provisions
to Sec. 701.21. Moreover, three commenters agreed with the NCUA's
assessment that the proposed changes to the definitions of ``indirect
lending arrangements'' and ``indirect leasing arrangements'' are
unlikely to have a material impact on credit unions' existing and
future indirect lending or indirect leasing arrangements. Another
commenter agreed that the proposed definitions use language that, while
generally similar to the language in current Sec. 701.23(b)(4)(iv),
provides much needed, common-sense clarification to both terms.
Discussion
Consistent with the support received from commenters on the
proposal, the Board is adopting new paragraph (c)(9) to Sec. 701.21
regarding the indirect loans and indirect leasing arrangements as
proposed for the reasons set forth in the notice of proposed
rulemaking. Although not raised by commenters, the final rule also adds
language and a cross citation to Sec. 714.2(b) to direct readers to
new Sec. 701.21(c)(9) and alert them to the relationship between
paragraph (c)(9) and part 714 of the NCUA's regulations regarding
leasing. No substantive change to the NCUA's regulations is intended by
this addition. This addition is discussed in more detail in the part of
the preamble associated with part 714 of the final rule.

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 deleting current paragraph (b)(4)(iv)
regarding indirect lending. Current Sec. 701.23(b)(4)(iv) excludes
certain loans acquired through indirect lending arrangements and
indirect leasing arrangements from the 5-percent

[[Page 67573]]

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 is
no longer 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,\14\ 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 adding new paragraph (c)(9) regarding
indirect lending and indirect leasing arrangements to Sec. 701.21. The
paragraph replaces the language defining indirect lending and indirect
leasing arrangements under current Sec. 701.23(b)(4)(iv).
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\14\ 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

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, new Sec. 701.21(c)(9)(i) provides 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. 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 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 revising 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 amendments are not
intended to change the current meaning of both terms. The Board
specifically requested 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.
Public Comments
One commenter recommended clarifying the meaning of the phrase
``inception of the obligation to extend credit.'' The commenter asked,
as an example of its confusion about the meaning of the phrase, does
this mean when the credit union verifies underwriting criteria, when
the borrower has a sufficient credit score according to the credit
union, or some other step in the process of extending credit?
Discussion
The Board believes the phrase ``inception of the obligation to
extend credit'' is clear and unambiguous. Merriam-Webster's Online
Dictionary defines the term ``inception'' as ``an act, process, or
instance of beginning: COMMENCEMENT.'' \15\ The inception of the
obligation to extend credit, then, is the point in time when the
indirect lender becomes obligated to extend credit to the borrower. As
with all its rules, however, the Board will monitor implementation and
provide additional clarifying guidance as it deems necessary.
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\15\ Available at <a href="https://www.merriam-webster.com/dictionary/inception">https://www.merriam-webster.com/dictionary/inception</a>.
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Should the Board further clarify the term ``final underwriting
decision''? The Board invited comments in the proposal 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 rule specify that a credit union in an indirect lending arrangement
must be involved or consulted at the time of the extension of credit?
In the alternative, should the rule specify that a credit union can
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?
Public Comments
In response to NCUA's question in the proposed rule preamble, two
commenters responded that the NCUA should not define the phrase ``final
underwriting decision.'' One of those commenters explained that the
implementation of additional requirements through a definition could
stifle innovation as new products are created and/or create unintended
regulatory burden that may be unnecessary due to the specifics of the
underwriting situation. Another commenter responded that, if the credit
union has provided its guidelines or other underwriting criteria and
has the ability to not approve or not fund a loan that does not meet
its criteria, there is no need to make the definition more specific. A
third commenter suggested that the current safety and soundness
requirements are sufficient to enable a credit union to identify,
isolate, and resolve any issues the credit union may later discover.
On the other hand, two commenters asked that the NCUA define the
phrase ``final underwriting decision.'' One of those commenters
recommended the phrase be defined to avoid ambiguity or potential
conflict with existing laws and regulations that require the loan
originator to make the final underwriting decision, and situations
involving prearranged underwriting and processing agreements between
third-party originators and the purchasing credit unions. The commenter
recommended further that the definition allow the seller (loan
originator) to use the purchasing credit union's underwriting
guidelines. Another commenter recommended defining the phrase to
clarify that the purchasing FCU is considered to have made the ``final
underwriting decision'' so long as the loan conforms to the FCU's pre-
approved underwriting criteria, even when a fintech company or other
indirect lending partner adds additional, more restrictive underwriting
criteria than the FCU requires. In the commenter's opinion, the
indirect lending partner is acting as a facilitator on behalf of the
credit union in such cases to provide credit enhancements and is not
overriding the credit union's underwriting criteria. The commenter also
suggested that indirect

[[Page 67574]]

lending partners weeding out bad loans in this fashion promotes safety
and soundness by reducing credit risk to FCUs, whether the indirect
lender uses an algorithm, natural persons' judgment, or both to provide
such credit enhancements. To clarify this point, the commenter
recommended the definition of ``final underwriting decision'' in Sec.
701.21(c)(9)(i) provide as follows:
The FCU makes the ``final underwriting decision'' so long as:

(1) The FCU establishes by contract that the indirect lending
partner must adhere to the underwriting standards set forth in the
indirect lending agreement; these underwriting standards are
typically included as an appendix or exhibit to the master agreement
for the indirect lending relationship; and
(2) The indirect lending partner can apply additional, more
restrictive underwriting criteria that go above-and-beyond the FCU's
underwriting requirements, whether those additional underwriting
criteria are part of an automated loan underwriting system and/or
are performed by a natural person individual who is not involved in
the disbursement of loan funds.

Several commenters did not expressly recommend defining the phrase
``final underwriting decision,'' but did offer recommendations about
how the term should be interpreted. Three commenters asked that credit
unions be allowed to charge third-party partners with prescribed
standards that must be met and manage the risk of the engagement
through due diligence and oversight. One of those commenters asked
further that credit unions then be allowed to choose to review loans
before or after funding, depending on their comfort and experience with
the third-party partner; the expectation being that the credit unions
be familiar with the third party's underwriting standards and where
those standards might be different (in more or less conservative ways)
than their own. Finally, the commenter suggested that the adequacy of a
credit union's due diligence and oversight of its third-party partners
is a safety and soundness issue best left to examiners in the field.
Another one of those commenters suggested that, if the NCUA needed to
strengthen this part of the rule to justify making this change, it
could consider also adding the following express requirements: (1) the
underwriting standards must be within the credit union's approved
underwriting and credit policies; (2) the underwriting standards must
be clearly referenced in the representations and warranties of the
agreement between the fintech/flow partner and the credit union and, if
not met, require repurchase of the loans by the fintech/flow partner;
and (3) the credit union must, as part of best practices and safety and
soundness considerations, review and analyze the indirect loan pools
prior to settlement or as soon as practical (for example, in the early
part of the month subsequent to the month in which the loans were
purchased) to ensure they are compliant with NCUA rules (for example,
maturity limits, the statutory maximum interest rate, etc.) and meet
the credit ``stips''/guidelines set forth in the agreement between the
parties.
Several commenters also recommend that, if the phrase ``final
underwriting decision'' is defined, the NCUA not require that credit
unions engaged in indirect lending be actively involved or consulted at
the time a facilitating partner extends credit to borrowers on the
credit union's behalf or limit the number of permissible facilitating
partners. The commenters suggested such a requirement would be
logistically challenging and could result in fewer loans being made
through indirect lending arrangements.
Discussion
The Board appreciates the detailed comments that were submitted
regarding defining the phrase ``final underwriting decision.'' While
the comments received in this area go beyond the scope of this
rulemaking, the comments will be retained for consideration by the NCUA
during future rulemakings relating to indirect lending.
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.\16\ In particular, in a
1997 legal opinion the NCUA explained:
---------------------------------------------------------------------------

\16\ 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).

\17\ NCUA Legal Op. 97-0546.

By requiring the purchasing credit union to make the final underwriting
decision in an indirect lending transaction, the NCUA ensures that the
purchasing credit union is 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.
The NCUA explained further in the same 1997 legal opinion that an
eligible organization may use an automated credit scoring system to
make its final underwriting decision so long as the ``score'' obtained
from the automated system is the sole determinant for granting credit.
When an eligible organization establishes the qualifying criteria for
the automated scoring system, it is effectively making an advance
decision on a particular application.\18\ 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.\19\
---------------------------------------------------------------------------

\18\ See id.; see also 63 FR 70997, 70997 (Dec. 23, 1998)
(agreeing with commenters that credit or electronic scoring by a
third-party vendor using the credit union's criteria is consistent
with the FCU making the final underwriting decision).
\19\ See id.
---------------------------------------------------------------------------

Nothing in current Sec. 701.23(b)(4)(iv) or Sec. 701.21(c)(9)(i)
of this the final rule, however, prohibits an indirect lending partner
from having its own separate underwriting criteria, which it may use to
screen borrowers before the credit union makes its final underwriting
decision. An indirect lending partner may screen applicants for a loan
using underwriting criteria from multiple lending partners; for
example, criteria such as credit score, debt-to-income or debt service
coverage ratios, collateral loan-to-value ratios, loan terms, and
interest rates. In such cases, the determining factor is not what
initial underwriting criteria the indirect lending partner may have
used, but whether the credit union made the final underwriting
decision. Thus, the indirect lending partner's initial underwriting
criteria may differ from the credit union's underwriting criteria but
the credit union must make the final underwriting decision to ensure
the loan meets the credit union's underwriting criteria. The Board
believes that what constitutes making a final underwriting decision may
continue to evolve as credit unions implement artificial intelligence
and machine learning based underwriting systems, as well as engage with
fintech companies.
In indirect lending situations not involving automated credit
scoring systems, a credit union may not wait until after the inception
of the

[[Page 67575]]

obligation to extend credit to review the loan application and
determine whether the transaction conforms to its lending policies
because the credit union then would not have made the final
underwriting decision. A credit union should retain approval authority
to engage in indirect lending (that is, employees or independent
contractors working for the indirect lending partner cannot make the
final underwriting decision on the credit union's behalf).\20\ For
large loans, complex loans, or both, a credit union may grant
preliminary approval of the loan based on the indirect lending
partner's representations to the credit union's loan officer that the
loan conforms to the credit union's underwriting policies. The credit
union must then review the loan application and determine that the
loan, the application, and the transaction conform to its lending
policies before the credit union grants its final approval and before
the loan proceeds are sent to the indirect lending partner.
---------------------------------------------------------------------------

\20\ NCUA Legal Op. 97-0546.
---------------------------------------------------------------------------

In all indirect lending transactions, credit unions should also
retain the right to deny a loan should it discover the loan does not
comply with the credit union's policies or standards upon receipt of
the final paperwork. A credit union should document this ``right'' in
the indirect lending agreement.
Should the Board define the phrase ``very soon after''? The Board
asked in the proposal whether additional clarification was needed such
as adding certain parameters around the meaning of ``very soon after''
for the assignment of the loan or contract to the credit union.
Examples given were within 7 days of the borrower executing the loan or
contract or assignment prior to the first loan payment.
Public Comments
Three commenters recommend not defining the phrase ``very soon
after.'' One commenter suggested that using the language ``very soon
after'' is appropriate and should not cause significant issues and that
setting a specific period is not necessary. Another commenter
acknowledged that timely assignment of a loan or sales contract should
be a factor in ensuring a FICU or other eligible organization is
prudently engaged in an indirect lending arrangement, but suggested the
FICU or other eligible organization's adherence to relevant safety and
soundness standards is far more determinative of any relevant risks
that may accrue to the institution or the Share Insurance Fund. The
commenter suggested further that a prescriptive loan or sales contract
transfer timeline could undermine indirect lending partnerships the
NCUA intends to promote. One commenter suggested that specifying a
prescriptive period could be disruptive to the marketplace and put
additional operational burdens on credit unions. The commenter also
observed that each program between a fintech/flow partner and a credit
union for a given loan category will have a cadence that is different
(given purchase timing preferences and operational logistics) and that,
if the timeframe set by regulation is too short, it could disrupt the
credit union's pre-purchase settlement analysis and review process of
the loan pool.
Six commenters recommend defining the phrase ``very soon after'' to
avoid confusion. Four of the commenters recommended providing a
specific number of days following the borrower's execution of the loan
or contract. One commenter suggested the specific number be 5 or 7
business days but not a window that is excessive, such as 10 days.
Another commenter suggested the number be 7 days. One commenter
suggested the number be no more than 7 or 10 days. And one commenter
suggested the number be 30 days or less.
Two commenters recommend defining ``very soon after'' more
generally to mean prior to the due date of the member's first loan
payment (other than any down payment). Two commenters also recommended
clarifying that the assignment can involve more than one party, such as
if a fintech indirect lending partner uses one or more agents or
subsidiaries to facilitate its operations prior to the loan being
delivered to the credit union. One of those commenters suggested the
changes discussed in this paragraph could be made to the rule by adding
a new paragraph to proposed Sec. 701.21(c)(9)(i) that would provide as
follows:

The requirement that the loan be assigned to the purchaser very
soon after the inception of the obligation to extend credit may be
satisfied regardless of whether the assignment process undergoes
multiple functional steps, with multiple entities, and including
where the assignment is processed as part of a batch of loans, on a
cyclical cadence or otherwise, so long as assignment occurs before
the first loan payment following any down payment.

Finally, one commenter suggested that if ``very soon after'' is
defined, the definition should ensure that appropriate flexibility is
given to address the various timeframes required to appropriately
assign loans backed by different collateral types and to ensure a more
forward-looking regulation that can help ensure future evolution as
loan and lease products continue to change.
Discussion
The Board appreciates the detailed comments that were submitted
regarding defining the phrase ``very soon after.'' Defining the phrase
in this final rule, however, would go beyond the scope of the proposal.
Accordingly, the comments received on this issue have been shared with
the Board, reviewed, and will be retained for consideration by the NCUA
in future rulemakings relating to indirect lending.
Several commenters expressed confusion regarding the NCUA's use of
the term ``very soon after'' in the regulation. The term very soon
after has been used but not defined in the NCUA's indirect lending
regulation since 1998.\21\ The period that satisfies the ``very soon
after'' \22\ element 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.\23\
``Very soon after'' is determined on a case-by-case basis by loan type
and in accordance with commercial reasonableness.\24\ The NCUA's
longstanding position is that the sooner the assignment is made the
more likely the point-of-sale retailer will be viewed as an indirect
lender and not the originating lender.\25\ Historically, NCUA
examination staff have generally used 7 days as a baseline for gauging
whether a transaction meets the ``very soon after'' timeframe, but this
has not been codified as a requirement. The longer the time between
formation of the contract and assignment, the more likely the
arrangement will be viewed as the purchase of a third-party loan rather
than the making of a loan through indirect channels.\26\ The NCUA also

[[Page 67576]]

notes that the technology used in many indirect lending relationships
today allows for an almost instantaneous assignment of loans.
---------------------------------------------------------------------------

\21\ 63 FR 70997 (Dec. 23, 1998).
\22\ The preamble to the 1998 proposal to amend the eligible
obligations rule requested public comment on whether 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 the Board 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).
\23\ NCUA Legal Op. 15-0813 (Aug. 10, 2015).
\24\ Id.
\25\ Id.
\26\ 63 FR 41976, 41977 (Aug. 6, 1998).
---------------------------------------------------------------------------

In addition, two commenters recommended defining ``very soon
after'' in a way that clarifies that the requirement for a loan to be
assigned to the purchaser very soon after the inception of the
obligation to extend credit may be satisfied regardless of whether the
assignment process undergoes multiple functional steps, with multiple
entities, so long as the other requirements of 701.21(c)(9) are met and
those steps occur before the loan is assigned. The Board appreciates
this recommendation, but believes this clarification is unnecessary
because the plain language of both current Sec. 701.23(b)(4)(iv) and
Sec. 701.21(c)(9)(i) of the final rule are clear. Neither paragraph
imposes a limitation on the number of functional steps or entities that
are involved in the assignment process, provided the loan is assigned
very soon after the inception of the obligation to extend credit and
all other applicable requirements are met.
Should the Board propose a separate indirect lending rule? The
Board asked in the proposal whether the NCUA should establish an
indirect lending rule. And if so, the Board asked what it should
consider in any future indirect lending rulemaking. The Board also
asked if a credit union should 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.
Public Comments
Two commenters responded in the negative to the NCUA's question
about whether the agency should establish a separate indirect lending
rule. One of those commenters recommended maintaining a principles-
based approach in this area and suggested such an approach requires no
separate rule. The other commenter suggested there are numerous
situations where a credit union would use a third party to assist in
the origination of loans and a separate indirect lending rule would not
change the overall impact of being considered the originating lender.
One commenter recommended not undertaking a separate indirect lending
rulemaking until the agency is able to evaluate and understand how
credit unions and other credit union industry stakeholders react to any
final rule the NCUA adopts related to this proposal. Finally, three
commenters recommended a separate indirect lending rulemaking to
provide greater clarity and encourage greater participation in this
area. One of those commenters suggested further that a new indirect
lending rulemaking could amplify participation and provide credit
unions, financial service providers, and CUSOs greater opportunity to
collaborate and impact member retention and growth.
Discussion
The Board appreciates the detailed comments that were submitted
regarding proposing a separate indirect lending rule. While the
comments received in this area go beyond the scope of this rulemaking,
the comments will be retained for consideration by the NCUA during
future rulemakings relating to indirect lending.

New Sec. 701.21(c)(9)(ii) Indirect Lending

New Sec. 701.21(c)(9)(ii), consistent with current Sec.
701.23(b)(4)(iv), clarifies 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.\27\ As previously mentioned, current
Sec. 701.23(b)(4)(iv) is removed by this final rule. Accordingly, new
Sec. 701.21(c)(9)(ii) provides 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.
---------------------------------------------------------------------------

\27\ (emphasis added); see also, e.g., NCUA Legal Op. 97-0546
(Aug. 6, 1997) (providing in relevant part as follows: ``FCUs may
participate in indirect lending arrangements under the authority to
make loans to members, 12 U.S.C. 107(5); 12 CFR701.21, 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.'').
---------------------------------------------------------------------------

Public Comments
One commenter suggested clarifying in proposed Sec.
701.21(c)(9)(ii) that for a loan to be classified as an ``indirect
loan,'' it must meet the requirements of Sec. 701.21 and the FCU
Act.<SUP>28</SUP>
---------------------------------------------------------------------------

\28\ (emphasis added).
---------------------------------------------------------------------------

Discussion
The Board believes the clarification requested above is
unnecessary. The requirement that FICUs also comply with the Act is
already clear under the NCUA's regulations given the authority for most
of the provisions in the NCUA's regulations are derived directly from
the Act itself. Moreover, adding such a statement in one provision
within the NCUA's regulations, but not everywhere, could give the false
impression that FICUs do not have to comply with the Act's requirements
in places where the NCUA's regulations do not specifically require it.
Accordingly, the final rule adopts the language proposed without change
for the reasons set forth in the notice of proposed rulemaking.

New Sec. 701.21(c)(9)(iii) Indirect Leasing

New Sec. 701.21(c)(9)(iii), consistent with current Sec. Sec.
701.23(b)(4)(iv) and 714.9, clarifies the difference between leases
made pursuant to indirect leasing arrangements under Sec. 714.2(b)
\29\ 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

[[Page 67577]]

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.\30\ Similarly, 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, new Sec. 701.21(c)(9)(iii) provides 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.
---------------------------------------------------------------------------

\29\ Section 714.2(b) (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.'').
\30\ Id. (emphasis added); see also 12 CFR 714.2(b) & 714.9; and
NCUA Legal Op. 00-0811 (Nov. 2000) (providing in part as follows:
``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.'').
---------------------------------------------------------------------------

Section 701.22 Loan Participations

As discussed in more detail below, the final rule makes 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).
Public Comments
Two commenters asked the NCUA to do more to reduce confusion
regarding whether Sec. Sec. 701.22 or 701.23 applies to a particular
transaction. One of those commenters recommended that the NCUA clarify
in the loan participation and eligible obligation rules that purchasing
FICUs have discretion to classify a partial interest in a loan under
either Section 701.22 or 701.23 when the terms and conditions of the
purchase meet the requirements of both rules.
Discussion
The specific clarifications requested above would expand the
authorities proposed beyond the scope of the proposed rule. As outlined
in the notice of proposed rulemaking, one purpose of the amendments was
to clarify ambiguities related to distinguishing between loan
participations and eligible obligations. To facilitate this, the
proposed definition of eligible obligation was revised to provide that
an eligible obligation is 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). The Board
believes the rule clarifies FICUs' authority to purchase partial loans
under Sec. 701.23 given that the amended definition of ``eligible
obligation'' expressly excludes the purchase of partial loans that meet
the definition of a ``loan participation,'' as that term is defined
under Sec. 701.22(a). An FCU is authorized under Sec. Sec. 701.22 and
701.23 to purchase a loan or part of a loan only if it meets the
definition of one of the following: (1) a ``loan participation,'' (2)
an ``eligible obligation,'' or (3) a ``note of a liquidating credit
union.'' \31\ For FCUs, a loan or partial loan purchased cannot meet
the definitions of both an eligible obligation and a loan
participation. Amending the final rule to provide otherwise would go
beyond the scope of this rulemaking. For FISCUs, partial loan purchases
that meet the definition of a ``loan participation'' must comply with
the requirements of Sec. 741.225 and the applicable requirements of
Sec. 701.22. Other types of loans purchased by FISCUs must meet the
requirements of both state law and part 741 of the NCUA's regulations.
Accordingly, the Board adopts the language originally proposed in Sec.
701.22 without change for the reasons set forth in the notice of
proposed rulemaking.
---------------------------------------------------------------------------

\31\ Note, Sec. 741.8 requires prior approval for the purchase
of certain types of loans and partial loans authorized under Sec.
701.23(b).
---------------------------------------------------------------------------

The purchase of part of a loan under Sec. 701.23 and the purchase
of a loan participation under Sec. 701.22 are treated as separate and
distinct transactions under the final rule. The purchase of part of a
loan by an FCU, provided it meets the definition of an eligible
obligation, is subject to the requirements and conditions of Sec.
701.23. The purchase of a loan participation, as defined under Sec.
701.22, by a FICU is subject to the requirements and conditions under
the NCUA's loan participation rule. Credit unions must properly
identify each transaction as either the purchase of an eligible
obligation or the purchase of a loan participation at the time of
purchase.

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).\32\ 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 is
explained as follows in the remainder of this paragraph. The
introductory text clarified the scope of the rule and helped
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 consumer FICU's purchase of a loan participation where the
borrower is not a member of that credit union. The introductory text
goes on to state that 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 consumer
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.\33\
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\32\ 78 FR 37946 (June 25, 2013).
\33\ Id. at 37948.
---------------------------------------------------------------------------

The introductory paragraph to current Sec. 701.22 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. 701.22. Section 741.225 also provides that
FISCUs are exempt from the borrower membership requirement in current
Sec. 701.22(b)(4). Seventh, the

[[Page 67578]]

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 about 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 introductory paragraph to current
Sec. 701.22 that parties have raised is when a FICU's partial loan
purchase is subject to that section. Parties have cited the continuing
contractual obligation qualifier as a source of confusion. The fourth
sentence in the introductory paragraph 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.\34\ The fifth 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.\35\ 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.\36\
---------------------------------------------------------------------------

\34\ Emphasis added.
\35\ Emphasis added.
\36\ Emphasis added.
---------------------------------------------------------------------------

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 fourth and fifth
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
fourth 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), 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 the 2022 proposed rule, the Board
requested 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.
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 deleting the continuing
contractual obligations sentence in current Sec. 701.23. The Board
intends the deletion to work in conjunction with the changes to the
introductory paragraph to current Sec. 701.22.
The Board proposed 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.\37\ The requirements of Sec. 701.22 apply to each
individual loan in which a FICU purchases a loan participation
interest.\38\
---------------------------------------------------------------------------

\37\ Emphasis added.
\38\ 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>.
---------------------------------------------------------------------------

The final rule amends the introductory text of Sec. 701.22 to
provide the following: First, Sec. 701.22 applies only to loan
participations as defined in paragraph (a). Second, Sec. 701.22 does
not apply to the purchase of an investment interest in a pool of loans.
Third, Sec. 701.22 establishes the requirements a FICU must satisfy to
purchase a participation in a loan. Fourth, FISCUs are required by
Sec. 741.225 to comply with the loan participation requirements of the
section. Fifth, Sec. 701.22 does not apply to corporate credit unions,
as that term is defined in Sec. 704.2.
Public Comments
Four commenters stated generally that they supported the proposed
changes to the introductory paragraph because the changes will reduce
confusion and better enable credit unions to evaluate

[[Page 67579]]

new loan participation opportunities without reducing credit unions'
loan participation authorities or increasing risks to individual credit
unions or the Share Insurance Fund. Four commenters stated that they
supported deleting the ``continuing contractual obligation'' clauses in
the introductory paragraph. In addition, one commenter recommended
removing the sentence in the introductory paragraph regarding the
restriction of corporate credit unions purchasing loan participations
from eligible organizations. The commenter explained that this issue is
covered in section 704 appendix B, which requires part IV authority be
granted by the NCUA for corporates to purchase participations. The
commenter recommended further that corporate credit unions be allowed
to purchase loan participations from FICUs by removing this sentence
and eliminating the Part IV authority requiring separate application
and approval for any purchase authority. The commenter suggested that
corporate credit unions act as a liquidity provider for credit unions
and being allowed to purchase loan participations with fewer
restrictions would provide much needed liquidity and improve the
overall safety and soundness for the credit union system.
Discussion
Commenters generally supported the proposed changes to the
introductory paragraph to Sec. 701.22, with one commenter suggesting
additional changes that go beyond the scope of the proposed rule. While
the Board appreciates that comment, the NCUA did not propose allowing
corporate credit unions to purchase loan participations from FICUs by
removing the last sentence of the current introductory paragraph and
eliminating the Part IV authority requiring separate application and
approval for any purchase authority. The NCUA will retain the comment,
however, for consideration as part of future rulemakings related to
loan participations or corporate credit union purchase authorities.
Given the NCUA received no comments in opposition to the proposed
changes, the Board is adopting the changes in this final rule as
proposed for the reasons set forth in the notice of proposed
rulemaking.
Defining the term ``investment interest in a pool of loans''? The
Board asked in the proposal whether it should define the term ``an
investment in a pool of loans'' in a future rulemaking. And, if so, the
Board asked how the term should be defined and why.
Public Comments
Three commenters responded in the affirmative to the NCUA's
question. One commenter recommended clarifying that the restrictions in
Sec. 701.22 (containing the memberization requirement for FCUs) do not
apply to an investment in a pool of loans. Another commenter suggested
the phrase is confusing as currently used and does not provide
information regarding what options credit unions may have to invest in
these types of transactions. The commenter asked, as an example, would
this include the ability to invest in a ``pool'' or ``fund'' of
subordinated debt loans made to credit unions? In the commenter's
opinion, credit unions should be allowed to purchase a percentage of a
pool of loans that credit unions are allowed to originate.
Discussion
The Board appreciates the comments received and will retain them
for consideration as part of future rulemaking efforts related to this
area of the NCUA's regulations.

Section 701.22(a)

The final rule adds 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.\39\ 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.\40\ In the 2013 Final Rule, the NCUA explained that this
requirement derives from sections 107(5) and (5)(E) \41\ of the
Act.\42\ Section 107(5) provides in relevant part that an FCU shall
have the power to participate with other credit unions, credit union
organizations, or financial organizations in making loans to credit
union members.\43\ 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 FCU's board of directors, provided that an FCU
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.\44\ 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.\45\
---------------------------------------------------------------------------

\39\ 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>.
\40\ 78 FR 37946, 37949 (June 25, 2013) (providing verbatim
that, ``[t]he 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)).
\41\ Sec. 1757(5) and (5)(E).
\42\ 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.).
\43\ 12 U.S.C. 1757(5) (emphasis added).
\44\ Section 1757(5)(E) (emphasis added).
\45\ See 76 FR 79548, 79548 (Dec. 22, 2011) (Explaining in part
that loan 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.
---------------------------------------------------------------------------

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 sales, arguably

[[Page 67580]]

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.\46\
---------------------------------------------------------------------------

\46\ 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.

As explained in more detail below, these concerns are fully
accounted for under the 2015 Opinion and this rulemaking 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.\47\
---------------------------------------------------------------------------

\47\ 78 FR 37949-37950 (emphasis added).

As noted, 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 2 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.\48\ In particular, in a
1997 legal opinion the NCUA explained as follows:
---------------------------------------------------------------------------

\48\ 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.\49\
---------------------------------------------------------------------------

\49\ 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 that 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 for the life of the loan.\50\ 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.
---------------------------------------------------------------------------

\50\ 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.'').
---------------------------------------------------------------------------

Furthermore, as discussed in the 1997 legal opinion quoted above,
the NCUA has long distinguished between indirect loans, made under
section 107(5) \51\ of the FCU Act and Sec. 701.21 of the NCUA's
regulations, and eligible obligations purchased under section 107(13)
\52\ of the FCU Act and Sec. 701.23 of the NCUA's regulations.\53\ 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
obligation rules, allowing the sale of participation interests in
indirect loans presents no such risk.
---------------------------------------------------------------------------

\51\ Sec. 1757(5).
\52\ Sec. 1757(13).
\53\ NCUA Legal Op. 97-0546.
---------------------------------------------------------------------------

Working within the regulatory and interpretative history discussed
above, the NCUA determined in the 2015 Opinion that an ``eligible
organization'' \54\ may be considered the ``originating lender'' for
purposes of Sec. 701.22 where the eligible organization generated the
loan through an ``indirect lending arrangement '' \55\ with a retailer

[[Page 67581]]

such as an auto dealer.\56\ 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.'' \57\ 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 that 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.
---------------------------------------------------------------------------

\54\ Id. (providing in relevant part as follows: ``Eligible
organization means a credit union, credit union organization, or
financial organization.'').
\55\ 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).
\56\ NCUA Legal Op. 15-0813.
\57\ Id. (providing in relevant part, ``[o]riginating 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.'').
---------------------------------------------------------------------------

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.\58\ 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.\59\ 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.\60\ When an eligible organization establishes the
qualifying criteria for the automated scoring system, it is effectively
making an advance decision on a particular application.\61\ 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.\62\
---------------------------------------------------------------------------

\58\ 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.' '').
\59\ See id.
\60\ See NCUA Legal Op. 97-0546.
\61\ See id.
\62\ See id.
---------------------------------------------------------------------------

Second, the sales contract must be assigned to the eligible
organization very soon after it is signed by the borrower and the
dealer.\63\ 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.\64\ 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.\65\ 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.\66\
---------------------------------------------------------------------------

\63\ Emphasis added.
\64\ See NCUA Legal Op. 97-0546.
\65\ 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.).
\66\ 63 FR 41976, 41977 (Aug. 6, 1998).
---------------------------------------------------------------------------

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 $336.8 billion outstanding
balance of indirect loans as of 2022 more than doubled the 2015 year-
end loan balance.\67\
---------------------------------------------------------------------------

\67\ NCUA Call Report data for all FICUs from the 4th quarter of
2015 through the 2nd quarter of 2022.
---------------------------------------------------------------------------

During the past 7 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.\68\ The speed of growth went back to double digits in
2021 and 2022, with FICUs reporting an aggregate 30.93 percent increase
during 2022.\69\ 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 22.36 percent as of 2022.\70\
---------------------------------------------------------------------------

\68\ NCUA Call Report data for all FICUs from the 4th quarter of
2015 through the 4th quarter of 2021.
\69\ NCUA Call Report data for all FICUs from the 4th quarter of
2015 through the 4th quarter of 2022.
\70\ Id.
---------------------------------------------------------------------------

Furthermore, between 2015 and 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 rate ranged between
0.70 percent and 0.24 percent.\71\
---------------------------------------------------------------------------

\71\ Id.

Table 1--FICU Indirect Lending Activities \72\
----------------------------------------------------------------------------------------------------------------
(in $ million) 2015 2016 2017 2018 2019 2020 2021 2022
----------------------------------------------------------------------------------------------------------------
Total Outstanding Indirect Loans 136,583 165,171 194,016 221,477 228,559 233,161 257,271 336,845
% Year over Year Growth......... 20.29 20.93 17.46 14.15 3.20 2.01 10.34 30.93
% Indirect Loans Outstanding/ 17.35 19.00 20.27 21.22 20.63 20.05 20.50 22.36
Total Loans....................
Total Del. Indirect Loans (>=60 988 1,264 1,391 1,494 1,513 1,291 1,198 2,479
Days)..........................
% Loans Delinquent >=60 Days/ 0.72 0.77 0.72 0.67 0.66 0.55 0.47 0.74
Total Indirect Loans...........
Net Indirect Loan Charge-Offs... 782 997 1,264 1,318 1,354 1,129 594 903

[[Page 67582]]

% Net Charge-Offs/Avg Indirect 0.63 0.66 0.70 0.63 0.60 0.49 0.24 0.30
Loans..........................
----------------------------------------------------------------------------------------------------------------

For the reasons discussed previously, and consistent with sections
107(5) and 107(5)(E) of the Act and the 2015 Opinion, the Board is
codifying 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 is
clarifying in the regulation that any ``eligible organization''--as the
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.
---------------------------------------------------------------------------

\72\ Id.
---------------------------------------------------------------------------

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 underwritten to the eligible organization's standards.
Accordingly, the final rule amends current Sec. 701.22(a) by adding to
the end of the definition of ``originating lender'' a second clarifying
sentence providing that the 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
relevant 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 requested comment in the proposal on whether there are
certain types of transactions that should be excluded from the
interpretation above. In particular, the Board asked whether there are
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, commenters were asked to explain why they should be excluded and
provide information about the transactions and the specific activities
undertaken by the parties.
Public Comments
All comments received on this issue supported revising the
definition of ``originating lender'' to codify the 2015 Opinion. One
commenter recommended the NCUA amend the definition of ``originating
lender'' further to recognize and separate the functions of the
originator, initial lender and subsequent owner/purchaser. The
commenter also recommended amending the definition to recognize the
different point in time of the legal ownership of the loan even though
such lending decisions are made in compliance with the underwriting
stipulations of the credit union that buys the loan after the initial
funding of the loan by the fintech/flow partner. The commenter
suggested these additional changes are important because they would (a)
follow the legal ownership of the loan, (b) place the responsibility on
the originator to comply with the requisite regulations--for example,
Consumer Financial Protection Bureau (CFPB) reporting--and (c) if
future regulatory requirements are placed on the originator, there
would be no confusion about which party is responsible for complying
with such requirements. In the commenter's opinion, the fintech
originator should have responsibility for complying with regulations
and the credit union's due diligence should include an extensive review
of the originator's policies and procedures to ensure compliance with
all regulations.
Another commenter asked that the NCUA clarify further in the
definition whether both the indirect loan source (e.g., dealer) and the
purchasing credit union are ``originators,'' because the current
language could cause interpretive confusion and raise questions as to
Call Report instructions and other areas regarding what the scope of
origination is versus other types of indirect lending, such as
correspondent mortgage lending. The commenter explained that the
language ``from the loan originator'' in the definition suggests that
when a broker closes a loan in the credit union's name it is not an
indirect loan, while prior interpretations have suggested that it might
be. The commenter recommended, in particular, that the NCUA not use the
word ``originator'' in the definition as it relates to sources of
indirect loans because it introduces confusion about the meanings of
terms under the 2015 Opinion and prior doctrine.
Discussion
The comments received regarding the changes to the definition of
``originating lender'' all generally supported the proposed change. The
NCUA did, however, receive comments requesting additional changes to
the proposed definition of ``originating lender'' and the associated
definition of ``indirect lending arrangement'' in Sec.
701.21(c)(9)(i). Those additional changes go beyond the scope of the
proposed rule and will be retained for consideration by the NCUA during
future rulemakings relating to indirect lending. Accordingly, the final
rule adopts the changes to the definition of ``originating lender'' in
Sec. 701.22(a) as proposed for the reasons set forth in the notice of
proposed rulemaking.
Some commenters requested additional clarification regarding the
relationship between the originating lender and indirect lender. The
term ``originating lender'' is defined in the final rule as the
participant with which the borrower initially or originally contracts
for a loan and who, thereafter, 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). The term ``loan
participation'' is defined as a loan where one or more eligible
organizations participate pursuant to a written agreement with the
originating lender, and the written agreement

[[Page 67583]]

requires the originating lender's continuing participation throughout
the life of the loan. For purposes of the NCUA's regulations, a FICU
acquiring a loan through an indirect lending arrangement is the
originating lender. The acquiring FICU, however, may not be considered
the originator under other applicable state laws, federal laws, or
both. In such cases, the acquiring FICU is generally required to comply
with all applicable laws.
Under Sec. 701.22(b), a FICU may purchase a participation interest
in a loan from an eligible organization only if the loan is one the
purchasing credit union is empowered to grant and certain additional
conditions are satisfied. Both the current rule and this final rule
limit purchases of loan participations to purchases from eligible
organizations. An ``eligible organization'' is defined in the current
and final rule as a credit union, credit union organization, or
financial organization. The term ``financial organization'' is defined
under the current and final rule as any federally chartered or
federally insured financial institution and any state or federal
government agency and its subdivisions. This final rule makes no
changes to either definition. The term ``financial organization''
includes participants outside the credit union industry, including
federally chartered and federally insured financial institutions, such
as banks, and state and federal government agencies and their
subdivisions.\73\ In addition, the current and final rule's definition
of ``eligible organization'' includes non-federally insured or non-
federally chartered credit unions through the definition's use of the
term ``credit union.'' \74\
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\73\ 78 FR 37946, 37948 (June 25, 2013).
\74\ Id. at 37949.
---------------------------------------------------------------------------

Additional concerns? The Board requested comment in the proposal 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.'' The
Board asked further whether there are 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. Finally, the
Board asked whether there are any additional safety and soundness or
compliance implications concerning the proposed definition of
``originating lender'' that the Board should consider.
Public Comments
One commenter responded that, in many instances, CUSOs assist
credit unions with various aspects of the loan origination process. The
commenter explained that CUSOs may provide specific expertise (such as
in member business loans) or other services to assist in credit unions
making appropriate decisions; however, the credit union is still
funding the loan according to its own guidelines (or as agreed upon
through a CUSO) and should be considered the originating lender.
Discussion
The Board appreciates the comment above and notes that the final
rule does not affect the ability of CUSOs to provide loan support
services to FICUs under part 712 of the NCUA's regulations and that
simply providing loan support services does not necessarily change what
entity is the originating lender.

Section 701.22(e) Temporary Regulatory Relief in Response to COVID-19

From April 21, 2020, to December 31, 2022, Sec. 701.22(e) of the
NCUA's regulations provided 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.\75\ The Board approved Sec. 701.22(e) to help ensure that
FICUs remained operational and had sufficient liquidity during the
COVID-19 pandemic.\76\ 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.\77\ As provided in paragraph
(e), the temporary regulatory relief provided under the paragraph
expired on December 31, 2022. Because the temporary regulatory relief
has expired, the Office of the Federal Register removed paragraph (e)
shortly after December 31, 2022, as part of its regular review and
editing process.
---------------------------------------------------------------------------

\75\ Emphasis added.
\76\ 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).
\77\ 85 FR 22010, 22010 (April 21, 2020).
---------------------------------------------------------------------------

Public Comments
Three commenters recommended the NCUA extend or permanently adopt
expired section 701.22(e)'s higher loan participation purchasing
threshold. One of the commenters suggested that loan participation
agreements generally have high fixed costs and comparatively modest
variable costs so a $10 million loan participation agreement does not
require significantly more due diligence or post-closing resources,
from either a loan originator or potential loan participation interest
purchasers, than a $2 million loan participation agreement.
Consequently, individual loan participation interests generally
represent larger rather than smaller capital commitments. Another
commenter suggested that the United States is currently entering a
period of declining liquidity access, raising concerns among FICUs
about their ability to access liquidity. The commenter suggested the
relief provided in Sec. 701.22(e) would be more useful now than it was
during the pandemic as the liquidity tightness the credit unions see
now is due to the business cycle. The commenter suggested further that
a permanent variation of this rule would not harm the safety and
soundness of the credit union system, and as such, it asked the NCUA to
reconsider removing this rule. One of the commenters suggested raising
the aggregate amount of loan participations that may be purchased may
decrease overall risks because it allows individual credit unions to
develop relationships and trust with each other with ongoing
transactions that reduce costs and risks for both.
Five commenters recommended the NCUA eliminate the limit on the
aggregate amount of loan participations that may be purchased from any
one originating lender altogether.
Discussion
The Board appreciates the comments that were submitted regarding
expiration of the temporary regulatory relief under Sec. 701.22(e).
The temporary regulatory relief provided under paragraph (e) expired on
December 31, 2022. The Board may consider approving temporary
regulatory relief again in the future if circumstances warrant.
Benefits of the temporary regulatory relief. The Board requested
comments on the impact, if any, that was experienced due to the
flexibilities provided in the temporary rule; whether the temporary
rule had any effect on the participation markets; and whether there are
safety and soundness or

[[Page 67584]]

compliance implications related to the expiration of the flexibilities.
Public Comments
One commenter responded to the NCUA's questions by stating that the
change did not have a material effect on credit unions because it was
temporary in nature but noted that the change did allow some credit
unions to manage their balance sheets in a more effective manner during
the relief period. The commenter suggested further that credit unions
that benefited from the temporary regulatory relief may now be unable
to work with those sellers/buyers again even though they have
established strong relationships due to expiration of the temporary
regulatory relief.
Discussion
The Board appreciates the comment that was submitted regarding the
benefits of the temporary regulatory relief under Sec. 701.22(e). The
Board may consider approving temporary regulatory relief again in the
future if circumstances warrant.
Other comments on the loan participation rule. The Board also
invited other recommendations it should consider in the loan
participation rule. For example, the Board asked whether it should
consider replacing prescriptive limits with principles-based
requirements, 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), or both.
Public Comments
One commenter responded to the NCUA's questions by stating that
eliminating the prescriptive limits and replacing them with principles-
based requirements allows credit unions the most flexibility in
managing their balance sheets. The commenter suggested that credit
unions have proven the ability to manage their risk levels with many
other prescriptive limits being removed.
Discussion
The Board appreciates the comment above and will consider replacing
prescriptive limits with more principles-based requirements where
appropriate in future rulemakings.

Section 701.23 Purchase, Sale, and Pledge of Loans

As discussed in more detail in this portion of the preamble, this
final rule makes 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
changes also 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.
In addition, the final rule adds new headings to a number of
subparagraphs under Sec. 701.23. The addition of these headings is a
non-substantive change to both the current regulation and proposed
Sec. 701.23, which is intended to add consistency to the section as
well as make the section more reader friendly. In addition to the other
changes discussed in this part of the preamble, the final rule adds the
following new headings to Sec. 701.23. Paragraph (b)(1) is amended to
add the heading purchase of obligations from any source. Paragraph
(b)(1)(i) is amended to add the heading eligible obligations. Paragraph
(b)(1)(ii) is amended to add the heading notes of a liquidating credit
union's individual members. Paragraph (b)(1)(iii) is amended to add the
heading student loans. Paragraph (b)(1)(iv) is amended to add the
heading real estate-secured loans. Paragraph (b)(3) is amended to add
the heading other requirements. Paragraph (b)(4) is amended to add the
heading five-percent limitation. Paragraph (b)(5) retains the heading
grandfathered purchases from the current rule. Paragraph (b)(6) is
amended to add the heading written purchase policies. Paragraph (h)(1)
is amended to add the heading expanded purchase authority.
Public Comments
Several commenters specifically offered strong support for the
proposed edits to Sec. 701.23. One commenter agreed that removing some
of the limits in the current regulation will greatly improve credit
union activity with eligible obligations and allow members to be served
within the industry without incremental risk being placed on the Share
Insurance Fund. Another commenter suggested that the clarifying
language on eligible obligations and removal of the prescriptive
limitations will eliminate ambiguity on the interpretation regarding
permissible activities. Another commenter supported the proposed
changes but thought more should be done to reduce confusion regarding
whether Sec. Sec. 701.22 or 701.23 applies to a particular
transaction. One commenter stated that FISCUs should also benefit from
this rule pursuant to state credit union act parity statutes. The
commenter recommended finalizing the amendments to Sec. 701.23 as
proposed. The commenter, however, also recommended that the NCUA
clarify in the loan participation and eligible obligation rules that a
purchasing FICU has discretion to classify a partial interest in a loan
under either Section 701.22 or 701.23 when the terms and conditions of
the purchase meet the requirements of both rules. As an alternative,
the commenter requested that, even if credit unions are obligated to
designate a transaction as a loan participation or eligible obligation
at or near the time of the sale/purchase (for example on a subsequent
Call Report), credit unions be given discretion to change that
designation at a later time if they choose so long as the terms and
conditions of the purchase meet the requirements of both rules. The
commenter suggested this change could be made by adding new paragraphs
to Sec. Sec. 701.22 and .23 providing as follows:

Each FICU that is party to a transaction may choose to
categorize it as either a transaction under this rule [Sec. 701.22
or Sec. 701.23], or alternatively as a transaction under [Sec.
701.22 or Sec. 701.23], and may designate it as such as necessary
(for example on a Call Report). FICUs that are party to the same
transaction do not have to categorize or designate the transaction
in the same manner, and FICUs retain discretion to recategorize and
redesignate the transaction from time to time.

Discussion
Consistent with the strong support received from commenters, the
Board is adopting the changes to Sec. 701.23 largely as proposed, for
the reasons set forth in the notice of proposed rulemaking, with
certain changes that are discussed in the section-by-section analysis
below. The changes and clarifications requested in the comments above
would expand the authorities proposed beyond the scope of the proposed
rule. Thus, the comments will be retained for consideration in future
rulemakings relating to loan purchases.

Section 701.23 Introductory Paragraph

The Board added the introductory paragraph to Sec. 701.23 as part
of the 2013 Final Rule.\78\ 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 that the rule
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 2013 Final Rule explained
further that RegFlex provides a limited

[[Page 67585]]

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.\79\
Specifically, the 2013 final rule explained that 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 2013 Final Rule also explained that it made a parallel
conforming amendment to the introductory text to Sec. 701.22 in this
regard.\80\
---------------------------------------------------------------------------

\78\ 78 FR 37946 (June 25, 2013).
\79\ 12 CFR 701.23(b)(2).
\80\ 78 FR 37954-37955.
---------------------------------------------------------------------------

The introductory paragraph to current Sec. 701.23 includes three
sentences. The first sentence 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 sentence also notes
that there is a limited exception to the membership requirement for
certain well-capitalized FCUs. The second sentence 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). The third sentence 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, which 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 previously mentioned, 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 final rule deletes the
continuing contractual obligations clause in current Sec. 701.23. The
Board intends this deletion to work in conjunction with the proposed
changes to the introductory paragraph to current Sec. 701.22.
The final rule also removes the clause in the first sentence of the
introductory paragraph to current Sec. 701.23 referring to the limited
exception for well-capitalized FCUs. As discussed in more detail
subsequently in the part of the preamble on Sec. 701.23(b)(2), the
final rule removes the well-capitalized requirements for FCU purchases
of certain non-member loans from FICUs. Accordingly, deleting the
clause in the introductory paragraph referring to the limited exception
for well-capitalized FCUs is a necessary conforming amendment.
The second sentence in the introductory paragraph to current Sec.
701.23 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
previously, there are express exceptions to the membership requirement
under paragraph (b)(1) as well as under 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 final rule
amends 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.
The third sentence in the introductory paragraph to current Sec.
701.23 provides that an FCU may not purchase a non-member loan to hold
in its 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
non-member loans solely to complete a pool of loans for resale. 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.\81\ 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) \82\ and (b)(2). Accordingly, the final rule deletes
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.
---------------------------------------------------------------------------

\81\ Emphasis added.
\82\ Authorizing FCUs to purchase eligible obligations of a
liquidating credit union's individual members, from the liquidating
credit union.
---------------------------------------------------------------------------

For the reasons outlined in the preceding paragraphs, the final
rule amends the introductory text of Sec. 701.23 to 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 provides 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.
Public Comments
Three commenters specifically expressed their support for the
clarifying amendments to the introductory paragraph to Sec. 701.23.
Another commenter offered support for removing the following sentence:
``A federal credit union may not purchase a non-member loan to hold in
its portfolio.'' And one commenter recommended amending the second
sentence of the introductory paragraph to clarify that an FCU may
purchase certain eligible obligations prior to the borrower becoming a
member of the purchasing FCU under Sec. Sec. 701.23(b)(1) and
701.23(b)(2).
Discussion
The comments received on the changes to the introductory paragraph
to 701.23 were strongly supportive. The

[[Page 67586]]

comment requesting that the Board allow purchases of certain eligible
obligations prior to the borrower becoming a member goes beyond the
scope of the proposal. Accordingly, the Board is adopting the changes
to the introductory paragraph as proposed for the reasons set forth in
the notice of proposed rulemaking.

Section 701.23(a) Definitions

The final rule, in addition to other changes discussed below,
amends current Sec. 701.23(a) to add the heading ``Definitions'' to
the paragraph and remove the numbering from the individual definitions
under paragraph (a). These changes are 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 Sec. 701.23(a)
are listed in alphabetical order but not numbered individually.
Eligible obligation.
The final rule amends the definition of eligible obligation under
Sec. 701.23(a) 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.\83\ As explained in the part of the preamble on Sec.
701.23(b)(4), the statutory 5-percent limitation on the aggregate of
the unpaid balance of notes purchased under Sec. 701.23 applies only
to notes of liquidating credit unions and not to eligible obligations
as that term is generally used under section 107(13) \84\ of the Act.
Accordingly, the final rule amends the definition of eligible
obligation to clarify that the term does not include a note held by a
liquidating credit union.\85\
---------------------------------------------------------------------------

\83\ See, e.g., Sec. Sec. 701.23(b)(1)(ii), (b)(2)(ii), and
(b)(4).
\84\ Section 1757(13) (authorizing 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 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[.]).
\85\ The new definition of eligible obligation excludes notes
held by a liquidating credit union.
---------------------------------------------------------------------------

The final rule also amends 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).\86\ The
Board believes that the amended definition of an eligible obligation
will provide clarity and reduce confusion in the credit union system
concerning when a transaction involving a loan purchased in part (a
partial loan) meets the regulatory definition of an eligible
obligation. Many credit union officials find the current eligible
obligations rule unclear, specifically when attempting to determine
which rule applies to a loan purchased in part. The amended definition
will help FCU officials to differentiate between transactions involving
partial loan purchases that meet the definition of an eligible
obligation under Sec. 701.23 and transactions involving partial loan
purchases that meet the definition of a loan participation under Sec.
701.22.
---------------------------------------------------------------------------

\86\ See 78 FR 37946, 37948 (June 25, 2013) (providing in part
as follows: ``[The introductory paragraph to Sec. 701.22] clarifies
that the [section] applies to a [consumer] 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
``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 that 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)).
---------------------------------------------------------------------------

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 amended Sec. 701.22(a), then the transaction may still be
permissible provided it meets the definition of an ``eligible
obligation'' under amended Sec. 701.23(a) and meets the requirements
under that section.
The final rule also amends 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 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).
Public Comments
Four commenters specifically expressed support for the revised
definition of eligible obligation as proposed. Two commenters
recommended further clarifying the definition of eligible obligation.
One of those commenters explained that further defining the term would
allow credit unions the ability to understand the accounting and loss
reserve ramifications on how the loan is sold. The commenter also asked
the following two clarifying questions: (1) If a credit union sells a
tranche in a portfolio of loans would this constitute an eligible
obligation? And (2) what if a credit union sold just the interest
portion of a loan?
Discussion
The comments received on the revised definition of eligible
obligation were generally supportive. Two commenters did request
further clarifying the definition; however one commenter did not
specify what aspects of the proposed definition were confusing or how
the definition could be clarified. The other commenter asked questions,
which are addressed below. Given the lack of objections to the proposed
definition, other than general requests for further clarification, the
Board is adopting the definition of eligible obligation as proposed for
the reasons set forth in the notice of proposed rulemaking.
Regarding the commenter's questions about selling a tranche in a
portfolio of loans or only selling the interest receivable of a loan,
the transaction must qualify for derecognition under generally accepted
accounting principles (GAAP). Additionally, when a loan is sold in part
under either Sec. Sec. 701.22 or 701.23 of the NCUA's regulations, the
transaction must meet the definition of a participation interest under
GAAP.\87\ This definition is applied at a loan level and not at the

[[Page 67587]]

portfolio level. If an interest in a loan is sold and does not meet the
definition of a participation interest under GAAP, in general, the
transaction must be recorded as a secured borrowing. To meet the
definition of a participation interest under GAAP, the transferor
generally must sell a pro-rata share of principal and interest, except
for market-based servicing fees. While the commenter did not provide
sufficient details in their questions for the Board to provide
definitive answers, the transactions would likely not qualify as the
sale of a participation interest under GAAP and, therefore, generally
are not covered by either Sec. Sec. 701.22 or 701.23 of the NCUA's
regulations. In general, the purchaser must record the asset regardless
of whether the seller qualifies for derecognition under GAAP.
---------------------------------------------------------------------------

\87\ Note that the definition of a participation interest under
GAAP (see ASC 860-10-40-6A) is not the same as the definition of a
loan participation under Sec. 701.22 of the NCUA's regulations.
---------------------------------------------------------------------------

Liquidating credit union.
The final rule adds a definition of liquidating credit union to
Sec. 701.23(a) to identify the point in time when a credit union
becomes a liquidating credit union for purposes of applying the 5-
percent limitation in 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 about proposed Sec.
701.23(b)(4), under this final rule, the 5-percent limitation applies
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.\88\
---------------------------------------------------------------------------

\88\ See Section 1757(13) (providing authority ``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 final rule provides that 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.
Public Comments
Four commenters expressed general support for adding the proposed
definition of liquidating credit union.
Discussion
Given the support received from commenters, and the lack of
objections, the Board is adopting the definition of liquidating credit
union as proposed.
Should other terms be defined? The Board requested comment on
whether there are additional terms used in Sec. 701.23, such as
``empowered to grant,'' that it should consider defining or further
clarifying in future rulemakings.
Public Comments
Two commenters responded that the NCUA should not define the term
``empowered to grant.'' One of the commenters explained that the term
should remain undefined so it can be sufficiently flexible to fully
incorporate credit unions' currently recognized lending authorities and
all those the NCUA recognizes in the future. On the other hand, one
commenter responded that the term ``empowered to grant'' should be
defined. The commenter explained that the term has a particular bearing
on credit union activity under Sec. 701.22 and Sec. 701.23 and has
been addressed in several NCUA legal opinion letters over the years.
The commenter recommended that the NCUA solicit specific feedback on
what should and should not fall within the scope of ``empowered to
grant.''
One commenter asked that the NCUA define the term ``notes'' to
avoid any future confusion regarding the purchase of notes of
liquidating credit unions. Another commenter specifically recommended
the term ``notes'' not be defined or clarified further.
Discussion
The Board appreciates the detailed comments submitted regarding
defining additional terms in Sec. 701.23. While the comments received
in this area go beyond the scope of this rulemaking, the comments will
be retained for consideration by the NCUA during future rulemakings
relating to the purchase, sale, and pledge of eligible obligations and
notes of liquidating credit unions.
In October 2004, the NCUA issued a legal opinion letter explaining
that ``the phrase `empowered to grant' as used in [the] NCUA's
regulations refers to the authority of an FCU to make the type of loans
permitted by the [FCU Act], NCUA regulations, FCU Bylaws, and its own
internal policies.'' \89\ The letter goes on to explain that the phrase
``empowered to grant'' does not include a membership requirement.\90\
---------------------------------------------------------------------------

\89\ OGC Op. 04-0713 (Oct. 25, 2004); see also OGC Op. 02-0824
(Nov. 5, 2002) (noting that an FCU is not empowered to grant a loan
with a prepayment penalty); and OGC Op. 01-1023 (Nov. 28, 2001)
(noting that if an FICU meets all other requirements of the NCUA's
regulations, the fact that the credit union has not itself granted
the type of loan in question does not mean it is not empowered to
grant such a loan.).
\90\ Id.
---------------------------------------------------------------------------

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 consistent with
amendments to other subsections. The final rule amends the heading to
current Sec. 701.23(b) to clarify which transactions are covered under
the paragraph. The Board believes that this would result in only a
minor technical change to current Sec. 701.23(b). The heading for
current paragraph (b) is ``Purchase.'' The final rule adds the words
``of loans'' after the word ``purchase'' to better clarify the type of
transactions this section would apply to, 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, notes of liquidating credit unions would no longer be
included within the definition of eligible obligations. Consistent with
that change, this final rule amends 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. Accordingly, Sec. 701.233(b)(1)(ii) is
amended to provide that an FCU may, subject to the requirements in
Sec. 701.23, purchase notes of a liquidating credit union's individual
members, from the liquidating credit union.

[[Page 67588]]

Public Comments
One commenter suggested that it understands keeping the 5-percent
limitation on the purchase of these types of notes but believed the
limitation could be eliminated because of (a) the relative rarity of
liquidations, and (b) the NCUA's role in approval of purchase and
assumption transactions to select those who can manage safety and
soundness concerns.
Discussion
Section 107(13) of the FCU Act, which authorizes the purchases of
notes of a liquidating credit union's members, provides that 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. Accordingly,
the Board is adopting the changes to Sec. 701.23(b)(4) and retaining
the 5-percent limitation as proposed for the reasons set forth in the
notice of proposed rulemaking.

Section 701.23(b)(1)(iv)

The word ``mortgage'' is misspelled in the first sentence of
current Sec. 701.23(b)(1)(iv). The final rule amends Sec.
701.23(b)(1)(iv) to correct that misspelling. No substantive changes
are made to current paragraph (b)(1)(iv).

Section 701.23(b)(2) Purchase of Obligations From a FICU

The final rule amends current Sec. 701.23(b)(2) 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 final rule provides FCUs additional authority to purchase loans by
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.\91\ The 2001 final rule explained, in
response to commenters suggestions that the requirements be removed, as
follows:
---------------------------------------------------------------------------

\91\ 66 FR 58656 (Nov. 23, 2001).

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.\92\
---------------------------------------------------------------------------

\92\ 66 FR 58656.

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 12 percent of FCUs were engaged in
the purchase, sale, or pledge of loans during 2022.\93\
---------------------------------------------------------------------------

\93\ NCUA Call Report data for all FCUs as of the 2nd quarter of
2022.
---------------------------------------------------------------------------

Additionally, the Board notes that this purchase authority is
limited to purchases from a FICU. Therefore, the loans able to be
purchased under this authority are already in the federally insured
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 small segment of the credit union system given that the
vast majority of FCUs have a CAMELS composite rating of 1 or 2 and are
well-capitalized.\94\ 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.
---------------------------------------------------------------------------

\94\ As of June 30, 2023, over 97 percent of FCUs were well-
capitalized. Additionally, 78.5 percent of FCUs were rated a CAMELS
composite 1 or 2 and these credit unions represented 95 percent of
total FCU assets.
---------------------------------------------------------------------------

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 final rule amends the introductory
paragraph to Sec. 701.23(b)(2) to provide that an FCU may purchase and
hold certain obligations if it would be empowered to grant them.
Public Comments
Twenty-six commenters offered their support for eliminating the
CAMELS rating and capital classification requirements for the reasons
provided in the proposal. One commenter suggested the change would
allow a greater flow of funds between FCUs and FISCUs. The commenter
suggested further that credit unions with CAMELS ratings of three and
lower are negatively impacted by their current inability to access this
market and allowing purchases of these obligations will help move them
into a higher CAMELS rating. Another commenter suggested the proposed
change will allow 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. Several
commenters suggested that the proposed change will make sure smaller
credit unions can also gain access to these loans and obtain some much-
needed additional return on assets. The commenters also suggested the
proposed change will allow larger credit unions to manage balance sheet
risk by selling some of these loans to other credit unions without
jeopardizing their relationships with non-credit union originators.
Discussion
Given the strong support expressed by commenters, and the lack of
objections, the Board is adopting the changes to Sec. 701.23(b)(2) as
proposed for the reasons set forth in the notice of proposed
rulemaking.

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 final rule notes of liquidating credit unions would no longer be
included within the definition of eligible obligation. Consistent with
that change, this final rule amends 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)

Section 701.23(b)(3)(ii)

The final rule amends the requirement in current Sec.
701.23(b)(3)(ii) 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

[[Page 67589]]

agreement are retained in the purchaser's office. Under the final rule,
the purchasing FCU must still retain the written loan purchase
agreement and a schedule of the eligible obligations covered by the
agreement but is no longer required to retain the documents 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. An FCU must still make the
loan purchase agreement and schedule of the eligible obligations
covered by the agreement available upon request by the NCUA.\95\ 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.\96\ Accordingly, Sec. 701.23(b)(3)(ii) of the final
rule provides that a written agreement and a schedule of the eligible
obligations covered by the agreement are retained by the purchaser.
---------------------------------------------------------------------------

\95\ See Sec. 749.2.
\96\ See appendix A to part 749.
---------------------------------------------------------------------------

This change will 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.\97\ 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.\98\ 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.\99\
---------------------------------------------------------------------------

\97\ See 12 CFR 749.5.
\98\ 12 CFR part 749, app. A.
\99\ 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>.
---------------------------------------------------------------------------

Public Comments
Two commenters specifically offered support for aligning the
requirements in Sec. Sec. 701.23(b)(3)(ii), (c)(2), and (d)(1)(iii)
with the electronic record availability and preservation standards
outlined in part 749 of the NCUA's regulations.
Discussion
Given the strong support expressed by commenters, and the lack of
objections, the Board is adopting the changes to Sec.
701.23(b)(3)(ii), (c)(2), and (d)(1)(iii) as proposed for the reasons
set forth in the notice of proposed rulemaking. Note also that current
Sec. 749.5 provides that, where NCUA regulations require credit unions
to retain certain writings, records or information, credit unions may
use any format that accurately reflects the information in the record,
is accessible to all persons entitled to access by statute, regulation
or rule of law, and is capable of being reproduced by transmission,
printing, or otherwise. Section 749.5 provides further that the credit
union must maintain the necessary equipment or software to permit an
examiner to access the records during the examination process.

Section 701.23(b)(4)

The final rule amends 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 the final rule, the 5-percent limitation applies solely
to notes of a liquidating credit union 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 one-size-fits-all limitation.
Section 701.23 provides both the regulatory authority for purchases
of eligible obligations by an FCU and the limitations. Under the
current rule, the 5-percent limitation applies to eligible obligations
purchased by an FCU under Sec. 701.23(b)(1) and (b)(2)(ii). In
general, current 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. Current 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 Act.\100\ Section 107 generally enumerates the powers of FCUs,
and paragraph (13) authorizes an FCU to make certain loan purchases.
Specifically, paragraph (13) provides the following authority,
verbatim: 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 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.\101\
---------------------------------------------------------------------------

\100\ 12 U.S.C. 1757(13).
\101\ Id. (emphasis added).
---------------------------------------------------------------------------

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.'' \102\ The 5-percent limitation is
specific to the ``aggregate unpaid

[[Page 67590]]

balances of notes'' \103\ 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.
---------------------------------------------------------------------------

\102\ Emphasis added.
\103\ Emphasis added.
---------------------------------------------------------------------------

Despite the statutory wording, current Sec. 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.'' \104\ Under the final rule,
the 5-percent limitation applies solely to an FCU's purchase of the
notes of a liquidating credit union. The limitation will not apply to
other loans purchased by an FCU under the authority of section 107(13).
---------------------------------------------------------------------------

\104\ 12 CFR 701.23(a).
---------------------------------------------------------------------------

The final rule also amends the definition of eligible obligations
to reflect the revised scope of the 5-percent limitation. As discussed
previously, the final rule revises the definition of eligible
obligation 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).'' \105\
---------------------------------------------------------------------------

\105\ 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 will apply to these loans
as they fall within the more specific category of eligible
obligations purchased from a liquidating credit union.
---------------------------------------------------------------------------

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.\106\
This rulemaking constitutes a reconsideration of the NCUA's prior
position. As noted, the NCUA has determined that the regulatory change
made by this final rule 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.
---------------------------------------------------------------------------

\106\ 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).
---------------------------------------------------------------------------

This new 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.\107\ 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.'' \108\ 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.
---------------------------------------------------------------------------

\107\ Antonin Scalia & Bryan A. Garner, Reading Law: The
Interpretation of Legal Texts, 148 (2012).
\108\ Id.
---------------------------------------------------------------------------

This 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.'' \109\ ``No word should be ignored.
None should needlessly be given an interpretation that causes it to
duplicate another provision or have no consequence.'' \110\ This
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.
---------------------------------------------------------------------------

\109\ Id. at 145.
\110\ Id.
---------------------------------------------------------------------------

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 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.\111\ That 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.'' \112\ 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.\113\ As a result, it
opted to limit the ability of an FCU to purchase notes of liquidating

[[Page 67591]]

credit unions to 5 percent of its unimpaired capital and surplus.\114\
---------------------------------------------------------------------------

\111\ Public Law 90-375 (approved July 5, 1968) (Providing
authority, 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)).
\112\ S. Rep. No. 1265, 90th Cong., 2d Sess., at 2 (June 18,
1968).
\113\ 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).
\114\ 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.\115\ 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.\116\ 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.
---------------------------------------------------------------------------

\115\ Public Law 95-22 (approved Apr. 19, 1977).
\116\ 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.''
\117\ 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.\118\ Second, and as discussed earlier, accepted canons of
statutory construction favor an interpretation that provides individual
terms with their own individual meaning.
---------------------------------------------------------------------------

\117\ 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'').
\118\ 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
regulatory change made by this final rule 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 Act
will remove the existing limit on the amount of eligible obligations
that an FCU could purchase, establishing risk management expectations
will reduce potential risk to the Share Insurance Fund while allowing
FCUs more flexibility in how they manage their eligible obligation
purchase activities. 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 final rule amends current Sec. 701.23(b)(4) to remove the
exclusions provided in paragraphs (b)(4)(i) through (iv) and revises
the current language to apply the 5-percent limit only to notes
purchased from liquidating credit unions. While the narrower
interpretation of section 107(13) of the FCU Act will 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, Sec. 701.23(b)(4) is revised to 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 invited comments concerning the proposed 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.
Public Comments
Twenty-seven commenters specifically offered support for narrowing
the 5-percent limitation to cover only notes of liquidating credit
unions for the reasons provided in the proposal. Three commenters
suggested the proposed change will allow credit unions, possibly
through CUSOs and other collaborations, to build strong relationships
with fintech companies, giving FICUs more tools to allow them to be a
part of the lending system as it has evolved with the use of
technology.
Discussion
Given the strong support expressed by commenters, and the lack of
objections, the Board is adopting the changes to Sec. 701.23(b)(4) as
proposed for the reasons discussed earlier and in the notice of
proposed rulemaking.

Section 701.23(b)(5) Grandfathered Purchases

The final rule amends current Sec. 701.23(b)(5) to broaden the
grandfathering provision in 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
revisions made by this final rule will avoid placing undue burden on
FCUs that were operating in compliance with the

[[Page 67592]]

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 grandfathering
provision will 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 an FCU's
eligible obligation loan portfolio.
Accordingly, the final rule amends Sec. 701.23(b)(5) to 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 complied with Sec. 701.23 at the time
the transaction was executed.
Public Comments
One commenter specifically offered support for the proposed
revisions to Sec. 701.23(b)(5). The commenter stated that FCUs that
have operated in compliance with the recently expired Sec. 701.23(i)
and the NCUA's other regulatory requirements should not be forced to
divest from their prudently purchased eligible obligations.
Discussion
Given the support expressed above, and the lack of objections, the
Board is adopting the changes to Sec. 701.23(b)(5) as proposed for the
reasons set forth in the notice of proposed rulemaking.

New Sec. 701.23(b)(6)

The final rule adds new paragraph (b)(6) to Sec. 701.23, which
sets forth basic due diligence, risk assessment, and risk management
requirements that must be addressed in an FCU's internal written
purchase policies.\119\ 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
to ensure the credit union operates safely and soundly and in
compliance with applicable laws and regulations. The introductory
paragraph to new Sec. 701.23(b)(6) provides 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.
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\119\ A credit union's written loan purchase policies may be
incorporated into the written lending policies required under Sec.
741.3(b)(2).
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The specific policy requirements, which are discussed in detail
below, are part of the basic fiduciary responsibilities and duties
required of boards of directors.\120\ The requirements in the final
rule address the basic elements necessary to administer a safe and
sound loan purchase program.
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\120\ See Sec. Sec. 701.4(b)(4), 701.21(c)(2), and 741.3(b)(2).
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As discussed previously, the Board is adding new requirements under
Sec. 701.23(b)(6) to mitigate the risk of removing certain regulatory
limits on the purchase of loans by FCUs. The requirements are crafted
to promote safe and sound loan purchase programs, which are intended to
protect credit unions and 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 requirements are intended to mitigate
unintended consequences related to the removal of the prescriptive
requirements in current Sec. 701.23(b)(2). The prescriptive
requirements in current paragraph (b)(2), 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 new requirements added by this final rule 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 new requirements 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 loan purchase activities being contemplated 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,
represent undue risk in relation to the credit union's financial
capacity, or beyond management's ability to manage can pose material
risks to an FCU's financial or operational condition.
The risk management expectations outlined in this final rule
reflect 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 Board requested comment on the following: (1) The new written
purchase policy requirements in paragraph (b)(6) of the rule; (2) the
principles-based due diligence, risk assessment, and risk management
requirements and whether they are 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; and (3) whether there are 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.
Public Comments
Several commenters offered general support for the proposed due
diligence requirements. One commenter suggested that most, if not all,
of these requirements are already done as a matter of course. Another
commenter believed the proposed requirements will help limit prudential
risks associated with FCUs' investments in eligible obligations in a
safe and sound manner. In response to a question in the proposed rule
preamble for commenters, one commenter stated that additional safety
and soundness criteria (beyond those included in the proposed rule)
would not be helpful or mitigate risk further. The commenter
recommended, however, that the limits imposed under Sec. 701.23 should
be comparable to those imposed on loan participation transactions; for
example, instituting a limit in line with the loan participation limit
of an amount of net worth to one seller. The commenter suggested that
this change would simplify any confusion for both buyers and sellers of
eligible obligations and allow examiners to compare to a benchmark when
reviewing credit unions who purchase eligible obligations. One
commenter recommended that each safety and soundness standard adopted
in the final rule be sufficiently flexible to permit credit unions to
adopt internal written purchase policy provisions that are commensurate
with the size, scope, type, complexity, and level of risk posed by
their individual eligible obligation activities.
Several commenters provided thoughts and recommendations regarding
specific proposed due diligence requirements. One commenter suggested
that requiring written purchase policies and established portfolio
concentration limits seems

[[Page 67593]]

prudent and valuable to ensure appropriate consideration by credit
unions engaging in eligible obligation activity.
One commenter suggested that requiring a legal review of agreements
seems unnecessary, as most credit unions already use legal counsel for
the drafting or review of agreements, and those that do not perhaps
have adequate internal expertise or expect to engage in a certain
activity in such a modest way that it poses no material risk. The
commenter suggested further that the requirement for legal review seems
overly intrusive to a credit union's responsibility to understand and
manage its risks. Another commenter recommended the NCUA further
clarify the differences in what is required in the legal agreements for
loan participations and eligible obligation purchases. The commenter
noted that some of the requirements in the respective provisions (Sec.
701.22(d) for loan participation agreements and proposed new Sec.
701.23(b)(6)(iv) for eligible obligation agreements) are similar and
yet worded differently. The commenter provided as an example that the
requirements in Sec. Sec. 701.22(d)(4)(i) and 701.23(b)(6)(iv)(A) to
identify the specific loans being purchased, and the requirement in the
loan participation rule at Sec. 701.22(d)(1) that the agreement be
properly executed under applicable law, do not appear at all in the
proposed eligible obligation rule's new language, although proposed
Sec. 701.23 does require a legal review of the eligible obligations
purchase. To address these types of differences, the commenter
recommended the following additions: (1) clarifying which of the loan
participation agreement requirements also apply to eligible obligations
(depending on whether servicing is retained or released) and (2)
specifying whether there are additional (or fewer) obligations that
apply to loan participations versus eligible obligations, including
specifically what those differences are. To effectuate this change, the
commenter recommended adding language to Sec. 701.23(b)(6)(iv) as
follows:
Require that the written purchase agreement include, in the case of
a servicing released transaction:
The following requirements referenced in the loan participation
rule (Sec. 701.22): [__].
The following additional requirements not referenced in the loan
participation rule (Sec. 701.22): [__].
Require that the written purchase agreement include, in the case of
a servicing retained transaction:
The following requirements referenced in the loan participation
rule (Sec. 701.22): [__].
The following additional requirements not referenced in the loan
participation rule (Sec. 701.22): [__].
One commenter suggested that partnering with responsible third
parties is often what is most suitable for the credit union and their
members. The commenter encouraged the NCUA to refresh its view on
conflicts-of-interest and shift to something more like ``credit unions
relying on third party underwriting performed by the seller or an agent
of the seller could be operating in an unsafe and unsound manner and
should establish and demonstrate clear risk management and oversight
protocols.''
Discussion
In recognition of the general support from commenters for this
proposed change, the Board is adopting the revisions as proposed for
the reasons set forth in the notice of proposed rulemaking. The Board
does not believe that performing a legal review of the written purchase
or sales agreements is burdensome because, as noted by one commenter,
most credit unions already carry out such reviews. Additionally, while
legal reviews may need to be conducted to ensure that the legal and
business interests of the credit union are protected against undue
risk, the final rule does not specify when legal reviews are required,
only that the credit union's internal written purchase policies 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. This requirement should be
based on the results of the due diligence and risk assessment processes
completed for the planned activity. The determination as to when such a
legal review would be required should be commensurate with the size,
scope, type, complexity, and level of risk posed by the planned
activity covered by the written agreement and contract.
When it is decided that a legal review by counsel is required, the
credit union's attorneys should review the written agreement or
contract to ensure that its legal and business interests are protected.
The review should include the terms, recourse and risk-sharing
arrangements, loan administration and controls. The credit union's
attorneys should also make sure the board of directors and management
clearly understand the rights and responsibilities of each party. For
example, the review should indicate which party bears the costs of
collateral disposition, and whether there are recourse arrangements, or
a commitment for the purchasing credit union to make additional loan
purchases and describe the interest being purchased. The legal review
should also ensure that the requirements for a written loan purchase
agreement under section Sec. 701.23 are adequately addressed and that
the agreement complies with all state and federal laws. The legal
review should address loan and collateral documentation and information
that the seller is required to share with the purchasing credit union,
status reports on payments and interest accrual, exit strategies or
termination clauses, procedures for modifying loan terms, notification
of adverse loan events, collection procedures if servicing rights are
retained by the seller, turnover in key staff of the seller or
servicer, and other provisions necessary to effectively manage credit
risk.
The credit union's board of directors and senior management should
exercise their right to negotiate the terms of any agreements or
contracts to make them mutually fair and equitable. Further, a credit
union should understand what actions it may take if the contract is
breached, or the seller, any sub-servicers, or sub-contractors are not
performing as expected. The written loan purchase agreement is a
critical component of any third-party transaction or relationship, and
thus, a legal review is a key element in the overall risk mitigation
and management process.

New Sec. 701.23(b)(6)(i)

New Sec. 701.23(b)(6)(i) requires 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).\121\
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\121\ 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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On several occasions, third-party relationships with credit unions
have resulted in financial stress due to unexpected costs, legal
disputes, and asset losses. Due diligence reviews are important because
they assist credit unions in risk identification and mitigation when
engaging with outside parties in a new loan program and when

[[Page 67594]]

enhancing services to members. Failure to complete adequate due
diligence can result in the acquisition of loan volumes that exceed the
board's risk appetite or credit union's financial capacity, 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 does not have the ability to
fulfill its contractual obligations. This could lead to disruptions in
member service, uncollected payments on loans, and potential losses if
the third party fails to 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 final 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 the following:
<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

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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.