More on "Pig-in-a-Poke" Comment

My February 26 posting generated a lot of comments. One commenter rightfully asked if there is any evidence that member business lending (MBL) risk exposure was greater prior to the 1998 legislative cap.

While I don't have loss rate data on member business loans prior to the cap, I believe the following information would indicate that business loans did impose a significant cost on the NCUSIF.

On June 26, 1986, NCUA proposed a rule to regulate credit union member business loans. In announcing the proposed rule , NCUA wrote “[t]he rule is considered necessary in light of recent liquidations and other problem cases involving unsound business lending practices by FICU's.”

As part of its background discussion, NCUA wrote:

The current decline in interest rates and the resulting pressures on credit unions to seek higher-yielding investments, along with the increased public awareness of credit unions, have led a number of federally-insured credit unions to grant member business loans. Many of these credit unions have entered the business lending market lacking the necessary expertise in underwriting and servicing such loans. During the last two years approximately half of the losses sustained by the National Credit Union Share Insurance Fund (NCUSIF), or about 20 to 30 million dollars, were directly or indirectly a result of business lending. Anticipated losses for the current year could result in amounts of at least that much, or more.

It is emphasized that the vast majority of FICU's are not involved in member business lending and the NCUA Board does not anticipate a major change in that respect. This regulation is intended not to foster business lending by credit unions, but rather to ensure that, in the case of those few FICU's that choose to exercise their authority to make loans to members for business purposes, the activity is carried out in a manner that mimimizes risk to the NCUSIF and the credit union system.

With the increased amount of credit union losses and failures attributed to business lending activity, the NCUA Board believes that the proposed rule is necessary. It is recognized that an increase in losses sustained by the NCUSIF translates into lower dividends on FICU deposits in the Fund and increases the likelihood of the assessment of share insurance premiums. The rule is intended to reduce losses by establishing a framework in which member business lending can be undertaken in a safe and sound manner.

In 1991, NCUA revisited its member business loan regulation. NCUA wrote the following to justify further modifications to its member business loan rules.

Member business lending has exposed both credit unions and the National Credit Union Share Insurance Fund (NCUSIF) to significant losses over the past 4 years. In a cursory review of the five largest failures in each region during fiscal year 1990, commercial lending was a factor in 16 of the 30 cases. These 16 cases caused losses in excess of $100 million. When combined with ineffective management and other contributing factors, commercial lending can and does result in significant losses. Clearly, the volume of losses attributable to member business loans is extraordinarily high in proportion to the total of all credit union lending…

In view of the small number of credit unions offering member business loans and the relatively high risk involved, it is not reasonable to expect all federally insured credit unions to indirectly share this risk through exposure to losses to the NCUSIF. Accordingly, the NCUA Board is proposing to impose additional requirements on credit unions involved with business lending. These additional requirements are determined to be necessary in order to assure that credit unions which grant member business loans apply safe and sound lending practices appropriate to this type of activity. Althouth these requirements do not prohibit commercial loans, they do seek to clarify certain areas of the existing regulation and strengthen other provisions. The NCUA Board believes that credit unions were formed primarily as consumer lenders and that member business loans be made available to finance the incidental needs of members -- not to engage in wholesale, high-risk commercial lending. (emphasis added)

It is clear that NCUA at that point in time viewed business lending to be riskier than other type of loans and business loans accounted for a disproportionate share of the losses to the NCUSIF, although business loans represented a relatively small portion of all credit union lending. Moreover, it appears that NCUA felt it was unfair to shift the cost associated with losses from business lending to the NCUSIF to all federally-insured credit unions, most not engaged in this practice.