[Federal Register Volume 64, Number 102 (Thursday, May 27, 1999)]
[Rules and Regulations]
[Pages 28721-28733]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-13310]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701, 722, 723 and 741

RIN 3133-AB91


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

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: The NCUA is updating, clarifying and streamlining its existing 
rules concerning member business loans and appraisals for federally 
insured credit unions, as well as implementing recent statutory 
limitations regarding member business loans.
    The intended effect of this rule is to reduce regulatory burden, 
maintain safety and soundness, implement statutory limits and provide 
guidance on the statutory exception for qualifying credit unions from 
the statutory aggregate limit on a credit union's outstanding member 
business loans.

DATES: This rule is effective June 28, 1999.

ADDRESSES: National Credit Union Administration, 1775 Duke Street, 
Alexandria, Virginia 22314-3428.

FOR FURTHER INFORMATION CONTACT: Michael J. McKenna, Senior Staff 
Attorney, Division of Operations, Office of General Counsel, at the 
above address or telephone: (703) 518-6540; or David M. Marquis, 
Director, Office of Examination and Insurance, at the above address or 
telephone: (703) 518-6360.

SUPPLEMENTARY INFORMATION:

A. Background

    On July 23, 1997, the Board issued proposed amendments to the 
regulation governing member business loans (Previous Section 701.21(h) 
and Proposed Part 723 of NCUA's Regulations) and appraisals (Part 722 
of NCUA's Regulations) with a sixty-day comment period. 62 FR 41313 
(August 1, 1997). The Credit Union Membership Access Act (the Act) was 
enacted into law on August 7, 1998. Public Law 105-219, 112 Stat. 913 
(1998). Among other things, the Act imposed a new aggregate limit on a 
federally-insured credit union's outstanding member business loans. 
However, the Act also provided for three circumstances where a credit 
union could qualify for an exception from the aggregate limit. On 
September 23, 1998, the NCUA Board issued an interim final member 
business loan rule with a sixty-day comment period. 63 FR 51793 
(September 29, 1998). The comment period was extended November 19, 
1998, for an additional sixty days. 63 FR 65532 (November 27, 1998).

B. Comments

    Eighty-seven comments were received. Comments were received from 
twenty-five federal credit unions, ten state-chartered credit unions, 
eleven state leagues, three national credit union trade associations, 
one association of state supervisors, one appraisal trade association, 
fifteen banks, eighteen bank trade associations, two law firms, and one 
government agency. Except for the bank and bank trade associations, the 
commenters were generally supportive of the interim final rule, 
although most commenters suggested ways they would modify the final 
rule. The bank and bank trade association comments are summarized in a 
separate section.

Section-by-Section Analysis and NCUA Board Decisions

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

    This section provides a definition of a member business loan. The 
Act sets forth the definition of a member business loan, so NCUA can no 
longer define the term.
    Therefore, a member business loan means any loan, line of credit, 
or letter of credit, the proceeds of which will be used for a 
commercial, corporate or other business investment property or venture, 
or agricultural purposes. Section 107A(c)(1)(a) of the Act. The final 
rule clarifies that unfunded commitments are included in determining 
whether a loan is a member business loan.
    Three commenters requested that loans made to churches or other 
religious organizations be exempt from the definition of a member 
business loan. These commenters stated that while churches may be 
organized as corporations, any loan to such a corporation would not be 
for a ``commercial'' purpose. These commenters stated that the term 
``business'' implies for-profit activity. The NCUA Board disagrees with 
these commenters. In general, a loan to a non-

[[Page 28722]]

natural person will qualify as a member business loan. Although a loan 
to a church is not for a profit making purpose, it does have a 
``corporate'' purpose as that term is generally understood. If the 
purpose of the loan is to benefit the institution, even a non-profit 
unincorporated association, then it has a corporate purpose. For 
example, a loan to build a new church has the same corporate purpose as 
a loan to a non-profit association to acquire a new headquarters 
building. Even though the purpose (functions) of the institutions 
differ, the purpose for the loan does not.

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

    This section sets forth five exceptions to the general definition 
of a member business loan. The exceptions are established by the Act 
and are virtually identical to the exceptions in the previous member 
business loan rule. The following loans are excepted from the member 
business loan definition: (1) an extension of credit fully secured by a 
lien on a 1-to-4 family dwelling that is the primary residence of a 
member; (2) an extension of credit fully secured by shares in the 
credit union making the extension of credit or deposits in financial 
institutions; (3) an extension of credit that meets the member business 
loan definition made to a borrower or an associated member that has a 
total of all such extensions of credit in an amount equal to or less 
than $50,000; (4) an extension of credit where the repayment is fully 
insured or fully guaranteed by, or where there is an advance commitment 
to purchase in full by, an agency of the federal government or of a 
state, or any political subdivision thereof; or (5) an extension of 
credit that is granted by a corporate credit union (as that term is 
defined by the Board) to another credit union.
    Three commenters requested that the $50,000 limit be increased to 
$100,000. Another commenter also suggested an increase in the limit. 
The NCUA Board cannot increase the dollar threshold because the Act 
sets the dollar limit.
    Two commenters recognized that NCUA does not have the authority to 
adopt a definition of a member business loan that is different from the 
one provided by the Act, but encouraged the agency to provide some 
guidance on the meaning of ``commercial'' loan or ``investment 
property.'' The NCUA Board believes that the interpretation given to 
these terms will depend on the facts of a particular case. However, in 
general, the NCUA Board interprets ``commercial'' as any loan that does 
not fit in the standard category of consumer lending. The NCUA Board 
interprets ``investment property'' as a property that is intended to 
produce income.
    Two commenters stated that NCUA should specifically exclude 
vacation homes and other residences related to a member's professional 
mobility that are not for investment purposes from the definition of 
``commercial.'' One commenter requested that a loan fully secured by a 
lien on a dwelling that is the member's secondary or vacation home 
should be added to the loans specifically excluded from the definition 
of member business loans. Two commenters requested that a second 1-to-4 
family home should also be excluded from the definition. The NCUA Board 
believes that since Congress used the term ``primary residence,'' the 
exemption cannot be expanded to include other types of homes a member 
may use as collateral in obtaining a loan. However, a loan to purchase 
or refinance a vacation home or other residence that is not generally 
used for investment purposes does not meet the definition of a member 
business loan.
    One commenter suggested that NCUA exempt retirement homes from the 
member business loan definition because such homes will eventually be a 
primary residence. This commenter also suggested defining ``primary 
residence'' in the definition section. Although the Board does not 
believe the term ``primary residence'' needs to be defined, to avoid 
any misunderstanding, the Board is once again reiterating that a 
federal credit union may finance a future retirement home under the 
long-term mortgage authority. If at the time the loan is made, the 
member's intent is to establish a new principal residence, either 
immediately or some time in the future, the federal credit union may 
grant a long-term mortgage secured by the second home. Under this 
analysis, since the member intends to occupy this residence as his or 
her primary residence, the credit union may grant a second home loan 
under the long-term mortgage authority and the loan is exempt from the 
definition of a member business loan as long as the source of repayment 
is not dependent on rental income involving the residence.
    One commenter suggested that the final rule clarify that an advance 
commitment to purchase a loan by a federally chartered financial 
institution would be considered a commitment from a federal agency and 
be excluded from the definition of a business loan. The NCUA Board does 
not believe such an exemption is permissible under the Act and thus is 
not adopting this commenter's suggestion in the final rule. Of course, 
loans to credit unions by a corporate credit union are exempt from the 
definition of a member business loan.
    One commenter requested that NCUA clarify that the amount of any 
loan fully guaranteed by the federal, state or local government is not 
included in determining whether the $50,000 threshold has been reached. 
The reason is that small business administration loan programs do not 
guarantee full repayment, only the amount of the loan that is not 
guaranteed should be considered in determining whether the threshold 
has been reached. The NCUA Board agrees and a credit union need not 
include that portion of a loan that is guaranteed toward the $50,000 
threshold.
    One commenter questioned whether the final rule applies to 
corporate credit unions, and specifically to corporate credit union 
loans to non-credit union members. The Act does not distinguish between 
corporate and natural person credit unions. Since the NCUA Board has 
not been provided any compelling reason on why this rule should not 
apply to corporate credit unions granting member business loans to 
entities other than credit unions, the final rule applies to all types 
of federally insured credit unions.

Section 723.2--What Are the Prohibited Activities?

    This section sets forth who is ineligible to receive a member 
business loan. The interim final rule identified as ineligible the 
following persons: (1) Any member of the board of directors who is 
compensated as such; (2) the chief executive officer; (3) any assistant 
chief executive officers; (4) the chief financial officer; or (5) any 
associated member or immediate family member of anyone listed in 1-4. 
The interim final rule also added senior management employees to the 
provision prohibiting equity agreements or joint ventures.
    Four commenters supported the prohibition on member business loans 
as set forth in this section. Six commenters requested that senior 
management officials, compensated directors, and immediate family 
members thereof, be able to receive member business loans. One 
commenter stated that associated members or immediate family members of 
anyone specifically prohibited should be eligible to receive a member 
business loan. One commenter stated that ten states allow compensation 
for the board of directors and the prohibition on compensated directors 
obtaining member business loans should not apply to state chartered 
credit unions.

[[Page 28723]]

    The agency has historically included compensated directors as 
persons who were prohibited from receiving member business loans. In 
the past, the agency has believed that the compensated director might 
unduly influence the other directors to have the credit union grant 
questionable and/or risky member business loans to the compensated 
director and/or their family members. Recent agency experience in other 
lending areas has led the NCUA Board to believe that such influence 
would probably be minimal or non existent. Therefore, the NCUA Board is 
eliminating the prohibition on member business loans to the compensated 
director. However, to maintain proper internal controls, the board of 
directors must approve the loan to the compensated director and the 
compensated director must be recused from the decision to grant or deny 
the loan.

Section 723.3--What Are the Requirements for Construction and 
Development Lending?

    This section sets forth the requirements for construction and 
development lending. NCUA clarified in the preamble to the interim 
final rule that construction and development loans below the dollar 
limits, individually and/or in the aggregate, are not considered to be 
member business loans for the purpose of this rule. Thus, if a member 
has a construction loan for $40,000, and no other outstanding business 
type loans, including unfunded business type lines of credit, then the 
construction loan is not a member business loan. No substantive 
comments were received on this section. The Board is adopting this 
section in final as set forth in the interim final rule, except the 
term ``reserves'' has been replaced by the term ``net worth'' and the 
word ``independent'' has been eliminated from paragraph (c) since most 
financial institutions use qualified employees to conduct draw 
inspections.

Section 723.4--What Are the Other Applicable Regulations?

    This section merely describes the other NCUA lending rules credit 
unions must follow when granting member business loans to the extent 
they are consistent with this regulation. One commenter supported this 
section. Six commenters opposed applying these standards to federally 
insured credit unions. These commenters requested that NCUA, instead, 
clearly state that this section does not apply to federally insured 
state chartered credit unions except as may be specified in Part 741 of 
NCUA's Regulations. The NCUA Board agrees and the final rule 
incorporates this change.

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

    This section sets forth the requirement that the board of directors 
adopt business loan policies and review them at least annually. This 
section also requires the board to use the services of an individual 
with at least two years direct experience in the type of lending in 
which the credit union will be engaging. The preamble to the interim 
final rule also clarified that NCUA does not necessarily require 
experience with business loans in general but, rather, the experience 
could also be with the type of loans the credit union intends to grant. 
The preamble also clarified that credit unions need not hire staff to 
meet the requirements of this section; however, credit unions must 
ensure that the expertise is available. Credit unions can meet the 
experience requirement through various approaches. For example, a 
credit union can use the services of a CUSO, an employee of another 
credit union or other financial institution, an independent contractor, 
or other third parties. However, the actual decision to grant a loan 
must reside with the credit union.
    Nine commenters believe the two-year experience requirement is 
reasonable. Three commenters objected to the two-year experience 
requirement. One commenter stated that the employee should only be 
required to have general business lending experience and not direct 
experience with a certain type of loan or collateral. One commenter 
believed this section should be clarified to state that a credit union 
need only have at least two years experience in making loans secured by 
a particular class of collateral and not necessarily two years 
experience in making business loans.
    The NCUA Board believes it crucial for a credit union to have 
experienced personnel involved in making decisions regarding business 
lending. Member business loans require special expertise in virtually 
all phases of origination and administration. The experience 
requirement can be met by either general business lending experience or 
experience with granting loans for a particular purpose or secured by a 
particular collateral. Therefore, the NCUA Board is adopting this 
section in the final rule as set forth in the interim final rule.

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

    This section set forth those items that credit unions must address 
in their written business loan policies. The interim final rule used 
the term ``determination of value'' instead of ``appraisal'' in the 
discussion of written loan policies. One commenter stated that NCUA 
should use the term ``appraisal.'' The Board believes that the term 
``determination of value'' is more appropriate since the term 
``appraisal'' unduly emphasizes member business loans as real estate 
loans. The term ``determination of value'' clarifies that, whether a 
member business loan is collateralized by real estate or other types of 
collateral, credit unions must address the value of the collateral.
    Two commenters requested that NCUA state that the maturity limit 
for member business loans applies only to federal credit unions and not 
state chartered credit unions. As stated in the preamble to the interim 
final rule, federally insured state-chartered credit unions can grant 
business loans with a maturity limit consistent with state law. The 
final rule does not impose any maturity limits for state-chartered 
credit unions.
    One commenter stated that all the documentation listed in this 
section is not necessary for every member business loan. The NCUA Board 
agrees. The interim final rule, as well as the final rule, provides the 
board of directors with significant discretion to determine the 
documentation necessary to make the decision whether a member business 
loan should be granted.
    One commenter stated that credit unions should be required to 
conduct a periodic review of financial statements. Agency experience 
has demonstrated that, in most cases, a credit union will ordinarily 
review the financial statements of its open-end business loans. The 
NCUA Board is not requiring in the final rule, a review of financial 
statements on all member business loans.
    The NCUA Board is adopting this section in final as set forth in 
the interim final rule except the term ``reserves'' has been replaced 
by the term ``net worth.''

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

    This section sets forth the remaining issues that written loan 
policies must address, including loan-to-value ratios and the 
requirement for the personal liability and guarantee of the member. As 
is the current practice, loan-to-value ratios apply to the entire loan 
that is in excess of $50,000.
    Questions have been raised on loan-to-value ratios for multiple 
member business loans to the same borrower. If multiple loans are on 
the same

[[Page 28724]]

collateral, the loan-to-value limitation will apply to any loan where 
the aggregate amount of the loans exceed $50,000. For example, if a 
credit union makes a loan on a piece of real estate for $40,000 and 
subsequently makes another $40,000 loan on the same collateral, the 
loan-to-value limitation applies to the second loan. The NCUA will not 
allow a credit union to circumvent the loan-to-value ratios simply be 
making numerous loans for less than $50,000 on the same collateral. If 
the first member business loan to a borrower is unsecured and the 
second loan is secured the loan-to-value ratios apply to the second 
loan if the aggregate amount of both loans exceeds $50,000.
    Three commenters supported including unfunded commitments when 
calculating the loan-to-value ratios. Two commenters objected to 
including unfunded commitments. The NCUA Board believes it is 
reasonable to include unfunded commitments when calculating the loan-
to-value ratios because, if they were excluded, the loan-to-value 
ratios could be exceeded when the entire loan is funded.
    Four commenters supported the second lien limitation at 80%. One 
commenter requested the number be raised. One commenter requested NCUA 
eliminate regulatory loan-to-value ratio requirements. One commenter 
stated that the regulation should allow for selected loans to exceed 
the proposed loan-to value ratios and/or occassionally be undersecured 
or unsecured. Five commenters stated that NCUA should be more flexible 
with respect to loan-to-value ratios for loans on personal property, 
vehicles and equipment. One commenter requested that the loan-to-value 
limitation be increased to 95%. The NCUA Board believes the specified 
loan-to-value ratios are appropriate for member business loans and 
although the exact wording has been modified, the same loan-to-value 
ratios are incorporated into the final rule. However, the NCUA Board is 
reiterating that, if there is a category of loans that a credit union 
believes should be allowed to exceed these ratios, the credit union can 
request a waiver from the appropriate Regional Director. For example, 
if a credit union regularly grants vehicle loans in excess of $50,000 
that meet the definition of member business loans, the credit union 
would likely be a good candidate to receive a waiver from the loan-to-
value ratio requirements for that category of loans.
    One commenter requested that NCUA allow borrowers that are 
corporations and other business entities, such as limited liability 
companies, to borrow in the name of the corporation whereby the 
guarantor is the corporation. The NCUA Board does not agree with such a 
change because it would allow a corporation to be liable instead of the 
individual. Past experience with credit union losses with this type of 
loan structure indicates that such a change would not be in the best 
interest of credit unions or the National Credit Union Share Insurance 
Fund (NCUSIF).
    One commenter recommended NCUA use the term ``principals'' instead 
of ``borrowers'' to avoid confusion when addressing the requirement for 
a personal guarantee since a borrower could be a non-natural person. 
The NCUA Board agrees this change would provide greater clarity and has 
incorporated it into the final rule.

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

    This section sets forth the aggregate amount of outstanding member 
business loans credit unions may grant to one member or a group of 
associated members. Unless NCUA grants a waiver, the interim final rule 
limited the aggregate amount of outstanding business loans to any one 
member or group of associated members to 15% of the credit union's 
reserves (less the Allowance for Loan Losses account) or $100,000, 
whichever is higher. The NCUA Board, in the final rule, is replacing 
the term ``reserves'' with the term ``net worth.'' This change will not 
make the 15% limit more restrictive in gross dollar terms.
    In the preamble to the interim final rule, the Board clarified how 
loan participations are treated in regard to business loan limits. In 
those situations where the credit union sold the participation without 
recourse, the amount sold would not be included when calculating the 
15% limit for a single borrower. However, if the credit union sold the 
participation with recourse (that is, the selling credit union retains 
a contingent liability), it would include the amount sold when 
calculating the 15% limit.
    Four commenters specifically approved of the aggregate loan limit 
to one member or group of associated members. One commenter stated that 
the restrictions on loan to one borrower should be deleted. One 
commenter supported the 15% limit but would eliminate the $100,000 
limitation. One commenter stated that unfunded commitments should be 
included in the aggregate loan limit. One commenter stated that 
unfunded commitments should not be included in the aggregate loan 
limit. The NCUA Board has not been provided with a convincing rationale 
for changing the loan limits to one borrower or for excluding unfunded 
commitments from the loan limits. Therefore, the NCUA Board is adopting 
the limitations in the interim final rule in the final rule.

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

    This section sets forth how a credit union calculates the aggregate 
15% limit. The interim final rule stated that, if any portion of a 
member business loan is secured by shares in the credit union or a 
deposit in another financial institution, or fully or partially insured 
or guaranteed by, or subject to an advance commitment to purchase by 
any agency of the federal government or of a state or any of its 
political subdivisions, such portion is not used in calculating the 15% 
limit. No substantive comments were received on this section. Except 
for inserting the term ``net worth'' for the term ``reserves'' the NCUA 
Board is adopting in final this section as it was set forth in the 
interim final rule.

Section 723.10--What Loan Limit Waivers Are Available?

    The interim final rule provided for a waiver from: (1) the maximum 
loan amount to one borrower or associated group of members; (2) loan-
to-value ratios; and (3) construction and development lending. The 
interim final rule stated that the waiver is for a category of loans. 
Two commenters supported the loan limit waiver provisions. In the 
interest of making this section more informative, the NCUA Board is 
also referencing the waivers that are available for appraisals under 
Part 722 and the requirement for the personal liability in Section 
723.7. Hence, this section is now retitled: ``What waivers are 
available?'' The NCUA Board has not made any other substantive changes 
to this section from the interim final rule.

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

    This section described the information that a federal credit union 
must submit to the Regional Director with a waiver request. This 
section also provided a mechanism for state chartered federally insured 
credit unions to have the waiver request processed through the state 
supervisory authority. If the state supervisory authority approves the 
request, the state regulator forwards the request to the Regional 
Director. A waiver is not effective until it is approved by the 
Regional Director.

[[Page 28725]]

    One commenter requested that NCUA specify that the state 
supervisory authority makes the decision whether or not to grant a 
waiver for a federally insured state chartered credit union and that 
state regulators may allow self-implementing waivers for categories of 
loans. The NCUA Board has not been provided any convincing rationale 
for not being part of the waiver process. Being part of the process 
allows NCUA, as the insurer of credit unions, to ensure that all waiver 
requests are properly reviewed.
    Furthermore, permitting self-implementing waivers would result in 
NCUA abdicating its regulatory responsibility and potentially 
threatening the NCUSIF. Except for some minor editing changes, 
including a reference for corporate federal credit unions, the NCUA 
Board has not made any substantive changes to this section from the 
interim final rule.

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

    This section sets forth what the Regional Director must consider in 
reviewing the waiver request and how the waiver is processed. The 
interim final rule stated that a Regional Director must act on a waiver 
request within 45 days (from receipt from the federal credit union or 
the state supervisory authority) and set forth an automatic waiver 
approval if a region does not take action on a request within the 
specified time frame.
    Any waiver is revocable at NCUA's sole discretion. If a waiver is 
revoked, loans granted under the waiver authority are grandfathered.
    Two commenters stated that NCUA should make the decision in 30 
days. One commenter stated that NCUA should make a decision in less 
than 45 days if the waiver was processed first through the state 
regulator. The NCUA Board is maintaining 45 days as the time frame the 
agency has to approve or deny the waiver because of the increase in the 
number of available waivers for credit unions.

Section 723.13--What Options Are Available if the Regional Director 
Denies My Waiver Request or a Portion of It?

    This section describes how a credit union may appeal the denial of 
its waiver request by the Regional Director to the NCUA Board. No 
substantive comments were received on this section. The NCUA Board is 
adopting this section in final as it was set forth in the interim final 
rule.

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

    This section addresses the criteria for determining the 
classification of loans. One commenter stated that the title of this 
section should be modified to address the classification of loans. The 
NCUA Board agrees with this commenter and has changed the title of this 
section accordingly.

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

    This section provides a schedule a credit union must use to reserve 
for classified loans. NCUA clarified the meaning of this section by 
stating that this is the minimum amount when establishing the reserve 
percentage. No substantive comments were received on this section. 
Except for a minor editing change, the Board is adopting this section 
in final as it was set forth in the interim final rule.

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

    The Act imposes a new aggregate limit on a credit union's 
outstanding member business loans (including any unfunded commitments) 
of the lesser of 1.75 times the credit union's net worth or 12.25% of 
the credit union's total assets. Net worth is all of the credit union's 
retained earnings. The definition of net worth should be determined 
under Generally Accepted Accounting Principles which includes retained 
earnings. Retained earnings normally includes undivided earnings, 
regular reserves and any other appropriations designated by management 
or regulatory authority. The final rule has been modified to reflect 
this definition accurately.
    If a credit union currently has business loans exceeding the 
aggregate loan limit and does not qualify for an exception, it has 
until August 7, 2001, to reduce the total amount of outstanding member 
business loans to below the aggregate loan limit. Furthermore, once the 
prompt corrective action provisions are implemented in a final 
regulation, an insured credit union that is undercapitalized may not 
make any increase in the total amount of member business loans until 
such time as the credit union becomes adequately capitalized as 
required by the prompt corrective action provisions of the Act. 12 
U.S.C. 216(g)(2).
    Four commenters opposed the statutory limitation. Two commenters 
objected to including unfunded commitments in determining the aggregate 
loan limit. Unfunded commitments are included in calculating the 
aggregate loan limit because to do otherwise could inadvertently place 
a credit union over the aggregate loan limit when the loan was fully 
funded. Such a result would violate the Act.
    One commenter requested guidance on how loan participations are 
treated for purpose of the aggregate loan limit. Unless otherwise 
exempt, loan participations that are made without recourse are not part 
of the loan limit for the originating credit union. However, such loans 
are to be counted against the aggregate loan limit for the 
participating credit union, unless otherwise exempt.

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

    The interim final rule set forth three exceptions to the aggregate 
loan limit: (1) credit unions that have a low-income designation or 
participate in the Community Development Financial Institutions 
program; (2) credit unions that have a ``a history of primarily making 
member business loans;'' or (3) credit unions that were chartered for 
the purpose of primarily making member business loans. A credit union 
that does not qualify for an exception must immediately stop making 
business loans that will exceed the aggregate loan limit.
    Five commenters stated that the exceptions for credit unions should 
be self-certifying and the examiners could review whether the exception 
is justified during the examination. The NCUA Board believes it would 
be abandoning its regulatory responsibility if it were to allow credit 
unions to self-certify. This could result in a credit union making 
member business loans in excess of the amount permitted under the Act. 
The NCUA Board believes that the process has worked properly since it 
was adopted in September, and therefore, it is retained in the final 
rule. In fact, of the eighty-three credit unions that exceeded the 
aggregate loan limit as of August 7, 1998, sixty-five have been granted 
exceptions, six requests were denied, and twelve have not sought an 
exception. If a credit union is eligible for an exception but chooses 
not to seek one, the credit union has until August 7, 2001 to reduce 
the total amount of business loans to below the aggregate loan limit. 
If an exception is revoked, current loans are grandfathered but the 
credit union cannot make any new member business loan until the credit 
union's total amount of business loans is below the aggregate loan 
limit.

[[Page 28726]]

History of Primarily Making Member Business Loans
    The NCUA Board defined ``a history of primarily making member 
business loans'' as either: (1) member business loans comprise at least 
25% of the credit union's outstanding loans; or (2) member business 
loans comprise the largest portion of the credit union's loan 
portfolio.
    Six commenters supported NCUA's definition of ``a history of 
primarily making member business loans.'' Two commenters stated that 
the 25% level was too high. One commenter recommended a percentage 
between 18-20% for determining whether a credit union has ``a history 
of primarily making member business loans.'' Another commenter 
suggested 17.5%. Four commenters suggested 15%. Two commenters stated 
that any credit union currently above the aggregate loan limit should 
be able to receive an exception. Two commenters requested a third 
category under this exception. These commenters believe an exception 
should also be granted to credit unions whose business loans have 
averaged 20% of total loans over a ten-year period. One commenter 
stated that NCUA should permit an exception if member business loans 
are the second largest category in the credit union's portfolio. One 
commenter stated that the Board should add a third criterion where 
loans are an integral part of the credit union's loan portfolio.
    The language of the statute is ambiguous and leaves to NCUA's 
discretion the responsibility for defining when a credit union has a 
``history of primarily making member business loan[s].'' The Board 
recognizes that only a limited number of credit unions will be eligible 
for this exception because the aggregate loan limit will prevent credit 
unions in the future from exceeding the cap. While the legislative 
history provides no definitive guidance, it does make clear that 
Congress intended that exceptions be crafted in a way that would allow 
those credit unions with a history of beneficial business lending to 
continue that practice. The Senate Report stated that the NCUA Board 
should

    interpret the exceptions under new section 107A(b), to permit 
worthy projects access to affordable credit union financing. Loans 
for such purposes as agriculture, self-employment, small business 
establishment, large up-front investments or maintenance of 
equipment such as fishing or shrimp boats, taxi cab medallions, 
tractor trailers, or church construction should not be unduly 
constricted as a result of the Board's actions.

    S. Rep. No. 105-193, p. 9 (1998). Report of the Committee on 
Banking, Housing, and Urban Affairs.
    The NCUA Board, believes that establishing the level at 25% of 
assets is consistent with congressional intent and permits credit 
unions with history and experience with member business loans to 
continue to engage in that activity. NCUA arrived at this number after 
reviewing the legislative history and other federal regulations and 
interpretations, including the ``principally engaged'' language in the 
Revenue Limit on Bank-Ineligible Activities of Subsidiaries of Bank 
Holding Companies Engaged in Underwriting and Dealing in Securities. 61 
FR 68750 (December 30, 1996).
    The second part of the Board's exception would apply when member 
business loans comprise the largest portion of a credit unions loan 
portfolio. For example, a credit union would meet this standard if it 
makes 23% member business loans, 22% first mortgage loans, 22% new 
automobile loans, 20% credit card loans and 13% other real estate 
loans.
    This approach is consistent with the definition of primarily as 
``being or standing first in a list [or] series.'' See Webster's II, 
New Riverside University Dictionary, 1994 Houghton Mifflin Company. It 
recognizes the primacy or state of being first when business loans form 
the largest type of lending in a credit union's portfolio. See Id. 
(Primacy defined as the state of being first or foremost) The Board 
also believes it is faithful to the intent of the legislative history, 
e.g., that those credit unions with a history of beneficial member 
business lending may continue that practice.
    The NCUA Board is requiring that, for determining the categories of 
loans, a credit union must use loan categories that are similar to 
those set forth in the call report such as: unsecured credit card 
loans/lines of credit; all other unsecured loans/lines of credit; new 
vehicle loans; used vehicle loans; total first mortgage loans; total 
other real estate loans; and total member business loans. In no case 
could a credit union have more than seven categories of loans for the 
purpose of qualifying for this exception. The NCUA Board believes that 
the largest book exception is consistent with congressional intent and 
is not subject to manipulation since only seven categories of loans can 
be used to calculate the largest book of loans.
    The NCUA Board believes that the two definitions of a ``history of 
primarily making member business loans'' are limited and carefully 
crafted. In fact, this exception is so narrowly tailored that less than 
ninety credit unions are even eligible for the exception.
    The NCUA Board is also clarifying in the final rule what is 
acceptable evidence to demonstrate a ``history of primarily making 
member business loans.'' Call reports and financial statements from 
January 1995 to September 1998 are acceptable evidence to demonstrate 
the primacy of business lending in a credit union's portfolio. Three 
commenters stated that credit union should be able to use call report 
data after September 1998 to demonstrate that the credit union has a 
``history of primarily making member business loans.'' The NCUA Board 
disagrees with these commenters. Under the Act, if a credit union 
exceeded the aggregate loan limit on September 30, 1998, and did not 
receive an exception, the credit union should not have granted any new 
member business loans, unless the credit union was pursuing an appeal.
    Some have suggested that reliance on the call report is not a 
history of lending but simply a snapshot in time. The NCUA Board 
disagrees. Credit union loan portfolios fluctuate over time based on 
such things as economic cycles, changes in membership and the needs and 
desires of members. By allowing call reports and financial statements 
from 1995 to September 1998 to support qualification for an exception, 
the NCUA Board has adopted an approach which addresses these issues by 
establishing a reasonable time period during which a credit union may 
establish it qualifies for an exception. The period is in the recent 
past and is of limited duration. This will assure that the exception is 
available only to those credit unions with a demonstrated recent 
history of primacy in the area of business lending.
    One commenter stated that NCUA should include unfunded commitments 
for purposes of calculating the amount of loans for the exception just 
as NCUA counts unfunded commitments in determining the number for the 
aggregate loan limit. The NCUA Board agrees and, therefore, unfunded 
commitments are included in calculating whether the credit union has a 
``history of primarily making member business loans.''
    Three commenters stated that credit unions should be allowed to 
count loans less than $50,000, as well as otherwise exempt loans, for 
purposes of qualifying for the ``history of primarily making member 
business loans'' exception. The NCUA Board disagrees. By definition, 
these loans are not member business

[[Page 28727]]

loans under the Act and therefore are not counted for either the 
aggregate loan limit or the exception from the limit. The final rule 
incorporates this interpretation in Sections 723.16 and 723.17.
Loan Participations
    Six commenters stated that loan participations should be excluded 
from the calculation of a credit union's aggregate member business loan 
limit, except for the originating credit union. Most of these 
commenters stated that the Act refers to loans ``made'' by federally 
insured credit unions and since the originating credit union ``makes'' 
the loan, purchasing credit unions would not be ``making'' the loan, 
and therefore, it should not count toward the statutory limits. The 
NCUA Board is not adopting this recommendation since it would promote 
form over substance and result in a large block of member business 
loans suddenly vanishing from the books of credit unions for purposes 
of calculating the aggregate loan limit.
    Eight commenters stated that NCUA should permit a credit union 
participating in a member business loan to classify the participation 
as an investment, rather than a member business loan. The NCUA Board 
disagrees since the authority for loan participations is located in the 
Federal Credit Union Act under the lending powers of credit unions and 
not the investment powers. 12 U.S.C. 1757(5) and 1757(7). In addition, 
NCUA, as well as credit unions, historically have classified loan 
participations as loans and not as investments. In certain limited 
circumstances the NCUA Board recognizes that a credit union can 
purchase a loan participation that is properly structured as a 
security. However, this does not mean that credit unions participating 
in a member business loan can classify the transaction as an 
investment.
    Seven commenters recommended that NCUA should permit a credit union 
participating in a loan to exclude it from its total member business 
loan amount if it was originated by a credit union that is exempt under 
the Act from the member business loan regulation limits. The exception 
would, in effect, travel with the loan. The NCUA Board is not adopting 
this recommendation. The Act exempts credit unions and not loans from 
the aggregate loan limit. If NCUA adopted this recommendation, it could 
lead to absurd results. For example, a credit union could have half of 
its assets in member business loan participations without falling 
within the aggregate loan limit and without receiving an exception. 
Clearly, such a result was not intended by Congress and does not make 
sense within the statutory scheme.
    One commenter stated that only the amount of the loan held by the 
originating credit union should be counted against the aggregate loan 
limit. The NCUA Board agrees as long as the loan participations are 
without recourse. One commenter stated that NCUA should exclude all 
loans to non-profits purchased through participation agreements, the 
proceeds of which are not used for commercial purpose. The NCUA Board 
does not believe there is any statutory authority to support such a 
position. Two commenters stated that a credit union that originates 
sufficient loans to meet NCUA's threshold requirements should qualify 
for the exception even if the credit union does not hold onto the 
loans. The NCUA Board is not sure that such an expansion of the 
exception is consistent with congressional intent.
Chartered for the Purpose of Making Member Business Loans
    The NCUA Board also stated that an exception may also be granted 
for credit unions that were chartered for the purpose of primarily 
making member business loans. It is up to the credit union to provide 
sufficient documentation to demonstrate it meets this exception. Due to 
the nature of federal chartering, the NCUA Board believed it would be 
unlikely that many federal credit unions would qualify for this type of 
exception. However, the NCUA Board sought comment on how it could more 
fully define credit unions that were ``chartered for the purpose of 
primarily making member business loans'' for the purpose of this 
exception.
    Four commenters stated that the interim final rule is more 
restrictive than the legislation by adding the word ``primarily'' to 
this exception. These commenters stated that the fact that Congress did 
not include the word ``primarily'' in the exception based on a credit 
union's charter but did add it to the exception regarding member 
business loan history is a strong indication that Congress did not 
intend for the NCUA Board to include the additional standard. After 
further review, the NCUA Board agrees with these commenters and the 
final rule has been changed accordingly.
    One commenter stated that, for this exception, NCUA should define 
the exception as a product of the credit union's field of membership 
and its lending history. For example, this commenter stated that this 
would allow NCUA to exempt credit unions that serve farm cooperatives 
or groups of self-employed individuals, such as taxi drivers; or 
community credit unions with a history or providing small business 
loans, and others. The NCUA Board generally agrees with this commenter 
and has incorporated this suggestion into the final rule.
    Two commenters stated that federal credit unions should be afforded 
the opportunity to prove, if they can, that they were chartered for the 
purpose of making member business loans. Two commenters suggested NCUA 
allow a broad range of evidence including historical documents such as 
original bylaws, articles of incorporation and the credit union's 
mission statement. One commenter recommended that NCUA state what the 
agency will consider as acceptable documentation to support such a 
showing. NCUA will consider any documentation from original charters, 
original bylaws, early business plans, mission statements, board 
minutes, original field of membership, early loan portfolios and any 
other appropriate evidence a credit union may submit to demonstrate 
that the credit union was chartered for the purpose of making a member 
business loan. The list of documentation that NCUA will consider in 
making this determination has been incorporated into the final rule.
    One commenter stated that NCUA should review a credit union's 
service area and, if the service area is rural or agricultural, the 
credit union should qualify for the exception. Simply because a credit 
union is located in a rural or agricultural area does not demonstrate 
that a credit union was chartered for the purpose of making member 
business loans. Additional evidence would be necessary to permit a 
credit union to obtain this exception.
    Nine commenters stated that this exception should be broadened so 
that an existing credit union can amend its charter to state that it is 
chartered for the purpose of making member business loans and thus 
qualify for the exception. The NCUA Board believes such a change would 
not generally be consistent with congressional intent. If any credit 
union simply could update its charter to state its purpose was to make 
business loans, and thereby be exempt, from the statutory limits, the 
result would be inconsistent with the entire statutory scheme. However, 
there may be certain circumstances, including safety and soundness 
reasons, that would require NCUA or the state supervisory authority to 
recommend to the credit union to amend its charter.

[[Page 28728]]

Section 723.18--How Do I Obtain an Exception?

    To obtain the exception, a federal credit union must submit 
documentation to the Regional Director, demonstrating that it meets the 
criteria of one of the exceptions. A state chartered federally insured 
credit union must submit documentation to its state regulator to 
receive the exception. Although effective when granted by the state 
regulator, the state regulator should forward its decision to NCUA. The 
exception does not expire unless revoked by the Regional Director for a 
federal credit union or by the state regulator for a federally insured 
state chartered credit union. If an exception is revoked, loans granted 
under the exception authority are grandfathered.
    One commenter stated that the preamble to the final rule should 
clarify that if a state regulator has approved an exception, NCUA 
cannot overturn the state regulator's decision. NCUA has no intention 
of overturning a state regulator's decision regarding the exception. 
The process simply requires the state regulator to notify NCUA that the 
exception has been granted.

Section 723.19--What Are the Recordkeeping Requirements?

    This section required a credit union to identify member business 
loans separately in its records and financial reports. No substantive 
comments were received on this section. The Board is adopting this 
section in final as it was set forth in the interim final rule.

Section 723.20--How Can a State Supervisory Authority Develop and 
Implement a Member Business Loan Regulation?

    The interim final rule allowed a federally-insured state-chartered 
credit union to obtain an exemption from NCUA's member business loan 
rule so that a state supervisory authority can enforce the state's rule 
instead of NCUA's rule. The NCUA Board must approve the state's rule 
before a federally-insured state-chartered credit union is exempt from 
NCUA's member business loan rule. The interim final rule identified the 
minimum requirements that a state regulation must address for a rule to 
be approved by the NCUA Board. Because of the new statutory 
requirements of the Act, no state rule is currently approved for use by 
federally-insured state-chartered credit unions. Therefore, states must 
seek a new determination from NCUA. In addition, the NCUA Board is 
reemphasizing that any state's rule must follow the new definitions and 
the statutory limits in the Act. That is, the definition of a member 
business loan, the exemptions from the definition of a member business 
loan, the aggregate loan limit, and the state's interpretation of the 
exceptions from the aggregate loan limit must mirror NCUA's Regulation.
    One commenter specifically approved of this section. Three 
commenters requested that NCUA eliminate the words ``substantial 
equivalency determination'' from this section. Two commenters did not 
agree in eliminating the words ``substantial equivalency 
determination'' from this section. The final rule does not contain the 
term ``substantial equivalency'' because of the continuing objections 
expressed by some state supervisory authorities. The Board acknowledges 
the concerns of the state supervisory authorities, and the final rule 
recognizes that, in deciding whether to allow a state to implement its 
own rule, the NCUA Board is concerned, as insurer, with safety and 
soundness issues and not whether the language of the rule is virtually 
identical to NCUA's rule.
    One commenter requested that the rule specify the time frame NCUA 
has to render a determination on a state's rule. Although no time frame 
is specified in the final rule, the NCUA Board has a goal of making a 
decision within 90 days of receiving a complete request for a 
determination.

Section 723.21--Definitions

    NCUA proposed a general definition section at the end of the rule. 
One commenter did not object to NCUA's definition of ``associated 
member'' but did question how NCUA applies it. This commenter 
specifically requested that, in cases where there are related parties, 
loans will be aggregated only when assets of the related parties 
provide the income for the repayment of the loan. This commenter states 
that the proper test for determining the status of an associated member 
is the existence of a nexus between the success of the endeavor and the 
ability to repay the loan. The NCUA Board agrees and the agency will 
apply the definition accordingly.
    In an attempt to make the regulation easier to understand, the NCUA 
Board has slightly modified the definition of ``construction or 
development loan'' and ``loan-to-value ratio'' and added a definition 
for ``net worth'' and deleted the definition of ``reserves.''

Miscellaneous

    Six commenters requested that NCUA develop two distinct classes of 
member business loans--one for real estate and one for other types of 
member business loans. At this time, the NCUA Board believes it is not 
necessary to have separate rules because this final rule provides 
sufficient flexibility and guidance.
    The interim final rule was written in a plain English, question and 
answer format. Two commenters approved of the plain English, question 
and answer format. Two commenters preferred the traditional regulatory 
style. The NCUA Board has not noted any problems with the plain 
English, question and answer format and believes the question and 
answer format is comprehensive and easy to understand. Therefore, the 
final rule is written in the plain English, question and answer format.
    A few commenters requested that NCUA's Chartering Manual be amended 
to describe how a credit union can be chartered for the purpose of 
making member business loans. The NCUA Board will review this issue the 
next time it amends the Chartering Manual. In the meantime, a new 
charter can simply incorporate into its charter or bylaws a statement 
that its purpose is to make member business loans. Obviously, the 
credit union must incorporate this statement in good faith and the 
credit union's business plan will be reviewed to ensure that it 
reflects this stated purpose.

Part 722--Appraisals

    Certain loans as specified in Section 722.3(a) do not require an 
appraisal. In addition, the interim final rule contains a waiver 
process from the appraisal requirement where the appraisal requirement 
is an unnecessary burden. Three commenters specifically approved of the 
waiver provision for appraisals. Two commenters requested more guidance 
on when a waiver would be granted for a category of loans. The NCUA 
Board believes a waiver on a category of loans should be granted 
whenever an appraisal would be virtually meaningless. For example, an 
appraisal on loans to construct churches is often unnecessary. Another 
example where an appraisal may be unnecessary is when the loan-to-value 
ratio is extremely low due to property ownership interests, such as 
borrowing a small amount to improve property that is already completely 
owned by the member.

C. Other Reductions In Regulatory Burden

    Under the previous member business loan rule, all loans, lines of 
credit, or letters of credit that met the definition of a member 
business loan had to be separately identified in the records of

[[Page 28729]]

the credit union and be reported as such in financial and statistical 
reports required by the NCUA. NCUA believes that this information is 
already collected, and readily available, through the 5300 Call Report. 
The previous requirement imposed an unnecessary burden on credit unions 
and, therefore, the NCUA Board deleted this monitoring requirement in 
the interim final rule.
    The previous member business loan rule required credit unions to 
provide periodic disclosures to credit union members on the number and 
aggregate dollar amount of member business loans. NCUA believed the 
language was ambiguous and did not serve any true safety or soundness 
issue purpose. Therefore, the NCUA Board deleted this requirement in 
the interim final rule.
    Two commenters supported the elimination of these reporting 
requirements. The Board has not been provided any convincing rationale 
for reimposing these reporting requirements on credit unions, 
therefore, the final rule, like the interim rule, does not contain 
these reporting requirements.

D. Comments From Banks and Bank Trade Organizations

    Briefly summarized, the bank commenters argued that NCUA did not 
interpret CUMAA correctly and some stated that federal credit unions 
should be subject to taxation like banks. In general, these commenters 
opposed: (1) NCUA's definition of a ``history of primarily making 
member business loans'' exception; (2) NCUA's addition of the word 
``primarily'' to the exception regarding the chartering of the credit 
union for the purpose of making business loans; (3) NCUA's attempt to 
reduce regulatory burden, including revisions regarding loans-to-one 
borrower, employee lending experience, loan-to-value ratios, appraisal 
rules, review of financial statements, and state waiver authority; and 
(4) NCUA's elimination of some burdensome reporting requirements.
    The Board has considered all issues raised by these commenters and 
has previously addressed the major issues in this preamble since other 
commenters also addressed many of the same provisions. As to the 
question of taxation, this issue was legislatively addressed in CUMAA 
at Section 2.(4), which states that ``[c]redit unions, unlike many 
other participants in the financial services market, are exempt from 
Federal and most State taxes because they are member-owned, 
democratically operated, not-for-profit organizations generally managed 
by volunteer board of directors and because they have the specified 
mission of meeting the credit and savings needs of consumers, 
especially persons of modest means.''

E. Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact any proposed regulation may 
have on a substantial number of small entities (primarily those under 
$1 million in assets). Aside from provisions mandated by the Act, the 
final member business loan rule would reduce existing regulatory 
burdens. In addition, most small credit unions do not grant member 
business loans. Therefore, the NCUA Board has determined and certifies 
that the final rule will not have a significant economic impact on a 
substantial number of small credit unions.
    Accordingly, the NCUA Board has determined that a Regulatory 
Flexibility Analysis is not required.

Paperwork Reduction Act

    The reporting requirements in part 723 have been submitted to and 
approved by the Office of Management and Budget under OMB control 
number 3133-0101. Under the Paperwork Reduction Act of 1995, no persons 
are required to respond to a collection of information unless it 
displays a valid OMB control number. The control number will be 
displayed in the table at 12 CFR part 795.

Executive Order 12612

    Executive Order 12612 requires NCUA to consider the effect of its 
actions on state interests. The final rule, as does the current rule, 
applies to all federally insured credit unions, including federally 
insured state chartered credit unions. However, since the final rule 
reduces regulatory burden, NCUA has determined that the final rule does 
not constitute a ``significant regulatory action'' for purposes of the 
Executive Order.

Congressional Review

    The Small Business Regulatory Enforcement Fairness Regulatory 
Enforcement Fairness Act of 1996 (Public Law 104-221) provides for 
Congressional review of agency rules.
    The reporting requirements is triggered in instances where NCUA 
issues a final rule as defined by section 551 of the Administrative 
Procedures Act, 5 U.S.C. 551.
    The Office of Management and Budget has determined this is not a 
major rule. A major rule is defined as being any final rule that the 
Office of Management and Budget finds has resulted in or is likely to 
result in: (1) an annual effect on the economy of $100 million or more; 
(2) a major increase in costs or prices for consumers, individual 
industries, Federal, State, or local government agencies, or geographic 
regions; or (3) significant adverse effects on competition, employment, 
investment, productivity, innovation, or on the ability of United 
States based enterprises to compete with foreign-based enterprises in 
domestic and export markets.

List of Subjects

12 CFR Part 701

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

12 CFR Part 722

    Appraisals, Credit, Credit unions, Reporting and recordkeeping 
requirements.

12 CFR Part 723

    Credit, Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 741

    Bank deposit insurance, Credit unions, Reporting and recordkeeping 
requirements.

    By the National Credit Union Administration Board on May 19, 
1999.
Becky Baker,
Secretary of the Board.
    Accordingly, the interim rule amending 12 CFR parts 701, 722, 723 
and 741 which was published at 63 FR 51793, September 29, 1998, is 
adopted as a final rule with the following changes:
    1. Part 723 is revised to read as follows:

PART 723--MEMBER BUSINESS LOANS

Sec.
723.1  What is a member business loan?
723.2  What are the prohibited activities?
723.3  What are the requirements for construction and development 
lending?
723.4  What are the other applicable regulations?
723.5  How do you implement a member business loan program?
723.6  What must your member business loan policy address?
723.7  What are the collateral and security requirements?
723.8  How much may one member, or a group of associated members, 
borrow?
723.9  How do you calculate the aggregate 15% limit?
723.10  What waivers are available?
723.11  How do you obtain a waiver?

[[Page 28730]]

723.12  What will NCUA do with my waiver request?
723.13  What options are available if the NCUA Regional Director 
denies my waiver request, or a portion of it?
723.14  How do I classify loans so as to reserve for potential 
losses?
723.15  How much must I reserve for potential losses?
723.16  What is the aggregate member business loan limit for a 
credit union?
723.17  Are there any exceptions to the aggregate loan limit?
723.18  How do I obtain an exception?
723.19  What are the recordkeeping requirements?
723.20  How can a state supervisory authority develop and enforce a 
member business loan regulation?
723.21  Definitions.

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

Sec. 723.1  What is a member business loan?

    (a) General rule. A member business loan includes any loan, line of 
credit, or letter of credit (including any unfunded commitments) where 
the borrower uses the proceeds for the following purposes:
    (1) Commercial;
    (2) Corporate;
    (3) Other business investment property or venture; or
    (4) Agricultural.
    (b) Exceptions to the general rule. The following are not member 
business loans:
    (1) A loan fully secured by a lien on a 1 to 4 family dwelling that 
is the member's primary residence;
    (2) A loan fully secured by shares in the credit union making the 
extension of credit or deposits in other financial institutions;
    (3) Loan(s) to a member or an associated member which, when added 
together, are equal to or less than $50,000;
    (4) A loan where a federal or state agency (or its political 
subdivision) fully insures repayment, or fully guarantees repayment, or 
provides an advance commitment to purchase in full; or
    (5) A loan granted by a corporate credit union to another credit 
union.


Sec. 723.2  What are the prohibited activities?

    (a) Who is ineligible to receive a member business loan? You may 
not grant a member business loan to the following:
    (1) Your chief executive officer (typically this individual holds 
the title of President or Treasurer/Manager);
    (2) Any assistant chief executive officers (e.g., Assistant 
President, Vice President, or Assistant Treasurer/Manager);
    (3) Your chief financial officer (Comptroller); or
    (4) Any associated member or immediate family member of anyone 
listed in paragraphs (a) (1) through (3) of this section.
    (b) Equity agreements/joint ventures. You may not grant a member 
business loan if any additional income received by the credit union or 
senior management employees is tied to the profit or sale of the 
business or commercial endeavor for which the loan is made.
    (c) Loans to compensated directors. A credit union may not grant a 
member business loan to a compensated director unless the board of 
directors approves granting the loan and the compensated director is 
recused from the decision making process.


Sec. 723.3  What are the requirements for construction and development 
lending?

    Unless the Regional Director grants a waiver, loans granted for the 
construction or development of commercial or residential property are 
subject to the following additional requirements.
    (a) The aggregate of all construction and development loans must 
not exceed 15% of net worth. To determine the aggregate, you may 
exclude any portion of a loan:
    (1) Secured by shares in the credit union;
    (2) Secured by deposits in another financial institution;
    (3) Fully or partially insured or guaranteed by any agency of the 
federal government, state, or its political subdivisions; or
    (4) Subject to an advance commitment to purchase by any agency of 
the federal government, state, or its political subdivisions;
    (b) The borrower must have a minimum of 35% equity interest in the 
project being financed; and
    (c) The funds may be released only after on-site, written 
inspections by qualified personnel and according to a preapproved draw 
schedule and any other conditions as set forth in the loan 
documentation.


Sec. 723.4  What are the other applicable regulations?

    The provisions of Sec. 701.21(a) through (g) of this chapter apply 
to member business loans granted by federal credit unions to the extent 
they are consistent with this part. Except as required by part 741 of 
NCUA's regulations, federally insured credit unions are not required to 
comply with the provisions of Sec. 701.21(a) through (g).


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

    The board of directors must adopt specific business loan policies 
and review them at least annually. The board must also utilize the 
services of an individual with at least two years direct experience 
with the type of lending the credit union will be engaging in.
    Credit unions do not have to hire staff to meet the requirements of 
this section; however, credit unions must ensure that the expertise is 
available. A credit union can meet the experience requirement through 
various approaches. For example, a credit union can use the services of 
a credit union service organization, an employee of another credit 
union, an independent contractor, or other third parties. However, the 
actual decision to grant a loan must reside with the credit union.


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

    At a minimum, your policy must address the following:
    (a) The types of business loans you will make;
    (b) Your trade area;
    (c) The maximum amount of your assets, in relation to net worth, 
that you will invest in business loans;
    (d) The maximum amount of your assets, in relation to net worth, 
that you will invest in a given category or type of business loan;
    (e) The maximum amount of your assets, in relation to net worth, 
that you will loan to any one member or group of associated members, 
subject to Sec. 723.8;
    (f) The qualifications and experience of personnel (minimum of 2 
years) involved in making and administering business loans;
    (g) A requirement to analyze and document the ability of the 
borrower to repay the loan;
    (h) Receipt and periodic updating of financial statements and other 
documentation, including tax returns;
    (i) A requirement for sufficient documentation supporting each 
request to extend credit, or increase an existing loan or line of 
credit (except where the board of directors finds that the 
documentation requirements are not generally available for a particular 
type of business loan and states the reasons for those findings in the 
credit union's written policies). At a minimum, your documentation must 
include the following:
    (1) Balance sheet;
    (2) Cash flow analysis;
    (3) Income statement;
    (4) Tax data;
    (5) Analysis of leveraging; and
    (6) Comparison with industry average or similar analysis;
    (j) The collateral requirements must include:

[[Page 28731]]

    (1) Loan-to-value ratios;
    (2) Determination of value;
    (3) Determination of ownership;
    (4) Steps to secure various types of collateral; and
    (5) How often the credit union will reevaluate the value and 
marketability of collateral;
    (k) The interest rates and maturities of business loans;
    (l) General loan procedures which include:
    (1) Loan monitoring;
    (2) Servicing and follow-up; and
    (3) Collection;
    (m) Identification of those individuals prohibited from receiving 
member business loans.


Sec. 723.7  What are the collateral and security requirements?

    (a) Unless your Regional Director grants a waiver, all member 
business loans must be secured by collateral as follows:

------------------------------------------------------------------------
                                                Minimum loan to value
                   Lien                             requirements
------------------------------------------------------------------------
All.......................................  LTV ratios for all liens
                                             cannot exceed 80% unless
                                             the value in excess of 80%
                                             is covered through private
                                             mortgage or equivalent
                                             insurance but in no case
                                             can it exceed 95%.
First with PMI or similar type of insurer.  You may grant a LTV ratio in
                                             excess of 80% only where
                                             the value in excess of 80%
                                             is covered through:
                                             acquisition of private
                                             mortgage or equivalent type
                                             insurance provided by an
                                             insurer acceptable to the
                                             credit union (where
                                             available); insurance or
                                             guarantees by, or subject
                                             to advance commitment to
                                             purchase by, an agency of
                                             the federal government; or
                                             insurance or guarantees by,
                                             or subject to advance
                                             commitment to purchase by,
                                             an agency of a state or any
                                             of its political
                                             subdivisions.
First.....................................  LTV ratios up to 80%.
Second....................................  LTV ratios up to 80%.
------------------------------------------------------------------------

    (b) Principals, other than a not for profit organization as defined 
by the Internal Revenue Service Code (26 U.S.C. 501) or those where the 
Regional Director grants a waiver, must provide their personal 
liability and guarantee.
    (c) Federally insured credit unions are exempt from the provisions 
of paragraphs (a) and (b) of this section with respect to credit card 
line of credit programs offered to nonnatural person members that are 
limited to routine purposes normally made available under those 
programs.


Sec. 723.8  How much may one member, or a group of associated members, 
borrow?

    Unless your Regional Director grants a waiver for a higher amount 
the aggregate amount of outstanding member business loans (including 
any unfunded commitments) to any one member or group of associated 
members must not exceed the greater of:
    (a) 15% of the credit union's net worth; or
    (b) $100,000.


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

    (a) Step 1. Calculate the numerator by adding together the total 
outstanding balance of member business loans to any one member, or 
group of associated members. From this amount, subtract any portion:
    (1) Secured by shares in the credit union;
    (2) Secured by deposits in another financial institution;
    (3) Fully or partially insured or guaranteed by any agency of the 
Federal government, state, or its political subdivisions;
    (4) Subject to an advance commitment to purchase by any agency of 
the Federal government, state, or its political subdivisions.
    (b) Step 2. Divide the numerator by net worth.


Sec. 723.10  What waivers are available?

    You may seek a waiver for a category of loans in the following 
areas:
    (a) Loan-to-value ratios under Sec. 723.7;
    (b) Maximum loan amount to one borrower or associated group of 
borrowers under Sec. 723.8;
    (c) Construction and development loan limits under Sec. 723.3;
    (d) Requirement for personal liability and guarantee under 
Sec. 723.7; and
    (e) Appraisal requirements under Sec. 722.3.


Sec. 723.11  How do you obtain a waiver?

    To obtain a waiver, a federal credit union must submit a request to 
the Regional Director (a corporate federal credit union submits the 
waiver request to the Director of the Office of Corporate Credit 
Unions). A state chartered federally insured credit union must submit 
the request to its state supervisory authority. If the state 
supervisory authority approves the request, the state regulator will 
forward the request to the Regional Director (or if appropriate the 
Director of the Office of Corporate Credit Unions). A waiver is not 
effective until it is approved by the Regional Director (or in the case 
of a corporate federal credit union the Director of the Office of 
Corporate Credit Unions). The waiver request must contain the 
following:
    (a) A copy of your business lending policy;
    (b) The higher limit sought (if applicable);
    (c) An explanation of the need to raise the limit (if applicable);
    (d) Documentation supporting your ability to manage this activity; 
and
    (e) An analysis of the credit union's prior experience making 
member business loans, including as a minimum:
    (1) The history of loan losses and loan delinquency;
    (2) Volume and cyclical or seasonal patterns;
    (3) Diversification;
    (4) Concentrations of credit to one borrower or group of associated 
borrowers in excess of 15% of net worth;
    (5) Underwriting standards and practices;
    (6) Types of loans grouped by purpose and collateral; and
    (7) The qualifications of personnel responsible for underwriting 
and administering member business loans.


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

    Your Regional Director (or the Director of the Office of Corporate 
Credit Unions) will:
    (a) Review the information you provided in your request;
    (b) Evaluate the level of risk to your credit union;
    (c) Consider your credit union's historical CAMEL composite and 
component ratings when evaluating your request; and
    (d) Notify you whenever your waiver request is deemed complete. 
Notify you of the action taken within 45 calendar days of receiving a 
complete request from the federal credit union or the state supervisory 
authority. If you do not receive notification within 45 calendar days 
of the date the complete request was received by the regional office, 
the credit union may assume approval of the waiver request.


Sec. 723.13  What options are available if the NCUA Regional Director 
denies my waiver request or a portion of it?

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

[[Page 28732]]

of Corporate Credit Unions) decision in writing to the NCUA Board. Your 
appeal must include all information requested in Sec. 723.11 and why 
you disagree with your Regional Director's (or the Office of Corporate 
Credit Union Director's) decision.


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

    Non-delinquent member business loans may be classified based on 
factors such as the adequacy of analysis and supporting documentation. 
You must classify potential loss loans as either substandard, doubtful, 
or loss. The criteria for determining the classification of loans are:
    (a) Substandard. Loan is inadequately protected by the current 
sound worth and paying capacity of the obligor or of the collateral 
pledged, if any. Loans classified must have a well-defined weakness or 
weaknesses that jeopardize the liquidation of debt. They are 
characterized by the distinct possibility that the credit union will 
sustain some loss if the deficiencies are not corrected. Loss 
potential, while existing in the aggregate amount of substandard loans, 
does not have to exist in individual loans classified substandard.
    (b) Doubtful. A loan classified doubtful has all the weaknesses 
inherent in one classified substandard, with the added characteristic 
that the weaknesses make collection or liquidation in full, on the 
basis of currently existing facts, conditions, and values, highly 
questionable and improbable. The possibility of loss is extremely high, 
but because of certain important and reasonably specific pending 
factors which may work to the advantage and strengthening of the loan, 
its classification as an estimated loss is deferred until its more 
exact status may be determined. Pending factors include: proposed 
merger, acquisition, or liquidation actions; capital injection; 
perfecting liens on collateral; and refinancing plans.
    (c) Loss. Loans classified loss are considered uncollectible and of 
such little value that their continuance as loans is not warranted. 
This classification does not necessarily mean that the loan has 
absolutely no recovery or salvage value, but rather, it is not 
practical or desirable to defer writing off this basically worthless 
asset even though partial recovery may occur in the future.


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

    The following schedule sets the minimum amount you must reserve for 
classified loans:

------------------------------------------------------------------------
              Classification                       Amount Required
------------------------------------------------------------------------
Substandard...............................  10% of outstanding amount
                                             unless other factors (for
                                             example, history of such
                                             loans at the credit union)
                                             indicate a greater or
                                             lesser amount is
                                             appropriate.
Doubtful..................................  50% of the outstanding
                                             amount.
Loss......................................  100% of the outstanding
                                             amount.
------------------------------------------------------------------------

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

    The aggregate limit on a credit union's outstanding member business 
loans (including any unfunded commitments) is the lesser of 1.75 times 
the credit union's net worth or 12.25% of the credit union's total 
assets. Net worth is all of the credit union's retained earnings. 
Retained earnings normally includes undivided earnings, regular 
reserves and any other appropriations designated by management or 
regulatory authorities. Loans that are exempt from the definition of 
member business loans are not counted for the purpose of the aggregate 
loan limit.


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

    There are three circumstances where a credit union qualifies for an 
exception from the aggregate limit. Loans that are excepted from the 
definition of member business loans are not counted for the purpose of 
the exceptions. The three exceptions are:
    (a) Credit unions that have a low-income designation or participate 
in the Community Development Financial Institutions program;
    (b) Credit unions that were chartered for the purpose of making 
member business loans and can provide documentary evidence (such 
evidence includes but is not limited to the original charter, original 
bylaws, original business plan, original field of membership, board 
minutes and loan portfolio);
    (c) Credit unions that have a history of primarily making member 
business loans, meaning that either member business loans comprise at 
least 25% of the credit union's outstanding loans (as evidenced in any 
call report filed between January 1995 and September 1998 or any 
equivalent documentation including financial statements) or member 
business loans comprise the largest portion of the credit union's loan 
portfolio (as evidenced in any call report filed between January 1995 
and September 1998 or any equivalent documentation including financial 
statements). For example, if a credit union makes 23% member business 
loans, 22% first mortgage loans, 22% new automobile loans, 20% credit 
card loans, and 13% total other real estate loans, then the credit 
union meets this exception.


Sec. 723.18  How do I obtain an exception?

    To obtain the exception, a federal credit union must submit 
documentation to the Regional Director, demonstrating that it meets the 
criteria of one of the exceptions. A state chartered federally insured 
credit union must submit documentation to its state supervisory 
authority. The state supervisory authority will forward its decision to 
NCUA. The exception does not expire unless revoked by the state 
supervisory authority for a state chartered federally insured credit 
union or the Regional Director for a federal credit union. If an 
exception request is denied for a federal credit union, it may be 
appealed to the NCUA Board within 60 days of the denial by the Regional 
Director. Until the NCUA Board acts on the appeal, the credit union can 
continue to make new member business loans.


Sec. 723.19  What are the recordkeeping requirements?

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


Sec. 723.20  How can a state supervisory authority develop and enforce 
a member business loan regulation?

    (a) The NCUA Board may exempt federally insured state chartered 
credit unions in a given state from NCUA's member business loan rule if 
NCUA approves the state's rule for use for state chartered federally 
insured credit unions. In making this determination, the Board is 
guided by safety and soundness considerations and reviews whether the 
state regulation minimizes the risk and accomplishes the overall 
objectives of NCUA's member business loan rule in this part. 
Specifically, the Board will focus its review on:
    (1) The definition of a member business loan;
    (2) Loan to one borrower limits;
    (3) Written loan policies;
    (4) Collateral and security requirements;
    (5) Construction and development lending; and
    (6) Loans to senior management.
    (b) To receive NCUA's approval of a state's members business loan 
rule, the state supervisory authority must submit its rule to the NCUA 
regional office. After reviewing the rule, the region will

[[Page 28733]]

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


Sec. 723.21  Definitions.

    For purposes of this part, the following definitions apply:
    Associated member is any member with a shared ownership, 
investment, or other pecuniary interest in a business or commercial 
endeavor with the borrower.
    Construction or development loan is a financing arrangement for 
acquiring property or rights to property, including land or structures, 
with the intent to convert it to income-producing property such as 
residential housing for rental or sale; commercial use; industrial use; 
or similar uses.
    Immediate family member is a spouse or other family member living 
in the same household.
    Loan-to-value ratio is the aggregate amount of all sums borrowed 
including outstanding balances plus any unfunded commitment or line of 
credit from all sources on an item of collateral divided by the market 
value of the collateral used to secure the loan.
    Net worth is retained earnings as defined under Generally Accepted 
Accounting Principles. Retained earnings normally includes undivided 
earnings, regular reserves and any other appropriations designated by 
management or regulatory authorities.

PART 741--REQUIREMENTS FOR INSURANCE

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

    Authority: 12 U.S.C. 1757, 1766 and 1781-1790. Section 741.4 is 
also authorized by 31 U.S.C. 3717.

Sec. 741.203  [Amended]

    3. Section 741.203 is amended in paragraph (a) by removing the 
second sentence and adding in its place a new sentence to read as 
follows: ``State-chartered, NCUSIF-insured credit unions in a given 
state are exempt from these requirements if the state supervisory 
authority for that state adopts substantially equivalent regulations as 
determined by the NCUA Board or, in the case of the member business 
loan requirements, if the state supervisory authority adopts member 
business loan regulations that are approved by the NCUA Board pursuant 
to Sec. 723.20.''

[FR Doc. 99-13310 Filed 5-26-99; 8:45 am]
BILLING CODE 7535-01-P