Remarks by NCUA Vice Chair JoAnn Johnson at CUNA’s Governmental Affairs Conference

Washington Hilton and Towers
Washington, DC

February 25, 2003

Thank you for your invitation to address the Credit Union National Association’s annual Governmental Affairs Conference. I consider it a privilege. During this past year, I have enjoyed the opportunity to meet and listen to many credit union members from across the country. These meetings and my personal visits have reinforced my belief that credit unions, regardless of size, charter type, or the products and services offered, effectively serve as an alternative to for-profit financial institutions. I continue to work closely with your state Leagues and your national trade association, CUNA, which by any standard are first class organizations. Your federation of credit unions, leagues, and CUNA present a powerful and effective voice for your constituencies. I want to express thanks to the leadership and staff of CUNA for the support that has been provided to me during this past year. As you should, you all take your responsibility to the movement seriously, and your heartfelt advocacy and mission-focused lobbying create an environment for your perspective to prevail. I take my responsibility for maintaining the safety and soundness of credit unions seriously. Working together, we will do our best to have credit unions not only safe and sound, but ready to meet the challenges ahead. I look forward to continuing this positive working relationship.

During the past year, I have met with all types of credit unions -- small and large, occupational and community, federal and state, and have learned first-hand how individual credit unions are effectively tailoring their product and service offerings to best serve their individual memberships. I want to commend all of you on the great job you do in providing more than 81 million Americans the access to credit unions and their low-cost financial services. As your federal regulator and insurer, my number one responsibility is ensuring the safety and soundness of credit unions. While the number of credit unions declined at a rate of two and one-third percent last year, during this same period, credit union membership increased by more than two percent, and the total assets held by all federally insured credit unions increased by more than 11%. As of year-end, federally insured credit unions held more than $557 billion dollars in assets and maintained an average net worth ratio of 10.7%. Due to your diligent management, America’s credit union system is safe and sound.

Listening closely to your concerns and perspectives, I have maintained my commitment made to you last year that I would seek to be a facilitator for positive results. While I need assurance that the regulations placed on credit unions ensure safe and sound practices, it is my intention to create a regulatory environment, within the bounds of the laws provided, where credit unions can continue to meet the changing demands of their dynamic fields of membership.

One area that I have focused on this past year is reviewing the existing regulations we place on credit unions. First, I want to make sure that the regulations are necessary and effective. Second, if the regulations are necessary, I want to determine if any additional flexibility can be granted without compromising safety and soundness.

One way in which our agency reviews rules is through an existing program administered by our Office of General Counsel. Our staff has an on-going regulatory review process designed to update, clarify and simplify existing regulations and eliminate redundant and unnecessary provisions. Each year, we review one-third of our regulations, so that over the course of every three years each regulation has been reviewed. While visiting with credit unions and discussing the existing regulatory review program, I learned that the credit union community wasn’t always aware of the regulations being reviewed by NCUA. It was suggested to me that it would be helpful for the credit union community to be notified in advance of the regulations being reviewed, thereby allowing credit unions the opportunity to share their ideas or suggestions. Believing there is no monopoly on good ideas, I checked with our General Counsel’s office to determine if this information could be disseminated to the credit union community. After finding out that this information could be shared, I initiated a change in our policy that I expect to be formalized during one of our next board meetings. As a result of this, during the first part of each year our General Counsel staff will notify the credit union community of the regulations that are under review. Again, please share your thoughts and ideas with me. While safety and soundness considerations may not allow us to always accommodate your suggestions; an open dialogue can yield positive results.

Today, I would like to visit with you about my work relating to the member business loan regulation and how this fits well with President Bush’s plan to strengthen small businesses. President Bush’s plan for jobs and economic growth will benefit small business owners across the country. The President has called on Congress to act on his economic proposals to encourage our Nation’s entrepreneurs, speed up economic growth, and generate new jobs for American workers. By reducing taxes, encouraging investment, and removing obstacles to growth, I believe the President’s plan will strengthen our prosperity -- so small businesses can flourish and every American who seeks work has opportunity for a job.

Along with President Bush’s plan, the Small Business Administration recently issued a legal opinion to authorize all credit unions to apply for participation in the 7(a) guaranteed loan program. I commend SBA Administrator Hector Baretto’s commitment to extend access to more Americans for small business capital. The result is consistent with the Administration’s emphasis on expanding the pool of SBA lenders and focusing more attention on small borrowers. All credit unions will now be positioned to become SBA qualified lenders and offer government guaranteed loans to their members with small business plans and goals.

As of year-end, 1,584 or 16% of all federally insured credit unions were engaged in member business lending. This represents an increase of 39 credit unions from the previous year. These credit unions are providing a much needed service by assisting existing small business owners as well as start-up businesses with financing assistance. I understand that there is a higher level of risk associated with member business lending, and I realize that this type of lending is not appropriate for every credit union. However, I encourage credit unions’ management and boards of directors to explore this product offering to see if it will work with your membership. Credit unions interested in implementing a member business loan program must adopt specific business loan policies, utilize the services of individuals with at least two years direct experience with this type of lending, and have at least 6% net worth.

Credit unions have a wonderful opportunity to assist small businesses currently adding value to our society as well as those start-up businesses that may be future dreams of members. Many members have had a credit union relationship for years and their consumer needs have been fulfilled. However, some credit union members who desire to start a new or expand an existing business find that one of the largest obstacles they face is the ability to obtain the necessary financing. I have heard stories from credit unions that after building up a relationship for years, and taking care of their members’ personal finances, have had to send their members elsewhere to fulfill their financing needs to begin or expand their small business. This is where a true opportunity lies for certain credit unions.

Small businesses represent more than 99 percent of all employers and employ more than half of the private work force. Small business entrepreneurs create more than two out of every three new jobs and generate about 50 percent of the nation’s gross domestic product. Nearly 40 percent of small businesses are owned by women and close to 15 percent of America’s small business owners are minorities – and the trend of minority ownership is accelerating. One challenge that continues to be reported throughout the country is the difficulty for small business owners to find financing. Who better than credit unions to step up to the plate and assist these small business owners?

More than three million minority-owned small businesses are providing job opportunities for millions of Americans in thousands of communities across the country. President Bush is committed to creating an environment where small businesses can flourish. Credit unions are a perfect ally to assist small businesses with their financing and deposit services needs. With a focus on members’ small business lending, credit unions can play a pivotal role in helping to reinvigorate the U.S. economy. That is why I developed a working group within the Agency to think creatively on ways in which we might enhance our member business loan rule. The only requirements that I gave my working group were that the integrity of safety and soundness could not be violated and we must live within our statutory limitations.

Currently, the NCUA board may exempt federally insured state chartered credit unions from our rules if the state supervisory authority has submitted an individual state rule for NCUA approval. In order to approve the rule, NCUA must determine that the state rule minimizes risk and accomplishes the overall objective of the federal member business loan rule. Currently, there are 7 states (Texas, Washington, Missouri, Maryland, Wisconsin, Connecticut, and Oregon) that have their own rule. Four (Wisconsin, Connecticut, Oregon, and Texas) of these have been approved since I joined the board. Our General Counsel staff developed an analysis of the state rules and identified three areas where exemptions have been granted where the state rules are less restrictive than the federal member business loan rule. These three areas are: 1) permitting unsecured member business loans within established limits; 2) removing the personal guarantee requirement; and 3) reducing the borrower’s equity requirement on construction and development loans.

Our work with the member business loan rule is a good example of a vibrant dual chartering system. This regulation provides an opportunity for individual states to write rules for their respective credit unions. This very authority provides a mechanism for experimentation within the regulatory process, while still maintaining a commitment to safety and soundness. I support the idea of providing these three issues of parity to all federally insured credit unions and I expect that the NCUA Board will do that. However, rather than just addressing the issues of parity, I wanted to take the opportunity to thoroughly review the regulation to determine if any additional substantive changes could be accomplished.

I informed Chairman Dollar of my desire to study the member business loan regulation in more depth and requested that he delay placing this item on the board agenda until I completed a comprehensive study. He supported my request. In addition to my internal working group reviewing the regulation for potential enhancements, I also solicited suggestions from the credit union community, including your trade association-CUNA, and your organization’s Small Business Lending Committee, as well as NAFCU and NASCUS.

After several months at work on this issue, my working group developed a list of enhancements that I will be recommending at our March Board meeting. This proposed rule will be issued for a 60-day comment period and I encourage each of you to review the rule and let us know your thoughts. The NCUA staff that assisted me in this comprehensive review has worked diligently. My internal working group included: Bob Fenner and Christy Loizos representing the Office of General Counsel; Dave Marquis and Linda Groth representing the Office of Examination and Insurance; Ed Dupcak, representing the Office of Strategic Program Support and Planning; Mick Wheeler representing Region I and Gayle Peterson representing Region V. I want to thank these individuals for their hard work.

Today, I want to take a few moments to discuss three of the more substantive changes that I will be proposing. The first issue deals with loan participations and incorporates changes for loan participations sold without recourse and for loan participations purchased. First, I am proposing to clarify that a loan participation sold without recourse will not be included as part of the outstanding member business loan balance. This is a matter of incorporating a recent opinion into the regulation.

Second, and more importantly, I will be proposing to exclude the purchase of a business loan participation interest from the calculation of a purchasing credit union’s aggregate member business loan limit. This represents a change from our prior regulation. However, this change is permitted within the plain language and purpose of the statute, and it will contribute in a positive way to diversification of assets and overall safety and soundness.

The Federal Credit Union Act requires a credit union to include only member business loans it makes to its members in calculating its aggregate limit. Moreover, a credit union that purchases loan participation interests from other lenders does so as a means of investing its excess funds and bases its participation decision on normal investment considerations, including safety and return. As member-owned and controlled lenders, credit unions will purchase participation interests only after meeting their members’ own lending needs. I believe safety and soundness is improved by credit unions participating out their loans with other financial institutions. The due diligence analysis by the purchasing credit union enhances the overall creditworthiness process in credit union business lending. Furthermore, these participation interests diversify the risk of member business loans within the credit union system, ultimately making credit unions safer and better able to meet the needs of both consumer and small business members.

While I am proposing that these participation interests will not count towards the twelve and one-quarter percent aggregate cap, these loans will still appear on the books as a business loan and the credit union will be required to comply with all other parts of the regulation and subject these loans to the PCA risk-weighting standards as though the credit union had originated the loan. So again, in the area of loan participations, I am proposing two things. First, loans sold without recourse will not count as a member business loan and second, loan participations purchased will not count against a credit union’s twelve and one-quarter percent aggregate member business loan limit.

Another change being proposed deals with the issue of exempting member business vehicle loans from the 80% loan-to-value requirement. Under our current regulation, if a business owner has a member business loan with their credit union and they want to obtain a vehicle loan to be used for business purposes, the credit union is only able to finance 80% of the vehicle. My proposal will exclude these business vehicle loans from the 80% loan-to-value requirement. Car loans made to consumers can be financed up to 100% and this standard represents the current business market. Therefore, I believe that vehicle loans made for a business purpose should be able to be financed up to 100%.

Finally, let’s discuss my proposed change in the treatment of member business loans for prompt corrective action (PCA) risk-based net worth rules. Currently, the standard risk-based net worth component presently divides the portfolio of member business loans by a single threshold of twelve and one-quarter percent. The amount of member business loans less than or equal to twelve and one-quarter percent of total assets is risk weighted at 6% and the amount in excess of the threshold is risk-weighted at 14%. I am proposing to reduce the risk weighting of member business loans by extending the 6% risk weighted category from the current twelve and one-quarter percent of total assets up to 15% of total assets, and by introducing a middle tier, of 15 to 25% of total assets, that would be risk-weighted at 8% instead of the current higher 14% level. I’ll briefly explain the reasons for this change.

My working group reviewed the standard risk-based net worth component to determine if we could change the methodology. First, we recognized that credit unions loss experience with member business loans since the prompt corrective action rule was first enacted warrants reconsidering the risk-weighting schedule. Since 1988, the loss history of member business loans has remained remarkably consistent at one tenth of one percent net charge offs. Most notably, net losses have not increased as economic conditions have deteriorated since 2000. Second, we compared this to the standard component for long-term real estate loans and recognized that the risk-weighting for member business loans climbs too prematurely and too dramatically. According to recent data, more than half of all member business loans are real estate loans. In view of this, the disparity in risk of loss is insufficient to justify triggering the 14 percent risk-weighting at twelve and one-quarter percent of total assets in the case of member business loans but at 25 percent of assets in the case of long-term real estate loans. It is widely recognized that default risk and interest rate risk generally increase as maturity increases with all other factors being constant. But our field staff indicates that credit union member business loans are generally short-term loans, maturing in 5 years or less, thereby limiting interest rate risk exposure, as supported by low loss history in recent years. Recent research indicates that credit union member business loans carry less risk, on average, than do similar commercial bank loans, which are risk-weighted at a uniform 8 percent.

Because of these factors, again, my proposal would extend the standard component to three tiers. The bottom tier, risk-weighted at 6 percent, would consist of the amount of member business loans less than or equal to 15 percent of total assets. The middle tier, risk-weighted at 8 percent, would consist of the amount of member business loans greater than 15 percent but less than or equal to 25 percent of total assets. The top tier, risk-weighted at 14 percent, would consist of the amount of member business loans in excess of 25 percent of total assets. I believe this change will provide needed relief in reserving requirements for credit unions engaged in member business lending and allow more favorable loan terms to worthy members with small business financing needs.

In addition to these three changes highlighted for you today, I have a number of other recommended changes that I believe credit unions will find beneficial in serving their members’ small business financing needs today as well as into the future. As I stated earlier, this member business loan proposal is scheduled to be addressed during our March board meeting, and a 60-day comment period will follow. I want to encourage credit unions to share their comments with us so that you can help structure the member business loan regulation to provide additional flexibility while maintaining our necessary safety and soundness standards. Again thanks to CUNA, who along with NAFCU, NASCUS and others within the credit union community contributed greatly to formulating some of the recommendations I outlined today.

In addition to providing small businesses with financing assistance, it is clear that small businesses are in need of deposit services, and I believe that credit unions are also suited to provide these services. CUNA continues to provide information and educational opportunities for credit unions in this area, and has some upcoming conferences scheduled. I hope you will avail yourselves to these resources.

As I have been out discussing my work on the member business loan regulation, I have often been asked about what we are doing to educate our staff on this subject. The issue of education has also been a focal point with my internal working group. Dave Marquis and his staff from the Office of Examination and Insurance continue to examine business lending educational opportunities for examiners. Qualified lenders require qualified examiners, and it remains our commitment to consumers, to credit unions, as well as to our examiners, to continue to provide appropriate training. Additionally, we have identified specialized subject-matter experts in the area of member business lending. We are also working with our examination team, so that the philosophy and vision of the NCUA Board is expressed to you and your board throughout the examination process.

As I have said before, we do not have all of the answers in Washington and I get some of my best guidance from those of you abiding by our regulations. I seek and value your input, and hope you will participate in the regulatory process. While the regulator and regulated may see the same issue from differing perspectives, I always look forward to working with you. Together, with innovation and vision we can continue to find ways to ensure that Americans, from all walks of life, continue to have the opportunity for affordable financial services. Thank you.