Special Premium Assessment for Privately Insured Credit Unions

Both Credit Union Times and Credit Union Journal are reporting that American Share Insurance (ASI) will levy a 15 basis point special premium assessment on privately insured credit unions.

Credit Union Journal reported that ASI said: “The premium is deemed necessary as a result of losses developing, or incurred, in a small number of primary insured member credit unions.”

The special assessment was necessary to restore the ASI guarantee fund’s equity ratio to above its minimum level of 1.30 percent.

Shouldn’t Federal Credit Unions Be Required to Report on Governance Policies?

As part of its redesign of its Form 990, the Internal Revenue Service will require almost all not-for-profit organizations to provide greater detail about their corporate governance practices. Organizations, such as American Bankers Association, CUNA, and state-chartered credit unions, will be required to provide this information.

Federal credit unions, on the other hand, will not have to disclose this information because they are exempt from filing a Form 990.

The IRS, in justifying these additional disclosures, stated that “[g]ood governance and accountability practices provide safeguards to help ensure that the organization’s assets will be used consistently with its exempt purposes. This is a critical tax compliance consideration, especially for organizations that are subject to private benefit, excess benefit, and private inurement prohibitions. In addition, well-governed and well-managed organizations are more likely to be transparent with regard to their operations, finances, fundraising practices, and use of assets for exempt and unrelated purposes.”

The new Part VI, Governance, Management, and Disclosures, includes three sections: a) Governing Body and Management, b) Policies, and c) Disclosure. This information looks at “how and by whom an organization is governed, its governance and management policies and practices, certain relationships between or among its governing and management officials, and how the organization makes certain important information available to its constituents.”

For example, some of the questions appearing in Part VI are:

• Did any officer, director, trustee, or key employee have a family relationship or a business relationship with any other officer, director, trustee, or key employee?
• Does the organization have a written conflict of interest policy?
• Are officers, directors or trustees, and key employees required to disclose annually interests that could give rise to conflicts?
• Does the organization have a written whistleblower policy?

To view Part VI, click on the image below.

There is not a sound public policy rationale for why federal credit unions should not disclose this information.

Since federal credit unions do not file a Form 990, NCUA should at least require federal credit unions to disclose the same information about their governance practices that other not-for-profit entities are required to file. This should not be that hard to do, since the IRS has already provided a template with the new Part VI.

3 Tampa Area CUs Charging Fee Per PIN Debit Purchase

News Channel 8 is reporting that at least 3 Tampa area credit unions are charging a fee for each PIN debit transaction.

According to the story, Bay Gulf Credit Union is assessing members 50 cents each time they use PIN debit for a purchase. GTE Federal Credit Union is charging 25 cents per transaction and The Railroad and Industrial Federal Credit Union is charging $1 every time its credit union members use their PIN numbers.

"Bay Gulf President Bill DeMare said the credit union was forced to impose the fees because of recent losses due to debit card skimming."

By charging a fee on PIN debit, this will create an incentive for their members to use signature debit in place of PIN debit.

It will also help the 3 credit unions' earnings, since the interchange fee received by a credit union or bank associated with signature debit transaction is higher than the interchange fee per PIN debit transaction.

Problem Credit Union Update

The National Credit Union Administration released updated data on the number of troubled credit unions at its December 17 Board meeting. There was a slight decrease in the number of problem credit unions; however, the total amount of deposits in these institutions edged higher.

NCUA reported that the number of problem credit unions, credit unions with a CAMEL code 4 and 5, fell by 9 from the previous month to 328 as of November 2009. In comparison, there were 271 problem credit unions at the end of 2008.


However, the amount of insured shares (deposits) in problem credit unions was $40.1 billion -- or 5.63 percent of the industry total insured shares -- more than double the amount of shares ($16.3 billion) in troubled credit unions at the end of 2008.


The following graph shows the distribution of problem credit unions by asset size.

Do Credit Unions Have a Public Mission?

Recently, a person with more than 35 years in the credit union business commented to my posting on nonmember business loans that I'm unaware of a "mission statement" appearing within the Federal Credit Union Act.

While there is not a mission statement in the Federal Credit Union Act, I would suggest looking at the findings or preambles of various credit union acts to understand the intent of Congress. These preambles and findings make it abundantly clear that credit unions have a mission and that mission is to focus on consumers, especially those of modest means.

Let me be very clear; I’m not the only person to point to these findings to make a policy case as to what Congress intended. The Credit Union National Association has a history of citing these congressional findings to justify various policy stances the association has taken over the years.

For example, the preamble to the Federal Credit Union Act of 1934 states that credit unions are intended “… to make more available to people of small means credit for provident purposes through a national system of cooperative credit, thereby helping to stabilize the credit structure of the United States.”

The Credit Union Membership Access Act (CUMAA) of 1998 (Public Law 105 - 219) in its findings states that Congress found that “(1) The American credit union movement began as a cooperative effort to serve the productive and provident credit needs of individuals of modest means.” (emphasis added)

Congress reaffirms the continuation of this mission of serving individuals of modest means in Finding 4 of CUMAA, which states that “Credit unions, unlike many other participants in the financial services market, are exempt from Federal and most State taxes because they are member-owned, democratically operated, not-for-profit organizations generally managed by volunteer boards of directors and because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means.” (emphasis added)

Finding 4 makes it abundantly clear that the credit union Federal tax exemption is tied to the mission of meeting the needs of consumers, especially persons of modest means.

While some credit unions may believe they don't have a specific public policy mission, I believe these congressional findings would suggest they do.

Nonmember Business Loans

The other day, I was speaking with a reporter about legislation introduced by Rep. Kanjorski to raise the aggregate business loan cap of credit unions from 12.25 percent of assets to 25 percent of assets. During the call, I mentioned that nonmember business loans do not count against the aggregate business loan limit.

The reporter was shocked that credit unions were funding business loans to nonmembers, as this seems to contradict the raison d’etre for credit unions as membership organizations.

In October 2003, the National Credit Union Administration (NCUA) liberally modified its member business loan rule to exclude participated or purchased business loans to nonmembers from the aggregate business loan cap.

Beginning in 2004, NCUA started to track purchased business loans and participations to nonmembers.

In March 2004, business loans to nonmembers totaled almost $1.36 billion. By September 2009, federally-insured credit unions reported almost $6.65 billion in business loans to nonmembers. Business loans to nonmembers today represent about 19.3 percent of total business loans by credit unions.

At the end of June 2009, 696 credit unions reported funding nonmember business loans. In fact, some of these credit unions held a significant amount of nonmember business loans. Below is a list of credit unions with the largest amount of nonmember business loans on their books, as of June 30, 2009.

• Patelco CU (CA), $412,989,000;
• Premier America CU (CA), $190,285,000;
• Western FCU (CA), $154,046,000;
• Schoolsfirst (CA), $137,610,000;
• America First FCU (UT), $123,114,000;
• Langley FCU (VA), $113,399,000;
• California Coast CU (CA), $110,977,000;
• Travis CU (CA), $101,782,000;
• Keypoint (CA), $98,312,000; and
• Texans CU (TX), $95,292,000.

I believe a lot of other people would be shocked to recognize the extent to which credit unions are funding business loans to nonmembers.

Surprising Stat

Do banks or credit unions have a greater percentage of their respective industry’s assets in problem institutions?

If you guessed banks, you’re wrong.

At the end of the third quarter of 2009, the percentage of banking industry assets in problem banks was 2.61 percent.

In comparison, 4.83 percent of the credit union industry’s assets are in problem credit unions.

NCUA Is Now Posting Closed Credit Union List

NCUA is making progress towards providing greater transparency regarding credit union failures.

In a July 8th posting , I called on the NCUA to become more forthcoming regarding information about credit union failures.

The agency now posts on its website a list of closed credit unions with the date the credit union is closed and a link to the press release announcing the closing.

This is progress, but NCUA needs to do more with regard to transparency.

The list appears to be incomplete as the number of closed credit unions does not match the number reported by the agency when it gave its NCUSIF monthly update at the November Board meeting.

The list names 18 credit unions that have failed through the end of November, but NCUA at its November Board meeting stated that 22 credit union had failed through the end of October. (click to enlarge graph)












Additionally, NCUA still is not providing information on the expected cost of these credit union failures to the National Credit Union Share Insurance Fund.

NCUA should make that its next step in providing greater disclosures.

Vermont CU Receives Statewide Field of Membership

The Vermont Department of Banking, Insurance, Securities and Health Care Administration approved Vermont State Employees CU’s request to serve anyone who lives or works in the state of Vermont.

This is the first statewide field of membership granted for a Vermont credit union.

When the field of membership includes anyone who lives or works in a state, is there really a common bond?

Isn't this credit union just a tax-exempt mutual bank?

Are Credit Unions Going to Repeat the Mistakes of the 1970s?

In a November 13 speech to the American Association of Credit Union Leagues, NCUA Chairman Deborah Matz expressed concern about credit unions holding fixed rate long-term mortgage loans on their books.

According to third quarter 2009 data, federally-insured credit unions held almost $131 billion in outstanding fixed rate first mortgages. This represents about 60.5 percent of all first mortgages on credit union books. This year, credit unions have granted an even higher percentage of fixed-rate first mortgages, 82.5 percent.

Ms. Matz pointed out that about 55 percent of all such long-term fixed rate mortgages granted this year are sold. The ones that are unsold are not spread out among all of the credit unions, but concentrated in certain institutions. Those credit unions that are keeping the loans on their books are exposed to greater interest rate risk, as they fund long-term fixed rate loans at historically low rates with short-term deposits.

Ms. Matz warns: “When interest rates go up – notice I said when, not if – those fixed-rate mortgages that are earning relatively high rates now could slip underwater. And then it would be too late to sell them.”

When interest rates begin to rise, the cost of funds will increase a lot more quickly than yield on assets as these credit unions are saddled with low-yielding legacy fixed rate mortgages.

Anyone who studied the S&L crisis of the 1980s knows that interest rate risk played a central role. Will credit unions repeat the mistakes that led to that crisis?

Velocity CU's Members to Vote on Becoming Privately Insured

Velocity Credit Union (Austin, Texas) is seeking to change from federal deposit insurance to private deposit insurance.

The management and the credit union’s board has requested that members vote for the change in deposit insurer.

If approved, accounts at Velocity CU would be insured through American Mutual Share Insurance (ASI), the last remaining provider of private share insurance.

The credit union cites several factors in favor of converting to private insurance.

Velocity points out that due to estimated losses in the National Credit Union Share Insurance Fund (NCUSIF), it was assessed a premium in 2009 of $675,106. Velocity CU stated that this premium payment adversely affected the credit union’s earnings and net capital in 2009.

Additionally, Velocity notes that with ASI coverage, each individual member’s account is insured up to $250,000 and there is no limit to the number of accounts insured up to the $250,000 limit.

However, a Las Vegas Review Journal article cites a Government Accountability Office (GAO) study from October 2003 study stating that “ASI has limited borrowing capacity and could find it difficult to cover catastrophic losses under extreme economic conditions because it does not have the backing of any governmental agency, its lines of credit are limited in the aggregate as to the amount and available collateral, and it has no reinsurance for its primary share insurance.”

ASI in response to the GAO study stated that “no member of an ASI-insured credit union has ever lost money” and it can reassess its member credit unions up to 3 percent of their total assets to raise more capital in the case of catastrophic losses.

But the Las Vegas Review Journal article points out that depositors in Rhodes Island did not fare as well when the private insurance fund in Rhodes Island failed.

For Velocity to convert from federal insurance to private insurance, at least 20 percent of the membership needs to vote on the proposal.

Below is a disclosure posted by Velocity Credit Union on the facts about the vote (click on image to enlarge).

San Diego County CU Extends Title Sponsorship to College Bowl Game

San Diego County Credit Union has extended its title sponsorship of the Poinsettia Bowl through 2010, with options for 2011 and 2012. The $4.8 billion credit union has been the title sponsor of the game since its inception in 2005.

While no figure regarding the cost of being a title sponsor is released, the Poinsettia Bowl does disclose that the cost of being a premiere club sponsor begins at $25,000.

If San Diego County Credit Union can afford to buy the naming rights to a college bowl game, I believe it can also pay its fair share in income taxes. After all, the credit union reported a return on assets of 1.58 percent – more than 4 times the average return on assets of its peers.

And by the way, I don’t plan on watching the bowl game. There is not enough Prevacid in the world to handle the heartburn I would get whenever the title sponsor's name is mentioned during the ESPN broadcast of the bowl game.

Seven CUs Sue Former Directors and Officers of WesCorp (Updated)

The Las Vegas Review Journal is reporting that 7 credit unions are suing directors and officers of Western Corporate Federal Credit Union, seeking damages for millions of dollars lost when the institution was put in conservatorship.

The lawsuit filed in Los Angeles Superior Court on Tuesday, November 24 alleges that WesCorp changed its investment focus in 2003 by borrowing up to $10 billion in short-term funds and using the proceeds to invest in risky, long-term mortgage backed securities.

By January 2008, WesCorp was essentially insolvent but continued to operate with emergency support from the National Credit Union Administration. In March 2009, WesCorp was placed into conservatorship, wiping out the ownership stake of credit unions that invested in WesCorp.

The lawsuit accuses WesCorp officers and directors of negligence and breach of their fiduciary duties. The plaintiffs are seeking a judgment for damages.

The seven plaintiff credit unions and their stated losses are as follows:

Cascade FCU, with a loss of more than $1.8 million;

Glendale Area Schools FCU, with a loss of more than $1.2 million;

KaiPerm Northwest FCU, with a loss of $51,374;

1st Valley CU, with a loss of $163,395;

Northwest Plus CU, with a loss of $549,327;

Stamford FCU, with a loss of $189,096; and

Tulare County FCU, with a loss of $212,922.

Updated Numbers on Problem Credit Unions

The National Credit Union Administration released updated data today on the number of troubled credit unions. The data shows that both the number and deposits in troubled credit unions have increased.

There were 337 problem credit unions, credit unions with a CAMEL code 4 and 5, in October. In comparison, there were 271 problem credit unions at the end of 2008.



At the end of October problem credit unions held $39.8 billion in insured shares (deposits) -- or 5.58 percent of the industry total insured shares -- more than double the amount of shares ($16.3 billion) in troubled credit unions at the end of 2008.



The following graph shows the distribution of problem credit unions by asset size.



Additionally, it is highly likely that more credit unions will migrate towards being classified as a problem credit union, as 1,640 credit unions currently have a CAMEL 3 ratings.

Investment Product Income from Nonmembers Taxable

Income from investment products, such as stocks, bonds, mutual funds and annuities, sold to nonmembers by a state-chartered credit union is subject to unrelated business income tax (UBIT), a federal court ruled last week.

“The sale of products to persons who are not members of a credit union at all cannot be considered substantially related to Bellco’s tax-exempt purpose,” Judge Christine Arguello wrote in Bellco Credit Union v. United States.

The credit union argued that income earned from nonmember sales was de minimis and thus should not be taxed. The judge wrote that the credit union did not provide any evidence from "case law to suggest income unrelated to its purpose, no matter how minor, can be shielded from UBIT."

So, if income from the sell of investment products is subject to UBIT, this would suggest that other income from nonmembers should be taxable, including income from loan participations to nonmembers, ATM surcharges, and wire transfer and check cashing services.

However, Arguello ruled that investment products made available to members were "substantially related" to Bellco's tax-exempt purposes, and therefore income from those activities is exempt from UBIT. She also deferred ruling on the treatment of Bellco's income from certain insurance products until the trial begins Dec. 7, and she suggested the trial address whether the sale of such products to nonmembers who belong to other credit unions qualifies for a UBIT exemption.

Ensign FCU Closed

The Las Vegas Journal Review is reporting that Ensign FCU failed.

The article states that EDS Credit Union took over the insolvent Ensign FCU.

"Ensign lost $10 million in the first nine months of this year as its delinquent and charged off loans totaled $13.4 million."

Ensign FCU is the fourth Nevada credit union to fail in the last couple of months.

Matz Asks FHFA to Force Fannie to Offer Better Settlement

National Credit Union Administration (NCUA) Chairman Debbie Matz on November 9 wrote the Federal Housing Finance Agency (FHFA) encouraging that regulator to get Fannie Mae to offer a more reasonable settlement to credit unions defrauded by CU National Mortgage.

Chairman Matz noted that approximately two dozen credit unions were scammed by CU National to a tune of more than $125 million in potential losses. CU National sold mortgage loans to Fannie Mae but did not remit sale proceeds back to the originating credit unions. Fannie Mae offered a settlement equal to approximately 15 percent of potential losses in August and subsequently raised the offer to closer to 25 percent, with a 3 percent bonus if at least 18 credit unions agreed to the offer. The NCUA said only two credit unions have agreed to the settlement.

"The outcome seems especially egregious considering Fannie Mae's status as a government-sponsored enterprise, and doubly so in light of the fact that it is currently in conservatorship and receiving billions of dollars of taxpayer assistance," wrote NCUA Chairman Matz to FHFA Acting Director Edward DeMarco.

Talk about the pot calling the kettle black. Federal credit unions have received the equivalence of taxpayer assistance being exempt from paying income taxes for the last 75 years.

Letter below. Click on image to enlarge.

Constitution Corporate Joins the Undead

Another corporate credit union has joined the ranks of the living dead.

Constitution Corporate FCU (Wallingford, Conn.) reported that losses had totally depleted all its capital and was now operating with a Prior Undivided Earnings Deficit of $2,442,918 guaranteed by the National Credit Union Share Insurance Fund (NCUSIF).

The corporate credit union reported a loss of $77.4 million through the first nine months of 2009, resulting from OTTI charges of $79.9 million.

Below are the unaudited income and balance sheet statements for the corporate credit unions (click on images to enlarge).

Study: Uniform Tax Exemption Flawed, Creates Perverse Incentives

A study, An Economic Policy Analysis of the Tax Subsidy for Credit Unions, by William Kelly, Jr. through the Prochnow Foundation at the Graduate School of Banking has recommended replacing the current blanket tax exemption for credit unions with more targeted tax credits that focus credit unions on their public mission of serving people of modest means.

William Kelly is a professor of economics and finance at Grinnell College and previously was senior economist for the Credit Union National Association (CUNA) and the director of Center for Credit Union Research at the University of Wisconsin-Madison.

The study estimates that the annual taxpayer subsidy to credit unions is about $2 billion per year. The bulk of that subsidy is skewed towards higher income credit union members. According to the study:
• 61 percent of credit union benefits go to households with incomes over $95,000;
• 29 percent go to households with incomes of $35,000 to $95,000; and
• 10 percent go to households making less than $35,000.

Kelly writes that the reason why the tax subsidy flows to higher income members is due to its flawed design. “The dollar value of a household’s benefit from favorable interest rates is proportional to the size of the loan or deposit account, and these accounts are larger for more affluent households.”

The study points out that “credit unions differ widely in how well they carry out their Congressionally‐mandated mission to serve 'especially people of modest means', having taxpayers provide a uniform subsidy to all credit unions generates a perverse incentive. The subsidy continues in the same way whether a credit union responds well, poorly, or even opposite to achieving the mission that taxpayers subsidize them to do.”

Therefore, the study concludes that taxpayers would benefit from credit unions paying taxes just like other businesses including cooperatives. Instead of a one-size fits all tax exemption, the study recommends the use of tax credits, which would be targeted at the credit union’s mission of serving people of modest means. For credit unions that are meeting their public policy purpose, the tax credit would offset any tax liability.

Common Bond Is A Donation

Several weeks ago, Bruen Credit Union Blog did a post What Field of Membership?

The post wrote that the common bond for Pentagon FCU is a $20 bill.

For $20 you can join National Military Family Association (NMFA) and immediately become eligible for membership at Pentagon FCU. Pentagon FCU makes it clear that continued membership in the National Military Family Association is not a requirement to remain a member of the Pentagon FCU.

In fact, one of my golfing buddies joined the NMFA in order to get a Pentagon FCU credit card.

NCUA’s regulations permit associational common bonds and some credit unions, such as Digital FCU, have been using associational groups as a strategy to effectively circumvent field of membership limitations.

It’s legal, but is it right?

Now some credit unions or credit union trade associations appear to be organizing associational groups for the primary purpose of allowing people to join the credit union.

For example, United Services of America FCU in San Diego allows people to join the credit union by becoming a member of Prime Meridian Association. For information on Prime Meridian people are advised to contact the credit union.

The creation of Prime Meridian Association fulfills a vision articulated by Mary Cunningham, the CEO of United Services of America FCU.

She wrote several years ago: “I believe that every red-blooded person living in America deserves the right to join a credit union, regardless of where they live or who their employer is or what language they speak…I believe the common bond is formed when a person walks into a credit union and lays down their $5 to join a credit union along with all the other members using it.”

GTE FCU has set up CU Savers, a non-profit educational club the credit union sponsors. By joining CU Savers, a person is eligible for membership in GTE FCU.

The formation of an association for the purpose of allowing people to join the credit union is an abuse of the credit union charter and a blatant manipulation of the system.

Excerpts from GAO Study on ASI

With the recent failure of Cumorah CU, I’ve received requests to look into the operations of American Share Insurance (ASI) – a private insurer of credit union shares.

Unfortunately, it is hard to find information about the current financial condition of ASI, but I believe the following information from a 2003 Government Accountability Office study regarding how ASI is funded and its risk management practices might provide some insights (discussion begins on page 66 of the report).

ASI is chartered in Ohio as a credit union share guaranty corporation. ASI started insuring credit union shares in 1974 and it provides both primary share insurance and excess share insurance.

The funding structure of ASI‘s primary share insurance coverage is similar to the National Credit Union Share Insurance Fund (NCUSIF). Each member credit union, as a condition of insurability, is required to place a non-interest bearing, refundable capitalization deposit with ASI. This deposit is at-risk.

However, unlike the NCUSIF capitalization deposit, ASI’s capitalization deposit takes into consideration the risk of the credit union. Currently, the deposit requirement ranges from 1.0 percent to 1.3 percent of a credit union‘s total shares and is tied to the financial condition of the credit union. The NCUSIF capitalization deposit is a flat 1 percent of insured shares.

Additionally, according to GAO, ASI has the contractual ability to reassess all member credit unions up to 3 percent of their total assets to raise additional funds to cover catastrophic loss and Ohio statute authorizes that the Superintendent of the Division of Financial Institutions can order ASI to reassess its insured credit unions up to the full amount of their capital.

ASI reviews the financial statements of member credit unions no less than quarterly and conducts on-site examinations of privately insured credit unions at least once every 3 years. GAO reported that for large credit unions ASI increased its monitoring by conducting semiannual, on-site examinations, as well as monthly and quarterly off-site monitoring, which included a review of the credit unions’ most recent audits (monthly) and financial information (quarterly).

Furthermore, ASI’s termination policy enables it to manage risk. ASI may terminate a credit union’s insurance with 30 days notice to the credit union and its regulator, if the credit union fails to comply with ASI requirements to remedy any unsafe or unsound conditions or remedy an audit qualification in a timely manner.

ASI is dually regulated by the Ohio Division of Financial Institutions and the Ohio Department of Insurance. “The Ohio Division of Financial Institutions conducts annual assessments of ASI, which evaluate ASI’s underwriting and monitoring procedures, financial soundness, and compliance with Ohio laws. Under Ohio law, its Department of Insurance also is required to examine ASI at least once every 5 years,” according to GAO.

Ohio law requires ASI to provide copies of written communication with regulatory significance to Ohio regulators, obtain the opinion of an actuary attesting to the adequacy of loss reserves, and apply annually for a license to do business in Ohio.

In addition, ASI is subject to state oversight and regulation in those states where ASI insures credit unions.

But GAO did caution that ASI could find it difficult to cover catastrophic losses under extreme economic conditions because it does not have the backing of any governmental agency and lacks reinsurance for its primary share insurance program.

Losses Keep on Coming at U.S. Central

U.S. Central released its third quarter results and recorded a $308.5 million net loss. Continued deterioration in the quality of its investment portfolio resulted in other than temporary impairment (OTTI) charges of $320 million in the quarter.

Year‐to‐date through September, net losses totaled $1.3 billion. The losses in 2009 are the result of OTTI charges, which totaled $1.3 billion through the first nine months.

U.S. Central is heavily invested in non-agency residential mortgage backed securities and asset backed securities – 90 percent of its securities portfolio.

Moreover, the quality of its securities portfolio has declined. At the end of 2008, 7.4 percent of its portfolio was below investment grade. As of the end of September, 37.3 percent of its investment portfolio was not investment grade.

As a result of OTTI charges recorded in 2008 and the first nine months of 2009, U.S. Central’s retained earnings were fully exhausted, all paid-in capital was fully depleted, and membership capital shares were depleted by $1.1 billion (88.7 percent) as of September 30, 2009.

The additional losses will spur another round of capital adjustments for retail corporate credit unions, and in turn, some natural person credit unions will have to recognize further impairments to their investments in retail corporate credit unions.

Below is U.S. Central’s balance sheet. (Click on the image to enlarge).

WesCorp Raises $1.5 Billion

Reuters reported that Western Corporate (WesCorp) Federal Credit Union on Wednesday sold $1.5 billion of notes. The notes are guaranteed by the National Credit Union Administration under the Temporary Corporate Credit Union Liquidity Guarantee Program.

WesCorp was placed under conservatorship on March 20 of this year.

Below are the terms of the debt offering.

BORROWER: WESTERN CORPORATE FEDERAL CREDIT UNION*
AMT $1.5 BLN
COUPON 1.75 PCT
NON-CALLABLE
MATURITY 11/2/2012
ISS PRICE 99.875
YIELD 1.793 PCT
SPREAD 35.9 BPS MORE THAN TREAS
MOODY'S Aaa
S&P TRIPLE-A

*GUARANTEED BY THE NATIONAL CREDIT UNION ADMINISTRATION.

What Risk Does Silver State Schools Pose to ASI?

After my recent posting on the failure of Cumorah CU, I was e-mailed the third quarter financial statement of Silver State Schools CU (Las Vegas, NV) filed with American Share Insurance, a private insurer of credit unions. Silver State Schools at $883 million is the largest privately insured credit union in the country.

As most people are aware, Nevada has been one of the hardest hit real estate markets in the country. Approximately 2/3rd of all mortgage loans in Nevada are underwater.

This information does not bode well for Silver State Schools CU, since it is heavily invested in real estate loans. Slightly more than $501 million of its $771 million loan portfolio is in real estate loans.

To draw your own conclusion about the risk Silver State Schools poses to American Share Insurance, you might review its financial information, which is posted below. Click on the images to enlarge.

Cumorah Credit Union Seized

Nevada officials on Friday shut down privately insured Cumorah Credit Union, which serves 15,000 members of The Church of Jesus Christ of Latter-day Saints. The assets and deposits were assumed by Credit Union 1, a $574 million institution based in Rantoul, Illinois.

George Burns, commissioner of the Financial Institutions Division. stated that none of Cumorah's members will lose their deposits because of the credit union failure.

Cumorah is the first privately insured Nevada credit union to fail since the financial crisis began. Deposits were insured by American Share Insurance.

"Due to inadequate capital and mounting loan losses, it was necessary to take possession of Cumorah Credit Union," Burns said in a statement.

In an administrative order, Burns said Cumorah was "operating in an unsafe and unsound manner" and was "in imminent danger of insolvency." Burns also cited lack of capital or net worth, poor liquidity, inadequate earnings and "excessive loan risk."

Paul Simons, the CEO of the Credit Union 1, disclosed that Cumorah ran into problems when its commercial real estate loans started to become delinquent.

The State of Privately Insured Credit Unions

As of June 30, 2009, there were 156 privately insured credit unions, representing about 2 percent of all credit unions in the country.

Nine states currently permit state chartered credit unions to be privately insured; but most privately insured credit unions are located in 5 states. Ohio had the most privately insured credit unions with 63 as of June 2009; followed by Illinois with 29, Idaho with 18, Indiana with 17, and California with 15.

However, the bulk of the assets in privately insured credit unions were concentrated in five states:
• 25.6 percent, California;
• 20.4 percent, Nevada;
• 20 percent, Illinois;
• 15.7 percent, Ohio; and
• 12.3 percent, Indiana.

Assets, Shares and Loans Increase

Assets, shares (deposits), and loans at privately insured credit unions grew over the last year. As of June 2009, privately insured credit unions held slightly more than $12.2 billion in assets and $10.7 billion in shares and deposits. Total loans were $8.2 billion. Compared to a year ago,

• Assets were up 3.8 percent;
• Shares and deposits grew by 4.8 percent; and
• Loans increased by 2 percent.

Thirty-two credit unions were larger than $100 million in assets with 9 exceeding $550 million. Sixty-one privately insured credit unions are smaller than $10 million in assets.

Privately Insured Credit Unions Lose $68.9 Million thru June

Privately insured credit unions reported a loss of $68.9 million through the first six months of 2009. In comparison, these same institutions reported a profit of $25.4 million for the same time period in 2008. The return on average assets for privately insured credit unions was -1.14 percent as of June 2009 compared to 0.44 percent one year earlier.

Approximately 47 percent of privately insured credit unions were unprofitable as of June 2009. Losses at unprofitable credit unions were $82.5 million through the first six months of the year.

Privately insured credit unions in California and Nevada have been particularly hard hit by the recession. Only one privately insured credit union in each state did not report a loss through the first six months of this year. California privately insured credit unions reported losses of almost $28.2 million. In Nevada, losses were $45.5 million.

Net Worth Falls, But Most Are Well Capitalized

The net worth of privately insured credit unions fell by 6.2 percent from a year ago to almost $1.275 billion. The average equity to asset ratio for privately insured credit unions was 10.35 percent, while the median equity capital ratio was 12.89 percent.

The vast majority of privately insured credit unions are well capitalized. Only 7 privately insured credit unions, if they were subjected to prompt corrective action, would not meet the regulatory requirement of adequately capitalized.

Credit Quality Deteriorates

Asset quality fell over the last year at privately insured credit unions. Loans 60 days or more delinquent increased from $81.9 million as of June 2008 to $152.8 million a year later – an increase of 86.5 percent. An additional $127.8 million loans were in one month to two month delinquency bucket.

The percent of loans that were two or months delinquent stood at 1.87 percent at the end of the second quarter of 2009, up from 1.02 percent a year earlier.

Total charge-offs more than double from a year ago to almost $60.7 million. Foreclosed and repossessed assets were up almost 183 percent to $40.1 million.

Kern Schools Confidential Supervisory Agreement

Credit Union Journal (subscription required) reported today that NCUA has imposed a supervisory agreement on Kern Schools FCU to rebuild its capital.

Credit Union Journal wrote that "the confidential agreement with NCUA was disclosed yesterday by Vincent Rojas, the departing CEO."

The story states that NCUA has given the credit union 24 months to restore its capital ratio to 7 percent -- the minimum requirement to be well capitalized.

Enforcement actions, such as written agreements, ceased and desist orders, and prompt corrective action capital directives, taken against banks by federal banking regulators have been public information since 1989.

The Federal Credit Union Act requires enforcement actions to be made public unless the Board determines it is not in the public interest to release this information.(emphasis added)

How would the publishing of this supervisory agreement be contrary to the public interest?

At the minimum, shouldn't Kern Schools members know whether their credit union is subject to an enforcement action?

Moreover, we know there are 326 problem credit unions from NCUA's Chairman Deborah Matz's testimony from last week.

So, how many other supervisory agreements have been not disclosed by NCUA?

What is this agency covering up?

U.S. Central Raises $4 Billion

Last Thursday, I commented on NCUA Chairman Matz's testimony. In her testimony, she stated that "WesCorp and U.S. Central are preparing to utilize external sources of funding through offering issuances guaranteed by the NCUSIF for terms of two to three years."

Well, last Wednesday U.S. Central tapped the capital markets and raised $4 billion through a public offering of medium-term notes. The offering was guaranteed through NCUA’s Temporary Corporate CU Liquidity Guarantee Program. The offering included a combination of a two-year floater ($500 million at three-month LIBOR + 0); two-year fixed ($1.5 billion at swaps + 0); and three-year fixed ($2 billion at swaps + 5).

An interesting commentary on the U.S. Central debt issuance can be found at Unrealized Losses blog. According to the blog, investors received a better yield than credit unions that have invested in CDs issued by corporate credit unions.

Matz on Emerging Concerns

NCUA Chairman Deborah Matz identified three areas of emerging concerns for the agency during an October 14 hearing before the Senate Banking, Housing and Urban Affairs Subcommittee on Financial Institutions – interest rate risk, member business lending, and growing number of troubled credit unions.

With regard to interest rate risk, Chairman Matz stated:

Given the refinancing activity that typically occurs during a period of low interest rates, NCUA has observed an increasing level of fixed rate real estate loans … NCUA is concerned with the increasing interest rate risk associated with a high level of fixed rate, long-term assets should rates rise rapidly.

As for member business lending, she testified:

NCUA has been monitoring the increasing level of member business loans within the credit union community, presently at $27.1 billion. While this figure represents only 3.11 percent of total credit union industry assets, NCUA is concerned with the increasing levels of delinquent member business loans, as well as an increasing concentration of large credit unions with supervisory concerns which are holding member business loans. As an example, a review of 71 credit unions with identified supervisory concerns was conducted as of June 30, 2009. These credit unions averaged $1.1 billion in assets and 62 of them reported member business loans. By way of contrast, in 2005, only 50 of these same credit unions held member business loans. These credit unions hold higher levels of member business loans than the industry as a whole, both in 2005 and today… For this group, delinquent member business loans increased from 0.17 percent to 8.34 percent in the last 42-month period, compared to the credit union trend of 0.47 percent to 3.19 percent during this same timeframe… NCUA is concerned with the additional risks to operations member business loans can pose when coupled with other operational concerns. NCUA will be proactively monitoring member business loan exposure and plans to issue additional guidance in the near future.

The agency is also concerned about the growing number of problem credit unions. A problem credit union has a CAMEL 4 or 5 rating. Chairman Matz noted:

There are currently 326 troubled credit unions holding $42.2 billion in assets, representing 4.2 percent of all credit unions and 4.9 percent of all credit union assets. While the number of troubled credit unions increased in the current year, the pace of that growth was slightly lower than in 2008. Troubled credit unions with over $100 million in assets have grown at a faster rate than those with assets under $100 million.

As of September 30, 2009, 66 credit unions with assets over $100 million were considered troubled credit unions, compared to 12 in 2007. NCUA anticipates the overall number of troubled credit unions is likely to increase through the end of 2010 and into 2011.

Later in her testimony, she expressed concern about the number and size of CAMEL 3 credit unions is increasing. A CAMEL 3 credit union exhibits some degree of supervisory concern. These credit unions exhibit a combination of weaknesses that may range from moderate to severe and generally are less capable of withstanding business fluctuations and are more vulnerable to outside influences.

The number of CAMEL 3 credit unions with assets greater than $100 million represented only 7.30 percent of total credit unions as of year-end 2007; however, this ratio increased to 13.48 percent as of September 30, 2009. Similarly, total assets for this group of credit unions increased to 10.43 percent of aggregate industry assets as of September 30, 2009, up from only 3.97 percent in 2007. While credit unions rated a CAMEL 3 have not quite reached the threshold of a troubled credit union, … they require enhanced and timely supervision to ensure corrective measures are implemented.

In response to these emerging trends, NCUA has shortened the examination cycle from 18 months to 12 months. It also has hired an additional 50 field examiners in 2009 and plans to hire 57 more examiners in 2010.

Matz on Corporate Credit Unions

On Wednesday, October 14th, NCUA Chairman Deborah Matz testified before the Senate Banking, Housing and Urban Affairs Subcommittee on Financial Institutions on the state of the credit union industry. Below are excerpts from Chairman Matz’s testimony on corporate credit unions.

The downturn in the residential mortgage-backed securities market had a devastating impact on the twenty-eight corporate credit unions ... While the majority of the investments were AAA or AA rated, even highly rated securities were not immune to the market contagion. In 2005 and 2006, significant levels of non-agency residential mortgage-backed positions in the ALT-A sector, with mezzanine ALT-A tranches, were added to the portfolios of the two largest corporate credit unions – Western Corporate Federal Credit Union (WesCorp) and U.S. Central Federal Credit Union (U.S. Central). The subsequent market downturn which began in 2007 forced both WesCorp and U.S. Central to reflect significant losses when performing a valuation of their investment portfolios.

The impact of the losses at U.S. Central reverberated through the rest of the corporate credit unions ... As the losses at U.S. Central exceeded retained earnings, the paid-in capital and membership capital accounts held by the retail corporates were depleted to absorb the losses ... The losses flowed through to natural person credit unions. Where losses exceeded retained earnings at the retail corporate credit union, than the paid-in capital and membership capital accounts invested by natural person credit unions were depleted.

NCUA is in the process of drafting significant revisions to its corporate credit union rule ... It is NCUA’s goal to issue the proposed rule for comment in November 2009 and have in place a new regulatory framework for the corporate credit union system by mid-2010 ... WesCorp and U.S. Central are preparing to utilize external sources of funding through offering issuances guaranteed by the NCUSIF for terms of two to three years. This action will provide liquidity within the credit union system during the regulatory transition period, and enable NCUA to consider alternatives in the disposition of the distressed assets on the corporate credit union balance sheets.

S&P: NCUA Corporate CU Efforts Preserve Liquidity, More Capital Will Be Needed

Standard & Poor’s on October 9th wrote that NCUA’s actions have preserved confidence in the credit union system by stemming the liquidity crunch within the corporate credit union system; but have not “addressed some of the structural aspects of the system that are likely to evolve, and that could significantly alter the current framework.”

Standard & Poor’s believes that the

“[e]vents of the past 18 months may shake members' faith in the cooperative nature of the system, which had been a major factor supporting the corporates' creditworthiness. Specifically, the burden of premium assessments on the members may appear too great when compared to the benefits of membership. Ultimately, we believe that the system will need capital to offset the increasingly likely losses stemming from mortgage-related structured securities.”

NCUA Offers Guidance on Converting to a Credit Union

NCUA has posted on its website information on bank-to-credit union conversions.

NCUA writes: “While unusual, such conversions may be possible for some financial entities. This document provides guidance on various issues that may arise when a non-credit union entity (NCE) is considering conversion to a credit union charter.”

NCUA does acknowledge that it would be quite difficult for a stock organization to change to a credit union charter.

The document explains some unique characteristics associated with the credit unions, such as field of membership requirements, volunteer directors, and lending practices.

I find it quite ironic, even unseemly, that an agency that has gone out of its way to erect obstacles limiting credit unions from exercising their freedom to select the charter that best meets their customers’ needs would post on its website a resource guide on how other financial institutions can become a credit union.

NAFCU Capital Proposal: Meet Charles Keating

Let me state upfront that I am an equal opportunity skewer of credit union trade associations.

In an earlier post, I criticized CUNA’s alternative capital recommendation, which would increase the level of interdependency risk within the credit union system, by allowing credit unions to make capital investments in other credit unions.

The National Association of Federal Credit Unions has set forth its own alternative capital proposal, which would let individual members of a credit union invest in alternative capital instruments issued by their credit union, even though the draft language makes it clear that this investment by members would be uninsured and available for loss.

A credit union insider contacted me stating that this proposal smelled a lot like Charles Keating and Lincoln Savings and Loan and the worthless bonds they pushed on customers.

In case your memory needs refreshing, Lincoln Saving and Loan's branch personnel convinced customers of the savings and loan to replace their federally-insured deposits with higher-yielding bonds issued by American Continental, the parent company of Lincoln. American Continental went bankrupt in April 1989 and about 23,000 customers were left with worthless bonds. Many of these investors lost their life savings. These customers later said they were never properly informed that the bonds were uninsured and very risky given the financial condition of American Continental.

I’m not saying this is going to happen; however, customers who trust their credit union can easily be duped into buying these risky capital investments, which may be entirely inappropriate for them.

CU Members Reject Rare CU- Bank Merger Plan

The members of KV Federal Credit Union have rejected plans to merge with a local bank.

Officials at KV Federal Credit Union and Kennebec Savings Bank confirmed Thursday that credit union members voted against the proposal to convert their credit union to a bank and merge with Kennebec Savings.

Click here to read the full story.

HMDA Data Shows CUs Gaining Market Share

According to recently released 2008 HMDA data by the Federal Reserve, credit unions have not experienced a significant reduction in home-lending activity over the past couple of years. As a result, credit unions have seen an increase in their market share of one-to-four family site-built HMDA loans, especially junior liens.

Credit union market share of first lien mortgage originations more than doubled from 2.6 percent in 2004 to 5.5 percent in 2008.

Junior lien market share experienced an almost four-fold increase from 7.6 percent to 28.3 percent. Because less than five percent of all junior liens at credit unions were for home purchases, the collapse in the housing market did not adversely impact credit union originations of junior liens.

Members' Own FCU Closed

The National Credit Union Administration (NCUA) liquidated The Members’ Own Federal Credit Union of Victorville, California.

Alaska USA Federal Credit Union purchased and assumed The Members’ Own Federal Credit Union’s assets, loans and shares.

The Members’ Own Federal Credit Union’s declining financial condition led to its closure and subsequent purchase and assumption by Alaska USA Federal Credit Union.

The Members’ Own Federal Credit Union had $85 million in assets and served 11,000 members.

West Texas CU Fails

The National Credit Union Administration (NCUA) announced that Security Service Federal Credit Union (San Antonio, TX) has purchased the assets and assumed the shares of liquidated West Texas Credit Union of El Paso, Texas.

The Texas Credit Union Department liquidated West Texas Credit Union on September 30, 2009 and discontinued its operation after determining the credit union was insolvent with no prospects for restoring viable operations.

At the time of liquidation, West Texas Credit Union had approximately $78 million in assets and served 25,000 members.

Does CUNA Suffer from Amnesia?

The Credit Union National Association (CUNA) in a September 28 press release stated that a potential source of alternative capital for credit unions could include permitting credit unions to invest in the capital of other credit unions.

Alternative capital is uninsured and subordinate to all other claims against the credit union, including the claims of creditors, shareholders, and the share insurance fund.

CUNA calls this proposal “credit unions helping credit unions.”

I call it a nutty idea.

How quickly CUNA has forgotten about the problem of interdependency risk associated with the corporate credit union fiasco.

Natural person credit unions that belonged to Western Corporate (WesCorp) have had to write down their equity investments in this failed corporate credit union, which is currently under NCUA conservatorship. As credit unions wrote down this capital investment, it adversely impacted their net worth.

Now, this recommendation of allowing CUs to hold capital investments in other credit unions only reinforces the interdependency risk within the credit union system. If a credit union, which received a capital investment from other credit unions, was to fail, this would cause the investing credit unions to write off their investment and this would reduce their capital.

Why would CUNA advocate a policy that would potentially increase systemic risk within the credit union industry?

Didn’t they learn anything from the failure of WesCorp?

The public policy lesson from the corporate credit union fiasco is the need to limit such interdependency risk, not advance policies that expand it.

Clearstar Financial CU Closed by Regulators

Clearstar Financial Credit Union, a Reno-based financial institution with 16,000 members, was seized and closed by regulators.

According to George Burns, commissioner of the Nevada Financial Institutions Division, $941 million United Federal Credit Union of St. Joseph, Mich., will assume all of Clearstar's deposits.

Clearstar Financial was chartered in 1949 to serve members of the Reno Classroom Teachers’ Association. Today, Clearstar serves
anyone who lives, works, worships, volunteers, does business, or attends school within thirteen Northern Nevada counties.

At the time of its closure, the credit union had $144 million in assets.

Burns said he closed the credit union because Clearstar's capital was inadequate and its loan losses were increasing.

This is the second Nevada-based credit union to fail this year. Community One Federal Credit Union was seized by NCUA in August.

Impact of Four Stress Test Scenarios on the NCUSIF

While the headlines coming out of the September 24 NCUA Board meeting focused on the 15 basis point assessment to be paid by federally-insured credit unions, what might be more important is the summary of findings about the maximum loss exposure to the National Credit Union Share Insurance Fund (NCUSIF) under four different stress test scenarios (see Board Action Item 1b).

The four scenarios were: impact of distressed real estate market on natural person credit union’s (NPCU) real estate loan portfolio; complete write down of NPCU capital investments in corporate credit unions (CCU); layering distressed real estate with complete write down of capital invested in corporate credit unions; and Treasury’s Supervisory Capital Assessment Program.

While NCUA staff believes that the NCUSIF has sufficient resources to handle a severe financial crisis, they acknowledge that the risk to the NCUSIF is increasing. The stress test results show that there is likely to be a material increase in the number of credit unions with inadequate capital and subjected to prompt corrective action.

Additionally, “increases in the number of troubled credit unions will result in stress to NCUA in resolving problem cases as resources will be strained both in terms of Agency manpower to properly supervise the credit unions and a probable reduction in the number of institutions willing and able to absorb the related assets and liabilities.”

Here is a summary of the findings from the four different scenarios.

1. Evaluating potential failures and losses due to the distressed real estate market, which includes applying an immediate shock on reserves given a variety of default and loss rates in NPCU real estate portfolios. The analysis revealed rising levels of defaults on all real estate related loans and rising levels of losses associated with the defaults. Additionally, the consensus forecast predicts further increases in the level of defaults. NCUA’s 2-year stress scenario resulted in the allocation of $32.5 billion in projected losses amongst NPCUs resulting in the potential failure of 90 NPCUs and a worst case projected loss exposure to the NCUSIF of $1.4 billion.

2. Measuring the risk presented by CCUs consisted of a complete write-off of current NPCU capital investments in CCUs, as well as the impact of an immediate assessment to NPCUs of an estimated Stabilization Fund liability of $7 billion. The analysis resulted in the allocation of $9.3 billion in losses amongst NPCUs and resulted in a projection of 25 NPCU failures presenting a maximum exposure to the NCUSIF of $80 million.

3. Evaluating the impact from both the real estate stresses and the CCU system, which allowed for analysis of the risk layering. As with the 2008 analysis, the layering of both the real estate and CCU risk on individual NPCUs resulted in a pronounced increase in both the number of failures and the level of potential losses to the NCUSIF. Combining the 2-year real estate stress scenario with the CCU stress scenario resulted in a projection of 227 NPCU failures and a maximum exposure to the NCUSIF of $6.4 billion.

4. Performing stress testing based upon the Treasury’s Supervisory Capital Assessment Program. This analysis provided a 2-year stress scenario under both an assumed path for the economy (baseline) and a deeper more protracted downturn (more adverse) that included non-real estate loans. This testing provided a measure of a NPCU’s capital buffer. The baseline analysis produced an allocation of $32.6 billion in losses resulting in 38 failures with a maximum exposure to the NCUSIF of $577 million. The more adverse scenario resulted in an allocation of $56.4 billion in losses resulting in 519 NPCU failures at a maximum exposure of $15.5 billion to the NCUSIF.

I believe that assuming the worst case scenario facing credit unions and the NCUSIF is a write down of capital investments in CCUs is overly optimistic. The most likely outcome is represented by either 2-year real estate stress test or combined real estate stress test and corporate credit union write down.

My thinking on this issue is supported by the evidence that there were 315 problem credit unions on August 31, 2009, with shares representing 4.55 percent of total insured shares.

Where Is the Audit on the Failure of Cal State 9?

It has been almost 15 months since NCUA liquidated Cal State 9 CU. At the time of its liquidation on July 1, 2008, Cal State 9 had a net worth of minus $217.5 million.

The NCUA’s Office of the Inspector General (OIG) is required to prepare a material loss review audit of any credit union failure where the loss to the NCUSIF exceeds $10 million.

Since the available evidence indicates that the failure of Cal State 9 will result in a loss to the NCUSIF in excess of $10 million, why is it taking the OIG so long to complete its review of Cal State 9 compared to the material loss reviews conducted by the other banking agencies?

Who Benefits from the Credit Union Tax Exemption?

This is an important public policy question that needs to be addressed.

This last week there have been numerous news reports about Western FCU suing Jim Press, the deputy chief executive of the Chrysler Group.

The lawsuit claims that Press owes $609,286 on a line of credit and that he missed two payments on the loan.

While at Toyota, Press took out an unsecured line of credit for over $800,000 from Toyota Federal Credit Union. Toyota FCU was subsequently acquired by Western FCU, which canceled Press' credit line and asked for repayment.

I’m not saying that Toyota FCU should not have served Jim Press. His 37 years of employment with Toyota qualified him for membership.

However, from a public policy perspective should a wealthy individual, such as Jim Press, receive taxpayer subsidized financial services or should the taxpayer subsidy be more targeted?

Lawsuit Alleges Fraud in Florida

On September 9, a lawsuit was filed in Federal Court against the NCUA, as liquidating agent of Huron River Area Credit Union, and others.

The 53-page complaint reads like a Carl Hiaasen novel and alleges fraud, breach of fiduciary duty, and criminal acts on the part of Huron River Area CU (Huron) and other defendants associated with speculative real estate transactions in Southwest Florida.

The following discussion highlights just some of the allegations in the lawsuit.

The complaint alleges that Construction Loan Company fraudulently assigned construction loans to Huron even though Huron and/or its agents knew that the borrowers did not meet the eligibility requirements for membership in Huron. The lawsuit claims that Huron and Construction Loan Corporation (CLC) illegally and without authorization altered and changed the membership applications that the Plaintiffs executed at the closing on the construction loan. The tampered application made it appear that the Plaintiffs were seeking membership “through Learn & Earn Credit, LLC, an entity unknown to the Plaintiffs.”

Second, the complaint claims that loan documents were fraudulently drafted to falsely identify the property as a primary or/principal residence when in fact the properties were investment properties. When Millionaire University (MU) students raised questions about the loan document being classified as a primary residence, they were advised to disregard the primary residence language and that the lender had taken care of that issue for them. The complaint states that “CLC and Huron drafted the documents in such a manner in order to mischaracterize the true nature of the loans and to avoid statutory and regulatory limits on business loans applicable to Huron River Area Credit Union.”

The lawsuit further alleges that CLC, Huron and United Mortgage, as well as the MU Partners, knew the appraisals upon which the construction loans were based, as well as the present market value representations in the loan applications, were fraudulent and grossly exaggerated. The complaint states that MU Partners set the appraisal price by first determining how much money the Defendants would make through the sale of the lot, the construction of the house and the financing of the purchase, including excessive fees. After the MU Partners know the amount, an appraisal by Real Pro/Wittig or Hot Appraisals/Seibert was arranged, which would value the property high enough so that the construction loan amount would be 80 percent of the appraised value.

In addition to seeking damages from the various defendants, the plaintiffs are asking the court to declare that the assignment of the notes and mortgages from CLC to Huron are illegal and void. Moreover, plaintiffs claim that allowing NCUA as liquidating agent for Huron to enforce the mortgages and notes would be unjust as said notes and mortgages are illegal contracts and thus not assets of Huron River Area Credit Union.

If the allegations in the complaint are true, then Huron and other parties conspired to commit fraud on a massive scale.

Zombie Update: U.S. Central FCU

On Friday, September 11, U.S. Central FCU, which was placed into conservatorship on March 20, 2009, released its highly anticipated audited 2008 annual report.

According to the annual report, U.S. Central FCU reported a $4.8 billion loss for 2008, quadrupling the previously announced estimated loss of $1.2 billion for 2008. The accumulated losses exceed all of U.S. Central’s retained earnings and capital; however, most of the losses, $3.7 billion, were reversed on January 1, 2009 when the unwinding of the credit-related part of 2008's OTTI occurred.

As of December 31, 2008, all of U.S. Central’s security portfolio was classified as available for sale (AFS). At the end of 2008, many of U.S. Central’s investment securities are in significant unrealized loss positions. Unrealized losses on AFS securities were $7.9 billion (see Note 4).

The annual report points out that both PIC 1 and PIC 2 (PIC stands for paid-in capital) have been depleted, along with $789.4 million in membership capital share (MCS) accounts, as of June 30, 2009 due to an additional $1.1 billion in OTTI charges. With the conservatorship of U.S. Central, MCS redemptions have been suspended (see Note 7). If there is a moratorium associated with MCS redemptions, should these accounts be reclassified as paid-in capital?

Also, the discussion associated with Note 1 is very interesting.

It clearly states that the only reason U.S. Central continues to operate is the level of unprecedented support and regulatory forbearance it has received from NCUA “in order to avoid being placed into liquidation and continue to access the debt markets.”

The note disclosed that the NCUA Board had authorized up to $3,000,000,000 of cash or non-cash special assistance to U.S. Central from the NCUSIF, including, but not limited to, a guaranteed prior undivided earnings deficit (i.e. negative retained earnings) and/or a capital note(s) in addition to the $1,000,000,000 capital note provided to U.S. Central in January 2009.

Additionally, it appears as if NCUA has no exit strategy with regard to the U.S. Central conservatorship.

On page 24 of the annual report, it states:

“The conservatorship has no specified termination date. There can be no assurance as to when or how the conservatorship will be terminated, or what U.S. Central’s business structure will be during or following the conservatorship.”

So, it seems that this zombie will be with us for a long time.

Are Credit Unions True to Their Mission?

The National Community Reinvestment Coalition (NCRC) released on September 8 a new report on the performance of credit unions in serving people of modest means. According to the NCRC study, “large credit unions do not serve people of modest means as well as mainstream banks, which must comply with the requirements of the Community Reinvestment Act (CRA). NCRC’s national analysis of the most recent home loan data for the years 2005 through 2007 reveals that banks perform better than credit unions on 65 percent of fair lending indicators in home purchase, refinance, and home improvement lending.”

Moreover, NCRC found that Massachusetts state-chartered credit unions, which are covered by CRA, outperformed on fair lending indicators CRA-exempt credit unions with a federal charter that operate in Massachusetts.

The NCRC study concludes that CRA should be expanded to large credit unions, because NCUA has failed to meaningfully measure credit union service to people of modest means. NCUA instead has adopted a defensive posture debating the meaning of credit unions’ public mission of serving people of modest means.

Additionally, the report states that CRA would be a boon for smaller credit unions, because larger credit unions would be encouraged to increase their level of deposits and investments in community development credit unions and low-income credit unions, which are dedicated to serving low-income people and neighborhoods.

What Do CU Members Really Own?

Part of the credit union industry’s branding campaign is pushing the concept that members are owners of their credit union.

However, what is the value of this ownership?

Alex Pollock, a resident fellow at the American Enterprise Institute, in a July 7, 2006 Viewpoint article in the American Banker (paid subscription) wrote:

"It can’t be sold. It has no market value. It can’t be redeemed. You can’t borrow against it. You can’t take it with you when you switch your account to another financial institution. Theoretically, you could get a distribution of any remaining net assets upon liquidation of the credit union, but if successful, it will never liquidate."

Alex points out that if a credit union does liquidate, it is because the credit union is insolvent and there is nothing left to distribute.

So, besides receiving a dividend on your share, which is comparable to interest on bank accounts, the only thing of value is the right to vote for the Board of Directors of a credit union.

But if you ask me, there is not much value there because each member has the same number of votes – one – regardless of how much business a member does with his or her credit union.

P.T. Barnum is probably smiling from the grave.

Credit Union Industry Financial Update at Mid-Year

According to mid-year statistics released by NCUA last week, federally-insured credit unions posted strong share (deposit) and asset growth during the first half of 2008. Shares grew by 8 percent through the first six months of 2009 to $735.5 billion and assets increased by 7.3 percent to $870.1 billion.

However, credit unions barely reported any loan growth as loans increased from $566 billion to $570 billion during the first half of the year. Used automobile loans grew 2.8 percent and first mortgage real estate loans and lines of credit grew 3.2 percent, while new automobile loans declined 2.8 percent and other mortgage loans declined 3.2 percent.

Credit unions added about $1 billion in equity capital during the first half of the year to $85.8 billion. However, the growth in capital did not keep pace with the growth in assets during the first six months of 2009. As a result, the net worth leverage ratio for credit unions slipped from 10.62 percent to 10.03 percent by mid-year; but was higher than the 9.67 percent reported at the end of the first quarter.

Credit unions reported a net income of $1.168 billion as of June 2009 – 42 percent below the $2 billion in profits reported for the comparable six month period in 2008. The return on average assets was .28 percent, as of the end of the second quarter in 2009. Strong growth in non-interest income – up almost 95 percent from June 2008 levels to slightly more than $8.6 billion as of mid-year 2009 – helped to offset cost associated with the NCUSIF stabilization expense and higher provisioning for loan and lease losses. Provisions for loan losses almost doubled from the comparable period in 2008 to slightly less than $4.6 billion.

The recession took a toll on asset quality as loans 60 days or more past due grew to $9 billion. In comparison, allowance for loan and lease losses was $7.5 billion. Credit unions have added almost $1.3 billion to their loan loss allowance accounts during the first half of 2009. This is comparable to the increase in loans 60 days or more past due over the same time period.

As a percent of total loans, delinquent loans increased by 21 basis points during the first half of the year to 1.58 percent of all loans. The delinquency rate on real estate loans at credit unions was 1.62 percent as of June 30, 2009 – 42 basis points higher than it was at the end of 2008. However, the delinquency rate for interest only and payment option mortgages went from 3.72 percent to 5.73 percent during the first half of 2009. Business loans 60 days or more past due were 3.03 percent – up 80 basis points since the beginning of the year.

Net charge-offs were almost $3.3 billion as of mid-year 2009 – almost 72 percent higher than the prior June’s level. During the first half of 2009, the ratio of net charge-offs to average loans grew from 0.85 percent to 1.15 percent.

Exotic Car Loans

Credit Union Times broke a story about an exotic car loan program operated by American First Credit Union in Orange County, California.

American First CU had an indirect lending relationship with Lamborghini of Orange County and had made loans through the dealer for three to four years.

The article references a lawsuit where American First Credit Union is suing a member who defaulted on a 2008 Lamborghini Gallardo, and owes nearly $226,000 plus interest

“For those with loads of disposable income, Gallardo has to be on the sports-car shopping list,” says the Arizona Republic. The manufacturer’s suggested retail price is between $185,000 and $225,000.

Additionally, American First CU is suing Reality TV star Simon Barney, who stars along with wife Tamra in The Real Housewives of Orange County, over a delinquent exotic car loan for a 1989 Ferrari.

Lamborghinis, Ferraris. Is this what the credit union tax exemption is meant to subsidize?

I really don’t believe that the tax exemption should go to finance exotic car loans for those individuals with loads of disposable income.

This is simply outrageous.

Tax Subsidized Rock Concert

Visions Federal Credit Union of Endicott, New York is sponsoring a free rock concert during Binghamton University’s Annual University Fest 2009 on August 29, 2009.

The sponsorship of the rock concert is part of the credit union’s efforts to reach out to Gen Y.

Now, a free concert sponsored by a credit union may be “really cool.”

But dude, should a credit union be using its tax subsidy to finance a rock-n-roll concert?

Spreading Its Wings

Wings Financial FCU (Apple Valley, MN) is proposing to convert to a state charter so that it can expand its membership base.

Currently, Wings Financial FCU has a Trade-, Industry-, and Profession-wide charter serving a national air transportation field of membership. But employment in the airline industry is down substantially, since the beginning of this decade, limiting the growth prospects for Wings Financial FCU.

By converting to a state chartered credit union, Wings Financial would be able to add to its field of membership individuals who live, work or worship in the 13 county Minneapolis/St. Paul metro area and still retain its national air transportation field of membership.

If Wing’s membership approves the switch from a federal to state charter, this would be the second billion-dollar plus credit union to do so this summer in order to take advantage of more liberal state field of membership requirements. Mid-Florida converted to a state charter earlier this summer.

Crawl Before You Walk

Speaking before the National Associations of State Credit Union Supervisors, NCUA Board Member Gigi Hyland suggested credit unions “should crawl before they walk” when increasing their capacity to make business loans, and that Congress should consider raising the current cap on member business loans of 12.25 percent of assets “in stages” for safety and soundness reasons.

Upon hearing about this remark, CUNA President and CEO Dan Mica blew a gasket.

“What Board Member Hyland suggests is addressed in the Kanjorski-Royce bill by raising the business lending cap to only 25 percent. We would like to see the cap taken off of member business lending by credit unions,” Mica stated.

I guess Dan Mica equates going from a business loan cap of 12.25 percent of assets to 25 percent of assets as crawling.

I beg to differ. Such an expansion in business lending capacity is a giant leap.

Breaking News - Zombie Update

Five months ago, NCUA placed Western Corporate (WesCorp) into conservatorship. According to its most recent regulatory filings posted with NCUA, WesCorp reported a capital ratio of minus 15.94 percent.

This breaking news just in, Western Corporate FCU is still dead!

Knee Jerk Response to Budget Proposal

Pennsylvania Auditor General Jack Wagner sent a list of recommendations including taxing credit unions to Gov. Ed Rendell and the General Assembly to consider as alternatives to raising state income taxes to resolve the state’s budget impasse that has been in effect since July 1.

The Pennsylvania Credit Union Association’s (PCUA) knee jerk reaction was to write the Auditor General that removing the credit union tax exemption would seriously harm the credit union business model.

The PCUA is implicitly acknowledging that credit unions need their market distorting preferential tax treatment from the government to be competitive.

NCUA Borrowed $10 Billion in June from the Treasury

The Federal Financing Bank (FFB) reported NCUA’s Central Liquidity Facility (CLF) borrowed $10.025 billion during the month of June.

Ten billion dollars of the borrowed funds were lent from the CLF to the NCUSIF, which then lent the proceeds to U.S. Central and Western Corporate FCUs – the two failed corporate credit unions.

The two 6-month notes for $5 billion each that mature on December 21, 2009 were borrowed by the CLF at a taxpayer subsidized rate of 0.456 percent.

The rate on 6-month Treasury bill on June 22 was 0.34 percent.

I doubt that these two failed corporate credit unions could borrow at a rate of 11.6 basis points above comparable Treasury debt.

That is a pretty sweet deal.

NCUA Closes Community One FCU

NCUA closed $159 million Community One FCU of Las Vegas on Tuesday, August 11th.

Community One was hard hit by the deteriorating Las Vegas economy. Between June of 2008 and June of 2009, as losses grew at the credit union, Community One’s net worth ratio slipped from 7.10 percent to 0.55 percent.

According to NCUA press release, America First FCU was the winning bidder for Community One and was authorized to purchase and assume the assets and shares (deposits) of Community One.

What was not disclosed by NCUA in its press release was the cost of this failure to the NCUSIF; how much of the assets were assumed by America First; and did America First pay a premium for Community One and if so, how much?

As a matter of public policy, NCUA needs to provide more transparency regarding its handling of credit union failures.

Costly Failures Due to Nonmembers

The NCUA’s Inspector General (IG) Reports on the failures of Norlarco Credit Union (Fort Collins, Colo) and Huron River Area Credit Union (Ann Arbor, Mich) highlight the role of nonmembers in the failures of the two credit unions.

The IG found that Huron River Area CU was granting Florida construction loans to borrowers that were outside of its field of membership, which fueled uncontrolled loan growth at the credit union. Florida construction loans were made to borrowers throughout the United States, including Puerto Rico. Applicants purportedly “joined” the credit union, under the aegis of Learn and Earn, LLC. The IG report stated:

"Florida construction loan applicants were not legal members of Huron. NCUA and the Michigan SSA indicated two steps were required to admit an employer or other organized group into Huron‟s FOM. The first step required Huron‟s Credit Union Service Organization (CUSO), Learn and Earn Credit, LLC, to submit a written request for services to Huron. Learn and Earn Credit, LLC met this requirement. The second step required Huron to request, from the SSA, a bylaw amendment to add Learn and Earn Credit, LLC, as an “other organized group”. Huron did not request the amendment; therefore, the Michigan SSA determined Learn and Earn, LLC, was not a legal member of Huron. Consequently, the applicants for Florida loans who were members of Learn and Earn, LLC, were not eligible for membership with Huron. We believe this relatively unrestricted FOM contributed significantly to the rapid and uncontrolled loan growth." (emphasis added)

With respect to Norlarco CU, the IG found management abused its field of membership in order to help fulfill its $30 million per month in Florida construction loan commitments. Norlarco used three Colorado-based associational groups to qualify individuals for membership:

• Rocky Mountain Bird Observatory,
• Boys & Girls Clubs of Larimer County, and
• Legacy Land Trust.

When NCUA examiners pulled a sample of the credit union’s Florida construction loans, they found that over 43 percent of the borrowers resided in the Miami-Dade County, Florida. The last time I looked Miami was not geographically located on the east slope of the Rocky Mountains.

Moreover, Norlarco management sent letters to the borrowers stating that Norlarco would close their accounts at the completion of their construction loans. This letter clearly indicated that these individuals were members only in name and that the credit union had no intention of establishing a banking relationship with these borrowers.

The abuse of its field of membership requirement fueled a rapid and uncontrolled expansion in the credit union’s Florida construction loan program, which ultimately contributed to the credit union’s failure.

This does raise an interesting question – are other credit unions getting into trouble because they have forsaken the requirement that members have an affinity with each other?