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.

NCUA: Earnings Up Sharply from One Year Ago

The National Credit Union Administration (NCUA) noted that although asset growth was anemic, earnings improved at federally-insured credit unions during the third quarter.

NCUA reported that assets, loans, and shares (deposits) grew by 0.4 percent, 0.1 percent, and 0.3 percent, respectively. Because shares were growing at a faster pace than loans, the loan to share ratio has dropped to 72.71 percent at the end of the third quarter of 2010 from 77.94 percent a year ago.

While loan growth was relatively flat during the quarter, used vehicle loans expanded 1.8 percent. Also, unsecured loans increased 1.4 percent and
real estate loans rose 0.1 percent. However, new vehicle loans declined 3.6 percent.

Credit Union See Improved Profitability

NCUA is reporting that profits at federally-insured credit unions were up almost 72 percent from a year ago to $3 billion, as of September 30, 2010. The return on assets (ROA) was up 17 basis points from a year ago and 5 basis points from the prior quarter to .45 percent.

NCUA attributed the improvement in the ROA to declining cost of funds, lower provision for loan loss expense, and higher fee and other income offsetting higher operating expenses. For example, provisions for loan and lease losses were down almost 24 percent from a year ago to slightly less than $5.3 billion.

Credit Unions Build Net Worth During the Quarter

Stronger earnings during the third quarter helped federally-insured credit unions to build their net worth. NCUA reported that credit union net worth improved by $1.3 billion during the quarter to $90.6 billion. As of the end of the third quarter, the net worth ratio for federally-insured credit unions was 9.97 percent, up 9 basis points from the second quarter.

Asset Quality Appears to Be Stabilizing

Asset quality appears to be stabilizing as the delinquency ratio stood at 1.74 percent compared to 1.76 percent in the first quarter of 2010 and 1.73 percent in the second quarter of this year. As of September 30, 2010, federally-insured credit unions reported holding almost $9.9 billion in loans that were 60 days or more past due.

One exception was the delinquency rate on business loans. As of September 2010, the delinquency rate on business loans was 4.29 percent -- 16 basis points higher than second quarter delinquency rate and 93 basis points above the delinquency rate a year earlier.

Moreover, delinquent business loans represented a disproportionate share of all delinquent loans. Although business loans were approximately 6.2 percent of all credit union loans, delinquent business loans accounted for more than 15 percent of all delinquent loans.

In addition. the net charge-off rate fell by 3 basis points during the third quarter to 1.13 percent. Net charge-offs were slightly more than $4.8 billion as of September 2010 compared to $5 billion a year ago.

NCUA further noted that as of September 2010, nearly 2 percent of all loans were modifications.

Foreclosed and repossessed assets grew 8.3 percent to $1.8 billion in the third quarter. Foreclosed real estate was up 43.7 percent from a year ago and 9.1 percent from the second quarter of 2010 to slightly more than $1.5 billion..

AFTRA-SAG FCU Asks Members to Move Their Deposits

The Los Angeles Times is reporting that AFTRA-SAG Federal Credit Union has asked its large depositors to withdraw funds from their deposit accounts and move those funds to another institution.

In a letter to members, the credit union wrote: “Due to the unusual economic and market conditions, we are asking you, a select group of our large depositors, to move a portion of your funds to another institution. This request is a temporary one, so we would like to explain why we are making this request: The Credit Union is ‘flooded with cash.’”

The key issue for the credit union is that it is having difficulty generating earnings to keep its net worth ratio above 7 percent, the minimum requirement for being well-capitalized. The credit union reported a loss of $3.9 million for 2009 and through the first 9 months of 2010, the loss was almost $807,000. As a result the credit union is having to shed assets and deposits to keep its net worth ratio above the 7 percent threshold.

Debt Reduction Task Force Recommends Eliminating CU Tax Exemption

The Washington, D.C.-based Bipartisan Policy Center's Debt Reduction Task Force last week released a 140-page report outlining a plan to cut $6 trillion from the federal debt by 2020. The task force, co-chaired by former Sen. Peter Domenici (R-N.M.) and Alice Rivlin, former vice chair of the Federal Reserve Board, recommended eliminating a long laundry list of tax expenditures -- including the credit union tax exemption.

The plan, among other things, also includes a one-year payroll tax holiday; a 6.5 percent national sales tax to lower the national debt; a five-year freeze on defense spending; a four-year freeze on nondefense domestic spending; and reductions in farm program spending. The corporate tax rate would be lowered to 27 percent, and individual taxes would have only two rates -- 15 percent and 27 percent.

In recommending either eliminating or scaling back almost all tax expenditures, the Task Force stated that "[w]hile some tax expenditures promote important social and economic goals, others have little economic justification."

The Task Force further states:

"Many tax expenditures,moreover, subsidize activities that generate no clear benefits beyond the rewards that private producers would receive in free markets. These tax expenditures misallocate resources by promoting over-investment in tax-favored industries and over-consumption of tax-favored goods and services. Tax expenditures also raise costs of compliance and administration and contribute to the high current levels of non-compliance. Eliminating almost all tax expenditures allows the Task Force plan to raise sufficient revenues with much lower individual and corporate tax rates than in current law."

To view a list of tax expenditures the Task Force recommended retaining, go to Appendix B on page 130 of the report.

IG Report: WesCorp to Cost TCCUSF $5.59 Billion

NCUA's Inspector General (IG) released its report on the failure of Western Corporate (WesCorp) FCU. The expected loss to the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) from the failure of WesCorp is $5.59 billion. The report finds ample blame to go around citing WesCorp's management, Board of Directors, and NCUA's Office of Corporate CU examiners (OCCU examiners).

The IG report criticizes WesCorp management and Board of Directors for an aggressive investment strategy that allowed for excessive investments in privately-issued residential mortgage backed securities (RMBS). So by December 31, 2008, nearly 70% ($15.8 billion) of WesCorp‘s $22.7 billion investment portfolio was comprised of privately-issued RMBS.

In addition, the IG report notes that most of the underlying mortgage collateral of WesCorp's investments were located in California. Between August 2004 and February 2008, the portion of the RMBS portfolio having collateral in California ranged between 45 percent and 67 pecent. Wescorp's investment policy provided that up to 75 percent of the underlying collateral of domestic mortgage-related securities in any one state was adequate geographic diversification.

The report also notes that the failed corporate credit union had a large concentration of RMBS with loans serviced or originated by Countrywide Home Loan, Inc.

Additionally, WesCorp's was overexposed in its investment portfolio to privately-issued securities in a higher risk subordinated classes.

Finally, WesCorp pursued a strategy of purchasing privately-issued RMBS collateralized by sub-prime and Alt-A residential mortgage loans. As of December 2008, its RMBS portfolio classified as Alt-A and sub-prime was $13.7 billion and accounted for 60 percent of the total $22.7 billion investment portfolio and 87 percent of the $15.8 million privately-issued RMBS.

But the IG report is also critical of OCCU examiners because they "did not adequately and aggressively address WesCorp‘s increasing concentration of privately-issued RMBS and the increasing exposure of WesCorp‘s balance sheet to credit, market, and liquidity risks."

The IG specificaly noted that "OCCU examiners did not critique or respond in a timely manner to WesCorp‘s growing concentrations of privately-issued RMBS in general and in particular RMBS: (1) backed by higher risk mortgage collateral; (2) concentrated in California; and (3) issued, originated, and serviced by Countrywide."

The evidence suggests that OCCU examiners did not require or even advise management to limit or reduce its concentration of privately-issued RMBS, or its concentration of RMBS backed by Alt-A and sub-prime mortgage collateral and collateral comprised of exotic adjustable rate mortgages until it was too late. In fact, OCCU examiners did not issue a finding or Document of Resolution (DOR) to address this concentration until February 2008, well after the credit and liquidity crisis surfaced.

NCUA to Liquidate Constitution Corporate FCU

NCUA announced that it liquidated Constitution Corporate FCU on November 30 as part of its legacy assets program. Constitution Corporate FCU was placed into conservatorship by the NCUA Board on September 24.

Problem Credit Union Update, October 2010

As of the end of October 2010, NCUA reported that the number of problem credit unions edged higher in October to 378 from 374 in September. A problem credit union is defined as a credit union that has a CAMEL code of 4 or 5.

However, shares (deposits) and assets in problem credit unions during October fell by $900 million to $39.1 billion and to $44.4 billion, respectively. The decline was attributable to a single $1 billion plus credit union migrating from a CAMEL code 4 or 5 to a CAMEL code 3.

As of October, problem credit unions accounted for 5.20 percent of all insured shares in credit unions and 4.91 percent of all assets.

For every month beginning with September 2009, more than 5 percent of the industry's insured deposits have been in problem credit unions; but the October reading of 5.20 percent is at its lowest level since the 5.13 percent of insured deposits as of the end of September 2009.

NCUA to Collect Between $1.5 and $2.7 Billion in Assessments in 2011 (Updated)

The NCUA Board today provided credit unions with guidance as to the anticipated premium assessment rate for 2011. Credit unions are expected to pay a combined premium rate between 20 and 35 basis points in 2011. NCUA is projecting that it will collect between $1.5 billion and $2.7 billion in premium revenues in 2011.

The premium revenues will be allocated between the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) and the National Credit Union Stabilization Fund (NCUSIF). NCUA set the premium range for the NCUSIF between 0 and 10 basis points and the premium for the TCCUSF between 20 basis points and 25 basis points for next year.

NCUA stated that a combined premium assessment of 20 basis points would result in 80 credit unions seeing their capital ratios falling below the standard for being well capitalized or 7 percent abd 32 credit unions would become undercapitalized. Also, 760 credit unions would shift from reporting a profit to a loss.

If the combined premium is 35 basis points, then 148 credit unions will slip below being well capitalized, another 62 credit unions would become undercapitalized, and 1,200 credit unions will go from a profit to a loss.

Prize-Linked Savings Accounts

Last night on Marketplace, a story about how a handful of Michigan credit unions are offering prize-linked savings accounts caught my attention.

According to the story, these credit unions have opened about 15,000 new accounts this year and have taken in $18 million in deposits.

The basic premise is to combine a lottery with a savings account. These accounts would pay below market rates; but the prize money comes from the difference between what people would typically earn in interest and the lower interest rate that depositors are being paid.

These accounts are viewed as no-lose lotteries; because your principal is not at risk.

Currently, Michigan is the only state that allows such accounts to be offered by credit unions.

The Sky Is Falling

The draft proposal of the co-chairs of the National Commission on Fiscal Responsibility and Reform recommended several options that would eliminate all or many tax expenditures. While not specifically mentioned in the draft proposal, one tax expenditure that may be repealed is the tax exemption for credit unions.

Tax expenditures are defined in the law as "revenue losses attributable to provisions of the federal tax laws which allow a specific exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability."

Responding to the co-chair's draft proposal, Bill Cheney, CEO and President of CUNA, wrote the Commission that if "faced with federal income tax liability, a number of credit unions may no longer feel compelled to operate a credit union and could close or convert to for-profit banks."

It is very clear from his statement that he believes that the credit union business model needs its tax exemption to survive or to provide a value proposition to consumers. In other words, CUNA believes the sky is falling.

I find this to be a very sad commentary and I believe there are a number of credit union CEOs that would disagree with his point of view.

Other businesses have lost their tax exemption and have not gone the way of the dodo bird and I suspect that credit unions will also adapt and compete if taxed.

Are Credit Unions Engaging Their Members?

In publicizing the credit union difference, credit unions regularly talk about their members as owners. However, are credit unions engaging their members as owners or are their members really just customers in the eyes of management?

What got me wondering about this question was a November 4th letter on Cooperative Operating Philosophy from the Farm Credit Administration (FCA), the regulator of the Farm Credit System (FCS), to Farm Credit institutions, financial cooperatives serving agriculture.

The letter encouraged Farm Credit institutions to engage their members as owners.

"Members need to know and understand their rights and benefits of ownership and be informed of the many ways they can exercise those rights and participate in the control of their institution."

While not mandating, the FCA wrote that FCS institutions could engage their members by:

1) posting their bylaws on their website;
2) ensuring that members petition rights are understood and fully supported; and
3) informing members how they may bring matters to the attention of the board or the membership as a whole.

I then went to several credit union websites including Navy FCU, State Employees CU, Altura CU, and Safe CU. I could not find their bylaws or any information on petition rights.

If management is not engaging members to participate in the control of their credit unions or providing them with the necessary information to participate in their institutions, then there may be a principal-agent problem.

Credit Union Ag Lending to Farmers and Ranchers

I've just returned from the North American Agricultural Lenders Conference in Omaha. While I was there, I had a conversation with Bert Ely, a financial industry consultant, about credit union lending to agriculture. Apparently Bert had gotten an earful from Minnesota and North Dakota bankers about credit union competition for loans to farmers and ranchers.

As a result of our conversation, I decided to take a look at the credit union ag lending scene.

As of June 30, 2010, 184 credit unions reported having agricultural loans on their books equal to almost $1.7 billion.

While in aggregate agricultural lending by credit unions represents a small fraction of all credit going to agriculture, in some local markets credit unions are significant competitors.

The credit union with the largest ag loan portfolio is privately-insured Beacon Credit Union of Wabash, Indiana with almost $324 million in farm loans. Farm loans account for 45 percent of the credit union's total assets. Rouding out the top 5 are Central Minnesota FCU (MN), First Community (ND), Town and Country (ND), and Interra (IN).

The following table (click to enlarge image) identifies the 25 credit unions with the largest agricultural loan portfolios. Also provided is information on the percent of the credit union's assets in farm loans.

Vystar CU on MBL Personal Guarantees

Under NCUA's regulations, a credit union making a business loan is required to obtain the personal liability and guarantee of the borrower’s principals as part of the rule’s collateral and security requirements. However, a federal credit union that qualified for NCUA's Regulatory Flexibility (RegFlex) program was exempted from this requirement.

However, during the October 21 NCUA Board meeting, the NCUA Board by a 2 to 1 vote rescinded this exemption for qualified federal credit unions along with other exemptions associated with the agency's RegFlex program.

While most credit unions argued for the continuation of the exemption for RegFlex credit unions citing competitive disadvantages, Vystar Credit Union argued that all credit unions that engage in business lending should be required to obtain these personal liability and guarantees.

Esther Schultz, Chairman of the Board of Vystar Credit Union, wrote:

"Our comment is on the changes related to Member Business Lending and requiring a credit union to obtain a personal liability and guarantee of the borrower's principals as part of the rule's collateral and security requirements. As a state chartered credit union we make Member Business Loans and have consistently adhered to the requirement to obtain these personal liability and guarantees. During this challenging economic time, we have found tremendous value in exercising such guarantees and strongly believe that they are critical to making a prudent Member Business Loan decision. Such guarantees have also enhanced our collection abilities in multiple situations, thereby helping to prevent losses to the credit union. Also, when borrowers have balked at agreeing to such requirements, we consider that to be a red flag indicating that additional due diligence is necessary before a loan decision is made."

Esther Schultz goes on to write saying that NCUA needs strength its rules associated with member business loans because of the risk business loans pose to the credit union insurance fund and credit unions.

"We have been making Member Business Loans for a number of years and we believe making them is important for the credit union industry. We also believe that it is important that credit unions engaged in Member Business Lending obtain the expertise to make such loans and service them properly. Each loan decision is unique in its own way and must be carefully evaluated, monitored and serviced after origination. The longer we make Member Business Loans the more we learn about how to improve our related risk management. Otherwise, it is a risk to the National Credit Union Share Insurance Fund and to all credit unions. We encourage NCUA to continue its efforts to strengthen its governance of Member Business Lending to ensure those credit unions doing so are not placing all credit unions at risk. We remain concerned that some credit unions are engaging in Member Business Lending without obtaining proper expertise to underwrite and service such portfolios."

.

Redacted Consent Orders

The Washington Department of Financial Institution's Division of Credit Unions is making public consent orders for state chartered credit unions. They should be commended for doing so. With the exception of the most recent order against The Union Credit Union, which failed on October 29th of this year, the state credit union regulator unfortunately has redacted most information from its consent ordersthat would have been of value to credit union members and the public.

The Division of Credit Unions does state on its website that "under Washington State law, examination reports and any information obtained in connection with the examination of a credit union are confidential and privileged and not subject to public disclosure. For this reason, portions of the administrative actions available on this website may be redacted."

Take for example the enforcement action against Global Credit Union in 2009, it is full of redactions.

Page 2 of the consent order reads, as follows:

"IT IS HEREBY AGREED AND ORDERED that the Credit Union cease and desist from [redacted text]." The consent order goes on to enumerate 8 additional items under A, which are all redacted.

Under section 2.a.2) dealing with asset quality, the order says: "The consultant must deliver copies of their report within 60 days of engagement to the Board and Assistant Director. At a minimum, the deliverables must include

i) [redacted]
ii) [redacted]
iii) Suggestions for [redacted]
iv) Suggestions for a [redacted]

The consent order has additional redactions, including key net worth ratios. For example, it redacts the net worth ratio the credit union needs to obtain by December 31, 2010.

The Division even redacted the date of the last exam of the credit union. How is providing the date of the last exam harmful?

I believe the Division of Credit Unions should take a very narrow instead of an expansive view of "confidential and privileged" information. This will result in greater transparency.

Retrospective on a Hostile Takeover that Did Not Happen

Alliant Credit Union of Chicago is in the process of acquiring financially troubled Continental Federal Credit Union of Tempe, AZ.

Continental is significantly undercapitalized and is hemorrhaging money. Because of its troubled financial status, the members of Continental will not vote on the merger, which is expected to be completed on January 28, 2011.

This got me wondering about what could have been.

Back in early 2007, Wings Financial (Apple Valley, MN) made a hostile bid to takeover Continental FCU after management and the board of Continental rejected previous advances from Wings.

Wings directly solicited the members of Continental FCU. Wings stated that members of Continental would be $1200 better off, if Wings and Continental merged given the lackluster performance of Continental, and Wings proposed to pay members a pre-merger dividend.

Wings withdrew its offer after NCUA ruled that the dividend would violate the Federal Credit Union Act.

This unsolicited bid caused many within the credit union industry to rally to the defense of Continental FCU's management and board. Credit union trade associations adopted anti-takeover resolutions. (At the end of this post is the resolution adopted by the Arizona Credit Union League).

However, in retrospect, was opposing this hostile bid in the best interest of the members of Continental FCU?

The Union Credit Union Closed

The Washington Department of Financial Institutions (DFI) closed The Union Credit Union (TUCU) and appointed the National Credit Union Administration (NCUA) as the liquidating agent.

Upon being appointed as liquidating agent, NCUA entered into agreements with Alaska USA Federal Credit Union of Anchorage and Numerica Credit Union of Spokane to purchase and assume certain assets and liabilities of TUCU.

Linda Jekel, Director of DFI's Division of Credit Unions, said: “The Union struggled primarily due to the unemployment of its members. This resulted in a high number of delinquencies, loan charge-offs, negative earnings and low net worth.”

TUCU was insolvent with a net worth ratio of -0.35 percent as of September 2009. The failed credit union reported that 6.78 percent of its loans were 60 days or more delinquent and had losses of almost $474,000 through the first 9 months of 2010.

At the time of liquidation, TUCU had approximately $11,909,715 in assets and served 3,115 members.

This is the 17th federally insured credit union liquidation in 2010.

Did Politics Influence Which Credit Unions Received TARP Funds?

Did political influence play a role as to which community development credit unions received funds from the TARP Community Development Capital Initiative (CDCI)?

This is the conclusion of a paper published by Linus Wilson at the University of Louisiana at Lafayette.

Forty-eight community development credit unions received almost $70 million in funds through CDCI, although 189 credit unions could have participated in the program. The study does state that it does not know which credit unions applied for the program, so it compares credit unions that received the funding to those that were eligible to receive CDCI funds.

The key finding of the paper was "that credit unions eligible for TARP funds were three times more likely selected for those funds if they were headquartered in the district of member of the U.S. House Financial Services Committee even after controlling for other factors. This indicates that political influence may have driven the selection of credit unions."

The study also concludes that credit unions that received CDCI funds had significantly lower loan-to-deposit ratios relative to other eligible credit unions that did not receive TARP investments. The author found this result to be startling, as these institutions were picked "because they would provide much needed loans to the credit union’s underserved communities.”

Furthermore, the study found mixed evidence as to whether regulators and Treasury selected stronger community development credit unions to receive these funds. The selected credit unions had significantly lower tangible net worth ratios; but also, had lower provisions for loans losses and fewer non-performing assets.

Excluding Faith-based Business Loans from the Aggregate Business Loan Cap

Should loans to nonprofit religious organizations be excluded from the member business loan cap of 12.25 percent of assets?

Legislation (H.R. 3380) was introduced in the current Congress that would have done just that and will probably be re-introduced in the next Congress.

While these loans would still be subject to NCUA’s Member Business Loan Rules and Regulations, credit unions would be able to expand their business lending portfolio beyond 12.25 percent of assets by assuming more exposure to such faith-based loans.

However, HR 3380 does not define a nonprofit religious organization. So, if the bill ever becomes law, it will be up to National Credit Union Administration to define what a nonprofit religious organization is and that scares me.

Consider a private university or a radio station affiliated with a religious group, or simply a large religious institution. Any of these might be considered “nonprofit religious organizations.” Lending for projects at institutions such as these could be just as risky as lending to a private organization.

In fact, NCUA has repeatedly stated that business loans are riskier than consumer loans. By excluding faith-based loans from the aggregate business loan cap, this could potentially cause an increase concentration in business loans and thus could pose a safety and soundness concern.

While data on church loan delinquencies are difficult to come by, research by Thomson Reuters found that more than 100 churches nationwide have filed for bankruptcy since early 2009, while the foreclosure rate has tripled in the past three years.

For example, Evangelical Christian Credit Union in Brea, California has foreclosed on more than 20 churches over the past three years. The credit union reported that 8.18 percent of its loans were at least 60 days or more past due as of June 2010.

But a bigger question is why should a certain class of business loans be excluded from the aggregate business loan cap? Is there something socially desirable about faith-based loans, so that we want to promote these loans over other form of business loans?

What’s next, excluding loans to green energy?

I personally believe that policymakers should not be making Swiss cheese of the aggregate business loan cap to advance some social engineering objectives.

Loans Going to Nonmembers

In an article in the Las Vegas Review Journal, John Edwards writes about three partners that invested in commercial real estate in Las Vegas and received financing through Ensign FCU, which was later seized by NCUA. The partners defaulted on the loan and NCUA is foreclosing on the property and is suing to enforce the personal guarantees.

The article points out that none of the three partners were members of Ensign and that they were referred to the credit union by a broker. The amount borrowed was $1.4 million.

This raises an important question:

How did these partners qualify to get a $1.4 million loan from Ensign FCU?

Moreover, this is not the first instance of loans going to people who were not credit union members.

NCUA has noted that loans went to people who were nonmembers of Norlarco CU and Huron River Area CU and that both credit unions subsequently failed. Air Force FCU is under a Letter of Understanding and Agreement for serving people who were not qualified for membership.

If this is an emerging pattern of credit unions flaunting their membership requirements, then this is very troubling and requires a closer examination of their preferential tax treatment.

IG Report: Key Risks Not Adequately Identified or Corrected in U.S. Central's Failure

A report on the failure of U.S. Central Federal Credit Union from the National Credit Union Administration's (NCUA) Inspector General (IG) found that examiners from the Office of Corporate Credit Unions (OCCU) and staff from Office of Capital Markets (OCM) failed to "adequately identify or correct key risks to U.S. Central's investment portfolio." As of June 30, 2010, NCUA stated that the Temporary Corporate Credit Union Stabilization Fund had recorded a loss of $1.45 billion for U.S. Central.

Excessive exposure to risky securities caused U.S. Central's failure.

The study largely did not reveal anything that was not already publicly known about the demise of U.S. Central. The failure of U.S. Central arose from its excessive holdings of private label sub-prime and Alt-A mortgage-backed securities (MBS).

The report noted U.S. Central's business strategy shifted in 2006 towards more aggressive growth. To help fuel this growth agenda, the IG report states that twice in 2006 at the recommendation of management, the Asset/Liability Committee and the Board approved increasing the limits on non-agency MBS that could be held in portfolio. In April 2006, the limits were increased from 7 times capital to 8 times capital. Later that year, limits rose from 8 times to 10 times capital. Setting the limit at 10 times capital meant that approximately half of U.S. Central's assets were in non-agency MBS. In other words, U.S. Central was increasing its exposure to these non-agency MBS just at the time the market for non-prime, non-agency MBS became dislocated.

The report also states that management did not recognize the impact of potential deterioration of the value of the underlying collateral on U.S. Central’s capital and ability to meet its liquidity needs. As U.S. Central’s investment portfolio declined in value, so did its borrowing capacity, as established lenders reduced their lines. As result, U.S. Central became heavily dependent on discount window borrowings from the Federal Reserve Bank of Kansas City in 2008. The report further discloses that the NCUSIF was required to lend U.S. Central $3.7 billion in December, 2008 to ensure that the U.S. Central could met year end liquidity demand.

An interesting nugget from the IG study is that in April 2007, U.S. Central launched Sandlot Funding LLC (Sandlot), an off-balance sheet asset-backed commercial paper (ABCP) conduit, which was the first of its kind in the corporate credit union network. Aside from the bad timing to form an ABCP conduit in 2007, the report questions "whether U.S. Central’s management and Board had the expertise to venture into the business of issuing commercial paper and managing an ABCP conduit."

The IG report concluded: "[W]e believe this growth strategy and accompanying investment decisions to purchase higher yielding securities to such extraordinary levels was contradictory to U.S. Central’s fundamental purpose as a wholesale corporate credit union, which was serving as a secure investment option and a source of liquidity for retail corporate credit unions, and support for the not for profit credit union structure." (page 2).

Examiners failed to identify and correct key risks in timely manner.

The study points out that a corporate credit union that qualifies for Type III supervision, which U.S. Central met the requirement, is assigned an on-site capital market specialist on a full-time basis to monitor and evaluate the corporate credit union's financial condition. (see footnote 7 on page 7)

Prior to the March 2008 examination, there were few criticisms of U.S. Central's management or operations. In fact, OCCU examiners and OCM staff noted no significant concerns regarding U.S. Central’s investment function or its strategy to purchase large amounts of securities backed by sub-prime residential loans. The report cites the following from an earlier exam report.

“U.S. Central’s investment function remains conservative with the portfolio consisting of primarily the highest rated securities. Investment transactions are subject to reasonable pre-purchase analysis in accordance with regulatory and policy requirements. Additionally, U.S. Central’s credit function provides adequate ongoing monitoring of all investment exposures which subject the corporate to credit risk.”

By the time the OCCU examiners and OCM staff identified and required corrective action on U.S. Central’s investment portfolio related to its concentration of mortgage-backed securities, it was too late. The IG report states that when the Document of Resolution was issued in July 2008, the MBS market had deteriorated to the point where these securities were no longer being actively traded.

The report is critical of the heavy reliance by OCCU examiners and OCM staff, as well as U.S. Central's management, on high credit ratings to determine credit risk in the portfolio.

However, the report does strike a somewhat sympathetic tone noting that NCUA examiners and staff did not have the appropriate regulatory support, such as more specific investment concentration limits, and lacked the regulatory leverage to limit or stop the growth of U.S. Central’s purchase of sub-prime MBS.

Problem Credit Unions Rose in September 2010

During the October 21 NCUA Board meeting, NCUA reported that the number of problem credit unions increased, as did assets and shares (deposits) in problem credit unions. A problem credit union is defined as having a CAMEL 4 or 5 rating.

NCUA reported that the number of problem credit unions increased by 14 during the month of September to 374. A year earlier, there were 326 problem credit unions.











Shares and assets in problem credit unions rose by $500 million each in September to $40 billion and $45.3 billion, respectively.

Approximately 5 percent of the industry’s assets and 5.32 percent of shares are in problem credit unions.

The number of $1 billion plus problem credit unions was 13 as of September -- a reduction of one -- and these 13 credit unions held $18 billion in shares (or 45 percent of the shares in problem credit unions). The net increase in problem credit unions came from institutions with $500 million or less in assets, which added 15 credit unions with $1.3 billion in shares.

Interesting Thoughts from Credit Union CEO on NCUSIF

Henry Wirz, CEO of SAFE Credit Union in North Highlands, California, expressed some interesting thoughts about the National Credit Union Share Insurance Fund (NCUSIF) in a letter to the Credit Union Journal. He advocated that credit unions should change the way they fund the NCUSIF from the one percent capitalization deposit to expensing premiums. He also writes that having the insurer and regulator under a single entity, NCUA, is a problem. He believes that this structure has contributed to regulatory forbearance.

Below is the letter.

Reprinted with Permission, Credit Union Journal, Oct. 11, 2010.

(Washington league CEO) John Annaloro is right (see related story [paid subcription]). The insurance fund deposit is procyclical. The insurance fund has an operating level of between 1.20 and 1.30% of insured shares. But only about one-sixth of the fund has been expensed by credit unions, the rest is carried as an asset. When a big crisis occurs we have to either take a big expense hit or we amortize the cost over the next seven years as we did with the corporate expense. Either alternative is bad accounting. GAAP calls for matching the expense with the period in which the expense is incurred. We should switch to a premium-based insurance fund and incur an annual premium.

The other problem with the insurance fund is that we have the regulator and the insurance fund as one entity. NCUA has failed to exercise prompt corrective action, because it is in NCUA's best interest to hide failures and to get rid of problems through mergers. The NCUA Inspector General has repeatedly cited NCUA for contributing to credit union failures through bad examination procedures. Granted, the main cause of failures is bad management, but forbearance and lack of prompt corrective action increases the cost of failures and the frequency of failures. NCUA has no incentive to be transparent about the costs of failures because that too is a sign of failure. FDIC is transparent and is prompt with corrective action because FDIC is independent of the regulator.

John Annaloro is right and the rest of the trades should support major changes to the insurance fund. We need a premium-based insurance fund and we need an independent insurance fund. We also need more changes in the NCUA examination and oversight function.

Examiners Missed Business Loan Red Flags in St. Paul Croatian Failure

Reading the NCUA Inspector General's report on the failure of St. Paul Croatian FCU made me madder than a wet hen.

The report demonstrates the unintended consequences associated with the Congressional decision in 1998 to exclude loans secured by shares (deposits) from the definition of a member business loan (MBL). I know that suspected fraud was present; but if it were not for this exemption from the MBL definition, it would have been more difficult for the alleged fraud to be perpetrated.

The IG report stated that although member business loans were present, these loans were not viewed as member business loans; because "examiners apparently took at face value that these loans were share secured and therefore not MBLs."

All I can say is that I’m sure glad these NCUA examiners are not arms control inspectors.

You shouldn’t take the credit union’s word at face value. President Reagan said it best --“Trust, but Verify.”

Examiners did not take any further action even though red flags were present, including:

• During the December 31, 2004 examination, the examiner stated “there were two loans that might have been business loans”;

• The examiner noted for the December 31, 2007 examination that a large number of share secured loans were for large dollar amounts and it appeared that this was a way for the credit union to make business loans without a lot of documentation;

• The December 31, 2008 examination noted there was evidence of MBLs, but all the loans were apparently share secured and therefore, not subject to NCUA MBL Rules and Regulations; and

• NCUA examiners did not take exception to many issues until after the FBI and IRS met with NCUA staff in January 2010. For example, during the December 31, 2009 examination the examiners found that the credit union had $68.6 million in member business loans - almost 29 percent of the credit union’s assets. Some of these business loans had been on the books of the credit union for years.

Moreover, examiners in the December 2009 examination found that the credit union did not have an MBL policy; did not have the data processing system to track MBLs; and business loans were not supported by adequate documentation such as corporate designation of authority to borrow.

A business loan policy is important because it addresses issues such as types of business loans that the credit union will make, concentration limits by type of business loans, trade area, collateral requirements, and so on. This is part of any sound banking practices. However, because these loans were treated as exceptions to the agency’s MBL Rules and Regulations, the credit union did not have to establish such policies.

We should keep an eye on the other exceptions to the definition of member business loans including: a loan fully secured by a lien on a 1 to 4 family dwelling that is the member’s primary residence or loan(s) to a member or an associated member which, when the net member business loan balances are added together, are equal to less than $50,000.

It makes me wonder how many other cases like St. Paul Croatian are out there; but have not been unearthed.

Massive Fraud Leads to Failure of St. Paul Croatian

The NCUA's Office of the Inspector General (IG) issued its Material Loss Review regarding the failure of St. Paul Croatian FCU. The IG concluded that suspected fraud was the direct cause of St. Paul Croatian's failure, which resulted in a loss of $170 million to the National Credit Union Share Insurance Fund.

The report notes that a substantial majority of the credit union's loans were supposedly secured by members' shares. Specifically, 52 percent of all loans were share secured in 2004, 70 percent in 2005, 66 percent in 2006, 76 percent in 2008, and 88 percent in 2009. However, many of the loans were secured by deposits (shares) of members unrelated to the loan recipients.

But a December 31, 2009 examination discovered that "the majority of the loans were not actually share secured and a number of them were allegedly fraudulent."

A number of these supposed share secured loans were actually member business loans, even though the credit union did not have a member business loan (MBL) policy. In fact, "St. Paul had an MBL portfolio of 133 loans valued at $68.6 million with $2.4 million originated prior to 2008, $18.6 million in 2008, $41.8 million in 2009, and the remainder during 2010." As of the end of 2009, almost 29 percent of its assets were in business loans. But because these loans were supposedly shared secured, they were not subject to NCUA's MBL Rules and Regulations.

The report also found that the chief executive officer (CEO) of the credit union "manipulated loan records and masked the suspected loan fraud by constantly refinancing certain loans or making advance payment on those loans."

The IG report states:

"According to credit union employees, during previous examinations when NCUA examiners requested loan files, the CEO stated the files were stored at the other branch and the CEO would have them available the next morning. The credit union employees alleged the CEO gathered the entire staff that evening and directed them to create loan documentation to support the loans the examiners selected. Since a majority of the loans was supposedly share secured, the CEO instructed the staff to find a member with sufficient shares in their account to cover the pledged shares. This account was listed on the share pledge security agreement for that borrower. Credit union staff would then allegedly “witness” forged signatures on the share pledge agreement. Furthermore, credit union staff members stated they would have members with large share balances sign blank share pledge agreements in the event credit union members needed a loan in a hurry.

According to NCUA staff, the CEO would then deliver the alleged fraudulent loan documents to the examiners the following day."

The IG report also noted that there was a lack of segregated duties as the CEO performed most of the accounting and lending processes. As a result, there was no institutional constraints to prevent the suspected loan fraud.

The report points out that the credit union did not have the data processing system "to freeze shares used to secure loans." In addition, the data processing system truncated large numbers, when printing loan documents with large amounts.

Moreover, the credit union's data processing system failed to generate reports related to compliance with the Bank Secrecy Act. It could not differentiate between cash and check transactions and inadequately monitored for suspicious activities. St. Paul's Board did not complete the required BSA training. In addition, Office of Foreign sset Control (OFAC) "lists of suspicious persons were not verified against the recipients of out-going wire transfers; the wire transfer log was manually kept; documentation for wire transfers was inadequate; and St. Paul staff did not update the OFAC list on a regular basis."

A disturbing finding of the report was after the credit union was placed into conservatorship, the credit union's staff lacked the basic knowledge to run the credit union's operations without the direction from the CEO.

The IG report faults NCUA for not adequately identifying the risk at St. Paul Croatian. The report notes that examiners missed warning signs. For example, one red flag was that "the credit union reported zero delinquency and charge-offs from, at least, 2004 through 2009. Examiners believed this was reasonable, stating that faith-based credit unions ... usually have low delinquency."

SEC Issues No-Action Letter on Corporate CU Legacy Assets Guaranteed Securities

Here is the link to the September 24 letter from the NCUA to the Securities and Exchange Commission (SEC) requesting a No-Action Letter from the SEC that the Guaranteed Securities to be issued regarding the resolution of the corporate credit union legacy assets "will be considered to be securities which are (i) guaranteed by an instrumentality of the United States Government for purposes of Section 3(a)(2) of the Securities Act and (ii) obligations guaranteed as to principal or interest by the United States for purposes of Section 3(a)(42)(A) of the Exchange Act, thus qualifying as "exempted securities" as defined in Section 3(a)(l2) of the Exchange Act and therefore not subject to registration under Section 12 of the Exchange Act."

Here is the SEC's No-Action Letter to NCUA.

Credit Unions with Net Worth Ratios Below 6 Percent, June 2010

As of June 2010, there were 182 federally-insured credit unions that had net worth leverage ratios below 6 percent.

A net worth ratio below 6 percent is associated with being undercapitalized.

These 182 credit unions held approximately $26.8 billion in assets.

Fifteen of these 182 credit unions were critically undercapitalized -- net worth ratio below 2 percent. Most of these critically undercapitalized credit unions have either failed or been merged into a healthy credit union.

Below is a list of credit unions with net worth ratios below 6 percent. (click on images to enlarge).

Whistleblower Lawsuit Alleges Financial Improprieties at Hawaii Community FCU

Former Vice President of Finance, Renee Inaba, filed a whistleblower lawsuit against Hawaii Community Federal Credit Union (HCFCU).

The complaint alleges insider enrichment by managers, use of HCFCU funds for personal expenses, and conflicts of interest arising from undocumented relationships with vendors.

The lawsuit claims that while implementing cost cutting measures, Ms. Inaba found "rampant, endemic corruption, financial improprieties, conflicts of interest and breaches of fiduciary duty by managers of HCFCU."

According to the complaint, HCFCU managers went to Mixx Bar and other bars charging the bar tabs for food and drinks to the credit union as a business expense.

Ms. Inaba questioned the propriety of using of credit union funds to fly management and the board to a luxury resort -- the Grand Wailea on Maui. She was rebuffed by management and told "it's not that bad, not like we have corporate jets like the guys on the mainland."

Paragraphs 27 through 32 outlines alleged conflicts of interest associated with the use of vendors for printing, mailing and cleaning services.

The lawsuit further alleges that management had pushed through a prior Board of Directors a compensation package that would benefit the managers at the expense of credit union members. The planned payments would range from planned payments to insiders of $750,000 and over $1,000,000.

If it was not for the lawsuit, members of HCFCU would be clueless about these alleged practices by management, especially management's compensation.

This raises an interesting point -- whatever happened to NCUA's Outreach Task Force recommendation that total compensation to senior executive officers be disclosed to the credit union members annually. NCUA, when it issued the report, stated that such transparency would provide credit union members with information to evaluate a material expense, as well as those officials responsible for establishing the compensation package.

Credit Unions Paid Higher Premiums in 2010 Than FDIC-Insured Banks

I was recently asked how would FDIC premium assessment rates compare to premium rates paid by credit unions.

The short answer is that a well run (CAMEL 1 or 2) and well capitalized credit union had a higher premium assessment rate in 2010 than comparably situated FDIC-insured banks. The same is likely to be true for 2011 and 2012.

Currently, the base assessment rate for FDIC-insured banks ranges between 12 and 16 basis points (depending on supervisory evaluations and financial ratios) for banks that are well capitalized and have a CAMELS composite rating of 1 or 2. But the actual risk-based premium rate includes adjustments for secured liabilities, brokered deposits and capitalization (and unsecured debt), which can increase or lower the premium rate paid. The ultimate range is between 7 and 24 basis points. If you go here, you can see the risk-based premium matrix for FDIC insured banks.

In comparison, credit unions faced a combined NCUSIF and Temporary Corporate Credit Union Stabilization Fund (TCCUSF) assessment of 25.82 basis points for 2010.

Going forward, the base assessment rate for FDIC-insured institutions will be raised 3 basis points beginning in 2011. So, the base rate will be between 15 and 19 basis points. But the actual premium rate will be subject to the same adjustments.

NCUA on the other hand stated that the resolution of toxic assets in the corporate credit unions means that "credit unions can expect higher assessments in 2011 and 2012 with assessments anticipated to level off thereafter." Go to page 5 (question 15) of the FAQ.

Therefore, credit unions should anticipate a premium rate higher than the 13.42 basis points they paid in 2010 to the corporate credit union stabilization fund in 2011 and 2012. On top of that, credit unions should prepare for a NCUSIF assessment, which NCUA will disclose in November during its Board meeting.

Moreover, this analysis does not take into consideration the opportunity cost associated with the one percent NCUSIF capitalization deposit, which is a non-earning asset.

NCUA Creates Two Bridge Corporate CUs

The National Credit Union Administration announced the creation of two bridge corporate credit unions to assume operations of U.S. Central Corporate Federal Credit Union (US Central) and Western Corporate Federal Credit Union (WesCorp). The new entities will be known as U.S. Central Bridge Corporate Federal Credit Union and Western Bridge Corporate Federal Credit Union.

NCUA has been running US Central and WesCorp, since placing them into conservatorship on March 20, 2009.

The creation of these two bridge corporate credit unions is part of NCUA's "Good Bank/Bad Bank" model for resolving the toxic assets held by the corporate credit union system.

The bridge corporate credit unions (“good banks”) will purchase and assume “good” assets and member share deposits from the conserved corporate credit unions (“bad banks”).

NCUA stated that the new bridge corporate credit unions will not be able to add new services, will not be able to accept new members, and will focus on payment and settlement services.

Additionally, bridge corporates will not offer investment products other than short-term certificates. The maturities for term deposits will be restricted to 180 days or less. Investments will be restricted to cash held in correspondent accounts or Treasury and Federal Agency Security with maximum (bullet) maturities of 180 days.

NCUA stated that these bridge corporates will have a limited life span, probably no more than 24 months. NCUA believes that this will give the members of the bridge corporate credit union enough time to either charter a new corporate credit unions or sell the operations to another entity.

CU TARP Recipients (Update)

Below is a list of more tax-exempt credit unions that received a taxpayer capital infusion from Treasury through the Community Development Capital Initiative. (See prior postings for the other credit unions that have received a capital infusion from Treasury).

Southern Chautauqua Federal Credit Union (Lakewood, NY) $1,709,000
Fidelis Federal Credit Union (New York, NY) $14,000
Bethex Federal Credit Union (Bronx, NY) $502,000
Shreveport Federal Credit Union (Shreveport, LA) $2,646,000
Carter Federal Credit Union (Springhill, LA) $6,300,000
Workers United Federal Credit Union (New York, NY) $57,000
North Side Community Federal Credit Union (Chicago, IL) $325,000
East End Baptist Tabernacle Federal Credit Union (Bridgeport, CT) $7,000
Community Plus Federal Credit Union (Rantoul, IL) $450,000
Border Federal Credit Union (Del Rio, TX) $3,260,000
Opportunities Credit Union (Burlington, VT) $1,091,000
First Legacy Community Credit Union (Charlotte, NC) $1,000,000
Union Settlement Federal Credit Union (New York, NY) $295,000
Southside Credit Union (San Antonio, TX) $1,100,000
D.C. Federal Credit Union (Washington, DC) $1,522,000
Faith Based Federal Credit Union (Oceanside, CA) $30,000
Greater Kinston Credit Union (Kinston, NC) $350,000
Hill District Federal Credit Union (Pittsburgh, PA) $100,000
Freedom First Federal Credit Union (Roanoke, VA) $9,278,000
Episcopal Community Federal Credit Union (Los Angeles, CA) $100,000
Vigo County Federal Credit Union (Terre Haute, IN) $1,229,000
Renaissance Community Development Credit Union (Somerset, NJ) $31,000
Independent Employers Group Federal Credit Union (Hilo, HI) $698,000
Brooklyn Cooperative Federal Credit Union (Brooklyn, NY) $300,000

IG Report on Ensign FCU Failure

NCUA's Inspector General issued a Material Loss Review on the failure of Ensign FCU in Henderson, Nevada. The expected losses to the NCUSIF from this failure should not exceed $30 million.

Ensign failed because management adopted a high-risk strategy that allowed up to 80 percent of its loan portfolio to be concentrated in real estate secured loans. The combination of rapidly declining real estate values and increasing unemployment caused the delinquency rates by September 2009 to exceed 13.6 percent compared to 0.30 percent two years earlier.

The IG study found that there was little evidence in the monthly Board minutes to suggest that management was actively monitoring the concentration levels and the associated risks.

The report also concluded that management had flawed allowance for loan loss methodology and lenient lending policies allowing loan-to-value ratios on Home Equity Lines of Credit (HELOC) loans up to 100 percent and 40-year terms on mortgages.

Additionally, management failed to implement an effective collection program.

Ensign experienced significant losses in its real estate loan portfolio, as 80 percent of all losses coming from the real estate secured loans.

The report noted that in December 2007, examiners identified violations governing Member Business Loan (MBL) limitations for Construction and Development loans, MBLs to one individual or associated group, and aggregate MBLs, respectively. The credit union was cited for the same violations during a 2004 examination. Ensign also granted certain MBLs in excess of 15-year terms in violatation of the FCU Act.

For example, the credit union approved two large member business loans ($2.2 million and $3.6 million), one of which represented 25 percent of net worth when it was approved, and ultimately foreclosed, costing the Credit Union over $1.5 million in losses due to property devaluations.

The report noted that Ensign exceeded the fixed asset limit. At failure, fixed assets were 11 percent of total assets.

Management also demonstrated poor liquidity strategies. In December 2007, management accepted a $12 million share account from one member and did not establish a contingency plan in the event this money was withdrawn. In January 2009, the member requested to close this account but Ensign did not have sufficient liquidity to process the withdrawal. With NCUA's assistance, Ensign obtained a $12.5 million 30-day loan from the Central Liquidity Fund (CLF).

The IG report states that the credit union signed a Letter of Understanding and Agreement (LUA) on February 26, 2009 and agreed to seek a merger partner. The LUA was never published by NCUA.