Transact In

In case you missed NCUA’s announcement on March 16th, it has approved the charter for a new low-income credit union – Inspire Community Development FCU. Regrettably, NCUA made a not-so-subtle change in its field of membership for community charters. Not only can this credit union serve people who live, work, worship, and attend school in the city of Battle Creek, but it also includes people who volunteer and transact in the city of Battle Creek.

According to NCUA’s field of membership manual, NCUA only “recognizes four types of affinity on which a community charter can be based – persons who live in, worship in, attend school in, or work in the community.” Neither “volunteer in” nor “transact in” is on the list.

While I have previously seen where NCUA has bent its rules on limited occasions by adding volunteer in as an affinity group, I’ve never seen “transact in” as an affinity group. So, now if you ever bought gas at a service station in Battle Creek, this qualifies you for membership in this credit union.

Give me a break! Purchasing a good or service from a business in Battle Creek does not qualify as an affinity group.

NCUA should have never permitted “transact in” to be an affinity group. But I guess being a rogue agency is part of NCUA’s culture. What’s the next new affinity group for a community charter – if you ever “drove through” a community?

Inspector General: Examiners Did Not Raise Problems to Superiors

“Insanity: doing the same thing over and over again and expecting different results.” Albert Einstein

A common theme has emerged from the NCUA’s Office of Inspector General (IG) reports on the failures of New London Security FCU and High Desert FCU – examiners failed to elevate repeated problems to their superiors for stronger supervisory actions after the credit unions’ managements repeatedly did not take corrective actions.

In the case of New London Security FCU, examiners repeatedly expressed concerns over and provided recommended corrective actions regarding the lack of a safekeeping agreement and an inactive supervisory committee. In four of the six examinations reviewed by the IG, these issues were identified in Documents of Resolutions (DORs). But the IG found that examiners did not ensure the credit union took corrective action on these repeat DOR issues and examiners did not elevate these issues to their superiors for stronger supervisory actions such as a Regional Director’s Letter or a Letter of Understanding and Agreement. As a result, the IG concludes they missed an opportunity to uncover suspected investment fraud at the credit union.

In the case of High Desert FCU, examiners on more than one occasion issued DORs related to the credit union's member business loan and construction loan portfolios. Items of concern included underwriting of member business loans, impermissible member business loans, the training of credit union loan officers, and monitoring waivers associated with its construction loan portfolio. While these problems were repeatedly cited, they were not resolved. But the examiners never elevated these issues to their supervisors for stronger supervisory actions. “Consequently, examiners did not expand examination procedures when they should have done so, which could have mitigated the loss to the NCUSIF.”

How many second chances were these NCUA examiners going to give the management of these credit unions?

At the end of its report on the failure of High Desert FCU, the IG wrote that NCUA should consider giving examiners clearer “guidance on when a DOR is required, detailed follow-up procedures and documentation requirement on repeat findings, and a defined process to elevate issues within the NCUA that have not been appropriately resolved.”

It sounds like the IG believes that this is an issue across NCUA’s examiner force.

As a related thought, I suspect that the failure to elevate problems for stronger supervisory actions explains the dearth of enforcement actions being reported by NCUA. Unfortunately, this also means that credit union members are being kept in the dark about repeated problems at their credit unions.

IG Report on Failure of High Desert FCU

NCUA’s Office of the Inspector General (IG) released this week its report on the failure of High Desert FCU (HDFCU). The IG estimated that the failure of HDFCU resulted in a $24.3 million loss to the NCUSIF.

According to the report, an excessive concentration in real estate construction loans combined with the collapse in real estate values caused the failure of HDFCU. The rapid growth in HDFCU's construction loan program was fueled by a waiver granted by the Regional Director in 2003 from NCUA’s minimum equity interest requirements associated with construction loans. The failure by management to take corrective actions and by examiners to elevate concerns to superiors for stronger supervisory actions increased the ultimate cost of the failure.

The report makes it clear that HDFCU’s management and board were engaged in extend and pretend with respect to its construction loan program. The IG wrote that “the number of loans reported as more than 12 months past their original maturity date grew from nine in March 2004 to 158 in September 2007. In September 2007, nearly 45 percent of the total construction loan portfolio was greater than 12 months past the original maturity date. This was due to management simply extending a loan once it matured. In many cases, management extended loans numerous times rather than start foreclosure procedures.”

The risk associated with excessive concentrations caused the IG to write that “NCUA should consider developing a more specific process to identify, analyze, and monitor loan concentration during exams as well as between exams. The NCUA should give strong consideration to a more detailed breakout of loan types on the 5300 Call Report to facilitate this analysis. Additionally, NCUA should consider developing concentration guidelines to assist both examiners and the credit unions in identifying and monitoring concentration risk.” (emphasis added)

Also, the IG wrote that NCUA granted a waiver in 2003 from the minimum equity interest limits to HDFCU with respect to its construction loan program. However, examiners did not require the credit union to implement a tracking system to monitor compliance with respect to the waiver until 3 years after the waiver was granted. The IG report recommended the following changes to enhance the waiver process:

1. NCUA should consider the ability of the region or credit union to track waivers. If a waiver requires the generation of detailed information from the recipient credit union that is not already captured in the Call Report or other financial reporting system, the NCUA should take into account the ability of credit union and the region's staff to adequately monitor the waiver.

2. Implementation of the monitoring process should be in place before granting a waiver.

3. Failure by a credit union to properly monitor and track a waiver, or noncompliance with a waiver during an examination, should result in suspension of activity allowed under the waiver until the credit union can reestablish an appropriate tracking model or become compliant with the waiver.

4. NCUA should consider a renewal period and/or a sunset provision for waivers granted related to significant risk areas of a credit union. At a minimum, this would include waivers related to loan concentrations, liquidity management, capital, or certain regulatory matters.

Will NCUA Cage Federal Credit Unions?

Could federal credit union officials and employees be held personally liable if a federal credit union (FCU) seeks to change its charter or insurance status?

This could become a new reality, if a proposed NCUA rule becomes finalized.

The NCUA Board is proposing that credit union officials and employees cannot be indemnified against liability based on an aggravated breach of the duty of care when such breach may affect fundamental member rights and financial interests. NCUA defines that matters affecting the fundamental rights and interest of federal credit union (FCU) members include charter and share insurance conversions and terminations.

NCUA states throughout its proposed rule that a change in charter or insurance status may significantly impact the members’ financial interest. NCUA insinuates that credit union officials and management are putting their personal financial interest ahead of the members’ financial interest when they consider such choices.

Therefore, any attempt by credit union officials and employees to exit the NCUSIF could be construed as a breach of their fiduciary responsibilities and as a result, they could be held liable, if a court determines they engaged in gross negligence, recklessness, or willful misconduct.

It seems that this is meant to be another weapon in NCUA’s arsenal to bully any credit union from seeking to change its charter or insurance status. This threat of personal liability is just a continuation of NCUA's campaign to effectively make federal credit unions a prisoner of the NCUSIF.

As Maya Angelou wrote in I Know Why the Caged Bird Sings,

“The free bird thinks of another breeze
and the trade winds soft through the sighing trees
and the fat worms waiting on a dawn-bright lawn
and he names the sky his own.

But a caged bird stands on the grave of dreams
his shadow shouts on a nightmare scream
his wings are clipped and his feet are tied
so he opens his throat to sing.”

So, will federal credit unions stand on the grave of dreams or name the sky as their own?

To Conserve

NCUA on Friday, March 19th placed $24 million Tracy FCU into conservatorship.

The Federal Credit Union Act authorizes the NCUA Board to appoint itself conservator when necessary to conserve the assets of a federally insured credit union, protect members’ interests or protect the National Credit Union Share Insurance Fund.

Tracy FCU reported a loss of $890,261 for 2009 and was undercapitalized with a net worth ratio of 4.99 percent as of December 2009.

I will be the first to admit that I don’t know all the details associated with Tracy FCU’s conservatorship. However, the absence of any formal enforcement actions on NCUA's website makes Tracy FCU's conservatorship troubling.

It is possible that new information came to light about Tracy FCU since the end of 2009 that necessitated NCUA act quickly to seize control of the institution.

But on Tracy FCU's website is a statement by Valley First Credit Union, which is now running the day to day operations of Tracy FCU, that it anticipates the two credit unions will be merged.

So, is NCUA using its conservatorship powers to force an arranged merger with Valley First Credit Union?

Unhappy Anniversary

One year ago, NCUA placed U.S. Central FCU and Western Corporate FCU into conservatorship.

Since then, NCUA has been operating these two corporate credit unions.

Unfortunately, it does not appear that NCUA is any closer to an exit strategy.

20 Fewer Problem Credit Unions in February

NCUA reported that the number of problem credit unions fell in February by 20 to 337 credit unions. NCUA defines a problem credit union, as a credit union with a CAMEL 4 or 5 rating. (click on image to enlarge)

Assets in problem credit unions decreased by $700 million in February to $47.6 billion. NCUA estimates that 5.38 percent of all credit union assets are in CAMEL 4 and 5 credit unions.

Additionally, the percentage of insured shares (deposits) in problem credit unions declined by 10 basis points in February to 5.72 percent. NCUA reported that problem credit unions held $41.6 billion in shares.

NCUA is reporting that as of February 2010, there were 9 credit unions with over $1 billion in assets on the problem list with $15.6 billion in shares. Eleven credit unions holding $500 million to $1 billion in assets were on the problem list. For credit unions between $100 million and $500 milion in assets, there were 57 credit unions on the problem list.

The following two graphs shows the change in the distribution of assets and shares by CAMEL codes over the last 5 years and the first two months of 2010.


NCUA reported that 6 credit unions have failed during the first two months of 2010.

Credit Unions Provide Good Lesson on Why Interest Rate Ceilings Are Bad Public Policy

Federal credit unions provide an excellent lesson regarding the unintended consequences associated with interest rate caps.

Currently, all federal credit unions are prohibited from increasing their loan rates beyond a current regulatory cap of 18 percent (12 U.S.C. §§1757(5)(A)(vii)).

On June 7, 2007, former NCUA Chairman JoAnn Johnson testified about the adverse impact of the interest rate cap on federal credit unions’ credit card operations.

NCUA Chairman Johnson pointed out that many federally insured credit unions may have sold or discontinued their credit card programs in recent years, because of rising variable costs and fixed interest margin potential. She noted that credit card portfolio brokers estimated that 318 credit unions have sold their credit card portfolios over the last five years. In other words, the inability to raise the interest rate in a rising interest rate environment did not allow the credit union to receive a risk-adjusted rate of return to warrant continuing this investment.

She also pointed out the interest rate ceiling limited the ability of credit unions to mitigate the higher credit risk of some borrowers through risk-based pricing. Therefore, the only way a credit union could manage such risk was to ultimately limit some credit union members’ access to credit.

While consumer advocates may think interest rate ceilings are the best idea since sliced bread, the experience of credit unions shows that price controls, such as interest rate caps, are bad public policy.

Cost of Recent CU Failures on NCUSIF

The only source of information regarding the cost of federally-insured credit union failures to the National Credit Union Share Insurance Fund (NCUSIF) comes from NCUA’s Office of the Inspector General (OIG).

The Federal Credit Union Act requires the OIG to review and report on any credit union material losses exceeding $10 million to the NCUSIF and a loss which is equal to or greater than 10 percent of the total assets of the failed credit union.

Reviewing published Material Loss Reviews plus the OIG’s 2010 Annual Performance Plan, I was able to identify 8 recent credit union failures that meet these de minimis thresholds.

I used the 2010 Annual Performance Report and 3 published Material Loss Reviews to obtain information on the cost of the failures. Information regarding the asset size of the credit union at failure and the timing of a credit union’s failure was obtained from NCUA press releases.

The most expensive credit union failure was Cal State 9 CU, which imposed an estimated loss on the NCUSIF of $206 million. The estimated loss rate per dollar of asset is almost 61 percent.

The following table provides information on these eight failures. (click on image to enlarge)


NCUA’s OIG stated that it expects to perform 10 to 15 material loss reviews in 2010. I will periodically update this information, as NCUA makes this information public.

Oregon's Point West CU Slashes Rates to Zero to Drive Away Deposits

There is an interesting article in the Oregonian about Point West Credit Union seeking to drive away depositors to improve its net worth ratio.

The credit union at the end of 2009 was significantly undercapitalized. However, the credit union was not able to generate income fast enough to offset its expenses and to improve its net worth ratio. As a result, it resorted to shrinking its balance sheet.

Credit Unions Post Strong Deposit Growth in 2009

The National Credit Union Administration (NCUA) on March 1 reported that federally-insured credit unions posted robust asset and share (deposit) growth in 2009.

Assets grew by 9.08 percent to $884.8 billion and shares (deposits) at federally-insured credit unions expanded at a robust 10.5 percent pace in 2009 to $752.7 billion. However, loans grew 1.1 percent to $572.4 billion. As a result, the loan to deposit ratio at credit unions fell from 83.1 percent to 76.05 percent.

Loans for credit cards, used autos and first mortgages/lines of credit grew during 2009, while new auto loans, other real estate loans/lines of credit, and leases contracted during the year.

Net worth grew 1.9 percent to $87.7 billion from $86.1 billion; but did not keep pace with asset growth. As a result, the net worth ratio for credit unions fell by 70 basis points to 9.71 percent.

Credit Unions Posted a Profit of $1.7 Billion

Net income was $1.7 billion – yielding a return on assets of 0.20 percent, which was up 24 basis points from 2008. Higher provisions, a NCUSIF capitalization expense of $3 billion, and lower interest income were a drag on credit union earnings, while a 22.6 percent decline in interest expense, a 4 percent drop in non-interest expenses, and a NCUSIF Stabilization Income of $3.3 billion helped to bolster credit union earnings.

Federally insured credit unions continued to build reserves to cover problem loans during 2009. Provisions for loan and lease losses grew by 34.1 percent during 2009, following a 120 percent increase in 2008. Over $9.4 billion was set aside to cover loan and lease losses. As a result, allowances for loan and lease losses increased by almost 41 percent to $8.77 billion.

Nonperforming Assets and Charge-offs Increase in 2009

Delinquent loans (loans 60 days or more past due) grew 33.7 percent to a reported $10.4 billion. At the end of 2009, 1.82 percent of loans were 60 days or more past due, up from1.38 percent at the end of 2008.

Additionally, federally-insured credit unions reported $9.3 billion in loans that were between 30 days and 60 days past due.

Credit unions reported holding $1.5 billion in foreclosed and repossessed assets at the end of 2009. This is up 48.4 percent from 2008’s level of about $1 billion.

There was a 48.7 percent increase in net charge-offs for 2009. Total net charge-offs were $6.9 billion. As a result, federally-insured credit unions reported that the net charge-offs to average loans ratio rose from 0.85 percent to 1.21 percent during the year.

Credit unions also reported writing down slightly more than $1.5 billion in capital investments in corporate credit unions during 2009.

Merger Would Create $5 Billion CU

The Portland Business Journal is reporting that First Tech CU (Beaverton, Ore.) has announced that it plans to merge with Addison Avenue FCU (Palo Alto, Calif.).

First Tech has assets of $2.2 billion with a 17-branch network across Oregon and Washington.

Addison Avenue has assets of $2.5 billion in assets with 21 branches in nine states and Puerto Rico.

If the merger is approved, the combined credit union would have almost $5 billion in assets and 320,000 members.

The combined credit union would be called First Tech Federal Credit Union

Why the Delay in Adopting a Tiered MBL Approval Process

Dear Chairman Matz:

Several weeks ago, you wrote Treasury Secretary Geithner that if credit unions were granted expanded member business lending (MBL) authority for credit unions, you would tighten the regulation of business lending of credit unions.

One of your recommendations was that NCUA would only allow credit unions to gradually increase their member business lending capabilities by adopting a tiered approval process.

However, the Federal Credit Union Act already exempts two classes of credit unions from the aggregate business loan of 12.25 percent of assets:
• credit unions that are chartered for the purpose of making or a history of primarily making member business loans to its members; and
• credit unions that predominately serve low income members or are community development financial institutions.

These institutions can already exceed the aggregate cap and there are no limitations on how aggressively they can expand their business loan portfolio.

If you think there is a need for a tiered approval process with regard to increased business lending by credit unions, why then has NCUA not proposed changes to its regulations that would only allow these credit unions to gradually increase their business lending authority through a tiered approval process?

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.

Southern Nevada-based CUs Lose $120 Million in 2009

The Las Vegas Review-Journal is reporting that Southern Nevada-based credit unions lost about $120 million in 2009.

The article reports that Silver State Schools Credit Union, Nevada Federal Credit Union, and Clark County Credit Union accounted for a majority of the losses.

Privately-insured Silver State Schools CU and Clark County CU reported losses of $50.9 million and $25.3 million, respectively.

Nevada Federal Credit Union lost $32 million.

Nevada Encouraging Savings Only Members to Withdrawal Funds

The Las Vegas Review-Journal is reporting that Nevada FCU will pay members that only use the credit union for savings to withdrawal their funds.

Nevada Federal Credit Union estimates that about 1,600 of its 85,000 members only use the credit union for savings. Because these savings only members don't have other financial relationships with the credit union, they are costing the credit union money.

The credit union has cut the variable interest rates on deposits held by members that only save money to zero.

Also, the credit union will pay these members a bonus of $25 bonus for withdrawing amounts between $25,000 and $49,999; $50 for amounts up to $74,999; and $75 for larger amounts.

Goose Egg

The March 3rd CUNA News quotes that the member business loan cap was a concern for Nikkei CU CEO Erick Orellana. According to CUNA News, Orellana said that his credit union is currently up against the 12.25 percent of assets member business loan cap.

I went to the credit union’s call report. This $89.2 million credit union reported zero member business loans at the end of 2009.

That’s right -- a giant goose egg!

The credit union, however, does report $10,560,265 in purchased business loans or participation interests to nonmembers. These nonmember business loans account for 36.5 percent of the credit union’s $28.9 million loan portfolio. The problem confronting this so-called credit union is that it cannot buy or participate in more loans to nonmembers.

$1 Billion NCUSIF Capital Note Partially Wrote Down

U.S. Central FCU reported a loss just shy of $477 million for the fourth quarter of 2009 -- bringing its loss for 2009 to almost $1.8 billion.

U.S. Central announced that its retained earnings have been fully exhausted, and all paid-in capital and membership capital shares balances have been fully depleted.

Moreover, the $1 billion NCUSIF capital note, issued on January 28, 2009, has been depleted by $331.0 million. But this capital note will probably be fully written off as U.S. Central recognizes additional losses from its investment portfolio.

2007 Form 990: CU Managers Compensation

Most state chartered credit unions file informational returns (Form 990) with the Internal Revenue Service disclosing what they pay their senior management, unlike federal credit unions.

You can download a state chartered credit union’s Form 990 from the GuideStar website.

Unfortunately, not all state chartered credit unions file a Form 990 as their state credit union regulators file a consolidated Form 990, thereby masking information about executive compensation.

While 2008 Form 990 returns are just being posted, below is a table showing the total compensation of managers for some of the largest state chartered credit unions in the nation that was pulled from their 2007 Form 990. Total compensation includes compensation plus deferred compensation plus expense accounts and other allowances. (Click image to enlarge)



The three highest paid credit union managers, according to these 2007 Form 990, were William Porter of Municipal CU (New York) at $3.1 million, David Maus of Public Service Employees CU (Denver) at $1.6 million, and Gordon Simmons of Service CU (Portsmouth, NH) $1.3 million.

When more of the 2008 Form 990s are available, I will provide a new update on senior management compensation at the largest state chartered credit unions.