[Federal Register Volume 62, Number 148 (Friday, August 1, 1997)]
[Proposed Rules]
[Pages 41313-41320]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-19936]


 ========================================================================
 Proposed Rules
                                                 Federal Register
 ________________________________________________________________________
 
 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
 ========================================================================
 

  Federal Register / Vol. 62, No. 148 / Friday, August 1, 1997 / 
Proposed Rules  

[[Page 41313]]


=======================================================================
-----------------------------------------------------------------------

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701, 722 and 723


Organization and Operations of Federal Credit Unions; Appraisals; 
and Member Business Loans

AGENCY: National Credit Union Administration (NCUA).

ACTION: Notice of proposed rulemaking.

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

SUMMARY: The NCUA is proposing to update, clarify and streamline its 
existing rules concerning member business loans and appraisals for 
federally insured credit unions. The intended effect of the proposal is 
to reduce regulatory burden, maintain safety and soundness, and expand 
the number and type of business loans a federal credit union may grant 
their members.

DATES: Comments must be received on or before September 30, 1997.

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, 
Division of Operations, Office of General Counsel, at the above address 
or telephone: (703) 518-6540; or Roger Blake, Program Officer, Division 
of Supervision, 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 increased amount of credit union losses and failures 
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 indicates that there may be 
a need for simplification, clarification, and improvement. In addition, 
NCUA is conducting a review of its regulations pursuant to the 
Regulatory Reinvention Initiative of the Vice President's National 
Performance Review and the NCUA Board's Regulatory Relief Project.
    In particular, NCUA is aware that certain business and legal 
developments make this a good time to review and update the member 
business loan rule. NCUA staff has over 5 years of experience with 
implementing and interpreting the regulation and believes it can be 
improved. The purpose of this notice of proposed rulemaking is to 
identify, and request public comment on reducing regulatory burden 
while ensuring the safety and soundness of federal credit unions and 
the NCUSIF.
    In providing comments upon the proposed rule, commentors should 
keep in mind the needs of small credit unions, especially community 
development and low-income designated credit unions, and their members. 
In some cases, member business loans provide an ideal means for smaller 
credit unions to expand the types of products and services offered to 
their memberships and enhance their members' lives. For these types of 
credit unions, member business loans may be the best method to help the 
credit union accommodate membership needs and improve the community.

B. Section-by-Section Analysis

    The most noticeable change in the proposed revision is the use of a 
plain English question and answer format. The federal government is 
promoting plain English to increase regulatory comprehension and 
improve compliance for users of regulations. An intended consequence of 
this format, other than anticipated compliance, is a lessening of 
misunderstandings caused by unclear standard regulatory language. NCUA 
requests comments regarding the new format and numbering system as well 
as moving the rule from Part 701 to Part 723 of NCUA's Regulations.

Proposed Section 723.1--What is a Member Business Loan?

    This section provides a definition of a member business loan. A 
member business loan is 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 is slightly different from the current 
rule in that the proposal deletes the term ``business'' from ``business 
investment property''. Investment property, whether business related or 
other, represents additional risk (beyond that of standard consumer 
lending) that credit unions must recognize and control through adequate 
underwriting standards and monitoring.
    NCUA proposes to move all other definitions to Section 723.19.

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 is proposing to retain the exceptions in the 
current rule and add one new exception to the definition. The proposed 
exception is for one other loan fully secured by a lien on 1 to 4 
family dwelling where the borrower does not rely upon rental or 
business income derived from that property to repay the loan. This 
exception would allow credit unions to make more than one real estate 
loan to one borrower, subject to the 15% limitation, without triggering 
the member business rule requirements. However, NCUA still believes 
that, given the risks associated with business lending, the source of 
repayment should be proven and stable and not related to any income 
produced by the collateral of that loan.
    To avoid any misunderstanding, the Board is once again reiterating 
that a federal credit union may finance a future retirement home under 
the long-term mortgage authority. If at the time the loan is made, the 
member's intent is to establish a new principal residence, either 
immediately or some time in the future, the federal credit union may 
grant a long-term mortgage loan secured by the second home. Under this 
analysis, since the member intends to occupy this residence as his or 
her primary residence, the credit union may grant a second home loan 
under the long-term mortgage authority and the

[[Page 41314]]

loan is exempt from the definition of a member business loan.
    The Board is requesting comments on whether a loan fully secured by 
a lien on a one to six family dwelling, that is the borrower's primary 
residence, should be exempt from the definition of a member business 
loan. It is the Board's understanding, that in some urban locations, 
there are few, if any, one to four family dwellings whereas one to six 
family dwellings are more common. The Board is considering this change 
to provide an opportunity for credit unions to help members renovate 
properties and increase home ownership by residents in low income 
areas. The Board requests that commentors address any additional risk 
associated with such properties and why this type of property should 
not be considered a member business loan. NCUA currently views this as 
a member business loan since five of the six units are likely to be 
rental units. Also, commentors should keep in mind that such loans 
would statutorily be limited to twelve years.
    The current rule exempts loans fully secured by shares in the 
credit union or deposits in other financial institutions. NCUA believes 
the current regulation may not be clear regarding the term ``financial 
institutions'' since the rule does not define the term. Therefore, NCUA 
proposes to clarify the term to read ``federally insured financial 
institutions'' since deposits in non-federally insured institutions may 
represent a greater risk of loss.
    NCUA proposes to increase the dollar threshold at which the rule 
applies from $50,000 to $100,000. NCUA has received many comments from 
credit unions regarding vehicle loans and vacation home loans that 
currently bump up against the threshold and have to be classified as 
business loans. NCUA has also received many comments regarding a 
situation where a member had a loan that was exempted because it was 
under the $50,000 threshold. Subsequently, the member desired to 
purchase an automobile for their business and in the business's name 
for tax purposes. If the credit union made the loan and the aggregate 
total of such loans exceeded the $50,000 threshold, then under the 
current regulation, the second loan is considered to be a member 
business loan. In essence, many credit unions have avoided making a 
good automobile loan because they are not structured to make member 
business loans. The increase in the exception threshold should 
alleviate these types of problems. Moreover, staff believes that most 
credit unions can handle the increased risk safely. However, NCUA 
continues to expect that a credit union will test ``business related 
loans'' against sound underwriting standards and the borrower's ability 
to repay, regardless of whether an exception applies.

Proposed Section 723.2--What Are the Prohibited Activities?

    NCUA is proposing no substantive changes from the current rule 
except for adding senior management employees and officials to the 
provision prohibiting equity agreements/joint ventures.

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 is proposing no substantive changes to this 
section from the current rule. However, NCUA wishes to clarify that 
member construction and development loans that are 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. Nevertheless, given 
the increased risk associated with these types of loans, NCUA expects 
credit unions to have adequate polices, procedures, and monitoring 
systems in place to address this type of lending.

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. NCUA is proposing no 
substantive changes from the current rule.

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

    Many credit unions have informed NCUA staff that they have not 
instituted a member business loan program because they could not meet 
the requirement to have a person on staff with two years of direct 
experience with business lending. Credit unions stated that they could 
not make certain vehicle loans to small businesses because their 
employees did not have experience in making business loans. NCUA has 
never required experience with business loans in general but rather 
experience with making loans the credit union intends to grant. Hence, 
if a loan officer has experience making vehicle loans to consumers, he 
or she would also have the requisite experience to make vehicle loans 
for a business purpose. To clarify the experience requirement, NCUA is 
proposing to change the terminology in the rule to ``* * * at least two 
years direct experience with the type of lending the credit union will 
be engaging in.'' NCUA believes that if a credit union has adequate 
policies, controls, and monitoring in place, employees with experience 
in the type of lending for which the credit union proposes to make 
business loans, it should be able to make those loans. Though a 
business automobile loan represents more risk than a consumer 
automobile loan, the credit union can manage that risk through 
policies, controls, and monitoring.
    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. They can meet the experience requirement through various 
approaches. For example, a credit union can utilize 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.

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 retains many of 
the requirements contained in the current regulation but they are now 
located in two sections, 723.6 and 723.7. The proposal adds a new 
requirement for credit unions to review financial statements. NCUA 
believes that, just periodically updating financial statements, is not 
sufficient. The benefits of updating this information come from the 
process of reviewing and analyzing this information.
    The proposal also changes the term ``appraisals'' to 
``determination of value.'' The current wording implies, or emphasizes, 
that member business loans center around real estate lending. 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.
    The proposal also clarifies that maturity of a member business loan 
may not exceed 12 years. Several credit unions have inquired about the

[[Page 41315]]

permissibility of structuring member business loans as 12-year-or less 
balloon notes, with the idea of refinancing the balloon for another 12 
years. It is permissible to use a balloon payment method to finance 
business loans provided that this type of financing is not being used 
to circumvent the 12 year maturity restriction imposed by the Federal 
Credit Union Act.

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 
current rule states that ``[u]nless a credit union loan program was in 
existence prior to January 1, 1992, and is granted an exemption by the 
regional director, loans shall be granted on a fully secured basis by 
collateral.'' Section 701.21(h)(2)(ii)(A). NCUA is proposing to expand 
the waiver for this section by eliminating the requirement that the 
member business loan program be in existence prior to January 1, 1992. 
This would permit credit unions that recently initiated member business 
loan programs to seek an exemption from the loan-to-value ratios.
    The NCUA Board is also proposing to increase the second lien 
limitation from 70% to 80% for collateral loan-to-value ratios. The 70% 
limit is not competitive in today's market. NCUA believes the increase 
represents little additional risk but does provide added flexibility 
for credit unions. 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.

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 current rule 
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 $75,000, 
whichever is higher. With the increase of the general exception dollar 
limit to $100,000, there must be a corresponding increase to $100,000 
for the aggregate limit.
    NCUA has received inquiries about loan participations 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 to one 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.

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 is 
proposing no substantive change 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. 
Credit unions must continue to meet its due diligence requirements 
regarding the underlying Small Business Administration loan.
    For consistency with proposed section 723.1(b), NCUA is proposing 
to change the term ``financial institution'' in this section to 
``federally insured financial institution''.

Proposed Section 723.10--What Loan Limit Waivers Are Available?

    The current rule 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. Except for 
the previously discussed expansion of the waiver on loan-to-value 
ratios, NCUA is proposing no substantive change to the current rule on 
what loan limit exceptions are available.

Proposed Section 723.11--How Do I Obtain an Available Waiver?

    This section describes the information that credit unions must 
submit to the Regional Director with their waiver request. NCUA is 
proposing no substantive changes to what the current rule requires.

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

    This section addresses what the Regional Director considers in 
reviewing the waiver request and how the waiver is processed. Many 
regional directors typically consider not only the credit union's 
historical CAMEL rating, but also that rating's components. Such a 
review is a prudent practice and provides more information than simply 
the CAMEL rating. The proposal would require that the Regional Director 
consider the composites to the CAMEL rating and not simply the overall 
CAMEL rating. In assessing risk, the Regional Director will determine 
if any safety and soundness concerns are raised due to granting the 
waiver.
    The proposal increases the number of days from 30 to 60 that a 
Regional Director has to act on a waiver request. It also eliminates 
the automatic waiver approval if a region does not take action on a 
request within the specified time frame. NCUA believes, that with the 
increase in the types of waivers available in the proposal, regions 
will have more requests to process. Hence, the regions will need more 
time to process the requests adequately.

Proposed Section 723.13--What Options Are Available to Us if the 
Regional Director Denies Our Waiver Request, or a Portion of it?

    Under the current rule, a credit union can appeal the denial of its 
request to the NCUA Board. NCUA proposes no substantive changes to this 
area.

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 change to the loan classification. However, NCUA proposes 
to move the current Appendix of Section 701.21(h) to this proposed 
section.

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 is proposing to clarify 
the meaning of this section by stating that this is the minimum amount 
when establishing the reserve percentage. This is simply a 
clarification so that a credit union will not misinterpret the stated 
percentages as an absolute.

[[Page 41316]]

Proposed Section 723.16--What Are The Recordkeeping Requirements?

    Consistent with the current rule, a credit union must separately 
identify member business loans in its records and financial reports. 
NCUA proposes no substantive change to this requirement from the 
current rule.

Proposed Section 723.17--What Additional Steps do Federally Insured 
State Chartered Credit Unions Have to Perform?

    NCUA believes it is important for state supervisory authorities to 
remain aware of, and involved in, member business loan activity in 
federally insured state chartered credit unions. Therefore, 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.

Proposed Section 723.18--How Can a State Supervisory Authority Develop 
and Implement a Member Business Loan Regulation?

    In the current rule, a federally insured state charter credit union 
may be exempt from NCUA's member business rule if the state had adopted 
a substantially equivalent regulation as determined by the NCUA board. 
The Board believes that this process has been effective. However, in 
order to provide better guidance to the states, the regulation 
identifies the minimum requirements that they must address for a rule 
to be deemed substantially equivalent.

Proposed Section 723.19--Definitions

    NCUA is proposing a general definition section at the end of the 
rule. NCUA is proposing to clarify 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.

C. Other Proposed Revisions--Reducing 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 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 proposing to delete this monitoring 
requirement.
    The current rule requires credit unions to provide periodic 
disclosure to credit union members of 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 proposes to delete this requirement.
    The current Section 701.21(c)(5) of NCUA's Regulations references 
the member business loan section. Due to the proposed change to the 
member business loan rule numbering system, NCUA proposes to update 
701.21(c)(5) to reference the appropriate sections of the proposed 
rule.

D. Part 722--Appraisals

    A number of credit unions have suggested that a credit union should 
be able to obtain a waiver from the appraisal requirement for member 
business loans. They argue that, since the appraisal requirement for 
business loans is significantly lower for credit unions (threshold is 
$50,000) than for banks (threshold is $250,000) that credit unions are 
at a severe competitive disadvantage in making business loans to people 
of modest means. Furthermore, they suggest that in some instances an 
appraisal is practically meaningless. One example they have provided is 
the requirement for an appraisal on a business loan to construct a 
church. Another example where an appraisal may be unnecessary is where 
the loan-to-value ratio is extremely low due to property ownership 
interests such as borrowing a small amount to improve property that is 
already completely owned by the member.
    The NCUA Board continues to believe that, for credit unions 
engaging in business lending that involves real estate, their greatest 
single risk protection is a licensed or certified appraisal to support 
the loan-to-value ratio. However, the Board is willing to provide for a 
waiver from the appraisal requirement because there may be a small 
number of loans that credit unions may grant where the appraisal 
requirement is an unnecessary burden. The church loan scenario is a 
good example of where an appraisal may not be necessary.
    When reviewing the waiver request, the Regional Director will 
consider: (1) the reason for the waiver of the appraisal requirement; 
(2) the credit union's written business loan policies; (3) an analysis 
of the credit union's prior experience making member business loans; 
and (4) written documentation provided by the credit union which may 
indicate present value (such as tax assessments, market analysis, 
etc.).

E. Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact any proposed regulation may 
have on a substantial number of small entities (primarily those under 
$1 million in assets). The proposed 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 proposed amendment, if adopted, 
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

    NCUA has determined that several requirements of this proposal 
constitute collections of information under the Paperwork Reduction 
Act. The requirements are that FICUs: (1) develop written loan polices; 
(2) provide waiver requests in writing. These sections are necessary to 
ensure the safety and soundness of credit unions involved in business 
lending as well as process requests for waivers. Other aspects of this 
proposal reduce the paperwork requirements in the current rule.
    It is NCUA's view that the time it takes a credit union to develop 
written loan policies is not a burden created by this regulation but is 
the usual and customary practice in the normal operations of a business 
entity. The paperwork burdens created by this rule is the written 
request for a waiver.
    NCUA estimates that it should take a credit union an average of 2 
hours to develop a written waiver request. NCUA estimates that it will 
receive 50 waiver requests in any given year. The annual reporting 
burden would be 100 hours to comply with this requirement. The total 
annual burden hours imposed by the proposed rule is 100 hours.
    The Paperwork Reduction Act of 1995 and regulations of the Office 
of Management and Budget (OMB) require that the public be provided an 
opportunity to comment on information collection requirements, 
including an agency's estimate of the burden of the collection of 
information.
    The NCUA Board invites comment on: (1) whether the collection of 
the information is necessary for the proper performance of the 
functions of NCUA,

[[Page 41317]]

including whether the information will have practical utility; (2) the 
accuracy of NCUA's estimate of the burden of the collection of 
information, including the validity of the methodology and assumptions 
used; (3) ways to enhance the quality, utility, and clarity of the 
information to be collected; and (4) ways to minimize the burden of 
collection of information on those who are to respond, including 
through the use of appropriate automated electronic, mechanical, or 
other technological collection techniques or other forms of information 
technology; e.g., permitting electronic submission of responses.
    OMB is required to make a decision concerning the collection of 
information contained in these proposed regulations between 30 and 60 
days after publication of this document in the Federal Register. 
Therefore, a comment to OMB is best assured of having its full effect 
if OMB receives it within 30 days of publication. This does not affect 
the deadline for the public to comment to the NCUA Board on the 
proposed regulation.
    Organizations and individuals desiring to submit comments on the 
information collection requirements should direct them to the Office of 
Information and Regulatory Affairs, OMB, Room 10235, New Executive 
Officer Building, Washington, D.C. 20503; Attention: Alex Hunt, Desk 
Officer for NCUA. Comments must also be sent to NCUA, 1775 Duke Street, 
Alexandria, VA 22314-3428; Attention: Betty May, Paperwork Reduction 
Act Coordinator, Telephone No. (703) 518-6410; Fax No. (703) 518-6433; 
E-Mail Address: [email protected]. Comments should be postmarked by 
September 30, 1997. All comments submitted in response to these 
proposed regulations will be available for public inspection, during 
and after the comment period, at NCUA's Central Office, 6th Floor, Law 
Library, 1775 Duke Street, Alexandria, VA between the hours of 9 a.m. 
and 1 p.m., Monday through Friday of each week except federal holidays, 
and by appointment through the Law Librarian at telephone no. (703) 
518-6540.

Executive Order 12612

    Executive Order 12612 requires NCUA to consider the effect of its 
actions on state interests. The proposed rule would, as does the 
current rule, apply to all federally insured credit unions, including 
federally insured state-chartered credit unions. However, since the 
proposed rule reduces regulatory burdens, NCUA has determined that the 
proposed rule does not constitute a ``significant regulatory action'' 
for purposes of the Executive Order. NCUA welcomes comment on means and 
methods to coordinate with the state credit union supervisors regarding 
achievement of shared goals involving viability, flexibility, parity, 
conformity, and safety and soundness regarding member business loans.

List of Subjects

12 CFR Part 701

    Credit, Credit unions, Insurance, Reporting and recordkeeping 
requirements, Surety bonds.

12 CFR Part 722

    Appraisals, Credit, Credit unions, Mortgages, Reporting and 
recordkeeping requirements, State-certified and State-licensed 
appraisers.

12 CFR Part 723

    Credit, Credit unions, Reporting and recordkeeping requirements.

    By the National Credit Union Administration Board on July 23, 
1997.
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, 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.

    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''.


Sec. 701.21  [Amended]

    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 loan 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 to us if the 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 are the recordkeeping requirements?
723.17 What additional steps do federally insured state chartered 
credit unions have to perform?
723.18 How can a State Supervisory Authority develop and enforce a 
Member Business Loan Regulation?

723.19 Definitions.

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


Sec. 723.1  What is a member business loan?

    (a) General rule. A member business loan includes any loan, line of 
credit, or letter of credit where the borrower uses the proceeds for 
the following purposes:
    (1) Commercial;
    (2) Corporate;
    (3) Investment property;
    (4) Business venture; or
    (5) Agricultural.
    (b) Exceptions to the general rule. The following are not member 
business loans:
    (1) Loan(s) fully secured by a lien on a 1 to 4 family dwelling 
that is the member's primary residence;
    (2) One other loan fully secured by a lien on a 1 to 4 family 
dwelling that does not rely upon rental or business

[[Page 41318]]

income derived from that property for repayment;
    (3) Loan(s) fully secured by shares in the credit union or deposits 
in other federally insured financial institutions;
    (4) Loan(s) to a member or an associated member which, when added 
together, are less than $100,000;
    (5) Loan(s) 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;
    nd
    (6) Loan(s) 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) Senior management employees. 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 where a portion of the amount of income received by the 
credit union, senior management employees, or officials in conjunction 
with the loan 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 percent 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 percent equity interest 
in the project being financed; and
    (c) The funds for these projects 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.


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, periodic updating, and review 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) Leveraging; and
    (6) Comparison with industry average or similar analysis;
    (j) The collateral requirements, including, but not limited to:
    (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 (maturity 
may not exceed 12 years);
    (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 NCUA Regional Director grants a waiver, all member 
business loans must be secured by collateral as follows:

------------------------------------------------------------------------
              Lien                  Minimum loan to value requirements  
------------------------------------------------------------------------
All.............................  LTV ratios cannot exceed 95%.         
First...........................  You may grant a LTV ratio in excess of
                                   80 percent only where the value in   
                                   excess of 80 percent is covered      
                                   through: in regards to 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.

[[Page 41319]]

    (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 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 NCUA Regional 
Director.


Sec. 723.9  How do I 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?

    You make seek a waiver 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 I obtain a waiver?

    To obtain a waiver, you must provide your NCUA Regional Director:
    (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 percent 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 60 calendar days of 
receiving your request.


Sec. 723.13  What options are available to us if the 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 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 (e.g., 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 are the recordkeeping requirements?

    You must separately identify member business loans in your records 
and in the aggregate on your financial reports.


Sec. 723.17  What additional steps do federally insured state chartered 
credit unions have to perform?

    When requesting a waiver from your Regional Director, federally 
insured state chartered credit unions must first submit their request 
to their state supervisory authority. If the state supervisory 
authority approves the request, the credit union must forward its 
request, with the state supervisory authority's written approval, to 
its Regional Director.

[[Page 41320]]

Sec. 723.18  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 Rule in this part if the state 
has adopted a rule substantially equivalent to NCUA's rule in this 
part. In a substantially equivalent determination, the Board 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 equivalency 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 a substantially equivalent determination, the State 
Supervisory Authority must submit their rule to the NCUA regional 
office. After reviewing the rule, the region will forward the request 
to the NCUA Board for final determination.


Sec. 723.19  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/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.

[FR Doc. 97-19936 Filed 7-31-97; 8:45 am]
BILLING CODE 7535-01-P