Subject of Possible Rule Making: (1) Revising rules of the Division of Credit Unions (DCU) on member business lending by state credit unions. This CR-101 supplements the CR-101 on the same subject matter filed by the director of the Department of Financial Institutions (DFI) on November 16, 1998, and published in the Washington State Register (WSR) at WSR 98-23-062.

     (2) Updating the "additional powers" granted by RCW 31.12.404(1).

Statutes Authorizing the Agency to Adopt Rules on this Subject: RCW 31.12.404(2), 31.12.436(1), 31.12.516(2), 43.320.040.

Reasons Why Rules on this Subject may be Needed and What They Might Accomplish: The purpose of this rule is to adopt a new rule on member business loans (MBL) made by Washington state-chartered credit unions (state credit unions), and to update the additional powers granted by RCW 31.12.404(1), as discussed in more detail below.

     (1) MBL: In 1998, DCU repealed its existing rules on MBL, at chapter 208-464 WAC, in anticipation that updated MBL rules would be adopted at a later time. The repeal was effected by the filing of a CR-103 by DFI on January 8, 1999, and published at WSR 99-03-009.

     State MBL Rules May Supersede NCUA's MBL Rules: All state credit unions are federally insured by the National Credit Union Share Insurance Fund (NCUSIF), administered by the National Credit Union Administration (NCUA). RCW 31.12.407. Among other requirements, the NCUA requires all federally-insured credit unions to comply with its MBL rules. 12 C.F.R. Section 741.203; 12 C.F.R. Part 723.

     The NCUA's MBL rules preempt the application of any less restrictive state MBL laws to federally-insured, state credit unions. However, the NCUA board may exempt state credit unions in a given state from NCUA's MBL rules if the NCUA approves the state's MBL rules for state credit unions (exemption determination). 12 C.F.R. Section 741.203(a), 723.20. Although in the past the NCUA would not issue an exemption determination unless the state MBL rules were virtually identical to the NCUA's, the NCUA has relaxed its standards for such a determination in Section 741.203(1) and 723.20.

     DCU believes that new state MBL rules should be adopted and that they should be submitted to the NCUA board for an exemption determination. DCU believes that MBL rules could be crafted that are more flexible than DCU's prior MBL rules, and more flexible than NCUA's MBL rules, while preserving the safety and soundness of state credit unions. More flexible rules will allow credit unions to better serve the needs of their members.

     DCU's new MBL rules will not take effect until the NCUA board has issued an exemption determination under 12 C.F.R. Section 741.203(a) and 723.20.

     Substance of DCU's New MBL Rules: DCU intends to use the NCUA's new MBL rules as a starting point for drafting DCU's new MBL rules. See the NCUA's final MBL rules at 64 Federal Register 28721, May 27, 1999.

     Included with this CR-101 is a preliminary draft of DCU's new MBL rules. DCU has worked with a task force of state credit union representatives to develop the preliminary draft.

     (2) Additional Powers: Washington state law grants state credit unions the powers and authorities conferred on federal credit unions as of December 31, 1993. Since that date, state credit union powers and authorities have fallen behind some powers and authorities of federal credit unions. State law permits the director by rule to update these additional powers for state credit unions, if the director finds that the exercise of the power or authority:

     1. Serves the convenience and advantage of members of credit unions; and

     2. Maintains the fairness of competition and parity between state and federal credit unions. RCW 31.12.404(2).

     The DCU intends to update these powers and authorities through this rule making. Included with this CR-101 is a preliminary draft of DCU's new wording to do so.

     (3) Regulatory Reform: DCU intends to review its rules through this and other rule-making proceedings, in accordance with Governor Locke's Executive Order 97-02 (EO 97-02) and DFI's regulatory improvement plan.

     EO 97-02 requires agencies to review their rules using the following criteria:

     A. Need. Is the rule necessary to comply with the statutes that authorize it? Is the rule obsolete, duplicative, or ambiguous to a degree that warrants repeal or revision? Have laws or other circumstances changed so that the rule should be amended or repealed? Is the rule necessary to protect or safeguard the health, welfare, or safety of Washington's citizens?

     B. Effectiveness and Efficiency. Is the rule providing the results that it was originally designed to achieve in a reasonable manner? Are there regulatory alternatives or new technologies that could more effectively or efficiently achieve the same objectives?

     C. Clarity. Is the rule written and organized in a clear and concise manner so that it can be readily understood by those to whom it applies?

     D. Intent and Statutory Authority. Is the rule consistent with the legislative intent of the statutes that authorize it? Is the rule based upon sufficient statutory authority? Is there a need to develop a more specific legislative authorization in order to protect the health, safety, and welfare of Washington's citizens?

     E. Coordination. Could additional consultation and coordination with other governmental jurisdictions and state agencies with similar regulatory authority eliminate or reduce duplication and inconsistency?

     F. Cost. Have qualitative and quantitative benefits of the rule been considered in relation to its cost?

     G. Fairness. Does the rule result in equitable treatment of those required to comply with it? Should it be modified to eliminate or minimize any disproportionate impacts on the regulated community? Should it be strengthened to provide additional protection?

     The DCU is interested in your comments on the MBL rules that DCU will develop in this rule-making proceeding in light of these criteria.

Other Federal and State Agencies that Regulate this Subject and the Process Coordinating the Rule with These Agencies: NCUA regulates MBL by federally-insured, state credit unions. However, as permitted by NCUA rules, and explained in more detail above, DCU's MBL rules may supersede the NCUA's MBL rules upon an exemption determination by the NCUA board. As indicated above, DCU's MBL rules will not take effect until the NCUA board has made such a determination. Consequently, state credit unions will not be subject to overlapping MBL rules at the state and federal level.

Process for Developing New Rule: The division solicits input from credits unions and related parties.

Interested parties can participate in the decision to adopt the new rule and formulation of the proposed rule before publication by providing comments and questions on the rules to Parker Cann, Director of Credit Unions, 210 11th Street S.W., Room 300, P.O. Box 41200, Olympia, WA 98504-1200, phone (360) 902-8778, fax (360) 704-8778, e-mail pcann@dfi.wa.gov.

July 21, 2000

John L. Bley

Director

OTS-3919.4

(1) Definition of MBL. "Member business loan" or "MBL" includes any loan, line of credit, letter of credit, or any unfunded commitment to make a loan, where the borrower intends to use the proceeds for any of the following purposes:

     (a) Commercial;

     (b) Corporate;

     (c) Investment property;

     (d) Business venture; or

     (e) Agricultural.

     (2) Exemptions. The following are not member business loans:

     (a) A business purpose loan fully secured by a lien on a one to four family dwelling that is the member's primary residence;

     (b) A business purpose loan fully secured by shares or deposits in the credit union making the extension of credit or in other credit unions, or by deposits in other financial institutions;

     (c) One or more business purpose loans to a member or any associated member which in the aggregate do not exceed the amount of fifty thousand dollars. The entire amount of such a loan that exceeds fifty thousand dollars, or that causes the aggregate to exceed fifty thousand dollars, is a MBL;

     (d) A business purpose loan where a federal or state agency or any of its political subdivisions fully insures repayment, or fully guarantees repayment, or provides an advance commitment to purchase in full; or

     (e) A loan granted by a corporate credit union to another credit union.

     (4) Other definitions. Certain other terms used in this chapter are defined in WAC 208-460-170.

[]

Reviser's note: The typographical error in the above section occurred in the copy filed by the agency and appears in the Register pursuant to the requirements of RCW 34.08.040.
NEW SECTION
WAC 208-460-020
What member business loans are prohibited?

(1) Who is ineligible to receive a member business loan? You may not grant a member business loan to the following:

     (a) Your chief executive officer (typically this individual holds the title of president or treasurer/manager);

     (b) Any assistant chief executive officers (e.g., assistant president, vice-president, or assistant treasurer/manager);

     (c) Your chief financial officer (comptroller); or

     (d) Any associated member or immediate family member of anyone listed in (a) through (c) of this subsection.

     (2) Equity agreements/joint ventures. You may not grant a member business loan if any additional income received by senior management employees is tied to the profit or sale of the business or commercial endeavor for which the loan is made.

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Unless the director grants a waiver, a credit union that makes MBL development or construction loans is subject to the following requirements:

     (1) The aggregate of all such loans may not exceed twenty percent of net worth. To determine the aggregate, you may exclude any portion of a loan:

     (a) Secured by shares or deposits in the credit union making the extension of credit or in other credit unions, and by deposits in another financial institution;

     (b) Insured or guaranteed by any agency of the federal government, state, or any of its political subdivisions; or

     (c) Subject to an advance commitment to purchase by any agency of the federal government, state, or any of its political subdivisions;

     (2) The borrower on such loans must have a minimum:

     (a) Thirty percent equity interest in the project being financed if the loan is for land development; and

     (b) Twenty-five percent equity interest in the project being financed if the loan is for construction or for a combination of development and construction;

     (3) The funds for such loans may be released only after on-site inspections, documented in writing, by qualified personnel and according to a preapproved draw schedule and any other conditions as set forth in the loan documentation; and

     (4) The credit union may not make such loans unless it utilizes the services of an individual with at least five years direct experience in development and construction lending.

[]

The board of directors must adopt specific member business loan policies and review them at least annually. The credit union must utilize the services of an individual with at least two years direct experience with the type of lending the credit union will be engaging in, except as required by WAC 208-460-030(4).

     Credit unions do not have to hire staff to meet the requirements of this section; however, credit unions must ensure that the expertise is available. A credit union can meet the experience requirement through various approaches. For example, a credit union can use the services of a credit union service organization, an employee of another credit union, an independent contractor, or other third parties. However, the actual decision to grant a loan must reside with the credit union.

[]

At a minimum, your member business loan policy must address the following:

     (1) The types of MBL you will make;

     (2) The maximum amount of your assets, in relation to net worth, that you will invest in MBL;

     (3) The maximum amount of your assets, in relation to net worth, that you will invest in a given type of MBL;

     (4) The maximum amount of your assets, in relation to net worth, that you will loan to a member or associated members, subject to WAC 208-460-070;

     (5) The qualifications and experience of personnel (minimum of two years) involved in making and administering loans;

     (6) A requirement for analysis and documentation of the ability of the borrower to repay the loan;

     (7) Receipt and periodic updating of financial statements and other documentation, including tax returns;

     (8) Documentation sufficient to support each request to extend credit, or increase an existing loan or line of credit, except where the board of directors finds that the required documentation is not generally available for a particular type of loan and states the reasons for those findings in the credit union's written policies. At a minimum, the documentation must include the following:

     (a) Balance sheet;

     (b) Cash flow analysis;

     (c) Income statement;

     (d) Tax data;

     (e) Analysis of leveraging; and

     (f) Comparison with industry average or similar analysis;

     (9) Collateral requirements, including:

     (a) Loan-to-value ratios;

     (b) Determination of value;

     (c) Determination of ownership;

     (d) Steps to secure various types of collateral; and

     (e) How often the credit union will reevaluate the value and marketability of collateral;

     (10) The interest rates and maturities of the loans;

     (11) General MBL procedures which include:

     (a) Loan monitoring;

     (b) Servicing and follow-up; and

     (c) Collection;

     (12) Identification of those individuals prohibited from receiving member business loans; and

     (13) Guidelines for purchase and sale of member business loans and loan participations, if the credit union engages in that activity.

     The division recognizes that all of the provisions of the policy may not apply to every MBL.

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(1) Unless the director grants a waiver:

     (a) All member business loans must be secured by collateral in accordance with this subsection (1), except the following:

     (i) A credit card line of credit granted to nonnatural persons that is limited to routine purposes normally made available under such lines of credit;

     (ii) A loan made by a credit union that meets each of the following criteria:

     (A) The amount of the loan does not exceed one hundred thousand dollars;

     (B) The aggregate of unsecured MBL under subsection (a)(ii) of this section does not exceed ten percent of the credit union's net worth; and

     (C) The credit union has a net worth of at least seven percent;

     (b) In the case of a member business loan secured by collateral on which the credit union will have a first lien, you may grant the loan with a LTV ratio in excess of eighty percent only where the value in excess of eighty percent is:

     (i) Covered through acquisition of private mortgage or equivalent type insurance provided by an insurer acceptable to the credit union; or

     (ii) Insured or guaranteed, or subject to advance commitment to purchase, by an agency of the federal government, state, or any of its political subdivisions;

     In no case may the LTV ratio exceed ninety-five percent;

     (c) In the case of a member business loan secured by collateral on which the credit union will have a second or lesser priority lien, you may not grant the loan(s) with a LTV ratio in excess of eighty percent; and

     (d) In the case of member business loans secured by the same collateral:

     (i) On which the credit union will have a first lien as well as other lesser priority liens, you may grant the loans with a LTV ratio in excess of eighty percent only if subsection (b)(i) or (ii) of this section is satisfied. In no case may the LTV ratio exceed ninety-five percent; and

     (ii) On which the credit union will have lesser priority liens but no first lien, you may not grant the loans with a LTV ratio in excess of eighty percent.

     (2) Unless the director grants a waiver, principals must provide their personal liability and guarantee, other than:

     (a) Principals of a not-for-profit organization as defined by the Internal Revenue Code (26 U.S.C. 501);

     (b) Principals of a nonnatural person that is the borrower on a credit card line of credit that is limited to routine purposes normally made available under such lines of credit;

     (c) Principals of publicly held corporations or partnerships;

     (d) Persons holding minority interests, unless no one person holds a majority interest; and

     (e) Principals of a borrower on an income property loan with a LTV ratio no greater than sixty percent and a debt service coverage of at least one and one-quarter percent.

[]

Unless the director grants a waiver for a higher amount, the aggregate amount of outstanding member business loans to a member or associated members may not exceed the greater of:

     (1) Fifteen percent of the credit union's net worth; or

     (2) One hundred thousand dollars.

[]

(1) Step 1. Calculate the numerator by adding together the amount of the member business loans to the member and associated members (if any). From this amount, subtract any portion:

     (a) Secured by shares or deposits in the credit union making the extension of credit or in other credit unions, or by deposits in other financial institutions;

     (b) Insured or guaranteed by any agency of the federal government, state, or any of its political subdivisions; or

     (c) Subject to an advance commitment to purchase by any agency of the federal government, state, or any of its political subdivisions.

     (2) Step 2. Divide the numerator by net worth.

[]

You may seek a waiver for a type of member business loan in the following areas:

     (1) Development and construction loan requirements under WAC 208-460-030;

     (2) Loan-to-value ratios under WAC 208-460-060(1);

     (3) Requirement for personal liability and guarantee under WAC 208-460-060(2);

     (4) Maximum loan amount to a member and associated members under WAC 208-460-070; and

     (5) Appraisal requirements under Section 722.3 of NCUA rules.

[]

(1) To obtain a waiver under WAC 208-460-090, a credit union must submit its request to the director. The waiver request must contain the following:

     (a) A copy of your member business loan policy;

     (b) The higher limit sought (if applicable);

     (c) An explanation of the need to raise the limit (if applicable);

     (d) Documentation supporting your ability to manage this activity; and

     (e) An analysis of the credit union's prior experience making member business loans, including, as a minimum:

     (i) The history of loan losses and loan delinquency;

     (ii) Volume and cyclical or seasonal patterns;

     (iii) Diversification;

     (iv) Concentrations of credit to a member and associated members in excess of fifteen percent of net worth;

     (v) Underwriting standards and practices;

     (vi) Types of loans grouped by purpose and collateral; and

     (vii) The qualifications of personnel responsible for underwriting and administering member business loans.

     (2) The director will:

     (a) Review the information you provided in your request;

     (b) Evaluate the level of risk to your credit union;

     (c) Consider your credit union's historical CAMEL composite and component ratings;

     (d) Notify you whenever your waiver request is deemed complete; and

     (e) Notify you of the action taken within forty-five calendar days of receiving a complete request.

     (3) In connection with a waiver request under WAC 208-460-090 (1) through (4):

     (a) The waiver is not effective until the director approves it;

     (b) If you do not receive notification within forty-five calendar days after the date the complete request was received by the director, the waiver request is deemed approved by the director; and

     (c) The director will promptly notify Region VI of the NCUA of his or her decision on the request.

     (4) In connection with a waiver request under WAC 208-460-090(5):

     (a) If the director approves the request, the director will promptly forward the request to Region VI of the NCUA for decision under NCUA rules at 12 C.F.R. 723.12;

     (b) The waiver is not effective until the regional director of the NCUA approves it in accordance with NCUA rules at 12 C.F.R. 723.12; and

     (c) The credit union may appeal the regional director's decision in accordance with NCUA rules at 12 C.F.R. 723.13.

[]

Nondelinquent member business loans may be classified based on factors such as the adequacy of analysis and supporting documentation. You must classify potential loss loans as either substandard, doubtful, or loss. The criteria for determining the classification of loans are:

     (1) Substandard. A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. The loan must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. It is characterized by the distinct possibility that the credit union will sustain some loss if the deficiency is not corrected. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans classified substandard;

     (2) Doubtful. A loan classified doubtful has all the weaknesses inherent in one classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include: Proposed merger, acquisition, or liquidation actions; capital injection; perfecting liens on collateral; and refinancing plans; and

     (3) Loss. A loan classified loss is considered uncollectible and of such little value that its continuance as a loan is not warranted. This classification does not necessarily mean that the loan has absolutely no recovery or salvage value, but rather, it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may occur in the future.

[]

The following schedule sets the minimum amount you must reserve for classified member business loans:

Classification	Amount Required
Substandard	10% of outstanding balance unless other factors (for example, history of such loans at the credit union) indicate a greater or lesser amount is appropriate.
Doubtful	50% of the outstanding balance.
Loss	100% of the outstanding balance.

[]

The aggregate limit on the amount of a credit union's member business loans is the lesser of:

     (1) One and three quarters times the credit union's net worth; or

     (2) Twelve and one quarter percent of the credit union's total assets.

[]

(1) Credit unions that meet any one of the following four criteria qualify for an exception from the aggregate member business loan limit in WAC 208-460-130:

     (a) Credit unions that have a low-income designation;

     (b) Credit unions that participate in the Community Development Financial Institutions program;

     (c) Credit unions that are chartered for the purpose of making member business loans, as supported by documentary evidence, such as the credit union's charter, bylaws, business plan, field of membership, board minutes and loan portfolio; and

     (d) Credit unions that have a recent history of primarily making member business loans, established by the fact that the outstanding balance of member business loans comprises:

     (i) At least twenty-five percent of the outstanding balance of the credit union's loans; or

     (ii) The largest portion of the outstanding balance of the credit union's loans.

     Such facts must be evidenced in an NCUA call report or any equivalent documentation, such as financial statements, for a period within two years before the date of application. For example, a credit union qualifies for the exception under subsection (d)(ii) of this section if, based on the outstanding balance of a credit union's loans, the credit union's loan portfolio is comprised of twenty-three percent member business loans, twenty-two percent first mortgage loans, twenty-two percent new automobile loans, twenty percent credit card loans, and thirteen percent total other real estate loans.

     (2) Unless the director gives his or her prior consent, a credit union granted an exception from the aggregate MBL limit may not make MBL in excess of the greater of:

     (a) Twelve and one quarter percent of the credit union's total assets; or

     (b) Three hundred percent of the credit union's net worth.

[]

(1) The exception under WAC 208-460-140 (1)(a) and (b) is effective upon written notice to the director of such designation or participation.

     (2) To obtain an exception under WAC 208-460-140 (1)(c) or (d), a credit union must submit its request to the director. An exception is not effective until it is approved by the director. The exception request must include documentation demonstrating that the credit union meets the criteria for one of the exceptions. The exception does not expire unless revoked for safety and soundness reasons by the director.

     (3) The director will promptly notify Region VI of the NCUA of his or her decision on the request.

[]

You must separately identify member business loans in your records and in the aggregate on your financial reports.

[]

For purposes of this chapter, the following definitions apply:

     (1) The "amount" of a MBL includes:

     (a) Any unfunded commitment to make the loan;

     (b) The outstanding balance of the loan; and

     (c) Any undisbursed proceeds of the loan.

     (2) A person is "associated" with another if they have a shared ownership, investment, or other pecuniary interest in a business or commercial endeavor.

     (3) A "business purpose" loan means a loan where the borrower intends to use the proceeds for any of the purposes listed in WAC 208-460-010(1).

     (4) "Development or construction loan" is a financing arrangement for acquiring real property or rights to real property, including land or structures, with the intent to develop or improve it for:

     (a) Residential housing for sale;

     (b) Income property;

     (c) Commercial use;

     (d) Industrial use; or

     (e) Similar uses.

     (3) "Immediate family member" is a spouse or other family member living in the same household.

     (4) "Loan-to-value ratio" or "LTV ratio" is derived by dividing:

     (a) The amount of all member business loans by the credit union and loans by other lenders secured by an item of collateral, by

     (b) The market value of the item of collateral.

     (5) "Member business loan" or "MBL" is defined in WAC 208-460-010.

     (6) "NCUA" means the National Credit Union Administration.

     (7) "Net worth" is retained earnings as defined under Generally Accepted Accounting Principles. Retained earnings normally includes undivided earnings, regular reserves and any other appropriations designated by management or regulatory authorities. Net worth does not include the allowance for loan and lease losses.

[]

Reviser's note: The typographical error in the above section occurred in the copy filed by the agency and appears in the Register pursuant to the requirements of RCW 34.08.040.
NEW SECTION
WAC 208-460-180
Effective date.

This chapter will take effect beginning on the date that the board of the NCUA determines that Washington state-chartered credit unions are exempt from NCUA's member business loan rules pursuant to 12 C.F.R. 723.20.

[]

OTS-4014.2

AMENDATORY SECTION(Amending WSR 97-23-071, filed 11/19/97, effective 3/19/98)

WAC 208-444-050
((Effective date.)) Update of additional powers.

((WAC 208-444-020, 208-444-030, and 208-444-040 will take effect on the date that these rules are determined by the Board of the National Credit Union Administration (NCUA) to be substantially equivalent to NCUA rules.)) (1) Notwithstanding any other provision of law, and in addition to all powers and authorities, express or implied, that a credit union has under the laws of this state, a credit union has the powers and authorities that a federal credit union had on December 31, 1993, or a subsequent date not later than (the effective date of this rule).

     (2) The restrictions, limitations, and requirements applicable to specific powers or authorities of federal credit unions apply to state credit unions exercising those powers or authorities permitted under this section but only insofar as the restrictions, limitations, and requirements relate to the specific exercise of the powers or authorities granted state credit unions solely under this section.

     (3) State credit unions exercising a power or authority under this section or RCW 31.12.404(1) should be:

     (a) Knowledgeable about the power or authority under federal law and applicable restrictions, limitations, and requirements in federal law; and

     (b) Be able to respond to examiners' questions with citations to the sources of the power or authority and applicable restrictions, limitations, and requirements.

     (4) As used in this section, "powers and authorities" include without limitation powers and authorities in corporate governance matters.

[Statutory Authority: RCW 31.12.535 and 43.320.040.      97-23-071, § 208-444-050, filed 11/19/97, effective 3/19/98 by letter filed as WSR 98-10-072.]

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