February 21, 2023
The Law Office of Michael S. Edwards on February 20, 2023 filed a comment letter in response to the National Credit Union Administration’s (NCUA) proposed rule on Financial Innovation: Loan Participations, Eligible Obligations and Notes of Liquidating Credit Unions that would amend Sections 701.21 (“Loans and Lines of Credit to Members”), 701.22 (“Loan Participations”), and 701.23 (“Eligible Obligations”) of NCUA rules. This office supported most aspects of this proposal because it would provide additional flexibility for federally insured credit unions (FICUs) to make use of advanced technologies and opportunities offered by the financial technology (fintech) sector as well as clarify ambiguities in existing NCUA rules. Our high-level comments included:
- Board Should Finalize Proposed Amendments to Section 701.23 Eligible Obligations Rule as Proposed: I strongly support the NCUA Board’s proposal to liberalize its Section 701.23 eligible obligations regulation by moving to a more principles-based rule. The Board should finalize these amendments as proposed.
- Board Should Remove CU Membership Requirement for Loan Participation Interests Purchased from Non-CUs: I urge the NCUA Board to lift the Section 701.22 loan participation regulation’s “membership requirement” for federal credit unions (FCUs) to be able to invest in a loan participation when the originator is not a credit union. Eliminating the requirement for a borrower to be a member of a credit union when the originator of the loan is a bank, CUSO, or other non-credit-union “eligible organization” is consistent with both the FCU Act and with NCUA regulations’ current treatment of federally insured state-chartered credit unions (FISCUs).
- CUs Should Have Discretion to Classify an Investment as Either a Loan Participation or an Eligible Obligation: I urge the Board to clarify in the final rule that investing FICUs have discretion to classify a partial interest in a loan acquired under either Section 701.22 or 701.23 when its terms and conditions meet both rules’ requirements.
- Loan Participations Structured as “Partial Assignments” Better Protect CUs Investing in these Items: The final rule should clarify that Section 701.22 loan participations can be structured as purchases of an economic participation interest in a loan or as a partial assignment of the loan. While I support giving FICUs the discretion to purchase either types of loan participation structure, as is current NCUA policy, purchases of “partial assignments” typically give credit unions better claims to these loans if the originator liquidates, is put into receivership, or declares bankruptcy.
- NCUA Should Regulate FICUs Selling Loan Participations: The final version of the loan participation regulation should apply to NCUA-regulated sellers, not just purchasers, when NCUA has jurisdiction over the seller.
- Final Rule Should Clarify that Sections 701.22 and 701.23 Apply Through the Life of the Loan: The final rule should codify NCUA Office of General Counsel Legal Opinion 18-0133, which clarified that these rules’ compliance obligations apply for the lifetime of the transaction, not just at the time of purchase, and that each separate loan participation or eligible obligation must be treated independently. Unless each loan is accounted for individually as a continuing compliance requirement for the servicer, FICUs purchasing (or even selling) loan participations may be short-changed and struggle to correctly account for the participations.
- Board Should Finalize Proposed Definition of “Originating Lender” With Clarifications: I strongly support the Board’s proposal to incorporate its indirect lending provision into Section 701.21(c)(9), which applies to FCU lending activities in general, as well as the Board’s proposal to codify NCUA Office of General Counsel Legal Opinion 15-0813, including the proposed definition of “originating lender” in Section 701.22(a). These amendments are consistent with longstanding NCUA policy and should be finalized as proposed with the following clarifications:
- FCU Makes “Final Underwriting Decision” Even When Indirect Lending Partner Applies Additional, More Restrictive Underwriting Criteria: The purchasing FCU should be 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. Indirect lending partners weeding out bad loans in this fashion promotes safety and soundness by reducing credit risk to FCUs, whether or not the indirect lender uses an algorithm and/or uses natural persons’ judgment to provide such credit enhancements.
- “Very Soon” Should Mean Before the First Loan Payment (Other than a Downpayment): Regarding the requirement that a loan be assigned to the purchaser “very soon after” the inception of the obligation to extend credit, to limit compliance burdens on FICUs by reducing regulatory uncertainty, I urge the Board to define “very soon after” to mean prior to the due date of the member’s first loan payment (other than any downpayment).