Mr. Robert J. Kremer
Laurel Capital Corporation
3810 McKnight East Drive
Pittsburgh, Pennsylvania 15237
Re: FCU Financing of Leases of Business Equipment.
Dear Mr. Kremer:
You have asked if federal credit unions (FCUs) may engage in indirect leasing of business equipment. If so, you have asked if NCUA’s member business loan rule and its loan-to-value requirements would apply. FCUs may engage in the leasing of business equipment and must comply with the loan-to-value requirements of the member business loan rule if the transferred business lease financing (the Company is the transferor and the FCU is the transferee) is a capital lease1 as to the lessee member. A summary of your proposed leasing program and a discussion of related issues follows.
In your program, an FCU provides a list of member prospects to you (the Company) and the Company contacts the members. FCU members apply through the Company to the FCU for lease financing. The FCU evaluates the application and, if approved, the Company prepares lease documents for the Company and the member to sign. The leases are net, full-payout leases, with an option to purchase the property at the end of the lease, typically for a nominal amount ($1.00). After the FCU receives the assignment and security agreement from the Company, the FCU funds the Company’s designated bank account. The Company intends to assign all its right, title, and interest in the lease and leased property to the FCU. The Company will use the FCU funds to pay third party vendors or reimburse itself for equipment costs it already paid. The Company will also perform various services as the FCU’s agent, including invoicing, lease payment collection, tax collection and payment, and Uniform Commercial Code (UCC) filings. As compensation, the Company keeps the first and last lease payments, which the member pays when the lease is signed.
NCUA’s leasing regulation recognizes that FCUs may engage in the leasing of personal property and does not distinguish between consumer and business leasing. 12 C.F.R. Part 714. The authority of FCUs to engage in secured lending is the basis for their authority to engage in leasing. Therefore, FCU leasing generally must comply with the statutory and regulatory requirements applicable to secured lending, including the member business loan rule. 12 C.F.R. Part 723. Our leasing regulation, however, notes exceptions from certain provisions of the lending rules that are not pertinent to leasing, for example, the interest rate ceilings. 12 C.F.R. §§714.10, 701.21(c)(7). In a lease, the lessee’s payments are periodic rental payments, not the repayment of principal and interest as in a loan.
Our member business loan rule applies to “any loan, line of credit, or letter of credit” where the proceeds are for a business purpose as defined in the rule. 12 C.F.R. §723.1(a). You question how the loan-to-value (LTV) requirements of the member business loan rule can apply to business leasing. 12 C.F.R. §723.7. Our view is that, when the lease is a capital lease, the loan-to-value requirements apply just as they would to a business loan.
NCUA’s Accounting Manual for Federal Credit Unions (Accounting Manual) defines a capital lease, in part, as one where the lease transfers ownership of the property to the lessee at the end of the lease term or contains an option to purchase the leased property at a bargain price. Accounting Manual, §6080.2.1. A capital lease is one that “transfers substantially all of the benefits and risks of ownership of the asset.” Accounting Manual, §6080.2. As described above, your leasing program provides for capital leases. Unless waived by the regional director, an FCU may only advance 80% of the fair market value of the property at the time of purchase for a capital lease. An FCU may advance in excess of 80% of the fair market value if private insurance covers the excess. 12 C.F.R. §723.7. An FCU financing a capital lease must comply with the LTV requirements of the business loan rule so that a capital lease cannot be used to circumvent application of the requirements to a business loan for equipment.
We want to highlight two points about your indirect leasing program that you should address. Our leasing regulation requires that an FCU in an indirect leasing program purchase the lease, receiving a full assignment of all rights and obligations. 12 C.F.R. §714.2(b). The Non-Recourse Assignment and Security Agreement (Security Agreement) between the Company and an FCU is unclear on this point. Paragraph (1) of the Security Agreement provides for the Company to assign and grant a security interest in “Collateral,” which includes the “Lease Agreement.” The FCU must receive ownership of, not merely a security interest in, the lease. Also, the Security Agreement provides in paragraph (3) “this Agreement shall not relieve the Company from or cause the Credit Union to be liable for, the obligations of the Company under the Schedule or Lease.” While the Company, as the FCU’s agent, will perform certain Lessor obligations after assignment of the lease, your documentation must be clear that all of the lease, including associated obligations, is transferred to the FCU. The Company may agree, as a separate contractual matter from the transfer of the lease, to carry out certain specified obligations as the FCU’s agent under the Program Agreement or Agency Agreement.
The second point we want to highlight is that our leasing regulation has additional requirements for an indirect leasing program if the FCU does not become the owner of the leased property. 12 C.F.R. §714.3. Your correspondence indicates that the Company will assign title to the leased property to the FCU but the Security Agreement indicates that the Company will grant a security interest in the property. In addition, the UCC may treat the transaction between the Company and member as an installment sale rather than a lease. UCC §1-202(37). This is because your lease provides for the lessee to be able to purchase the equipment at the end of the lease for a nominal amount. As a result, the Company will be required to file as a secured creditor under Article 9 and the interest the Company transfers to the FCU will be a security interest rather than title.
Also, we note that your program provides for an FCU to identify members you can solicit to participate in the leasing program. An FCU will have to comply with the provisions of NCUA’s recent rule on the Privacy of Consumer Financial Information to be able to release this information to you. 12 C.F.R. Part 716. This rule will be effective November 13, 2000, although compliance is not required until July 1, 2001. A similar Federal Trade Commission (FTC) rule will affect your ability to use and reuse this information. 16 C.F.R. Part 313.
Finally, FCUs with assets of $10 million of more must account for the lease arrangement and the transfer of the lease arrangement (financial asset) consistent with generally accepted accounting principles. The transfer of the lease financing may need to be reflected at fair market value, which may be different that the transferor’s (the Company’s) recorded value. The credit union may need to consult with an independent accountant in applying GAAP to the lease assignment transaction.
Our review is limited to interpreting the Federal Credit Union Act and our regulations, and we offer no opinion on the permissibility of your program under other federal or state laws or the soundness of your program as a business venture. While our leasing rule only applies to FCUs, some provisions of our lending rules apply to federally-insured, state chartered credit unions. 12 C.F.R. §741.203(a). We suggest you consult with state regulators or private counsel if you have questions about the permissibility of your program for state-chartered credit unions.
Sheila A. Albin
Associate General Counsel
1 A lessee classifies a lease as either a capital lease or an operating lease. If a particular lease meets any one of the following four classification criteria, it is a capital lease (as to the lessee):
- The lease transfers ownership of the property to the lessee by the end of the lease term.
- The lease contains an option to purchase the leased property at a bargain price.
- The lease term is equal to or greater than 75 percent of the estimated economic life of the leased property.
- The present value of rental and other minimum lease payments equals or exceeds 90 percent of the fair value of the leased property less any investment tax credit retained by the lessor. The last two criteria are not applicable when the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property. If none of the above criteria is met, the lease is classified as an operating lease. NCUA Accounting Manual for Federal Credit Unions §§6080.2.1, 6080.3. The Accounting Manual may be downloaded from the NCUA website, www.ncua.gov.