Bankruptcy Reform Preview
Credit unions were among the prime supporters of bankruptcy "reform" legislation signed by President Bush in April. But will the bill, which goes into effect Oct. 17, really provide credit unions with what they were seeking?
With just one week until the bill officially becomes law, two analysts are giving its prospects mixed reviews.
Jerry Liudahl, VP-lending with Eugene-based Oregon Community Credit Union, and Thomas Orr, a partner in the Eugene, Ore.-based Hutchinson, Cox, Coons, DuPriest, Orr and Sherlock, told the Credit Union Lending Network that the goal of the bill is to push more debtors out of Chapter 7 bankruptcy and into Chapter 13, meaning fewer complete discharges of debt and more three- or five-year payoff plans. But Liudahl and Orr believe both debtors and financial institutions have reason to be leery of the new rules.
"The changes to bankruptcy law may affect loan and collection operations at credit unions," Liudahl told attendees. "On the positive side, the road map for Chapter 7 versus 13 is a lot clearer now, but there are some negatives."
Among the pitfalls Liudahl foresees: a provision requiring credit counseling for consumers-which he said might not work due to the system being overwhelmed by numbers; a dependence on bankruptcy trustees to decide which chapter debtors can file; a reliance on credit card processors to handle new disclosure requirements, and the possibility of "redemption financing."
The latter item stems from the end of most "cram-downs"-the lowering of the amount owed on secured debts. Orr said under the new rules, if a debtor buys a car and files bankruptcy within 2.5 years, he or she must pay the full balance of the loan. However, a "replacement value" clause might hurt lenders.
Liudahl's question for credit unions is this: "Are you ready for more repossessions? Because there will be more due to the 'no cram-down' rule change. And, credit unions must be aware of redemption financing due to the replacement value provision. If a member owes $17,000 on a car and it is worth $10,000, he or she can pay off the car with $10,000 and the credit union is out $7,000.
"There are lenders standing by ready to make these loans," he added.
Under the new bankruptcy code, potential debtors will have to pass a "means test" to determine his or her path: Chapter 7 or 13. If the person's income is above the median for his or her state and he or she has the ability to pay back $100 per month over the next five years (a total of $6,000) after deductions, he or she is required to enter Chapter 13. If the person has $166.67 or more per month for five years ($10,000) left over, the debtor is said to have "presumed abuse."
This presumption of guilt is one of several reasons why consumers have been racing to the courthouse to file bankruptcy before the new rules take hold. Liudahl said 1.6 million American consumers filed for bankruptcy in 2004. Of that number, 267,000 were credit union members.
"It was projected bankruptcy filings in 2005 would be up slightly from last year. In reality, filings were up 3% in the first quarter, and 12% in the second quarter. There is a significant run up of people trying to file before the changes."
Despite the supposedly pro-creditor leanings of the new laws, Liudahl said credit unions actually must be more careful in lending. He suggested credit unions will have to avoid making loans to any members whose credit history even hints at the possibility of bankruptcy.
"The changes will help credit unions...on paper, in a perfect world. But, a lot depends on judges' interpretations," he assessed. "Bottom line-be careful what you wish for."