NCUA: Corporate Consolidation Raises Systemic Risk Concerns

NCUA issued a guidance letter on consolidation issues in the corporate credit union network.

The corporate credit union network is consolidating. In recent weeks, 3 mergers have been announced and more are likely to be announced as the new corporate regulations become effective, especially the new capital directives.

But this consolidation may result in a concentration of services or the aggregation of service volumes in one entity large enough to introduce systemic risk. NCUA views such a "too big to fail" scenario as unacceptable.

NCUA cautions about the potential operational risk that could arise from service interruption arising from a single large entity or the failure of such entity. NCUA advises that contingency plans need to address such concerns.

Moreover, the agency advises that contingency plans should not count on the agency providing systemic support in the future, as it has done with the conservatorship of four corporate credit unions during the finacial crisis.

The agency wrote:

"Going forward, an entity that will primarily be a service provider must be able to demonstrate the ability to safely generate adequate income not only to maintain existing services and the operational systems and staffing to deliver them, but must also adequately fund for identifying risks and for ensuring operational security and stability in the future. The capability for testing to identify and address any system weaknesses is critical to mitigate the risk of service interruptions."

Read the letter.

Executive Compensation Rules Proposed

The FDIC on February 7 issued an interagency notice of proposed rulemaking to implement Section 956 of the Dodd-Frank Act, a provision aimed to prohibit executive and incentive compensation plans that encourage risk taking.

The proposal is a joint rulemaking by the five federal members of the Federal Financial Institutions Examination Council (FFIEC), the Securities Exchange Commission (SEC) and the Federal Housing Finance Agency (FHFA).

All depository institutions with assets greater than $1 billion will be required to file an annual report that details the structure of its incentive-based compensation plans. The report must include a clear narrative of incentive-based compensation arrangements, and specific reasons the institution believes the structure of its incentive-based compensation plan does not provide covered persons incentives to engage in behavior that is likely to cause a material financial loss, and does not provide excessive compensation.

The proposed rule asks whether there are other types of financial institutions, such as a credit union service organization (“CUSO”), that the Agencies should treat as a covered financial institution to better promote the purpose of section 956 and competitive equity. Currently, no CUSOs wholly owned by a federally insured credit union have total consolidated assets of $1 billion or more.

Larger covered institutions will also have to provide a succinct description of any specific incentive compensation policies for the institution’s executive officers, and others who individually have the ability to expose the institution to possible losses that are substantial in relation to the institution’s size, capital, or overall risk tolerance.

The term “larger covered financial institution” for the Federal banking agencies and the SEC means those covered financial institutions with total consolidated assets of $50 billion or more. For the NCUA, all credit unions with total consolidated assets of $1 billion or more are larger covered financial institutions. For the FHFA, all Federal Home Loan Banks with total consolidated assets of $1 billion or more are larger covered financial institutions.

Along with other restrictions, the rule requires that at least 50% of incentive-based payments be deferred for a minimum of three years for designated executives at larger covered institutions.

The proposed rule would move the U.S. closer to international compensation standards by

requiring deferral of a substantial portion of incentive compensation for executive officers of large institutions;
prohibiting incentive-based compensation that would encourage inappropriate risks by providing excessive compensation;
prohibiting incentive-based compensation arrangements that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss;
requiring policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institution; and
requiring annual reports on incentive compensation structures to the institution's appropriate Federal regulator.

To read the proposed rule, click here.

Follow Up: Hawaii State FCU Directors Agree to Cut Their Benefits

In the wake of member criticism, the directors for the Hawaii State Federal Credit Union, the state's second largest, agreed to cut the benefits they give themselves. Read the article in the Honolulu Star Advertiser.

On February 3, I wrote about an investigative article appearing in Honolulu Star Advertiser about excessive perks the board members of Hawaii State FCU had awarded to themselves and possible conflicts of interest.

Oakland Municipal CU Closed

The National Credit Union Administration (NCUA) was appointed liquidating agent of Oakland Municipal Credit Union of Oakland, by the California Department of Financial Institutions (DFI); and Western Federal Credit Union of Manhattan Beach, California, immediately purchased and assumed Oakland Municipal’s assets, liabilities and members.

At closure, Oakland Municipal had approximately $88 million in assets and served 7,800 members.

The credit union reported a net worth ratio of 4.95 percent as of the end of 2010. It also reported that $8.3 million in loans were at least 60 days or more past due or 14.39 percent of its loans. Roughly $3 million in loans were charged off in 2010 for a net charge-off rate of 4.81 percent.

Read NCUA Press Release

Financial Performance of Credit Unions In Conservatorship

The following table provides a look at the year-end financials for four credit unions that are currently under NCUA conservatorship, A.E.A FCU, Arrowhead FCU, Family First FCU, and Keys FCU. (click on image to enlarge)

A.E.A FCU and Family First FCU are insolvent with net worth ratios of -7.63 percent and -10.49 percent, respectively. Family First, which was placed into conservatorship on July 30, has reported a negative net worth ratio since June 2010.

Article Exposes Concerns About Excessive Benefits and Conflicts of Interest at Hawaii State FCU

An article appearing in the January 30, 2011 Honolulu Star Advertiser reports on potential conflicts of interest and excessive benefits to the board members of Hawaii State Federal Credit Union, the second largest credit union in the state.

The article cites as examples of excessive benefits that the credit union pays for up to seven off-island trips annually for each board member with up to four trips to the mainland, covers travel expenses for spouses, and reimburses board members for health insurance costs.

Frank Diekmann, editor and publisher of Credit Union Journal, is quoted as saying that these benefits are pretty much in excess of what credit union boards receive regardless of the size of the credit union.

Additionally, according to documents obtained by the newspaper, regulators raised red flags with respect to "the use of a travel agency owned by the board chairwoman to book official trips, frequently at higher prices than what the airlines offered directly, and accepting free rooms at a Waikiki hotel where the annual membership meetings were held."

To read the article, click here.

Read editorial Uphold credit union trust

Interest Rate Risk Exposure

During the current low interest rate environment, credit unions in search of yield have increased their holdings of longer term assets. Credit union regulators have expressed concerns about credit unions taking on more interest rate risk, as an increase in market rates would cause the value of these long-term assets to drop.

For example, the Texas Credit Union Department in its January 2011 newsletter advised:

"credit unions with a Net Long-Term Assets Ratio near or exceeding 25 percent, policies and procedures should be in place to fully evaluate the impact of a 100-300 basis point increase in market interest rates. Each credit union’s policies and procedures for this area will be reviewed closely during the examinations completed in 2011."

As of the end of the third quarter of 2010, there were 872 credit unions with $50 million or more in assets with a Net Long-Term Assets Ratio of 25 percent or higher.

The following table ranks the top 50 credit unions with $50 million or more in assets that have the highest Net Long-Term Assets Ratio as of September 30, 2010. (click to enlarge the image)