[Federal Register Volume 65, Number 105 (Wednesday, May 31, 2000)]
[Rules and Regulations]
[Pages 34581-34587]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-13509]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 714


Leasing

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: The final leasing rule updates and redesignates NCUA's long-
standing policy statement on leasing, Interpretive Ruling and Policy 
Statement (IRPS) 83-3, as an NCUA regulation. IRPS 83-3 authorizes 
federal credit unions (FCUs) to engage in either direct or indirect 
leasing and either open-end or closed-end leasing of personal property 
to their members if such leasing arrangements are the functional 
equivalent of secured loans. In addition, the final rule formalizes 
NCUA's position, set forth in legal opinion letters, that FCUs do not 
have to own the leased property in an indirect leasing arrangement if 
certain requirements are satisfied.

DATES: This rule is effective June 30, 2000.

FOR FURTHER INFORMATION CONTACT: Paul M. Peterson, Staff Attorney, 
Division of Operations, Office of the General Counsel, (703) 518-6555.

SUPPLEMENTARY INFORMATION:

A. Background

    In 1983, the NCUA Board issued Interpretive Ruling and Policy 
Statement (IRPS) 83-3, Federal Credit Union Leasing of Personal 
Property to Members, 48 FR 52560 (November 21, 1983), stating that FCUs 
may lease personal property to their members if the leasing of the 
personal property is the functional equivalent of secured lending. In 
1997, the NCUA Board determined that IRPS 83-3 would be better suited 
as a regulation. 62 FR 11773 (March 13, 1997). In 1998, the Board 
issued a notice of proposed rulemaking (NPRM) and request for comment 
on leasing. 63 FR 57950 (October 29, 1998). The Board evaluated the 
comments received and incorporated many of the suggested changes. Due 
to these changes to the original proposed leasing regulation, the Board 
issued a second NPRM and request for comment. 64 FR 55866 (October 15, 
1999). The comment period for the second NPRM expired on December 17, 
1999.

B. Comments

    NCUA received twelve comments on the second proposed leasing 
regulation. Comments were received from three federal credit unions, 
two credit union trade associations, four credit union leagues, one 
bank trade association, one insurance company, and one leasing company. 
In general, the commenters support the rule, although most commenters 
suggest modifications. Those commenters who compared the second 
proposed rule to the first think the second proposal is an improvement. 
Specific comments are addressed in the section-by-section analysis 
below.

C. Format

    In drafting the proposed leasing regulation, the NCUA Board chose 
to use a plain English, question and answer format. The Board supports 
plain English as a means to increase regulatory comprehension and 
improve compliance among those affected by the regulation. Plain 
English drafting emphasizes the use of informative headings (often 
written as a question), lists and charts where appropriate, non-
technical language, and sentences in the active voice. The NCUA wrote 
this proposed regulation as a series of questions and answers. The word 
``you'' in an answer refers to an FCU.

D. Section-by-Section Analysis

    This analysis contains a section-by-section summary of the second 
proposed rule; discusses the comments received on each section, if any; 
and describes any changes made as a result of those comments. The 
phrase ``proposed section'' as used below refers to draft language in 
the second NPRM.

Section 714.1--What Does This Part Cover?

    Proposed Sec. 714.1 stated that part 714 covers the standards and 
requirements that an FCU must follow when engaged in the lease 
financing of personal property. We received no comments and made no 
changes in the final rule.

Section 714.2--What are the Permissible Leasing Arrangements?

    Proposed Sec. 714.2 stated that FCUs may engage in direct or 
indirect leasing, and closed-end or open-end leasing.
    Proposed Sec. 714.2(c) provides ``[i]n an open-end lease, your 
member assumes the risk and responsibility for any difference in the 
estimated residual value and the actual value of the property at lease 
end.'' Proposed Sec. 714.2(d) provides that for a closed-end lease the 
FCU assumes the risk and responsibility for that same difference. Two 
commenters note that any excessive wear and tear on the leased property 
will be included in the difference between the estimated residual value 
and the actual value of the property at lease end so that the proposed 
rule apparently assigns the responsibility for excessive wear and tear 
differently depending on whether the lease is open-end or closed-end. 
One of these commenters suggests that Sec. 714.2 be modified to place 
the risk and responsibility for excess wear and tear on the lessor FCU, 
regardless of the form of leasing. The other commenter suggests that 
the responsibility for excess wear and tear should always be with the 
member lessee.
    As stated in the preamble to IRPS 83-3, the lessee is always 
responsible for a decrease in value due to excessive wear and tear. The 
lessee, with possession of the leased property, is in the best position 
to protect the property from excess wear and tear regardless of whether 
the lease is open-end or closed end. Accordingly, the Board amends 
Sec. 714.2(d) to clarify that, in closed-end leasing, the member lessee 
will be responsible for excessive wear and tear and the FCU will be 
responsible for the remainder of the difference between the estimated 
residual value and the actual value. Proposed Sec. 714.2(c) on open-end 
leasing already places the responsibility for excessive wear and tear 
on the member lessee and needs no modification in the final rule.
    The following example illustrates the allocation of risks in 
closed-end leasing. Assume you, an FCU, lease a $12,000 car under a 
closed-end leasing arrangement. At lease inception, the car has an 
estimated residual value of $3,000. The lease is not covered by any

[[Page 34582]]

residual value insurance or third-party guarantee. Assume further that, 
during the term of the lease, the used car market for this particular 
make and model softens. When the car is returned at the end of the 
lease, you sell it at public auction for only $2,000, which is $1,000 
less than your estimated residual value. If the car suffers from normal 
wear and tear, you are responsible for the entire difference between 
the estimated residual value and the actual residual value. If, 
however, excess wear and tear reduced the car's actual residual value 
by $500, the member will be responsible for $500 and you will be 
responsible only for the remaining $500 of residual value loss.

Section 714.3--Must You Own the Leased Property in an Indirect Leasing 
Arrangement?

    Proposed Sec. 714.3 stated that an FCU does not have to own the 
leased property in an indirect leasing arrangement if the FCU: (1) 
Receives a full assignment of the lease; (2) is named as the sole 
lienholder of the property; (3) enters into a security agreement with 
the leasing company to protect the FCU's lien on the property; and (4) 
takes all necessary steps to record and perfect the security interest.
    One commenter supports the full assignment requirement. Three other 
commenters believe that the full assignment of the lease is unnecessary 
and decisions about how much of the lease should be assigned are best 
left to the discretion of the FCU. One of these three commenters noted 
that the Office of the Comptroller of the Currency (OCC) has no full 
assignment requirement in its leasing rules for national banks, and 
another argued that full assignment was unnecessary if the FCU ``can 
protect its interest by possession.'' The commenters opposed to full 
assignment did not specify any particular harm to FCUs arising from the 
requirement. Also, the Board notes that the one leasing company that 
commented on the second NPRM stated that full assignment was 
``unnecessary but not objectionable.'' (emphasis added).
    The final rule leaves the full assignment requirement intact. The 
full assignment requirement stems from two main concerns. First, in the 
event of a leasing company's bankruptcy, the failure to obtain a 
complete assignment of the lease may permit the bankruptcy trustee to 
argue that the trustee owns the lease and can treat it as an executory 
contract subject to repudiation. Second, the Board is concerned that 
advancing the funds to allow a nonmember leasing company to purchase 
property for leasing, and then allowing that nonmember to retain both 
lease and title to the underlying property, is tantamount to making a 
loan to a nonmember. While banks regulated by the OCC may lend money to 
anyone, FCUs may only lend money to members. 12 U.S.C. 1757. The second 
NPRM contains additional discussion of these concerns. 64 FR 55866, 
55867 (October 15, 1999). Also, with regard to the comment about 
protection of its interest by ``possession,'' the FCU may protect its 
lease assignment by possession of the original lease documents or by an 
appropriate filing. U.C.C. Sec. 9-102(1)(b) (sale of chattel paper), 
Sec. 9-304(1), Sec. 9-305. However, the FCU must still obtain a full 
assignment.
    Two commenters object to the following statement in the preamble to 
the proposed Sec. 714.3: ``It (the security agreement) must set forth 
the terms and conditions upon which the leasing company or the member 
may be in default and thus entitle the FCU to take immediate possession 
of the property.'' These commenters read the quoted language as 
requiring the security agreement to contain an exhaustive list of every 
obligation under the lease and every possible form of default.
    The Board does not intend to mandate that every leasing security 
agreement include an exhaustive listing of obligations and defaults on 
those obligations. The Board does believe that an FCU ``should consider 
the contingencies that may seriously affect (its) security and see that 
the security agreement specifies them as events of default.'' James J. 
White and Robert S. Summers, Uniform Commercial Code, Sec. 34-2 (4th 
ed. 1995). Section 714.3 provides that the FCU must have the right to 
take possession and dispose of the leased property in the event of ``a 
default by the lessee, a default in the leasing company's obligations 
to you, or a material adverse change in the leasing company's financial 
condition.'' Ultimately, the FCU must determine for itself how much 
detail about these and other default contingencies is included in the 
security agreement.
    Another commenter asked whether NCUA intended to require a detailed 
security agreement for each lease, or whether the substance of a well-
drafted security agreement could be subsumed into a lease program 
agreement. The Board believes that obligations and defaults may be 
described in the security agreement itself or may be incorporated by 
clear reference to some other document such as the master leasing 
agreement or contract. Also, a single security agreement may cover 
multiple leases, so long as the agreement sufficiently describes which 
leases are covered.
    One commenter suggests that the rule should reinstate the 
requirement for an irrevocable power of attorney contained in the first 
NPRM but dropped from the second. The NCUA Board believes that a power 
of attorney is unnecessary for an FCU holding a well-defined and 
perfected security interest in the leased property. In the event of a 
default by a leasing company or lessee, an FCU should be able to take 
possession and dispose of the collateral without the power of attorney. 
Accordingly, the final rule no longer contains any requirement for a 
power of attorney. The Board notes, however, that the final rule does 
not prohibit an FCU from employing a power of attorney, in addition to 
a security agreement.

Section 714.4--What Are the Lease Requirements?

    Proposed Sec. 714.4 stated that leases must be net, full payout 
leases, with a maximum estimated residual value of 25% of the original 
cost of the leased property unless guaranteed. In a full payout lease, 
the FCU must recoup its entire investment in the leased property, plus 
the cost of financing that investment, from the lessee's payments and 
the estimated residual value of the leased property.
    Numerous comments were directed to the guarantee requirement. Some 
commenters want the requirement eliminated, some want the 25% threshold 
raised, and others want the requirement maintained at 25% or lowered.
    The commenters who want to eliminate the guarantee requirement cite 
the authority of national banks and federal thrifts to engage in 
certain leasing transactions without any guarantee. As discussed below, 
however, the legal authority supporting FCU leasing varies from that 
for national banks and federal thrifts. Unlike banks and thrifts, which 
have express authority to lease, FCUs have no express authority.
    Prior to 1982, all federal depository institutions relied on the 
same source of legal authority for leasing: their express authority to 
lend money and the argument that leasing is incidental to this express 
lending authority. A lease under this incidental authority must be the 
equivalent of a secured loan. Dependence on the residual value to 
recover the depository institution's costs involves risks that are 
unlike those of secured lending and, hence, the residual value must 
``contribute insubstantially'' to the institution's recovery of its 
costs. M&M Leasing Corporation v. Seattle

[[Page 34583]]

First National Bank, 563 F.2d 1377, 1384 (9th Cir. 1977), cert. denied, 
436 U.S. 956 (1978). For national banks, the OCC quantified M&M 
Leasing's ``insubstantial'' contribution at 25%, and required any 
reliance above 25% be guaranteed. 12 CFR 23.21(a)(2). The NCUA adopted 
this same 25% limit on the unguaranteed portion of the residual value 
in IRPS 83-3.
    In the 1980s, Congress provided national banks and federal thrifts 
with additional, express statutory authority to conduct leasing 
activities in an aggregate amount not to exceed ten percent of assets. 
See the Garn--St. Germain Depository Institutions Act of 1982, Pub. L. 
No. 97-320, Sec. 330(3), codified at 12 U.S.C. 1464(c)(2)(A); and the 
Competitive Banking Equality Act of 1987 (CEBA), Pub. L. No. 100-86, 
Sec. 108, codified at 12 U.S.C. 24(Tenth). This express leasing 
authority empowers national banks and federal thrifts to assume 
increased risks in areas unique to leasing, including residual value 
risk. For example, in the Senate Report accompanying CEBA's grant of 
express authority to national banks, the Senate Committee on Banking, 
Housing, and Urban Affairs stated its expectation that with the express 
authority to lease ``the Comptroller will relax or eliminate the 
residual value limitation [on national banks] in the Comptroller's 
regulation in a manner consistent with sound banking practices.'' S. 
Rep. No. 100-19, at 42 (1987). Accordingly, neither OCC nor OTS require 
residual value guarantees for leases aggregating less than ten percent 
of assets and so covered by express leasing authority. See 12 CFR part 
23, subpart B; 12 CFR 560.41(d). However, both the OCC and OTS still 
require residual value guarantees for banks and thrifts for leases in 
excess of ten percent of assets and thus subject to the restrictions on 
residual value risk enunciated in M&M Leasing. See 12 CFR part 23, 
subpart C; 12 CFR 560.41(c), (b)(2).
    One commenter that supported elimination of the guarantee 
requirement asks, in the alternative, if credit unions with a 
demonstrated ability to handle risk could set the unguaranteed portion 
of the residual at some level higher than 25% of original cost. Other 
commenters support the guarantee at its current 25% level or feel that 
the 25% level should be lowered. The Board has carefully considered 
whether it should set the unguaranteed portion of the residual at some 
level other than the 25% figure contained in IRPS 83-3. As discussed 
below, the Board is not inclined to vary from the long-standing 25% 
limitation.
    Any increase in the unguaranteed residual value above 25% may cause 
the unguaranteed residual to ``contribute substantially'' to the 
recovery of an FCU's costs and thus render the FCU's leasing program 
illegal under M&M Leasing. The line between ``substantial'' and 
``insubstantial'' is imprecise and not susceptible to exact 
quantification. Nevertheless, the Board considers a 25% contribution to 
cost recovery as insubstantial, and any figure larger than 25% as 
problematic. The OCC has used the current 25% figure for decades.
    Also, the Board believes that the economic impact of the guarantee 
requirement is not significant. Insurance companies offer reasonably-
priced residual value insurance that satisfies the current 25% 
requirement. In vehicle leasing, for example, a policy with a 25% 
deductible can generally be obtained for a small, one-time premium of 
between one-half to one percent of the estimated residual value. In 
addition, the Board is aware of FCUs that purchase residual insurance 
in coverage amounts exceeding the requirements of the rule and yet 
remain competitive in their vehicle leasing markets.
    The Board also considered the possibility of tightening the 25% 
guarantee requirement. The Board notes that, with the authority to put 
up to 25% of the original cost at risk, credit unions may still suffer 
significant losses if actual residual values fall short of estimates. 
Nevertheless, in the past FCUs have handled this risk well. The Board 
is willing to allow FCUs to use their business judgment in deciding how 
to handle residual value risks up to the 25% level.
    One commenter suggests that instead of tying the guarantee to 25% 
of the original cost, it should be tied to ``a certain percentage of 
the blue book value.'' The Board believes that the guarantee 
requirement is best tied to an FCU's actual investment in the property, 
as the key to loss avoidance in leasing is recovery of costs. Also, the 
leasing regulation covers leasing of all personal property, not just 
vehicles. No particular publication such as the ``blue book'' provides 
property values on every form of personal property. The leasing rule's 
guarantee requirement is stated in terms flexible enough to cover all 
personal property leasing.
    Five commenters request that any guarantee requirement extend only 
to the amount of the estimated residual needed to satisfy the full 
payout test. These commenters believe that the proposed rule, which 
separates the residual value guarantee requirement from the full payout 
test, is inconsistent with the OCC leasing rule and IRPS 83-3. The 
Board concurs with these commenters. The full payout test requires that 
FCUs plan to recover all leasing costs from the combination of lease 
payments and the estimated residual value. The guarantee requirement is 
intended to protect an FCU against the possibility of excessive 
residual losses. The Board believes that an FCU should only be required 
to guarantee the portion of the estimated residual value that is above 
25% of the original investment that is needed to meet the full payout 
requirement, meaning the amount an FCU relies on to recover its costs. 
The Board has changed the final rule to connect the guarantee 
requirement clearly with the full payout test. This connection results 
in a lesser guarantee requirement and a corresponding reduction in the 
burden on FCUs. An illustration of the effect of the final rule 
follows.
    Assume you, an FCU, pay $12,000 for a car and lease it under a 
closed-end leasing arrangement. Assume that your internal cost of 
financing is $2,000 and that lease payments over the life of the lease 
will be $8,500. To meet the full payout requirement, you must recover 
$14,000 (your investment and the cost of financing) from the lease 
payments and your estimated residual value. Thus, in addition to the 
$8,500 in lease payments, you will be relying on $5,500 in residual 
value to meet the full payout requirement. You only have to guarantee 
the portion of the residual value on which you rely to meet the full 
payout requirement that exceeds 25% of the cost of the car, in this 
case, $3,000. Thus, the amount of the residual value that must be 
guaranteed will be $2,500 ($5,500-$3,000).
    For leases with estimated residual values in excess of 25% of 
original cost and subject to the guarantee requirement, two commenters 
were uncertain whether an FCU may assume the first dollars of residual 
risk or must guarantee the first dollars. These commenters request 
clarification.
    Neither the proposed rule nor the IRPS require that FCUs guarantee 
the first dollars of residual risk. Conversely, neither the rule nor 
the IRPS require that FCUs assume the first dollar of residual risk. 
FCUs are free to guarantee or assume the first dollars of residual risk 
as they deem appropriate. The Board is aware that insurers offer 
residual value policies with deductibles that place the first dollars 
of risk on the FCU. Such policies are an acceptable form of guarantee.
    The Board also notes that residual value insurance policies offer 
different payout formulae. For example, one form

[[Page 34584]]

of insurance pays the difference between the estimated residual value 
and the actual sales price of the property at the time of disposition. 
Another, more common form pays the difference between the estimated 
residual value and the average price being obtained for the given type 
of property at the time of disposition. Either of these payout 
formulae, with appropriate deductibles, is permissible for FCUs. 
However, if the FCU elects to purchase residual insurance that relies 
on average sale prices rather than the specific sale proceeds from the 
property at lease end, the FCU should ensure the terms of insurance are 
reasonable in relation to the method the FCU uses to dispose of the 
leased property. For example, if the FCU expects to dispose of leased 
vehicles at wholesale auction, it should use residual insurance that 
pays based on wholesale prices. Likewise, if the FCU expects to get 
most of its leased vehicles back in ``average'' condition, it should 
look for insurance tied to that condition.
    Seven commenters object to language in the preamble to the second 
NPRM on the financing of certain costs associated with the lease. The 
preamble states that the financing of mechanical breakdown protection, 
credit life and disability premiums, and license and registration fees 
raised safety and soundness concerns and these services should not be 
financed. The preamble cites a specific concern that an FCU will have 
little or no value in the collateral to secure the financing of the 
additional costs. The commenters generally recognized the problem with 
undercollateralization but do not believe a blanket prohibition on the 
financing of particular items was the best response. As one commenter 
put it, ``the problem of undercollateralization is best determined by 
how much is financed relative to the collateral, not by what expenses 
are financed.'' Some commenters note that the current industry practice 
among banks and credit unions is to finance some or all of these costs 
in particular cases. Some commenters suggest that FCUs should adopt 
lease-to-value guidelines similar to the loan-to-value guidelines used 
in lending programs, such as a maximum lease investment (or loan 
investment) of 110% of the vehicle's MSRP.
    The Board remains concerned that FCUs not overextend themselves but 
recognizes that a blanket prohibition on the financing of certain 
enumerated services is not the best approach to this issue. Instead, 
the Board recommends that FCUs take appropriate measures to ensure that 
their leases are properly collateralized and their leasing programs 
remain the functional equivalent of secured lending.

Section 714.5--What is Required if You Rely on an Estimated Residual 
Value Greater than 25% of the Original Cost of the Leased Property?

    Proposed Sec. 714.5 provided that an estimated residual value 
greater than 25% of the original cost of the leased property may be 
used if a financially capable party guarantees the amount above 25% of 
the original cost of the property. If the guarantor is an insurance 
company, the guarantor must have an A.M. Best rating of at least a B+ 
or the equivalent from another major rating company. The FCU must have 
financial documentation on hand demonstrating that the guarantor has 
the resources to meet the guarantee.
    Two commenters object to the establishment of a minimum rating for 
insurance companies. One of these commenters cites state regulation of 
insurance companies as sufficient to establish any particular company's 
soundness. A third commenter agreed with the concept of a minimum 
rating but thought it should be tougher than B+, such as a minimum 
``A'' or ``AA'' rating.
    The NCUA Board believes that establishing a minimum rating standard 
ensures that an insurance company guarantor will have the resources to 
meet the guarantee. A Best's rating of B+ is the lowest rating that is 
considered by Best to be ``secure,'' while any rating lower than a B+ 
is considered to be ``vulnerable.'' FCUs that satisfy the guarantee 
requirement through residual insurance are dependent on the insurance 
company's ability to pay residual claims when the leases end, often 
years into the future. The Board believes that FCUs should not use 
insurers who are identifiable as financially vulnerable.
    The requirement for a residual insurer to maintain a B+ rating also 
makes it easier for an FCU using an insurance company to satisfy the 
financial documentation requirement of Sec. 714.5. An FCU that 
maintains a recent report indicating that their residual insurer is 
rated B+ or better would meet the minimum documentation requirements. 
If the FCU desires to use the Internet, an up-to-date rating can be 
obtained at any time both cheaply and quickly.
    One commenter, citing IRPS 83-3 and current OCC rules, requests 
that Sec. 714.5 be amended to specifically exclude an affiliate of the 
FCU from acting as residual value guarantor. The Board notes that 
credit union service organizations (CUSOs) have specified, limited 
powers. 12 CFR part 712. Although CUSOs may engage in insurance 
brokerage or agency activities, they have no authority to assume 
insurable risks, such as residual value risk, for FCUs or other 
entities. 12 U.S.C. 1757(7); 12 CFR 712.5, 712.6; 51 FR 10353, 10357 
(March 26, 1986). The Board does not believe a modification to 
Sec. 714.5 is necessary.

Section 714.6--Are You Required to Retain Salvage Powers Over the 
Leased Property?

    Proposed Sec. 714.6 states that an FCU must retain salvage powers 
over the leased property. NCUA received no comments on this section, 
and it remains unchanged.

Section 714.7--What are the Insurance Requirements Applicable to 
Leasing?

    Proposed Sec. 714.7 provides that the FCU must maintain a 
contingent liability insurance policy with an endorsement for leasing 
or be named as the co-insured. The insurance company must have a rating 
of at least B+. The lessee must carry the normal liability and 
collateral protection insurance on the leased property, and the FCU 
must be named as an additional insured on the liability insurance 
policy and as the loss payee on the collateral protection insurance 
policy.
    Two commenters suggest that the phrase ``collateral protection 
insurance'' be replaced with ``physical damage'' or ``property 
insurance'' to more accurately reflect the type of insurance a lessee 
would purchase. The Board concurs with these commenters. The Board 
replaced the phrase ``collateral protection insurance'' with ``property 
insurance,'' which would include protection from physical damage, loss, 
or theft.

Section 714.8--What Rate of Interest May be Charged Under a Lease?

    Proposed Sec. 714.8 stated that the interest rate provisions of the 
NCUA lending rule are not applicable to lease transactions. Proposed 
Sec. 714.8 also exempted lease transactions from the NCUA lending rules 
on early payment. NCUA received no comments on this section, and it 
remains unchanged in the final version.

Section 714.9--When Engaged in Indirect Leasing, Must You Comply With 
the Purchase of Eligible Obligation Rules Set Forth in Sec. 701.23 of 
This Chapter?

    Proposed Sec. 714.9 provided that indirect leasing arrangements are 
not subject to the purchase of eligible obligation rules set forth in 
Sec. 701.23 if the lease complies with the FCU's

[[Page 34585]]

leasing polices and the FCU receives a full assignment of the lease no 
more than five business days after it is signed by the member and the 
leasing company.
    Two commenters object to the five-business-day requirement. One 
commenter believes the time required to transfer paper in indirect 
lending is similar to that required in indirect leasing and states that 
many retail installment contracts are not received within five days. 
This commenter recommends changing the five-business-day requirement to 
thirty business days. The other commenter states that the five-day 
language does not mirror the ``very soon'' language employed in the 
eligible obligations rule and that the difference may cause confusion. 
The eligible obligations rule has a provision specifying which indirect 
lending and indirect leasing obligations will be classified as loans 
and not as eligible obligations for purposes of the aggregate 5% 
limitation imposed on eligible obligations. 12 CFR 701.23(b)(3)(iv). 
One of the specified criteria for excluding indirect leasing 
arrangements from this 5% limitation is that the ``lease contract [be] 
assigned to the federal credit union very soon after it is signed.'' 
The latter commenter prefers that the ``very soon'' language of the 
eligible obligations rule be used in Sec. 714.9, the corresponding 
provision of the leasing rule. For consistency between the leasing rule 
and the eligible obligations rule and to maintain flexibility, the 
Board has replaced the language of the proposed Sec. 714.9 with a 
direct reference to Sec. 701.23(b)(3)(iv) including a restatement of 
its requirements.

Section 714.10--What Other Laws Must You Comply With When Engaged in 
Leasing?

    Proposed Sec. 714.10 set forth the additional laws with which an 
FCU must comply when engaged in leasing. One commenter notes that 
national bank and federal thrift leasing activities are subject to 
lending limits and recommends that our regulatory limits on loans to 
one borrower and loans to officials limitations be incorporated into 
the final leasing regulation. The Board notes that the proposed 
Sec. 714.10 already required FCUs engaged in leasing to comply with the 
greater part of the NCUA lending rule, Sec. 701.21, including the 
lending limits found at Secs. 701.21(c)(5) and (d). Accordingly, no 
change to Sec. 714.10 was made in the final rule.

E. Other Comments

    Two commenters ask that we address the risks of balloon lending in 
the leasing regulation. Assured-value balloon loans, or ``lease-look-
alike'' loans, allow the borrower to return the financed property at 
the end of the loan term in lieu of making the remaining balloon 
payment. The commenters argue that these loans carry residual risks for 
FCUs very similar to those in traditional closed-end leasing and should 
be regulated similarly.
    As was discussed in the preamble to the second NPRM, the primary 
distinction between a loan and a lease is who owns the underlying 
property. In a loan, the borrower owns the property and the lender is a 
lienholder. In a lease, the borrower-lessee has no ownership or 
lienhold interest in the property. Accordingly, it is the NCUA Board's 
position that programs, which involve loans and not leases, are 
significantly different from leasing arrangements, and should not be 
addressed in a leasing regulation.

F. Regulatory Procedures

Paperwork Reduction Act

    The NCUA Board determined that the requirement in Sec. 714.5 that 
an FCU must obtain or have on file statistics documenting that a 
guarantor has the resources to meet an estimated residual value 
guarantee constitutes a collection of information under the Paperwork 
Reduction Act. Both NPRMs contained a description of the requirement 
and an estimate of the associated workload. No comments were received 
on the estimated workload. OMB assigned control number 3133-0151 to 
this collection. 12 CFR part 795.

Regulatory Flexibility Act

    The NCUA Board certifies that the proposed regulation will not have 
a significant economic impact on a substantial number of small credit 
unions. Small credit unions are defined by NCUA, pursuant to its 
authority to define ``small organizations,'' as those credit unions 
with assets of $1 million or less. 5 U.S.C. 601(4), (6); NCUA IRPS 81-
4, 46 FR 29248 (1981); NCUA IRPS 87-2, 12 CFR 791.8(a). As of December 
31, 1999, there were 1,069 FCUs that met the small organization 
standard. Of these 1,069 FCUs, only seven report any leasing activity, 
with a total of only 66 leases amongst these credit unions. 
Accordingly, a regulatory flexibility analysis is not required.

Executive Order 13132

    Executive Order 13132, Federalism, dated August 4, 1999, prescribes 
certain requirements for executive branch policies ``that have 
federalism implications.'' Policies that have federalism implications 
include any regulations that have substantial direct effects on the 
States, on the relationship between the national government and the 
States, or on the distribution of power and responsibilities among the 
various levels of government. Independent regulatory agencies, such as 
NCUA, are not required to follow EO 13132 but are encouraged to do so, 
and NCUA voluntarily complies with EO 13132. The final leasing rule, 
however, will only apply to federally-chartered credit unions. The rule 
has no substantial direct effects on States or on the relationship or 
distribution of power and responsibility between the national 
government and the States. NCUA has determined that this rule does not 
constitute a policy that has federalism implications for purposes of 
the executive order.

Assessment of Federal Regulations and Policies on Families

    NCUA has determined that this rule will not affect family well-
being within the meaning of Section 654 of the Treasury and General 
Government Appropriations Act, 1999, Pub. L. No. 105-277, 112 Stat. 
2681 (1998).

Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996 
(Pub. L. No. 104-21) provides generally for congressional review of 
agency rules. A reporting requirement 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 reviewed this rule and has determined that for purposes 
of the Small Business Regulatory Enforcement Fairness Act of 1996 it is 
not a major rule.

List of Subjects in 12 CFR Part 714

    Credit unions, Leasing.

    By the National Credit Union Administration Board on May 24, 
2000.
Becky Baker,
Secretary to the Board.

    For the reasons set forth above, NCUA adds 12 CFR part 714 to read 
as follows:

PART 714--LEASING

Sec.
714.1   What does this part cover?
714.2   What are the permissible leasing arrangements?
714.3   Must you own the leased property in an indirect leasing 
arrangement?

[[Page 34586]]

714.4   What are the lease requirements?
714.5   What is required if you rely on an estimated residual value 
greater than 25% of the original cost of the leased property?
714.6   Are you required to retain salvage powers over the leased 
property?
714.7   What are the insurance requirements applicable to leasing?
714.8   Are the early payment provisions, or interest rate 
provisions, applicable in leasing arrangements?
714.9   Are indirect leasing arrangements subject to the purchase of 
eligible obligation limit set forth in Sec. 701.23 of this chapter?
714.10   What other laws must you comply with when engaged in 
leasing?

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


Sec. 714.1  What does this part cover?

    This part covers the standards and requirements that you, a federal 
credit union, must follow when engaged in the leasing of personal 
property.


Sec. 714.2  What are the permissible leasing arrangements?

    (a) You may engage in direct leasing. In direct leasing, you 
purchase personal property from a vendor, becoming the owner of the 
property at the request of your member, and then lease the property to 
that member.
    (b) You may engage in indirect leasing. In indirect leasing, a 
third party leases property to your member and you then purchase that 
lease from the third party for the purpose of leasing the property to 
your member. You do not have to purchase the leased property if you 
comply with the requirements of Sec. 714.3.
    (c) You may engage in open-end leasing. In an open-end lease, your 
member assumes the risk and responsibility for any difference in the 
estimated residual value and the actual value of the property at lease 
end.
    (d) You may engage in closed-end leasing. In a closed-end lease, 
you assume the risk and responsibility for any difference in the 
estimated residual value and the actual value of the property at lease 
end. However, your member is always responsible for any excess wear and 
tear and excess mileage charges as established under the lease.


Sec. 714.3  Must you own the leased property in an indirect leasing 
arrangement?

    You do not have to own the leased property in an indirect leasing 
arrangement if:
    (a) You obtain a full assignment of the lease. A full assignment is 
the assignment of all the rights, interests, obligations, and title in 
a lease to you, that is, you become the owner of the lease;
    (b) You are named as the sole lienholder of the leased property;
    (c) You receive a security agreement, signed by the leasing 
company, granting you a sole lien in the leased property and the right 
to take possession and dispose of the leased property in the event of a 
default by the lessee, a default in the leasing company's obligations 
to you, or a material adverse change in the leasing company's financial 
condition; and
    (d) You take all necessary steps to record and perfect your 
security interest in the leased property. Your state's Commercial Code 
may treat the automobiles as inventory, and require a filing with the 
Secretary of State.


Sec. 714.4  What are the lease requirements?

    (a) Your lease must be a net lease. In a net lease, your member 
assumes all the burdens of ownership including maintenance and repair, 
licensing and registration, taxes, and insurance;
    (b) Your lease must be a full payout lease. In a full payout lease, 
you must reasonably expect to recoup your entire investment in the 
leased property, plus the estimated cost of financing, from the 
lessee's payments and the estimated residual value of the leased 
property at the expiration of the lease term; and
    (c) The amount of the estimated residual value you rely upon to 
satisfy the full payout lease requirement may not exceed 25% of the 
original cost of the leased property unless the amount above 25% is 
guaranteed. Estimated residual value is the projected value of the 
leased property at lease end. Estimated residual value must be 
reasonable in light of the nature of the leased property and all 
circumstances relevant to the leasing arrangement.


Sec. 714.5  What is required if you rely on an estimated residual value 
greater than 25% of the original cost of the leased property?

    If the amount of the estimated residual value you rely upon to 
satisfy the full payout lease requirement of Sec. 714.4(b) exceeds 25% 
of the original cost of the leased property, a financially capable 
party must guarantee the excess. The guarantor may be the manufacturer. 
The guarantor may also be an insurance company with an A.M. Best rating 
of at least a B+, or with at least the equivalent of an A.M. Best B+ 
rating from another major rating company. You must obtain or have on 
file financial documentation demonstrating that the guarantor has the 
resources to meet the guarantee.


Sec. 714.6  Are you required to retain salvage powers over the leased 
property?

    You must retain salvage powers over the leased property. Salvage 
powers protect you from a loss and provide you with the power to take 
action if there is an unanticipated change in conditions that threatens 
your financial position by significantly increasing your exposure to 
risk. Salvage powers allow you:
    (a) As the owner and lessor, to take reasonable and appropriate 
action to salvage or protect the value of the property or your 
interests arising under the lease; or
    (b) As the assignee of a lease, to become the owner and lessor of 
the leased property pursuant to your contractual rights, or take any 
reasonable and appropriate action to salvage or protect the value of 
the property or your interests arising under the lease.


Sec. 714.7  What are the insurance requirements applicable to leasing?

    (a) You must maintain a contingent liability insurance policy with 
an endorsement for leasing or be named as the co-insured if you do not 
own the leased property. Contingent liability insurance protects you 
should you be sued as the owner of the leased property. You must use an 
insurance company with a nationally recognized industry rating of at 
least a B+.
    (b) Your member must carry the normal liability and property 
insurance on the leased property. You must be named as an additional 
insured on the liability insurance policy and as the loss payee on the 
property insurance policy.


Sec. 714.8  Are the early payment provisions, or interest rate 
provisions, applicable in leasing arrangements?

    You are not subject to the early payment provisions set forth in 
Sec. 701.21(c)(6) of this chapter. You are also not subject to the 
interest rate provisions in Sec. 701.21(c)(7).


Sec. 714.9  Are indirect leasing arrangements subject to the purchase 
of eligible obligation limit set forth in Sec. 701.23 of this chapter?

    Your indirect leasing arrangements are not subject to the eligible 
obligation limit if they satisfy the provisions of 
Sec. 701.23(b)(3)(iv) that require that you make the final underwriting 
decision and that the lease contract is assigned to you very soon after 
it is signed by the member and the dealer or leasing company.


Sec. 714.10  What other laws must you comply with when engaged in 
leasing?

    You must comply with the Consumer Leasing Act, 15 U.S.C. 1667-67f, 
and its implementing regulation, Regulation M, 12 CFR part 213. You 
must comply with state laws on consumer leasing, but only to the extent 
that the state leasing laws are consistent with the Consumer

[[Page 34587]]

Leasing Act, 15 U.S.C. 1667e, or provide the member with greater 
protections or benefits than the Consumer Leasing Act. You are also 
subject to the lending rules set forth in Sec. 701.21 of this chapter, 
except as provided in Sec. 714.8 and Sec. 714.9 of this part. The 
lending rules in Sec. 701.21 address the preemption of other state and 
federal laws that impact on credit transactions.

[FR Doc. 00-13509 Filed 5-30-00; 8:45 am]
BILLING CODE 7535-01-U