[Federal Register Volume 70, Number 244 (Wednesday, December 21, 2005)]
[Proposed Rules]
[Pages 75753-75759]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-7584]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701 and 741


Third-Party Servicing of Indirect Vehicle Loans

AGENCY: National Credit Union Administration (NCUA).

ACTION: Notice of proposed rulemaking (NPR).

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SUMMARY: The NCUA is issuing a proposed rule to regulate purchases by 
federally insured credit unions of indirect vehicle loans serviced by 
third-parties. NCUA proposes to limit the aggregate amount of these 
loans serviced by any single third-party to a percentage of the credit 
union's net worth. The effect of the proposed rule would be to ensure 
that federally insured credit unions do not undertake undue risk with 
these purchases.

DATES: Comments must be received on or before February 21, 2006.

ADDRESSES: You may submit comments by any of the following methods 
(Please send comments by one method only):
     NCUA Web Site: http://www.ncua.gov/news/proposed_regs/proposed_regs.html. Follow the instructions for submitting comments.
     E-mail: Address to [email protected]. Include ``[Your 
name] Comments on Advance Notice of Proposed Rulemaking (Specialized 
Lending Activities)'' in the e-mail subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for e-mail.
     Mail: Address to Mary Rupp, Secretary of the Board, 
National Credit Union Administration, 1775 Duke Street, Alexandria, 
Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.

FOR FURTHER INFORMATION CONTACT: Paul Peterson, Staff Attorney, Office 
of General Counsel, at the above address or telephone (703) 518-6540, 
Matt Biliouris, Program Officer, Office of Examination and Insurance, 
at the above address or telephone (703) 518-6360, or Steve Sherrod, 
Division of Capital Markets Director, Office of Capital Markets and 
Planning, at the above address or telephone (703) 518-6620.

SUPPLEMENTARY INFORMATION:

A. Background

    Indirect lending involves credit union financing for the purchase 
of goods at the point-of-sale. The merchant, typically an automobile 
dealer, brings a potential member-borrower to the credit

[[Page 75754]]

union and also assists with underwriting. When done properly, indirect 
lending has certain advantages for credit unions, including possible 
growth in membership and lending volume. Still, because the dealer's 
primary interest is in facilitating a vehicle sale and not in careful 
underwriting, indirect lending poses particular risks to credit unions.
    Some vendors offer indirect lending programs in which the vendor 
manages the credit union's relationship with the automobile dealer and, 
through loan servicing conducted by the vendor or a related business 
entity, the credit union's relationship with the member. These vehicle 
lending programs, referred to in this preamble as ``indirect, 
outsourced programs,'' carry all the risks of indirect lending programs 
as well as additional risks.
    NCUA is concerned some credit unions may increase risk exposures in 
indirect, outsourced programs without first conducting adequate due 
diligence, implementing appropriate controls, and gaining experience 
with servicer performance. Some credit unions have realized weaker than 
expected earnings because of participation in these programs. 
Therefore, the Board has determined that regulatory concentration 
limits on indirect, outsourced programs are appropriate.
    The types of risk associated with these indirect, outsourced loan 
programs include: (1) Credit risk, (2) liquidity risk, (3) transaction 
risk, (4) compliance risk, and (5) reputation risk. A credit union 
should exercise caution and gain experience before significantly 
growing a portfolio of loans underwritten and serviced by a third 
party. A credit union's due diligence should include an initial review 
of each of these risks, as well as ongoing reviews.
    Credit risk. Both underwriting and post-underwriting factors 
generate potential credit risk. Credit loss experience may be worse if 
the indirect, outsourced loan program uses more permissive underwriting 
criteria than the credit union uses for its direct lending. Post-
underwriting, credit loss experience may be worse if the quality of a 
third-party's servicing is not as good as that of the credit union's 
own servicing. Credit unions should adopt appropriate metrics (e.g., 
performance standards) in their servicing agreements to ensure timely 
servicing and collection performance by the third-party servicer.
    Liquidity risk. A credit union's liquidity position may suffer if 
the credit union experiences a sudden increase in indirect, outsourced 
loans. Liquidity may also be impaired if an indirect, outsourced 
arrangement restricts the ability to transfer servicing by imposing a 
material cost for the transfer, including the loss of a material 
economic benefit, such as cancellation of an insurance policy. 
Additionally, loans contractually bound to a third-party servicer may 
have a more limited market than the market for loans sold with 
servicing released.
    Transaction risk. Transaction risk (also referred to as operating 
or fraud risk) may arise in indirect, outsourced programs because the 
credit union is relying to a significant extent on the third-party 
servicer's internal controls, information systems, employee integrity, 
and operating processes. A credit union's due diligence should include 
continuing review of each of these areas, as well as the financial 
condition of the servicer.
    Compliance risk. Compliance risk in lending programs may arise from 
violations of, or nonconformance with, consumer protection laws, such 
as the Truth-in-Lending Act and Fair Debt Collection Practices Act. To 
the extent a credit union has reduced control and supervision of a 
third-party servicer's collection activities, a credit union's 
compliance risk in an indirect, outsourced program may be greater than 
that of an in-house servicing program.
    Reputation risk. Reputation risk may result from a third-party 
servicer's compliance failures or transaction losses. Poor quality 
servicing, improper collection processes, and questionable or excessive 
fees assessed against the borrower by the servicer may also alienate 
members from the credit union and affect the ability of the credit 
union to maintain existing relationships or establish new ones.
    NCUA has discussed sound business practices related to this form of 
lending in a series of letters to credit unions going back several 
years. In November 2001, for example, NCUA published NCUA Letter to 
Credit Unions (LTCU) No. 01-CU-20, Due Diligence over Third Party 
Service Providers, providing minimum due diligence practices over 
third-party service providers In September 2004, the Board expressed 
its concern with specialized lending activities and the associated 
risks in NCUA LTCU No. 04-CU-13, Specialized Lending Activities. That 
letter discussed three, higher risk lending activities: subprime 
lending, indirect lending, and outsourced lending relationships, and 
included three examiner questionnaires so credit unions could see how 
examiners evaluate the risks in these activities. These two letters are 
available on NCUA's Web site at http://www.ncua.gov/letters/2001/01-CU-20.pdf and http://www.ncua.gov/letters/2004/04-CU-13.pdf, respectively. 
Members of the public without access to the internet may request copies 
of letters to credit unions and other NCUA publications by calling 
NCUA's publication line at (703) 518-6340.
    Since the summer of 2004, NCUA has also observed a significant 
increase in specialized lending activities, including the use of third 
parties to service indirect vehicle loans. NCUA began collecting 
indirect loan data from all credit unions beginning with the June 30, 
2004, Call Report. The portfolios of credit unions reporting indirect 
loans increased to $58 billion (at June 30, 2005) from $45 billion (at 
June 30, 2004), a 29 percent increase in one year.\1\ Based on 
supervision and insurance information, the growth in indirect, 
outsourced vehicle loan programs was even more rapid, and NCUA also 
detected increasing concentration levels at particular credit unions in 
these loans. Currently, NCUA estimates there are approximately twenty 
or more credit unions with more than 100 percent of their net worth 
invested in indirect, outsourced vehicle loans.
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    \1\ Based on anecdotal information, NCUA believes that the vast 
majority of these indirect loans are vehicle loans.
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    In June 2005, the NCUA Board issued Risk Alert 05-RISK-01 (the Risk 
Alert), Subject: Specialized Lending Activities--Third-Party Subprime 
Indirect Lending and Participations, available on NCUA's website at 
http://www.ncua.gov/letters/RiskAlert/2005/05-RISK-01.pdf. The Risk 
Alert discussed concerns related to subprime, indirect automobile loans 
underwritten or serviced by third parties. The Risk Alert further 
discussed due diligence practices and on-going control mechanisms 
appropriate for such programs.
    Despite these NCUA supervision and insurance initiatives, the Board 
remains concerned that some credit unions engaging in these programs 
still do not undertake the requisite due diligence to understand and 
protect themselves from the risks inherent in these programs. In fact, 
some credit unions with significant concentrations in indirect, 
outsourced loans have indicated to NCUA their desire to fund new loans 
even though they have not yet completed the due diligence described in 
NCUA issuances.

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B. Proposed Rule

1. General
    NCUA proposes a two-step, regulatory concentration limit for 
indirect, outsourced programs with a waiver provision for higher limits 
in appropriate cases. The Board believes the proposed rule is necessary 
to protect the National Credit Union Share Insurance Fund (NCUSIF) from 
the risks associated with this activity.
    For the first 30 months of a new relationship, Sec.  701.21(h)(1) 
limits a credit union's interest in indirect vehicle loans serviced by 
any single third party to 50 percent of the credit union's net worth. 
This permits a credit union to enter and gain experience with a new 
indirect, outsourced vendor program. After 30 months of experience with 
that third party's program, the proposed rule permits a credit union to 
increase its interests in that program to 100 percent of the credit 
union's net worth.
    The Board believes that limits of 50 percent and 100 percent are 
appropriate, assuming credit unions maintain an adequate due diligence 
program. As explained below, however, a credit union that can 
demonstrate appropriate initial and ongoing due diligence may apply for 
a waiver to obtain higher limits.
    In determining these concentration limits, the Board noted that 
indirect, outsourced programs typically require a credit union to give 
a third party servicer significant control over the loan assets. For 
example, the third-party generally makes all contacts with the member-
borrowers; determines when the loans are in default; determines the 
pace of and resource allocation to loan collection, vehicle 
repossession, and vehicle remarketing; and also controls all the cash 
flows.
    The indirect lending aspect of these programs creates additional 
loss of control for the credit union, as member-borrower information 
does not come directly to the credit union but instead is filtered 
through both the dealer and the vendor. In some of these programs, the 
third-party also controls the quality of the loan receivables because 
it dictates the underwriting criteria and processes the loan 
applications. In addition, some third-party vendors control the 
insurance coverage associated with these loans. The third-party may 
even assume some of the credit risk through reinsurance arrangements or 
stop-loss agreements. All these factors increase a credit union's 
reliance on the third-party to produce a positive return for the credit 
union. Some vendors have advertised these programs in the past by 
promoting them as ``turn-key'' and suggesting that credit unions need 
do very little in the way of due diligence.
    The control exercised by the third-party in indirect, outsourced 
programs is similar to the control exercised by an issuer of an asset 
backed security (ABS) collateralized by loan receivables. The 
originator of a pool of loan receivables (e.g., auto loans) sells the 
receivables into a bankruptcy-remote grantor trust or owner trust 
(i.e., the ABS issuer). The ABS issuer contracts with a servicer, 
usually affiliated with the seller (e.g., seller/servicer), to service 
the receivables, and determines what sort of credit enhancements or 
insurance will be necessary to support issuance of ABS. The ABS issuer 
also controls the cash flows. The Board believes the risks to a credit 
union from indirect, outsourced programs are similar to those posed by 
the purchase of an ABS investment. Accordingly, in determining 
appropriate concentration limits for indirect, outsourced vendor loan 
programs the Board examined established concentration limits for 
investment in ABS.
    Natural person federal credit unions are not authorized to invest 
in ABS, even highly rated ABS.\2\ 12 U.S.C. 1757. National banks may 
invest in ABS, but the Office of the Comptroller of the Currency (OCC) 
limits a bank's aggregate investments in ABS issued by any one issuer 
to 25 percent of capital and surplus.\3\ 12 CFR 1.3(f). For purposes of 
this limit, the OCC requires aggregation of ABS issued by obligors that 
are related directly or indirectly through common control. 12 CFR 
1.4(d)(i).
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    \2\ NCUA's corporate credit union rule, however, does permit 
corporate credit unions to invest in ABS. 12 CFR 704.5(c)(5). The 
corporate rule generally limits the aggregate of all investments, 
including ABS, issued by any single obligor to 50 percent of the 
corporate credit union's capital or $5 million, whichever is 
greater. 12 CFR 704.6(c).
    \3\ The capital and surplus of a national bank is roughly 
equivalent to the net worth of a natural person credit union. 
Compare 12 CFR 1.2(a) with 12 CFR 702.2(f) and the definition of the 
``net worth'' in proposed Sec.  701.21(h)(3)(iv).
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    The OCC established this 25 percent limit in 1996. Originally, the 
OCC proposed an even more restrictive 15 percent limit, but ultimately 
chose a 25 percent limit with the following explanation:

    The OCC believes the 25 percent of capital limit is a prudential 
limit that provides sufficient protection against undue risk 
concentrations. This limit parallels the 25 percent credit 
concentration benchmark in the Comptroller's Handbook for National 
Bank Examiners. The Handbook identifies credit concentrations in 
excess of 25 percent of a bank's capital as raising potential safety 
and soundness concerns. For this purpose, the Handbook guidance 
aggregates direct and indirect obligations of an obligor or issuer 
and also specifically contemplates application of the 25 percent 
benchmark to concentrations that may result from an acquisition of a 
volume of loans from a single source, regardless of the diversity of 
the individual borrowers.

61 FR 63972, 63977 (Dec. 2, 1996)(emphasis in original).

    In comparing indirect, outsourced programs and ABS, the Board notes 
there are certain protections for the ABS investor that do not exist in 
the indirect, outsourced loan programs. The creation and sale of ABS 
securities are regulated by the Securities and Exchange Commission, 
while the various vendors that currently market indirect, outsourced 
loan programs to credit unions have no specific regulatory oversight. 
Further, the only ABS that corporate credit unions and national banks 
may invest in are reviewed and rated by nationally recognized 
statistical rating organizations (NRSROs) while the vendors currently 
offering indirect, outsourced programs to credit unions are often 
privately held companies with no NRSRO rating.
    The proposed rule, with limits of 50 and 100 percent, is less 
restrictive than the 25 percent that the OCC permits for national bank 
investment in ABS. While investing is a secondary activity for credit 
unions, lending is a primary purpose. Credit unions should have maximum 
flexibility to make loans to members within the bounds of safety and 
soundness.
    The Board is generally not inclined to allow a credit union to 
place over 100 percent of its net worth at risk. A credit union is not 
likely to experience a 100 percent devaluation of any particular 
indirect, outsourced vehicle loan portfolio but substantial 
devaluations are possible, particularly in portfolios of poor credit 
quality or in the event of fraud. In addition, inadequate oversight in 
one credit union program, such as a lending program, may indicate poor 
due diligence and potential losses in other programs at that credit 
union. Accordingly, the Board has determined that a credit union should 
be held to a maximum concentration of 100 percent of net worth unless 
it can demonstrate a high level of due diligence and controls.
    In determining when a credit union may move from the 50 percent 
limit to the 100 percent limit, the Board examined the average life of 
the loans that make up an indirect, outsourced program portfolio. 
Average vehicle loan life depends on various factors. For

[[Page 75756]]

example, it can be as little as 20 to 24 months for subprime vehicle 
loans, and as much as 36 months or more for prime, new vehicle loans. 
After about 30 months of experience, then, a credit union that is 
properly monitoring loan performance on vehicle loans should have a 
sufficient understanding of the historical performance of that 
portfolio. At the 30-month point, the Board believes that an increase 
in concentration limits from 50 percent of net worth to 100 percent is 
appropriate.
    Regardless of whether a credit union is at or below its 
concentration limit, all credit unions should conduct due diligence, 
both before entering into indirect, outsourced lending programs and on 
an on-going basis. Even at lesser concentration levels, these programs 
entail significant risk that can negatively affect net worth. All 
credit unions involved in these programs must be familiar with relevant 
regulatory limitations and guidance, including those documents 
referenced earlier in this preamble.
    The proposed rule is limited in scope, in that it is limited to 
loans made to finance vehicle purchases and the concentration limits do 
not apply to servicers that are federally-insured depository 
institutions or wholly-owned subsidiaries of federally-insured 
depository institutions. The risks to credit unions associated with 
these servicers are mitigated because federal regulators have access to 
and oversight of these entities. Of course, credit unions must still 
conduct appropriate due diligence even when using these servicers.
    The proposed concentration limits are not, however, limited to 
loans of any particular credit quality, such as prime, nonprime, or 
subprime loans. Still, loan portfolios of lesser credit quality require 
greater due diligence, as described in the Risk Alert.\4\ Also, the due 
diligence required for a waiver of the concentration limits may 
increase for portfolios of lesser credit quality.
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    \4\ The Board would like to clarify that, potentially, there 
could be vendor programs affected by this rulemaking that are not 
affected by the Risk Alert, and vice versa. For example, an 
indirect, outsourced program that only involves vehicle loans of 
prime credit quality would be affected by the limits in this 
proposed rule but not by the Risk Alert. On the other hand, any 
vendor program that requires the credit union adopt vendor-generated 
subprime underwriting criteria but does not involve any third-party 
servicing would be subject to portions of the Risk Alert but not 
subject to the limits imposed by this proposed rule.
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2. Waiver Provision
    Section 701.21(h)(2) of the proposed rule establishes a waiver 
process to permit credit unions with high levels of due diligence and 
tight controls to have greater concentration limits. A credit union 
requesting a waiver of the concentration limits may apply to the 
regional director who will consider various criteria in determining 
whether to grant a waiver, including:
     The credit union's understanding of the third party 
servicer's business model, organization, financial health, and the 
program risks;
     The credit union's due diligence in monitoring and 
protecting against program risks;
     The credit union's ability to control the servicer's 
actions and replace an inadequate servicer as provided by contract;
     Other relevant factors related to safety and soundness 
considerations.
    If a regional director determines that a waiver is appropriate, the 
regional director will include appropriate limitations on the waiver 
such as a substitute concentration limit and a waiver expiration date.
3. Waiver Criteria
    Credit unions that desire greater concentration limits must have 
high levels of due diligence and tight controls. A discussion of the 
criteria a regional director will use when reviewing an application for 
waiver follows.
a. The Credit Union's Understanding of the Third Party Servicer's 
Organization, Business Model, Financial Health, and Program Risks
    Often, an indirect, outsourced vendor is a privately held company 
that processes significant cash flows for the credit union and also 
controls important credit union records, such as the vehicle title 
documents and current member contact information. A credit union 
requesting a concentration limit waiver must demonstrate a 
comprehensive understanding of the third party's organization, business 
model, financial health, and the risks associated with the vendor's 
program. The credit union must also demonstrate that the servicer is 
adequately capitalized to meet its financial obligations.
    A credit union requesting a waiver should provide detailed 
information about the following in its waiver request to the regional 
director:
     The vendor's organization, including identification of 
subsidiaries and affiliates involved in the program and the purpose of 
each;
     The various sources of income to the vendor and the credit 
union in the program and any potential vendor conflicts with the 
interests of the credit union;
     The experience, character, and fitness of the vendor's 
owners and key employees;
     The vendor's ability to fulfill commitments, as evidenced 
by aggregate financial commitments, capital strength, liquidity, 
reputation, and operating results; \5\
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    \5\ NRSRO ratings, multi-year audited and segmented financials, 
and explanations of related party transactions and changes to the 
net worth of the vendor, if any, are also relevant.
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     How loan-related cash flows, including borrower payments, 
borrower payoffs, and insurance payments, are tracked and identified in 
the program;
     The vendor's internal controls to protect against fraud 
and abuse, as documented by, for example, a current SAS 70 type II 
report prepared by an independent and well-qualified accounting firm;
     Insurance offered by the vendor, including interrelated 
insurance products, premiums, conditions for coverage beyond the 
control of the credit union (e.g., a prohibition on extension of the 
insured loans past maturity), and limitations such as aggregate loss 
limits;
     The underwriting criteria provided by the vendor, 
including an analysis of the expected yield based on historical loan 
data, and a sensitivity analysis considering the potential effects of a 
deteriorating economic environment, failure of associated insurance, 
the possibility of fraud at the servicer, a decline in average 
portfolio credit quality, and, if applicable, movement in the program 
back toward industry-wide performance statistics; \6\
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    \6\ If the program loans have historically outperformed industry 
averages, perhaps because of lower prepayment rates or lower default 
proportions, the credit union should calculate expected yield should 
the prepayment rates or default proportions move upwards toward the 
industry averages.
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     Vendor involvement in the underwriting and processing of 
loan applications, including use of proprietary scoring or screening 
models not included in the credit union approved underwriting criteria; 
and
     The program risks, including (1) credit risk, (2) 
liquidity risk, (3) transaction risk, (4) compliance risk, (5) 
strategic risk, (6) interest rate risk, and (7) reputation risk.
    Some indirect, outsourced programs have complex business models 
that include vendor management of the dealer relationship and also 
insurance provided by the vendor. These business models can produce 
situations where the vendor's financial interests are not aligned with 
the credit union's interests. The credit union needs to be aware of

[[Page 75757]]

these situations and, if appropriate, take protective action.
    For example, the dealer's interest in an indirect lending situation 
is to obtain financing so that the dealer can sell a vehicle. The 
credit union's interest is to ensure that loan applications are 
properly underwritten, and that only members who are qualified for 
loans receive loans. With an indirect, outsourced program, the third-
party vendor controls information on the quality of all of a particular 
dealer's originations. A vendor could present loans to a credit union 
from a changing list of dealers, making it difficult for the credit 
union to identify and screen out such substandard dealers. This creates 
a potential for the vendor to permit dealers with substandard 
underwriting performance to remain active in the program.
    Unlike typical indirect lending where the dealer receives an 
origination fee, in some vendor programs the vendor processes the loan 
application for the credit union and the vendor also receives 
significant income from dealer fees. The credit union needs to fully 
understand the relationship between the vendor and the dealers. Credit 
unions seeking a concentration limit waiver should review agreements 
between the vendor and associated dealers.
    Some vendors provide third-party default insurance to credit 
unions, and this presents a potential conflict. This insurance pays 
most of the loan deficiency balance to the credit union if a loan 
defaults and a vehicle is repossessed and sold at auction. In the event 
of high loan default rates, the interests of the credit union and 
insurance company may conflict. The credit union would like the 
vehicles repossessed and sold and the insurance paid, while the 
insurance company would rather not pay the claims if they can be 
legally avoided. Some vendors align their interests with the insurance 
company, not the credit union, through guaranty or reinsurance 
agreements. That is, if the vehicle is repossessed and sold, the 
insurance company passes some or all of its costs for paying the claim 
through to the vendor. This creates a potential conflict of interest 
and an incentive for the vendor, as servicer, not to repossess 
vehicles. For example, a delay in repossession increases the odds that 
a vehicle will disappear (i.e., go skip) or a borrower will declare and 
complete a bankruptcy under chapter 13, and in neither situation will 
the default insurance pay. In addition, a delay in repossession on a 
default near loan maturity may also cause the insurance coverage to 
lapse whether or not the vehicle is ultimately repossessed. 
Accordingly, a credit union needs to understand the relationship 
between the vendor and the insurance company and the associated risks 
to the credit union. To understand this relationship fully, a credit 
union desiring a concentration limit waiver should review all 
agreements between the vendor, affiliates of the vendor, and the 
associated insurance companies.
    Another potential conflict exists where the vendor controls the 
dealer relationship and can route a potential loan to multiple funding 
sources. For example, some vendors track statistics on loan performance 
by dealership. A credit union should be aware if a vendor then routes 
loan applications from the preferred dealerships to the preferred 
funding sources. A credit union desiring a waiver should understand the 
various funding sources available to the vendor and document how the 
vendor tracks vendor performance and makes funding decisions.
b. The Credit Union's Due Diligence in Monitoring and Protecting 
Against Program Risks
    Credit unions must design a due diligence program that identifies 
and assesses all material risks. The nature and extent of the due 
diligence required for a waiver depends on the nature and extent of the 
identified risks. Higher concentration levels entail more risk to the 
net worth of the credit union, and so the requisite due diligence also 
depends on the substitute concentration limit that the credit union 
requests.
c. Whether Contracts Between the Credit Union and the Third-Party 
Servicer Grant the Credit Union Sufficient Control Over the Servicer's 
Actions and Provide for Replacing an Inadequate Servicer
    After a loan is funded, the most important activity affecting loan 
performance is the quality of the servicing. As NCUA stated in LTCU No. 
04-CU-13, and, again, in the Risk Alert, safety and soundness requires 
a credit union to limit the power of a third-party servicer to alter 
loan terms. Also, the servicing contract must contain a mechanism, or 
exit clause, to replace an unsatisfactory servicer.
    To qualify for a waiver of these regulatory concentration limits, 
the servicing agreement should include more than minimal protections 
for the credit union. Servicer performance standards should be 
objective and clear, and the waiver request should clearly articulate 
how the performance standards protect the interests of the credit 
union. The exit clause, including any cure period, should be 
exercisable in a reasonable period of time. The more intensive the 
requisite servicing, such as for nonprime or subprime loans, the 
shorter that period of time should be. A credit union's right to exit 
the servicing agreement should be exercisable at a reasonable cost to 
the credit union. If the credit union must pay a punitive fee to 
replace a poor servicer, or give up valuable insurance protection or 
legal rights without adequate compensation, the servicing agreement 
will not satisfy this waiver criterion.
    The regional director may also consider any legal reviews obtained 
by the credit union on these contracts. The regional director should 
consider the scope and depth of the review and the qualifications of 
the reviewer.
d. Other Factors Related to Safety and Soundness
    Regional directors may consider other relevant factors when 
determining whether to grant a waiver of the concentration limits as 
well as the size of any substitute limit. Other factors include, but 
are not limited to, the demonstrated strength of the credit union's 
management and the credit union's previous history in exercising due 
diligence over similar programs.
4. Grandfathering
    Several credit unions that currently participate in indirect, 
outsourced programs have concentration levels that exceed the proposed 
concentration limits. For those credit unions that exceed the 
concentration limits on the effective date of any final rule, the rule 
will not require any divestiture. The rule will prohibit these credit 
unions from purchasing any additional loans, or interests in loans, 
from the affected vendor program until such time as the credit union 
either reduces its holdings below the appropriate concentration limit 
or the credit union obtains a waiver to permit a greater concentration 
limit.
    The Board is concerned that some credit unions may consider making 
large purchases of loans that would be subject to the rule before the 
effective date of a final rule. NCUA will review any large purchases 
closely and credit unions should be advised that NCUA may consider 
appropriate supervisory action, including divestiture, to ensure that 
the credit union's actions were safe and sound.

Regulatory Procedures

Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic

[[Page 75758]]

impact a proposed rule may have on a substantial number of small credit 
unions (those under $10 million in assets). This proposed rule 
establishes for federally-insured credit unions a concentration limit 
on indirect vehicle loans serviced by third parties. As of May 31, 
2005, NCUA estimates no more than five small credit unions were 
involved in purchasing vehicle loans, or interests in loans, from an 
indirect, outsourced vendor program. The proposed rule, therefore, will 
not have a significant economic impact on a substantial number of small 
credit unions and a regulatory flexibility analysis is not required.

Paperwork Reduction Act

    The waiver provision of section 701.21(h)(2) contains information 
collection requirements. As required by the Paperwork Reduction Act of 
1995 (44 U.S.C. 3507(d)), NCUA has submitted a copy of this proposed 
rule as part of an information collection package to the Office of 
Management and Budget (OMB) for its review and approval of a new 
Collection of Information, Third-Party Servicing of Indirect Vehicle 
Loans.
    The proposed Sec.  701.21(h)(2) requires that credit unions 
requesting a waiver provide sufficient information to NCUA to determine 
if a waiver is appropriate. NCUA is not certain how many credit unions 
may request a waiver. Currently, there are approximately twenty credit 
unions that have in excess of 100 percent of net worth invested in 
indirect, outsourced vehicle loan programs. NCUA believes that no more 
than ten of these credit unions will request a waiver during the first 
year. Also, during the first year, NCUA estimates that no more than 
five additional credit unions will approach their concentration limits 
and also request a waiver. It will take a credit union approximately 
fifty hours to prepare the waiver request, including preparing a 
description of current and planned due diligence efforts and making 
copies of all supporting documentation. Fifteen respondents times fifty 
hours each is a total annual burden of seven hundred and fifty hours.
    Organizations and individuals desiring to submit comments on the 
information collection requirements should direct them to the Office of 
Information and Regulatory Affairs, OMB, Attn: Mark Menchik, Room 
10226, New Executive Office Building, Washington, DC 20503.
    The NCUA considers comments by the public on this proposed 
collection of information in--

--Evaluating whether the proposed collection of information is 
necessary for the proper performance of the functions of the NCUA, 
including whether the information will have a practical use;
--Evaluating the accuracy of the NCUA's estimate of the burden of the 
proposed collection of information, including the validity of the 
methodology and assumptions used;
--Enhancing the quality, usefulness, and clarity of the information to 
be collected; and
--Minimizing the burden of collection of information on those who are 
to respond, including through the use of appropriate automated 
electronic, mechanical, or other technological collection techniques or 
other forms of information technology; e.g., permitting electronic 
submission of responses.

    The Paperwork Reduction Act requires OMB to make a decision 
concerning the collection of information contained in these proposed 
regulations between 30 and 60 days after publication of this document 
in the Federal Register. Therefore, a comment to OMB is best assured of 
having its full effect if OMB receives it within 30 days of 
publication. This does not affect the deadline for the public to 
comment to the NCUA on the proposed regulations.

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. The proposed rule would 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 proposed 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

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

List of Subjects

12 CFR part 701

    Credit unions, Loans.

12 CFR part 741

    Credit unions, Requirements for insurance.

    By the National Credit Union Administration Board on December 
15, 2005.
Mary Rupp,
Secretary of the Board.
    For the reasons stated in the preamble, the National Credit Union 
Administration proposes to amend 12 CFR parts 701 and 741 as set forth 
below:

PART 701--ORGANIZATION AND OPERATIONS OF FEDERAL CREDIT UNIONS

    1. The authority citation for part 701 continues to read as 
follows:

    Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a, 
1761b, 1766, 1767, 1782, 1784, 1787, and 1789. Section 701.6 is also 
authorized by 31 U.S.C. 3717. Section 701.31 is also authorized by 
15 U.S.C. 1601 et seq.; 42 U.S.C. 1981 and 3601-3619. Section 701.35 
is also authorized by 42 U.S.C. 4311-4312.

    2. In part 701, add a new paragraph (h) to Sec.  701.21 to read as 
follows:


Sec.  701.21  Loans to Members and Lines of Credit to Members.

* * * * *
    (h) Third-Party Servicing of Indirect Vehicle Loans.
    (1) A federally-insured credit union must not acquire any vehicle 
loan, or any interest in a vehicle loan, serviced by a third-party 
servicer if the aggregate amount of vehicle loans and interests in 
vehicle loans serviced by that third-party servicer and its affiliates 
would exceed:
    (i) 50 percent of the credit union's net worth during the initial 
thirty months of that third-party servicing relationship; or
    (ii) 100 percent of the credit union's net worth after the initial 
thirty months of that third-party servicing relationship.
    (2) Regional directors may grant a waiver of the limits in 
paragraph (h)(1) of this section to permit greater limits upon written 
application by a credit union. In determining whether to grant or deny 
a waiver, a regional director will consider:
    (i) The credit union's understanding of the third party servicer's 
organization, business model, financial health, and the related program 
risks;
    (ii) The credit union's due diligence in monitoring and protecting 
against program risks;

[[Page 75759]]

    (iii) Whether contracts between the credit union and the third-
party servicer grant the credit union sufficient control over the 
servicer's actions and provide for replacing an inadequate servicer; 
and
    (iv) Other factors relevant to safety and soundness.
    (3) For purposes of paragraph (h) of this section:
    (i) The term ``third-party servicer'' means any entity, other than 
a federally-insured depository institution or a wholly-owned subsidiary 
of a federally-insured depository institution, that receives any 
scheduled periodic payments from a borrower pursuant to the terms of a 
loan and distributes the payments of principal and interest and such 
other payments with respect to the amounts received from the borrower 
as may be required pursuant to the terms of the loan.
    (ii) The term ``its affiliates,'' as it relates to the third-party 
servicer, means any entities that:
    (A) Control, are controlled by, or are under common control with, 
that third-party servicer; or
    (B) Are under contract with that third-party servicer or other 
entity described in paragraph (h)(3)(ii)(A) of this section.
    (iii) The term ``vehicle loan'' means any installment vehicle sales 
contract or its equivalent that the credit union must report as an 
asset under generally accepted accounting principles. The term does not 
include loans made directly by the credit union to a member.
    (iv) The term ``net worth'' means the retained earnings balance of 
the credit union at quarter end as determined under generally accepted 
accounting principles. 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 National Credit Union Share Insurance Fund.
* * * * *

PART 741--REQUIREMENTS FOR INSURANCE

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

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

    4. Add a new paragraph (c) to Sec.  741.203 to read as follows:


Sec.  741.203  Minimum loan policy requirements.

* * * * *
    (c) Adhere to the requirements stated in Sec.  701.21(h) of this 
chapter concerning third-party servicing of indirect vehicle loans. 
Before a state-chartered credit union applies to a regional director 
for a waiver under Sec.  701.21(h)(2) it must first notify its state 
supervisory authority. The regional director will not grant a waiver 
unless the appropriate state official concurs in the waiver.

 [FR Doc. E5-7584 Filed 12-20-05; 8:45 am]
BILLING CODE 7535-01-P