Credit Unions Gone Wild

The Star Tribune has an excellent article, Credit Unions: Where the Credit Flowed Too Freely, on Minnesota credit union lending going wild.

Like co-eds on Spring Break, these credit unions engaged in riskier behavior.

These credit unions “pursued bigger, riskier and more elaborate loan deals in markets far removed from their everyday customers.”

As bankrupt real estate developer Richard Lewandowski told the Star Tribune, “one thing about credit unions, they didn’t ask many questions. Some of us in the development business, we’d sometimes smile about it … They were hungry to do a deal, any deal, if it meant they could get in on the real estate boom.”

I guess now many of these credit unions are waking up wondering was it worth the risk.

Shouldn't Credit Unions Be Subject to Branch Deposit Reporting?

A reader recently pointed out a competitive advantage that credit unions have over banks that rarely gets discussed -- credit unions are exempt from the disclosure of midyear branch deposit data which banks and thrifts file each year.

As Kenneth Thomas in a July 14, 2006 American Banker Viewpoint article wrote: "This was an insignificant issue when credit unions were employer-based and had no retail branches. Today, however, this disclosure exemption translates into a valuable advantage.

Credit unions know exactly how much every bank branch and thrift office has on deposit every June 30 from the FDIC's Summary of Deposits. Credit unions can use this market information to make better decisions on branch location and other matters."

Moreover, this deposit data is used for anti-trust calculations to determine the impact of mergers on local markets and other regulatory decisions. By excluding credit union's from such disclosures, this could result in sub-optimal regulatory decisions.

As a matter of good public policy, credit unions should be required to disclose their deposits by branch locations, just like all other depository institutions.

Comment from Reader: NCUA Can't Adequately Supervise Corporate CUs

Last week, a credit union vendor replied to my posting about Why Is WesCorp Still Open. While the person disagreed with my assumption that this failed corporate credit union should be closed, the credit union vendor did write something that I found very interesting and thought I would share.

"As an observation, I don’t believe the NCUA has the skill-set to adequately regulate corporates of any great size. Possibly a joint NCUA/FDIC approach would be worth considering. I do believe that corporates must meet higher standards of capital and investment oversight to be worthy of managing the asset levels anywhere near what they have in the past."

If NCUA does not have the skills to competently regulate large corporate credit unions, perhaps it is time for this agency to fade away.

Insurance Premium – Strong CUs Subsidizing Weak CUs

At its September Board meeting, the NCUA Board will be considering whether to assess an insurance premium on all federally-insured credit unions.

By law, if the NCUSIF equity ratio is below 1.2 percent, NCUA must assess all credit unions to restore the share insurance fund to 1.2 percent. All indicators suggest that the NCUSIF will be below the 1.2 percent threshold.

The credit union trade press is estimating that this assessment will be about 15 basis points of insured shares (deposits) to return the fund to its desired level.

The Federal Credit Union Act requires the premium assessment to be the same for all insured credit unions regardless of the risk the credit union poses to the insurance fund.

So, when NCUA mails the invoices to all insured credit unions, the vast majority of sound and well-managed credit unions will be subsidizing the behavior of the riskier, poorly operated credit unions. Because they will all pay the same rate. Moreover, the loss burden from any credit union failures will be disproportionately shared by these stronger performers.

Instead of the current flat rate assessment, the credit union industry and its regulator should advocate for a risk-based premium system. This risk-based system can be designed to work in conjunction with the current NCUSIF capitalization deposit to better align incentives.

This would ensure riskier credit unions are paying their fair share of the cost to the NCUSIF.

Central Liquidity Facility SAR

I wish I could file a suspicious activity report (SAR) against the NCUA.

NCUA has stretched its legal authority by using the Central Liquidity Facility (CLF) to provide loans to two troubled, if not insolvent, corporate credit unions – U.S. Central FCU and Western Corporate (WesCorp) FCU, even though corporate credit unions cannot join or borrow from the CLF.

The CLF, which was established in 1978 to provide emergency liquidity to credit unions, receives an annual appropriation from Congress. As part of the last year’s continuing resolution to keep the government funded into 2009, Congress raised the borrowing authority for the CLF from $1.5 billion to its full statutory authority of $41 billion.

NCUA had tapped this enhanced lending authority to funnel money into two troubled corporate credit unions to prevent the disorderly collapse of corporate credit unions. At the end of August 2008, CLF borrowings from Federal Financing Bank (FFB) were zero; but were quickly ratcheted up. Total borrowings from the FFB peaked in March at $19.2 billion and as of May stood at $18.7 billion.

According to its most recent financial statement, the CLF borrowings from the FFB to provide liquidity to corporate credit unions include a $10 billion loan to the NCUSIF and an $8.2 billion loan to the Credit Union System Investment Program (CU SIP).

The NCUSIF financial statement reports that two credit unions have received loans totaling $10 billion from the NCUSIF. It is understood that the two credit unions are U.S. Central and WesCorp.

Under the CU SIP, participating creditworthy credit unions would borrow from the CLF and invest in a SIP Note. The CLF will designate which corporate will issue SIP Notes to which credit unions. Each SIP Note will be fully guaranteed by the NCUSIF. Once again, the $8.2 billion were targeted at U.S. Central and WesCorp.

It is troubling enough that NCUA is using the CLF to provide liquidity to corporate credit unions – an authority it does not have. But even worse, it is using the funds to prop up failing institutions and thereby potentially raising the cost to taxpayers.

In 1991, the Federal Deposit Insurance Corporation Improvement Act (FDICIA) explicitly prohibited the Federal Reserve from acting as a source of liquidity for financial institutions in danger of failing. The same policy should apply to the CLF.

Why Is WesCorp Still Open?

Four months ago on March 20, the National Credit Union Administration placed Western Corporate (WesCorp) FCU into conservatorship.

WesCorp is insolvent. Its 2008 Annual Report showed an operating loss of almost $7.6 billion and a capital position of negative $5.8 billion.

However, NCUA is providing special assistance to keep the credit union up and running.

WesCorp’s auditors wrote that the corporate credit union “is dependent upon the continued support and forbearance of the NCUA” and had received assurances from NCUA that it would provide appropriate financial resources and assistance to continue normal operations at WesCorp and no actions will be taken to disrupt core services and operations for a minimum of one year from the date of auditors’ opinion.

As a result, WesCorp is able to provide uninterrupted service to its 1,000 plus credit union members, including the payment of dividends on regular shares (i.e., share, share draft and share certificate accounts).

Instead of conservatorship, NCUA needs to put WesCorp into receivership and WesCorp’s member credit unions should be required to make alternative arrangements for services they are currently receiving from this zombie corporate credit union.

After all, WesCorp is not the only game in town.

GTE FCU and Suncoast Schools FCU Terminate Merger

On July 15, GTE FCU and Suncoast Schools FCU called off the largest merger in credit union history, which would have created an $8 billion credit union.

The press release announcing the termination of merger stated that “the potential disruption in operations to both organizations was extensive enough to outweigh the potential benefits of the merger.”

What was unsaid is that this merger probably would not have received regulatory approval.

Both credit unions as of the end of the first quarter were less than well capitalized. In fact, Suncoast Schools barely met the requirement of being adequately capitalized with a net worth ratio of 6.05 percent.

GTE reported a loss of almost $6.8 million and 2.49 percent of its loans were 60 days or more past due. Suncoast Schools reported a loss of $23 million and 3.88 percent of its loans were 60 days or more delinquent.

As this quick look at their financial reports show, this proposed merger of two dented credit unions would have a hard time cutting the regulatory mustard.

Movement versus Members

Credit Union Journal (paid subscription) reported that Space Coast CU does not expect to receive any assistance from the NCUSIF regarding its merger with failed Eastern Financial Florida CU.

While Space Coast’s action may benefit the credit union industry by limiting the hit to its share (deposit) insurance fund and premiums paid by other credit unions, is this decision in the best interest of the Space Coast’s members?

Space Coast stated that the merger would cause the credit union to plummet from being very well capitalized to adequately capitalized.

What is left unsaid is that this merger will dilute the residual claim of its members – if the credit union was to voluntarily liquidate.

Before the merger, for every $1,000 on deposit at Space Coast, a member had a claim of almost $133 on Space Coast CU. After the merger, the new combined membership claim on the net worth fell to almost $75 for every $1,000 on deposit.

This analysis is based upon first quarter data filed by Eastern and Space Coast with the National Credit Union Administration.

This begs the question – did the Board of Space Coast fulfill its fiduciary responsibility to its members by approving this merger without seeking some type of capital infusion from the NCUSIF?

Risky Loans – Part II

My June 26 commentary focused on credit unions making interest only (IO) and payment option (PO) mortgages.

This posting follows up on that earlier posting by looking at the performance of exotic mortgages at these credit unions.

At the end of the first quarter of 2009, $486 million or 6.54 percent of all IO and PO 1st mortgages were 30 days or more past due.

The credit union with the greatest amount of delinquent exotic 1st mortgages was Texans CU in Richardson, TX. Texans had $109.3 million in delinquent IO and PO 1st mortgages, which equaled 92 percent of the credit union’s net worth.

Rounding out the top 5 credit unions with delinquent IO and PO 1st mortgages are: Kinecta (Manhattan Beach, CA) with $69.5 million; North Island Financial (San Diego, CA) with $34.1 million; Wescom Central (Pasadena, CA) with $17.7 million; and Meriwest (San Jose, CA) with $11.5 million.

To view the twenty-five credit unions with the most delinquent IO & PO 1st mortgages, click here.

Additionally, 7 of these 25 credit unions have delinquent non-traditional mortgages greater than 25 percent of their net worth and 4 credit unions exceed 50 percent.

Stay tuned for more analysis of credit union financials.

Where Have All the New Charters Gone?

A recent Credit Union Times headline caught my attention – ‘Where Are New Charters?’ Asks Ex-League Head.

Congress in 1998, when it authorized multiple common bond credit unions, made it perfectly clear that NCUA was to encourage common bond groups to form new separately chartered credit unions rather than to merge the groups into existing credit unions.

However, between 2003 and 2007, only 40 new credit unions were chartered (data for 2008 is not yet available). That’s 8 new credit unions per year.

Does NCUA suffer from ADD (attention deficit disorder) or does the agency just have a hard time following instructions?

So, why were so few credit unions chartered?

Much of the problem has to be laid at the feet of the credit union regulators. They have erected barriers to entry making it virtually impossible for new credit unions to be formed.

While any size group may apply for a credit union charter, the group needs to demonstrate that the credit union will be economically viable. NCUA’s chartering manual states that the size of the group is a potential indicator of a successful start-up. In other words, bigger is better.

NCUA will require groups with fewer than 3,000 potential primary members to jump though more hoops to prove they are economically viable.

Why would any group subject themselves to this gauntlet, when it is easier to join an existing credit union than to form a new credit union?

How Much Do CU Failures Cost: Who Knows?

If you are interested in finding information about the cost of an individual credit union failure to the National Credit Union Share Insurance Fund (NCUSIF), sorry Charlie – you are largely out of luck.

You may find a press release announcing the credit union failure; but the National Credit Union Administration (NCUA) does not disclose information about the impact of a failure on the NCUSIF unless the failure is expensive enough to warrant a Material Loss Review by the Inspector General Office. Unfortunately, there is a long time lag between a credit union failure and the release of the Inspector General report.

In comparison, the Federal Deposit Insurance Corporation (FDIC) post on its website the estimated cost of each bank failure to its insurance fund.

There is not any compelling policy reason for NCUA to keep this information from the public and the credit unions it insures.

I’ve spoken with the General Counsel at NCUA about making this information publicly available on the NCUA’s website. But I wouldn’t bet the ranch on NCUA doing the responsible thing and making this information publicly available.

Corporate Credit Union Capital: Back to the Future

Reading NCUA’s Chairman Fryzel’s testimony on May 20th before the House Financial Services subcommittee was like engaging in time travel without the flux capacitor to circa 2001 and 2002.

Many of the recommendations posed by Chairman Fryzel in his testimony were exactly what NCUA had contemplated in the earlier part of this decade. But credit union industry opposition largely short-circuited these reforms.

In his testimony, Fryzel stated “it is my intent that NCUA will revise the capital standards corporates are subject to, ensuring they are consistent with capital and prompt corrective action standards for all other federally insured financial institutions.”

NCUA is contemplating the following elements as part of any capital rule it proposes:
• A minimum leverage ratio of core capital;
• A requirement that a percentage of total core capital included in the leverage ratio must be retained earnings;
• A minimum risk-based capital ratio, based on Basel standards; and
• A requirement that all capital instruments qualify as capital under the Basel standards.

In justifying a minimum retained earnings requirement, Chairman Fryzel cautioned that it is bad policy to have the capital base of a corporate credit union consist entirely of contributed capital, because contributed capital results in the downstreaming of corporate credit union losses to natural person credit unions.

This is exactly what happened with the NCUA’s seizure of Western Corporate FCU, which resulted in approximately $1.14 billion of contributed capital of member credit unions being wiped out.

As an editorial note: rather than requiring a minimum retained earnings ratio, I prefer Treasury’s 1997 recommendation which would require credit unions to deduct their contributed capital in corporate credit unions when calculating their net worth ratio for prompt corrective action purposes as a vehicle for limiting losses at corporate credit unions from cascading to natural person credit unions.