CUNA applauds Reg-Flex and offers recommendations for expansion

CUNA Comment Letter

CUNA applauds Reg-Flex and offers recommendations for expansion

May 14, 2001

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

Dear Ms. Baker:

Never has the Credit Union National Association been as pleased to file a comment letter with the National Credit Union Administration as we are today in submitting our letter on the Reg-Flex proposal. CUNA represents more than ninety percent of our nation's state and federal credit unions, which have more than eighty million members and assets of over $475 billion. CUNA's letter was developed under the auspices of our Federal Credit Union Subcommittee, chaired by Mr. Edwin Collins, President/CEO of Lockheed Georgia Employees FCU, and we also relied upon input from leagues and other credit union officials in formulating our views.

If adopted, the Reg-Flex program would allow certain credit unions to be exempt from some of NCUA's regulatory provisions that are not specifically required by law or only be subject to those provisions on a limited basis. The objective of the program is to provide regulatory flexibility without jeopardizing the safety and soundness of participating credit unions or the National Credit Union Share Insurance Fund.

Summary of CUNA's Comments

The following summarizes our comments regarding the Reg-Flex proposal and related issues.

CUNA views the Reg-Flex proposal as an excellent approach to regulation.
CUNA commends Chairman Dollar for his leadership on Reg-Flex.
CUNA commends leagues and credit unions for their efforts to weigh-in on Reg-Flex.
CUNA supports the appraisal rule change.
While Reg-Flex is an excellent approach, we feel there is room for expansion.
Reg-Flex should include state CUs.
Additional net worth above the PCA well-capitalized level should not be required for Reg-Flex.
Regional Directors should not have the authority to revoke Reg-Flex status if the standards for eligibility are met.
CUNA supports the proposed components of Reg-Flex that would provide relief in the area of investments, fixed assets, sale and purchase of loans, charitable donations and public unit funds.
Regarding fixed assets, Reg-Flex credit unions should not be required to demonstrate that partial utilization will be completed within three years.
Regarding investments, the relaxation of the prohibition on mortgage-based securities, CMOs and similar investments should be incorporated into Reg-Flex.
Regarding public unit funds, state chartered credit unions as well as federal credit unions should be able to obtain relief in this area as well as others.
Additional issues NCUA should include are:
review mortgage lending limits;
undertake examination relief;
review MBL restrictions;
provide leasing relief; and
allow secondary capital to count toward Reg-Flex, if the agency approves secondary capital for PCA.
Consistent implementation of Reg-Flex is essential and should entail:
an ombudsman to track Reg-Flex progress;
staff training;
incorporation of additional relief as outlined in this letter;
annual review of rules for Reg-Flex application; and
even application of Reg-Flex throughout NCUA.

Commendation for NCUA Board

Before turning to specific issues related to the proposal, CUNA wholeheartedly commends the NCUA Board for proposing the Reg-Flex approach.

In particular, we want to single out Chairman Dennis Dollar for his vision and leadership in developing a proposal that is designed to remove the agency from the routine operations of healthy federal credit unions in several areas.

Commendation for Leagues and Credit Unions

We also want to applaud credit unions, which commented to NCUA on this proposal in record numbers, many through CUNA's Operation Comment website. Also, the leadership of the leagues in emphasizing Reg-Flex and formulating their own comments has been very impressive. The level of support within the credit union system indicates that NCUA has identified an excellent approach for the agency that will allow it to focus on safety and soundness while permitting qualifying federal credit unions to pursue their primary obligation -- providing the best possible products and services for their members.

However, while the approach is extremely favorable, the Reg-Flex relief under the current proposal can be expanded as we discuss below.

Appraisals

Originally part of the Reg-Flex program, the NCUA Board has decided to propose increasing the threshold for an appraisal for a real estate loan and for a member business loan involving real estate to $250,000 from $100,000 for all federally insured credit unions. While all the federal financial regulators are required to have an appraisal rule and have set their thresholds at $250,000, currently NCUA's regulation is the most stringent and has been for several years. We strongly support this change to raise the threshold and help reduce the burden of obtaining a required appraisal for real estate related loans.

Components of Reg-Flex

Reg-Flex Should Include State CUs

We urge NCUA to develop a Reg-Flex program for state chartered credit unions in coordination with state regulators that would allow them to obtain relief from NCUA rules that apply to their operations. In that connection, we strongly encourage NCUA to undertake in the very near future a review of Part 741 of its rules and other pertinent provisions to determine how Reg-Flex could be applied to state chartered credit unions. CUNA would be pleased to work with the agency in this review. As addressed below, we also support the ability of state chartered credit unions to obtain Reg-Flex relief from the limits on public unit funds, as NCUA is proposing for federal credit unions.

How Federal Credit Unions Would Qualify for Reg-Flex

To qualify for Reg-Flex treatment, a credit union must:

Have a CAMEL rating of 1 or 2 in at least two consecutive exams; and
Have a net worth ratio of at least nine percent.

If "complex" under PCA, the credit union must have 200 basis points over its risk-based net worth level or nine percent, whichever is higher.

While CUNA is an ardent supporter of the Reg-Flex concept, and we support generally including credit unions with a CAMEL 1 or 2 rating, we do not support a requirement that a credit union must have net worth of nine percent. We believe this is an arbitrary target, and the agency has not provided sufficient explanation to support the 9 percent level. The Advance Notice of Proposed Rulemaking issued last year provides the only insight into the agency's rationale for the nine percent level. It states that the nine percent net worth requirement "indicates that a credit union has both demonstrated the ability to build capital and has accumulated at least a 200 basis point cushion over the minimum level to be classified as well-capitalized under the NCUA's recently adopted prompt correction action regulation. This cushion of 200 basis points or greater presents a significant decrease in risk to both the credit union and the NCUSIF."

In our view, Reg-Flex should apply to well-capitalized credit unions. As both the Federal Credit Union Act and the agency's Prompt Corrective Action rules establish that a well-capitalized credit union is one with net worth of seven percent or more, we do not believe there is any risk to the Fund or to the credit union if the Reg-Flex level were identical to that required for a well-capitalized credit union under PCA, including any PCA complex credit union requirements. We firmly believe that it is unnecessary and unproductive to set an even higher net worth requirement for Reg-Flex credit unions than what PCA already mandates for a well-capitalized credit union.

As an alternative, if the agency is convinced that the 200 basis point cushion is critical, it should add the cushion to the 6 percent adequately capitalized level.

How FCUs Obtain Reg-Flex Status

Under the proposal, as soon as a federal credit union meets the eligibility standards, it would have Reg-Flex status. We support this approach.

We also support the Board's addition to the proposal that would allow a federal credit union to seek Reg-Flex status from its regional director even when the CAMEL rating and net worth requirements have not been met.

Under the proposal, if a credit union is a CAMEL 3 (or CAMEL 1 or 2 for less than 2 consecutive cycles) with a net worth of over nine percent or if the CU is a CAMEL 1 or 2 with net worth under nine percent or if complex is 200 basis points over its risk-based net worth level or nine percent, whichever is higher, it can apply to its NCUA Regional Director for Reg-Flex designation for all or some of the flexibility provided under the proposal.

This exception authority is very positive, and we support its concept. However, as stated above, the nine percent net worth criteria should be replaced with a seven percent threshold and if a credit union receives a Reg-Flex designation under the exception authority, it should qualify for all Reg-Flex benefits. The Supplementary Information states that when applying for Reg-Flex designation under this provision, the credit union should justify how the entrance into the program will not affect the safety and soundness of the institution. NCUA should provide more guidance to credit unions on using the exemption authority and make it as quick and easy to apply as possible.

Losing Reg-Flex Status

Under the proposal, eligibility may be lost in two ways. One is if the credit union no longer meets the criteria regarding net worth and CAMEL rating. Also, a regional director "for substantive and documented safety and soundness reasons may revoke Reg-Flex authority in whole or in part. The credit union must be given written notice, along with the regional director's reasons."

We do not believe that an NCUA regional director should be able to revoke Reg-Flex status, as long as a credit union is meeting the standards under which its Reg-Flex designation was granted. In our view, if a credit union meets the automatic standard, its Reg-Flex status would remain in effect as long as the net worth and CAMEL requirements are met. If a credit union is designated as Reg-Flex eligible under the exception authority, it would continue that eligibility as long as it maintained the requirements imposed on it when it entered the program.

The agency has not explained under what circumstances the regional director would be able to remove Reg-Flex, and we do not believe that safety and soundness requires that a regional director be authorized to revoke Reg-Flex for any reason not related to the Reg-Flex standards.

If NCUA does retain the revocation authority, we urge the agency to spell-out the situations under which Reg-Flex status could be revoked even if the thresholds for eligibility are met. Also, if the authority to revoke Reg-Flex remains, we support having an appeals process, which the agency is proposing. However, because of the minimal risk to the credit union and the Fund, we do not think that a credit union has to surrender its Reg-Flex designation during the appeal.

The proposal provides that if a credit union loses its Reg-Flex status, any activities undertaken by a credit union as part of Reg-Flex status will be grandfathered, although NCUA has the authority to require a federal credit union to divest its investments or assets for substantive safety and soundness reasons as it does in any event. We support the grandfathering provision.

Specific Rules Identified

NCUA has identified several regulations from which Reg-Flex credit unions would be exempt. These are:

Fixed assets limits. Under the current rules, a federal credit union must apply to NCUA for approval if it wants to invest in aggregate total fixed assets in an amount that exceeds 5 of shares and retained earnings. Reg-Flex credit unions would not have to seek such a waiver.
CUNA supports this provision. The request for comments also asks whether NCUA should consider a tiered limit on fixed assets for all federal credit unions, which would allow greater flexibility depending on net worth. We could support this approach, depending on how it is structured.

The proposal states that a federal credit union would still have to comply with Sec. 701.36(d) that states when real property is acquired for future expansion, partial utilization must be accomplished within three years, unless otherwise approved in writing by NCUA. We do not believe that Reg-Flex credit unions should be under these restrictions.
Investments. Investment provisions from which Reg-Flex credit unions would be exempt are quarterly stress testing for complex securities, Sec. 703.90(c); removing or modifying the 100 percent-of-net-capital limits on discretionary delegation of investments to third parties, Sec. 703.40(c)(6); and extending the current maturity limit on zero coupon investments, now at under 10 years, Sec. 703.110(d).
We support the inclusion of these provisions in Reg-Flex.

Although NCUA sought comment on waiving or modifying the prohibition on stripped, mortgage-backed securities, residual interests in CMOs/REMICs, mortgage servicing rights, commercial mortgage-related securities or small business related securities under the Advance Notice of Proposed Rulemaking last year, this has not been incorporated into the new Reg-Flex proposal.

Credit unions that have, as NCUA requires, developed sound risk management processes should be able to assume a higher risk profile, as long as they can safely and effectively manage the risk. We do believe NCUA has not provided a rationale based on safety and soundness as to why the prohibitions contained in 12 CFR 703.110 should not be lifted as part of Reg-Flex.
Charitable donations. Currently, federal credit unions are limited to providing charitable donations to organizations located in or conducting activities in a community in which the credit union has a place of business. The credit union's board must approve the donation, based on a determination that the gift is in the best interests of the credit union and is a reasonable amount.
We agree that this provision should be part of Reg-Flex. We could also support allowing all federal credit unions to escape this regulation if the entire NCUA Board agrees with this approach.
Shares of Public Units and Nonmembers. Currently, maximum shares of public units and nonmember shares (for low-income credit unions) are limited to 20 percent of total shares of the federal credit union or $1.5 million, whichever is greater. NCUA is proposing that Reg-Flex credit unions could be exempted from these limits.
We support this addition to Reg-Flex. We also support the development of

Reg-Flex for state chartered credit unions, as mentioned above, which should include relief from the limits on the receipt of public unit funds for state chartered credit unions.
Purchase, Sale and Pledge of Eligible Obligations. NCUA is proposing that a Reg-Flex credit union could sell or purchase any auto loan, credit card loan, member business loan, student or mortgage loan from any other credit union, as long as it was a loan the credit union was empowered to grant.
We believe this provision is one of the most significant aspects of Reg-Flex, and we strongly support inclusion of the eligible obligation provisions in the Reg-Flex program. We could also support application of this relief to all federal credit unions, as long as all members of the NCUA Board favor this approach.

Additional Issues

The agency has requested comments not only on the substance of the proposal but also on additional areas that could be considered for inclusion in Reg-Flex. We offer the following suggestions for consideration and as part of the Board's ongoing construction of the Reg-Flex model.

A number of our recommendations were included in our comments last year, and we feel they bear repeating. These are recommendations regarding loan maturities, exam relief, member business loan regulatory restrictions, and leasing. We are also recommending the consideration of secondary capital for Reg-Flex eligibility and consistent application of Reg-Flex throughout the agency, as discussed below.

Loan Maturities

The Federal Credit Union Act provides that residential real state loans may be made with maturities of up to 30 years or longer as set by the NCUA Board. The regulation provides that maturities on such loans may be of up to 40 years, or longer as permitted on a case-by case basis. Similarly, the statute states that mobile home loans, second mortgages and home improvement loans may have maturities of up to 15 years or a longer period and the regulation provides a 20 year maturity. We recommend that NCUA allow Reg-Flex credit union boards to set maturity limits on these loans as they determine are prudent and appropriate for their operations. This would allow such credit unions to avoid seeking permission from NCUA to exceed the maturities established in the regulation.

Examination Relief

We encourage NCUA to afford examination relief to Reg-Flex credit unions. Such relief could be very important to such credit unions without jeopardizing safety and soundness. We recommend that NCUA allow Reg-Flex credit unions to receive examinations on an 18-month cycle. We do not believe this will affect safety and soundness as NCUA receives timely call report data designed to identify problems. If NCUA determines that an annual exam is necessary, then we recommend that the agency limit the scope for Reg-Flex credit unions. Alternating limited-scope exams with a full exam every other year could do this. For the limited scope exams, we recommend that NCUA authorize examiners to rely on financial audit reports and call reports for Reg-Flex credit unions, rather than on-site exams.

Member Business Loan Rule Restrictions

We are aware that NCUA has said it will not entertain changes in the member business lending area for the present. Nonetheless, we feel that this is a regulation that imposes numerous burdens for these engaging in such lending. Some provisions, we believe, are overkill and are ripe for review in the context of Reg-Flex.

Credit unions involved in member business lending and those that contemplate such lending programs for their members must comply with the statutory restrictions on aggregate MBL limits (the lesser of 1.75 times the credit union's net worth or 12.25 percent of the credit union's total assets.)

While NCUA has no authority to change those limits, it does have the power to remove limitations that are not expressly required by the statute. For Reg-Flex credit unions, we recommend that the MBL rule be reduced to the statutory requirements, thus eliminating or substantially reducing restrictions on construction and development lending; collateral requirements; limits on outstanding MBL loans to one borrower; loan-to-value ratios; personal liability; and appraisal requirements.

We also encourage you to reconsider whether a federal credit union may amend its charter to reflect that it is organized for the purpose of making member business loans, and thus qualify for an exemption from the aggregate MBL limits.

Leasing

We believe that credit unions, particularly Reg-Flex credit unions, should have more leeway to engage in leasing arrangements. In that connection, we urge NCUA to permit Reg-Flex credit unions to be exempt from the 25 percent unguaranteed residual value limit, which would put them in a more favorable competitive position with other financial institutions which have more flexibility in this area.

Secondary Capital to Qualify for Reg-Flex

The agency is considering the use of secondary capital to meet prompt corrective action requirements. Should the agency permit the use of such capital, we urge the Board to allow Reg-Flex credit unions to utilize secondary capital to meet their Reg-Flex net worth requirements.

Consistent Implementation

In order for Reg-Flex to be truly meaningful, it must be implemented properly. The devil is always in the details. In our view, appropriate implementation should include:

an ombudsman to track Reg-Flex implementation and be a focal point for concerns and new ideas (we do not believe this would require a new position, but could be assigned to the deputy executive director or other existing senior position);
senior staff and examiner training regarding the Reg-Flex approach;
the incorporation of additional components, as outlined in this letter, that will enhance Reg-Flex as an incentive for well-run credit unions to remain healthy;
annual review of NCUA's regulations to determine what additional regulatory areas could be included; and
consistent application of Reg-Flex throughout the agency so that all guidelines, letters to credit unions, legal opinions and other relevant official documents from the central and regional offices will reflect the Reg-Flex approach.

Conclusion

We believe the importance of Reg-Flex as a major new undertaking for NCUA cannot be overstated. It indicates that the agency, under NCUA Board Chairman Dennis Dollar, wants to take a different approach to regulation that will minimize government interference while enabling credit unions to develop innovative and attractive products and services. The Board and staff have done an outstanding job of crafting a proposal that is one of the most significant in recent times for the regulatory paradigm it embraces.

Thank you again for the development of this remarkable proposal and the opportunity to share our views on Reg-Flex. We look forward to working with the agency in its efforts to implement the Reg-Flex program this year and in the future. If you have any questions, please do not hesitate to contact me or CUNA's General Counsel Eric Richard, Chief Economist Bill Hampel or Associate General Counsel Mary Dunn at 202-682-4200.

Sincerely,

Daniel A. Mica
CUNA President and CEO

Cc:
NCUA Board Chairman Dennis Dollar
NCUA Board Member Yolanda Wheat
NCUA Board Member Geoff Bacino
CUNA Board
CUNA Governmental Affairs Committee
CUNA Federal Credit Union Subcommittee
CUNA Examination and Supervision Subcommittee

CUNA Comment Letter