S. 4036

Before adjourning, Congress passed credit union legislation (S. 4036) requested by National Credit Union Administration (NCUA).

The bill includes three technical amendments. One measure will clarify the application of an accounting standard that enables the NCUA to provide capital assistance to troubled credit unions, thereby encouraging mergers with healthy credit unions.

The other amendments will allow the NCUA to assess premiums for expenditures related to the Temporary Corporate Credit Union Stabilization Fund without first borrowing from Treasury, and clarify that the National Credit Union Share Insurance Fund equity ratio is based solely on its own unconsolidated financial statements.

The bill will also require the Government Accountability Office (GAO) to study the NCUA’s supervision of corporate credit unions and implementation of prompt corrective action. The legislation mandates that the GAO determine the reasons for the corporate credit union failures, and also evaluate the NCUA’s response to those failures. The measure also requires the GAO to evaluate the NCUA’s use of prompt corrective action with corporate credit unions and natural person credit unions and the agency's implementation of recommendations contained in previous reports from its own inspector general financial crisis. The completed report will go to the Senate Banking Committee, the House Financial Services Committee and the Financial Stability Oversight Council.

Wall Street Journal: NCUA Budget Criticized by CUs

The Wall Street Journal is reporting how NCUA's budget is drawing criticism from credit unions.

The 2011 budget for the National Credit Union Association will rise 12 percent. NCUA Chairman Debbie Matz justifies the increase stating: "Times are difficult, and we are very mindful of that, [but] we are not going to cut corners on safety and soundness,"

New Fiduciary Duty Standards and Disclosure of Enforcement Actions

Will NCUA's new fiduciary responsibility rule mean that federal credit unions will have to make public enforcement orders to the credit unions' membership?

As readers of this blog know, I have derided the NCUA about not making public all enforcement actions, such as Letters of Understanding and Agreement and other consent orders.

However, the new standards of fiduciary duty for federal credit union directors adopted by NCUA Board on December 16 may result in these enforcement actions being made public by federal credit unions.

The final rule will require directors to act in the best interests of credit union members, particularly in connection with matters affecting the fundamental rights of members.

In my estimation, regulatory enforcement orders are material events that affect the fundamental rights of credit union members and therefore, should be disclosed. Members have the right to know whether management and the board have engaged in unsafe and unsound banking practices or have violated the law.

Not disclosing this information could be viewed as a breach of the directors' fiduciary duty.

Now, if only we could get NCUA to practice what it preaches. If NCUA really believes that part of its job is to protect the interest of credit union members, shouldn't the agency publish all enforcement actions?

Customer Satisfaction at CUs Drop

According to the American Customer Satisfaction Index, credit unions suffered a sharp drop in customer satisfaction. The satisfaction index fell by almost 5 percent to 80.

Difficulties associated with managing rapid growth along with financial losses were cited as contributing factors to the decline in customer satisfaction. The December 14 press release states:

"Since credit unions can’t raise capital by selling stock, the only recourse to recover losses is through cost-cutting, which usually leads to less customer service, or raising fees, which leads to higher customer cost."

Credit unions and community banks have the same satisfaction index.

To read the press release, click here.

NCUA Wants Ability to Examine Third-Party Vendors

A legislative priority for NCUA in the next Congress is the ability to examine third-party vendors, such as credit union service organizations (CUSOs).

In her December 9th testimony, NCUA Chairman Debbie Matz stated:

"NCUA is the only regulator subject to the Financial Institutions Reform, Recovery and Enforcement Act of 1989 that does not have authority to perform examinations of vendors which provide services to insured institutions. Credit unions are increasingly relying on third-party vendors to support technology-related functions such as internet banking, transaction processing, and funds transfers. Vendors are also providing important loan underwriting and management services for credit unions. The third-party arrangements present risks such as threats to credit risk, security of systems, availability and integrity of systems, and confidentiality of information. Without vendor examination authority, NCUA has limited authority to minimize risks presented by vendors."

The Government Accountability Office (GAO) back in 2003 expressed concerns writing that "the lack of such authority could limit NCUA’s effectiveness in ensuring the safety and soundness of credit unions."

In fact, GAO's warnings became a reality in recent years. For example, third-party vendors were cited as playing a role in several high profile credit union failures -- Cal State 9 CU, Norlarco CU, and Huron River Area CU.

It seems prudent that NCUA should be granted this authority to examine third-party vendors.

Credit unions are making greater reliance on these third-party vendors. Without the ability to examine these entities, credit unions are increasingly exposed to operational and reputational risk.

Until NCUA is granted this authority, NCUA should put in place a moratorium on granting new authorities for third-party vendors such as CUSOs.

A.E.A. FCU Placed into Conservatorship

NCUA announced that A.E.A. FCU of Yuma, Ariz. was placed into conservatorship.

A.E.A. Federal Credit Union was placed into conservatorship due to declining financial condition. The credit union was significantly undercapitalized with a net worth ratio of 2 percent as of September 2010.

NCUA cited that the credit union has earnings insufficient to enable it to continue under present management. The credit union reported a 2009 loss of almost $25.9 million and a year-to-date loss of nearly $4.7 million.

As of September 2010, the credit union reported that 19.12 percent of its loans were 60 days or more past due. The credit union’s difficulties stemmed from problems in its commercial loan portfolio, where $45.5 million in business loans were 60 days or more past due. This translates into 64.27 percent of its business loans being delinquent.

Recently, Bill Liddle, who formerly managed AEA's business loan department, his wife and local businessman Frank Ruiz were indicted by a grand jury in an alleged kickback scheme related to business loans made to Ruiz.

Assets and Deposits at Problem Credit Unions Decline During November

During its update on the NCUSIF, NCUA reported that the number of problem credit unions declined by 6 during November to 372; but is up by 21 since the end of 2009. A problem credit union is defined as a credit union that has a CAMEL code of 4 or 5.

Between the end of October and the end of November, shares (deposits) and assets in problem credit unions fell by $800 million to $38.3 billion and $1 billion to $43.4 billion, respectively. NCUA reported that problem credit unions held 5.10 percent of the credit union industry’s insured shares and 4.80 percent of the industry’s assets.

The number of problem credit unions with assets of $1 billion or more was unchanged during the month at 12, although shares fell by $100 million to $16.8 billion.

Problem credit unions with between $500 million and $1 billion in assets fell by 2 during November to 6. This decline in problem credit unions in the $500 million to $1 billion asset size category led to a $1.1 billion reduction in aggregate shares to $3.5 billion.

NCUA noted that the number of problem credit unions with between $100 million and $500 million in assets increased by 1 to 61 and aggregate shares increased by $500 million to $13.6 billion.

Beehive CU Closed

The National Credit Union Administration (NCUA) was appointed liquidating agent of Beehive Credit Union of Salt Lake City, by the Utah Department of Financial Institutions; and Security Service Federal Credit Union of San Antonio, Texas, immediately purchased and assumed Beehive’s assets, liabilities and members.

At closure, Beehive had approximately $145 million in assets and served 18,000 members.

The Commissioner of Utah Department of Financial Institutions took possession of Beehive Credit Union in order to protect members and the public, finding, among other things, that the credit union had a negative net worth and was not in a safe or sound condition to transact business. Its net worth ratio was -0.38 percent at the end of the third quarter of 2010 and 5.66 percent of its loans were 60 days or more past due.

This is the 18th federally insured credit union liquidation in 2010.

NCUSIF Assessments Will Be More Pro-Cyclical Than FDIC Assessments

During yesterday's Federal Deposit Insurance Corporation (FDIC) Board meeting, the FDIC stated that assessments for banks will be less pro-cyclical under its new system than assessments under the National Credit Union Share Insurance Fund (NCUSIF) system.

FDIC was responding to issues raised by two bank trade associations about competitive imbalances regarding the change in the minimum DIF reserve ratio which would exceed the top statutory reserve ratio of 1.50 percent for the NCUSIF.

Below is FDIC's discussion.

"Two trade groups also noted that the National Credit Union Share Insurance Fund (NCUSIF) reserve ratio is limited by statute to 1.5 percent and argued that a higher DIF reserve ratio could exacerbate competitive imbalances. The presence or absence of a cap on fund size is but one of several statutory differences between FDIC-insured institutions and federally insured credit unions. The FDIC has proposed lower assessment rates that would go into effect when the reserve ratio reaches 1.15 percent. The FDIC believes that these assessment rates are sufficiently moderate that any competitive effect is likely to be small. Moreover, this difference is likely to be more than offset by the lower assessment rates that the FDIC should be able to maintain during a downturn. 2010, for example, credit unions paid on average slightly less than 26 basis points of insured shares. Since almost all credit union deposits are insured, insured shares are analogous to domestic deposits as an assessment base. In comparison, the FDIC estimates that, in 2010, banks and thrifts will have paid an average assessment rate of slightly less than 18 basis points on a domestic-deposit-related assessment base. (Emphasis added) Under the assessment rates that the FDIC proposed in the October NPR, banks and thrifts would pay much lower average assessment rates during a future crisis similar in magnitude to the current one. The proposed system is less pro-cyclical than both the existing system and the NCUSIF system, which is a positive feature when considered across a complete business cycle.

The new system with a higher designated reserve ratio will result in less pro-cyclical assessments compared to the NCUSIF system. That means that FDIC-insured banks will pay slightly more in premium assessments than NCUSIF-insured credit unions during good times; however, banks will pay lower assessment rates during economic downturns than credit unions, when insured institutions can least afford to pay high deposit (share) insurance assessment rates.

In fact, even under FDIC's existing system, federally-insured credit unions in 2010 paid a higher average assessment rate than FDIC-insured banks -- slightly less than 26 basis points versus slightly less than 18 basis points.

Modified Business Loans

As I reported earlier, NCUA stated that as of September 2010 federally-insured credit unions had modified approximately $11.2 billion in loans. NCUA reported that modified business loans accounted for almost $1.9 billion of the $11.2 billion in loan modifications.

Evangelical Christian CU (Brea, CA) has the most modified business loans at almost $159 million. The following table provides a listing of the credit unions with the most modified business loans. (click to enlarge the image)













NCUA also reported that the delinquency rates on modified commercial real estate loans and on modified non-real estate business loans were 24.18 percent and 18.54 percent, respectively.

America First in Riverdale, Utah reported having the most delinquent modified business loans at $43.59 million in business loans -- all were commercial real estate loans. The following table provides a ranking of the 25 credit unions with the most delinquent business loans. (click to enlarge image)

Loan Modifications, September 2010

NCUA reported that federally insured credit unions had approximately $11.2 billion in loan modifications on their books as of the end of September 2010. In other words, 1.98 percent of all loans on the books of credit unions have been modified.

The following table ranks the top 50 credit unions -- both federally insured and privately insured -- with at least $25 million in outstanding total loans as of September 30, 2010 that have the highest percentage of modified loans. (click on image to enlarge)

As of the end of the third quarter, thirty-eight credit unions reported having at least 10 percent of their outstanding loans modified with Beehive Credit Union in Utah reporting that almost 28 percent of its loans (dollar volume) have been modified.

Hearing on the State of the Credit Union Industry

NCUA Chairman Debbie Matz testified that as of September 30, 2010, aggregate net worth of the credit union industry was $90.6 billion, which equates to a net worth ratio of 9.97 percent of total assets. Ninety-eight percent of all credit unions were at least adequately capitalized or better and 94.8 percent of all credit unions were well capitalized.

Her testimony noted that since the end of 2006, the delinquent loan ratio and net charge-off ratio have more than doubled. She also noted that 270 of the 633 credit unions, which have a 3, 4, or 5 CAMEL rating and make member business loans (MBLs), business lending is the primary or secondary contributing factor for the supervisory concern.

NCUA requested that three changes be made to the Federal Credit Union Act that are technical and non-controversial.

"Change the Net Worth definition to allow certain loans and accounts established by the NCUA Board to count as net worth. NCUA‘s ability to resolve problem credit unions at the least cost to the NCUSIF has been limited by the Financial Accounting Standard Board‘s changes in accounting standards, in combination with the existing statutory definition of net worth. Since NCUA does not have the ability to adjust the definition of net worth similar to the Federal Deposit Insurance Corporation‘s authority, this results in the dilution of a credit union‘s net worth when it acquires another credit union, regardless of whether or not NCUSIF assistance is provided to facilitate the acquisition. This increases costs to resolve failed institutions and necessitates more outright liquidations instead of mergers. Liquidations immediately cut members off from credit union services.

Amend the Act to clarify that the equity ratio of the NCUSIF is based on NCUSIF only, unconsolidated financial statements. Evolving accounting standards could result in the consolidation of the financial statements of the NCUSIF with regulated entities when NCUA exercises its role as the government regulator and insurer by conserving failed institutions. The requested amendment would be consistent with Congress‘ original intent in defining the NCUSIF equity ratio, and prevent insured credit unions from being assessed artificially-inflated insurance premiums resulting from the consolidation of financial statements with failed institutions.

Streamline the operation of the Stabilization Fund. As currently written, the Stabilization Fund must borrow from the U.S. Treasury to obtain funds to make expenditures related to losses in the corporate credit union system. The Stabilization Fund then assesses federally insured credit unions to repay the U.S. Treasury borrowing over time. Relevant amendments to Section 217(d) of the Act would give NCUA the option of making premium assessments on federally insured credit unions in advance of anticipated expenditures, thereby avoiding borrowing directly from the U.S. Treasury. In addition, while the existing statutory language includes the implicit authority for ongoing advances, a clarification of this in the statute is recommended."

During the question and answer part of hearing before the Senate Banking Committee, NCUA Chairman Matz made some interesting comments:

1. NCUA will be issuing next year a proposed regulation on concentration limits.

2. NCUA will examine all state chartered credit unions with over $250 million in assets annually.

3. NCUA examiners were given guidance and told that credit unions get only one shot at addressing Documents of Resolutions. If credit unions do not comply within 90 to 120 days, NCUA will escalate administrative actions.

4. NCUA would like the authority to exam third party vendors.

5. A small number of credit unions are at the aggregate member business loan limit.

6. When asked about the number of problem credit unions, Chairman Matz answered 50 credit unions. (Editorial comment: At the end of October, there were 378 credit unions with either a CAMEL 4 or 5 rating. I suspect the 50 number is the number of credit unions that NCUA may have slated to close or involuntarily merge.)

To view the hearing, click on this link.

NCUA's Equitable Sharing Provision of TCCUSF Expenses

NCUA is proposing to add a new amendment to its corporate credit union rule that would provide for the equitable sharing of Temporary Corporate Credit Union Stabilization Fund (TCCUSF) expenses among all members of corporates, including both credit union and noncredit union members.

The new proposed Section 704.21 provides that when the NCUA Board assesses a TCCUSF premium on federally-insured credit unions (FICUs), NCUA will request existing non FICU members to make voluntary payments to the TCCUSF. In the event one or more of these non FICUs declines to make the requested payment, or makes a payment in an amount less than requested, the proposal requires the corporate conduct a member vote on whether to expel that non FICU. NCUA writes that non FICU members will not likely pay without some encouragement. (Emphasis added)

The proposed amendment defines non FICU to mean every corporate member that is not insured by the National Credit Union Share Insurance Fund (NCUSIF). This would include trade associations, CUSOs, non credit union cooperatives, banks, insurance companies, and privately insured credit unions.

Through this proposed amendment, NCUA is seeking to shift the cost of the TCCUSF expense from FICUs to non FICUs, even though the real beneficiaries from creation of the TCCUSF are the NCUSIF and FICUs, not non FICUs.

If it weren’t for the creation of the TCCUSF, FICUs were looking at a huge one-time assessment in 2009 associated with NCUA’s efforts to stabilize the corporate credit union network and the conservatorships of U.S. Central and Western Corporate Federal Credit Unions. FICUs were facing a one-time assessment of 99 basis points to restore the NCUSIF back to its normal operating level of 1.30 percent of insured deposits – 69 basis points write down of its one percent NCUSIF capitalization deposit and a premium assessment of 30 basis points. Testifying before the House Financial Services Subcommittee on Financial Institutions and Consumer Credit on May 29, 2009, NCUA Chairman Fryzel stated that the 99 basis point cost to FICUs would equate to a 72 basis point reduction in each FICU’s return on assets and 65 basis point reduction in net worth.

Furthermore in a June 2009 letter to FICUs, NCUA wrote how both the NCUSIF and FICUs benefited from the creation of the TCCUSF. The TCCUSF “allows the Board to improve the NCUSIF’s equity ratio to better position the NCUSIF to cover future insurance losses. Essentially, it means insured credit unions will not bear a significant, current, concentrated, onetime burden for stabilizing the corporate system.”

Non FICU members of corporates, however, did not face this one-time assessment. Non FICUs did not benefit from shifting the obligation of resolving failed corporate credit unions from the NCUSIF to the TCCUSF and from the spreading out of the cost associated with corporate resolutions over a number of years.

Moreover, to call this payment voluntary or a gift is a sham.

NCUA would like you to believe that it is an innocent by-stander and not influencing the actions of non FICUs regarding the fictitious voluntary payments. NCUA wrote that it “does not ultimately make the determination of whether a non FICU should make a payment to the TCCUSF or the amount of the payment. The non FICU makes that determination. NCUA also does not make the determination of the adequacy of any payment. The members of the affected corporate make that determination when deciding whether or not to expel the non FICU member.”

In fact, NCUA is sending an invoice to non FICUs. If a non FICU does not pay up the requested amount, the corporate is required to hold a special meeting of the members to vote on the expulsion of the non-paying, non FICU member.

Most casual observers would hardly view this as voluntary and definitely not a gift. According to The American Heritage College Dictionary Third Edition, the word “voluntary” means “1) arising from or acting on one’s own free will or 2) acting, serving, or done willingly and without constraint or expectation of reward.”

Is this payment being done willingly without constraint?

In my opinion, non FICUs are being coerced into making this payment by a rogue agency that is abusing its powers.

Beehive Will Cost NCUSIF More Than $25 Million

NCUA's Inspector General stated that it will perform a Material Loss Review on Beehive Credit Union. The Inspector General in its 2011 Annual Performance Plan stated that the loss to the NCUSIF from this soon-to-be closed credit union will exceed $25 million.

What is odd is that while NCUA's Inspector General has announced that it preparing to look into the causes of this credit union's failure, neither the Utah credit union regulator nor the NCUA have bothered to seize this credit union.

Deficit Commission Report Calls for Eliminating CU Tax Exemption, Falls Short of 14 Votes Needed for a Vote on the Plan

The National Commission on Fiscal Responsibility and Reform released this week its report, The Moment of Truth.

Among its recommendations for reforming the corporate tax code was the elimination of all corporate tax expenditures, including the credit union tax exemption. Both the Office of Management and Budget and the Joint Committee on Taxation identify the credit union tax exemption as a corporate tax expenditure.

The report stated that eliminating business tax expenditures would allow for the corporate tax rate to be lowered and would also help to reduce the deficit. Lower corporate tax rates will make American businesses more competitive and abolishing special subsidies will create an even playing field for all businesses instead of artificially picking winners and losers.

While the Commission's deficit reduction plan fell short of the 14 votes needed to present its recommendations to Congress for a vote, a bipartisan majority, 11 out of 18 members, voted for the plan.

I believe this Commission has provided a valuable service in advancing the discussion. But the path to fiscal sustainability won't be easy. The special interests, which include credit unions and their trade associations and federal regulator, will vigorously fight to preserve their favorable tax treatment.

CUs Used Federal Reserve's Emergency Loan Facilities

The Federal Reserve released data on Wednesday showing that several corporate and natural person credit unions accessed its emergency loan facilities during the financial crisis.

Three credit unions used the Federal Reserve's Term Auction Facility -- U.S. Central (Lenexa, KS), Marine CU (Fond Du Lac, WI), and Service CU (Portsmouth, NH).

U.S. Central FCU between July 14, 2008 and September 11, 2008 accessed the Federal Reserve's Term Aucttion Facility (TAF) 5 times. The amounts borrowed ranged from $500 million to $5 billion. Each borrowing from the TAF had a duration of 28 days.

Marine CU borrowed from the TAF five times. The first borrowing was October 22, 2009 for $10 million. The subsequent four borrowings from the TAF were for $28.3 million with the last borrowing occuring on March 11, 2010 for 28 days.

Service CU borrowed 6 times from the TAF. Each borrowing was $12 million. The first borrowing was February 12, 2009. The last loan was originated on November 5, 2009. Durations of loans varied between 28 days and 84 days.

In addition, two corporate credit unions -- Members United Corporate FCU and Wisconsin Corporate CU -- used the Federal Reserve's Commercial Paper Funding Facility. The Federal Reserve purchased $268 million in commercial paper from Members United on October 27,2008 and $98.3 million in commercial paper from Wisconsin Corporate CU on October 28, 2008.

Recap of 10 Costly Credit Union Failures

NCUA's Inspector General (IG) issued a report summarizing significant findings associated with 10 costly natural person credit union failures between November 2008 and October 2010. The report notes that (1) poor strategic planning and decision making; (2) inadequate policies and internal controls; and (3) fraud contributed to these failures.

The following table lists areas of concern that were common with each failure (click on table to enlarge).












Appendix B lists various recommendations to NCUA management to address concerns identified by the IG report and managements comments regarding these recommendations.

For example, to address concentration risk, the IG recommends that credit unions provide more information on their call report breaking out unfunded commitments by loan type. NCUA management agreed with the recommendation and will add two additional categories of unfunded commitments not currently captured on the 5300 Call Report: indirect and third-party loans.

CU Member Files Lawsuit Over Gift Card Fees

A class action lawsuit has been filed against Visa, Services Credit Union and 1st MidAmerica Credit Union alleging that these companies failed to disclose administrative fees for gift cards.

The plaintiffs, Karen Rhodes and Gene Rhodes, allege that the defendant companies deducted administrative fees before the "valid through" date, making the cards worth less than face value. The lawsuit was filed in Madison County Circuit Court.

Karen Rhodes claims she bought a gift card for her father-in-law that had a $50 value with a valid thru date printed on its face. Unknown to her, the actual value of the Visa Gift Card was only $35 at the time she purchased it because the defendants had imposed administrative fees of $2.50 per month before she even bought the gift card. When her father-in-law went to use the card it actually had a value of $2 due to the application of monthly administrative fees.

The suit claims that the credit union violated the Illinois' Consumer Fraud and Deceptive Business Policies Act.

The lawsuit is asking the court to declare a class action for everyone who bought gift cards from the credit union around the same time and to repay the members the costs of the administrative fees.