[Federal Register Volume 70, Number 244 (Wednesday, December 21, 2005)]
[Rules and Regulations]
[Pages 75719-75723]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-24285]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 723


Member Business Loans

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: NCUA is revising its member business loans (MBL) rule to 
clarify the minimum capital requirements a federally insured corporate 
credit union (corporate) must meet to make unsecured MBLs to members 
that are not credit unions or corporate credit union service 
organizations (corporate CUSOs). NCUA is also revising the definition 
of a construction or development loan (C&D loan) to include certain 
loans to borrowers who already own or have rights to property and the 
definition of net worth to be more consistent with its definition in 
the Federal Credit Union Act (Act) and NCUA's prompt corrective action 
regulation (PCA). Finally, the rule clarifies that a state may rescind 
a state MBL rule without NCUA's approval.

DATES: This rule is effective January 20, 2006.

FOR FURTHER INFORMATION CONTACT: Frank Kressman, Staff Attorney, at the 
above address, or telephone: (703) 518-6540.

SUPPLEMENTARY INFORMATION:

A. Background

    In addition to making regulatory changes as the need arises, NCUA 
also reviews all of its existing regulations every three years. This 
review is conducted on a rolling basis so that a third of the 
regulations are reviewed each year. This helps NCUA update its 
regulations to address current regulatory concerns. NCUA provides 
notice to the public of those regulations under review so the public 
has an opportunity to comment. As a result of this process and comments 
received on a previous MBL rulemaking, NCUA issued proposed revisions 
to the MBL rule with a request for comments in April 2005. 70 FR 20487 
(April 20, 2005).

B. Corporate Credit Union Capital Requirements

    MBLs made by corporates to member credit unions and corporate CUSOs 
are exempt from the MBL rule. 12 CFR 704.7(e)(1), (2); 12 CFR part 723. 
MBLs made by corporates to other members, however, are subject to the 
MBL rule. Accordingly, when the MBL rule applies, a corporate must 
comply with the rule's collateral and security requirements. 12 CFR 
723.7.
    For example, one of the conditions a credit union must meet to make 
unsecured MBLs is to be ``well capitalized as defined by Sec.  
702.102(a)(1)'' of the PCA rule. 12 CFR 723.7(c)(1); 12 CFR part 702. 
The PCA rule, however, does not apply to corporates. 12 U.S.C. 
1790d(m); 12 CFR 702.1(c). Rather, Corporate CUs generally must 
maintain a minimum capital ratio of four percent or a different minimum 
capital ratio under special circumstances. 12 CFR 704.3(d), (e). 
Accordingly, NCUA proposed to amend the MBL rule's capital requirements 
for unsecured MBLs to accommodate the differences between the general 
capital requirements for natural person credit unions and those for 
corporates. The proposed amendment is adopted in the final rule without 
change.

C. Definition of Net Worth

    The definition of net worth in the MBL rule is slightly different 
than in the Act and PCA. 12 U.S.C. 1790d(o)(2); 12 CFR 702.2(f). To 
avoid confusion, NCUA proposed to revise the definition of net worth in 
the MBL rule to be the same as in PCA. The PCA rule's definition of net 
worth expands slightly the definition in the Act. The PCA and Act 
definitions both state that secondary capital accounts are counted in 
the net worth of low income credit unions. The proposed amendment is 
adopted in the final rule without change.

D. Definition of Construction or Development Loan

    C&D loans are subject to more stringent regulatory limitations than 
other MBLs because C&D loans pose a significantly greater risk than 
other less speculative MBLs. Typically, NCUA has cited examples of C&D 
loans as including loans to finance development of: (1) Residential 
real estate projects, such as condominiums and single and multi-family 
housing; and (2) commercial real estate, such as hotels, strip malls, 
and office buildings. 56 FR 15053 (April 15, 1991). This type of 
lending is generally characterized by reliance on the anticipated 
future sale of the project or future cash flow of an uncompleted 
project to repay the loan. Id. Additionally, this type of lending is 
premised on the project being completed on time, within budget and a 
successful business enterprise. 56 FR 2723 (January 24, 1991). None of 
these conditions are assured and changing markets further complicate 
the underwriting analysis.\1\ As a result, C&D loans are more 
speculative in nature than other MBLs.
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    \1\ While the MBL rule contains collateral and security 
requirements and limits of various sorts, it does not require a 
credit union to employ specific underwriting methods. Rather, a 
credit union should establish an underwriting process that is 
tailored to the types of loans it makes, within the bounds of safety 
and soundness, and in conformity with industry best practices.
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    The MBL rule's current definition of C&D loans is limited to 
financing arrangements for acquiring property or rights to property 
with the intent to convert it to an income producing property. This 
definition, by its terms, would exclude a loan if a borrower already 
owns or has rights to the property.
    In the proposal, NCUA stated it believed an appropriate test for 
determining if a loan is a C&D loan is whether the loan will be used to 
renovate or otherwise develop a property for an income producing 
purpose. NCUA also stated it did not believe loans for these purposes, 
the essential nature of which is related to construction or 
development, should be excluded from the definition of C&D

[[Page 75720]]

loan just because the borrower has already acquired the property or 
rights to it. NCUA proposed a revised definition of C&D loans to 
reflect this and still believes that MBLs to borrowers who have already 
acquired a property or right to property should not be excluded on that 
basis from the requirements applicable to C&D loans. NCUA recognizes, 
however, that the proposed definition and the test articulated for 
determining what is a C&D loan were too broadly stated, especially as 
related to renovations. NCUA understands that the proposed definition 
could have been read more broadly than intended.
    Accordingly, NCUA is adjusting the definition of C&D loans as 
discussed in the summary of comments section below to clarify NCUA's 
intent to broaden the definition to capture only true C&D loans to 
borrowers who have already acquired the subject property or rights to 
it.

E. Government Guaranteed Loan Programs

    In October 2004, NCUA amended the MBL rule to permit credit unions 
to make Small Business Administration (SBA) guaranteed loans under 
SBA's less restrictive lending requirements instead of under the more 
restrictive MBL rule. 69 FR 62563 (October 27, 2004). Before issuing 
the amendment, NCUA reviewed the SBA's loan programs in which credit 
unions can participate and determined they provide reasonable criteria 
for credit union participation and compliance within the bounds of 
safety and soundness.
    Additionally, NCUA determined these SBA programs are ideally suited 
to the mission of many credit unions to satisfy their members' business 
loans needs.
    When NCUA solicited public comment on the SBA amendment, a number 
of commenters suggested expanding the scope of the amendment to include 
other government guaranteed loan programs. Some commenters specifically 
named the Farm Service Agency and United States Department of 
Agriculture (USDA) loan programs. Others suggested all government 
guaranteed loan programs be included.
    NCUA is willing to consider other government guaranteed loan 
programs as it becomes apparent there is demand for the program among 
credit unions. Since October 2004, NCUA has learned there may be such 
demand and solicited comment in the proposal on how best to broaden the 
MBL rule to enable credit unions to participate more fully in other 
government guaranteed loan programs.
    NCUA noted its interest in receiving comments on whether to broaden 
the MBL rule in this regard, and, if so, if it is better to permit only 
specifically identified programs on a case-by-case basis or to permit 
all such programs. The comments received are discussed in the summary 
of comments section below.

F. Summary of Comments

    Although NCUA received 134 comment letters on the proposal, 100 
came from one particular federal credit union (FCU), its members and 
employees, and 4 came from a state credit union. When multiple letters 
are received from the same party with the same comment, NCUA regards 
them as one comment. Accordingly, NCUA summarizes total comments 
received as 32: 11 from FCUs, 5 from state credit unions, 2 from 
corporates, 2 from credit union service organizations, 10 from credit 
union trade associations, 1 from a professional association of state 
and territorial regulatory agencies, and 1 from a banking trade 
association.
    Sixteen commenters addressed the proposal to clarify the minimum 
capital requirements for corporates, and eighteen commenters addressed 
the proposal to revise the definition of ``net worth.'' All voiced 
their support for those proposed amendments and they will become part 
of the MBL rule.
    Seventeen commenters responded to NCUA's request for comments on 
how best to amend the MBL rule to enable credit unions to participate 
more fully in government guaranteed loan programs beyond the SBA's 
programs. All supported expanding the MBL rule to include all 
government guarantee programs, although with little discussion about 
safety and soundness issues other than generally contending government 
guaranteed loan programs should be presumed safe and sound. Some 
commenters stated this expansion also should include programs of 
government sponsored enterprises and requested additional relief from 
various aspects of the MBL rule not raised in this rulemaking. The 
banking trade association stated that liberalizing the collateral 
requirements for government guaranteed loan programs would conflict 
with what it believes is Congress' intent regarding commercial lending 
limits for credit unions.
    NCUA remains committed to enabling credit unions to participate 
more fully in more government guaranteed loan programs. To this end, 
NCUA has entered into a memorandum of understanding with the USDA to 
identify and promote appropriate USDA Rural Development programs to 
credit unions NCUA insures and regulates and has specifically 
acknowledged at least two programs permissible for FCUs. NCUA has also 
entered into a similar memorandum of cooperation with the Export-Import 
Bank of the United States. Safety and soundness concerns, however, 
dictate that NCUA move forward carefully. There are significant 
differences in the terms of various government guarantee programs, some 
with complex participation and guarantee requirements that could be 
problematic for inexperienced credit unions. Accordingly, although NCUA 
is not ready to expand the universe of permissible programs to include 
all government programs in this rulemaking, NCUA will take the comments 
received into account as it considers future amendments to the MBL rule 
in this regard.
    Thirteen commenters supported the proposed revision to the 
definition of C&D loans; 16 commenters opposed it. Many of those 
opposed supported a change in the definition for the purposes NCUA 
stated in the proposal but did not believe the language of the proposed 
definition achieved that purpose.
    The most frequent concern about the proposed definition was that it 
is too broad and could be read to include significantly more MBLs as 
C&D loans than NCUA intends. Many commenters believed the definition 
could be read to include loans for routine maintenance, upkeep, and 
minor improvements for an income producing property.
    NCUA is revising the proposed definition of a C&D loan to address 
the concerns raised by these commenters. NCUA's intent is to broaden 
the scope of the definition of C&D loans beyond those exclusively 
related to financing to acquire property for C&D purposes to include 
loans for C&D purposes to borrowers that already own the property. 
NCUA's intent is not to capture less risky MBLs in a definition 
intended to describe more risky and more speculative loans.
    Even with a revised definition, the specific facts and context of a 
particular loan will need to be analyzed to determine if it fits the 
definition of a C&D loan. If a member borrows money to repair a roof on 
a barn on an existing farming operation, this is an MBL but is not a 
C&D loan. A C&D loan does not include a loan for routine maintenance of 
a borrower's existing business or a loan to enhance or expand a 
borrower's existing business unless those renovations convert the 
property to a different use, which NCUA considers highly speculative, 
or are so major as to be the equivalent of converting the use of the 
property. For example, a loan to expand the parking lot of a small 
strip

[[Page 75721]]

shopping center would not be a C&D loan, but a loan to renovate the 
small strip shopping center into a mega-mall would be a C&D loan as it 
would be viewed as a major renovation that converts the use of the 
property, and, therefore, is highly speculative. NCUA does not want to 
establish specific dollar or percentage of property value limits to 
determine when a renovation is so major as to be the equivalent of 
converting the use of the property. NCUA believes it is better and 
provides more flexibility to analyze this based on the unique facts 
surrounding a particular loan.
    The Office of General Counsel has previously addressed the issue of 
renovation of commercial property and concluded that a loan for 
renovation of a commercial property already owned by the borrowers 
would be considered a C&D loan in an opinion letter issued two years 
ago. OGC Opinion Letter 03-0430 (September 25, 2003) (referencing OGC 
Opinion Letter 00-0809 (September 21, 2000)). Letter 03-0430, while 
based on a limited factual example, contemplated renovation to 
buildings that were part of a warehouse and office complex and 
refinancing of an existing mortgage. As noted in Letter 00-0809, the 
determination of whether a particular loan is a C&D loan may depend on 
the particular facts surrounding the granting of the loan. This final 
rule clarifies that a loan to finance a renovation will be subject to 
the additional requirements of a C&D loan if it is a major renovation. 
As discussed above, this clarification means that MBLs that finance 
maintenance or repair of a property without changing the use of the 
commercial property will not be considered C&D loans. Of course, even 
if a loan is deemed to be a C&D loan, a credit union may apply for a 
waiver of the aggregate limit for C&D loans and minimum borrower equity 
requirement.
    Loans to convert a property to a different use are C&D loans. For 
example, a loan to convert a movie theater into a restaurant is a C&D 
loan. A loan to convert a large Victorian home used for residential 
purposes into a six-room inn also would be a C&D loan. In both 
instances, the loans are for the purpose of converting the use of the 
properties, which is speculative. By contrast, a loan to repair the 
roof or replace the carpet and wallpaper of an operating inn would not 
be a C&D loan as it neither converts the use of the property, nor is so 
major a renovation to be considered the equivalent of converting the 
use of the property. Another example is a hotel with a fair market 
value of $10 million that wants to borrow $1 million to build and 
outfit an exercise facility in the hotel to enhance and expand its 
business. While the loan amount represents a significant percentage of 
the fair market value of the property, 10% in this example, this is not 
a construction or development loan. It is a member business loan to 
improve or renovate an existing incoming producing property, but it is 
not so major a renovation as to be considered the equivalent of 
converting the use of the property. Alternatively, if the same hotel 
with a fair market value of $10 million wanted to borrow $4 million or 
$5 million to build a luxury health spa on the hotel grounds, it should 
be considered a construction and development loan. The loan amount is 
40% to 50% of the fair market value of the property and, even if the 
use of the property has not been converted, the expansion and 
renovation are so major as to be considered the equivalent of 
converting the use of the property, which is speculative.
    NCUA believes that loans in the range of 40%-50% of the fair market 
value of a property or business would, in most cases, be considered 
construction or development loans and worthy of additional regulatory 
scrutiny. NCUA cautions that even loans representing a smaller 
percentage of the fair market value of an existing property could be 
considered construction or development loans if they do, in fact, 
involve large dollar amounts, new construction, or new uses for the 
property.
    The NCUA Board believes it should not attempt to establish by 
regulation a specific dollar amount or a fixed percentage of a 
property's fair market value as a threshold to determine when a 
renovation is so major as to be considered the equivalent of converting 
the use of the property or a major expansion of its current use. 
Rather, NCUA believes, given the nature of construction and development 
loans, that credit unions must analyze the facts and circumstances of a 
particular loan keeping in mind the regulatory definition. To assist 
credit unions and others that refer to the regulation, examples as 
discussed in the preamble are being incorporated into the final rule 
itself as guidance. While the NCUA Board wants to provide flexibility 
in its regulation, it advises credit unions that they must keep in mind 
that construction and development loans are, by their nature, more 
speculative and present greater risks than other business loans. 
Accordingly, they warrant greater regulatory scrutiny and limitations.
    In refining the definition of a C&D loan in the final rule, NCUA 
has considered if it would be helpful to look to a borrower's 
accounting treatment of expenditures under generally accepted 
accounting principles (GAAP), either as part of the definition of a C&D 
loan in the regulation or as guidance. NCUA has decided not to link the 
classification of an MBL as a C&D loan to a borrower's accounting of 
expenditures as expenses or capital improvements requiring 
depreciation. Whether a credit union classifies an MBL as a C&D loan is 
to be determined on the basis of the provisions in Part 723, without 
regard to GAAP's requirements applicable to a borrower's accounting 
treatment of its expenditures.

G. Technical Correction and Clarification

    As noted above, NCUA revised the definition of net worth in Sec.  
723.21, the definitions sections of the MBL rule, to be more consistent 
with the way that term is defined in the Act and PCA. That term is also 
used in Sec.  723.16 in a way that is not identical to the revised 
definition in Sec.  723.21. Accordingly, NCUA is revising Sec.  723.16 
to eliminate that inconsistency.
    NCUA has long taken the position that a state, which has a state 
MBL rule in place previously approved by NCUA for use for federally-
insured state chartered credit unions (FISCUs), may rescind that state 
MBL rule without NCUA approval. The effect of that rescission is that 
FISCUs subject to the previous state MBL rule would be subject to 
NCUA's MBL rule. NCUA believes it would be helpful to make this 
clarification in the MBL rule as questions have arisen from time to 
time. To ensure MBL oversight, a state supervisory agency should notify 
NCUA if it decides to rescind its state MBL rule and the rule also 
includes a notice provision.

Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact a rule may have on a 
substantial number of small credit unions (those under ten million 
dollars in assets). This rule clarifies capital requirements for making 
unsecured MBLs, revises definitions for consistency and practical 
application and addresses comments on expanding the MBL rule regarding 
government guaranteed loan programs, without imposing any additional 
regulatory burden. This rule would not have a significant economic 
impact on a substantial number of small credit

[[Page 75722]]

unions, and, therefore, a regulatory flexibility analysis is not 
required.

Paperwork Reduction Act

    NCUA has determined that the final rule would not increase 
paperwork requirements under the Paperwork Reduction Act of 1995 and 
regulations of the Office of Management and Budget.

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their actions on state and local interests. In 
adherence to fundamental federalism principles, NCUA, an independent 
regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies 
with the executive order. This rule will not have substantial direct 
effects on the states, on the connection between the national 
government and the states, or on the distribution of power and 
responsibilities among the various levels of government. NCUA has 
determined that this rule does not constitute a policy that has 
federalism implications for purposes of the executive order.

The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families

    The NCUA has determined that this rule would not affect family 
well-being within the meaning of section 654 of the Treasury and 
General Government Appropriations Act, 1999, Pub. L. 105-277, 112 Stat. 
2681 (1998).

Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996 
(Pub. L. 104-121) 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 
Procedure Act. 5 U.S.C. 551. The Office of Management and Budget has 
determined that this rule is not a major rule for purposes of the Small 
Business Regulatory Enforcement Fairness Act of 1996.

List of Subjects in 12 CFR Part 723

    Credit, Credit unions, Reporting and recordkeeping requirements.

    By the National Credit Union Administration Board on December 
15, 2005.
Mary F. Rupp,
Secretary of the Board.

0
For the reasons stated above, NCUA amends 12 CFR part 723 as follows:

PART 723--MEMBER BUSINESS LOANS

0
1. The authority citation for part 723 continues to read as follows:

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


0
2. Revise Sec.  723.7(c)(1) to read as follows:


Sec.  723.7  What are the collateral and security requirements?

* * * * *
    (c) * * *
    (1) You are a natural person credit union that is well capitalized 
as defined by Sec.  702.102(a)(1) of this chapter or you are a 
corporate credit union that maintains a minimum capital ratio as 
required by Sec.  704.3(d) of this chapter or a different ratio as 
permitted under Sec.  704.3(e) of this chapter;
* * * * *
0
3. Revise Sec.  723.16, paragraph (a) to read as follows:


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

    (a) General. The aggregate limit on a credit union's net member 
business loan balances is the lesser of 1.75 times the credit union's 
net worth or 12.25% of the credit union's total assets. Loans that are 
exempt from the definition of member business loans are not counted for 
the purpose of the aggregate loan limit.
* * * * *

0
4. Revise Sec.  723.20 by adding new paragraph (c) to read as follows:


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

* * * * *
    (c) A state supervisory authority that administers a state member 
business loans rule, approved by NCUA under Sec. Sec.  723.20(a) and 
(b), may rescind its rule without NCUA approval. A state supervisory 
authority should notify NCUA if it anticipates rescinding its rule to 
foster regulatory continuity and cooperation.

0
5. Revise the definitions of ``Construction or development loan'' and 
``Net worth'' in Sec.  723.21 to read as follows:


Sec.  723.21  Definitions.

* * * * *
    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. Construction or development loan includes a financing 
arrangement for the major renovation or development of property already 
owned by the borrower that will convert the property to income 
producing property or convert the use of income producing property to a 
different use from its use before the major renovation or development 
or is a major expansion of its current use. Construction or development 
loan does not include loans to finance maintenance, repairs, or 
improvements to an existing income producing property that do not 
change its use. Examples to illustrate when a loan is or is not a 
construction or development loan follow.

    Example 1. If a member borrows money to repair a roof on a barn 
on an existing farming operation, this is a member business loan but 
is not a construction or development loan. A construction or 
development loan does not include a loan for routine maintenance of 
a borrower's existing business or a loan to enhance or expand a 
borrower's existing business unless those renovations convert the 
property to a different use or are so major as to be considered the 
equivalent of converting the use of the property.
    Example 2. A loan to convert a movie theater into a restaurant 
is a construction or development loan. A loan to convert a large 
Victorian home used for residential purposes into a six-room inn 
also would be a construction or development loan. In both instances, 
the loans are for the purpose of converting the use of the 
properties. By contrast, a loan to repair the roof or replace the 
carpet and wallpaper of an operating inn would not be a construction 
or development loan as it neither converts the use of the property, 
nor is so major a renovation to be considered the equivalent of 
converting the use of the property.
    Example 3. A loan to expand the parking lot of a small strip 
shopping center would not be a construction or development loan, but 
a loan to renovate the small strip shopping center into a mega-mall 
would be a construction or development loan as it would be viewed as 
a major renovation that converts the use of the property.
    Example 4. A hotel with a fair market value of $10 million 
borrows $1 million to build an exercise facility in the hotel to 
enhance the property. The loan amount is 10% of the fair market 
value of the property. This is not a construction or development 
loan. It is a member business loan to improve or renovate an 
existing incoming producing property, but it is not so major a 
renovation as to be considered the equivalent of converting the use 
of the property. In another scenario, a hotel with a fair market 
value of $10 million borrows $5 million to build a luxury health spa 
on the hotel grounds. The loan amount is 50% of the fair market 
value of the property. This is a construction or development loan, 
even if the use of the property has not been converted, as the 
renovation is so major as to be considered the equivalent of 
converting the use of the property.
* * * * *

[[Page 75723]]

    Net worth means the retained earnings balance of the credit union 
at quarter end as determined under generally accepted accounting 
principles. Retained earnings consists of undivided earnings, regular 
reserves, and any other appropriations designated by management or 
regulatory authorities. This means that only undivided earnings and 
appropriations of undivided earnings are included in net worth. For low 
income-designated credit unions, net worth also includes secondary 
capital accounts that are uninsured and subordinate to all other 
claims, including claims of creditors, shareholders and the NCUSIF. For 
any credit union, net worth does not include the allowance for loan and 
lease losses account.

[FR Doc. 05-24285 Filed 12-20-05; 8:45 am]
BILLING CODE 7535-01-P