98-25959. Organization and Operation of Federal Credit Unions; Appraisals; Member Business Loans; and Requirements for Insurance  

  • [Federal Register Volume 63, Number 188 (Tuesday, September 29, 1998)]
    [Rules and Regulations]
    [Pages 51793-51802]
    From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
    [FR Doc No: 98-25959]
    
    
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    NATIONAL CREDIT UNION ADMINISTRATION
    
    12 CFR Parts 701, 722, 723 and 741
    
    
    Organization and Operation of Federal Credit Unions; Appraisals; 
    Member Business Loans; and Requirements for Insurance
    
    AGENCY: National Credit Union Administration (NCUA).
    
    ACTION: Interim final rule with request for comments.
    
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    SUMMARY: The NCUA is updating, clarifying and streamlining its existing 
    rules concerning member business loans and appraisals for federally 
    insured credit unions, as well as implementing recent statutory 
    limitations regarding member business loans. The intended effect of 
    this rule is to reduce regulatory burden, maintain safety and 
    soundness, and provide an exception for qualifying credit unions from 
    the statutory aggregate limit on a credit union's outstanding member 
    business loans.
    
    DATES: Effective September 29, 1998. Comments must be received on or 
    before November 30, 1998.
    
    ADDRESSES: Direct comments to Becky Baker, Secretary of the Board. Mail 
    or hand-deliver comments to National Credit Union Administration, 1775 
    Duke Street, Alexandria, Virginia 22314-3428. Fax comments to (703) 
    518-6319. Please send comments by one method only.
    
    FOR FURTHER INFORMATION CONTACT: Michael J. McKenna, Staff Attorney, 
    Office of General Counsel at the above address or telephone: (703) 518-
    6540; or David Marquis, Director, Office of Examination and Insurance, 
    at the above address or telephone: (703) 518-6360.
    
    SUPPLEMENTARY INFORMATION:
    
    A. Background
    
        The NCUA Board adopted its first member business loan rule in April 
    1987 due to the increased amount of credit union losses attributed to 
    business lending activity. In response to continued losses to credit 
    unions and the National Credit Union Share Insurance Fund (NCUSIF) due 
    to member business loans, the NCUA Board adopted a more restrictive 
    member business loan rule in September 1991. In general, the results of 
    the 1991 revision have been very positive. Nonetheless, experience with 
    the regulation indicated a need for simplification, clarification, and 
    improvement. Therefore, on July 23, 1997, the Board issued proposed 
    amendments to the regulation governing member business loans (Current 
    Section 701.21(h) and Proposed Part 723 of NCUA's Regulations) and 
    appraisals (Part 722 of NCUA's Regulations) with a sixty-day comment 
    period. 62 FR 41313 (August 1, 1997).
        The NCUA Board was considering adopting a final member business 
    loan rule in March of this year, when it became apparent that Congress 
    was considering legislation regarding the ability of credit unions to 
    grant member business loans. The NCUA Board decided to defer 
    consideration of a final rule until Congress had acted on this 
    legislation. Since then, the Credit Union Membership Access Act (the 
    Act) was enacted into law on August 7, 1998. Public Law 105-219. Among 
    other things, the Act imposes a new aggregate limit on a credit union's 
    outstanding member business loans. However, the Act also provides for 
    three circumstances where a credit union may qualify for an exception 
    from the aggregate limit.
        The NCUA Board has decided to finalize those aspects of the 
    proposed
    
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    rule that are not affected by the Act, as well as set forth the 
    procedures for obtaining an exception from the aggregate limit as 
    provided for by the Act. The Board is issuing this rule as an interim 
    final rule because there is no public interest in delaying action on 
    exceptions from the aggregate limit. On the contrary, there is a strong 
    public interest in permitting credit unions to continue to grant, and 
    members to receive, business loans. Therefore, the Board finds it 
    necessary and appropriate to act expeditiously to allow certain credit 
    unions to obtain an exception to continue to grant business loans that 
    would exceed the aggregate loan limit. If this rule is not effective 
    immediately, a number of credit unions and their members could be 
    adversely impacted. Accordingly the Board, for good cause, finds that 
    (1) pursuant to 5 U.S.C. 553(b)(3)(B), notice and public procedures are 
    impracticable, unnecessary, and contrary to the public interest; and 
    (2) pursuant to 5 U.S.C. 553(d)(3), the rule shall be effective 
    immediately and without 30 days advance notice of publication. Although 
    this rule is being issued as an interim final rule and is effective 
    immediately, the NCUA Board encourages interested parties to submit 
    comments, especially on the exception from the aggregate loan limits.
    
    B. Previous Comments and New Statutory Provisions
    
        Thirty-four comments were received. Comments were received from 
    eight federal credit unions, seven state chartered credit unions, ten 
    state leagues, three national credit union trade associations, one 
    bank, four bank trade associations, and one consulting group. Except 
    for the bank and bank trade associations, the commenters were very 
    supportive of the proposal, although most commenters suggested ways to 
    improve the final rule. Two commenters expressed complete support for 
    the proposal.
    
    Section-by-Section Analysis
    
        The proposed amendments were written in a plain English question 
    and answer format. Eight commenters approved of the plain English 
    format but some of these commenters questioned whether a question and 
    answer format would be comprehensive. The commenters expressing doubt 
    requested an additional section of supplementary information.
        Four commenters opposed the plain English question and answer 
    format. They believe that using it is not in the best interest of the 
    credit union industry because this format is not comprehensive and 
    would limit the creativity of credit unions in providing business loans 
    to their members. These commenters recommend that the regulation be 
    written in the traditional regulatory style and be supplemented with 
    questions and answers for further clarification of the rule.
        The NCUA Board has not received any evidence to indicate any 
    problems with the plain English format. The NCUA Board believes the 
    question and answer format will lessen misunderstandings and is 
    comprehensive and easy to understand. The NCUA Board does not believe a 
    supplementary information section in the final rule is necessary. 
    Therefore, the final rule is written in this format.
        NCUA proposed moving the rule from Part 701 to Part 723 of NCUA's 
    Regulations. Five commenters approved placing the member business loan 
    rule in its own Part. The NCUA Board agrees and the final rule will be 
    in Part 723.
    
    Proposed Section 723.1--What is a Member Business Loan?
    
        This section provides a definition of a member business loan. The 
    proposal defined a member business loan as any loan, line of credit, or 
    letter of credit where the borrower uses the proceeds for the following 
    purposes: commercial, corporate, investment property, business venture 
    or agricultural. This definition was slightly different from the 
    current rule in that the proposal deletes the term ``business'' from 
    ``business investment property.'' However, NCUA may no longer define 
    what is a member business loan by regulation because the Act defines 
    the term. Therefore, a member business loan means any loan, line of 
    credit or letter of credit, the proceeds of which will be used for a 
    commercial, corporate or other business investment property or venture, 
    or agricultural purpose. Section 107A(c)(1)(a) of the Act.
    
    Proposed Section 723.1(b)--Exceptions to the General Rule?
    
        This section sets forth the exceptions to the definition of a 
    member business loan. NCUA proposed to increase the dollar threshold at 
    which the rule applies from $50,000 to $100,000. Fifteen commenters 
    supported the new threshold. Some of these commenters believe the 
    change would help small and low-income credit unions. However, the Act 
    sets forth the applicable exceptions to the definition of a member 
    business loan. The dollar threshold is set at $50,000.
        The new regulation sets forth five exceptions that are virtually 
    identical to the exemptions in the current member business loan 
    regulation. The following loans are exempt from the member business 
    loan definition: (1) an extension of credit that is fully secured by a 
    lien on a 1-to-4 family dwelling that is the primary residence of a 
    member; (2) an extension of credit that is fully secured by shares in 
    the credit union making the extension of credit or deposits in 
    financial institutions; (3) an extension of credit that meets the 
    member business loan definition made to a borrower or an associated 
    member that has a total of all such extensions of credit in an amount 
    equal to or less than $50,000; (4) an extension of credit the repayment 
    of which is fully insured or fully guaranteed by, or where there is an 
    advance commitment to purchase in full by, an agency of the Federal 
    Government or of a State, or any political subdivision thereof; or (5) 
    an extension of credit that is granted by a corporate credit union (as 
    that term is defined by the Board) to another credit union.
    
    Proposed Section 723.2--What are the prohibited activities?
    
        NCUA proposed no substantive changes from the current rule, except 
    to add senior management employees and officials to the provision 
    prohibiting equity agreements or joint ventures. Four commenters agreed 
    with NCUA that senior management employees and officials should be 
    prohibited from receiving income tied to a business loan the credit 
    union makes. Two opposed the proposal.
        One commenter believed it would be inconsistent to prohibit non-
    compensated officials from entering into equity agreements and joint 
    ventures involving business loans while permitting credit unions to 
    make business loans to those officials. However, this commenter agreed 
    with the proposal to extend the prohibition against equity agreements 
    and joint ventures involving business loans to senior management 
    employees as long as NCUA excludes non-compensated officials from the 
    prohibition. The NCUA Board agrees and has incorporated this change 
    into the final rule.
        Two commenters believed that the current prohibition on senior 
    management officials receiving business loans should be eliminated. The 
    NCUA Board has not been provided with any convincing reason to 
    eliminate the prohibition. One commenter correctly pointed out that the 
    title to this section should be changed to ``who is ineligible to 
    receive a member business loan.'' This commenter stated that otherwise 
    it would make senior management
    
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    employment a prohibited activity. The NCUA Board agrees and has 
    retitled the section accordingly.
    
    Proposed Section 723.3--What are the requirements for construction and 
    development lending?
    
        This section sets forth the requirements for construction and 
    development lending. NCUA proposed no substantive changes to this 
    section from the current rule. NCUA clarified that construction and 
    development loans below the dollar limits, individually and/or in the 
    aggregate, are not considered to be member business loans for the 
    purpose of this rule. Thus, if a member has a construction loan for 
    $40,000, and no other outstanding business type loans, including 
    unfunded business type lines of credit, then the construction loan is 
    not a member business loan. No substantive comments were received on 
    this section. The NCUA Board is adopting this section in final as 
    proposed.
    
    Proposed Section 723.4--What are the other applicable regulations?
    
        This section merely describes the other lending rules credit unions 
    must follow when granting member business loans to the extent they are 
    consistent with this regulation. NCUA proposes no substantive changes 
    from the current rule. One commenter objected to incorporating Sections 
    701.21(a) through (g) of NCUA's regulations into this regulation. One 
    commenter supported this provision. The NCUA Board has not been 
    provided with any convincing reason to change this section, so it is 
    adopting it in final as proposed.
    
    Proposed Section 723.5--How do I implement a member business loan 
    program?
    
        This section requires the board of directors to adopt business loan 
    policies and review them at least annually. This section also requires 
    the board to use the services of an individual with at least two years 
    direct experience in the type of lending in which the credit union will 
    be engaging. The preamble to the proposal also clarified that NCUA has 
    never required experience with business loans in general but, rather, 
    has required experience with making loans the credit union intends to 
    grant. The preamble also clarified that credit unions need not hire 
    staff to meet the requirements of this section; however, credit unions 
    must ensure that the expertise is available. Credit unions can meet the 
    experience requirement through various approaches. For example, a 
    credit union can use the services of a CUSO, an employee of another 
    credit union, an independent contractor, or other third parties. 
    However, the actual decision to grant a loan must reside with the 
    credit union.
        Two commenters supported NCUA's clarification that the rule does 
    not require two years experience specifically in business lending. Two 
    commenters did not believe there would be any hindrances in obtaining a 
    staff person with two years relevant lending experience. Two commenters 
    believe it is difficult to find someone who has the relevant experience 
    for every type of commercial loan. One commenter stated that the real 
    issue is having the money to hire such experienced people.
        Two commenters recommended eliminating the two-year experience 
    requirement. Two commenters believed NCUA should allow credit unions to 
    address qualifications based on what the credit union desires. One 
    commenter agreed with the new language but believed it is still overly 
    restrictive and represents an attempt to micromanage credit unions.
        One commenter appreciated NCUA's clarification that the requirement 
    to retain staff with two years of experience does not mean specific 
    business lending experience. This commenter stated that allowing two 
    years of lending experience to suffice without a specific requirement 
    for business lending experience, coupled with the ability of a credit 
    union to use CUSO services, an employee from another credit union, or a 
    contractor, will remove a business lending impediment for many credit 
    unions.
        The NCUA Board believes it is crucial for a credit union to have 
    experienced personnel involved in making decisions regarding business 
    lending. Member business loans require special expertise in virtually 
    all phases of origination and administration. Prior to NCUA's 
    imposition of the experience requirement, a number of credit unions 
    suffered losses from member business loans as a result of poorly 
    structured and administered loans. Most of these problems could have 
    been avoided had the credit union been better informed and prepared 
    through the use of experienced personnel. Therefore, the NCUA Board is 
    continuing to require credit unions instituting member business loan 
    programs to retain personnel with two years of business lending 
    experience.
        Two commenters requested that the final regulation contain some of 
    the examples in the preamble to the proposal of proper arrangements 
    such as the use of a CUSO or an employee of another credit union. The 
    Board agrees and the final rule contains examples of how to fulfill the 
    two-year requirement.
    
    Proposed Section 723.6--What must our member business loan policies 
    address?
    
        This section sets forth those items that credit unions must address 
    in their written business loan policies. The proposal adds a new 
    requirement for credit unions to review financial statements. One 
    commenter believed it is overly burdensome to review and analyze the 
    member's entire financial statements instead of reviewing updates. Five 
    commenters did not believe it would be excessively burdensome. After 
    further consideration, the NCUA Board does not see any significant 
    benefit in requiring a review of financial statements on all member 
    business loans. In most cases, a credit union engaging in business 
    lending will ordinarily review the financial statements of its open-end 
    business loans. Therefore, the final rule does not require credit 
    unions to review financial statements.
        The proposal also changes the term ``appraisals'' to 
    ``determination of value.'' The wording in the current rule unduly 
    emphasizes member business loans as real estate loans. The proposed 
    wording clarifies that, whether a member business loan is for real 
    estate or non-real estate, credit unions must meet the collateral 
    requirements. The proposal also changes the term ``title search'' to 
    ``determination of ownership'' for the same reason.
        One commenter believed the present regulatory distinction between 
    real estate secured business loans and other business loans is often 
    blurred and that the proposed new regulation does little to recognize 
    this distinction. This commenter stated that the terms used in this 
    regulation are more applicable to real estate lending. Another 
    commenter suggested that NCUA consider two distinct classes of member 
    business loans: one for real estate, incorporating underwriting 
    criteria such as higher loan-to-value ratios, owner occupancy 
    standards, lien position requirements, longer loan terms; and one for 
    other types of business loans, with flexible underwriting criteria 
    appropriate to the specific loan. Although there is a distinction 
    between real estate secured business loans and other types of business 
    loans, the NCUA Board believes the stated requirements are necessary 
    for both. The NCUA Board believes the proposed changes in language will 
    be helpful to credit unions in making business loans.
        The proposal also clarified that the maturity of a member business 
    loan may not exceed twelve years. The proposal
    
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    inadvertently failed to exclude federally insured state chartered 
    credit unions from this requirement as NCUA has consistently done in 
    the past. Nine commenters stated that the twelve-year maturity limit 
    should not apply to state chartered credit unions. NCUA agrees and the 
    final rule permits state chartered credit unions to grant business 
    loans with a maturity limit consistent with state law. Five credit 
    unions requested that the twelve-year maturity limit be increased for 
    federal credit unions. This is currently impermissible for federal 
    credit unions since the Federal Credit Union Act limits such loans to 
    twelve years.
    
    Proposed Section 723.7--What other items must the member business loan 
    policy address?
    
        This section sets forth the remaining issues that written loan 
    policies must address, including loan-to-value ratios and the 
    requirement for the personal liability and guarantee of the member. The 
    proposal increases the second lien limitation from 70% to 80% for 
    collateral ratios. The proposal also clarifies that private mortgage 
    insurance for first liens with a loan-to-value ratio exceeding 80% 
    applies only to real estate loans. Twelve commenters supported the 
    increase in the second lien limitation from 70% to 80%. However, some 
    commenters questioned whether the same stringent loan-to-value ratios 
    would be required for loans on personal properties, vehicles and 
    equipment. They believed that NCUA's approach could hinder the 
    competitiveness of credit unions wanting to provide business loans to 
    their members. One commenter believed the second lien limitation should 
    be increased further while another commenter believed the 70% loan-to-
    value is adequate. Two commenters believed that credit unions need more 
    flexibility for loan to value ratios. One commenter believed NCUA 
    should allow loan-to-value ratios up to 100%. The NCUA Board believes 
    the specified loan limits are appropriate for member business loans and 
    has incorporated them into the final rule.
        One commenter stated that the regulation should be clarified so 
    that the loan-to-value ratios for business loans are applicable only 
    for member business loans. For example, if a business loan for $50,000 
    is granted on an unsecured basis and if an additional $40,000 is 
    granted to the borrower, only $40,000 would be subject to the loan-to-
    value limitations. The Board agrees that only that portion of member 
    business loans in excess of $50,000 are subject to the loan-to-value 
    limitations. However, if the two loans are on the same collateral, the 
    loan-to-value limitation will apply to the aggregate amount of the 
    loans. For example, if the credit union makes a loan on a piece of real 
    estate for $40,000 and subsequently makes another $40,000 loan on the 
    same collateral, the loan-to-value limitation will apply to the entire 
    $80,000.
        This proposed section would also allow any credit union to seek a 
    waiver from the loan-to-value ratios for a particular business loan 
    program. Five commenters agreed with expanding the waiver provision to 
    permit credit unions that recently initiated member business loan 
    programs to seek an exemption from loan-to-value limitations. The final 
    rule includes this waiver authority from the loan-to-value limitations.
        The proposal exempts federally insured credit unions from the loan-
    to-value ratios with respect to credit card line of credit programs 
    offered to nonnatural persons that are limited to routine purposes 
    normally made under those programs. One commenter supported this 
    proposal. One commenter erroneously believed this section did not apply 
    to federal credit unions.
    
    Proposed Section 723.8--How much may one member or a group of 
    associated members borrow?
    
        This section sets forth the aggregate amount of outstanding member 
    business loans that credit unions may grant to one member or a group of 
    associated members. Unless NCUA grants a waiver, the proposal limits 
    the aggregate amount of outstanding business loans to any one member or 
    group of associated members to 15% of the credit union's reserves (less 
    the Allowance for Loan Losses account) or $100,000, whichever is 
    higher. Six commenters agreed with the 15% threshold although one 
    commenter would delete the dollar threshold. One commenter requested 
    that the 15% limit be increased. The NCUA Board has not been provided 
    with a convincing rationale for raising the 15% limit and is adopting 
    the proposal in final.
        The NCUA Board is clarifying how loan participations are treated in 
    regard to business loan limits. In those situations where the credit 
    union sold the participation without recourse, the amount sold would 
    not be included when calculating the 15% limit for a single borrower. 
    However, if the credit union sold the participation with recourse (that 
    is, the selling credit union essentially retains a contingent 
    liability), it would include the amount sold when calculating the 15% 
    limit.
        The NCUA Board is also clarifying that the aggregate amount of 
    outstanding member business loans to any one member includes any 
    unfunded commitments.
    
    Proposed Section 723.9--How do I calculate the aggregate 15% limit?
    
        The current rule states that, if any portion of a member business 
    loan is secured by shares in the credit union or a deposit in another 
    financial institution, or fully or partially insured or guaranteed by, 
    or subject to an advance commitment to purchase by any agency of the 
    federal government or of a state or any of its political subdivisions, 
    such portion is not used in calculating the 15% limit. NCUA proposed no 
    substantive changes to the current rule on the calculation of the 15% 
    limit. Some credit unions have asked NCUA staff whether the partial 
    guarantee by a federal agency includes loans guaranteed by the Small 
    Business Administration. The amount of the loan guaranteed by the Small 
    Business Administration is not used in calculating the 15% limit.
        For the purpose of being consistent with proposed section 723.1(b), 
    NCUA proposed to change the term ``financial institution'' in this 
    section to ``federally insured financial institution.'' Since the Act, 
    in setting forth the exceptions to the member business loan definition, 
    does not require the financial institution to be federally insured, 
    NCUA is not adopting this change.
    
    Proposed Section 723.10--What loan limit waivers are available?
    
        The proposal provides for a waiver from: (1) the maximum loan 
    amount to one borrower or associated group of members; (2) loan-to-
    value ratios; and (3) construction and development lending. Although a 
    number of commenters approved of the waiver provision, twelve 
    commenters specifically questioned whether the waivers apply to 
    individual loans or to a category of loans. The intent of the proposal 
    was to exempt categories of loans. A loan-by-loan waiver would be 
    unworkable and overly burdensome for credit unions and NCUA. The final 
    rule clearly states that the waiver is for a category of loans.
    
    Proposed Section 723.11--How do I obtain an available waiver?
    
        This section describes the information that a credit union must 
    submit to the Regional Director with a waiver request. NCUA proposed no 
    substantive changes to the requirements of the current rule. However, 
    in the interim final rule, the NCUA Board is providing a mechanism for 
    state chartered federally insured credit unions to have the waiver 
    request
    
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    processed through the state supervisory authority.
    
    Proposed Section 723.12--What will NCUA do with my waiver request?
    
        This section addresses what the Regional Director must consider in 
    reviewing the waiver request and how the waiver is processed. The 
    proposal increased the number of days from 30 to 60 that a Regional 
    Director must act on a waiver request. It also eliminated the automatic 
    waiver approval if a region does not take action on a request within 
    the specified timeframe. Twelve commenters believed that the number of 
    days NCUA should have to process the waiver should be limited to 30 
    days and the automatic waiver provision should be reinstated. A few 
    commenters requested that NCUA have less than 30 days to approve or 
    disapprove the request. One commenter asked that NCUA clarify whether 
    there are any time limits once a waiver has been approved. The NCUA 
    Board is extending the number of days the agency has to process the 
    waiver to 45 days (from the receipt from the federal credit union or 
    the state supervisory authority) and has restored the automatic waiver 
    approval if a region does not take action on a request within the 
    specified timeframe. Any waiver is revocable in NCUA's sole discretion. 
    If a waiver is revoked, loans granted under the waiver authority are 
    grandfathered.
    
    Proposed Section 723.13--What options are available if the Regional 
    Director denies our waiver request or a portion of it?
    
        Under the current rule, a credit union may appeal the denial of its 
    waiver request by the Regional Director to the NCUA Board. NCUA 
    proposed no substantive changes to this area and no substantive 
    comments were received. The Board is adopting this section in final as 
    proposed.
    
    Proposed Section 723.14--How do I reserve for potential losses?
    
        Consistent with the current rule, this section addresses the 
    criteria for determining the classification of loans. NCUA proposes no 
    substantive changes to the loan classification. However, NCUA proposes 
    to move the current Appendix of Section 701.21(h) to this proposed 
    section. No substantive comments were received on this section. The 
    Board is adopting this proposed section in final.
    
    Proposed Section 723.15--How much must I reserve for potential losses?
    
        This section provides a schedule a credit union must use to reserve 
    for classified loans. NCUA proposes no substantive changes to this 
    schedule from the current rule. However, NCUA clarified the meaning of 
    this section by stating that this is the minimum amount when 
    establishing the reserve percentage. One commenter opposed the 
    mandatory reserve requirement. The Board believes the current 
    requirement is working well and is retained as proposed.
    
    New Section 723.16--What is the aggregate member business loan limit?
    
        The Act imposes a new aggregate limit on a credit union's 
    outstanding member business loans (including any unfunded commitments) 
    of the lesser of 1.75 times the credit union's net worth or 12.25% of 
    the credit union's total assets. Net worth is all of the credit union's 
    retained earnings. Retained earnings normally includes undivided 
    earnings, regular reserves and any other reserves. If a credit union 
    currently has business loans that exceed the aggregate loan limit and 
    does not qualify for an exception, it has until August 7, 2001 to 
    reduce the total amount of outstanding member business loans or below 
    the aggregate loan limit. Furthermore, an insured credit union that is 
    undercapitalized may not make any new business loans until such time 
    the credit union becomes adequately capitalized as required by the 
    prompt corrective action provisions of the Credit Union Membership 
    Access Act of 1998.
    
    New Section 723.17--Are there any exceptions to the aggregate loan 
    limit?
    
        The Act sets forth three exceptions to the aggregate limit: (1) 
    credit unions that have a low-income designation or participate in the 
    Community Development Financial Institutions program; (2) credit unions 
    that have a ``a history of primarily making member business loans,'' or 
    (3) credit unions that were chartered for the purpose of primarily 
    making member business loans.
        A credit union that does not currently have a low-income 
    designation and is seeking to determine whether it qualifies should 
    contact its regional director or the appropriate state supervisor. The 
    Board is defining ``a history of primarily making member business 
    loans'' as either (1) member business loans that comprise at least 25% 
    of the credit union's outstanding loans (as evidenced in a call report 
    for 1998 or any of the three prior years); or (2) member business loans 
    comprise the largest portion of the credit union's loan portfolio. For 
    example, if a credit union makes 23% member business loans, 22% first 
    mortgage loans, 22% new automobile loans, 20% credit card loans and 13% 
    other real estate loans, then the credit union would be considered as 
    meeting the primarily making business loan standard. For determining 
    the categories of loans the credit union should use loan categories 
    that are similar to those set forth in the call report such as: 
    unsecured credit card loans/lines of credit; all other unsecured loans/
    lines of credit; new vehicle loans; used vehicle loans; total first 
    mortgage loans; total other real estate loans; total member business 
    loans. NCUA estimates that less than 70 credit unions, out of a total 
    of 11,125 federally insured credit unions, will qualify for either of 
    these exceptions.
        An exception may also be granted for credit unions that were 
    chartered for the purpose of primarily making member business loans. It 
    is up to the credit union to provide sufficient documentation to 
    demonstrate it meets this exception. Due to the nature of federal 
    chartering it is unlikely that many federal credit unions will qualify 
    for this type of exception. Furthermore, the NCUA Board is seeking 
    comment on how it can more fully define credit unions that were 
    ``chartered for the purpose of  * * * primarily making business loans'' 
    for the purpose of the exception.
        A credit union that does not qualify for an exception must 
    immediately stop making business loans that will exceed the aggregate 
    loan limit. Credit unions that, in good faith, believe they qualify for 
    an exception can continue to make new member business loans as long as 
    they have applied for an exception.
    
    New Section 723.18--How do I obtain an exception?
    
        To obtain the exception, a federal credit union must submit 
    documentation to the Regional Director, demonstrating that it meets the 
    criteria of one of the exceptions. The regional director will process 
    requests for exemptions expeditiously for federal credit unions. 
    Although NCUA believes most exceptions will be granted in 1998 it is 
    possible for a credit union to qualify in the future. For example, a 
    credit union that receives a low-income designation in the year 2001 
    could apply for and receive an exception on that basis.
        A state chartered federally insured credit union must submit 
    documentation to its state regulator to receive the exception. Although 
    effective when granted by the state regulator, the state regulator 
    should forward its decision to NCUA.
        The exception does not expire unless revoked by the regional 
    director for a
    
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    federal credit union or by the state regulator for a federally insured 
    state chartered credit union. If an exception is revoked, loans granted 
    under the exception authority are grandfathered.
        If an exception request is denied for a federal credit union, it 
    may be appealed to the NCUA Board within 60 days of the denial by the 
    regional director. A federal credit union can continue to make business 
    loans until the NCUA Board decides the appeal.
    
    Proposed Section 723.16--What are the recordkeeping requirements?
    
        This proposed section, consistent with the current rule, requires a 
    credit union to identify member business loans separately in its 
    records and financial reports. NCUA proposed no substantive changes to 
    this requirement from the current rule. Four commenters believed that 
    this recordkeeping would be burdensome and unnecessary. NCUA believes 
    it is important for credit unions as well as NCUA to be able to monitor 
    business lending activity. Therefore, the Board is not making any 
    changes to this section in the final rule, except to renumber it as 
    Section 723.19.
    
    Proposed Section 723.17--What additional steps do federally insured 
    state chartered credit unions have to perform?
    
        In the preamble to the proposal, the Board stated that it believes 
    it is important for state supervisory authorities to remain aware of, 
    and involved in, member business loan activities in federally insured 
    state chartered credit unions. This new section would require federally 
    insured state chartered credit unions to obtain written approval for a 
    waiver from their state supervisory authority prior to submitting the 
    waiver request to NCUA. Three commenters questioned why NCUA believes 
    it is necessary to have this section. The commenters asked what would 
    happen if a state had no policy on waivers and declined to rule on the 
    waiver. These commenters believed this provision simply makes it more 
    difficult for a state chartered federally insured credit union to 
    obtain a waiver and that it makes little sense to restrict state 
    chartered credit unions in such a manner.
        It appears that some of the commenters believed the waiver process 
    was on a loan-by-loan basis instead of a category loans. The NCUA Board 
    still believes it is important for state supervisory authorities to be 
    involved in waivers from the member business loan rule. Therefore, 
    Section 723.11 requires a federally insured state chartered credit 
    union to process its waiver request through the state supervisory 
    authority. The NCUA Board believes the state supervisory authorities 
    will expeditiously process this request and there will only be a 
    minimal increase in time in processing waivers from state chartered 
    federally insured credit unions. NCUA will not approve a waiver request 
    that the state supervisory authority has not forwarded to NCUA or a 
    request that the state supervisory authority recommends denial.
    
    Proposed Section 723.18--How can a state supervisory authority develop 
    and implement a member business loan regulation?
    
        As in the current rule, the proposal allows a federally insured 
    state chartered credit union to obtain an exemption from NCUA's member 
    business rule so that a state supervisory authority can enforce the 
    state's rule instead of NCUA's rule. The NCUA Board must approve the 
    state's rule before a federally insured state chartered credit union is 
    exempt from NCUA's member business loan rule. To provide better 
    guidance to the states, the proposal identifies the minimum 
    requirements that they must address for a rule to be approved by the 
    NCUA Board. One commenter opposes the application of NCUA's member 
    business rule to federally insured state chartered credit unions and 
    requests that it be eliminated for them. Past practice has indicated 
    the importance of this rule being applied to state chartered federally 
    insured credit unions. However, the NCUA Board recognizes the concerns 
    of the state supervisory authorities and the interim final rule 
    modifies this section to demonstrate that the NCUA Board in reviewing a 
    state's rule is concerned, as insurer, with the safety and soundness 
    issues presented by the rule and not whether the language of the rule 
    is virtually identical to NCUA's rule.
        Three commenters questioned whether the adoption of the revised 
    rule by NCUA automatically means a state's rule is no longer 
    ``substantially equivalent.'' Because of the new statutory requirements 
    of the Act, no state rule is currently approved for use by federally 
    insured state chartered credit unions. Therefore, states must seek a 
    new determination from NCUA.
        Three commenters encouraged the NCUA Board to allow more 
    flexibility in the interpretation of what is ``substantially 
    equivalent'' where safety and soundness can be maintained. In making 
    its determination to approve a state's rule, the Board is primarily 
    concerned with safety and soundness considerations, and that is why the 
    minimum standards for such a determination are set forth in the 
    regulation.
        Because proposed section 723.17 is deleted from the final rule, 
    this section is renumbered as Section 723.20.
    
    Proposed Section 723.19--Definition
    
        NCUA proposed a general definition section at the end of the rule. 
    This section clarified the loan-to-value ratio by including terminology 
    that requires the inclusion of unfunded commitments and/or lines of 
    credit when determining the aggregate sum. Six commenters believed NCUA 
    should require credit unions to include unfunded commitments and/or 
    lines of credit in the aggregate sum to determine loan-to-value ratios. 
    One commenter disagreed. The NCUA Board is adopting in final the 
    proposal to include unfunded commitments and/or lines of credit in the 
    aggregate sum for loan-to-value determinations since this is the total 
    amount that the credit union agreed to loan to the borrower. However, 
    this section in the final rule is numbered section 723.21.
    
    Miscellaneous
    
        One commenter requested that the preamble or final regulation state 
    that credit scoring is permitted to assist in determining the credit 
    worthiness of a business loan applicant. Although not stated in the 
    regulation, we note that credit scoring that complies with equal credit 
    opportunity laws is permitted in evaluating the credit worthiness of a 
    business loan applicant.
    
    Part 722--Appraisals
    
        Certain loans as specified in Section 722.3(a) do not require an 
    appraisal. In addition, the NCUA Board proposes a waiver process from 
    the appraisal requirement where the appraisal requirement is an 
    unnecessary burden. Eight commenters supported the waiver appraisal 
    provision, although there was some confusion on whether it applied to a 
    loan program or individual loans. The intent of the proposal was to 
    apply to a loan program. The final rule reflects that the waiver 
    applies to a loan program. Three commenters objected to having a waiver 
    process. The NCUA Board does not believe that a waiver process will 
    have a negative effect on the safety and soundness of credit unions.
    
    C. Other Reductions in Regulatory Burden
    
        Under the current rule, all loans, lines of credit, or letters of 
    credit that meet the definition of a member business loan must be 
    separately identified in the
    
    [[Page 51799]]
    
    records of the credit union and be reported as such in financial and 
    statistical reports required by the NCUA. NCUA believes that this 
    information is already collected, and readily available, through the 
    5300 Call Report. The current requirement imposes an unnecessary burden 
    on credit unions and, therefore, the NCUA Board is deleting this 
    monitoring requirement.
        The current rule requires credit unions to provide periodic 
    disclosures to credit union members on the number and aggregate dollar 
    amount of member business loans. NCUA believes the language is 
    ambiguous and does not serve any true safety or soundness issue or 
    concern. Therefore, the NCUA Board is deleting this requirement.
        Current Sec. 701.21(c)(5) references the member business loan 
    section. Due to the proposed change to the member business loan rule 
    numbering system, NCUA is updating Sec. 701.21(c)(5) to reference the 
    appropriate sections of the final rule.
    
    D. Regulatory Procedures
    
    Regulatory Flexibility Act
    
        The Regulatory Flexibility Act requires NCUA to prepare an analysis 
    to describe any significant economic impact any proposed regulation may 
    have on a substantial number of small entities (primarily those under 
    $1 million in assets). The final member business loan rule would reduce 
    existing regulatory burdens. In addition, most small credit unions do 
    not grant member business loans. Therefore, the NCUA Board has 
    determined and certifies that the final rule will not have a 
    significant economic impact on a substantial number of small credit 
    unions. Accordingly, the Board has determined that a Regulatory 
    Flexibility Analysis is not required.
    
    Paperwork Reduction Act
    
        The reporting requirements in part 723 have been submitted to the 
    Office of Management and Budget for approval and the OMB number will be 
    published as soon as it is received by NCUA. Under the Paperwork 
    Reduction Act of 1995, no persons are required to respond to a 
    collection of information unless it displays a valid OMB control 
    number. The control number will be displayed in the table at 12 CFR 
    Part 795.
    
    Executive Order 12612
    
        Executive Order 12612 requires NCUA to consider the effect of its 
    actions on state interests. The final rule, as does the current rule, 
    applies to all federally insured credit unions, including federally 
    insured state chartered credit unions. However, since the final rule 
    reduces regulatory burden, NCUA has determined that the final rule does 
    not constitute a ``significant regulatory action'' for purposes of the 
    Executive Order.
    
    Congressional Review
    
        The Office of Management and Budget has determined this is not a 
    major rule.
    
    List of Subjects
    
    12 CFR Part 701
    
        Credit, Credit unions, Insurance, Mortgages, Reporting and 
    recordkeeping requirements, Surety bonds.
    
    12 CFR Part 722
    
        Appraisals, Credit, Credit unions, Reporting and recordkeeping 
    requirements, State-certified and State-licensed appraisers.
    
    12 CFR Part 723
    
        Credit, Credit unions, Reporting and recordkeeping requirements.
    
    12 CFR Part 741
    
        Bank deposit insurance, Credit unions, Reporting and recordkeeping 
    requirements.
    
        By the National Credit Union Administration Board on September 
    23, 1998.
    Becky Baker,
    Secretary of the Board.
    
        For the reasons set forth in the preamble, it is proposed that 12 
    CFR chapter VII be amended as follows:
    
    PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS
    
        1. The authority citation for part 701 continues to read as 
    follows:
    
        Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a, 
    1761b, 1766, 1767, 1782, 1784, 1787, and 1789. Section 701.6 is also 
    authorized by 31 U.S.C. 3717. Section 701.31 is also authorized by 
    15 U.S.C. 1601 et seq., 42 U.S.C. 1861 and 3601-3610. Section 701.35 
    is also authorized by 42 U.S.C. 4311-4312.
    
    
    Sec. 701.21  [Amended]
    
        2. Section 701.21 is amended in paragraph (c)(5) by revising 
    ``Sec. 701.21(h)(1)(i)'' to read ``Sec. 723.1 of this chapter'' and 
    ``Sec. 701.21(h)(2)(ii)'' to read ``Secs. 723.8 and 723.9 of this 
    chapter.''
        3. Section 701.21(h) is removed and reserved.
    
    PART 722--APPRAISALS
    
        4. The authority citation for part 722 continues to read as 
    follows:
    
        Authority: 12 U.S.C. 1766, 1789 and 3339.
    
        5. Section 722.3 is amended by removing ``or'' at the end of 
    paragraph (a)(7), by removing the period at the end of paragraph 
    (a)(8)(ii) and adding ``; or'' in its place, and by adding a new 
    paragraph (a)(9) to read as follows:
    
    
    Sec. 722.3  Appraisals required; transactions requiring a State 
    certified or licensed appraiser.
    
        (a) * * *
        (9) The regional director has granted a waiver from the appraisal 
    requirement for a category of loans meeting the definition of a member 
    business loan.
    * * * * *
        6. Part 723 is added to read as follows:
    
    PART 723--MEMBER BUSINESS LOANS
    
    Sec.
    723.1  What is a member business loan?
    723.2  What are the prohibited activities?
    723.3  What are the requirements for construction and development 
    lending?
    723.4  What are the other applicable regulations?
    723.5  How do you implement a member business loan program?
    723.6  What must your member business loan policy address?
    723.7  What are the collateral and security requirements?
    723.8  How much may one member, or a group of associated members, 
    borrow?
    723.9  How do you calculate the aggregate 15% limit?
    723.10  What loan limit waivers are available?
    723.11  How do you obtain a waiver?
    723.12  What will NCUA do with my waiver request?
    723.13  What options are available if the NCUA Regional Director 
    denies our waiver request, or a portion of it?
    723.14  How do I reserve for potential losses?
    723.15  How much must I reserve for potential losses?
    723.16  What is the aggregate member business loan limit for a 
    credit union?
    723.17  Are there any exceptions to the aggregate loan limit?
    723.18  How do I obtain an exception?
    723.19  What are the recordkeeping requirements?
    723.20  How can a state supervisory authority develop and enforce a 
    member business loan regulation?
    723.21  Definitions.
    
        Authority: 12 U.S.C. 1756, 1757, 1757A, 1766, 1785, 1789.
    
    
    Sec. 723.1  What is a member business loan?
    
        (a) General rule. A member business loan includes any loan, line of 
    credit, or
    
    [[Page 51800]]
    
    letter of credit where the borrower uses the proceeds for the following 
    purposes:
        (1) Commercial;
        (2) Corporate;
        (3) Other business investment property or venture; or
        (4) Agricultural.
        (b) Exceptions to the general rule. The following is not a member 
    business loan:
        (1) A loan fully secured by a lien on a 1 to 4 family dwelling that 
    is the member's primary residence;
        (2) A loan fully secured by shares in the credit union making the 
    extension of credit or deposits in other financial institutions;
        (3) Loan(s) to a member or an associated member which, when added 
    together, are equal to or less than $50,000;
        (4) A loan where a federal or state agency (or its political 
    subdivision) fully insures repayment, or fully guarantees repayment, or 
    provides an advance commitment to purchase in full; or
        (5) A loan granted by a corporate credit union to another credit 
    union under part 704 of this chapter.
    
    
    Sec. 723.2  What are the prohibited activities?
    
        (a) Who is ineligible to receive a member business loan? You must 
    not make a member business loan to the following:
        (1) Any member of the board of directors who is compensated as 
    such;
        (2) Your chief executive officer (typically this individual holds 
    the title of President or Treasurer/Manager);
        (3) Any assistant chief executive officers (e.g., Assistant 
    President, Vice President, or Assistant Treasurer/Manager);
        (4) Your chief financial officer (Comptroller); or
        (5) Any associated member or immediate family member of anyone 
    listed in paragraphs (a)(1) through (4) of this section.
        (b) Equity agreements/joint ventures. You may not grant a member 
    business loan if any additional income received by the credit union, 
    senior management employees, or any member of the board of directors 
    who is compensated as such, is tied to the profit or sale of the 
    business or commercial endeavor for which the loan is made.
    
    
    Sec. 723.3  What are the requirements for construction and development 
    lending?
    
        Unless the Regional Director grants an exemption, loans granted for 
    the construction or development of commercial or residential property 
    are subject to the following additional requirements.
        (a) The aggregate of all construction and development loans must 
    not exceed 15% of reserves, (excluding the Allowance for Loan Losses 
    account). To determine the aggregate, you may exclude any portion of a 
    loan:
        (1) Secured by shares in the credit union;
        (2) Secured by deposits in another federally insured financial 
    institution;
        (3) Fully or partially insured or guaranteed by any agency of the 
    federal government, state, or its political subdivisions; or
        (4) Subject to an advance commitment to purchase by any agency of 
    the federal government, state, or its political subdivisions;
        (b) The borrower must have a minimum of 35% equity interest in the 
    project being financed; and
        (c) The funds may be released only after on-site, written 
    inspections by independent, qualified personnel and according to a 
    preapproved draw schedule and any other conditions as set forth in the 
    loan documentation.
    
    
    Sec. 723.4  What are the other applicable regulations?
    
        The provisions of Sec. 701.21(a) through (g) of this chapter apply 
    to member business loans to the extent they are consistent with this 
    part.
    
    
    Sec. 723.5  How do you implement a member business loan program?
    
        The board of directors must adopt specific business loan policies 
    and review them at least annually. The board must also utilize the 
    services of an individual with at least two years direct experience 
    with the type of lending the credit union will be engaging in. Credit 
    unions do not have to hire staff to meet the requirements of this 
    section; however, credit unions must ensure that the expertise is 
    available. A credit union can meet the experience requirement through 
    various approaches. For example, a credit union can use the services of 
    a credit union service organization, an employee of another credit 
    union, an independent contractor, or other third parties. However, the 
    actual decision to grant a loan must reside with the credit union.
    
    
    Sec. 723.6  What must your member business loan policy address?
    
        At a minimum, your policy must address the following:
        (a) The types of business loans you will make;
        (b) Your trade area;
        (c) The maximum amount of your assets, in relation to reserves, 
    that you will invest in business loans;
        (d) The maximum amount of your assets, in relation to reserves, 
    that you will invest in a given category or type of business loan;
        (e) The maximum amount of your assets, in relation to reserves, 
    that you will loan to any one member or group of associated members, 
    subject to Sec. 723.8;
        (f) The qualifications and experience of personnel (minimum of 2 
    years) involved in making and administering business loans;
        (g) A requirement to analyze and document the ability of the 
    borrower to repay the loan;
        (h) Receipt and periodic updating of financial statements and other 
    documentation, including tax returns;
        (i) A requirement for sufficient documentation supporting each 
    request to extend credit, or increase an existing loan or line of 
    credit (except where the board of directors finds that the 
    documentation requirements are not generally available for a particular 
    type of business loan and states the reasons for those findings in the 
    credit union's written policies). At a minimum, your documentation must 
    include the following:
        (1) Balance sheet;
        (2) Cash flow analysis;
        (3) Income statement;
        (4) Tax data;
        (5) Analysis of leveraging; and
        (6) Comparison with industry average or similar analysis.
        (j) The collateral requirements must include:
        (1) Loan-to-value ratios;
        (2) Determination of value;
        (3) Determination of ownership;
        (4) Steps to secure various types of collateral; and
        (5) How often the credit union will reevaluate the value and 
    marketability of collateral;
        (k) The interest rates and maturities of business loans;
        (l) General loan procedures which include:
        (1) Loan monitoring;
        (2) Servicing and follow-up; and
        (3) Collection;
        (m) Identification of those individuals prohibited from receiving 
    member business loans.
    
    
    Sec. 723.7  What are the collateral and security requirements?
    
        (a) Unless your Regional Director grants a waiver, all member 
    business loans must be secured by collateral as follows:
    
    [[Page 51801]]
    
    
    
    ------------------------------------------------------------------------
                   Lien                  Minimum loan to value requirements
    ------------------------------------------------------------------------
    All...............................  LTV ratios cannot exceed 95%.
    First.............................  You may grant a LTV ratio in excess
                                         of 80% only where the value in
                                         excess of 80% is covered through:
                                         for real estate member business
                                         loans, acquisition of private
                                         mortgage or equivalent type
                                         insurance provided by an insurer
                                         acceptable to the credit union
                                         (where available); insurance or
                                         guarantees by, or subject to
                                         advance commitment to purchase by,
                                         an agency of the federal
                                         government; or insurance or
                                         guarantees by, or subject to
                                         advance commitment to purchase by,
                                         an agency of a state or any of its
                                         political subdivisions.
    First.............................  LTV ratios up to 80%.
    Second............................  LTV ratios up to 80%.
    ------------------------------------------------------------------------
    
        (b) Borrowers, other than a not for profit organization as defined 
    by the Internal Revenue Service Code (26 U.S.C. 501) or those where the 
    Regional Director grants a waiver, must provide their personal 
    liability and guarantee.
        (c) Federally insured credit unions are exempt from the provisions 
    of paragraphs (a) and (b) of this section with respect to credit card 
    line of credit programs offered to nonnatural person members that are 
    limited to routine purposes normally made available under those 
    programs.
    
    
    Sec. 723.8  How much may one member, or a group of associated members, 
    borrow?
    
        The aggregate amount of outstanding member business loans 
    (including any unfunded commitments) to any one member or group of 
    associated members must not exceed the greater of:
        (a) 15% of the credit union's reserves (excluding the Allowance for 
    Loan Losses account); or
        (b) $100,000; or
        (c) An amount approved by the credit union's Regional Director.
    
    
    Sec. 723.9  How do you calculate the aggregate 15% limit?
    
        (a) Step 1. Calculate the numerator by adding together the total 
    outstanding balance of member business loans to any one member, or 
    group of associated members. From this amount, subtract any portion:
        (1) Secured by shares in the credit union;
        (2) Secured by deposits in another federally insured financial 
    institution;
        (3) Fully or partially insured or guaranteed by any agency of the 
    Federal government, state, or its political subdivisions;
        (4) Subject to an advance commitment to purchase by any agency of 
    the Federal government, state, or its political subdivisions.
        (b) Step 2. Divide the numerator by all reserves, excluding the 
    Allowance for Loan Losses account.
    
    
    Sec. 723.10  What loan limit waivers are available?
    
        In addition to an individual waiver from the personal liability and 
    guarantee requirement, you also may seek a waiver for a category of 
    loans in the following areas:
        (a) Loan-to-value ratios;
        (b) Maximum loan amount to one borrower or associated group of 
    borrowers; and
        (c) Construction and development loan limits.
    
    
    Sec. 723.11  How do you obtain a waiver?
    
        To obtain a waiver, a federal credit union must submit a request to 
    the Regional Director. A state chartered federally insured credit union 
    must submit the request to its state supervisory authority. If the 
    state supervisory authority approves the request, the state regulator 
    will forward the request to the Regional Director. A waiver is not 
    effective until it is approved by the Regional Director. The waiver 
    request must contain the following:
        (a) A copy of your business lending policy;
        (b) The higher limit sought;
        (c) An explanation of the need to raise the limit;
        (d) Documentation supporting your ability to manage this activity; 
    and
        (e) An analysis of the credit union's prior experience making 
    member business loans, including as a minimum:
        (1) The history of loan losses and loan delinquency;
        (2) Volume and cyclical or seasonal patterns;
        (3) Diversification;
        (4) Concentrations of credit to one borrower or group of associated 
    borrowers in excess of 15% of reserves (excluding the Allowance for 
    Loan Losses account);
        (5) Underwriting standards and practices;
        (6) Types of loans grouped by purpose and collateral; and
        (7) The qualifications of personnel responsible for underwriting 
    and administering member business loans.
    
    
    Sec. 723.12  What will NCUA do with my waiver request?
    
        Your Regional Director will:
        (a) Review the information you provided in your request;
        (b) Evaluate the level of risk to your credit union;
        (c) Consider your credit union's historical CAMEL composite and 
    component ratings when evaluating your request; and
        (d) Notify you of the action taken within 45 calendar days of 
    receiving the request from the federal credit union or the state 
    supervisory authority. If you do not receive notification within 45 
    calendar days of the date the request was received by the regional 
    office, the credit union may assume approval of the waiver request.
    
    
    Sec. 723.13  What options are available if the NCUA Regional Director 
    denies our waiver request, or a portion of it?
    
        You may appeal the Regional Director's decision in writing to the 
    NCUA Board. Your appeal must include all information requested in 
    Sec. 723.11 and why you disagree with your Regional Director's 
    decision.
    
    
    Sec. 723.14  How do I reserve for potential losses?
    
        Non-delinquent loans may be classified based on factors such as the 
    adequacy of analysis and supporting documentation. You must classify 
    potential loss loans as either substandard, doubtful, or loss. The 
    criteria for determining the classification of loans are:
        (a) Substandard. Loan is inadequately protected by the current 
    sound worth and paying capacity of the obligor or of the collateral 
    pledged, if any. Loans classified must have a well-defined weakness or 
    weaknesses that jeopardize the liquidation of debt. They are 
    characterized by the distinct possibility that the credit union will 
    sustain some loss if the deficiencies are not corrected. Loss 
    potential, while existing in the aggregate amount of substandard loans, 
    does not have to exist in individual loans classified substandard.
        (b) Doubtful. A loan classified doubtful has all the weaknesses 
    inherent in one classified substandard, with the added characteristic 
    that the weaknesses make collection or liquidation in full, on the 
    basis of currently existing facts, conditions, and values, highly 
    questionable and improbable. The possibility of loss is extremely high, 
    but because of certain
    
    [[Page 51802]]
    
    important and reasonably specific pending factors which may work to the 
    advantage and strengthening of the loan, its classification as an 
    estimated loss is deferred until its more exact status may be 
    determined. Pending factors include: proposed merger, acquisition, or 
    liquidation actions; capital injection; perfecting liens on collateral; 
    and refinancing plans.
        (c) Loss. Loans classified loss are considered uncollectible and of 
    such little value that their continuance as loans is not warranted. 
    This classification does not necessarily mean that the loan has 
    absolutely no recovery or salvage value, but rather, it is not 
    practical or desirable to defer writing off this basically worthless 
    asset even though partial recovery may occur in the future.
    
    
    Sec. 723.15  How much must I reserve for potential losses?
    
        The following schedule sets the minimum amount you must reserve for 
    classified loans:
    
    ------------------------------------------------------------------------
                 Classification                      Amount required
    ------------------------------------------------------------------------
    Substandard............................  10% of outstanding amount
                                              unless other factors (for
                                              example, history of such loans
                                              at the credit union) indicate
                                              a greater or lesser amount is
                                              appropriate.
    Doubtful...............................  50% of the outstanding amount.
    Loss...................................  100% of the outstanding amount.
    ------------------------------------------------------------------------
    
    Sec. 723.16  What is the aggregate member business loan limit for a 
    credit union?
    
        The aggregate limit on a credit union's outstanding member business 
    loans (including any unfunded commitments) is the lesser of 1.75 times 
    the credit union's net worth or 12.25% of the credit union's total 
    assets. Net worth is all of the credit union's retained earnings. 
    Retained earnings normally includes undivided earnings, regular 
    reserves and any other reserves.
    
    
    Sec. 723.17  Are there any exceptions to the aggregate loan limit?
    
        There are three circumstances where a credit union may qualify for 
    an exception from the aggregate limit. The three exceptions are:
        (a) Credit unions that have a low-income designation or participate 
    in the Community Development Financial Institutions program;
        (b) Credit unions that were chartered for the purpose of primarily 
    making member business loans and can provide documentary evidence; or
        (c) Credit unions that have a history of primarily making member 
    business loans, meaning that either member business loans comprise at 
    least 25% of the credit union's outstanding loans (as evidenced in a 
    call report for 1998 or any of the three prior years) or member 
    business loans comprise the largest portion of the credit union's loan 
    portfolio. For example, if a credit union makes 23% member business 
    loans, 22% first mortgage loans, 22% new automobile loans, 20% credit 
    card loans, and 13% total other real estate loans, then the credit 
    union meets this exception.
    
    
    Sec. 723.18  How do I obtain an exception?
    
        To obtain the exception, a federal credit union must submit 
    documentation to the Regional Director, demonstrating that it meets the 
    criteria of one of the exceptions. A state chartered federally insured 
    credit union must submit documentation to its state regulator. The 
    state regulator should forward its decision to NCUA. The exception does 
    not expire unless revoked by the state regulator for a state chartered 
    federally insured credit union or the Regional Director for a federal 
    credit union. If an exception request is denied for a federal credit 
    union, it may be appealed to the NCUA Board within 60 days of the 
    denial by the Regional Director. Until the NCUA Board acts on the 
    appeal, the credit union can continue to make new business loans
    
    
    Sec. 723.19  What are the recordkeeping requirements?
    
        You must separately identify member business loans in your records 
    and in the aggregate on your financial reports.
    
    
    Sec. 723.20  How can a state supervisory authority develop and enforce 
    a member business loan regulation?
    
        (a) The NCUA Board may exempt a federally insured state chartered 
    credit union from NCUA's member business loan rule, if, NCUA approves 
    the state's rule for use for state chartered federally insured credit 
    unions. In making this substantial equivalency determination, the Board 
    is guided by safety and soundness considerations and reviews whether 
    the state regulation minimizes the risk and accomplishes the overall 
    objectives of NCUA's member business rule in this part. Specifically, 
    the Board will focus its review on the definition of:
        (1) A member business loan;
        (2) Loan to one borrower limits;
        (3) Written loan policies;
        (4) Collateral and security requirements;
        (5) Construction and development lending; and
        (6) Loans to senior management.
        (b) To receive NCUA's approval of a state's members business rule, 
    the state supervisory authority must submit its rule to the NCUA 
    regional office. After reviewing the rule, the region will forward the 
    request to the NCUA Board for a final determination.
    
    
    Sec. 723.21  Definitions.
    
        For purposes of this part, the following definitions apply:
        Associated member is any member with a shared ownership, 
    investment, or other pecuniary interest in a business or commercial 
    endeavor with the borrower.
        Construction or development loan is a financing arrangement for 
    acquiring property or rights to property, including land or structures, 
    with the intent to convert it to income-producing property such as 
    residential housing for rental or sale; commercial use; industrial use; 
    or similar uses.
        Immediate family member is a spouse or other family member living 
    in the same household.
        Loan-to-value ratio is the aggregate amount of all sums borrowed, 
    outstanding balances plus any unfunded commitment or line of credit, 
    from all sources on an item of collateral divided by the market value 
    of the collateral used to secure the loan.
        Reserves are all reserves, including the Allowance for Loan Losses 
    and Undivided Earnings or surplus.
    
    PART 741--REQUIREMENTS FOR INSURANCE
    
        7. The authority citation for part 741 continues to read as 
    follows:
    
        Authority: 12 U.S.C. 1757, 1766 and 1781-1790. Section 741.4 is 
    also authorized by 31 U.S.C. 3717.
    
    
    Sec. 741.203  [Amended]
    
        8. Section 741.203 is amended in paragraph (a) by revising 
    ``Sec. 701.21(h)'' to read ``part 723.''
    
    [FR Doc. 98-25959 Filed 9-28-98; 8:45 am]
    BILLING CODE 7535-01-P
    
    
    

Document Information

Effective Date:
9/29/1998
Published:
09/29/1998
Department:
National Credit Union Administration
Entry Type:
Rule
Action:
Interim final rule with request for comments.
Document Number:
98-25959
Dates:
Effective September 29, 1998. Comments must be received on or before November 30, 1998.
Pages:
51793-51802 (10 pages)
PDF File:
98-25959.pdf
CFR: (24)
12 CFR 701.21
12 CFR 722.3
12 CFR 723.1
12 CFR 723.2
12 CFR 723.3
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