Hearing on Bankruptcy Reform and Financial Services Issues

Prepared Testimony of Mr. Brian McDonnell
President and CEO
Navy Federal Credit Union

9:30 a.m., Thursday, March 25, 1999


The National Association of Federal Credit Unions (NAFCU) is the only national organization exclusively representing the interests of the nation's federally chartered credit unions. NAFCU is comprised of approximately 1,100 federal credit unions--financial cooperatives from across the nation--that collectively hold approximately 70 percent of total federal credit union assets; NAFCU represents the interests of approximately 25 million individual credit union members. NAFCU and the entire credit union community appreciates this opportunity to participate in the discussion regarding the need for reform of the nation's bankruptcy system.

Nature of Credit Unions

Historically, credit unions have served a unique function in the delivery of financial services to people of modest means. Every credit union is, by statute and practice, a cooperative association organized "for the purpose of promoting thrift among its members and creating a source of credit for provident or productive purposes." [12 USC 1752(1)] While more than 60 years have passed since the Federal Credit Union Act was signed into law, two fundamental principles regarding the operation of credit unions remain every bit as important today as

they were when Congress first authorized the establishment of federal credit unions:

First, credit unions remain totally committed to providing their members with efficient, low-cost personal service.

Second, credit unions continue to emphasize traditional cooperative values, such as democracy and volunteerism.

As members of not-for-profit, cooperative financial institutions united by a common bond, all credit union members have an equal say in the operation of their credit union--regardless of the amount they have on account at the credit union. These singular rights extend all the way from making basic operating decisions to electing the board of directors. Unlike banks and thrifts, federal credit union directors, motivated by an altruistic desire to be of service to others, serve without remuneration--a fact that epitomizes the true "volunteer spirit" which permeates the credit union community.

Credit unions play an important role in the financial lives of more than 70 million Americans from all walks of life who have chosen the convenient and low-cost financial services that only credit unions can provide. As the package of services offered by various types of financial institutions becomes more and more homogenized, the emphasis shifts from the type of service offered to the quality and cost of service provided. Historically, credit unions have been second to none in providing their members with quality personalized service at the lowest possible cost. According to an annual survey conducted by the American Banker newspaper, 1997 was the thirteenth consecutive year in which credit unions have rated higher than all other financial institutions in overall service quality and this trend shows no sign of change.

Need For Bankruptcy Reform

Navy Federal Credit Union (Navy Federal) is the nation's largest credit union. Navy Federal serves civilian and military employees of the United States Department of the Navy and their families, serving almost 1.8 million members around the world through 86 branch offices, 208 proprietary surcharge-free automated teller machines (ATMs), access to world-wide ATM networks, and "24 hour/365 day-a-year" telephone and internet service from its Vienna, Virginia headquarters and operations center. As with all federal credit unions, Navy Federal is a not-for-profit cooperative, governed by a volunteer and unpaid board of directors who are elected by the credit union's member-owners. Navy Federal operates in the cooperative credit union spirit of "people helping people."

Unfortunately, a small but growing number of consumers are not financially responsible and abuse the bankruptcy system at a high cost to the consumers and the national economy. The credit union community feels strongly that bankruptcy reform is needed to encourage financial responsibility for debtors and for those creditors who would mislead or take advantage of consumers. The bankruptcy reform issue is not an issue of balancing the pursuits of debtors with the interests of creditors. It is simply an issue of financial responsibility versus financial irresponsibility.

The credit union community does not oppose bankruptcy relief for persons who have encountered extraordinary circumstances in life and have a bona fide need for relief. Instead, the concern is with those consumers who use bankruptcy as a financial planning tool and those who turn to bankruptcy as the "easy way out."

Costs of Bankruptcy

Nationally, consumer bankruptcies have spiraled upward. In 1998, there was a dramatic rise in the number of consumers filing for bankruptcy. From 1993 to 1997, there was an average of 989,000 personal bankruptcy filings a year. In 1998, there were 1.4 million personal bankruptcy filings. NAFCU estimates that if this trend continues there will be 2.3 million bankruptcy filings by the year 2003.

Credit union members have not been immune to the rising trend in personal bankruptcies. In 1998, 250,000 credit union members, who held $1 billion in loans outstanding at their credit unions, filed for bankruptcy. On average, nearly half of all loan losses at federally insured credit unions in 1998 were due to bankruptcy. Bankruptcy accounted for more than 70 percent of all charge-offs among 27 percent of all credit unions.

In recent years, Navy Federal has experienced a significant increase in the number of members seeking relief through the bankruptcy courts. Each month, Navy Federal charges off $2 to $3 million in loans to bankrupt members. In 1998, Navy Federal's charge-offs to bankrupt members totaled $30 million--a figure up from $1.5 million from 16 years ago. What is particularly significant is that while the non-bankruptcy loss ratio increased 35 percent, the bankruptcy loss ratio increased at a pace 7.5 times that rate: a staggering 264 percent.

As with other credit unions, the costs of bankruptcy at Navy Federal must be borne by the financially responsible members of the credit union. In 1998, if Navy Federal had experienced no bankruptcy losses, consumer loan rates could have been reduced by more than one-half of 1 percentage point. Navy Federal's VISA Classic credit card rate, which is currently 12.5 percent with no annual fee, could have been reduced 1.3 percentage points. It is important to understand that bankruptcy is anti-consumer in nature because responsible consumers pay the debts of the few who elect bankruptcy as a financial planning tool--encouraged by the advertising of unscrupulous attorneys or financial advisors. The seemingly quick "fix" of filing for bankruptcy is also harming young consumers as more and more are choosing it as an alternative. Once a young person chooses bankruptcy, he or she often has difficulty obtaining credit at reasonable rates from responsible financial institutions.

Credit Union Response to Consumer Bankruptcy

Most credit unions have lower operating margins than other types of lenders. Typically, credit unions pay higher rates on savings and charge lower rates on loans than other financial institutions. For example, Navy Federal currently pays 5.39 percent on its most popular share savings certificates, up to 6.18 percent on IRA share certificates, and charges 7.5 percent on the most popular auto loan. Because of these smaller margins, credit unions are hit harder than other financial institutions by escalating bankruptcy costs. A natural reaction for some institutions is to increase interest rates, but that is not what credit unions do. Credit unions keep interest rates as low as possible for the benefit of their members.

Credit unions also do much to promote financial responsibility among their members. Because credit union members pool their resources for the mutual benefit of all members, they have traditionally relied heavily on member education and individual counseling to encourage and promote financial responsibility. Navy Federal trains its employees in financial counseling, check book balancing and family budgeting. Employees advise members on the merits of saving and the consequences of heavy debt loads. Member newsletter articles are published and brochures are provided for members to assist in making responsible financial decisions.

In addition to member education and counseling activities, Navy Federal, like most credit unions, places an extremely high priority on sound underwriting practices. Navy Federal is continually upgrading and refining its underwriting techniques and tools. Automated tools are used in conjunction with traditional loan officer evaluations for all loans. Navy Federal attempts to reach those members with limited financial resources who truly need credit by meticulously scrutinizing all applications. If an applicant's circumstances do not support the requested amount, Navy Federal may offer to assist by countering with a lower debt limit offer that the member may be able to repay.

Again, like most credit unions, Navy Federal does an excellent job of member education and loan underwriting, but at Navy Federal this is taken one step further. To illustrate, a young husband and wife, both in the military and Navy Federal members, recently scheduled an appointment to seek legal advice for bankruptcy. Before the meeting, they received in their monthly statement from Navy Federal, a flier entitled "Bankruptcy, A Problem We All Share." As a result of reading the flier, they contacted Navy Federal's Budgetary Counseling Staff regarding alternatives to bankruptcy. The counselors explained the credit union's intensive "Budgetary Counseling and Debt Management Program" and asked if the family wanted to participate. They agreed. We negotiated with other creditors for debt adjustments and lowered Navy Federal's payments. Except for essential family living expenses, they send all their income to Navy Federal. We actually pay their monthly bills and make their loan payments to other lenders. We are counseling this family on the wise use of credit and the responsible use of their financial resources. In a few months we will begin to return financial responsibility back to this family as they learn to become financially responsible consumers. In 1998, Navy Federal assisted nearly 3,000 families who participated in this program.

Navy Federal's members are charged nothing for this service even though the annual direct labor and supporting cost for the "Budgetary Counseling and Debt Management Program" is approximately $800,000 excluding debt and interest adjustments. Often, interest is reduced or waived to enable members to continue making loan payments. Currently, over $3.2 million of Navy Federal's consumer loan and credit card portfolio accrues zero interest at an annual loss to the credit union of an additional $300,000. However, assisting members to become financially responsible is a sound investment of credit union resources; Navy Federal believes it is also a good example of creditor responsibility.

Reform Efforts: Credit Union Perspective

Because of the rising number of personal bankruptcy filings, the credit union community believes that legislative action is necessary to improve the current bankruptcy system. To support Congress in that effort, NAFCU established an ad hoc Bankruptcy Committee in 1997. After extensive study and bolstered with the input of a nationwide survey of credit unions, NAFCU's ad hoc Bankruptcy Committee approved a formal "Proposal to Improve the Bankruptcy System" (see Appendix 1). The product is a genuine effort to improve the nation's bankruptcy laws and procedures.

To better understand how the nation's credit unions are affected by bankruptcy, NAFCU's ad hoc Bankruptcy Committee surveyed over 1,050 federally chartered credit unions. The survey revealed three issues at the forefront of credit unions' agenda regarding bankruptcy reform.

First is requiring Chapter 13 consideration before establishing eligibility for Chapter 7. Bankruptcy courts do not require any showing of need or minimum level of debt. The bankruptcy court simply accepts the debtor's assertion that bankruptcy is necessary. As a result, Chapter 7 often gives more relief than is truly necessary. The full discharge of debts provided by Chapter 7 is a carryover from the last century, when most credit was secured by tangible assets. Today's consumer-based economy is built on unsecured revolving credit with the promise that debtors will pay from future income. Approximately 97 percent of the respondents support a bankruptcy system that is needs-based. This would help to increase debtor accountability, create a fairer bankruptcy system, and more fairly distribute payments among all creditors.

Second is mandatory financial education for all bankruptcy filers. Credit unions have a long history of educating their members in financial matters. The wise use of credit as well as the value of systematic savings are basic credit union principles. Most credit unions attempt to provide the best possible education for their members. Of those surveyed by NAFCU, 84 percent support a requirement that would require debtors to participate in credit counseling before filing bankruptcy.

Third is strengthening the right of reaffirmation for credit union members. Credit unions traditionally have higher reaffirmation rates than other lenders, partly because their members realize that credit unions offer them lower interest rates on loans, higher dividend rates on savings and minimal fees. The higher credit union reaffirmation rates also reflect characteristics of the credit union cooperative philosophy such as the knowledge that fellow credit union members will bear the costs of any debt discharged in bankruptcy. Credit unions believe that their members should be assured that they can retain their relationship with their credit union by voluntarily reaffirming their loans at reasonable rates, rather than being at the mercy of other lenders who will charge higher rates and greater fees. Seventy-six percent of those surveyed believe that the bankruptcy code should not include any limitations on the right to reaffirm

As reflected in NAFCU's ad hoc Bankruptcy Committee's proposal, credit unions throughout the country advocate meaningful reform of the bankruptcy system. NAFCU's proposal includes these recommendations:

l The Bankruptcy Code should require that debtors who are able to pay a portion of their debts file a repayment plan under Chapter 13;

l The Code should establish uniform rules and procedures for processing creditors' claims and payments;

l The Code should establish uniform federal exemptions;

l Debtors should be required to complete a basic financial education course prior to receiving discharge;

l A debtor should be required to notify secured creditors, within ten days of filing bankruptcy, whether the debtor intends to surrender, redeem, or reaffirm the collateral; and,

l For creditors seeking to recover collateral, the automatic stay should expire at the end of the notification period.

NAFCU also recommends establishing a Bankruptcy Advisory Council that includes debtor and creditor representatives. The council should be charged with studying bankruptcy and bankruptcy reform. This council could be established under the auspices of the U.S. Department of Justice. Alternatively, the Federal Reserve Board's existing Consumer Advisory Council should be required to submit an annual report to Congress on bankruptcy and bankruptcy reform.

Reform Efforts: Congressional Action

Despite all of the efforts to educate, to make sound loans, and to assist those in trouble, bankruptcy reform is needed and is needed now to encourage financial responsibility. A critical component of bankruptcy reform must be a debtor's right to reaffirm those debts that enable him or her to continue to meet basic family living needs by maintaining access to essential and low cost financial services. Unfortunately, bankruptcy reform bills introduced in the 105th Congress were later amended to greatly diminish a debtor's right to reaffirm. We believe those amendments were ill-advised. They would have required judicial review and approval of reaffirmation agreements as is the case with S. 625, The Bankruptcy Act of 1999. We believe judicial reviews are unnecessary and will serve to increase burdens on the bankruptcy system (burdens that would likely lead to non-uniform treatment by the various courts), increase court costs, reduce debtors' choices and ultimately work to the disadvantage and detriment of debtors. An exemption to the judicial review requirements for federally insured credit unions was inserted in the 1998 conference report for H.R. 3150 (H. Report 105-794) and included in H.R. 833, The Bankruptcy Reform Act of 1999. If it is not possible to amend S. 625 to exempt federally insured credit unions, we would strongly urge Congress to permit the current law to stand.

Reform Efforts: Disclosures

Included in both bankruptcy reform bills in the 105th Congress, the Consumer Bankruptcy Reform Act of 1997, S. 1301 and the Bankruptcy Reform Act of 1998, H.R. 3150, and also in H.R. 833, are disclosure requirements that would amend the Truth in Lending Act (TILA). Generally, disclosures are essential to protect consumers from those who would use inaccurate and incomplete information to their advantage. Also, disclosures that aid consumers in making informed decisions are necessary. Unfortunately, all mandatory disclosures increase the regulatory burden and the costs of delivering financial services. These are costs that must be passed on to the credit unions' member-owners and to the customers of other financial institutions.

The Consumer Bankruptcy Reform Act of 1997, S. 1301, as passed by the Senate in 1998, would have amended TILA to require additional disclosures regarding the income tax treatment of interest payments on certain real estate loans. In the absence of convincing information to the contrary, the effectiveness of such disclosures could be questioned because many consumers believe they are already inundated with information. They simply do not take the time to read existing disclosures.

However, H.R. 833 would direct the Federal Reserve Board to conduct a study concerning the adequacy of consumer information regarding the income tax treatment of interest payments on real estate loans. NAFCU does not oppose an impartial study. If a thorough analysis indicates additional disclosures would benefit credit union members, NAFCU and the credit union community would welcome a reasonable approach to providing that information to its members. The implementing regulations for any required disclosures should acknowledge a history that indicates tax rules are subject to change and sometimes with short notice.

Unplanned changes in disclosures can be disruptive, costly and place excessive burdens on credit unions. It would be especially hard for small credit unions to handle the increased cost and burden. Just last week, at the National Credit Union Administration's (NCUA) regular Board meeting, Board Member Dennis Dollar, in a discussion of the agency's new small credit union program related that at a small credit union, an employee, in a single day, might be called upon to take deposits, approve a loan and complete reports to the NCUA. Dollar said he knew about a credit union employee's responsibilities because he had been that employee. The members of the Committee should thoroughly consider all of the consequences, especially those on small credit unions with limited resources, of requiring tax planning information in loan disclosures.

With respect to the proposed disclosures in H.R. 833 relating to minimum monthly payments on credit card debt, their usefulness to consumers could be questioned. NAFCU and member credit unions would not be opposed to the specific disclosures if an impartial study determined they would be in the best interest of the credit union members. Experience demonstrates that most members want to know the card's annual interest rate, the amount of any fees, and, most importantly, the amount of their monthly payment.

Last year's S. 1301 contained a provision that would have required monthly disclosures of the payoff period for credit card debt if the consumer paid the minimum payment shown on the statement. This information could be a useful tool to assist credit union members in making payments decisions. However, before Congress adopts such requirements, it should direct the Federal Reserve Board to make an impartial study to determine how useful the information would be to consumers and the additional burden that it would impose on financial institutions. If the disclosures would be useful to consumers, sufficient time should be given to implement computer systems in an orderly manner to hold down the implementation costs that must be passed on to our members.

Conceptually, the proposal to annually send a worksheet to each credit card borrower to assist in determining his or her household income and debt obligation has merit. However, the practical value of the requirement comes into question. It would require a considerable amount of the consumer's time to read, understand, and complete the document. Without the continual effort of the consumer's financial institution, the worksheet would likely fall into the trash can.


NAFCU believes the consumer information and disclosure studies proposed in H.R. 833 would be useful to determine whether additional information should be disclosed to consumers. Congress should consider impartial studies of the practices of lenders to determine the extent to which certain practices may contribute to the over indulgence of credit by consumers that results in bankruptcy. Congress should consider a wide range of issues to foster responsibility and accountability among all persons involved in the personal financial services arena. These issues include strengthening the educational system, thoroughly evaluating lending practices, enacting needs-based bankruptcy system that retains a credit union members' right to reaffirm their debts and streamlines uniform administrative procedures.

NAFCU recognizes the need for reform and is grateful that Congress is focused on the problem and is determined to implement reforms. On behalf of NAFCU, thank you for considering the credit union perspective. NAFCU applauds the efforts of the Committee and hopes to continue to work with you to resolve this and other challenging issues.

Appendix 1



Executive Summary

January 1999


The costs of bankruptcy losses are borne by consumers as a group through increased loan rates, stricter lending standards, and decreased dividend rates on savings. This situation clearly points to the need for substantive bankruptcy reform which encourages personal responsibility for both debtors and creditors. On October 20, 1997, the National Bankruptcy Review Commission (NBRC) submitted a report to Congress, the President and the Supreme Court which recommended changes to the Bankruptcy Code.


NAFCU strongly believes that the recommendations contained in the NBRC report greatly increase the rights of debtors without regard to the rights of creditors and the effects on consumers.

NAFCU opposes the NBRC's recommendation to prohibit reaffirmation of unsecured loans and severely limit reaffirmation of secured loans.

NAFCU opposes the unnecessary and burdensome valuation hearings proposed by the NBRC.

NAFCU is disappointed that the NBRC only recommends that debtors have an "opportunity" to participate in financial education programs.

NAFCU believes the NBRC's valuation methods generally favor unsecured creditors and debtors to the detriment of secured creditors.

NAFCU views the Commission's exemption levels to be overly generous to debtors.

NAFCU opposes the modification of second mortgages secured by a debtor's principal residence.

NAFCU advocates meaningful reform of the bankruptcy system which balances the needs of creditors and consumers, including debtors.

The Bankruptcy Code (Code) should require that debtors who are able to pay a portion of their debts file a Chapter 13 (repayment) bankruptcy.

The Code should establish uniform rules and procedures for processing creditor's claims and payments.

The Code should establish uniform federal exemptions, ranging from $15,000 to $30,000.

Debtors should be required to complete a financial education course prior to receiving a discharge.

A debtor should be required to notify secured creditors, within 10 days of filing bankruptcy, whether the debtor intends to surrender, redeem, or reaffirm the collateral.

For creditors seeking to recover collateral, the automatic stay should expire at the end of the notification period.

The Code should clarify the right of debtors to reaffirm both secured and unsecured debts.

NAFCU recommends establishing a Bankruptcy Advisory Council, which includes debtor and creditor representatives.

The Council should be charged with studying bankruptcy and bankruptcy reform.

Alternatively, the Federal Reserve Board's existing Consumer Advisory Council should be required to submit an annual report to Congress on bankruptcy and bankruptcy reform.

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