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.