Financial Innovation: Loan Participations, Eligible Obligations, and Notes of Liquidating Credit Unions
Final rule.
CFR Part: "12 CFR Parts 701 and 714"
RIN Number: "RIN 3133-AF49, 3133-AE96"
Citation: "88 FR 67570"
Document Number: "NCUA-2022-0185"
Page Number: "67570"
"Rules and Regulations"
Agency: "
SUMMARY: The NCUA Board (Board) is amending the NCUA's regulations regarding the purchase of loan participations and the purchase, sale, and pledge of eligible obligations and other loans (including notes of liquidating credit unions). The final rule clarifies the NCUA's current regulations and provides additional flexibility for federally insured credit unions (FICUs) to make use of advanced technologies and opportunities offered by the financial technology (fintech) sector. The final rule also amends the NCUA's rule regarding loans to members and lines of credit to members by adding new provisions about indirect lending arrangements and indirect leasing arrangements. Finally, the final rule makes certain conforming changes and technical amendments to the NCUA's regulations. The Board does not view the conforming changes and technical amendments as substantive.
DATES: This final rule is effective
FOR FURTHER INFORMATION CONTACT: For policy questions:
SUPPLEMENTARY INFORMATION:
I. Background
A. Introduction On
FOOTNOTE 1 Note that the terms credit union, federal credit union, federally insured, state-chartered credit union, corporate credit union, and FICU are used throughout the document and are not necessarily interchangeable. Specifically, while
The Board believes shifting to a more principles-based approach with respect to loan participations and eligible obligations is appropriate and will be beneficial to FICUs. The intent behind the final rule is to advance the NCUA's efforts to strike an appropriate balance between mitigating risk to the
B. Summary of the Final Rule
The Board is now amending the NCUA's regulations regarding the purchase of loan participations and the purchase, sale, and pledge of eligible obligations and other loans (including notes of liquidating credit unions). The final rule adopts the amendments largely as proposed with a few changes, which are discussed in the section-by-section analysis of the preamble below. The final rule relocates and clarifies the NCUA's provisions regarding indirect lending and indirect leasing. The final rule also provides credit unions with additional flexibility to participate in loans acquired through indirect lending arrangements, allowing FICUs to use advanced technologies and opportunities offered by the fintech sector. In addition, the final rule removes certain prescriptive limitations and other qualifying requirements relating to eligible obligations and provides credit unions with additional flexibility to purchase eligible obligations of their members.
Removing the prescriptive limitations and other qualifying requirements is intended to allow FCUs additional flexibility to engage with the advanced technologies and other opportunities offered by the fintech sector. The greater flexibility and individual autonomy will also allow FCUs to establish their own risk tolerance limits and governance policies for these activities provided they are safe and sound given the FCU's financial and operational capabilities, while codifying due diligence, risk assessment, compliance and other management processes that are consistent with the Board's long-standing expectations for safe, sound, fair, and affordable lending practices.
As discussed in greater detail in the section-by-section analysis of the preamble, the final rule amends
The final rule also amends
FOOTNOTE 2 NCUA Legal Op. 15-0813 (
In addition, the final rule amends
* Makes clarifying and conforming amendments to the introductory paragraph.
* Removes the CAMELS ratings and well-capitalized requirements under paragraph (b)(2) for FCU purchases of certain non-member loans from FICUs.
* Narrows the application of the 5-percent limit on the purchase of eligible obligations to cover only purchases of notes of liquidating credit unions.
* Adds safety and soundness requirements to paragraph (b)(6)(i)-(vi) concerning the purchase of eligible obligations, to offset risks associated with removing the CAMELS ratings and well-capitalized requirements from paragraph (b)(2). Safety and soundness requirements would apply to all FCUs engaged in the purchase of eligible obligations and notes from a liquidating credit union. In particular, the final rule requires an FCU purchasing eligible obligations or notes from a liquidating credit union to comply with the following:
o Establish written, board-approved policies, risk assessments, and risk management processes that are commensurate with the size, scope, type, complexity, and level of risk posed by the planned purchase activities. These policies would include underwriting standards for the loans, ongoing performance and risk monitoring, including compliance risk, tailored to the types of loans purchased and the sellers as applicable, and portfolio concentration limits by loan types and risk categories in relation to net worth;
o Conduct due diligence on a seller prior to a purchase;
o Include certain contract language and provisions in the written loan purchase agreements (similar to the standards currently established for loan participation agreements under
o Address in internal written purchase policies when a legal review of agreements or contracts will be performed to ensure that the legal and business interests of the credit union are protected against undue risk.
* Revises the definition of "eligible obligation" under paragraph (a)(1) to clarify the distinction between transactions treated as loan participations and those treated as eligible obligations.
* Revises the applicability of the 5-percent limitation under current paragraph (b)(4) to cover only "notes" purchased by an FCU from a liquidating credit union.
* Revises the "grandfathered purchases" section to include eligible obligation purchases that were executed before the effective date of this final rule, provided the purchases complied with the version of the rule that was effective at the time the transaction was executed, and subject to safety and soundness and other compliance considerations.
* Adds safety and soundness requirements to paragraph (c) concerning the sale of eligible obligations, requiring the selling FCU to do the following:
o Obtain a review and assessment of all applicable loan sale agreements or contracts to protect the FCU's legal and business interests; and
o Identify the specific loan(s) being sold either directly in the written loan sale agreement or through a document incorporated by reference into the loan sale agreement.
The final rule also amends
Finally, the final rule also makes certain conforming changes and technical amendments in other sections of the NCUA's regulations. The Board does not view these additional conforming technical changes as substantive.
C. Effective Date
Under the Administrative Procedure Act, the NCUA is generally required to provide a minimum of 30 days from the date of publication in the
FOOTNOTE 3 5 U.S.C. 553(d). END FOOTNOTE
II. Legal Authority
Section 120(a) /4/ of the Federal Credit Union Act (Act) authorizes the Board to prescribe rules and regulations for the administration of the Act. /5/ Similarly, section 209 /6/ of the Act authorizes the Board to prescribe such rules and regulations as it may deem necessary or appropriate to carry out the share insurance provisions of subchapter II of the Act. In addition, section 206 of the Act provides the Board with broad authority to take enforcement action against a FICU or an "institution-affiliated party" /7/ that is engaging or has engaged, or the Board has reasonable cause to believe is about to engage, in an unsafe or unsound practice in conducting the business of such credit union. /8/
FOOTNOTE 4 12 U.S.C. 1766(a) (The Board may prescribe rules and regulations for the administration of 12 U.S.C. chapter 14 (including, but not by way of limitation, the merger, consolidation, and dissolution of corporations organized under the chapter). Any central credit union chartered by the Board shall be subject to such rules, regulations, and orders as the Board deems appropriate and, except as otherwise specifically provided in such rules, regulations, or orders, shall be vested with or subject to the same rights, privileges, duties, restrictions, penalties, liabilities, conditions, and limitations that would apply to all Federal credit unions under the chapter.). END FOOTNOTE
FOOTNOTE 5 Sections 1751-1795k. END FOOTNOTE
FOOTNOTE 6 Section 1789(11) (providing in relevant part as follows: "In carrying out the purposes of this subchapter, the Board may--[. . .] prescribe such rules and regulations as it may deem necessary or appropriate to carry out the provisions of [12 U.S.C. 1781-1790e]."). END FOOTNOTE
FOOTNOTE 7 See section 1786(r) (providing that for purposes of the FCU Act, the term "institution-affiliated party" means--(1) any committee member, director, officer, or employee of, or agent for, an insured credit union; (2) any consultant, joint venture partner, and any other person as determined by the Board (by regulation or on a case-by-case basis) who participates in the conduct of the affairs of an insured credit union; and (3) any independent contractor (including any attorney, appraiser, or accountant) who knowingly or recklessly participates in--(A) any violation of any law or regulation; (B) any breach of fiduciary duty; or (C) any unsafe or unsound practice, which caused or is likely to cause more than a minimal financial loss to, or a significant adverse effect on, the insured credit union.). END FOOTNOTE
FOOTNOTE 8 Section 1786. END FOOTNOTE
Section 107(5)(E) of the Act authorizes FCUs to engage in participation lending with other credit unions, credit union organizations, or financial organizations in accordance with written policies of the credit union's board of directors. /9/ Section 107(5)(E) also provides that an FCU that originates a loan for which participation arrangements are made in accordance with this subsection shall retain an interest of at least 10 per centum of the face amount of the loan. /10/
FOOTNOTE 9 Section 1757(5)(e). END FOOTNOTE
FOOTNOTE 10 Id. END FOOTNOTE
Section 107(13) of the Act authorizes FCUs, in accordance with rules and regulations prescribed by the Board, to purchase, sell, pledge, or discount or otherwise receive or dispose of, in whole or in part, any eligible obligation (as defined by the Board) of its members. /11/ In addition, section 107(13) authorizes FCUs, in accordance with rules and regulations prescribed by the Board, to purchase from any liquidating credit union notes made by individual members of the liquidating credit union at such prices as may be agreed upon by the board of directors of the liquidating credit union and the board of directors of the purchasing credit union, but no purchase may be made under authority of this paragraph if, upon the making of that purchase, the aggregate of the unpaid balances of notes purchased under authority of this paragraph would exceed 5 per centum of the unimpaired capital and surplus of the credit union. /12/
FOOTNOTE 11 Section 1757(13). END FOOTNOTE
FOOTNOTE 12 Id. END FOOTNOTE
Section 107(14) of the Act authorizes FCUs, subject to regulations of the Board, to sell all or a part of their assets to another credit union, to purchase all or part of the assets of another credit union, and to assume the liabilities of the selling credit union and those of its members. /13/
FOOTNOTE 13 Section 1757(14). END FOOTNOTE
III. Section-by-Section Analysis of the Final Rule and Comments on the Proposal
The NCUA received 42 unique comment letters on the proposed rule. In general, the overwhelming majority of commenters strongly supported the proposed rule and agreed with the NCUA regarding the need for and the rationale supporting the proposed changes. The commenters also agreed with the proposal's shift toward more principles-based regulations and suggested the proposed changes would allow credit unions to be nimble in the future. Accordingly, the Board is now issuing this final rule to adopt the amendments proposed with certain changes that are discussed in more detail in the parts of the preamble below corresponding with the amended sections.
The NCUA has summarized the comments received that were within the scope of this rulemaking under the parts of the preamble below corresponding with the amended sections and subsections. The NCUA received many comments that were outside the scope of this rulemaking. The NCUA has read and is considering the comments beyond the scope of this rule for future rulemakings. Most of the comments received that go beyond the scope of the proposal, even if summarized, are not specifically responded to by the NCUA in the preamble to this final rule.
A. Part 701 Organization and Operation of Federal Credit Unions
As discussed in more detail below, this final rule makes several changes to sections in part 701 of the NCUA's regulations. These changes clarify numerous provisions regarding loans to members and lines of credit to members under
Public Comments
Several commenters noted that the proposed changes would clarify credit unions' loan participation and eligible obligation authorities, benefiting not only credit unions but also NCUA examiners and various other stakeholders. In addition, many commenters expressly offered support for the proposal's general shift toward a more principles-based approach with respect to the NCUA's loan participation and eligible obligation regulations. One commenter suggested that prescriptive regulations, with fixed limits and rules, prevent credit unions from evolving with shifting market forces (e.g., the rise of fintechs). The commenter explained further that a principles-based approach to risk tolerance and appetite will provide the opportunity for credit union service organizations (CUSOs) to create comprehensive underwriting guidelines acceptable to all participating credit unions, which will allow credit unions to collectively compete against banks and other financial institutions and be more attractive to lending platform providers, original automotive equipment manufacturers, and point of sale retailers. Another commenter specifically asked that the Board not adopt new prescriptive definitions and regulations. The commenter requested further that all safety and soundness standards imposed in the final rule should be sufficiently flexible to permit credit unions to adopt internal written purchase policy provisions commensurate with the size, scope, type, complexity, and level of risk posed by their individual activities. Several commenters requested, generally, that the NCUA do more to clarify the rules, expand credit unions' authority in this area, or both.
Discussion
Consistent with the strong support received from commenters, the Board is adopting the rule largely as proposed, for the reasons set forth in the notice of proposed rulemaking, with certain changes discussed in the section-by-section analysis below. In addition, several commenters requested additional clarification on certain aspects of the proposal. The NCUA has provided further clarifying guidance to credit unions where appropriate.
Section 701.21 Loans to Members and Lines of Credit to Members
Section 701.21(c) General Rules
As discussed in more detail below, this final rule, as a conforming amendment, adds new provisions to
Public Comments
Most commenters offered support for the proposed changes to the NCUA's regulations regarding indirect lending and indirect leasing arrangements, agreed the proposed changes would provide additional clarification to affected parties, and supported moving the provisions to
Discussion
Consistent with the support received from commenters on the proposal, the Board is adopting new paragraph (c)(9) to
New
For reasons discussed in the preamble discussion on current
FOOTNOTE 14 See, e.g., NCUA Legal Op. 97-0546 (
New
New
Both new definitions would use language that is generally similar, but not identical, to the language in current
Public Comments
One commenter recommended clarifying the meaning of the phrase "inception of the obligation to extend credit." The commenter asked, as an example of its confusion about the meaning of the phrase, does this mean when the credit union verifies underwriting criteria, when the borrower has a sufficient credit score according to the credit union, or some other step in the process of extending credit?
Discussion
The Board believes the phrase "inception of the obligation to extend credit" is clear and unambiguous. Merriam-Webster's Online Dictionary defines the term "inception" as "an act, process, or instance of beginning: COMMENCEMENT." /15/ The inception of the obligation to extend credit, then, is the point in time when the indirect lender becomes obligated to extend credit to the borrower. As with all its rules, however, the Board will monitor implementation and provide additional clarifying guidance as it deems necessary.
FOOTNOTE 15 Available at https://www.merriam-webster.com/dictionary/inception. END FOOTNOTE
Should the Board further clarify the term "final underwriting decision"? The Board invited comments in the proposal on what it means for the credit union to make the final underwriting decision regarding making the loan in an indirect lending arrangement. For example, should the rule specify that a credit union in an indirect lending arrangement must be involved or consulted at the time of the extension of credit? In the alternative, should the rule specify that a credit union can simply provide its underwriting standards to the other party in the indirect lending arrangement and clarify in the indirect lending agreement that only those loans meeting the credit union's underwriting standards will be accepted for funding? Would a credit union still be making the final underwriting decision if a third party includes significantly more underwriting criteria that are more restrictive, for example, than the credit union requires?
Public Comments
In response to NCUA's question in the proposed rule preamble, two commenters responded that the NCUA should not define the phrase "final underwriting decision." One of those commenters explained that the implementation of additional requirements through a definition could stifle innovation as new products are created and/or create unintended regulatory burden that may be unnecessary due to the specifics of the underwriting situation. Another commenter responded that, if the credit union has provided its guidelines or other underwriting criteria and has the ability to not approve or not fund a loan that does not meet its criteria, there is no need to make the definition more specific. A third commenter suggested that the current safety and soundness requirements are sufficient to enable a credit union to identify, isolate, and resolve any issues the credit union may later discover.
On the other hand, two commenters asked that the NCUA define the phrase "final underwriting decision." One of those commenters recommended the phrase be defined to avoid ambiguity or potential conflict with existing laws and regulations that require the loan originator to make the final underwriting decision, and situations involving prearranged underwriting and processing agreements between third-party originators and the purchasing credit unions. The commenter recommended further that the definition allow the seller (loan originator) to use the purchasing credit union's underwriting guidelines. Another commenter recommended defining the phrase to clarify that the purchasing FCU is considered to have made the "final underwriting decision" so long as the loan conforms to the FCU's pre-approved underwriting criteria, even when a fintech company or other indirect lending partner adds additional, more restrictive underwriting criteria than the FCU requires. In the commenter's opinion, the indirect lending partner is acting as a facilitator on behalf of the credit union in such cases to provide credit enhancements and is not overriding the credit union's underwriting criteria. The commenter also suggested that indirect lending partners weeding out bad loans in this fashion promotes safety and soundness by reducing credit risk to FCUs, whether the indirect lender uses an algorithm, natural persons' judgment, or both to provide such credit enhancements. To clarify this point, the commenter recommended the definition of "final underwriting decision" in
The FCU makes the "final underwriting decision" so long as:
(1) The FCU establishes by contract that the indirect lending partner must adhere to the underwriting standards set forth in the indirect lending agreement; these underwriting standards are typically included as an appendix or exhibit to the master agreement for the indirect lending relationship; and
(2) The indirect lending partner can apply additional, more restrictive underwriting criteria that go above-and-beyond the FCU's underwriting requirements, whether those additional underwriting criteria are part of an automated loan underwriting system and/or are performed by a natural person individual who is not involved in the disbursement of loan funds.
Several commenters did not expressly recommend defining the phrase "final underwriting decision," but did offer recommendations about how the term should be interpreted. Three commenters asked that credit unions be allowed to charge third-party partners with prescribed standards that must be met and manage the risk of the engagement through due diligence and oversight. One of those commenters asked further that credit unions then be allowed to choose to review loans before or after funding, depending on their comfort and experience with the third-party partner; the expectation being that the credit unions be familiar with the third party's underwriting standards and where those standards might be different (in more or less conservative ways) than their own. Finally, the commenter suggested that the adequacy of a credit union's due diligence and oversight of its third-party partners is a safety and soundness issue best left to examiners in the field. Another one of those commenters suggested that, if the NCUA needed to strengthen this part of the rule to justify making this change, it could consider also adding the following express requirements: (1) the underwriting standards must be within the credit union's approved underwriting and credit policies; (2) the underwriting standards must be clearly referenced in the representations and warranties of the agreement between the fintech/flow partner and the credit union and, if not met, require repurchase of the loans by the fintech/flow partner; and (3) the credit union must, as part of best practices and safety and soundness considerations, review and analyze the indirect loan pools prior to settlement or as soon as practical (for example, in the early part of the month subsequent to the month in which the loans were purchased) to ensure they are compliant with NCUA rules (for example, maturity limits, the statutory maximum interest rate, etc.) and meet the credit "stips"/guidelines set forth in the agreement between the parties.
Several commenters also recommend that, if the phrase "final underwriting decision" is defined, the NCUA not require that credit unions engaged in indirect lending be actively involved or consulted at the time a facilitating partner extends credit to borrowers on the credit union's behalf or limit the number of permissible facilitating partners. The commenters suggested such a requirement would be logistically challenging and could result in fewer loans being made through indirect lending arrangements.
Discussion
The Board appreciates the detailed comments that were submitted regarding defining the phrase "final underwriting decision." While the comments received in this area go beyond the scope of this rulemaking, the comments will be retained for consideration by the NCUA during future rulemakings relating to indirect lending.
The NCUA has long used the act of underwriting a loan as a feature to distinguish between transactions where a FICU makes a loan and transactions where a FICU purchases a loan. /16/ In particular, in a 1997 legal opinion the NCUA explained:
FOOTNOTE 16 See, e.g., NCUA Legal Op. 92-1203 (
FCUs may participate in indirect lending arrangements under the authority to make loans to members, 12 U.S.C. 107(5); 12 CFR 701.21, rather than the authority to purchase eligible obligations, 12 U.S.C. 107(13); 12 CFR 701.23, as long as two conditions are met. First, the FCU must make the final underwriting decision. That is, before the retailer and the member complete the loan or sales contract, the FCU must review the application and determine that the transaction conforms to its lending policies. This is because an FCU may not delegate its lending authority to a third party. /17/
FOOTNOTE 17 NCUA Legal Op. 97-0546. END FOOTNOTE
By requiring the purchasing credit union to make the final underwriting decision in an indirect lending transaction, the NCUA ensures that the purchasing credit union is not relying on the due diligence of the loan seller who might otherwise have had a decreased interest in properly underwriting the loan knowing it would later be sold.
The NCUA explained further in the same 1997 legal opinion that an eligible organization may use an automated credit scoring system to make its final underwriting decision so long as the "score" obtained from the automated system is the sole determinant for granting credit. When an eligible organization establishes the qualifying criteria for the automated scoring system, it is effectively making an advance decision on a particular application. /18/ So long as the party entering the borrower's application information does not exercise any judgment regarding that information, the score will be deemed to reflect the FCU's lending policies. /19/
FOOTNOTE 18 See id.; see also 63 FR 70997, 70997 (
FOOTNOTE 19 See id. END FOOTNOTE
Nothing in current
In indirect lending situations not involving automated credit scoring systems, a credit union may not wait until after the inception of the obligation to extend credit to review the loan application and determine whether the transaction conforms to its lending policies because the credit union then would not have made the final underwriting decision. A credit union should retain approval authority to engage in indirect lending (that is, employees or independent contractors working for the indirect lending partner cannot make the final underwriting decision on the credit union's behalf). /20/ For large loans, complex loans, or both, a credit union may grant preliminary approval of the loan based on the indirect lending partner's representations to the credit union's loan officer that the loan conforms to the credit union's underwriting policies. The credit union must then review the loan application and determine that the loan, the application, and the transaction conform to its lending policies before the credit union grants its final approval and before the loan proceeds are sent to the indirect lending partner.
FOOTNOTE 20 NCUA Legal Op. 97-0546. END FOOTNOTE
In all indirect lending transactions, credit unions should also retain the right to deny a loan should it discover the loan does not comply with the credit union's policies or standards upon receipt of the final paperwork. A credit union should document this "right" in the indirect lending agreement.
Should the Board define the phrase "very soon after"? The Board asked in the proposal whether additional clarification was needed such as adding certain parameters around the meaning of "very soon after" for the assignment of the loan or contract to the credit union. Examples given were within 7 days of the borrower executing the loan or contract or assignment prior to the first loan payment.
Public Comments
Three commenters recommend not defining the phrase "very soon after." One commenter suggested that using the language "very soon after" is appropriate and should not cause significant issues and that setting a specific period is not necessary. Another commenter acknowledged that timely assignment of a loan or sales contract should be a factor in ensuring a FICU or other eligible organization is prudently engaged in an indirect lending arrangement, but suggested the FICU or other eligible organization's adherence to relevant safety and soundness standards is far more determinative of any relevant risks that may accrue to the institution or the
Six commenters recommend defining the phrase "very soon after" to avoid confusion. Four of the commenters recommended providing a specific number of days following the borrower's execution of the loan or contract. One commenter suggested the specific number be 5 or 7 business days but not a window that is excessive, such as 10 days. Another commenter suggested the number be 7 days. One commenter suggested the number be no more than 7 or 10 days. And one commenter suggested the number be 30 days or less.
Two commenters recommend defining "very soon after" more generally to mean prior to the due date of the member's first loan payment (other than any down payment). Two commenters also recommended clarifying that the assignment can involve more than one party, such as if a fintech indirect lending partner uses one or more agents or subsidiaries to facilitate its operations prior to the loan being delivered to the credit union. One of those commenters suggested the changes discussed in this paragraph could be made to the rule by adding a new paragraph to proposed
The requirement that the loan be assigned to the purchaser very soon after the inception of the obligation to extend credit may be satisfied regardless of whether the assignment process undergoes multiple functional steps, with multiple entities, and including where the assignment is processed as part of a batch of loans, on a cyclical cadence or otherwise, so long as assignment occurs before the first loan payment following any down payment.
Finally, one commenter suggested that if "very soon after" is defined, the definition should ensure that appropriate flexibility is given to address the various timeframes required to appropriately assign loans backed by different collateral types and to ensure a more forward-looking regulation that can help ensure future evolution as loan and lease products continue to change.
Discussion
The Board appreciates the detailed comments that were submitted regarding defining the phrase "very soon after." Defining the phrase in this final rule, however, would go beyond the scope of the proposal. Accordingly, the comments received on this issue have been shared with the Board, reviewed, and will be retained for consideration by the NCUA in future rulemakings relating to indirect lending.
Several commenters expressed confusion regarding the NCUA's use of the term "very soon after" in the regulation. The term very soon after has been used but not defined in the NCUA's indirect lending regulation since 1998. /21/ The period that satisfies the "very soon after" /22/ element depends on the nature of the loan and the practical realities of assigning certain kinds of loans in the current marketplace and in accordance with prevailing industry standards. /23/ "Very soon after" is determined on a case-by-case basis by loan type and in accordance with commercial reasonableness. /24/ The NCUA's longstanding position is that the sooner the assignment is made the more likely the point-of-sale retailer will be viewed as an indirect lender and not the originating lender. /25/ Historically, NCUA examination staff have generally used 7 days as a baseline for gauging whether a transaction meets the "very soon after" timeframe, but this has not been codified as a requirement. The longer the time between formation of the contract and assignment, the more likely the arrangement will be viewed as the purchase of a third-party loan rather than the making of a loan through indirect channels. /26/ The NCUA also notes that the technology used in many indirect lending relationships today allows for an almost instantaneous assignment of loans.
FOOTNOTE 21 63 FR 70997 (
FOOTNOTE 22 The preamble to the 1998 proposal to amend the eligible obligations rule requested public comment on whether NCUA should specify a certain number of days as constituting "very soon." 63 FR 41976, 41977 (
FOOTNOTE 23 NCUA Legal Op. 15-0813 (
FOOTNOTE 24 Id. END FOOTNOTE
FOOTNOTE 25 Id. END FOOTNOTE
FOOTNOTE 26 63 FR 41976, 41977 (
In addition, two commenters recommended defining "very soon after" in a way that clarifies that the requirement for a loan to be assigned to the purchaser very soon after the inception of the obligation to extend credit may be satisfied regardless of whether the assignment process undergoes multiple functional steps, with multiple entities, so long as the other requirements of 701.21(c)(9) are met and those steps occur before the loan is assigned. The Board appreciates this recommendation, but believes this clarification is unnecessary because the plain language of both current
Should the Board propose a separate indirect lending rule? The Board asked in the proposal whether the NCUA should establish an indirect lending rule. And if so, the Board asked what it should consider in any future indirect lending rulemaking. The Board also asked if a credit union should be considered the originating lender in cases where an intermediary is added to a loan transaction between the initial party extending credit and a credit union, including a third party facilitating the loan transaction. The NCUA received several inquiries from the credit union system related to CUSOs that work with other lenders to extend credit. The CUSOs in those cases then either receive an immediate assignment of the loans and/or act as a facilitator in immediately assigning loans further to credit unions, where the loans meet the credit unions' underwriting criteria.
Public Comments
Two commenters responded in the negative to the NCUA's question about whether the agency should establish a separate indirect lending rule. One of those commenters recommended maintaining a principles-based approach in this area and suggested such an approach requires no separate rule. The other commenter suggested there are numerous situations where a credit union would use a third party to assist in the origination of loans and a separate indirect lending rule would not change the overall impact of being considered the originating lender. One commenter recommended not undertaking a separate indirect lending rulemaking until the agency is able to evaluate and understand how credit unions and other credit union industry stakeholders react to any final rule the NCUA adopts related to this proposal. Finally, three commenters recommended a separate indirect lending rulemaking to provide greater clarity and encourage greater participation in this area. One of those commenters suggested further that a new indirect lending rulemaking could amplify participation and provide credit unions, financial service providers, and CUSOs greater opportunity to collaborate and impact member retention and growth.
Discussion
The Board appreciates the detailed comments that were submitted regarding proposing a separate indirect lending rule. While the comments received in this area go beyond the scope of this rulemaking, the comments will be retained for consideration by the NCUA during future rulemakings relating to indirect lending.
New
New
FOOTNOTE 27 (emphasis added); see also, e.g., NCUA Legal Op. 97-0546 (
Public Comments
One commenter suggested clarifying in proposed
FOOTNOTE 28 (emphasis added). END FOOTNOTE
Discussion
The Board believes the clarification requested above is unnecessary. The requirement that FICUs also comply with the Act is already clear under the NCUA's regulations given the authority for most of the provisions in the NCUA's regulations are derived directly from the Act itself. Moreover, adding such a statement in one provision within the NCUA's regulations, but not everywhere, could give the false impression that FICUs do not have to comply with the Act's requirements in places where the NCUA's regulations do not specifically require it. Accordingly, the final rule adopts the language proposed without change for the reasons set forth in the notice of proposed rulemaking.
New
New
FOOTNOTE 29 Section 714.2(b) (Providing: "[An FCU] may engage in indirect leasing. In indirect leasing, a third party leases property to [the FCU's] member and [the FCU] then purchases that lease from the third party for the purpose of leasing the property to [the FCU's] member. [The FCU does] not have to purchase the leased property if [it complies] with the requirements of
FOOTNOTE 30 Id. (emphasis added); see also 12 CFR 714.2(b) & 714.9; and NCUA Legal Op. 00-0811 (
Section 701.22 Loan Participations
As discussed in more detail below, the final rule makes clarifying amendments to
Public Comments
Two commenters asked the NCUA to do more to reduce confusion regarding whether [Sec.]
Discussion
The specific clarifications requested above would expand the authorities proposed beyond the scope of the proposed rule. As outlined in the notice of proposed rulemaking, one purpose of the amendments was to clarify ambiguities related to distinguishing between loan participations and eligible obligations. To facilitate this, the proposed definition of eligible obligation was revised to provide that an eligible obligation is a whole loan or part of a loan (other than a note held by a liquidating credit union) that does not meet the definition of a loan participation under
FOOTNOTE 31 Note,
The purchase of part of a loan under
701.22 Introductory Paragraph
The introductory paragraph to current
FOOTNOTE 32 78 FR 37946 (
FOOTNOTE 33 Id. at 37948. END FOOTNOTE
The introductory paragraph to current
In the 2013 Final Rule, the Board added a similar introductory paragraph to
Since adopting the prefatory language in both sections, the NCUA has received inquiries from NCUA examiners, FICUs, fintech companies, and other parties who have expressed confusion about how to interpret many of these provisions. This confusion has led to inconsistent reporting of loan interests by FICUs and uncertainty about which of the two sections,
One significant issue with the introductory paragraph to current
FOOTNOTE 34 Emphasis added. END FOOTNOTE
FOOTNOTE 35 Emphasis added. END FOOTNOTE
FOOTNOTE 36 Emphasis added. END FOOTNOTE
In practice, however, purchase agreements, regardless of whether the transactions involve the purchase of an eligible obligation or a loan participation, frequently contain some form of continuing contractual obligation between the buyer and the seller, including representations and warranties regarding the loans and loan repurchase agreements, servicing agreements, and other similar types of ongoing obligations set forth under the agreements. The Board believes the continuing contractual obligation clauses in the fourth and fifth sentences in the introductory paragraphs to current
In addition to the concerns explained above, the clause where the borrower is not a member of that credit union in the first part of the fourth sentence of the introductory paragraph conflicts with another provision in
Accordingly, the NCUA believes the removal of this clause will serve to clarify and reduce confusion when
The NCUA recognizes that whether the purchase of a partial loan is a loan participation under
As discussed in more detail in the part of the preamble below regarding
The Board proposed no other changes to the introductory paragraph to current
FOOTNOTE 37 Emphasis added. END FOOTNOTE
FOOTNOTE 38 See, e.g., NCUA Legal Op. 18-0133 (
The final rule amends the introductory text of
Public Comments
Four commenters stated generally that they supported the proposed changes to the introductory paragraph because the changes will reduce confusion and better enable credit unions to evaluate new loan participation opportunities without reducing credit unions' loan participation authorities or increasing risks to individual credit unions or the
Discussion
Commenters generally supported the proposed changes to the introductory paragraph to
Defining the term "investment interest in a pool of loans"? The Board asked in the proposal whether it should define the term "an investment in a pool of loans" in a future rulemaking. And, if so, the Board asked how the term should be defined and why.
Public Comments
Three commenters responded in the affirmative to the NCUA's question. One commenter recommended clarifying that the restrictions in
Discussion
The Board appreciates the comments received and will retain them for consideration as part of future rulemaking efforts related to this area of the NCUA's regulations.
Section 701.22(a)
The final rule adds a second sentence to the current definition of "originating lender" in
FOOTNOTE 39 NCUA Legal Op. 15-0813 (
FOOTNOTE 40 78 FR 37946, 37949 (
FOOTNOTE 41
FOOTNOTE 42 See 76 FR 79548, 79549 (
FOOTNOTE 43 12 U.S.C. 1757(5) (emphasis added). END FOOTNOTE
FOOTNOTE 44 Section 1757(5)(E) (emphasis added). END FOOTNOTE
FOOTNOTE 45 See 76 FR 79548, 79548 (
In the 2013 Final Rule, the Board noted two specific safety and soundness concerns as reasons for adopting the current definition of "originating lender," explaining in relevant part as follows:
The 2013 Final Rule requires an originating lender to remain part of the participation arrangement and to retain a continuing interest in the loan in order to be a true participant. Otherwise, the transaction is not a loan participation but more akin to the sale of an eligible obligation. As the Board noted in 1991, permitting the sale of participation interests in eligible obligations will blur the distinction between loan participations and loan purchases and sales, arguably circumventing the purpose of the loan participation and eligible obligations rules. Additionally, the Board believes the continued participation of the lender that initially originated the loan is integral to a safe and sound participation arrangement. In 1991, the Board expressed its concern that a lender may have a decreased interest in properly underwriting a loan if they know they can later reduce their risk by selling participation interests in it. The requirement for the originating lender's continued participation in a loan participation arrangement is intended to address this safety and soundness concern. /46/
FOOTNOTE 46 78 FR 37946, 37948 & 37949 (emphasis added) (providing also that in granting [loan participation authority to FCUs],
As explained in more detail below, these concerns are fully accounted for under the 2015 Opinion and this rulemaking by limiting the interpretation to indirect loans and requiring that such loans meet the same general requirements applicable to indirect loans made by FCUs under current
The 2013 Final Rule responded to concerns raised by commenters regarding the proposed definition of "originating lender" and its application in situations where a CUSO underwrites and processes a loan, but the FICU funds the loan. In response to this feedback the Board provided the following explanation:
These commenters observed that a CUSO often serves as an originator in name only and, thus, is not the most appropriate party to regard as the originating lender for the purposes of the rule. For example, loans may be underwritten and processed by a CUSO, but funded by its owner credit union. The Board acknowledged that this CUSO model is not uncommon within the industry and permissible under
FOOTNOTE 47 78 FR 37949-37950 (emphasis added). END FOOTNOTE
As noted, the Board's responses to commenters in the 2013 Final Rule regarding the definition of originating lender were limited to situations in which a FICU purchased a loan from a CUSO that had underwritten the loan. The Board did not discuss the application of the definition of originating lender to CUSOs or other entities in the context of indirect lending arrangements in which a purchasing FICU underwrites the loan and makes the final underwriting decision. Accordingly, the application of the definition of originating lender to CUSOs or other entities in the context of indirect lending arrangements was left unaddressed in the 2013 Final Rule and open to later interpretation by the NCUA, which is what it did 2 years later in the 2015 Opinion discussed in more detail in the following paragraphs.
The NCUA has long used the act of underwriting a loan as a feature to distinguish between transactions where a FICU makes a loan and transactions where a FICU purchases a loan. /48/ In particular, in a 1997 legal opinion the NCUA explained as follows:
FOOTNOTE 48 See, e.g., NCUA Legal Op. 92-1203 (
FCUs may participate in indirect lending arrangements under the authority to make loans to members, 12 U.S.C. 107(5); 12 CFR 701.21, rather than the authority to purchase eligible obligations, 12 U.S.C. 107(13); 12 CFR 701.23, as long as two conditions are met. First, the FCU must make the final underwriting decision. That is, before the retailer and the member complete the loan or sales contract, the FCU must review the application and determine that the transaction conforms to its lending policies. This is because an FCU may not delegate its lending authority to a third party. Second, the retailer must assign the loan or sales contract to the FCU very soon after it is completed. Assignment close in time to the making of the loan allows the retailer to function as the facilitator of the loan while the FCU remains the true lender. As the time between completion and assignment of the loan lengthens, the FCU's payment to the retailer becomes the purchase of the loan rather than part of the processing of the loan. /49/
FOOTNOTE 49 NCUA Legal Op. 97-0546 (emphasis added). END FOOTNOTE
By requiring the purchasing credit union to make the final underwriting decision in an indirect lending transaction, the NCUA ensured that the purchasing credit union was not relying on the due diligence of the loan seller who might otherwise have had a decreased interest in properly underwriting the loan knowing that it would later be sold. Moreover, under the NCUA's loan participation regulation, the originating lender is required to retain at least a 5-percent interest in any participation for the life of the loan. /50/ Accordingly, where an eligible organization makes a loan through an indirect lending arrangement there is no greater risk of incentives for lax or improper underwriting for purposes of
FOOTNOTE 50
Furthermore, as discussed in the 1997 legal opinion quoted above, the NCUA has long distinguished between indirect loans, made under section 107(5) /51/ of the FCU Act and
FOOTNOTE 51
FOOTNOTE 52
FOOTNOTE 53 NCUA Legal Op. 97-0546. END FOOTNOTE
Working within the regulatory and interpretative history discussed above, the NCUA determined in the 2015 Opinion that an "eligible organization" /54/ may be considered the "originating lender" for purposes of
FOOTNOTE 54 Id. (providing in relevant part as follows: "Eligible organization means a credit union, credit union organization, or financial organization."). END FOOTNOTE
FOOTNOTE 55 See SEC 701.23(b)(4)(iv) ("An indirect lending or indirect leasing arrangement that is classified as a loan and not the purchase of an eligible obligation because the Federal credit union makes the final underwriting decision and the sales or lease contract is assigned to the Federal credit union very soon after it is signed by the member and the dealer or leasing company.") (emphasis added). END FOOTNOTE
FOOTNOTE 56 NCUA Legal Op. 15-0813. END FOOTNOTE
FOOTNOTE 57 Id. (providing in relevant part, "[o]riginating lender means the participant with which the borrower initially or originally contracts for a loan and who, thereafter or concurrently with the funding of the loan, sells participations to other lenders."). END FOOTNOTE
The 2015 Opinion explained further that a loan purchased by an eligible organization must satisfy two conditions to be classified as an "indirect loan" and not the purchase of a loan. /58/ First, the eligible organization must make the final underwriting decision regarding the loan. In other words, a loan must be underwritten by the purchasing eligible organization before completion of the loan or sales contract. /59/ An eligible organization may use an automated credit scoring system to make its final underwriting decision as long as the "score" obtained from the automated system is the sole determinant for granting credit. /60/ When an eligible organization establishes the qualifying criteria for the automated scoring system, it is effectively making an advance decision on a particular application. /61/ So long as the party entering the borrower's application information does not exercise any judgment regarding that information, the score will be deemed to reflect the FCU's lending policies. /62/
FOOTNOTE 58 See SEC 701.22(b)(4)(iv); see also NCUA Legal Op. 15-0813; and 78 FR 37946, 37949 (explaining that "a lender 'may have a decreased interest in properly underwriting a loan if they know they can later reduce their risk by selling participation interests in it.' "). END FOOTNOTE
FOOTNOTE 59 See id. END FOOTNOTE
FOOTNOTE 60 See NCUA Legal Op. 97-0546. END FOOTNOTE
FOOTNOTE 61 See id. END FOOTNOTE
FOOTNOTE 62 See id. END FOOTNOTE
Second, the sales contract must be assigned to the eligible organization very soon after it is signed by the borrower and the dealer. /63/ As explained in a separate NCUA legal opinion, assignment close in time to the making of the loan allows the retailer to function as the facilitator of the loan while the eligible organization remains the true lender. /64/ The length of time that satisfies "very soon after" depends on the nature of the loan and the practical realities of assigning certain kinds of loans in the current marketplace and in accordance with prevailing industry standards. /65/ While "very soon after" is generally determined on a case-by-case basis by loan type and in accordance with commercial reasonableness, the longer the time between the formation of the contract and its assignment, the more likely the program will be viewed as involving the purchase of an eligible obligation rather than the making of a loan. /66/
FOOTNOTE 63 Emphasis added. END FOOTNOTE
FOOTNOTE 64 See NCUA Legal Op. 97-0546. END FOOTNOTE
FOOTNOTE 65 The preamble to the 1998 proposal to amend the eligible obligations rule requested public comment on whether the NCUA should specify a certain number of days as constituting "very soon." 63 FR 41976, 41977 (
FOOTNOTE 66 63 FR 41976, 41977 (
The Board believes that codifying the 2015 Opinion will clarify the loan participations rule and facilitate further growth in credit unions' purchase and sale of indirect loan participations. Industry data shows significant growth in credit unions engaging in indirect lending programs, which have become an important channel for credit unions to extend services to their members and provide a viable source of income to support their growth.
Since 2015, FICUs have experienced large growth in indirect lending programs as reflected in Table 1. The
FOOTNOTE 67 NCUA Call Report data for all FICUs from the 4th quarter of 2015 through the 2nd quarter of 2022. END FOOTNOTE
During the past 7 years, FICUs' indirect lending activities had double-digit increases (ranging from 14 percent to 21 percent) year over year between 2016 and 2018, and a low single-digit increase in 2019 and 2020. /68/ The speed of growth went back to double digits in 2021 and 2022, with FICUs reporting an aggregate 30.93 percent increase during 2022. /69/ The share of indirect loans outstanding in FICUs' total loan portfolio increased from 17.35 percent in 2015 to 21.22 percent in 2018, and reached 22.36 percent as of 2022. /70/
FOOTNOTE 68 NCUA Call Report data for all FICUs from the 4th quarter of 2015 through the 4th quarter of 2021. END FOOTNOTE
FOOTNOTE 69 NCUA Call Report data for all FICUs from the 4th quarter of 2015 through the 4th quarter of 2022. END FOOTNOTE
FOOTNOTE 70 Id. END FOOTNOTE
Furthermore, between 2015 and 2022, the delinquency rate on the indirect lending program was relatively stable, ranging from 0.77 percent to 0.47 percent, while the net charge-off rate ranged between 0.70 percent and 0.24 percent. /71/
FOOTNOTE 71 Id. END FOOTNOTE
Table 1-FICU Indirect Lending Activities (72M) (in $ million) 2015 2016 2017 2018 2019 2020 2021 2022 Total Outstanding 136,583 165,171 194,016 221,477 228,559 233,161 257,271 336,845 Indirect Loans % Year over Year 20.29 20.93 17.46 14.15 3.20 2.01 10.34 30.93 Growth % Indirect Loans 17.35 19.00 20.27 21.22 20.63 20.05 20.50 22.36 Outstanding/Total Loans Total Del. Indirect 988 1,264 1,391 1,494 1,513 1,291 1,198 2,479 Loans (>=60 Days) % Loans Delinquent 0.72 0.77 0.72 0.67 0.66 0.55 0.47 0.74 >=60 Days/Total Indirect Loans Net Indirect Loan 782 997 1,264 1,318 1,354 1,129 594 903 Charge-Offs % Net Charge-Offs/Avg 0.63 0.66 0.70 0.63 0.60 0.49 0.24 0.30 Indirect Loans
For the reasons discussed previously, and consistent with sections 107(5) and 107(5)(E) of the Act and the 2015 Opinion, the Board is codifying into the NCUA's regulations its interpretation that an eligible organization may be considered an "originating lender" for purposes of
FOOTNOTE 72 Id. END FOOTNOTE
Where an indirect loan is underwritten by the purchasing eligible organization before the loan is made and the loan is transferred to the eligible organization very soon after the inception of the obligation to extend credit, the Board believes there is little risk the loan will not be underwritten to the eligible organization's standards. Accordingly, the final rule amends current
The Board requested comment in the proposal on whether there are certain types of transactions that should be excluded from the interpretation above. In particular, the Board asked whether there are transactions in which eligible organizations acquire loans through indirect lending arrangements, but the third parties making the loans do not act as administrative functionaries processing the loan on behalf of the eligible organizations, and the third parties' activities are not part and parcel, and an extension, of the eligible organizations' lending operations. If there are transactions of this type, commenters were asked to explain why they should be excluded and provide information about the transactions and the specific activities undertaken by the parties.
Public Comments
All comments received on this issue supported revising the definition of "originating lender" to codify the 2015 Opinion. One commenter recommended the NCUA amend the definition of "originating lender" further to recognize and separate the functions of the originator, initial lender and subsequent owner/purchaser. The commenter also recommended amending the definition to recognize the different point in time of the legal ownership of the loan even though such lending decisions are made in compliance with the underwriting stipulations of the credit union that buys the loan after the initial funding of the loan by the fintech/flow partner. The commenter suggested these additional changes are important because they would (a) follow the legal ownership of the loan, (b) place the responsibility on the originator to comply with the requisite regulations--for example,
Another commenter asked that the NCUA clarify further in the definition whether both the indirect loan source (e.g., dealer) and the purchasing credit union are "originators," because the current language could cause interpretive confusion and raise questions as to Call Report instructions and other areas regarding what the scope of origination is versus other types of indirect lending, such as correspondent mortgage lending. The commenter explained that the language "from the loan originator" in the definition suggests that when a broker closes a loan in the credit union's name it is not an indirect loan, while prior interpretations have suggested that it might be. The commenter recommended, in particular, that the NCUA not use the word "originator" in the definition as it relates to sources of indirect loans because it introduces confusion about the meanings of terms under the 2015 Opinion and prior doctrine.
Discussion
The comments received regarding the changes to the definition of "originating lender" all generally supported the proposed change. The NCUA did, however, receive comments requesting additional changes to the proposed definition of "originating lender" and the associated definition of "indirect lending arrangement" in
Some commenters requested additional clarification regarding the relationship between the originating lender and indirect lender. The term "originating lender" is defined in the final rule as the participant with which the borrower initially or originally contracts for a loan and who, thereafter, concurrently with the funding of the loan, sells participations to other lenders. Originating lender includes a participant that acquires a loan through an indirect lending arrangement as defined under
Under
FOOTNOTE 73 78 FR 37946, 37948 (
FOOTNOTE 74 Id. at 37949. END FOOTNOTE
Additional concerns? The Board requested comment in the proposal on whether there are other factors, changes, safety and soundness, or compliance implications the NCUA should consider related to the proposed amendments to the definition of "originating lender." The Board asked further whether there are structural, safety and soundness, or compliance concerns that would warrant considering that the addition of intermediaries in loan origination transactions, including CUSOs, precludes a credit union assignee from being considered the originating lender under the revised definition in the proposed rule. Finally, the Board asked whether there are any additional safety and soundness or compliance implications concerning the proposed definition of "originating lender" that the Board should consider.
Public Comments
One commenter responded that, in many instances, CUSOs assist credit unions with various aspects of the loan origination process. The commenter explained that CUSOs may provide specific expertise (such as in member business loans) or other services to assist in credit unions making appropriate decisions; however, the credit union is still funding the loan according to its own guidelines (or as agreed upon through a CUSO) and should be considered the originating lender.
Discussion
The Board appreciates the comment above and notes that the final rule does not affect the ability of CUSOs to provide loan support services to FICUs under part 712 of the NCUA's regulations and that simply providing loan support services does not necessarily change what entity is the originating lender.
Section 701.22(e) Temporary Regulatory Relief in Response to COVID-19
From
FOOTNOTE 75 Emphasis added. END FOOTNOTE
FOOTNOTE 76 See 85 FR 22010 (
FOOTNOTE 77 85 FR 22010, 22010 (
Public Comments
Three commenters recommended the NCUA extend or permanently adopt expired section 701.22(e)'s higher loan participation purchasing threshold. One of the commenters suggested that loan participation agreements generally have high fixed costs and comparatively modest variable costs so a
Five commenters recommended the NCUA eliminate the limit on the aggregate amount of loan participations that may be purchased from any one originating lender altogether.
Discussion
The Board appreciates the comments that were submitted regarding expiration of the temporary regulatory relief under
Benefits of the temporary regulatory relief. The Board requested comments on the impact, if any, that was experienced due to the flexibilities provided in the temporary rule; whether the temporary rule had any effect on the participation markets; and whether there are safety and soundness or compliance implications related to the expiration of the flexibilities.
Public Comments
One commenter responded to the NCUA's questions by stating that the change did not have a material effect on credit unions because it was temporary in nature but noted that the change did allow some credit unions to manage their balance sheets in a more effective manner during the relief period. The commenter suggested further that credit unions that benefited from the temporary regulatory relief may now be unable to work with those sellers/buyers again even though they have established strong relationships due to expiration of the temporary regulatory relief.
Discussion
The Board appreciates the comment that was submitted regarding the benefits of the temporary regulatory relief under
Other comments on the loan participation rule. The Board also invited other recommendations it should consider in the loan participation rule. For example, the Board asked whether it should consider replacing prescriptive limits with principles-based requirements, consider removing the limit on the amount of loan participations that could be purchased from any one originating lender under current
Public Comments
One commenter responded to the NCUA's questions by stating that eliminating the prescriptive limits and replacing them with principles-based requirements allows credit unions the most flexibility in managing their balance sheets. The commenter suggested that credit unions have proven the ability to manage their risk levels with many other prescriptive limits being removed.
Discussion
The Board appreciates the comment above and will consider replacing prescriptive limits with more principles-based requirements where appropriate in future rulemakings.
Section 701.23 Purchase, Sale, and Pledge of Loans
As discussed in more detail in this portion of the preamble, this final rule makes several changes to current
In addition, the final rule adds new headings to a number of subparagraphs under
Public Comments
Several commenters specifically offered strong support for the proposed edits to
Each FICU that is party to a transaction may choose to categorize it as either a transaction under this rule [
Discussion
Consistent with the strong support received from commenters, the Board is adopting the changes to
Section 701.23 Introductory Paragraph
The Board added the introductory paragraph to
FOOTNOTE 78 78 FR 37946 (
FOOTNOTE 79 12 CFR 701.23(b)(2). END FOOTNOTE
FOOTNOTE 80 78 FR 37954-37955. END FOOTNOTE
The introductory paragraph to current
Since amending
The clause in the first sentence of the introductory paragraph to current
The final rule also removes the clause in the first sentence of the introductory paragraph to current
The second sentence in the introductory paragraph to current
The third sentence in the introductory paragraph to current
FOOTNOTE 81 Emphasis added. END FOOTNOTE
FOOTNOTE 82 Authorizing FCUs to purchase eligible obligations of a liquidating credit union's individual members, from the liquidating credit union. END FOOTNOTE
For the reasons outlined in the preceding paragraphs, the final rule amends the introductory text of
Public Comments
Three commenters specifically expressed their support for the clarifying amendments to the introductory paragraph to
Discussion
The comments received on the changes to the introductory paragraph to 701.23 were strongly supportive. The comment requesting that the Board allow purchases of certain eligible obligations prior to the borrower becoming a member goes beyond the scope of the proposal. Accordingly, the Board is adopting the changes to the introductory paragraph as proposed for the reasons set forth in the notice of proposed rulemaking.
Section 701.23(a) Definitions
The final rule, in addition to other changes discussed below, amends current
Eligible obligation.
The final rule amends the definition of eligible obligation under
FOOTNOTE 83 See, e.g., [Sec.]
FOOTNOTE 84 Section 1757(13) (authorizing FCUs, in accordance with rules and regulations prescribed by the Board, to purchase, sell, pledge, or discount or otherwise receive or dispose of, in whole or in part, any eligible obligations (as defined by the Board) of its members and to purchase from any liquidating credit union notes made by individual members of the liquidating credit union at such prices as may be agreed upon by the board of directors of the liquidating credit union and the board of directors of the purchasing credit union, but no purchase may be made under authority of this paragraph if, upon the making of that purchase, the aggregate of the unpaid balances of notes purchased under authority of this paragraph would exceed 5 per centum of the unimpaired capital and surplus of the credit union[.]). END FOOTNOTE
FOOTNOTE 85 The new definition of eligible obligation excludes notes held by a liquidating credit union. END FOOTNOTE
The final rule also amends the definition of eligible obligation to clarify that the term includes a whole loan or part of a loan. The NCUA has long held the position that the term "eligible obligation" includes loans, in whole or in part, provided the loan does not meet the definition of a loan participation under
FOOTNOTE 86 See 78 FR 37946, 37948 (
Current
The final rule also amends the definition of "eligible obligation" to remove the words "group of loans." The words are redundant because the term "eligible obligation" is used in its plural form, eligible obligations, throughout proposed and current
Public Comments
Four commenters specifically expressed support for the revised definition of eligible obligation as proposed. Two commenters recommended further clarifying the definition of eligible obligation. One of those commenters explained that further defining the term would allow credit unions the ability to understand the accounting and loss reserve ramifications on how the loan is sold. The commenter also asked the following two clarifying questions: (1) If a credit union sells a tranche in a portfolio of loans would this constitute an eligible obligation? And (2) what if a credit union sold just the interest portion of a loan?
Discussion
The comments received on the revised definition of eligible obligation were generally supportive. Two commenters did request further clarifying the definition; however one commenter did not specify what aspects of the proposed definition were confusing or how the definition could be clarified. The other commenter asked questions, which are addressed below. Given the lack of objections to the proposed definition, other than general requests for further clarification, the Board is adopting the definition of eligible obligation as proposed for the reasons set forth in the notice of proposed rulemaking.
Regarding the commenter's questions about selling a tranche in a portfolio of loans or only selling the interest receivable of a loan, the transaction must qualify for derecognition under generally accepted accounting principles (GAAP). Additionally, when a loan is sold in part under either [Sec.]
FOOTNOTE 87 Note that the definition of a participation interest under GAAP (see ASC 860-10-40-6A) is not the same as the definition of a loan participation under
Liquidating credit union.
The final rule adds a definition of liquidating credit union to
FOOTNOTE 88 See Section 1757(13) (providing authority "to purchase from any liquidating credit union notes made by individual members of the liquidating credit union at such prices as may be agreed upon by the board of directors of the liquidating credit union and the board of directors of the purchasing credit union, but no purchase may be made under authority of this paragraph if, upon the making of that purchase, the aggregate of the unpaid balances of notes purchased under authority of this paragraph would exceed 5 per centum of the unimpaired capital and surplus of the credit union;" (emphasis added).). END FOOTNOTE
Accordingly, the final rule provides that liquidating credit union means, (1) in the case of a voluntary liquidation, a credit union is a liquidating credit union as of the date the members vote to approve liquidation; and (2) in the case of an involuntary liquidation, a credit union is a liquidating credit union as of the date the board of directors is served an order of liquidation issued by either the NCUA or the state supervisory authority.
Public Comments
Four commenters expressed general support for adding the proposed definition of liquidating credit union.
Discussion
Given the support received from commenters, and the lack of objections, the Board is adopting the definition of liquidating credit union as proposed.
Should other terms be defined? The Board requested comment on whether there are additional terms used in
Public Comments
Two commenters responded that the NCUA should not define the term "empowered to grant." One of the commenters explained that the term should remain undefined so it can be sufficiently flexible to fully incorporate credit unions' currently recognized lending authorities and all those the NCUA recognizes in the future. On the other hand, one commenter responded that the term "empowered to grant" should be defined. The commenter explained that the term has a particular bearing on credit union activity under
One commenter asked that the NCUA define the term "notes" to avoid any future confusion regarding the purchase of notes of liquidating credit unions. Another commenter specifically recommended the term "notes" not be defined or clarified further.
Discussion
The Board appreciates the detailed comments submitted regarding defining additional terms in
In
FOOTNOTE 89 OGC Op. 04-0713 (
FOOTNOTE 90 Id. END FOOTNOTE
Section 701.23(b) Purchase of Loans
Current
Section 701.23(b)(1)
Section 701.23(b)(1)(ii)
Current
Public Comments
One commenter suggested that it understands keeping the 5-percent limitation on the purchase of these types of notes but believed the limitation could be eliminated because of (a) the relative rarity of liquidations, and (b) the NCUA's role in approval of purchase and assumption transactions to select those who can manage safety and soundness concerns.
Discussion
Section 107(13) of the FCU Act, which authorizes the purchases of notes of a liquidating credit union's members, provides that no purchase may be made under authority of this paragraph if, upon the making of that purchase, the aggregate of the unpaid balances of notes purchased under authority of this paragraph would exceed 5 per centum of the unimpaired capital and surplus of the credit union. Accordingly, the Board is adopting the changes to
Section 701.23(b)(1)(iv)
The word "mortgage" is misspelled in the first sentence of current
Section 701.23(b)(2) Purchase of Obligations From a FICU
The final rule amends current
The CAMELS rating and capital classification requirements were added to the NCUA's regulations as part of a 2001 final rule regarding the NCUA's RegFlex program. /91/ The 2001 final rule explained, in response to commenters suggestions that the requirements be removed, as follows:
FOOTNOTE 91 66 FR 58656 (
The Board continues to believe that CAMEL ratings and net worth ratios are the best measures of how well a credit union is managed and how much risk it presents to the NCUSIF and the credit union system. That is, consistent with safety and soundness concerns, credit unions with advanced levels of net worth and consistently strong supervisory examination ratings have earned exemptions from certain NCUA Regulations. /92/
FOOTNOTE 92 66 FR 58656. END FOOTNOTE
FCUs have generally managed their loan purchase, sale, and pledge activity well since the addition of the CAMELS and capital requirements and continue to do so. Approximately 12 percent of FCUs were engaged in the purchase, sale, or pledge of loans during 2022. /93/
FOOTNOTE 93 NCUA Call Report data for all FCUs as of the 2nd quarter of 2022. END FOOTNOTE
Additionally, the Board notes that this purchase authority is limited to purchases from a FICU. Therefore, the loans able to be purchased under this authority are already in the federally insured credit union system. Moving the obligation from one FICU to another FICU generally is not expected to result in a significant increase to the
Further, the current CAMELS and net worth restrictions are only applicable to a small segment of the credit union system given that the vast majority of FCUs have a CAMELS composite rating of 1 or 2 and are well-capitalized. /94/ Expansion of this authority would allow slightly more FCUs to purchase obligations from a FICU, potentially creating additional revenue and capital for the purchaser and providing an additional outlet for selling FICUs, creating additional liquidity channels in the credit union system.
FOOTNOTE 94 As of
The NCUA believes any increased risk associated with removing the CAMELS rating and capital classification requirements in current
Public Comments
Twenty-six commenters offered their support for eliminating the CAMELS rating and capital classification requirements for the reasons provided in the proposal. One commenter suggested the change would allow a greater flow of funds between FCUs and FISCUs. The commenter suggested further that credit unions with CAMELS ratings of three and lower are negatively impacted by their current inability to access this market and allowing purchases of these obligations will help move them into a higher CAMELS rating. Another commenter suggested the proposed change will allow more FCUs to purchase obligations from a FICU, potentially creating additional revenue and capital for the purchaser and providing an additional outlet for selling FICUs, creating additional liquidity channels in the credit union system. Several commenters suggested that the proposed change will make sure smaller credit unions can also gain access to these loans and obtain some much-needed additional return on assets. The commenters also suggested the proposed change will allow larger credit unions to manage balance sheet risk by selling some of these loans to other credit unions without jeopardizing their relationships with non-credit union originators.
Discussion
Given the strong support expressed by commenters, and the lack of objections, the Board is adopting the changes to
Section 701.23(b)(2)(ii) Notes of a
Current
Section 701.23(b)(3)
Section 701.23(b)(3)(ii)
The final rule amends the requirement in current
The Board acknowledges the requirement for the FCU to retain the written loan purchase agreement and schedule of the eligible obligations in the purchaser's office could imply that the written loan purchase agreement and schedule be retained in a hard-copy format, which is outdated given the current digital environment. An FCU might choose to store its records in electronic format, in the cloud, or housed in off-site servers or databases. An FCU must still make the loan purchase agreement and schedule of the eligible obligations covered by the agreement available upon request by the NCUA. /95/ Credit unions that have some or all of their records maintained by an off-site data processor are considered to be in compliance for the storage of those records if the service agreement specifies the data processor safeguards against the simultaneous destruction of production and back-up information. /96/ Accordingly,
FOOTNOTE 95 See SEC 749.2. END FOOTNOTE
FOOTNOTE 96 See appendix A to part 749. END FOOTNOTE
This change will align this requirement with the NCUA's regulations and guidelines for FICUs on records preservation programs. Under part 749, the NCUA does not require or recommend a particular format for record retention. If the credit union stores records on microfilm, microfiche, or in an electronic format, the stored records must be accurate, reproducible, and accessible to an NCUA examiner. /97/ If records are stored on the credit union premises, they should be immediately accessible upon the examiner's request; if records are stored by a third party or off site, then they should be made available to the examiner within a reasonable time after the examiner's request. /98/ The credit union must maintain the necessary equipment or software to permit an examiner to review and reproduce stored records upon request. The credit union should also ensure that the reproduction is acceptable for submission as evidence in a legal proceeding. /99/
FOOTNOTE 97 See 12 CFR 749.5. END FOOTNOTE
FOOTNOTE 98 12 CFR part 749, app. A. END FOOTNOTE
FOOTNOTE 99 See generally part 749; and NCUA Legal Op. 07-0812 (
Public Comments
Two commenters specifically offered support for aligning the requirements in [Sec.]
Discussion
Given the strong support expressed by commenters, and the lack of objections, the Board is adopting the changes to
Section 701.23(b)(4)
The final rule amends current
Section 701.23 provides both the regulatory authority for purchases of eligible obligations by an FCU and the limitations. Under the current rule, the 5-percent limitation applies to eligible obligations purchased by an FCU under
The statutory source of the 5-percent limitation is section 107(13) of the Act. /100/ Section 107 generally enumerates the powers of FCUs, and paragraph (13) authorizes an FCU to make certain loan purchases. Specifically, paragraph (13) provides the following authority, verbatim: in accordance with rules and regulations prescribed by the Board, to purchase, sell, pledge, or discount or otherwise receive or dispose of, in whole or in part, any eligible obligations (as defined by the Board) of its members and to purchase from any liquidating credit union notes made by individual members of the liquidating credit union at such prices as may be agreed upon by the board of directors of the liquidating credit union and the board of directors of the purchasing credit union, but no purchase may be made under authority of this paragraph if, upon the making of that purchase, the aggregate of the unpaid balances of notes purchased under authority of this paragraph would exceed 5 per centum of the unimpaired capital and surplus of the credit union. /101/
FOOTNOTE 100 12 U.S.C. 1757(13). END FOOTNOTE
FOOTNOTE 101 Id. (emphasis added). END FOOTNOTE
Section 107(13) applies to the purchase of two mutually exclusive categories of loans-- "eligible obligations" (as that term may be defined by the Board) of the purchasing FCU's members and the "notes" of a liquidating credit union made to the liquidating credit union's members. The 5-percent limitation, however, applies solely to the second category of loans; that is, the notes of a liquidating credit union to its members. The statutory language specifies that "no purchase may be made . . . if, upon the making of that purchase, the aggregate of the unpaid balances of notes purchased under authority of this paragraph would exceed 5 per centum of the unimpaired capital and surplus of the credit union." /102/ The 5-percent limitation is specific to the "aggregate unpaid balances of notes" /103/ purchased "under authority of this paragraph" (that is, paragraph (13) of section 107). As italicized in the preceding quotes, the only notes authorized to be purchased pursuant to section 107(13) are those of a liquidating credit union to its members. Notwithstanding the ambiguity introduced by the reference to the entire "paragraph" (13) in the context of the 5-percent limitation, the following term "notes" narrows the required scope of its application to purchases from a liquidating credit union.
FOOTNOTE 102 Emphasis added. END FOOTNOTE
FOOTNOTE 103 Emphasis added. END FOOTNOTE
Despite the statutory wording, current
FOOTNOTE 104 12 CFR 701.23(a). END FOOTNOTE
The final rule also amends the definition of eligible obligations to reflect the revised scope of the 5-percent limitation. As discussed previously, the final rule revises the definition of eligible obligation to mean "a whole loan or part of a loan (other than a note held by a liquidating credit union) that does not meet the definition of a loan participation under
FOOTNOTE 105 Under the current definition of eligible obligation, there may be instances where the notes of the liquidating credit union members are also eligible obligations of the members of the purchasing FCU. The 5-percent limitation will apply to these loans as they fall within the more specific category of eligible obligations purchased from a liquidating credit union. END FOOTNOTE
The Board acknowledges that the current scope of the 5-percent limitation reflects or implies an alternate legal reading of the statutory language, which the Board recognizes as a plausible reading. The alternate reading hinges on the language providing that "no purchase may be made under authority of this paragraph." The term "this paragraph" encompasses paragraph (13) of section 107 in its entirety. This reading applies the 5-percent limitation to all instruments (eligible obligations and notes) purchased pursuant to paragraph (13). The current regulation reflects such an interpretation, and the Board has made past statements in support of this reading. /106/ This rulemaking constitutes a reconsideration of the NCUA's prior position. As noted, the NCUA has determined that the regulatory change made by this final rule is more consistent with the language of the FCU Act and is more aligned with the different safety and soundness considerations with respect to eligible obligations in general and notes purchased from a liquidating credit union.
FOOTNOTE 106 For example, the preamble to the 1979 final rule implementing the NCUA's eligible obligations authority contained the following statement: "The Administration feels that the language of Section 107(13) is clear, and that the best interpretation is that adopted in the proposed rule" (that is, the currently codified regulatory text). 44 FR 27068, 27070 (
This new reading is better supported by accepted canons of statutory construction. The statutory construction canon of "consistent usage" logically presumes that different words denote different ideas. /107/ Accordingly, the use of the terms "eligible obligations" and "notes" is intended to distinguish between two mutually exclusive categories of loans. Further, the canon holds that "a word or phrase is presumed to bear the same meaning throughout a text." /108/ The use of the word "notes" in paragraph 107(13) is appropriately interpreted consistently and exclusively to reference only notes made by a liquidating credit union to its members.
FOOTNOTE 107 Antonin Scalia &
FOOTNOTE 108 Id. END FOOTNOTE
This reading also aligns with the "surplusage" canon of statutory interpretation. Under this canon, "every word and every provision is to be given effect if possible." /109/ "No word should be ignored. None should needlessly be given an interpretation that causes it to duplicate another provision or have no consequence." /110/ This interpretation accounts for language subsequent to "under authority of this paragraph" that modifies the clause's scope. This subsequent language specifies that the prohibition applies only "if, upon the making of that purchase, the aggregate of the unpaid balances of notes purchased under authority of this paragraph would exceed 5 per centum of the unimpaired capital and surplus of the credit union." Thus, the limit's application is required only with respect to the purchase of "notes," which, as stated previously, is appropriately narrowed to solely cover loans made by liquidating credit unions to their members. Reading the statute to require application of the 5-percent limitation to "eligible obligations" conflates the terms "notes" and "eligible obligations," despite the different terminology
FOOTNOTE 109 Id. at 145. END FOOTNOTE
FOOTNOTE 110 Id. END FOOTNOTE
It also bears noting that the stated rationale for original enactment of the 5-percent limitation does not apply to the purchase of eligible obligations. The 5-percent limitation language in section 107(13) of the Act was added by
FOOTNOTE 111 Public Law90-375 (approved
FOOTNOTE 112 S. Rep. No. 1265, 90th Cong., 2d Sess., at 2 (
FOOTNOTE 113 Statement of
FOOTNOTE 114 H.R. Rep. No. 1372 (
The express authority to purchase eligible obligations was later added to the text of section 107(13) in 1977. /115/ The legislative history from that time shows the amendment was intended to provide FCUs with flexibility to use secondary market facilities to enhance liquidity, especially in relation to real estate loans. /116/ The purchase by an FCU of loans made to its own members is not analogous to, and does not pose the same inherent risk that, purchasing the notes of a liquidating credit union does. Accordingly, it is reasonable that
FOOTNOTE 115 Public Law 95-22 (approved
FOOTNOTE 116 H.R. Rep. No. 95-23, at 16 (
The 1977 legislative history in several instances also refers to the amendment granting FCUs the ability to purchase the "notes" of its members. One could infer from this that the term "eligible obligations" was intended to be read synonymously with "notes." /117/ This reading appears at least plausible because the broad category of "notes" could be seen to encompass various debt instruments, including notes or written documents evidencing a member's eligible obligations. Such a reading, however, is not required and is inferior to the interpretation the Board is proposing in this rule for two reasons. First,
FOOTNOTE 117 See, for example, 123 Cong. Rec. H 1521-32, at H-1524 (Daily ed.
FOOTNOTE 118 Scalia & Garner, supra note 7 at 64 ("[T]he purpose must be derived from the text, not from extrinsic sources such as legislative history or an assumption about the legal drafter's desires"). END FOOTNOTE
For the preceding reasons, the NCUA has determined that the regulatory change made by this final rule is more consistent with the language of the FCU Act. The NCUA also has determined that the amendment will not pose a safety and soundness risk due to the addition of principles-based risk management requirements. By amending the current rule to narrow the application of the 5-percent limitation to the aggregate of the unpaid balances of loans purchased from any source to instead apply to only the "notes" of a liquidating credit union, the Board intends to allow FCUs greater capacity, flexibility, and individual autonomy to establish their own risk tolerance limits for the amount of the loans of its members that can be purchased from any source other than a liquidating credit union. This includes other financial institutions, fintech companies, third-party loan acquisition channels such as CUSOs, and other loan-originating retailers.
While the narrower interpretation of section 107(13) of the Act will remove the existing limit on the amount of eligible obligations that an FCU could purchase, establishing risk management expectations will reduce potential risk to the
The final rule amends current
The Board invited comments concerning the proposed narrowing the application of the 5-percent limitation to only apply to the aggregate amount of "notes" that can be purchased by an FCU from a liquidating credit union.
Public Comments
Twenty-seven commenters specifically offered support for narrowing the 5-percent limitation to cover only notes of liquidating credit unions for the reasons provided in the proposal. Three commenters suggested the proposed change will allow credit unions, possibly through CUSOs and other collaborations, to build strong relationships with fintech companies, giving FICUs more tools to allow them to be a part of the lending system as it has evolved with the use of technology.
Discussion
Given the strong support expressed by commenters, and the lack of objections, the Board is adopting the changes to
Section 701.23(b)(5) Grandfathered Purchases
The final rule amends current
Accordingly, the final rule amends
Public Comments
One commenter specifically offered support for the proposed revisions to
Discussion
Given the support expressed above, and the lack of objections, the Board is adopting the changes to
New
The final rule adds new paragraph (b)(6) to
FOOTNOTE 119 A credit union's written loan purchase policies may be incorporated into the written lending policies required under
The specific policy requirements, which are discussed in detail below, are part of the basic fiduciary responsibilities and duties required of boards of directors. /120/ The requirements in the final rule address the basic elements necessary to administer a safe and sound loan purchase program.
FOOTNOTE 120 See [Sec.]
As discussed previously, the Board is adding new requirements under
The new requirements added by this final rule provide credit unions with expanded flexibility to develop loan purchase policies that are commensurate with the size, scope, type, complexity, and level of risk posed by the planned loan purchase activities. The new requirements are intended to provide principles-based requirements that are useful for credit unions of any size or complexity to implement the appropriate level of due diligence, risk assessment, and management.
When determining whether to start a loan purchase program and developing related written policies, credit unions should consider whether the loan purchase activities being contemplated are consistent with the FCU's overall business strategy and risk tolerances and financial and operational capabilities. Loan purchase, sale, or pledge activities that are inconsistent with the FCU's risk tolerance levels, represent undue risk in relation to the credit union's financial capacity, or beyond management's ability to manage can pose material risks to an FCU's financial or operational condition.
The risk management expectations outlined in this final rule reflect key components of long-standing supervisory expectations as communicated to credit unions through NCUA Letters to Credit Unions (LCU), Supervisory Letters, and the Examiner's Guide.
The Board requested comment on the following: (1) The new written purchase policy requirements in paragraph (b)(6) of the rule; (2) the principles-based due diligence, risk assessment, and risk management requirements and whether they are sufficient to offset the risk associated with removing the CAMELS rating and "well capitalized" requirements for a credit union to purchase and hold eligible obligations from a FICU; and (3) whether there are other principles-based safety and soundness or compliance criteria the Board should consider that would mitigate the risk of removing certain prescriptive requirements from the rule.
Public Comments
Several commenters offered general support for the proposed due diligence requirements. One commenter suggested that most, if not all, of these requirements are already done as a matter of course. Another commenter believed the proposed requirements will help limit prudential risks associated with FCUs' investments in eligible obligations in a safe and sound manner. In response to a question in the proposed rule preamble for commenters, one commenter stated that additional safety and soundness criteria (beyond those included in the proposed rule) would not be helpful or mitigate risk further. The commenter recommended, however, that the limits imposed under
Several commenters provided thoughts and recommendations regarding specific proposed due diligence requirements. One commenter suggested that requiring written purchase policies and established portfolio concentration limits seems prudent and valuable to ensure appropriate consideration by credit unions engaging in eligible obligation activity.
One commenter suggested that requiring a legal review of agreements seems unnecessary, as most credit unions already use legal counsel for the drafting or review of agreements, and those that do not perhaps have adequate internal expertise or expect to engage in a certain activity in such a modest way that it poses no material risk. The commenter suggested further that the requirement for legal review seems overly intrusive to a credit union's responsibility to understand and manage its risks. Another commenter recommended the NCUA further clarify the differences in what is required in the legal agreements for loan participations and eligible obligation purchases. The commenter noted that some of the requirements in the respective provisions (
Require that the written purchase agreement include, in the case of a servicing released transaction:
The following requirements referenced in the loan participation rule (
The following additional requirements not referenced in the loan participation rule (
Require that the written purchase agreement include, in the case of a servicing retained transaction:
The following requirements referenced in the loan participation rule (
The following additional requirements not referenced in the loan participation rule (
One commenter suggested that partnering with responsible third parties is often what is most suitable for the credit union and their members. The commenter encouraged the NCUA to refresh its view on conflicts-of-interest and shift to something more like "credit unions relying on third party underwriting performed by the seller or an agent of the seller could be operating in an unsafe and unsound manner and should establish and demonstrate clear risk management and oversight protocols."
Discussion
In recognition of the general support from commenters for this proposed change, the Board is adopting the revisions as proposed for the reasons set forth in the notice of proposed rulemaking. The Board does not believe that performing a legal review of the written purchase or sales agreements is burdensome because, as noted by one commenter, most credit unions already carry out such reviews. Additionally, while legal reviews may need to be conducted to ensure that the legal and business interests of the credit union are protected against undue risk, the final rule does not specify when legal reviews are required, only that the credit union's internal written purchase policies must address when a legal review of agreements or contracts will be performed to ensure that the legal and business interests of the credit union are protected against undue risk. This requirement should be based on the results of the due diligence and risk assessment processes completed for the planned activity. The determination as to when such a legal review would be required should be commensurate with the size, scope, type, complexity, and level of risk posed by the planned activity covered by the written agreement and contract.
When it is decided that a legal review by counsel is required, the credit union's attorneys should review the written agreement or contract to ensure that its legal and business interests are protected. The review should include the terms, recourse and risk-sharing arrangements, loan administration and controls. The credit union's attorneys should also make sure the board of directors and management clearly understand the rights and responsibilities of each party. For example, the review should indicate which party bears the costs of collateral disposition, and whether there are recourse arrangements, or a commitment for the purchasing credit union to make additional loan purchases and describe the interest being purchased. The legal review should also ensure that the requirements for a written loan purchase agreement under section
The credit union's board of directors and senior management should exercise their right to negotiate the terms of any agreements or contracts to make them mutually fair and equitable. Further, a credit union should understand what actions it may take if the contract is breached, or the seller, any sub-servicers, or sub-contractors are not performing as expected. The written loan purchase agreement is a critical component of any third-party transaction or relationship, and thus, a legal review is a key element in the overall risk mitigation and management process.
New
New
FOOTNOTE 121 Available at https://ncua.gov/regulation-supervision/letters-credit-unions-other-guidance. END FOOTNOTE
On several occasions, third-party relationships with credit unions have resulted in financial stress due to unexpected costs, legal disputes, and asset losses. Due diligence reviews are important because they assist credit unions in risk identification and mitigation when engaging with outside parties in a new loan program and when enhancing services to members. Failure to complete adequate due diligence can result in the acquisition of loan volumes that exceed the board's risk appetite or credit union's financial capacity, loan types that go beyond management's ability to manage, or loan types or volume that exceed the capabilities of current loan processing and management information systems. The use of third parties can add complexity and additional risk to a credit union's activities and may also expose the credit union to consumer compliance and other legal risks. For example, failure to conduct adequate due diligence could lead to an FCU entering into agreements with a third party that does not have the ability to fulfill its contractual obligations. This could lead to disruptions in member service, uncollected payments on loans, and potential losses if the third party fails to remit funds that are due to the purchasing FCU.
The responsibility to perform appropriate due diligence remains with the FCU's board of directors and management and cannot be outsourced. Overreliance on the due diligence information provided by a third party without independent review by the FCU's board and management could result in unsafe and unsound practices.
The final rule allows FCUs the flexibility to determine the level and depth of due diligence reviews that are necessary based on the level of risk posed by the loans being purchased and the third-party relationships. Several factors may be considered when determining the appropriate nature of due diligence for third-party loan purchases and programs, including the following:
* the transaction's complexity;
* the purchasing FCU's internal lending policies and procedures;
* the transaction's size relative to the FCU's existing loan portfolio, concentrations, and net worth level; and
* the purchasing FCU's management and staff expertise regarding the types of loans being purchased.
Additionally, FCUs can take a tiered approach when establishing their due diligence processes in their loan purchase policies. For example, when conducting background checks the FCU can determine how best to assess a third party's business reputation, potential conflicts of interest, experience, and compliance with federal and state laws, rules, and regulations based on the type of relationship with the third party and its risk exposure.
Accordingly, new
New
New
FOOTNOTE 122 Available at https://ncua.gov/regulation-supervision/letters-credit-unions-other-guidance. END FOOTNOTE
Adequate risk management processes include ongoing monitoring and oversight of the loan purchase program. This includes formal reporting to the board of directors and the FCU's senior management, which will ensure the board is able to fulfill its duties. An FCU's management reporting should be timely and commensurate with the size, complexity, and risk exposure of the FCU. For example, the board of directors should be informed when targets are met or exceeded, or limits breached. Reports should also consist of appropriate information that the board of directors and management could use to make informed decisions and take timely corrective action when warranted. For effective governance, an FCU's board of directors and senior management must understand the nature and level of risk associated with the FCU's purchased loan portfolio and program and receive periodic updates and reports on its performance.
The final rule provides FCUs the flexibility to tailor their risk assessment and management processes to fit within their governance framework and other operations, while providing a basic framework to follow when developing their initial and ongoing risk assessment and management processes. Accordingly, new
New
New
The FCU's internal policies must address the level of underwriting to be performed for the purchase of loans. Underwriting should identify all risks that could materially influence the purchasing FCU's decision to proceed with a loan purchase. Appropriate underwriting standards that adequately address how to analyze a borrower's ability to repay their loan and the support provided by collateral are a basic tenet of lending and help ensure that the FCU will be repaid, which protects its members and the
An FCU engaging in loan purchases should conduct an independent credit analysis and assessment of the borrower's creditworthiness and ability-to-repay, the support provided by collateral if relied on as part of the credit decision, and changes to the risk profile of the purchased loans. A purchasing FCU should not rely on the underwriting and analysis performed by the seller, or work performed by other third-party underwriters on behalf of a seller. To do so is an unsafe and unsound practice.
An FCU can leverage its current internal underwriting policies for similar loan types when developing its loan purchase policies. Performing credit and collateral analysis as if it were the originator should result in purchased loans that are consistent with the board of director's overall business strategy, risk tolerances, and credit quality standards. To the extent a purchasing FCU relies on a third party's credit models for credit decisions, the purchasing FCU should perform due diligence on the credit model. An FCU is not prohibited from relying on a qualified and independent third party to perform model validation. However, the purchasing FCU should review the model validation to determine if it is sufficient.
The purchasing FCU's internal loan purchase policies should outline and identify the loan types that are acceptable for purchase. For example, acceptable loan types could include residential real estate (one-to-four family or multi-family first lien and/or junior lien), solar loans, automobile loans, student loans, unsecured loans, out-of-territory loans, commercial loans, or government guaranteed loans (guaranteed and/or unguaranteed portion).
The loan purchase policy should address the level and depth of the underwriting and analysis that is required for loan purchase activities based on the specific loan category, type, size, complexity, and risk profile of the borrower. The proposed rule allows flexibility to establish those parameters, while providing a basic framework for FCUs to follow when developing their policies.
Accordingly, new
New
New
The written loan purchase agreement is a critical component of any third-party relationship. In addition to establishing the rights and obligations of each party to the loan agreement, it should clearly address how the relationship operates. The written loan purchase agreement should fully describe the roles and responsibilities of all parties to the agreement, including any subcontractors. A well-written loan purchase agreement should address dispute resolution, requirements for any ongoing credit information if necessary for the loan type, remedies upon loan default and bankruptcy, which party bears the costs of collateral disposition, whether there are recourse arrangements for early pay-off, and if there is an obligation for the purchasing FCU to make any additional purchases or credit advances.
The purchasing FCU's board of directors and senior management should understand that they may have limited control over credit decisions for loans purchased in part, including, for example, limitations on the ability of the purchasing FCU to participate in loan modifications, act on defaulted loans, or decline to make additional advances if the purchasing FCU deems such advances are not prudent in relation to the loan quality. The written loan agreement must address these circumstances, and other conditions under which the parties to the agreement may replace the servicer if services are not performed in accordance with the terms of the written loan purchase agreement. The purchasing FCU must also know the location and custodian for the original loan documents if the original loan documents are not required to be transferred to the purchasing FCU as part of the loan purchase transaction. The purchasing FCU could be required to provide the original loan documents to various parties involved in the administration and collection of the purchased loans. Therefore, the purchasing FCU needs to know where the original documents are located and whom to contact if the FCU needs to obtain the documents.
The written loan purchase agreement must, prior to the loan purchase transaction, identify the specific loan or loans purchased, and the interest purchased. A loan purchase transaction may involve a single or multiple loans, purchased in whole or in part. The documentation, for example, can be as simple as an addendum or schedule identifying each loan, provided the addendum or schedule is incorporated by reference into the loan purchase agreement. This provision clarifies in the existing rule that the loan purchase transaction involves the purchase of an individual loan or loans, and it is not the purchase of an investment interest in a pool of loans. FICUs should also keep in mind the requirements under GAAP for participation interests, which were discussed earlier in the part of the preamble about the changes to
Accordingly, for the reasons outlined in this portion of the preamble, new
New
New
An FCU's loan purchase policy should establish credit underwriting and administration requirements that address the risks and characteristics unique to the loan types permitted for purchase. An FCU's loan purchase policy concentration limits should be considered for the aggregate amount of total purchased loans, for each loan type, risk factor, or category permitted. For example, concentration limits can be set by loan or collateral type but may also be set by associated borrower, origination channel, geographic area, or other risk category as applicable.
An FCU's board of directors should establish concentration risk limits commensurate with its net worth levels and consider how the limits fit into the overall strategic plan of the FCU. When credit union loan portfolios are concentrated in a small number of loan products that are significantly exposed to similar or correlated risk factors, a single event can impact a large portion of the loan portfolio and result in elevated losses that, if not managed appropriately, can lead to the credit union's failure. Since the year 2000, more than 50 percent of the NCUA's postmortems and material loss reviews have cited concentration risk as a central component of credit union failures. An FCU's board of directors should use a comprehensive perspective when developing loan purchase concentration policy limits, including identifying outside forces (such as economic or housing price uncertainty) that would affect the ability to manage concentration risk. The parameters set by the board of directors should be specific to each portfolio and should include limits on loan types and third-party relationship exposure, at a minimum. The concentration risk limits should correlate to the FCU's overall growth objectives, financial targets, and net worth plan. The concentration risk limits set forth in the FCU's policy should be closely linked to those codified in related policies, including, but not limited to, real estate loans, member business loans, asset/liability management, and investment policies. Concentrations that exceed net worth must be monitored carefully, and the board of directors should document an adequate rationale for undertaking that level of risk. /123/
FOOTNOTE 123 See attachment to NCUA Letter to FICUs 10-CU-03 (
New
New
A legal review of the written loan purchase agreements and contracts will help an FCU ensure that the board of directors and senior management understand the rights and responsibilities of each party. For example, the review could identify which party bears the costs of collateral disposition, whether there are recourse arrangements, or whether the agreement includes a commitment for the purchasing FCU to make additional loan purchases and describe the interest being purchased. A legal review may also reduce a credit union's legal, compliance, or reputation risk by ensuring that the written loan purchase agreement complies with all applicable state and federal laws.
Further, an FCU should understand what actions it may take if the contract is breached or services are not performed as expected. For example, the legal review could determine if the written loan purchase agreements include recourse language that requires a seller to buy back loans with missing documents, made outside of policy, or otherwise not in conformance with representations and warranties. The written loan purchase agreement is a critical component of the third-party relationship and, as such, a legal review is a key element in the overall risk mitigation and management process.
Section 701.23(c) Sale
The final rule makes a non-substantive conforming change to current
Section 701.23(c)(1)
As required by the changes discussed in the following paragraphs, the final rule makes a conforming amendment to current
Public Comments
One commenter recommended amending proposed
Discussion
The Board did not propose substantive changes to
Section 701.23(c)(2)
The final rule amends current
This change will align
FOOTNOTE 124 See 12 CFR 749.5. END FOOTNOTE
FOOTNOTE 125 See generally part 749; and NCUA Legal Op. 07-0812 (
New
The final rule adds new paragraph (c)(3) to
Accordingly, new
Public Comments
One commenter noted their support for the proposed legal review requirement in
Discussion
In response to comments received, the Board is adopting the changes to
Section 701.23(d) Pledge
The final rule amends current
FOOTNOTE 126 See SEC 749.2. END FOOTNOTE
This change will align this requirement with the NCUA's regulations and guidelines for FICUs on records preservation programs. Under part 749, the NCUA does not require or recommend a particular format for record retention. If the credit union stores records on microfilm, microfiche, or in an electronic format, the stored records must be accurate, reproducible, and accessible to an NCUA examiner. /127/ If records are stored on the credit union premises, they should be immediately accessible upon the examiner's request; if records are stored by a third party or off site, then they should be made available to the examiner within a reasonable time after the examiner's request. The credit union must maintain the necessary equipment or software to permit an examiner to review and reproduce stored records upon request. The credit union should also ensure that the reproduction is acceptable for submission as evidence in a legal proceeding. /128/
FOOTNOTE 127 See 12 CFR 749.5. END FOOTNOTE
FOOTNOTE 128 See generally part 749; and NCUA Legal Op. 07-0812 (
Accordingly,
Section 701.23(g) Payments and Compensation
The final rule amends current
Section 701.23(i) Temporary Regulatory Relief in Response to COVID-19
The final rule does not extend the regulatory relief in
FOOTNOTE 129 Emphasis added. END FOOTNOTE
Public Comments
One commenter recommended the NCUA study the extent to which the flexibility provided in the expired temporary regulatory relief was used by credit unions, along with any increased risk associated with transactions made that would not otherwise have been permitted and consider providing such regulatory relief to address future system challenges that may not necessarily rise to the level of the COVID-19 pandemic.
Discussion
The Board appreciates the comments that were submitted regarding expiration of the temporary regulatory relief under
Section 714.2(b)
In the proposal, the Board requested comment on the placement of the definition of indirect leasing arrangement in
Although not raised by commenters, the Board believes the relationship between the indirect leasing provisions in
Section 714.9 [Removed and Reserved]
Current
IV. Regulatory Procedures
Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) generally requires that, in connection with a final rulemaking, an agency prepare and make available for public comment a final regulatory flexibility analysis that describes the impact of the final rule on small entities. A regulatory flexibility analysis is not required, however, if the agency certifies that the rule will not have a significant economic impact on a substantial number of small entities (defined for purposes of the RFA to include credit unions with assets less than
FOOTNOTE 130 See 80 FR 57512 (
The Board fully considered the potential economic impact of the changes made by this final rule during its development. As noted in the preamble, the final rule clarifies the NCUA's current regulations and provides additional flexibilities to FICUs, making it easier to take advantage of advanced technologies and opportunities offered by the fintech sector.
The final rule does not impose any new significant burden on FICUs and may ease some existing requirements. Small FICUs are not obligated to buy and sell eligible obligations and loan participations. Additionally, while the final rule introduces risk management and due diligence policy expectations, FICUs have the flexibility to tailor required processes and policies to fit within their existing governance framework and commensurate with their size and complexity. Accordingly, the NCUA certifies that this final rule will not have a significant economic impact on a substantial number of small FICUs.
Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) applies to rulemakings in which an agency by rule creates a new paperwork burden on regulated entities or modifies an existing burden. /131/ For purposes of the PRA, a paperwork burden may take the form of a reporting, disclosure, or recordkeeping requirement, each referred to as an information collection. The NCUA may not conduct or sponsor, and the respondent is not required to respond to, an information collection unless it displays a currently valid
FOOTNOTE 131 44 U.S.C. 3507(d). END FOOTNOTE
The rule as previously published contains information collections in the form of a written policy requirement and a transaction documentation requirement, covered by OMB control numbers 3133-0127 (Purchase, Sale, and Pledge of Eligible Obligations) and 3133-0141(Organization and Operations of Federal Credit Unions--Loan Participation). The proposed changes to part 701 did not affect the burdens under OMB Control Numbers 3133-0127 and 3133-0141. Adjustments to the burdens reflect a reduction in the current number of credit unions or to reflect a more accurate response rate per respondent. Under OMB Control Number 3133-0127, the number of respondents decreased; thereby, decreasing the burden to 1,830 annual hours. The NCUA estimates that the burden will increase, however, under OMB Control Number 3133-0141 by 4,994 annual burden hours because the responses per respondent will likely increase.
Executive Order 13132
Executive Order 13132 encourages independent regulatory agencies to consider the impact of their actions on state and local interests. The NCUA, an independent regulatory agency as defined in 44 U.S.C. 3502(5), voluntarily complies with the principles of the executive order to adhere to fundamental federalism principles. This final rule would reduce regulatory burdens on, and expand the authority of, federally insured credit unions, including federally insured, state-chartered consumer credit unions to purchase certain loans and loan participations. It may have, to some degree, a direct effect on the states, on the relationship between the federal government and the states, or on the distribution of power and responsibilities among the various levels of government. It does not, however, rise to the level of material impact for purposes of Executive Order 13132.
Assessment of Federal Regulations and Policies on Families
The NCUA has determined that this final rule will not affect family well-being within the meaning of section 654 of the
Small Business Regulatory Enforcement Fairness Act (Congressional Review Act)
The Small Business Regulatory Enforcement Fairness Act of 1996 (Pub. L. 104-121) (SBREFA) generally provides for congressional review of new agency rules that qualify as "major" under criteria specified in the Act. /132/ Analysis performed by the
FOOTNOTE 132 5 U.S.C. 801-804. END FOOTNOTE
List of Subjects
12 CFR Part 701
Advertising, Aged, Civil rights, Credit, Credit unions, Fair housing, Individuals with disabilities, Insurance, Marital status discrimination, Mortgages, Religious discrimination, Reporting and recordkeeping requirements, Sex discrimination, Signs and symbols, Surety bonds.
12 CFR Part 714
Credit unions, Leasing, Reporting and recording keeping requirements.
By the National Credit Union Administration Board on
Secretary of the Board.
For the reasons discussed in the preamble, the Board amends 12 CFR parts 701 and 714 as follows:
PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS
1. The authority citation for part 701 continues to read as follows:
Authority: 12 U.S.C. 1752(5), 1755, 1756, 1757, 1758, 1759, 1761a, 1761b, 1766, 1767, 1782, 1784, 1785, 1786, 1787, 1788, 1789. Section 701.6 is also authorized by 15 U.S.C. 3717. Section 701.31 is also authorized by 15 U.S.C.
2. Amend
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(c) * * *
(9) Indirect lending and indirect leasing arrangements--(i) Definitions.For purposes of this chapter, the following definitions apply:
Indirect leasing arrangement means a written agreement to purchase leases from the leasing company where the purchaser makes the final underwriting decision, and the lease agreement is assigned to the purchaser very soon after it is signed by the member and the leasing company.
Indirect lending arrangement means a written agreement to purchase loans from the loan originator where the purchaser makes the final underwriting decision regarding making the loan, and the loan is assigned to the purchaser very soon after the inception of the obligation to extend credit.
(ii) Indirect lending. A loan acquired pursuant to an indirect lending arrangement, and that meets the requirements of this section, is classified as a loan and not the purchase of a loan for purposes of this chapter.
(iii) Indirect leasing. A lease acquired pursuant to an indirect leasing arrangement, and that meets the requirements of part 714 of this chapter, is classified as a lease and not the purchase of a lease for purposes of this chapter.
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3. Amend
a. Revising the introductory text; and
b. Revising the definition of "Originating lender" in paragraph (a).
The revisions read as follows:
This section applies only to loan participations as defined in paragraph (a) of this section. It does not apply to the purchase of an investment interest in a pool of loans. This section establishes the requirements a federally insured credit union must satisfy to purchase a participation in a loan. Federally insured, state-chartered credit unions are required by
(a) * * *
Originating lender means the participant with which the borrower initially or originally contracts for a loan and who, thereafter or concurrently with the funding of the loan, sells participations to other lenders. Originating lender includes a participant that acquires a loan through an indirect lending arrangement as defined under
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4. Amend
a. Revising the introductory text, paragraph (a), the heading to paragraph (b);
b. Adding a heading to paragraph (b)(1) and (b)(1)(i);
c. Revising paragraph (b)(1)(ii);
d. Adding a heading to paragraphs (b)(1)(iii) and (iv);
e. Removing the word "mortage" from the first sentence in paragraph (b)(1)(iv) and adding in its place the word "mortgage";
f. Revising paragraphs (b)(2) introductory text, and (b)(2)(ii);
g. Adding a heading to paragraph (b)(3);
h. Revising paragraph (b)(3)(ii), and (b)(4) and (5);
i. Adding paragraph (b)(6);
j. Revising paragraphs (c)(1) and (2);
k. Adding paragraph (c)(3);
l. Revising paragraph (d)(1)(iii); and
m. Adding a heading to paragraphs (g) and (h)(1). The revisions and additions read as follows:
This section governs a Federal credit union's purchase, sale, or pledge of all or part of a loan to one of its own members, subject to certain exceptions. For purchases of eligible obligations, except as otherwise described under paragraph (b) of this section, the borrower must be a member of the purchasing Federal credit union before the purchase is made.
(a) Definitions. For purposes of this section:
Eligible obligation means a whole loan or part of a loan (other than a note held by a liquidating credit union) that does not meet the definition of a loan participation under
Liquidating credit union means:
(i) In the case of a voluntary liquidation, a credit union is a liquidating credit union as of the date the members vote to approve liquidation.
(ii) In the case of an involuntary liquidation, a credit union is a liquidating credit union as of the date the board of directors is served an order of liquidation issued by either the NCUA or the state supervisory authority.
Student loan means a loan granted to finance the borrower's attendance at an institution of higher education or at a vocational school, which is secured by and on which payment of the outstanding principal and interest has been deferred in accordance with the insurance or guarantee of the Federal Government, of a state government, or any agency of either.
(b) Purchase of loans. (1) Purchase of obligations from any source. * * *
(i) Eligible obligations. * * *
(ii) Notes of a liquidating credit union's individual members. Notes of a liquidating credit union's individual members, from the liquidating credit union;
(iii) Student loans. * * *
(iv) Real estate-secured loans. * * *
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(2) Purchases of obligations from a FICU. A Federal credit union may purchase and hold the following obligations, provided that it would be empowered to grant them:
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(ii) Notes of a liquidating credit union. Notes of a liquidating credit union, without regard to whether they are notes of the liquidating credit union's members;
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(3) Other requirements. * * *
(ii) A written agreement and a schedule of the eligible obligations covered by the agreement are retained by the purchaser; and
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(4) Five-percent limitation. The aggregate of the unpaid balance of notes purchased under paragraphs (b)(1)(ii) and (b)(2)(ii) of this section shall not exceed 5 percent of the unimpaired capital and surplus of the purchaser.
(5) Grandfathered purchases. Subject to safety and soundness considerations, a Federal credit union may hold any of the loans described in paragraph (b) of this section that were acquired before
(6) Written purchase policies. Purchases of eligible obligations and notes of liquidating credit unions must comply with the purchasing Federal credit union's internal written purchase policies, which must:
(i) Require that the purchasing Federal credit union conduct due diligence on the seller of the loans and other counterparties to the transaction prior to the purchase.
(ii) Establish risk assessment and risk management process requirements that are commensurate with the size, scope, type, complexity, and level of risk posed by the planned loan purchase activities.
(iii) Establish internal underwriting and ongoing monitoring standards that are commensurate with the size, scope, type, complexity, and level of risk posed by the loan purchase activities. Underwriting and ongoing monitoring standards must address the borrower's creditworthiness and ability to repay, and the support provided by collateral if the collateral was used as part of the credit decision.
(iv) Require that the written purchase agreement include:
(A) The specific loans being purchased (either directly in the agreement or through a document that is incorporated by reference into the agreement);
(B) The location and custodian for the original loan documents;
(C) An explanation of the duties and responsibilities of the seller, servicer, and all parties with respect to all aspects of the loans being purchased, including servicing, default, foreclosure, collection, and other matters involving the ongoing administration of the loans, if applicable; and
(D) The circumstances and conditions under which the parties to the agreement may replace the servicer when the seller retains the servicing rights for the loans being purchased, if applicable.
(v) Establish portfolio concentration limits by loan type and risk category in relation to net worth that are commensurate with the size, scope, and complexity of the credit union's loan purchases. The policy limits must consider the potential impact of loan concentrations on the purchasing credit union's earnings, loan loss reserves, and net worth.
(vi) Address when a legal review of agreements or contracts will be performed to ensure that the legal and business interests of the credit union are protected against undue risk.
(c) * * *
(1) The board of directors or investment committee approves the sale;
(2) A written agreement, and a schedule of the eligible obligations covered by the agreement, is retained by the selling credit union that identifies the specific loans being sold either directly in the agreement or through a document that is incorporated by reference into the agreement; and
(3) A review of the written agreement is completed that includes the terms, recourse, and risk-sharing arrangements, and, as applicable, loan administration and controls, to ensure that the selling Federal credit union's legal and business interests are protected from undue risks.
(d) * * *
(1) * * *
(iii) A written agreement covering the pledging arrangement is retained by the credit union that pledges the eligible obligations.
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(g) Payments and compensation--* * *
(h) Additional authority--(1) Expanded purchase authority. * * *
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PART 714--LEASING
5. The authority citation for part 714 continues to read as follows:
Authority: 12 U.S.C. 1756, 1757, 1766, 1785, 1789.
6. Amend
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(b) You may engage in indirect leasing as described under
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7. Remove and reserve
[FR Doc. 2023-20950 Filed 9-28-23;
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