ANALYSIS: The NCUA recently amended its rules to improve the ability of federally insured credit unions (FICUs) to partner with financial technology companies. The final rule amends existing regulations regarding indirect lending, loan participations, and “the purchase, sale, and pledge of eligible obligations and notes of liquidating credit unions.”
As described by NCUA Board Chairman Todd Harper, “This new rule codifies several long-standing supervisory guidance letters on third-party due diligence, indirect lending, and loan participations, and it shifts the regulatory framework from a prescriptive structure to a principles-based system.”
According to the NCUA, the new rule:
- Relocates and clarifies the NCUA’s provisions regarding indirect lending and indirect leasing.
- Provides credit unions with additional flexibility to participate in loans acquired through indirect lending arrangements, allowing federally insured credit unions to use advanced technologies and opportunities offered by the fintech sector.
- Removes certain restrictions and other qualifying requirements relating to eligible obligations and provides credit unions with additional flexibility to purchase eligible obligations of their members.
The NCUA’s amendment is dense and covers several complex issues, but we want to stress one aspect of importance to credit unions involved in loan participation arrangements and indirect lending. Let’s start with a quick recap of what those terms mean:
- Indirect lending can take various forms. The most typical is an arrangement where a credit union contracts with a merchant to originate loans at the point of sale, such as an auto dealer, which then assigns the loan to the credit union. Other indirect lending relationships allow a third-party vendor such as a Credit Union Service Organization (CUSO) or other outside party to perform activities related to indirect lending: including underwriting, servicing, repossession, or insurance processing. For links to guidance and other resources, please see The League’s Compliance Topics A to Z page on indirect lending.
- A loan participation occurs when the ownership interests in a loan are divided up and sold. The NCUA rules (§701.22) allow FICUS to buy participation interests in loans if certain conditions are met. We summarize those NCUA rules (and some NCUA guidance) in The League’s ii Release No. B052.
The NCUA has strict requirements for loan participations, including this one: The “originating lender” must retain an interest in the loan – at least 5% or 10%, depending on institution type – for the life of the loan. The term “originating lender” has been defined to mean the participant with which the borrower initially or originally contracts for a loan and who sells participations to other lenders.
How does that work when an indirect loan is being participated? Is the dealer that makes the loan with the vehicle buyer the “originating lender,” or is it the credit union that takes assignment of the loan from the dealer? The NCUA had addressed this in previous guidance, but its new rule makes it clear: A FICU engaged in an indirect lending relationship can meet the definition of “originating lender” if 1) it makes the final underwriting decision regarding the loan and 2) the loan is assigned to the purchaser very soon after the inception of the obligation to extend credit.
This means that, if interests in that indirect loan were to be divided and sold as participation interests, the “originating lender” that must retain an interest in the loan would not be the indirect lending partner (i.e., the auto dealership); instead, it would be the credit union that partnered with them and made the final underwriting decision.
America’s Credit Unions (formerly CUNA & NAFCU, which have now officially merged) advises credit unions to keep these points in mind about compliance with the new NCUA rule:
How does that work when an indirect loan is being participated? Is the dealer that makes the loan with the vehicle buyer the “originating lender,” or is it the credit union that takes assignment of the loan from the dealer? The NCUA had addressed this in previous guidance, but its new rule makes it clear: A FICU engaged in an indirect lending relationship can meet the definition of “originating lender” if 1) it makes the final underwriting decision regarding the loan and 2) the loan is assigned to the purchaser very soon after the inception of the obligation to extend credit.
This means that, if interests in that indirect loan were to be divided and sold as participation interests, the “originating lender” that must retain an interest in the loan would not be the indirect lending partner (i.e., the auto dealership); instead, it would be the credit union that partnered with them and made the final underwriting decision.
America’s Credit Unions (formerly CUNA & NAFCU, which have now officially merged) advises credit unions to keep these points in mind about compliance with the new NCUA rule:
- The final underwriting decision must be made by the credit union and cannot be made by employees or contractors working for an indirect lending partner on the credit union’s behalf.
- 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.
- In all indirect lending transactions, credit unions should 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. This should be specified in the indirect lending agreement.
If you have questions about the NCUA’s new rule, or any other compliance issues, please contact The League’s Compliance Hotline at (800) 242-0833 or email.