CUNA Comment Letter

NCUA Board's Request for Comments on the Interim Final Rule on Member Business Loans

January 29, 1999

Ms. Becky Baker
Secretary to the Board
National Credit Union Administration
1775 Duke Street
Alexandria, VA 22314-3428

Re: NCUA Board's Request for Comments on the Interim Final Rule on Member Business Loans

Dear Ms. Baker:

The Credit Union National Association is pleased to respond to the National Credit Union Administration Board's Request for Comments on the Interim Final Rule on Member Business Loans, which appeared in the Federal Register on September 29, 1998. CUNA represents over 90% of the nation's more than 11,400 state and federal credit unions. Our Examination and Supervision Subcommittee and HR 1151 Advisory Group took the lead in developing CUNA's positions, which are reflected in this letter.

Summary of CUNA's Position

NCUA's interim final regulation is the result of statutory requirements imposed by Congress as part of the Credit Union Membership Access Act. We believe the current NCUA Board supports member business lending for credit unions as a legitimate activity that fulfills an important borrowing need for an appreciable number of members and that the Board has made a diligent effort to develop an interim member business loan regulation faithful to the Act.

CUNA strongly supports the objectives of the interim final rule, which are to "reduce regulatory burden, maintain safety and soundness, and provide an exception for qualifying credit unions from the statutory aggregate limit on a credit union's outstanding member business loans."

However, we believe the statute provides the NCUA Board with greater authority than it has utilized to effect the statutory exemptions. We urge the Board to adopt important changes as detailed in this letter, which will facilitate the ability of credit unions to qualify for one of the statutory exemptions, as Congress intended. Our recommendations are:

Importance of Credit Union Member Business Lending

While only 14% of credit unions make member business loans today, those engaged in this activity fulfill an important economic mission for their members. Member business lending has been an integral part of the activities of some credit unions from the earliest days of credit unions in the United States. CUNA strongly supports the ability of all credit unions to provide such loans to their members if they so choose, both now and in the future. We also support the NCUA Board's efforts to develop a final member business loan regulation that will allow credit unions to respond to their members' needs, while respecting the intent of Congress as expressed in the Act. As NCUA stated in the Supplementary Information accompanying the interim final regulation, "...(T)here is a strong public interest in permitting credit unions to continue to grant, and members to receive business loans"(63 Federal Register at 51794). We wholeheartedly concur.

New Statutory Provisions

Among other things, the interim final rule implements provisions of the Credit Union Membership Access Act, PL 105-219, "the Act" that govern member business lending. The Act defines MBLs; limits the total amount of outstanding MBLs a credit union may have at any one time; provides exceptions from the aggregate MBL limitations to facilitate such lending; gives credit unions over the aggregate limit that do not qualify for an exemption until August 2001 to conform to the limit; directs the NCUA Board to work with state regulators in implementing the MBL provisions for state credit unions; and requires the Treasury Department to study MBLs and report to Congress by August 1999.

During the development of the Act, Congress considered many proposals to eliminate member business lending or to impose drastic restrictions on such activity by federally insured credit unions. Congress accepted the credit union movement's arguments against the most egregious assaults, but provisions were incorporated into the Act that place statutory limits on MBLs if credit unions cannot meet at least one of the exemptions. CUNA strenuously opposed such limitations and will continue to seek legislative opportunities that will minimize or reduce the scope of the statutory limitations on MBLs found in the Act. We believe the interim final rule demonstrates the Board's intention to facilitate MBLs within the legal parameters of the Act. Our recommendations are likewise designed to foster MBLs while fully respecting all the requirements of the new law.

CUNA's Recommendations

The Act defines a "member business loan" as "any loan, line of credit, or letter of credit, the proceeds of which will be used for a commercial, corporate or other business investment property or venture, or agricultural purpose..." (12 USC 1257a(c)(1). In our view, the plain language of the statute does not encompass MBLs made by church-based credit unions. The structure of the language of 12 USC 1257 (a)(1) makes clear that the phrase "or other business" modifies the terms "commercial" and "corporate" that immediately precedes it. No one would think of any legitimate church as "commercial" or as being made for any "commercial business" purpose. And while some churches may be organized as corporations, any loan to such a corporation would not be for a "commercial business" purpose. The term "business" certainly implies for-profit activity. Loans provided to non-profit religious and service organizations and to other non-profit corporations are not the focus of the Act. In fact, we believe it is a reasonable interpretation of the Act to exclude any credit union's loan otherwise covered if made to a religious or charitable non-profit organization.

It could be argued that because Congress did not include loans to religious or charitable non-profit organizations in the five statutory exclusions that such loans should included as MBLs. We think the definition of MBL in the Act clearly excludes loans to non-profit organizations and thus, a specific exclusion would be redundant.

Our interpretation is also consistent with the intent of the Act regarding MBLs. The legislative history of the Act indicates the MBL provisions were added to HR 1151 in the Senate Banking Committee to address safety and soundness concerns -- even though such concerns were never substantiated. (In fact, the evidence shows member business lending under the current regulation has not resulted in safety and soundness problems, and certainly not of the magnitude suggested by MBL opponents during the development of HR 1151.)

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 ...losses through the National Credit Union Share Insurance Fund." (S. Rpt. 105-195 at 10.)

While member business lending in general has not proven to be risky, this is particularly true of church-based credit unions, given the small number of these institutions and the good track records of their church-related lending.

Rather than treating such activity as an MBL, we believe it should be addressed as a non-commercial loan or investment of the credit union. (Treating such activity as in investment would be consistent with the manner in which NCUA directs credit unions to account for and report loans to other credit unions.)

The Act allows a credit union to be exempt from the statutory limits on aggregate MBL activity if the credit union is or was "chartered for the purpose of" making such loans (12 USC 1757a(b)(1)). However, the interim final regulation interposes an additional requirement in order for a credit union to obtain such an exemption. That is, the credit union must show it was or is chartered "primarily" to make MBLs.

Congress could have easily included this word and thus imposed a stricter standard for this exemption, but it did not. In the very next phrase, Congress did include this term, and a credit union seeking an exemption on the basis of its MBL history must show "a history of primarily making MBLs."

The fact that Congress did not include the word "primarily" in the exemption based on a credit union's charter but did add it to the exemption regarding MBL history is a strong indication, we believe, that Congress did not intend for the NCUA Board to include this additional standard. We urge the Board not to rewrite 12 USC 1757a(b)(1), to include "primarily" when Congress did not mean for this word to be added.

The Act stipulates that the statutory aggregate MBL limits do not apply to "an insured credit union chartered for the purpose of making" such loans. As the legislative history demonstrates, an earlier version of HR 1151 considered by the Senate Banking Committee (which added the statutory limits on MBLs) provided an exemption for "an insured credit union that was chartered for the purpose of making" MBLs.

However, the Committee removed the word, "was," indicating that a new credit union chartered among other things to provide MBLs could qualify for the exemption. It also indicates, we firmly believe, that a federal or state chartered credit union could amend its charter to include an MBL purpose. We understand several state regulators, based on that analysis, have already permitted state credit unions substantially engaged in providing MBLs to revise their charters.

There is nothing in the Act that would preclude a similarly situated federal credit union from changing its charter to reflect an MBL purpose. The Supplementary Information accompanying the interim final rule states, "Due to the nature of federal chartering it is unlikely that many federal credit unions will qualify for this type of exception" (63 Fed. Reg. at 51797). This does not have to be the case.

We believe minor changes in the NCUA Board's chartering policies could allow a federal credit union to amend its charter. Appropriate documentation, such as a bylaw amendment, a copy of the Board's relevant meeting minutes or the Board's written rationale for changing its charter, could be supplied to NCUA to support the change.

Federal credit unions should also be afforded the opportunity to prove, if they can, that they were chartered in the past primarily for the purpose of making MBLs. For example, a transmittal letter or other charter-related documents a federal credit union has in its files and provided to NCUA as part of the chartering process in the past could provide evidence that a credit union was "chartered for the purpose of making" MBLs. In the rare cases where federal credit unions can document the appropriate history, they should not be precluded from doing so.

We urge NCUA to amend the rule to clarify that a federal credit union may show that it was or is chartered for the purpose of making member business loans and what the agency will consider as acceptable documentation to support such a showing.

Under the interim final rule, a credit union may qualify for an exemption from the statutory aggregate limit based on a "history of primarily making MBLs" if it has at least 25% of its outstanding loans in MBLs. We believe a credit union that originates sufficient loans to meet NCUA's threshold requirements, should qualify for the exemption even if it doesn't hold onto the loans.

Under the interim final rule, a credit union may qualify for the exemption. We believe NCUA has tried in good faith to set a threshold for qualifying for an exemption that gives meaning to the statute while facilitating member business lending. However, we believe the statute supports a more liberal interpretation to insure credit unions continue making member business loans. "The Committee intends for the Board to interpret the exceptions under new section 107A(b), to permit worthy projects access to affordable credit union financing" (S. Rpt. 105-193 at 10).

Regarding the phrase "a history of primarily making," neither Congress nor the legislative history has defined this term and thus, NCUA has the responsibility to effect this phrase in the context of its implementing regulation.

We believe a reasonable approach for the Board to take would be to take some guidance from the manner in which the Federal Reserve Board has defined the terms, "engaged primarily" under Section 32 and "principally engaged" in Section 20 of the Glass-Steagall Act.

Section 32 of the Glass-Steagall Act prohibits individuals who are "engaged primarily" in underwriting or other securities activities from serving as officials of Federal Reserve member banks. As recognized and upheld by the courts, the Federal Reserve's position that "primarily" in Section 32 and "principally" engaged in Section 20 of the Glass- Steagall Act both mean a "substantial activity" and "not necessarily first, chief or principal." (Board of Governors of Federal Reserve System v. Agnew, and Securities Association v. Board of Governors of the Federal Reserve System (SIA I and II).

For Section 32, the Federal Reserve Board originally defined the term" substantial activity" on a case-by-case basis. For purposes of Section 20, the Board defined that term as 5% or more of gross revenues (a covered securities activity of a company would be substantial if the company's revenues from such activities were at least 5% of gross revenues.) SIA I and II upheld the 5% level as reasonable, and this is still good law.

In December 1996, the Federal Reserve Board raised the Section 20 threshold to 25% (from the 10% level it adopted in 1987). The increase was not based on a legal constraint that required the Board to raise the threshold. Rather it was based on "the experience (the Board) has gained through supervision of the section 20 subsidiaries over a nine-year period " (61 Fed. Reg. at 68751).

Also, the Board raised the limit to facilitate underwriting. "The Board stated its belief that the limitation of 10% of total revenue it adopted in 1987, without benefit of this experience, had unduly restricted the underwriting and dealing activity of section 20 subsidies" (61 Fed. Reg. at 68751).

Just as the Federal Reserve Board is fully authorized to raise its threshold to 25% to facilitate underwriting, the NCUA Board has the authority to lower its interim final threshold to below 25% to facilitate MBLs. We believe an 18-20% level is fully justified, and is consistent with the court's interpretation of the Federal Reserve Board's authority to set thresholds under Sections 20 and 32 of the Glass-Steagall Act. Certainly, the Board is on the right track in looking to Federal Reserve Board's interpretation. However, we urge the NCUA Board to undertake a more careful analysis of the history and the courts' interpretations of the Federal Reserve Board's authority to set thresholds. We believe this will allow the Board to lower the 25% threshold to a more reasonable level, consistent with the Act.

Under the interim final regulation, a credit union could qualify for an exception if its MBLs constitute 25% of its outstanding loans based on a 1998 call report (filed before the effective date of the interim final rule) or any call report in the three prior years. While we support the Board's apparent objective to permit flexibility in qualifying for the exemption, we have a few concerns with this approach.

The effect of the Board's interpretation is that a credit union may not qualify for this exemption after September 29, 1998. The Board's interpretation is based on its reading of the Act, which states:

On and after the date of enactment of this section, no insured credit union may make any member business loan that would result in a total amount of such loans outstanding" that would exceed the MBL limit (12 USC 1757a(a)).

However, this subsection must be read with 12 USC 1757a(b) which provides: "Subsection (a) does not apply" if a credit union qualifies for one of the statutory exemptions.

We believe reading these subsections together allows a credit union which exceeds the limit after September 29, 1998 to qualify for an exemption based on evidence of a "history of primarily making" MBLs (until August 7, 2001, when all credit unions must bring their MBLs under the limit unless they qualify for one of the exemptions. For example, a credit union that makes an MBL or MBLs in 1999 that cause it to exceed the Act's limits should be entitled to show it qualifies for the exemption based on a 1999 call report, if it meets NCUA's threshold. It also should be able to count the MBL or MBLs that caused it to exceed the statutory limit.

We believe this interpretation is fully supported by the language of the Act and is consistent with the directive to NCUA in the Senate Report to facilitate "worthy" MBLs (S. Rpt. 105-193 at 10.)

A credit union may experience cyclical trends and increased consumer lending that would cause its MBLs to fail to meet the exemption test. Thus, we believe that NCUA should allow credit unions to qualify for the exemption using call report data prior to 1995 to show that they have a history of primarily making MBLs. For example, a credit union should be able to demonstrate that it qualifies for the exemption if in the last ten years, the credit union has met the threshold in any three of those years, as reflected in its call reports. NCUA has considerable discretion to structure the exemptions, and we believe this recommendation is within the scope of NCUA's reasonable authority under the Act.

Under the interim final regulation, a credit union may be exempted from the MBL threshold if its MBL activity represents its largest loan category. We believe that NCUA has authority to be more expansive in formulating this exemption to exclude credit unions from the MBL limits if such loans constitute their second largest loan category.

The language of the Act, which directs the NCUA Board to determine the scope of the exemptions as well as the Senate Report, justifies this interpretation. In addition, the description of the MBL exemptions by one of the Act's chief architects, Rep. Kanjorski, during debate on HR 1151 August 4, 1998, squarely supports this position:

Under the bill the NCUA has broad authority to determine whether a credit union is chartered for the purpose of, or has a history of primarily making, member business loans to its members. This broad authority is important because member business loans need not be the largest category of loans in order for a credit union to qualify for this exception. Member business lending merely needs to constitute a significant portion of the portfolio or a significant number of loans in order for the NCUA to determine that a credit union is eligible for this exception (144 Cong. Rec. H7045).

We urge the Board to amend the regulation to allow credit unions that have MBLs as their second largest loan category to qualify for the exemption.

Under the Act, NCUA is precluded from requiring credit unions to count loans of less than $50,000 as MBLs for purposes of determining whether a non-exempt credit union is complying with the statutory limits. However, we do not believe that the statute or legislative history requires NCUA to prevent a credit union from including loans of less than $50,000 in calculating whether it qualifies for a statutory exemption from the MBL limits.

The purpose of the MBL provisions is to minimize risk. Thus, loans under $50,000 are not included toward the statutory ceiling because they pose minimal or no safety and soundness concerns. However, such loans should be allowed to be included to show that a credit union has a history of making MBLs. Nothing in the Act prevents this interpretation. We believe this approach is consistent with the Act's intent to limit risk, because such action will have no safety and soundness implications. We believe the Act gives NCUA the regulatory discretion to allow this result, and we urge the Board to amend the rule to permit such loans to be included if a credit union chooses to do so in order to qualify for an exemption.

The interim final regulation does not address the issue of whether a credit union may use loan participations as means to facilitate MBL activities. Certainly the Act does not prohibit such an approach. In fact, we believe the Act gives NCUA broad authority to allow credit unions to use loan participations as a means to continue and increase their MBL activity.

Loan participations could be utilized in several important ways to support MBL programs. For example, under the interim final rule, loans sold without recourse are not counted when determining whether the limits on loans to one borrower have been met, while loans with recourse are counted. The NCUA Board should allow MBL participations to be treated similarly for purposes of calculating the amount of member business loans to reach the exemption threshold.

In addition, the NCUA Board should permit a credit union purchasing an MBL participation to classify the participation as an investment, rather than an MBL. If the Board determines that an MBL participation must be characterized as a loan, the NCUA Board should permit a credit union investing in the participation to exclude it from its total MBL amount if the loan were originated by a credit union that is exempt from the statutory MBL limits.

Some state chartered credit unions have raised the concern that NCUA might want to second guess or review exemptions from the MBL limits provided by state regulators. We believe that regulatory or Supplementary Information should clarify that if a state regulator has approved an exemption, NCUA does not have authority to overturn the state regulator's decision.

Other Issues

NCUA Should Raise the Appraisal Level

Under the interim final regulation, the NCUA Board requires credit unions to obtain a real estate appraisal for any residential loan over $100,000 and any MBL over $50,000. Other financial institutions are subject to appraisal requirements for residential loans of $250,000 or more and commercial loans of $1 million or more. We urge NCUA to review the appraisal threshold requirements for credit unions and bring its standards closer to those of the other financial regulators.

Applicability to State Chartered Credit Unions

The interim final rule clarifies that state chartered federally insured credit unions are not subject to the maturity limits that apply to federal credit unions, but rather must comply with state law requirements. We support this clarification, which was not included in the prior MBL proposal.

The interim final rule, as under the current regulation, allows a state chartered credit union to be exempt from NCUA's rule if its state regulator has developed a MBL rule that NCUA "approves." According to the interim final rule, the state's regulation must be substantially equivalent. The language of the Supplementary Information clarifies that "the Board recognizes the concerns of the state supervisory authorities.... the NCUA Board in reviewing a state's rule is concerned, as insurer, with the safety and soundness issues presented by the rule and not whether the language of the rule is virtually identical to NCUA's rule." (63 Fed. Reg. at 51802). We urge the Board to include this clarification in the regulation as stated in the Supplementary Information.

Conclusion

In conclusion, CUNA commends the NCUA Board for its efforts to implement the member business loan provisions of the Act in a fair manner, consistent with the new statutory requirements. We believe the agency has considerable discretion under the Act to develop a member business loan regulation that will allow credit unions to provide such loans in response to members' needs, both now and into the future. We urge the Board to amend its regulation to include these important changes we are recommending on behalf of credit unions and their members. If you have any questions, please telephone Eric Richard, Mary Dunn or William Hampel at (202) 682-4200.

Sincerely,


Daniel A. Mica
President and CEO

Cc: NCUA Chairman of the Board Norman D'Amours
NCUA Board Member Yolanda Wheat
NCUA Board Member Dennis Dollar