Improving Financial Conditions in Q1 2013

The financial performance of federally-insured credit unions continued to improve in the first quarter of 2013, according to information released by the National Credit Union Administration (NCUA).

For the first quarter, federally insured credit unions had a net income of almost $2.2 billion.

The industry’s return on average assets ratio was a healthy 83 basis points -- down 3 basis points from the prior quarter. However, the low interest rate environment continued to squeeze the net interest margins at credit unions, which fell by 16 basis points in the quarter to 2.77 percent.

Credit unions’ total assets grew by $33.6 billion in the first quarter to $1.06 trillion, while the industry's net worth rose to $108.8 billion, up $2.1 billion for the quarter. Because asset growth outpaced net worth growth, credit unions’ net worth ratio fell slightly during the quarter to 10.31 percent.

At the end of the first quarter of 2013, 95.8 percent of the industry remains well-capitalized reporting a net worth ratio above 7.0 percent. However, 92 credit unions were undercapitalized with net worth ratios below 6 percent, a net gain of 17 credit unions from the end of 2012.

Federally-insured credit unions reported their eighth consecutive quarter of loan growth. Total outstanding loans grew by $2.3 billion in the first quarter to $599.9 billion. On the other hand, deposits (shares) at federally-insured credit unions increased by $32.0 billion in the first quarter to nearly $910.0 billion. As the result, the loan-to-share ratio fell 214 basis points to 65.92 percent.

Asset quality continued to improve. The delinquency ratio of federally insured credit unions declined in the first quarter, shedding 14 basis points to 1.02 percent. Credit unions’ net charge-off ratio also dropped significantly by 12 basis points, to 0.61 percent. This improvement in asset quality caused credit unions to significantly reduce their provisions for loan losses.

NCUA Chairman Debbie Matz expressed concern about the unevenness of industry's performance, as larger credit unions outperformed the industry.

Matz said: "The 423 largest credit unions had a return on average assets of 100 basis points for the quarter. In comparison, 2,279 credit unions with less than $10 million in assets had a return on average assets of negative 14 basis points, and 3,007 credit unions with $10 million to $100 million in assets had a return on average assets of 30 basis points."

To review a summary of first quarter data, click here.

To read the press release.

2013 Insured Depositor Payoffs Ahead of Last Year's Pace

So far this year, the pace of credit union failures involving insured depositor payoffs is running ahead of last year's pace.

In 2013, six of the seven credit union liquidations have involved insured depositor payoffs. It would have been seven out of seven; but Kinecta acquired I.C.E. Federal Credit Union several days after NCUA had liquidated the credit union.

In comparison, there were only six credit union failures in 2012 that involved insured depositor payoffs.

As a general rule, insured depositor payoffs tend to be more expensive to the insurance fund than purchase and assumption agreements.

There are several possible reasons for the 2013 pace to be ahead of the 2012 pace. These failures arose out of the blue and did not give NCUA adequate time to shop the failed credit union. The insured depositor payoffs involved small credit unions that have very little franchise value and thus were not attractive to potential bidders.

I will be interested to see if this trend of insured depositor payoffs continues for the remainder of 2013.

CFE FCU Pays Almost $4 Million for Arena's Naming Rights

Another credit union has bought the naming rights to an arena.

The latest credit union is Central Florida Educators' (CFE) Federal Credit Union in Lake Mary, Florida. The $1.4 billion credit union paid $3.95 million over 7 years for the naming rights to a 10,000 seat arena at the University of Central Florida.

Going forward, the arena will be known as the CFE Federal Credit Union Arena -- or the CFE Arena for short.

While buying the naming rights will help to improve the credit union's brand visibility, is this the intended purpose of the credit union's tax exemption?

I don't believe so.

Read the press release.

Arrowhead Central CU Emerges from Conservatorship

Arrowhead Central Credit Union (San Bernardino, CA) emerged from conservatorship almost 3 years after NCUA assumed control of the credit union. NCUA placed Arrowhead Central Credit Union into conservatorship on June 25, 2010. Arrowhead Central CU is the first credit union since 2007 to emerge from NCUA conservatorship.

Read NCUA's press release.

Sub S Taxation Is Not the Same as CU Tax Exemption

In case you missed it, Tom Bengtson unloaded both barrels on an April 2013 article, "Banks and Credit Unions: Competition Not Going Away," appearing in the Federal Reserve Bank of St. Louis Regional Economist.

Bengtson writes that "[w]hile the article is generally an even-handed description of the competitive landscape for banks and credit unions, the authors veer off course in their description of the tax differences between banks and credit unions."

The paper stated that banks organized as S corporations and credit unions are similarly exempt from taxation.

Let's just say that this comparison got Tom Bengtson's goat.

"To suggest that a sub S bank and credit union have equal tax treatment is extremely misleading. From a practical perspective it is a lie and I don’t understand why two professionals at the Federal Reserve Bank of St. Louis would propagate such nonsense.

To suggest that sub S business owners (banks and otherwise) don’t pay federal income taxes is an insult to every sub S business owner out there, including your’s truly."

To read his commentary, click here.

Tiny Texas Credit Union Liquidated

The National Credit Union Administration (NCUA) liquidated Electrical Workers #527 Federal Credit Union of Texas City, Texas.

NCUA made the decision to liquidate Electrical Workers #527 Federal Credit Union and discontinue its operations after determining the credit union was insolvent and had no prospect for restoring viable operations.

The credit union posted a loss of $295,220 in the first quarter of this year after reporting a loss of $122,290 for all of 2012. As of March 31, 2013, its net worth ratio was -36.07 percent.

Electrical Workers #527 Federal Credit Union was a low-income designated credit union serving 527 members and had assets of $622,857.

This is the seventh credit union to fail this year. The last Texas credit union to fail was Women's Southwest FCU of Dallas (TX) on October 31, 2012.

Read the press release.

Accounting Change Would Increase Burden on Community Banks and Credit Unions

Federal bank regulators have weighed in on the Financial Accounting Standards Board’s (FASB) proposed changes relating to classifying and measuring financial instruments. In a joint comment letter, the Federal Reserve, FDIC, National Credit Union Administration, and OCC found that many aspects of the FASB's Exposure Draft do not "achieve the FASB’s simplification objective; in certain cases the Exposure Draft would reduce the overall usefulness of financial reporting."

Among these concerns are that the guidance’s application “could have the unintended consequence of requiring relatively simple traditional lending products . . . to be measured entirely at [fair value through net income].” They also said that the guidance would “significantly increase complexity and operational burden for all financial institutions, but particularly for community banks and credit unions, without commensurate benefit to financial statement users.”

Read the letter.

Accusations of Payday Lending at Credit Unions

The National Consumer Law Center (NCLC) and the Center for Responsible Lending (CRL) wrote NCUA Chairman Debbie Matz asking NCUA to stop federal credit unions from making triple-digit payday loans.

The letter alleges that some federal credit unions are making balloon-payment, short-term loans with APRs approaching 300 percent -- well-above the legal 18 percent usury cap.

NCLC in a recent study names nine federal credit unions in five states for making triple digit payday loans (see below).

The letter also states that the reputation of the rest of credit union industry is at risk because of the behavior of these few credit unions.

The letter notes that in some cases credit unions are partnering with credit union service organizations (CUSOs) to make the loans.

The two consumer groups recommend that "[w]hen FCUs offer their name to CUSOs, NCUA should tighten up its finder’s fee rule to ensure that FCUs are not incurring third party risk and profiting off of loans that are illegal for them to make directly."

Flexibility in Mortgage Disclosure Rule

A coalition of 12 trade groups sent joint letters last week to Reps. Steve Stivers (R-Ohio) and Ed Perlmutter (D-Colo.) thanking them for their help in urging the Consumer Financial Protection Bureau (CFPB) to adjust a provision in its proposed mortgage disclosure rules that could cause costly delays in closings.

The provision requires that borrowers receive their final closing disclosure three business days prior to closing, and that if a cost that the borrow must pay to close increases during that time, a new statement and waiting period must be initiated.

Because changes frequently occur in the three days prior to a closing, the three-day-restart provisions can reduce consumers’ ability to make changes to their purchase, put their mortgage rate lock at risk and even cause their purchase contract to expire, the trade groups explained.

Reps. Stivers and Perlmutter have asked fellow Representatives to cosign a letter to the CFPB urging more flexibility in the rule.

The letter is below (click on image to enlarge).

NCUA Conserves Tiny Alabama Credit Union

The National Credit Union Administration (NCUA) assumed control of First Kingdom Community Federal Credit Union of Selma, Ala.

During the conservatorship, NCUA will work to resolve issues affecting the institution’s safety and soundness. The credit union is undercapitalized with a net worth ratio of 5.64 percent and unprofitable.

Chartered in 2007, First Kingdom Community Federal Credit Union is a low-income credit union serving Dallas County, Alabama. As of the end of March 2013, the credit union reported serving 76 members and has assets of approximately $88,400.

Read the press release.

Study: Two Florida CUs Have the Greatest Incidence of Complaints

Two Florida credit unions had the highest incidence of consumer complaints in 2012.

While other institutions had more complaints, these two credit unions had the most complaints relative to their size.

K. H. Thomas Associates calculates the Bank Complaint Index© or BCI, which is defined as a bank’s relative portion of state complaints in a given year divided by its deposit market share as of the midpoint in the year (June 30).

A BCI of 1.0 means that a bank’s complaints are equal to its market share. A BCI above 1 means that complaints are greater than the institutions market share.

According to the Florida Bank Complaint Analysis, Space Coast Credit Union in Melbourne had the highest BCI of 7.5. This is the third year in a row that Space Coast Credit Union had the highest BCI score.

Joining Space Coast in the 2012 rankings was Fairwinds Credit Union in Orlando with a BCI of 5.3.

These two credit unions were the only institutions with a BCI score above 5.

Lithuanian CU Placed Under Enforcement Order

The California Department of Financial Institutions (DFI) has entered into an enforcement order with Lithuanian Credit Union of Los Angeles, California.

The enforcement order cited numerous safety and soundness violations at the credit union.

Below are some of the concerns noted by the DFI.

The order instructs the credit union to retain management and maintain a Board of Directors that is acceptable to the Commissioner of Financial Institutions.

The credit union was ordered to develop and implement appropriate allowance for loan loss methodology and fully fund its allowance for loan loss account.

The order also cited the credit union for its underwriting policies. For example, the credit union needs to develop policies and procedures on the maximum loan amount to collateral value ratio and establish maximum aggregate exposure for each category of high risk loans, as well as maximum limit on each individual loan.

The credit union further needed to improve its loan collection procedures and implement a system to ensure adequate documentation of all contacts with delinquent members.

Maybe NCUA can follow California's example and start to publish enforcement actions in a timely manner.

Read the order.

Impermissible Advertising

The California Department of Financial Institutions is reporting that some California credit unions are engaged in impermissible advertising campaigns by stating “everyone can join” or “all individuals can join” the credit union.

Advertisements that display this message violate state regulation concerning common-bond requirements for field of membership.

Title 10 California Code of Regulations § 30.51 provides that members must share a common bond “beyond obtaining financial services.” Stating that “everyone can join” or that “all can join” the credit union incorrectly suggests that the common-bond requirement does not apply.

Does the Tax Subsidy Get Passed Through to Members?

A 2005 study by the Tax Foundation concluded that very little of the benefits from the credit union tax exemption was passed through to the members in the form of lower loan rates or higher savings rates. Most of the tax benefit was retained by credit unions, which went either towards increasing the size of credit unions or to higher labor costs.

The study found:

"Of the 50 basis points in subsidy that the tax exemption provides, at least 33 basis points accrue to owners in the form of larger equity and larger assets. Approximately 6 basis points may accrue to credit union borrowers through lower interest rates, and not more than 11 basis points are absorbed by higher labor costs. There is little or no effect on deposit rates or other costs."

Does Director Pay and Taxes Impact Rates and Fees?

At one time, NCUA required that any converting credit union include the following information in any disclosure to its members.

EXPENSES AND THEIR EFFECT ON RATES AND SERVICES. Most credit union directors and committee members serve on a volunteer basis. Directors of a mutual savings bank are compensated. Credit unions are exempt from federal tax and most state taxes. Mutual savings banks pay taxes, including federal income tax. If [insert name of credit union] converts to a mutual savings bank, these ADDITIONAL EXPENSES MAY CONTRIBUTE TO LOWER SAVINGS RATES, HIGHER LOAN RATES, OR ADDITIONAL FEES FOR SERVICES.

While it is true that federal credit union directors and committee members serve on a volunteer basis, it is not true for all state-chartered credit unions. Some states, including Pennsylvania, Rhode Island, Indiana, and Texas, currently allow their state-chartered credit unions the option to pay their board members.

In addition, some states tax their state-chartered credit unions. For example, Indiana and Oklahoma tax their state-chartered credit unions. In addition, state-chartered credit unions are subject to the unrelated business income tax.

If it is true that these additional expenses impact interest rates and fees, then there should be differences in the interest rates and fees between federal credit unions and state-chartered credit unions in states that allow for directors to be paid or where state chartered credit unions pay taxes.

NCUA's Chief Economist John Worth should conduct a statistical analysis comparing savings rates, loan rates, and fees between federal credit unions and state-chartered credit unions and publish the results.

NCUA Goes Rogue

On April 30, 2013, NCUA denied my FOIA request for the Letter of Understanding and Agreement (LUA) between the agency and failed Telesis Community Credit Union from June 2010 and May 2011. The denial letter from NCUA is posted below (click on image to enlarge).

However, this FOIA denial shows how NCUA seems to flaunt the rule of law. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 modified the Federal Credit Union Act requiring the disclosure of enforcement actions. But NCUA is using the FOIA exemptions to keep from releasing this information.

Section 206(s)(1) of the Federal Credit Union Act states the following:

(s) Public Disclosure of Agency Action.—
(1) In general.—The Board shall publish and make available to the public on a monthly basis—
(A) Any written agreement or other written statement for which a violation may be enforced by the Board, unless the Board, in its discretion, determines that publication would be contrary to the public interest;
(B) any final order issued with respect to any administrative enforcement proceeding initiated by the Board under this
section or any other law; and
(C) any modification to or termination of any order or agreement made public pursuant to this paragraph.

Paragraph (s)(5) of Section 206 states that the publication of the order can be delayed for a reasonable time under exceptional circumstances.

Delay of publication under exceptional circumstances.—If the Board makes a determination in writing that the publication of a final order pursuant to paragraph (1)(B) would seriously threaten the safety and soundness of an insured depository institution, the agency may delay the publication of the document for a reasonable time.

I can't see how releasing the two LUAs would constitute a serious threat to the safety and soundness of Telesis Community CU, because the credit union has already failed.

Moreover, this rogue agency rarely discloses any enforcement action in a reasonable time.

HELOCs

According to the Federal Reserve's Flow of Funds, credit unions reported $75.4 billion in home equity loans and home equity lines of credit (HELOCs) at the end of 2012.

Between 2003 and 2008, outstanding home equity loans and HELOCs at credit unions rose from $51.7 billion to $98.7 billion.

On April 29, Fitch published a report, U.S. Banks -- Home Equity Reset Risk Hitting the Reset Button in 2014.

The report noted that during the mid-2000s many HELOCs originated featured an interest-only draw period up to 10 years, followed by either a balloon payment at maturity or an amortization period requiring principal and interest payments.

The interest-only draw period is now coming to an end. When this occurs, HELOCs will begin to mature or convert to fully amortizing loans. Fitch notes that it is this maturity or conversion that presents the increased credit risk.

Credit risk could emerge from two areas. First, borrowers facing balloon payments may have difficulty refinancing if they don't have any equity in their homes. Second, as HELOCs recast to fully amortizing, some borrowers will be confronted with payment shock. Also, when rates begin to rise, these borrowers will be confronted with a interest rate reset which will lead to higher debt payments.

While I don't know the specific practices of credit union, I suspect many HELOCs underwritten by credit unions possessed the same features.

As of December 31, 2012, there were 160 credit unions with at least $100 million in assets that reported more HELOCs than net worth. Six credit unions had HELOCs to Net Worth exposure in excess of 300 percent. Another 16 credit unions had a HELOC to Net Worth ratio between 200 percent and 300 percent.

The following table ranks credit unions with at least $100 million in assets with the greatest exposure to HELOCs (click on image to enlarge).

Lynrocten FCU Closed

The National Credit Union Administration (NCUA) liquidated Lynrocten Federal Credit Union of Lynchburg, Va.

NCUA made the decision to liquidate Lynrocten Federal Credit Union and discontinue operations after determining the credit union was insolvent and had no prospect for restoring viable operations.

Local media reported that the credit union was being investigated by the Lynchburg police for criminal activity.

Lynrocten Federal Credit Union served 1,068 members and had assets of approximately $13.8 million.

This is the sixth credit union to fail in 2013 and the second Virginia credit union to be closed in 2013.

Read the press release.

Crawling Before Walking?

In 2011, NCUA Chairman Debbie Matz stated that credit unions that wanted expanded business lending authority needed to crawl before they walk.

NCUA Chairman Matz during her testimony regarding raising the member business loan (MBL) cap before the Senate Banking Committee on June 16, 2011 stated in response to a question that the agency would put in place regulations "to ensure that ... the credit unions that go above the cap do so in a moderate way, that they crawl before they walk."

However, last year NCUA significantly expanded the number of credit unions that had an exception to the MBL cap by streamlining the process for credit unions to receive a low-income designation. The only thing a credit union needs to do is opt-in when notified by NCUA that they qualified for this designation.

One benefit associated with accepting this low-income credit union designation is that the credit union is no longer subject to the member business loan cap of 12.25 percent of assets.

NCUA reported on October 18, 2012 that 676 federal credit unions accepted the low-income designation increasing the number of low-income credit unions to 1,874. Since then, more credit unions have been designated as low-income credit unions.

But NCUA has not proposed any rules to moderate the rate of growth of business lending by low-income credit unions. These credit unions, if they wanted to, could aggressively ramp up their business lending operations.

What happened to crawling before walking?

Profits Before People

Credit unions like to talk about how they put people ahead of profits; but a complaint before the South Dakota Supreme Court against Black Hills Federal Credit Union (Rapid City, SD) and CUNA Mutual Insurance Society (CUMIS) seeking class certification paints an entirely different picture.

The issue deals with credit disability insurance sold by Black Hills FCU to borrowers provided by CUMIS.

The complaint states that on July 1, 1999 Black Hills FCU unilaterally changed the terms of the policy by increasing what it charged for coverage with negligible increase in disability coverage. According to the complaint, the new coverage was 68% more expensive than the coverage that the insureds bought.

It alleges that CUMIS and Black Hills FCU consulted with each other before changing the terms and determined that the change would bring them significant financial benefit.

The complaint states the Black Hill FCU consulted with CUMIS on the placement of the "Notice to Members" so that the notice would not attract attention.

The "Notice to Members" of the change was buried inside the credit union's newsletter on the bottom of the fourth page. Information at the top of the page was in bold typeface and large font, "so that the reader’s eye and attention would be drawn to the bold typeface and large font, rather than to the “Notice to Members” at the bottom of the page."

The complaint stated that Black Hills FCU under the advice from CUMIS concealed:

• "The rate the members were paying before the increase;
• The percentage amount of the increase;
• The dollar amount of the increase over the life of the loan;
• The increased amount of interest that BHFCU would collect over the life of the loan as a result of the increased premium; and
• The insignificant benefit of the negligibly increased insurance coverage."

The complaint alleges that if the members "understood how much their premium was being increased, and how little increased benefit that they were providing with the premium increase," the members would have rejected the change.

The lawsuit accuses CUMIS and Black Hills FCU of breach of contract and unjust enrichment, along with other violations.

In addition, the South Dakota Division of Insurance had informed CUMIS that it had acted illegally because the newsletter notice did not comply with state requirements.