Dodd Frank's Risk Retention Requirement Silent on Credit Unions

This week six federal agencies are issuing a proposed rule implementing the risk retention requirement of the Dodd Frank Act (section 941), which requires issuers of securitized loans to retain a 5 percent interest in the risk of loss. The proposed rule provides an exemption for qualified residential mortgages.

According to advocates of the risk retention requirement, if a lender has "skin in the game," the loans will be underwritten more conservatively and will perform better; because the lender is retaining some credit risk.

Noticeable in its absence is the National Credit Union Administration (NCUA). The Dodd Frank Act did not include credit unions under its risk retention requirement; but it should also be noted that credit unions were not specifically excluded.

Section 941 of the Dodd Frank Act is just silent when it comes to credit unions.

This raises a relevant policy question -- should credit unions be subject to this risk retention requirement?

Data from the NCUA shows a substantial expansion in real estate loans sold but serviced by credit unions. According to NCUA, outstanding real estate loans sold but serviced by federally-insured credit unions has almost doubled between 2006 and 2010 to $108.4 billion at the end of 2010.

Moreover, for the last two years more than half of the first mortgage real estate loans granted by credit unions were sold in the secondary market. Credit unions reported that 54.08 percent and 52.24 percent of their first mortgage real estate loans granted in 2009 and 2010 were sold, respectively.

In 2010, 5 credit unions sold over $1 billion in first mortgages in the secondary market. The credit union that sold the most mortgages in the secondary market was Kinecta FCU in Manhattan Beach (CA), followed by Navy Federal in Vienna (VA).

The table below shows the 50 credit unions that sold the most first mortgages in the secondary market during 2010. (click on image to enlarge)

Threatened Lawsuits Deflects Attention from NCUA's Regulatory Failures

NCUA is trying to deflect attention from its failure as a regulator by threatening to sue several investment banks over mortgage-backed securities they sold to five failed corporate credit unions.

We know that full-time on-site capital markets specialists from the Office of Corporate Credit Unions (OCCU) were assigned to both U.S. Central and Western Corporate (WesCorp) -- two of the five failed corporate credit unions.

Despite having a permanent presence at these two failed corporate credit unions, the NCUA's Inspector General (IG) reports on the failures of U.S. Central and WesCorp paint a picture of examiners who either did not recognize the risks or failed to take action with respect to potential risks associated with concentrations in privately-issued mortgage-backed securities at WesCorp and U.S. Central.

The Inspector General report on the failure of WesCorp found that OCCU examiners did not require or advise management to limit or reduce its concentration to private label mortgage-backed securities (MBS), despite observing WesCorp's growing concentration in these investments. Examiners also failed to limit WesCorp's exposure to Alt-A and sub-prime mortgage collateral and collateral comprised of exotic adjustable rate mortgages.

Also, NCUA during examinations between July 2003 and July 2006 never questioned the quality of the collateral backing up WesCorp's MBS portfolio and never warned WesCorp about the risk associated with such investments until April 2007.

Additionally, "OCCU examiners either did not recognize or did not take issue with the potential risk associated with WesCorp‘s geographic, issuer, originator, and servicer limits or concentrations early on. As a result, WesCorp‘s concentrations of RMBS with collateral in a single state – California – became excessive." Moreover, there is no evidence that NCUA examiners ever questioned WesCorp with regard to increases in issuer limits.

The IG reports make it clear that NCUA failed natural person credit unions. The agency's lax oversight of these corporate credit unions is the real story that needs to be pursued.

IG Report on WesCorp.

IG Report on U.S. Central.

Significantly or Critically Undercapitalized Credit Unions

A credit union is considered significantly undercapitalized, if its net worth ratio is below 4 percent. A credit union with a net worth ratio below 2 percent is critically undercapitalized.

Below is a list of credit unions that have a net worth ratio below 4 percent as of the end of 2010 (click to enlarge the image). Some of these credit unions are no longer independent. NCUA has either closed the credit union or the credit union has been acquired by another credit union.

Don't Count Your Chickens Before They Are Hatched

The National Credit Union Administration (NCUA) wants several investment banks to repurchase $50 billion in non-agency mortgage-backed securities that they sold to five failed corporate credit unions; but there is no guarantee that NCUA's repurchase request will succeed.

There are a number of factors that will influence the success of such a repurchase request.

The first issue is materiality. In general, pooling and servicing agreements (PSA) permit a loan to be put-back due to a breach in warranties and reps, if the breach materially and adversely affect the interest of the bondholders in any mortgage. But materiality may be difficult to prove, especially where borrowers made their payments for a period of time before defaulting. In other words, did the default arise from a breach or from factors unrelated with the origination of the loan that caused the default.

A second factor is access to loan files and voting rights. Before a trustee can request access to loan files, investors in private-label MBS need to reach a certain voter threshold. In some PSAs, this requires reaching a certain voter threshold for each tranche. According to Fitch, this voter threshold is a large hurdle to overcome.

Third, once access is obtained, investors will need to review the loan files. This could result in substantial cost with no guarantees of sizable returns.

The next issue deals with guidelines, as most private-label loans are underwritten to the guidelines in effect at the time the loan was originated. Investors will need to identify loans that were not underwritten to the originator's guidelines and this could be very difficult.

Furthermore, most PSAs include a qualified fraud representations stating that to the best of the seller's knowledge no fraud was committed. Therefore, it is not enough for the investor to prove fraud, the investor needs to prove that the representation provider knew about the fraud or should have known.

Ultimately, if NCUA's repurchase request are ignored or denied, the agency can sue, as they have threatened. But litigation could take years to work its way through the legal system and there is not any guarantee that the NCUA will prevail.

So, there are a number of hurdles confronting NCUA that may limit the success of its put-back requests.

Therefore, credit unions should not start counting their chickens until they are hatched. In other words, credit unions should not expect this put-back gambit to have any impact for the foreseeable future on their corporate credit union assessments.

NCUA Threatens to Sue Investment Banks

The Wall Street Journal is reporting that the National Credit Union Administration (NCUA) has threatened to sue several investment banks unless they refund over $50 billion of mortgage-backed securities sold to the five failed corporate credit unions.

The $50 billion in bonds currently have a face value of $25 billion.

The NCUA alleges that several investment banks misrepresented the risks of the bonds to these corporate credit unions.

NCUA seized the five corporate credit unions in 2009 and 2010 after their investments in sub-prime and interest only mortgage-backed securities soured.

The five failed corporate credit unions are U.S. Central Corporate FCU in Lenexa, KS; Western Corporate FCU in San Dimas, CA; Constitution Corporate FCU in Wallingford, CT; Members United Corporate FCU in Warrenville, IL; and Southwest Corporate FCU in Plano, TX.

Read the article (subscription may be required).

Where Does the 350 Come From?

The Credit Union National Association (CUNA) has been saying that "there are nearly 350 credit unions at or quickly approaching" the member business loan cap of 12.25 percent of assets. This is the same number being quoted by Senator Udall, who is the chief sponsor of a bill to raise the business loan cap for credit unions.

But I just don't see how the 350 number was derived.

Any analysis of credit unions at or approaching the cap needs to exclude credit unions that were exempted by the Credit Union Membership Access Act of 1998.

First, credit unions that have a history of making business loans or were chartered for the purpose of making business loans are exempted from the aggregate business loan cap. According to NCUA, approximately 90 credit unions were eligible for this exemption (see Federal Register, Vol. 64 (No. 102), May 27, 1999, p. 28726).

Second, credit unions that are either low-income or community development financial institution credit unions are exempted from the aggregate member business loan cap.

So, if these credit unions are included, then the results are being fudged.

By my estimation, once these institutions are excluded, the member business loan to asset ratio has to fall below 6 percent to ascertain the 350 credit union number. A credit union with a member business loan to asset ratio below 6 percent is not in the vicinity of its business loan cap.

According to my analysis, approximately one half of one percent of credit unions are near the member business loan cap. I define "near" as having a member business loan to asset ratio between 11.25 percent and 12.25 percent.

Therefore, the claim that 350 credit unions are being impacted by the member business loan cap seems inflated.

Does N Stand for Nanny?

NCUA believes that part of its mission is to protect credit union members' rights.

But how can this agency say its protecting members' rights with a straight face when it rarely makes public enforcement actions that may materially affect their credit unions?

According to an article in the February 28, 2011 Credit Union Journal, "Are Examiners Overcompensating?", as of January 31, 2011, 333 credit unions are under Letters of Understanding and Agreement, 86 credit unions are under preliminary warning letters, and 28 credit unions are under cease and desist orders.

However, as I've previously pointed out, you will have a hard time finding these enforcement orders on NCUA's website. Only 1 cease and desist order and 4 Letters of Understanding were publicly available in 2010.

So, where are the other enforcement actions?

Alas, I guess the "N" in NCUA stands for nanny, as NCUA has made the decision that credit union members can't handle the truth.

Credit Union Foreclosures

At the end of 2010, NCUA reported that federally-insured credit unions held slightly more than $1.6 billion in foreclosed real estate as of the end of 2010 -- up 39.1 percent from 2009.

The credit union with the most foreclosed real estate is Texans Credit Union in Richardson, Texas. It was holding $93 million at the end of 2010.

The following table lists the 40 credit unions with the most foreclosed real estate (click on image to enlarge). The table includes the number of foreclosed properties, the dollar volume, and the net worth of both federally-insured and privately-insured credit unions.

Problem Credit Unions Update

NCUA reported that the number of problem credit unions declined from 369 at the end of January to 360 at the end of February. A problem credit union is defined as a credit union that has a CAMEL code of 4 or 5.










Problem credit union held fewer shares (deposits) and assets at the end of February. Shares (deposits) and assets in problem credit unions as of the end of February were $37.7 billion and $42.5 billion, respectively. NCUA reported that problem credit unions held 4.97 percent of the credit union industry’s insured shares and 4.64 percent of the industry’s assets.











The number of problem credit unions with $1 billion or more in assets increeased by one to 11 holding $18.5 billion in shares. The number of problem credit unions with between $500 million and $1 billion in assets fell from 6 in January to 5 in February with $3.3 billion in shares. There were 52 problem credit unions with between $100 million and $500 million in assets (4 fewer than in January) holding $11.5 billion in shares.










Also, NCUA reported that the number of credit unions with a CAMEL 3 rating, credit unions that pose some supervisory concern, fell for the second conseutive month to 1803 credit unions. These CAMEL 3 credit unions hold $133.9 billion in shares or about 17.67 percent of the industry's insured shares.

In a related story, Weiss Ratings, which is now providing ratings on the nation's credit unions, reported that 2,573 credit unions, or 34.3 percent of the industry, are included on its "Weakest List," while only 760, or 10.1%, are on the "Strongest List." A credit union with a rating of D+ or lower qualifies for its Weakest List, while a credit union with a B+ or higher rating qualifies for its Strongest List.

To access Weiss Ratings, click here.

Matz: Privately-Insured CUs Pose a Risk to Federally-Insured CUs

In testimony from last December before the Sanate Banking Committee, NCUA Chairman Debbie Matz identified privately-insured credit unions as a potential future risk to federally-insured credit unions.

Chairman Matz stated:

"While NCUA has no regulatory authority over privately-insured institutions, they do pose a unique reputation risk to federally-insured credit unions. All financial institutions have been negatively affected by high unemployment, declines in real estate values, and loan losses all arising from the recent, protracted recession. Consumers do not always differentiate between private share insurance and federal share insurance. As a result, any pervasive problems that may develop with privately-insured credit unions could have an impact on federally-insured credit unions.

American Mutual Share Insurance Corporation (ASI) is a private share insurer
incorporated in Ohio. ASI, along with its wholly-owned subsidiary Excess Share
Insurance Corporation (ESI), provides primary share insurance to 152 credit unions in
nine states and excess share insurance to several hundred credit unions, including federally-insured credit unions, in 32 states. ASI has geographic concentration in two states particularly hard hit by the recent recession: California and Nevada."

Matz's statement should garner a lot of attention given the story this last weekend in the Las Vegas Review Journal that focused on the largest privately-insured credit union. Read March 12th blog post.

Brief Filed in Lawsuit on Durbin Amendment

Every major bank and credit union trade associations filed on Friday a friend-of-the-court brief in support of TCF National Bank’s legal challenge to the Durbin Amendment. TCF’s lawsuit challenges rules being promulgated by the Federal Reserve that would cap debit-card interchange fees at an amount far below issuers’ costs.

The amici make their case that the Federal Reserve is erroneously interpreting the debit card interchange fee provisions of the Durbin Amendment. The Federal Reserve is proposing to implement the Durbin Amendment by imposing price caps that:

1. Are improper under the Durbin Amendment;
2. Raise serious constitutional issues, due to their confiscatory nature; and
3. Threaten substantial harm to consumers, banks, credit unions, the electronic payments system, and the economy as a whole.

The price caps that are currently under consideration would increase banking fees and costs for consumers and deprive significant numbers of Americans (particularly low-income Americans) of access to this reliable, convenient, secure, and efficient method of payment.

The brief was signed by the American Bankers Association, The Clearing House, Consumer Bankers Association, Credit Union National Association, The Financial Services Roundtable, Independent Community Bankers of America, Mid-Size Bank Coalition of America, and National Association of Federal Credit Unions.

Read the brief.
Read the press release.

After Long Delay Silver State's Financials Released

The Las Vegas Review Journal reported on the performance of Silver State Schools Credit Union, the largest privately insured credit union in the country.

After a long delay, American Share Insurance (ASI) posted the results on Wednesday showing that Silver State Schools Credit Union lost $21.5 million last year, including $4.5 million in the fourth quarter.

The delay was attributed to the books of the credit union being examined by both ASI and the state credit union regulator, which required Silver State Schools to increase its allowances for loan losses.

American Share made a $22 million subordinated loan to Silver State in February 2010, which the credit union has counted as part of its net worth. The term of the loan from ASI, which was to be repaid in August 2010, was extended to 2015.

Read the article.

Delaware FCU Underserving the Underserved (Update 1)

I received an anonymous tip about Delaware FCU, also known as Del-One FCU, not serving the city of Newark, Delaware, which the credit union added as an underserved community.

NCUA, according to its September 2005 Insurance Activity Report approved Delaware FCU's application to add persons who live, work, worship, or go to school in, and businesses and other legal entities in the city of Newark, Delaware to its field of membership.

In June 2006, NCUA amended its chartering manual requiring that "once an underserved area is added to a federal credit union's field of membership, the credit union must establish and maintain an office or service facility in the community within two years." NCUA defined a service facility as "a credit union owned branch, a shared branch, a mobile branch, an office operated on a regularly scheduled weekly basis, or a credit union owned facility that meets, at a minimum, these requirements. This definition does not include an ATM or the credit union’s Internet web site."

At the time NCUA finalized the rule, the agency decided that the service facility requirement would only apply to credit unions adding an underserved area going forward.

We know that Delaware FCU opposed the requirement of establishing and maintaining a physical presence in the underserved community. Duke Strosser, the CEO of Delaware FCU, wrote on March 29, 2006:

"If it can be proven that low-cost, public transportation is afforded to members of the underserved communities, allowing them to reach remote credit union locations easily and safely, then consideration should be given to longer timeframes for establishing a facility in the underserved area. Consideration should also be given to expanding the “acceptable” distance between the underserved area and the nearest service facility."

Based upon information on NCUA's website, more than 5 years after adding Newark as an underserved community to its field of membership Delaware FCU does not have a physical presence in Newark. The credit union is also not part of a shared branching network.

I know that Delaware FCU is not required to have a physical presence in Newark, because Newark was added before the physical presence requirement became effective.

However, it seems to me that the credit union should comply with the spirit of the chartering manual and establish a branch in Newark.

If it does not do so, then it should divest itself of Newark.

Additionally, NCUA should examine all credit unions that have been granted an underserved community to see whether a credit union has established a physical presence in the underserved area -- not just those granted after the physical presence requirement became effective.

Update: I received a call from another anonymous tipster stating that the management tried to open a branch in Newark, but the Board of the credit union opposed these efforts.

Its Deja Vu All Over Again

Last night, Senator Mark Udall (D - CO) introduced legislation (S. 509) that would more than double the business lending authority for eligible credit unions.

Currently, the member business lending limit is 12.25 percent of assets. This bill would raise the aggregate limit to 27.5 percent of assets.

This marks the fifth consecutive Congress where legislation has been introduced to raise the member business lending limit for credit unions.

I feel like I am trapped in a time loop and like Phil Connors (Bill Murray) in the movie Groundhog Day, instead of waking up to Sonny and Cher on the radio, I am waking to a credit union business lending bill.

NCUA Liquidates Land of Enchantment FCU

The National Credit Union Administration placed Land of Enchantment Federal Credit Union of Santa Fe, New Mexico, into liquidation.

Guadalupe Credit Union of Santa Fe, New Mexico, purchased and assumed Land of Enchantment’s assets, liabilities and members.

At closure, Land of Enchantment Federal Credit Union had approximately $8.6 million in assets and served 1,593 members. The credit union was critically undercapitalized as of December 2010 with a net worth ratio of 1.40 percent and reported that 9.67 percent of its loans were at least 60 days delinquent. Land of Enchantment FCU had reported losses for the last three years of $38,100 for 2008, $763,552 for 2009, and $296,856 for 2010.

This is the fifth credit union to be liquidated in 2010.

Read the press release.

Should the Small Credit Union Threshold Be Raised?

Addressing the Credit Union National Association's Government Affairs Conference, NCUA Board Member Gigi Hyland last week stated that she believed the asset size threshold for a small credit union should be raised, as a way of reducing credit union regulatory burden.

Board Member Hyland stated: "I believe NCUA should seriously consider revising the definition of “small entity” to a larger number, perhaps from $10 million to $50 million.... I'll be pursuing these revisions with NCUA staff and my Board colleagues."

NCUA policy requires the agency to "prepare and make available for public comment an initial regulatory flexibility analysis for any regulation that will have a significant economic impact on a substantial number of small entities."

In 2003, NCUA raised the small entity asset size threshold from $1 million in assets to its current threshold of $10 million. This $10 million asset size threshold meant that approximately 52 percent of federally-insured credit unions were treated as a small entity -- a percentage much closer to the percentage captured by the asset standard when its policy was originally adopted, which defined a small entity as having $1 million or less in assets.

So, how would raising the threshold to $50 million impact the credit union industry?

According to September 2010 financial data, if you raise the threshold from $10 million to $50 million, the number of federally-insured credit unions that would be treated as a small credit union would increase from 2831 or 38.26 percent of the industry to 5,244 or almost 71 percent of federally-insured credit unions.

Therefore, an increase of the asset size threshold to $50 million would result in a larger percent of credit unions being defined as a small credit union compared to when the NCUA Board raised the threshold in 2003.

However, raising the asset size threshold from $10 million to $50 million would greatly outpace the increase in the consumer price index, which increased by slightly more than 21 percent between the January 2003 and January 2011. If you only adjust for inflation, the new small credit union asset size threshold would be $12.1 million.

Read the speech.

Small Wisconsin CU Closed

The National Credit Union Administration (NCUA)was appointed liquidating agent of Wisconsin Heights Credit Union of Ogema, Wisconsin, by the Wisconsin Office of Credit Unions. NCUA immediately signed an agreement with CoVantage Credit Union of Antigo, Wisconsin, to assume the members, assets and liabilities of Wisconsin Heights Credit Union.

At closure, Wisconsin Heights Credit Union had $713,000 in assets and served 501 members. As of the end of 2010, the credit union had a net worth ratio of 2.64 percent and reported that 27.44 percent of its loans were at least 60 days delinquent.

Wisconsin Heights Credit Union is the fourth federally insured credit union liquidation in 2011. The last Wisconsin credit union to fail was First American Credit Union of Beloit, Wisconsin on August 31, 2010.

Read NCUA's press release.

Credit Union Profits Increase by 208 Percent for 2010

NCUA reported that federally-insured credit unions reported a net income of $4.6 billion for 2010, up 208 percent from $1.6 billion for 2009. The industry’s return on average assets was 0.51 percent for 2010 compared to 0.18 percent for 2009.

Lower cost of funds and provisions for loan and lease losses more than offset the drop in interest income allowing credit unions to post the strong increase in earnings. Provisions for loan and lease losses fell by 26.9 percent to just below $7 billion and interest expense declined by 26.4 percent to $10.9 billion. Non-interest income (net of NCUSIF stabilization income) rose 14 percent to almost $12 billion.

Federally-insured credit unions reported a decline in outstanding loans by 1.3 percent to $564.8 billion. On the other hand, assets and shares grew by 3.4 percent and 4.5 percent, respectively.

NCUA reported that used car loans, credit card loans, and first mortgages were up for 2010, but new auto loans experienced a sharp decline falling by more than 16 percent to $62.9 billion at the end of 2010.

The net worth ratio for credit unions increased to 10.06 percent as credit unions increased their net worth by 5.2 percent to $92.1 billion.

The number of delinquent loans fell by 5.3 percent in 2010 to $9.85 billion. Delinquencies remained at historically high levels, ending 2010 at 1.74 percent; however, it is 10 basis points below the final 2009 number of 1.84 percent.

Loan categories with the highest delinquency rate were member business loans and participation loans at 3.92 percent and 3.83 percent, respectively.

Allowances for loan and lease losses rose during 2010 to $9.4 billion, up from $8.9 billion at the end of 2010. So, even though provisions for loan losses fell, it still exceed net charge-offs for the year.

Charge-offs fell and recoveries increased during 2010. As a result, net charge-offs were $6.4 billion at the end of 2010 down from $6.9 billion at the end of 2009.

NCUA reported that foreclosed and repossessed assets rose by almost 24 percent to $1.86 billion.

Additionally, The number of federally-insured credit unions contracted by 215 during 2010 to 7,339 and credit unions reported a slight increase (0.3 percent) in full time employees to 219,880.

Read the press release.

Media Stereotypes Lead to Lack of Objectivity

The national media appears to have bought into a stereotype that credit unions are the best deal for consumers.

Here are some examples of the lack of objectivity from these consumer reporters. Farnoosh Torabi for moneyeatch.com wrote “I’ve always been a huge advocate of credit unions.” Tim Chen, a reporter for The Christian Science Monitor, wrote “given their reputation for great customer service and consumer-friendly policies, I highly recommend you ditch your national bank for a credit union.”

But stereotypes are standardized and simplified conceptions, which are based on some prior assumptions, and as a result may cause a person to make a poor financial decision.

If people only believe that they can only get favorable treatment or deals from credit unions, then they will miss opportunities offered by other financial institutions.

In fact, there are taxpaying banks that are offering better deals to consumers than credit unions.

For example, a friend recently bought a pre-owned car. When this friend went to finance the purchase, the best rate was from a bank, not credit unions – even with their tax advantage.

So while NCUA Board Member Michael Fryzel in a recent speech stated that credit unions leave money in the consumers’ pockets, NCUA also stated that credit unions with higher net worth ratios have paid for the higher net worth ratios with reduced services and less favorable rates [Federal Register (Volume 75, Number 248) December 28, 2010, p. 81384].

Moreover, it seems in the case of my friend, it was the bank that left more money in his wallet, not a credit union.

What this points out is that it pays to shop around. Just because a financial institution has the word “credit union” on its door does not mean that it is the best deal for consumers.

It is time that the national media removes their credit union blinders and stop being a credit union pom pom squad.

Tough Love Saved Credit Unions from Even Higher Premiums

In a speech before the Credit Union National Association's Government Affairs Conference, NCUA Chairman Debbie Matz said that NCUA's tough love saved credit unions from "hundreds of millions of dollars in additional insurance premiums."

She stated in her speech that in the last 18 months, several billion-dollar credit unions were on the verge of failure. If these CAMEL 4 credit unions had failed, credit unions faced an additional $1.5 billion in premiums.

She outlined specific steps that NCUA took to keep credit union failures from having a catastrophic impact on the National Credit Union Share Insurance Fund (NCUSIF).

1. NCUA crafted very prescriptive enforcement actions to commit certain problem credit unions to specific performance targets.

2. NCUA arranged marriages for credit unions that simply could not survive on their own.

3. NCUA "worked with several credit union boards to select new CEOs who had the skills and experience to address the specific problems that their credit unions faced."

4. NCUA conserved some credit unions withy the goal of returning the credit unions back to their members.

She noted that these actions were not popular; but concluded that if these actions had not be taken, the NCUSIF would have incurred significant losses.

She also mentioned that to help catch problems before they festered into larger problems, NCUA had shortened the exam cycle from 18-months to 12-months and had expanded its budget to employ more examiners.

To read the speech, click here.