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Letters to Regulators
Prompt Corrective Action; Corporate Credit Unions; Credit Union Service Organizations; Member Business Loans
June 3, 2003
une 3, 2003
Becky Baker, Secretary of the Board
Re: 12 CFR Part 702,703,712, and 723: Prompt Corrective Action; Corporate Credit Unions; Credit Union Service Organizations; Member Business Loans
Dear Ms. Baker:
The Independent Community Bankers of America (ICBA)1 appreciates the opportunity to offer the following comments on the National Credit Union Administration's (NCUA) proposed amendments to its member business loan (MBL) regulation.
The NCUA Board ("Board") is proposing several amendments to its member business loan (MBL) regulation to revise and clarify certain provisions that have caused, in the words of the Board, "confusion or created unnecessary regulatory burden." These include changing certain requirements for construction and development loan equity requirements, personal guarantees by principals, and unsecured MBLs; revising and clarifying provisions regarding MBL aggregate loan limits, loan-to-value requirements, loans to credit unions and credit union service organizations (CUSOs); and simplifying and removing unnecessary provisions in the MBL regulation.
The ICBA opposes the proposed changes in the NCUA's MBL regulation as contrary to federal law, and finds nothing in the legislative history of the Credit Union Membership Access Act (CUMAA) to support these changes. Instead of making credit unions safer as the NCUA Board asserts, these changes will subject credit unions to greater lending risks and divert them from their central mission of serving the credit needs of consumers.
CUMAA's Legislative History
Contrary to the Board's assertion, there is nothing in CUMAA's legislative history to support the relaxation of the Board's rules concerning credit union business lending. When CUMAA was adopted in 1998, Congress made it clear by imposing a percentage- of-assets cap on member business loans that it wanted to curtail business lending to ensure that credit unions focus on their mission of meeting the credit needs of consumers and to minimize the risk of losses to the National Credit Union Share Insurance Fund. For instance, in the report of the Senate Committee on Banking, Housing & Urban Affairs, the Committee stated the following with regard to Section 203 of CUMAA:
[T]he Committee has imposed substantial new restrictions on commercial business lending by insured credit unions. These restrictions are intended to ensure that credit unions continue to fulfill their specified mission of meeting the credit and savings needs of consumers, especially persons of modest means, through an emphasis on consumer rather than business loans. The Committee action will prevent significant amounts of credit union resources from being allocated in the future to large commercial loans that may present additional safety and soundness concerns for credit unions, and that could potentially increase the risk of taxpayers losses through the National Credit Union Share Insurance Fund.2
The additional views of Senators Hagel, Enzi and Reed reflect the fact that many in Congress thought that the new restrictions on commercial business lending were not strict enough and that even small amounts of business lending would be risky for credit unions. Senator Hagel said:
I am concerned that, as currently written, H.R. 1151 would have unintended negative consequences for credit union members and taxpayers. The legislation is risky for credit union members who rely on their credit union for small, consumer loans because it would allow credit unions to shift their focus from consumer service to large-scale commercial lending. Congress should place limits on commercial lending by credit unions-and those limits should be real.
Senator Enzi also expressed misgivings about the new restrictions in CUMAA when he said:
Commercial lending has generally been considered riskier business than consumer lending. From this notion comes the premise of restricting the amount of lending that can be used for commercial purposes. Even though H.R. 1151 limits commercial ending activity, the restriction in my belief is dubious at best.4
Senator Reed also had serious concerns with the new restrictions when he stated:
In view of these facts, I believe that commercial lending by credit unions should be limited. As such, I support provisions in H.R. 1151 that imposed an aggregate cap on commercial lending by credit unions of 12.25 percent of outstanding loans. However, I am concerned that this cap is too permissive and could have adverse safety and soundness implications in the future.5
The legislative history of CUMAA therefore expresses a clear concern that if there were no strict restrictions on commercial lending, credit unions might stray from their mission of meeting the credit needs of consumers. In addition, Congress wanted to impose these limits so that credit unions would not engage in these riskier lending activities that could put the National Credit Union Insurance Fund at risk.
The Board's Proposed Amendments
Excluding Loan Participations
The Board is proposing that (1) loan participations purchased by credit unions and (2) loan participations sold without recourse be excluded from the calculation of the aggregate MBL limit. Currently, the aggregate limit on a credit union's outstanding member business loan balances is the lesser of 1.75 times the credit union's net worth or 12.25% of the credit union's total assets.6 The Board believes that participation interests purchased by a credit union from an originating eligible organization are not loans made by the participating credit union. Since the Federal Credit Union Act states that "no insured credit union may make any member business loan…" in excess of the statutory limits, the Board believes that purchased participations can be excluded on the basis of this statutory language alone since credit unions are supposed to include in their aggregate limit only business loans made by a credit union.7 Furthermore, it is the Board's contention that the legislative history of CUMAA supports this interpretation as consistent with the congressional goal that credit unions fulfill their mission of meeting the credit and savings needs of consumers. In the Board's own words, " these participations diversify the risk of MBLs within the credit union system, ultimately making credit unions safer and better able to meet the needs of both consumer and small business members." The Board admits that this is a reversal of its past position on this issue.
ICBA believes that this is a strained interpretation of the aggregate MBL limit and finds nothing in the legislative history of CUMAA to support this interpretation. To the contrary and as shown above, the clear intent of Congress when it enacted CUMAA was to establish limitations on the member business loan activities of federally insured credit unions, based upon a belief that (1) credit unions should maintain their focus on consumer lending, not business lending, and (2) continued credit union safety and soundness requires restrictions in the area of business lending. In lieu of carrying out this intent, the Board is merely looking for ways to circumvent the MBL limit and increase the amount of business lending that credit unions can participate in. Instead of making credit unions safer, this change will only increase the interest and credit risks that credit unions are subject to.
The NCUA's interpretation of Section 1757a is also questionable. The definition of "member business loan" in subsection (c) is broad enough to encompass a participation in a loan purchased by a credit union as long as the proceeds for the loan are used for a "commercial, corporate or other business investment property or venture, or agricultural purposes."8 Just because the prohibition in Section 1757a(a) refers to credit union "making" a member business loan does not mean that only member business loans originated by a credit union should be counted towards the aggregate limit.
It is the contention of the ICBA that any business loan that qualifies as a member business loan under the statute, whether purchased or originated by a credit union, should be counted toward the overall aggregate limit on business loans. The purpose of the MBL restriction was clearly to limit the total credit exposure that credit unions have to any business lending. That exposure is the same whether the business loans are originated or purchased by a credit union. The ICBA urges the NCUA to reject this exclusion as being contrary to the very purpose for which these restrictions were adopted.
Since the NCUA is proposing to exclude from the aggregate MBL limitations both the sale and purchase of business loan participations, the ICBA also is concerned that these rules, if adopted, may be used by credit unions to circumvent the MBL limitation altogether. In effect, a credit union that engaged entirely in the business of buying and selling business loans could avoid the limits altogether, completely circumventing the law. This is far from the intent of Congress when it curtailed business lending under CUMAA.
Reducing Requirements on Business Loans
The Board is also proposing a reduction in equity interest held by the borrower in business loans, to remove the principal liability and guarantee requirement, to change the loan-to-value ratios, to loosen the standards for construction lending, to permit unsecured business lending and to amend the prompt corrective action rule regarding the risk weighting of MBLs. Collectively, these changes will only encourage credit unions to make more business loans and therefore will increase the risks of further losses to the National Credit Union Insurance Fund. As the Board points out in its release, more than half of all MBLs are real estate loans and these loans do expose credit unions to significant interest rate as well as credit risks. Permitting credit unions to make unsecured MBL loans, for instance, or removing the principal liability and guarantee requirement for MBL loans will only increase the credit exposure of credit unions.
Furthermore, many of the NCUA's justifications for these provisions are unfounded. For instance, the NCUA says that it decided to exclude MBLs made for the purchase of vehicles from the rule's loan-to-value requirements if the vehicle is a car, van, pick-up truck or sport utility vehicle that is used for commercial purposes. The Board's basis for doing this is because loans a credit union makes to purchase these vehicles for consumer use are not subject to the loan-to-value ratios required under the MBL rule. In the Board's opinion, these MBLs present little or only minimally greater risk than a comparable consumer loan. However, the Board does not cite any evidence to support that contention which, in the opinion of many bankers, is incorrect. A commercial loan secured by commercial vehicles is often riskier than a consumer loan and certainly can be more difficult to recover from if there is a default by the borrower.
The Board's proposal to remove the requirement for principals to provide their personal liability and guarantee on member business loans is contrary to the concept that a credit union be a cooperative of natural persons.9 Credit unions that primarily serve natural persons should not be in the business of making business loans to corporations or other business entities when those loans are not at least guaranteed by a principal. The Board argues that some credit unions lend to cooperative entities with hundreds of members, making it impractical to obtain personal guarantees from every principal. If that is the case, then the Board should make an exception just for business loans made to cooperatives. In the case of other types of business loans and in particular, corporate business loans, credit unions should still be required to have a personal liability or guarantee from a principal.
Expansion of CUSO Authority to Originate MBLs
Finally, the Board proposes to add business loan origination to the credit union service organizations (CUSOs) list of permissible activities. The Board believes that by authorizing CUSOs to engage in business loan origination, CUSOs will better serve credit union members by offering loans to members that their credit unions may be unable to grant. According to the Board, CUSOs are a good vehicle for these loans because MBL regulations and safe and sound underwriting practices require specialized lending experience and CUSOs would be in position to offer that specialized experience. Credit unions will be able to leverage their business loan expertise with CUSO business loan personnel.
However, if the proposal to exclude purchased participations is adopted and CUSOs are allowed to originate loans and then sell them, credit unions will be in the position to totally circumvent the MBL restrictions. The Board claims that this will not happen because, under the existing and proposed regulations, credit union purchases of loan participations must qualify as bona fide transactions that fulfill a business purpose before they can be excluded. However, this will not prevent credit unions from being able to purchase substantial amounts of loan participations from CUSOs. As long as some business purpose can be claimed (e.g., the need to diversify their loan portfolio, etc.), credit unions will be able to exploit this loophole.
Furthermore, this proposal will clearly expand the opportunity of credit unions to engage in riskier, large-scale commercial lending. Instead of hiring their own lending personnel, credit unions will be able to invest in CUSOs that specialize in originating business loans. This will give credit unions the opportunity to participate in large business lending programs in direct competition with commercial banks. This change is not supported by the legislative history of CUMAA which not only placed limits on credit union business lending but sought to limit the business lending that credit unions participate in to small, community businesses.
NCUA's Justifications for these Amendments to the MBL Rule
Some of the NCUA's justifications for these amendments to the Business Loan Rule are unfounded and have incensed community bankers. In a speech before the National Association of Federal Credit Unions on January 24, 2003, NCUA Board Member Deborah Matz said:
Credit union commercial lending is for members who want to start a home cleaning business or buy a dump truck or open an ethnic market. These are loans that banks won't make - not because they are risky, but because they are too small.
This assertion is clearly untrue. Community banks typically make business loans smaller than $100,000 particularly to farmers and other small businesses. Community banks are always prepared to lend to the small businessman. The assertion that the small business market is inadequately served by the community banking industry because banks will not make small loans is demonstrably false.
Congress never intended to allow the NCUA to relax the restrictions on credit union business lending that were adopted under CUMAA. Instead, Congress wanted credit unions to focus on serving the savings and credit needs of consumers. The NCUA's proposed amendments are nothing more than a way to circumvent the restrictions imposed by CUMAA. They will encourage credit unions to engage in business lending in excess of the statutory limits and, at the same time, will increase the risks to the National Credit Union Administration Fund, contrary to Congressional intent. The ICBA urges the NCUA to withdraw these proposals.
If you have any questions or need any additional information, please contact Chris Cole, ICBA's regulatory counsel at 202-659-8111 or Chris.Cole@icba.org.
1 ICBA is the primary voice for the nation's community banks, representing 5,000 institutions at more than 17,000 locations nationwide. Community banks are independently owned and operated and are characterized by attention to customer service, lower fees and small business, agricultural and consumer lending. ICBA's members hold more than $511 billion in insured deposits, $624 billion in assets and more than $391 billion in loans for consumers, small businesses and farms. They employ nearly 231,000 citizens in the communities they serve.
2 Senate Report 105-193, pp..9 -10.
3 Senate Report,/i> 105-193, p. 24.
4 Senate Report 105-193, p. 28.
5 Senate Report 105-193, p. 29.
6 12 CFR Section 723.16
7 12 U.S.C. 1757a(a)
8 12 U.S.C. Section 1757a(c)
9 12 CFR Section 723.7