[Senate Hearing 111-920]
[From the U.S. Government Publishing Office]
S. Hrg. 111-920
THE STATE OF THE CREDIT UNION INDUSTRY
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE HEALTH OF THE CREDIT UNION INDUSTRY AS WE EMERGE FROM THE
FINANCIAL CRISIS AND RECOVER AND GROW OUR ECONOMY
__________
DECEMBER 9, 2010
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin KAY BAILEY HUTCHISON, Texas
MARK R. WARNER, Virginia JUDD GREGG, New Hampshire
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado
Edward Silverman, Staff Director
William D. Duhnke, Republican Staff Director
Lynsey Graham Rea, Chief Counsel
Laura Swanson, Professional Staff Member
Erin Barry, Legislative Assistant
Brian Filipowich, Legislative Assistant
Mark Oesterle, Republican Chief Counsel
Andrew J. Olmem, Jr., Republican Senior Counsel
Dawn Ratliff, Chief Clerk
Levon Bagramian, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
?
C O N T E N T S
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THURSDAY, DECEMBER 9, 2010
Page
Opening statement of Senator Johnson............................. 1
Prepared statement........................................... 15
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
Senator Hutchison............................................ 2
WITNESS
Deborah Matz, Chairman, National Credit Union Administration..... 3
Prepared statement........................................... 15
Additional Material Supplied for the Record
Letter Submitted by Fred R. Becker, Jr., President and Chief
Executive Officer, National Association of Federal Credit
Unions......................................................... 35
Letter Submitted by Bill Cheney, President and Chief Executive
Officer, Credit Union National Association..................... 37
Statement Submitted by the Credit Union National Association..... 39
Statement Submitted by the American Bankers Association.......... 61
Statement Submitted by Mary Martha Fortney, President and Chief
Executive Officer, National Association of State Credit Union
Supervisors.................................................... 66
(iii)
THE STATE OF THE CREDIT UNION INDUSTRY
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THURSDAY, DECEMBER 9, 2010
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:06 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Tim Johnson, presiding.
OPENING STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. I would like to call this hearing to
order.
Today's first hearing will examine the current state of the
credit union industry, including the National Credit Union
Administration's ongoing efforts to stabilize the corporate
credit union system. As the supervisor of Federal credit unions
that insure the deposits of over 90 million account holders in
all Federal credit unions and many State-chartered credit
unions, this hearing is an important and needed opportunity to
explore the health of the credit union industry as we emerge
from the financial crisis and recover and grow our economy.
I want to welcome and thank NCUA Chairman Debbie Matz for
being here today. The NCUA has taken unprecedented steps over
the past several years to stabilize the credit union system as
the troubled corporates pulled liquidity and capital out of the
natural person credit unions. The system has also shared many
of the same challenges as the FDIC concerning the insurance of
Americans' savings and retirement.
These steps have had a significant impact on thousands of
credit unions across the country, and I am pleased that we can
have a serious conversation about the current state of the
credit union industry and the impact of increased assessments
on credit unions that serve millions of Americans across this
country. I have certainly heard concerns from my constituents
in South Dakota about this matter.
This is not the first, and certainly not the last, hearing
on the financial condition of specific sectors of our financial
services industry. The financial crisis took a toll, and the
historic Dodd-Frank legislation will bring many additional
changes to all sectors of this industry. It is very important
to me that these types of hearings become a common occurrence
with all of the financial institutions' regulators. I look
forward to your testimony, Chairman Matz, and to the question-
and-answer period.
Senator Shelby, your opening statement.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman. I will try to be
brief here today. This is a very important hearing, I believe.
Like other financial institutions, credit unions have faced
unprecedented challenges from the financial crisis and our weak
economy. Five of the largest corporate credit unions suffered
substantial losses on mortgage-backed securities and had to be
placed into conservatorship by the National Credit Union
Administration. The NCUA had to take extraordinary actions to
prevent the failure of these corporate credit unions from
triggering problems with traditional credit unions. Given that
these events occurred more than 1 year ago, an examination by
the National Credit Union Administration of our Nation's credit
unions I believe is long overdue.
Accordingly, I hope that today's hearing will shed light on
the reasons for the failure of the corporate credit unions, the
adequacy of the National Credit Union Administration's rescue
plan, and whether these failures pose any risks to our
taxpayers. I also hope to hear the NCUA's assessment of what
steps need to be taken to prevent large-scale failures from
happening again.
Mr. Chairman, there are a number of legislative measures
before the Committee that have been proposed by the National
Credit Union Administration. This hearing I hope will provide
us with an opportunity to discuss their merits and whether they
should be enacted into law.
But because credit unions play a vital role in providing
loans to American consumers, a strong and vibrant credit union
industry will be an important participant in any economic
recovery in the future. Weak and failing credit unions will
only further erode our Nation's already struggling economy and
prolong unprecedented levels of unemployment.
Thank you for calling this hearing.
Senator Johnson. Senator Reed.
Senator Reed. Mr. Chairman, I just want to thank you for
calling the hearing, and I look forward to the witnesses. Thank
you.
Senator Johnson. Senator Hutchison.
STATEMENT OF SENATOR KAY BAILEY HUTCHISON
Senator Hutchison. Well, thank you, Mr. Chairman. I, too,
appreciate that she is here to talk about the state of credit
unions, and I would just say that I think the NCUA has done a
great job in not burdening taxpayers with help for the credit
unions. But I also want to hear what she says about the
assessments and the cost to the credit unions of those
assessments, because we do not want to hurt their capability to
be solvent and successful, too.
Thank you, Mr. Chairman.
Senator Johnson. Senator Johanns.
Senator Johanns. Mr. Chairman, my time here today is
somewhat limited, so I think I will just offer that if I have
anything in terms of an opening, I will submit it in writing,
and we will get right to the witness.
Senator Johnson. Mrs. Matz has had a distinguished public
and private career. She served at the Department of Agriculture
where she was Deputy Assistant Secretary for Administration and
also chaired the Loan Resolution Task Force, which was charged
with the responsibility of resolving over $1 billion in
delinquent farm loans. Prior to her service at USDA, Mrs. Matz
was an economist with the Joint Economic Committee of Congress.
She served as a board member of NCUA from January 2002 to
October 2005. In the private sector, Mrs. Matz was the
executive vice president and chief operating officer of a large
Federal credit union. She was confirmed as Chairman of the NCUA
in August 2009.
Mrs. Matz, before you begin, please be assured that your
written statement will be part of the record. If you could
confine your remarks to 5 to 8 minutes, that would be greatly
appreciated. Any other materials we have received will also be
added to the record.
Mrs. Matz, you can begin your statement.
STATEMENT OF DEBORAH MATZ, CHAIRMAN, NATIONAL CREDIT UNION
ADMINISTRATION
Ms. Matz. Thank you, Mr. Chairman, for inviting me to
appear before this Committee to discuss the state of the credit
union industry. Today I will update you on major developments
since I last appeared before the full Committee in August 2009
at my confirmation hearing.
As with other sectors of the financial service industry,
the credit union industry faced unprecedented threats to its
stability in 2008 and 2009. When the housing bubble burst and
the value of mortgage-backed securities plummeted, several of
the largest corporate credit unions were in danger of
insolvency. This posed a grave threat to the industry because
corporate credit unions provide needed liquidity for 7,400
consumer credit unions and process electronic payments for 90
million credit union members.
Five corporate credit unions held extremely high
concentrations of what were once highly rated mortgage-backed
securities. When the market for those securities dried up, it
froze their liquidity and threatened their operations. If these
corporates had been forced to sell their assets at that time,
at least $30 billion in losses would have flowed through the
system, causing thousands of consumer credit unions to fail.
From the onset of this crisis, NCUA took decisive actions.
We worked in consultation with Congress, the Treasury
Department, and the Fed to design a comprehensive plan to
stabilize, resolve, and reform the corporate system. On behalf
of the NCUA Board, I sincerely thank this Committee for the
instrumental role you played in creating the Temporary
Corporate Credit Union Stabilization Fund in 2009. The
Stabilization Fund permitted NCUA to assess credit unions to
cover the costs of corporate losses over 7 years rather than in
one lump sum.
On September 24, 2010, with concurrence from Treasury
Secretary Geithner, NCUA extended the Stabilization Fund
through June 2021. This means credit unions will reimburse the
fund for an additional $7 to $9 billion over the next 10 years.
Let me emphasize this point. These losses are being paid for
entirely by credit unions.
Throughout the fall of 2010, NCUA has taken aggressive
actions to remove the long-term threats in the corporate
system. We conserved three additional corporates that were no
longer viable. We seized control of over 98 percent of all
impaired securities and began an orderly disposition. We
securitized cash-flows from those impaired securities to raise
billions of dollars in liquidity. We created four bridge
corporates to effect the winding down of the five conserved
corporates with no interruption in service to consumers. And we
finalized a new rule to ensure that remaining corporates
operate with much stronger standards for safety and soundness.
NCUA's actions meet the four strategic objectives we set
from the beginning of the crisis. We prevented any disruption
in service to 7,400 consumer credit unions and 90 million
consumers. We preserved public confidence in the credit union
system. We resolved the problem at the lowest long-term cost
consistent with sound public policy, and we facilitated an
orderly transition to a new regulatory regime.
Even as NCUA managed the corporate resolution, we have been
working diligently to protect the safety and soundness of
consumer credit unions. Despite the challenging economy,
America's credit unions remain strong overall. Total assets are
over $900 billion. Net worth is holding steady. Delinquencies
are showing signs of moderating, and charge-offs have inched
lower. However, credit unions have not escaped the effects of
the economic downturn. Millions of credit union members are
suffering from falling home values, business failures,
unemployment, and bankruptcy. Some credit union balance sheets
reflect their members' struggles.
This situation has caused us to reevaluate our resource
needs as well as our examination procedures. As a result, since
2009 NCUA has hired more than 100 examiners. To be effective,
however, the field staff needed to be reinforced by more
frequent exams. We are, therefore, examining credit unions at
least annually. By conducting more frequent exams and
increasing offsite supervision, we are identifying issues
earlier.
To this end, NCUA enhanced our red flag early warning
system. To resolve issues before they become material concerns,
examiners are reviewing credit union data off-site. When they
find credit unions holding high concentrations of fixed-rate
mortgages, rising delinquencies or other red flags, they follow
up with immediate corrective actions. We are taking these
actions in an effort to save as many credit unions as possible.
NCUA's increased supervision has contributed significantly
to the credit unions' ability to withstand the extraordinary
economic shocks over the past 2 years. Our experience
demonstrates the value of rigorous regulation, diligent
oversight, and a healthy insurance fund. Equity in the National
Credit Union Share Insurance Fund is now up to 1.29 percent,
near the high end of its normal operating range.
To improve the tools for supervising and insuring credit
unions, NCUA has a package of three technical amendments that
clarify important provisions of the Insurance Fund and the
Stabilization Fund.
The first amendment would strengthen the ability of NCUA to
complete emergency mergers. A recent change in merger
accounting would dilute the net worth of the recipient credit
union, thus discouraging the merger. Often, as a result, the
troubled credit union has to be liquidated. We are requesting
that NCUA assistance to the failing credit union be counted as
capital by the surviving credit union, as in the past. This
would reduce the costs to the Insurance Fund and provide
members of troubled credit unions with continued services from
healthy credit unions.
The second amendment would prevent credit unions from being
assessed artificially inflated insurance premiums. The language
clarifies that the equity ratio of the Insurance Fund is based
solely on its own unconsolidated financial statements. This
would eliminate any confusion about whether the Insurance Fund
is required to consolidate statements with the Stabilization
Fund or with credit unions under conservatorship. It would
ensure that independent accounting would be consistent with the
original congressional intent.
The third amendment would allow NCUA the option of repaying
expenditures from the Stabilization Fund without having to
first borrow from Treasury. Current statute requires NCUA to
borrow from Treasury before making assessments. We are
requesting a modification to permit NCUA to assess credit
unions when necessary and appropriate to satisfy the
Stabilization Fund's obligations, thus avoiding the cost of
interest payments.
With this legislation, America's credit unions would be
even better positioned to help consumers take advantage of
opportunities that a recovering economy will offer.
Again, I appreciate this opportunity to come before you and
look forward to answering your questions.
Senator Johnson. Thank you, Chairman Matz.
I am going to put 7 minutes on the clock for Members'
questions. Also, if Members have additional questions, you can
submit them for the record, and I ask you, Chairman Matz, to
respond in a timely manner.
Chairman Matz, as you have noted in your testimony,
extensive losses by some corporate credit unions have led to
conservatorships and also to significant losses to the National
Credit Union Share Insurance Fund. What is the extent of the
losses to the Share Insurance Fund in 2010? And how did this
compare to previous years? Also, to what extent do the losses
result from corporate failures?
Ms. Matz. Thank you, Mr. Chairman. The losses that have
occurred in the corporate sector have been separated from the
Share Insurance Fund, and those are reflected in the Corporate
Stabilization Fund. The loss to the Share Insurance Fund this
year I believe is about $250 million, and the number of
failures is not far off from what we had last year.
The Corporate Stabilization Fund is where we realize the
losses from the corporate credit unions, and overall we expect
the losses to total about $15 billion. But credit unions have
already paid in about $7 billion of that through the capital
that was in the corporates and through two assessments this
past year that totaled $1.3 billion. So we anticipate that over
the next 10 years credit unions will be assessed a total of
between $7 and $9 billion.
Senator Johnson. What new steps has the NCUA taken to
ensure that credit unions do not accumulate a concentration of
high-risk assets?
Ms. Matz. In terms of the corporates where that was a
problem--I should indicate that when we passed the previous
corporate rule in 2002, I voted against the rule. I was the
only Member who voted against it because it did not contain
limits on concentration risk. On September 24, 2010, the NCUA
Board approved a new rule which has very stringent limits on
concentration risk by sector and by obligor, and I believe that
will satisfy that issue going forward.
As far as consumer credit unions, we are currently working
on a proposal that we will likely put out for comment in the
first or second quarter of next year to address concentration
risks in natural person credit unions, and we have already put
out guidance to credit unions and to examiners dealing with
that issue.
Senator Johnson. What will be the ultimate cost to
federally insured credit unions from the resolution of problem
corporate credit unions?
Ms. Matz. The ultimate cost we estimate will be between $7
and $9 billion paid over the next 10 years.
Senator Johnson. You indicate in your written testimony
that NCUA has shortened its exam cycle to 12 months from the
previous 18-month cycle in order to stay ahead of developing
problems at Federal credit unions. Has the agency taken any
other steps to detect problems in the natural person or
corporate credit unions in a more rapid or effective manner?
Ms. Matz. Yes. We have hired 100 additional examiners in
the past 2 years and are intending to hire 61 more examiners
this year. In addition to doing the annual exams at federally
chartered credit unions, we are going to be examining all
State-chartered credit unions over $250 million every year. We
have also enhanced our red flag alert system, so we have
examiners reviewing quarterly the call reports of credit
unions. Those are the reports that display all the financial
data for credit unions. And if they see any aberration, a sharp
increase in delinquencies or some other red flag that catches
their eye, they will not wait for the next exam. Examiners will
immediately go into the credit union and address the problem.
In addition, when I came on as chairman, I learned that
there were some credit unions that were repeatedly being cited
for the same infractions, through the most benign
administrative sanction that we utilize, which is called a
Document of Resolution. They were getting the same Document of
Resolution over and over again, but that stopped last year at
this time. Our examiners were given guidance and told that a
credit union gets one shot at addressing a Document of
Resolution. Examiners are to go back very quickly, within 90 or
120 days, and if that DOR has not been addressed, they will
escalate the administrative action.
So we are working very diligently to address problems as
early as possible and to keep costs to the system as low as
possible.
Senator Johnson. The October NCUA Inspector General report
said that credit unions' management's actions greatly
contributed to the ten largest credit union failures.
Specifically, there were significant actions that management
was either unwilling or unable to effectively manage or
mitigate that exposed these credit unions to significant
amounts of risk. The Office of the IG also identified several
shortcomings related to NCUA supervision efforts, specifically
examiner deficiencies and quality control efforts in
examination procedures. The OIG reported that had the problems
been identified sooner, the eventual losses to the NCUSIF could
have been stopped or mitigated.
First, do you think this assessment is accurate?
Ms. Matz. Yes, I do.
Senator Johnson. Second, what is the NCUA doing to address
management and risk management within the credit unions and
deficiencies in supervision and examination at the NCUA?
Ms. Matz. First, I would just like to point out that the IG
provided material loss reviews on any financial institution
that incurs losses of more than $10 million to the Share
Insurance Fund. So just to put it in perspective, over the
period studied, which was about 24 months, there were 10 such
institutions out of over 7,400 credit unions. I just wanted to
put into perspective, that it is really a small number of
credit unions that actually caused material losses.
Nonetheless, we are working closely to address those issues.
I also wanted to point out that the 10 credit unions are
all federally insured, but only four of them are federally
chartered. The others are State-chartered, and their primary
supervisor is the State supervisor. So I just wanted to make
that distinction.
The IG had pointed out that the management in the 10 credit
unions overall lacked strategic decision making and oversight
of lending and investments, and in several instances there was
fraud. As far as the examiner supervision, the IG recommended
that we should be improving our examination and regs as related
to concentration risks, third-party vendors, our quality
control reviews, our examination of new business strategies,
and that we should step up our administrative actions when
Documents of Resolution have been issued.
We have begun to address all of these issues. As I
indicated before, we have put out guidance on concentration
risks and are working on a new reg to address that issue. We do
not have authority to examine third-party vendors as all the
other FIRREA agencies have. So we work with the credit unions
to get the data that we need, but if we find a problem or
suspect there is a problem, we can only request that credit
union stop doing business with that third-party vendor. We do
not have control over the third-party vendor.
We are working to improve our quality control reviews.
Those are reviews of examinations to make sure that they are
being done properly and that there is sufficient supporting
documentation. And the staff for the past year, has been
working on reviewing and revising our national examination
standards, and those should be in effect relatively soon. In
addition, the IG commented on our examination of new business
strategies, when credit unions take on a new line of business.
We believe that our annual exams will help catch any problems
that develop with new lines of business.
So we are pleased that we have such a good relationship
with the IG. We work very closely with them. And we have
already taken steps to implement all of their findings.
Senator Johnson. Thank you, Chairman Matz.
Senator Shelby.
Senator Shelby. Thank you.
I want to continue in the line of questioning that the
Chairman was into, the Inspector General report. I will try not
to replicate it all. But I want to just read into the record
part of the report, and it said, and I am quoting: ``Had
examiners acted more aggressively in their supervision actions
over these critical issues, the looming safety and soundness
concerns that were present early on in nearly every failed
institution could have been identified sooner and the eventual
losses to the National Credit Union Share Insurance Fund could
have been stopped or mitigated.''
I am going to ask you again. Do you agree with that
assessment? I think you indicated you did.
Ms. Matz. Yes, I do.
Senator Shelby. I think that is very important. Now, what
steps specifically have you taken--it has been over a year--to
ensure that the problems identified by the Inspector General
will be corrected? In other words, that we will not go down
this road again; perhaps we will never visit the taxpayer.
Ms. Matz. Probably the biggest change that we have made is
going from an 18-month exam cycle to an annual exam cycle so
that we get into the credit unions every 12 months and can
catch problems earlier. That is probably the single biggest
change that we have made. Also, not allowing credit unions to
receive repeat administrative sanctions. Complying with
administrative sanctions is not optional. They get one shot to
comply, and if they do not comply within 90 or 120 days, we
take more aggressive action. I think those two actions in and
of themselves will go a long way toward preventing any of these
problems in the future, but in addition, we are in the process
of overhauling our quality control review process. That should
be done very soon, and that will make sure that all the regions
have the same standards for conducting exams and for verifying
the accuracy of the exams. And we will be putting out a new reg
on concentration limits for natural person credit unions.
Senator Shelby. Aren't the credit unions generally getting
more and more into--or want to get into commercial loans and
small business loans and so forth? Is that the trend?
Ms. Matz. There are more credit unions making business
loans today than there were several years ago.
Senator Shelby. Is that dangerous to you, I mean from your
perspective, because so many of the banks have gotten in
trouble with lack of supervision, lack of control, quality
control and so forth?
Ms. Matz. As a regulator, I think all lending is risky.
Senator Shelby. Well, we know that, but from your
perspective to protect that fund.
Ms. Matz. I think it is more important how they manage the
risk. I think business lending is an extremely important
service for credit unions to offer their members. The average
credit union business loan is about $250,000, which is a very,
very small loan, and those are often loans to people who really
do not have access to capital from other institutions. For
example, a credit union business loan might be to open up a car
repair shop or a small boutique. So I think it is a very, very
important service that they provide, and it just needs to be
done carefully.
Senator Shelby. Are a lot of these loans that you make to
small businesses and so forth what we would call in the
financial world ``covered loans''? Do you do that with part of
your capital? Do you sell these loans or what do you do?
Ms. Matz. Some of them are sold, and some are not.
Senator Shelby. I know, but ``some'' is what percentage?
Ms. Matz. I do not know the percentage.
Senator Shelby. Can you furnish that for the record?
Ms. Matz. I certainly can.
Senator Shelby. OK.
You talked about the assessment as part of the plan to
resolve the corporate credit union debacle, that you intend to
impose assessments on credit unions to pay for the losses you
expect to suffer on $50 billion in troubled mortgage-backed
assets. In your testimony you stated that the National Credit
Union Administration expects to levy approximately $8 billion
in assessments, which is a good bit of money. What impact will
these assessments have on credit unions? Can they sustain this
and still be viable?
Ms. Matz. Generally, yes. In the aggregate, the credit
union industry is well capitalized. They have capital of about
$90 billion, and that is just under 10 percent. No doubt the
assessments are a burden to credit unions, and I hear that all
the time, and that is why we try to keep the assessments as low
as possible. The Corporate Stabilization Fund was one way of
doing that. We appreciate your support for that. It allowed us
to spread out the costs to the credit unions. The assessments
will affect the ROA of some credit unions, but overall we do
feel that because of the significant capital credit unions
have, they will be able to meet those assessments.
Senator Shelby. Your Insurance Fund, what is the value of
it today?
Ms. Matz. It is about $800 billion.
Senator Shelby. In other words, you have $800 billion in
hand? Now, that would be a lot more money than the FDIC ever
had--surplus, so to speak.
Ms. Matz. $8 billion. I am sorry.
Senator Shelby. How much?
Ms. Matz. $8 billion on hand.
Senator Shelby. $8 billion. Now you are coming back----
Ms. Matz. Yes.
Senator Shelby. Now, that $8 billion insures how many--the
value of your accounts right now today roughly, 1st of
December?
Ms. Matz. The insured shares of the credit unions are about
$800 billion.
Senator Shelby. $8 billion insures the credit, in other
words, the integrity of $800 billion. Do you think that is
adequate?
Ms. Matz. Yes, I do.
Senator Shelby. Especially in today's world?
Ms. Matz. I do.
Senator Shelby. OK. Is that $8 billion shrinking or
growing? In other words, are your assets shrinking or growing
or remaining constant?
Ms. Matz. It has been pretty constant this year.
Senator Shelby. My last area, and I appreciate the
Chairman's indulgence here, the National Credit Union
Administration's regulations governing the investments of
corporate credit unions, which I think is an important area,
relied heavily on the use of credit ratings. Specifically, the
regulations allowed corporate credit unions to invest in
securities rated AAA or AA by credit rating agencies. We now
know that the credit ratings on mortgage-backed securities were
deeply flawed. In fact, the Dodd-Frank Act requires, as you
probably know, all Federal agencies, which you are one of them,
to review and to modify regulations to remove any reference to
a requirement of reliance on credit ratings and to substitute a
standard of creditworthiness.
What steps are you and your administration taking to ensure
that credit unions do their own due diligence, so to speak,
when evaluating investments to make them creditworthy rather
than an investment based on the opinion or the rating of an
agency which we know is very flawed?
Ms. Matz. When we voted on the rule on September 24, the
rule had been put out for comment and pretty much finalized
before the Dodd-Frank Act was passed. The language in the
corporate rule says that the credit unions need to get ratings
from multiple agencies and then to use the least of those----
Senator Shelby. Wait a minute. Say that again. In other
words, you have ratings--you are going to still get ratings
from the agencies that are so flawed?
Ms. Matz. No, we will be modifying that rule.
Senator Shelby. Are you going to do your own due diligence?
Ms. Matz. We do not have the proposed rule out yet, but we
are going to modify the current rule.
Senator Shelby. Well, are you thinking about doing that? I
guess my question to you, if you look at some of the financial
institutions, insurance companies, and so forth, all financial,
that have weathered the recent debacle--I can name a few, but I
will not here on the podium--and that are really well done did
their own due diligence and are very viable today, did not ask
for money from the taxpayers, no bailout and so forth. So you,
as the administrator of the credit unions, I think it is very
important for you to do your own due diligence. That is my
message, and I think that was the message of this legislation.
Do you disagree with that?
Ms. Matz. I do not disagree with that, and as I said, we
are in the process of drafting a revision, so we will
certainly----
Senator Shelby. Do you have now or will you have the
personnel in your administration to evaluate the
creditworthiness of your investments? In other words, you have
been relying--a lot of people have been relying on the credit
rating agencies--Moody's, S&P, Fitch, and so forth. Well, we
know the history of that.
Ms. Matz. Yes.
Senator Shelby. Are you going to have the proper people to
do that? I think this is important, that you have personnel
that can do this in lieu of outsourcing it to something that we
know is a dead end.
Ms. Matz. We might have to enhance our Office of Capital
Markets----
Senator Shelby. What does ``might'' mean?
Ms. Matz. It means that I do not have an answer to your
question right now.
Senator Shelby. Will you let us know in the Committee?
Ms. Matz. Yes.
Senator Shelby. We think this is very important because we
want the credit unions to remain viable and strong and not ever
visit, to come up here for problems.
Ms. Matz. I appreciate that, and we will get back to you on
that.
Senator Shelby. Thank you, Mr. Chairman.
Senator Johnson. Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman, and
thank you, Madam Chairman.
Does the NCUA have a list of problem credit unions similar
to what the FDIC does in terms of their watch list, and if so,
how many of these institutions are on your list?
Ms. Matz. We do have a list of credit unions that we watch.
There are about 2 dozen institutions on the list.
Senator Reed. Which would be roughly what percentage?
Ms. Matz. Well, we have over 7,400 institutions that we
insure.
Senator Reed. Is there any geographic concentration or
business model concentration that is more prone on this list
than----
Ms. Matz. Yes, credit unions that are located in the States
that were most distressed. Florida, California, Arizona, Utah,
and Nevada have been hit the worst.
Senator Reed. Let me ask a question that parallels some of
the comments made by both the Chairman and the Ranking Member.
In your testimony, you indicate that there are a growing level
of delinquent member business loans----
Ms. Matz. Yes.
Senator Reed. ----and that they are a primary or secondary
contributing factor for supervisory concern in many cases. And
so the first question, are you concerned with this increasing
number of member business loan delinquencies?
Ms. Matz. I am concerned, but it is still a relatively
small number of affected credit unions.
Senator Reed. You are aware there are proposals to increase
the level of lending in member business loans. What would be
your view on that proposed, or these proposed legislative----
Ms. Matz. I support that.
Senator Reed. And support that given the indication that
there are increasing, as you would, I think put in context, not
as yet decisive but increasing delinquencies in this category?
Ms. Matz. Yes, because as I said, I believe that it is
still a very small number of credit unions. There are 2,200
credit unions that make member business loans and there are 270
that fall into the category where they are either what we call
CAMEL 3 or CAMEL 4. CAMEL 4 are the troubled ones where the
business lending is the primary or secondary reason for their
being there. So it is a manageable number. We do not like to
have credit unions in that category, period, but we feel that
business lending done properly is really an important tool for
credit unions to have at their disposal to serve their members.
Also, in terms of the legislation, if the cap gets lifted,
we would anticipate coming through with very rigorous
regulations. We would not just be opening the flood gates, so
all credit unions ccould not just go in and make high levels of
loans. They would have to demonstrate their ability to make a
low level of loans, and once they demonstrate that, we would
increase it by a small amount and then keep working with them,
supervising them, and let them gradually increase to a higher
level.
Senator Reed. Do you have a notion of the number of credit
unions that have already reached their limit? I mean, is this a
situation where a huge majority of credit unions have no extra
capacity, or is this a few members or concentrated in a few
areas?
Ms. Matz. It is a small number.
Senator Reed. That have reached----
Ms. Matz. That are at their cap.
Senator Reed. That have reached their cap.
Ms. Matz. Yes.
Senator Reed. And is there any particular area of the
country where the cap is reached, or is it just dispersed
somewhat random?
Ms. Matz. I am guessing that it is dispersed, but I do not
know that for sure. We can get back to you on that.
Senator Reed. All right. There is another aspect that I
want to explore and that is that the NCUA is the only regulator
subject to FIRREA that does not have the authority to examine
vendors that provide services to insured institutions. And now
with the increasing role of particularly information management
systems, computer systems, et cetera that are provided to
vendors, and concerns about money laundering, privacy, a host--
I do not have to tell you the concerns--are you concerned this
lack of authority affects your ability to fully implement your
statutory responsibilities?
Ms. Matz. Absolutely.
Senator Reed. Absolutely. So that you would like to have
that authority in place?
Ms. Matz. Yes. I think we could do a better job of
protecting the safety and soundness of credit unions if we had
that authority.
Senator Reed. Let me ask the question--I think we will get
the same answer, but are there instances where you have seen
significant problems at credit unions causing you to have to
step in because of vendor contracts and other arrangements that
you might have been upset about but could take no effective
steps until, in fact, the institution became insolvent?
Ms. Matz. Yes.
Senator Reed. Yes. Would that apply to the corporate credit
unions, also?
Ms. Matz. Correct.
Senator Reed. Correct. Well, thank you very much, Madam
Chairman. Thank you.
Senator Johnson. Senator Johanns.
Senator Johanns. Thank you, Mr. Chairman.
Let me, if I might, just get a little perspective here. The
institutions that went into conservatorship, basically, their
problem was real estate lending, would that be the case, or is
it----
Ms. Matz. The corporate credit unions?
Senator Johanns. Yes.
Ms. Matz. It was an over-concentration of mortgage-backed
securities.
Senator Johanns. So it was real estate related?
Ms. Matz. Yes.
Senator Johanns. Yes. When you look at the other issues
that you were talking about, the commercial lending, you said
that was a relatively small number of credit unions out there
that were dealing with that. Let me just ask your opinion on
something. Would you describe that as something that just
normally you would go through in a recession, that that is what
you are seeing, or are you seeing something bigger and greater
and more problematic there than that description?
Ms. Matz. With the business lending?
Senator Johanns. Yes.
Ms. Matz. It is probably somewhat higher than it would
ordinarily have been because some of the loans were
collateralized by real estate.
Senator Johanns. Yes. So again, we kind of get back to
that----
Ms. Matz. Yes.
Senator Johanns. ----problem that everybody has dealt with.
Now, the Ranking Member read into the record an IG report
that basically said, I think, if I could summarize it, that if
there had been better oversight, a lot of these problems would
not have occurred, and you agree with that assessment.
Ms. Matz. Yes.
Senator Johanns. I am just going to offer an observation,
that if the whole system, whether it is banks or credit unions
or whatever, if there had been better oversight, we would have
avoided a lot of these problems. Is that a fair--do you kind of
agree with that?
Ms. Matz. Well, you know, the IG was addressing these 10
credit unions----
Senator Johanns. Yes.
Ms. Matz. ----and I certainly agree with it in terms of
those 10 credit unions. You know, I think in terms of the
consumer credit unions, I think we have done an adequate job.
Of course, nobody could have foreseen the significant drop in
the value of real estate and all the havoc that that has
created. But, certainly in terms of those 10 credit unions, we
could have done a better job.
Senator Johanns. As I talk to small businesses that I
interface with, and we have had small business roundtables and
a whole host of efforts to try to be attuned to challenges that
they are facing, one of the things I hear, and I am sure every
Member on the Committee is hearing it, whatever State they are
in, and that is that credit is still very tough for a small
business. I was just in a small business over Thanksgiving, and
boy, that was the message. ``I cannot get credit.''
And I see your efforts, and I do not disagree with them. I
think you are trying to make sure that your fund is stable,
that--and I think you are trying to do those things to kind of
rebuild from what was a fairly disastrous situation. But it
does occur to me that as we pull that capital into whatever
fund or try to minimize risk by requiring margin, et cetera,
that capital is not available to be lent. What is your
observation on that? Does that appear problematic to you?
Ms. Matz. We encourage credit unions that are interested in
making business loans to make sure that they have commercial
lending staff that can do very solid underwriting. We also are
concerned that credit unions reserve for losses adequately, and
that does take capital out of the system. But it protects the
Share Insurance Fund, and if it prevents losses, it also
prevents additional assessments, ultimately. So we do make sure
that credit unions are adequately allowing for potential
losses.
Senator Johanns. As you should. But that kind of describes
what small businesses are struggling with. They are struggling
to find somebody who will be their lender, because the system
very, very quickly became risk adverse. Would you agree with
that?
Ms. Matz. I think that credit unions have always been
conservative and perhaps they are being more conservative now,
but I do believe that credit unions are still making business
loans. In fact, business lending has gone up in the last
quarter. Of course, there are only 2,200 credit unions making
business loans, so it is not a lot of capital. But in the
communities that they serve, I think they make an important
difference to the small businesses.
Senator Johanns. Just to wrap up in this vein, just for my
education, and, of course, maybe other Members of the Committee
would also be interested, I would like to see whatever charts
or analysis you have available of what happened over the last
2, 3 years relative to lending. Again, I think that would be
good information just in terms of trying to work with small
businesses who are continuing to describe this very difficult
problem of getting access to capital.
Ms. Matz. Are you interested in lending in general or
specifically small business lending?
Senator Johanns. Whatever you provide will be helpful.
Ms. Matz. Credit union lending has actually grown over the
past few years, despite the downturn, except for the most
recent quarter, where it has leveled off. But that is not
specific to business lending.
Senator Johanns. Yes. I would be interested in business
lending if those numbers can be extracted from the whole, if
you will.
Ms. Matz. We will get that for you.
Senator Johanns. OK. Thank you. Thank you, Mr. Chairman.
Senator Johnson. I would like to thank Chairman Matz for
testifying today, and with that, conclude our first hearing
today.
[Whereupon, at 10:54 a.m., the hearing was adjourned.]
[Prepared statements and additional material supplied for
the record follow:]
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Today's first hearing will examine the current state of the credit
union industry, including the National Credit Union Administration's
ongoing efforts to stabilize the corporate credit union system. As the
supervisor of Federal credit unions that insure the deposits of over 90
million account holders in all Federal credit unions and many State-
chartered credit unions, this hearing is an important and needed
opportunity to explore the health of the credit union industry as we
emerge from the financial crisis and recover and grow our economy.
I want to welcome and thank NCUA chairman Debbie Matz for being
here today. The NCUA has taken unprecedented steps over the past
several years to stabilize the credit union system as the troubled
corporates pulled liquidity and capital out of the natural person
credit unions. The system has also shared many of the same challenges
as the FDIC concerning the insurance of Americans' savings and
retirement.
These steps have had a significant impact on thousands of credit
unions across the country, and I am pleased that we can have a serious
conversation about the current state of the credit union industry and
the impact of increased assessments on credit unions that serve
millions of Americans across this country. I have certainly heard
concerns from my constituents in South Dakota about this matter.
This is not the first, and certainly not the last, hearing on the
financial condition of specific sectors of our financial services
industry. The financial crisis certainly took a toll, and the historic
Dodd-Frank legislation will bring many additional changes to all
sectors of this industry. It is very important to me that these types
of hearings become a common occurrence with all of the financial
institutions regulators. I look forward to your testimony, Chairman
Matz, and to the question and answer period.
______
PREPARED STATEMENT OF DEBORAH MATZ
Chairman, National Credit Union Administration
December 9, 2010
I. Introduction
The National Credit Union Administration (NCUA) appreciates the
opportunity to provide views on ``The State of the Credit Union
Industry.'' NCUA's primary mission is to ensure the safety and
soundness of federally insured credit unions. It performs this
important public function by examining all Federal credit unions,
participating in the supervision of federally insured State-chartered
credit unions in coordination with State regulators, and insuring
federally insured credit union members' accounts. In its statutory role
as the administrator for the National Credit Union Share Insurance Fund
(NCUSIF), \1\ NCUA provides oversight and supervision to 7,402
federally insured credit unions, representing 98 percent of all credit
unions and 90.8 million members. \2\
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\1\ The NCUSIF was created by Public Law 91-468 (Title II of the
Federal Credit Union Act), which was amended in 1984 by Public Law 98-
369. The Fund was established as a revolving fund in the United States
Treasury under the NCUA Board for the purpose of insuring member share
deposits in all Federal credit unions and in qualifying State credit
unions that request insurance.
\2\ Approximately 152 State-chartered credit unions are privately
insured and are not subject to NCUA oversight. The term ``credit
union'' is used throughout this statement to refer to federally insured
credit unions.
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The severe economic crisis that began in earnest in 2007 has
impacted all facets of the financial sector. Though credit unions by
and large maintained traditional standards and risk profiles, they have
not been immune to the broad effects of historically high unemployment
and severely declining home values. More specifically, these national
trends systemically affected credit unions in two particular ways.
First, several of the largest corporate credit unions' \3\ investment
portfolios were subjected to material losses.
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\3\ Corporate credit unions provide necessary liquidity,
investment, and payment services to consumer credit unions.
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Second, many consumer credit unions, \4\ have experienced increased
delinquency and loan losses. This is most pronounced in States hardest
hit by the economic downturn, such as Arizona, California, Florida, and
Nevada. The combined impact of these two occurrences has presented
significant financial and operational challenges for both NCUA and
credit unions and is discussed in detail in sections II and III below.
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\4\ The term ``consumer'' credit union is used throughout this
document to refer to retail ``natural person'' credit unions which
interact with consumers on a daily basis. ``Corporate'' credit unions
provide services to consumer credit unions and process consumer
payments, but do not interact with consumers directly.
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Throughout the crisis, NCUA, with the assistance of Congress and
the Administration, has taken extraordinary steps to successfully
maintain the stability of the credit union system for the 90 million
Americans who depend on it.
II. Corporate Credit Union System
The primary purpose of a corporate credit union is to provide
consumer credit unions with correspondent banking, liquidity and
investment services. Correspondent banking services help financial
institutions, including credit unions, to process and clear checks,
process and settle electronic transactions, and move funds through the
financial system.
In the mid-2000s, several of the largest corporate credit unions
invested heavily in mortgage-backed securities (MBS), which resulted in
concentrated exposure to the real estate market. Virtually all of the
investments were AAA or AA rated when purchased. However, their value
plummeted when the housing bubble burst.
In April 2007, several months before the distress in the mortgage
market surfaced, NCUA issued Corporate Credit Union Guidance Letter No.
2007-02. This letter addressed credit, liquidity, market, and
concentration risks associated with MBS. By and large, corporates
ceased the purchase of nonagency mortgage-related securities by mid-
2007. At that time, all investments held by corporate credit unions,
including MBS, were rated investment grade, and 98 percent were rated
AA or higher.
What began as a market disruption thought to stem from concerns
with subprime products, spread throughout the overall financial and
real estate markets sector with unprecedented severity. By the time it
became apparent that this was not an isolated market dislocation, there
was no longer an active market for these types of securities. Like
other financial institutions, the corporates could not have found
buyers for the volume of these types of investments they held. The
declining values of these mortgage-backed securities created severe
liquidity and capital problems for these institutions.
Five corporate credit unions, which served more than half of the
entire credit union system, were financially imperiled by the losses in
their investment portfolios, with a far-reaching effect on the entire
credit union industry. The industry has been adversely impacted by
consumer credit union losses from impaired capital investments held in
corporate credit unions.
Consumer credit unions will continue to face necessary NCUA
assessments to resolve the nonfinancially viable corporates. Had the
agency not acted to inject liquidity and guarantee deposits in the
corporate credit unions in the face of this crisis, the costs to the
industry would have been far greater--threatening the entire credit
union system.
Without NCUA intervention, the losses, in their entirety, from
immediate failure of large corporates would have cascaded to consumer
credit unions via their uninsured shares in the corporates. \5\ This
would have resulted in the failure of approximately 1,000 consumer
credit unions. Consistent with the manner in which deposit insurance
functions, the costs of resolving these failures would have been borne
by all remaining federally insured credit unions, generating additional
losses and failures. Ultimately, inaction would have resulted in
massive disruption to consumer services and total costs to any
remaining insured credit unions would have been far greater than the
resolution strategy NCUA employed.
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\5\ Credit unions refer to deposit and savings accounts as share
accounts, or ``shares'' for short.
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To address the systemic financial and operational impact of these
five troubled corporate credit unions, NCUA designed a three-phase
strategy to stabilize, resolve, and reform the corporate system based
on the following guiding principles:
Prevent interruption of payments services to consumer
credit unions and their 90 million members;
Preserve confidence in the credit union system;
Manage to the least long-term cost consistent with sound
public policy; and
Facilitate an orderly transition to a new regulatory
framework for the corporate credit union system based on
consumer credit union choice.
Specific details of the actions implemented during these three
phases are discussed below.
Stabilization Phase
Given the deterioration of the corporates' financial conditions and
quality of their investment portfolios, their access to external
sources of funds was compromised. This resulted in consumer credit
unions losing confidence in the corporate credit unions and starting to
withdraw their deposits. These withdrawals, and the prospect of a wave
of additional withdrawals, placed severe liquidity pressures on the
corporates, peaking in 2008. The losses and operational impact on the
credit union system from a nonorderly resolution of this crisis would
have been untenable, severely impacting consumer credit unions and
their 90 million members.
Accordingly, in the fall of 2008, it became critical for NCUA to
initiate dramatic action to bolster confidence in the corporates and
ensure the flow of liquidity in the credit union system. In the last
half of 2008, NCUA began implementing actions to stabilize and
strengthen the credit union system. The first step in the stabilization
program was to increase liquidity throughout the entire credit union
system, especially within the corporates.
NCUA's primary tool to address liquidity concerns in the credit
union industry is the Central Liquidity Facility (CLF). \6\ At the
time, the CLF was operating under a Congressionally imposed borrowing
cap of $1.5 billion. At the NCUA Board's request, in September 2008,
Congress raised the CLF's borrowing cap to its full statutory limit of
approximately $41 billion. Ultimately, lifting the cap proved to be one
of the primary reasons NCUA could successfully develop and implement a
series of critical liquidity interventions that served as the
foundation for its corporate stabilization efforts.
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\6\ The Central Liquidity Facility was created by Congress in 1978
to improve the general financial stability of the credit union industry
by meeting the liquidity needs of individual credit unions.
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With the full borrowing authority of the CLF now available, NCUA
began working with staff at both the Board of Governors of the Federal
Reserve System (FRB) and the U.S. Department of the Treasury (U.S.
Treasury) to develop tools, such as the Credit Union System Investment
Program and the Credit Union Homeowners Affordability and Relief
Program, to address the liquidity pressures in corporates. These two
programs enabled consumer credit unions to essentially invest funds
borrowed from the CLF into corporate credit union offerings, which
raised approximately $8.5 billion in liquidity.
The NCUA Board approved the ``Temporary Corporate Credit Union
Liquidity Guarantee Program'' (TCCULGP) on October 16, 2008. Under the
TCCULGP, the NCUSIF provided a 100 percent guarantee on new unsecured
debt obligations issued by eligible corporates on or before June 30,
2009, and maturing on or before June 30, 2012. \7\ The TCCULGP and the
other CLF-based programs were successful in restoring credit lines and
funding in the corporate system.
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\7\ On May 21, 2009, the TCCULGP was revised to cover unsecured
debt obligations issued on or before June 30, 2010, and maturing on or
before June 2017.
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To address the lack of confidence in the corporates and the
resulting deposit outflow, the NCUA Board approved the ``Temporary
Corporate Credit Union Share Guarantee Program'' (TCCUSGP), which
presently guarantees uninsured shares, excluding capital accounts, at
participating corporates through December 31, 2012. This program was
vital in maintaining the confidence of consumer credit unions and
stabilizing the precarious liquidity situation at the corporates. The
TCCUSGP has proven very successful in stabilizing liquidity and
continues to serve an important role in the transition process under
the resolution phase discussed later.
The NCUA Board also issued a $1 billion NCUSIF capital note to U.S.
Central Federal Credit Union (U.S. Central) to address realized losses
on MBS and other asset-backed securities. This action was necessary to
maintain external sources of funding and to preserve confidence in U.S.
Central, given its pivotal liquidity and payment systems roles as a
wholesale service provider to the corporate credit union system.
Creation of the Temporary Corporate Credit Union
Stabilization Fund
The stabilization programs discussed so far came at a significant,
but unavoidable, cost to the industry. Given the structure of the
NCUSIF and existing law in early 2009, NCUA would have been required to
assess this cost to consumer credit unions in one lump sum. To give the
NCUA Board flexibility to manage the impact of the costs to consumer
credit unions, NCUA requested that Congress establish the Temporary
Corporate Credit Union Stabilization Fund (Stabilization Fund). On May
20, 2009, the Helping Families Save Their Homes Act of 2009 \8\ was
signed into law and created the Stabilization Fund, allowing costs to
be assessed over a 7-year period instead of in a lump sum. \9\ This is,
perhaps, the most critical tool available to NCUA to help ease the
credit unions' burden of resolving the corporate crisis. The NCUA Board
is appreciative that Congress acted so quickly to pass this
legislation.
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\8\ Public Law 111-22, which was amended in July 2010 by Public
Law 111-203.
\9\ The closing date of the Stabilization Fund can be extended
with the concurrence of the U.S. Treasury. Subsequently, as part of its
plan to reduce the annual burden of assessments on credit unions, in
September 2010, NCUA requested the concurrence of the U.S. Treasury to
extend the life of the Stabilization Fund to June 2021; the U.S.
Treasury concurred with this request.
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In addition to the Stabilization Fund provision, the Helping
Families Save Their Homes Act of 2009 also contains another important
provision that assisted NCUA's ability to mitigate the corporate
problems. This law increases the NCUSIF's authority to borrow from the
U.S. Treasury from $100 million to $6 billion, an aggregate total
available to both the Stabilization Fund and the NCUSIF. The
Stabilization Fund relies on the $6 billion borrowing authority in
providing the NCUA Board flexibility to manage the impact of the
assessments on credit unions. The enhanced authorities provided by
Congress will permit NCUA to fairly and effectively distribute the
insurance costs associated with the current economic downturn,
including not just the costs of the corporate losses but also other
costs that may arise. The Stabilization Fund must repay the U.S.
Treasury, with interest, all amounts borrowed. As such, the total costs
of the corporate stabilization, resolution, and reform will be fully
borne by credit unions with the flexibility to absorb those costs over
a longer time period.
NCUA's stabilization efforts were successful in preserving the
vital electronic payments and liquidity services that credit unions
provide to over 90 million Americans.
Resolution Phase
The stabilization phase provided NCUA with the time and resources
to design and implement a strategy to resolve the troubled corporate
credit unions and the distressed securities they held. Collaborating
with the FRB and the U.S. Treasury, NCUA carefully evaluated a wide
range of options to arrive at the least cost, long-term solution
consistent with sound public policy. On September 24, 2010, the NCUA
Board approved a comprehensive strategy to fully resolve the ongoing
solvency, liquidity, and reputation risks associated with the
nonfinancially viable corporate credit unions.
NCUA conducted a comprehensive evaluation of the entire corporate
system. Of the 27 corporates, this evaluation identified five
corporates that were not financially viable. These five corporates
represented approximately 70 percent of the entire corporate system's
assets and 98.6 percent of the investment losses within the system.
NCUA took direct control of these five institutions through Federal
conservatorship. \10\ In doing so, NCUA was able to achieve the goals
of (1) protecting the vital services to the thousands of consumer
credit unions that rely on the corporate network and (2) implementing
the process to resolve the distressed assets.
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\10\ On September 24, 2010, NCUA conserved Constitution Corporate
Federal Credit Union, Members United Corporate Federal Credit Union,
and Southwest Corporate Federal Credit Union. Western Corporate Federal
Credit Union and U.S. Central were conserved on March 20, 2009.
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NCUA employed a traditional resolution model used in the financial
sector often referred to as the ``good bank/bad bank'' model. The
``good bank/bad bank'' model was necessary given that the conserved
corporates were correspondent service providers to thousands of credit
unions and no viable acquisition partners were available. This strategy
involved the creation of new charters, called ``bridge'' corporates,
and transfer of the good assets, deposits, and operations from the
conserved corporates to these new entities.
The four bridge corporates are led by chief executive officers
selected by NCUA, and who report directly to NCUA. Additionally, NCUA
maintains control over their operations. NCUA has established policies
to ensure that the bridge corporates operate soundly, and minimize the
long-term costs to the insurance fund. The bridge corporates are
temporary entities, created to maintain necessary services during the
transition period. NCUA intends to maintain the bridge corporate
operations long enough to allow consumer credit unions adequate time to
determine their long-term service options, perform appropriate due
diligence, and implement the necessary operational changes.
Remaining assets in the failed corporate charters were then placed
into an inactive status and managed via asset management estates
established to house the ``legacy assets'' \11\ With the legacy assets
isolated in the asset management estates, NCUA is pursuing a least-cost
solution for an orderly disposition of these assets. After extensive
analysis, NCUA determined that the least-cost disposition strategy
involved holding the distressed assets by obtaining long-term funding.
This strategy prevents much larger market losses and, in conjunction
with the extension of the Stabilization Fund, provides credit unions
more time to absorb the lower credit losses.
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\11\ The term ``legacy assets'' is used to describe the impaired
private-label residential mortgage backed securities and other asset-
backed securities held by the failed corporates.
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The long-term funding is being obtained through securitizing the
legacy assets. In summary, the legacy assets are being combined into
new structured securities that are being issued in the financial
markets as NCUA Guaranteed Notes (ticker symbol NGN). The new
securities have a guarantee on the timely payment of principal and
interest from NCUA, which is backed by the full faith and credit of the
United States. To date, NCUA has finalized four issuances of the
structured notes; all met with strong investor demand.
The underlying defaults on distressed legacy assets and other
resolution costs are expected to be between $13.9 billion to $16.1
billion. \12\ This cost will be borne solely by the credit union
system. Credit unions that contributed capital to the corporates
holding these legacy assets bear the first loss, totaling $5.6 billion.
The losses above $5.6 billion will be borne by all federally insured
credit unions through Stabilization Fund assessments over time.
Currently the expected range of total assessments is between $8.3
billion and $10.5 billion. Credit unions have already paid $1.3 billion
in assessments. Thus, the projected range of remaining assessments is
$7.0 billion to $9.2 billion to be paid in annual installments through
2021.
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\12\ Given the complexity of projecting credit losses, the NCUA
has relied on multiple expert sources to validate NCUA's internal
results. These external sources include the analysis done by the
corporates' external vendors; a detailed, bond-by-bond analysis
conducted by the Pacific Investment Management Company (PIMCO)
expressly for NCUA; and a detailed bond-by-bond analysis performed by
Barclays Capital, New York, New York, as part of the securitization.
These analyses incorporate assumptions about future economic events.
Hence NCUA relies on a range of estimates to project future costs to
credit unions.
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Reform Phase
On September 24, 2010, NCUA issued a final rule reshaping the
regulatory framework of corporate credit unions, addressed in Part 704
of NCUA's rules. NCUA's primary purpose in reforming Part 704 was to
prevent catastrophic losses from ever recurring. The new corporate
regulation is designed to both address the cause of the current crisis
and to provide stronger protections against future potential risks.
The major elements of this new corporate rule can be divided into
(1) investment and asset liability management (ALM) restrictions, (2)
capital standards, and (3) corporate governance.
Investment and ALM Restrictions
Through a series of provisions related to investment suitability
and asset liability management, NCUA's new corporate rule will force
corporate credit unions to properly diversify their investments and
take other steps to minimize potential credit, market, and liquidity
risk. In short, key provisions:
Institute a variety of more stringent standards that each
security must pass before a corporate can purchase the
investment.
Prohibit certain highly complex and leveraged securities.
Going forward, a corporate cannot buy a particular security if
it is a collateralized debt obligation, a net interest margin
security, a private-label residential mortgage-backed security,
or a security subordinated to any other securities in the
issuance.
Reduce the single obligor limit. The new rule tightens the
existing limit on securities from a single obligor from 50
percent of capital down to 25 percent of capital.
Establish sector concentration limits. The new rule
establishes sector concentration limits to diversify the
composition of the investment portfolio.
Limit portfolio Weighted Average Life (WAL) to 2 years or
less. The WAL limit reduces not only market and liquidity risk,
but also credit risk, since credit fears negatively affect the
price of longer-lived assets more severely than shorter-lived
assets.
The new rule contains other ALM measures to reduce risk. For
example, to discourage investment arbitrage, the rule tightens a
corporate's borrowing limits. To reduce the potential for
overdependence by a corporate on one member credit union, the rule also
limits funding from a single member, whether it comes from deposits or
loans.
Capital Standards and Prompt Corrective Action
The new corporate rule strengthens capital requirements including
new minimum capital ratios, new risk-based capital calculations, and
new definitions of capital modeled after the Basel I capital
requirements. \13\ Corporate credit unions will now need to satisfy
three different minimum capital requirements: a 4 percent leverage
ratio, a 4 percent tier one risk-based capital ratio, and an 8 percent
total risk-based capital ratio. \14\ The rule also mandates that a
certain portion of a corporate's capital consist of retained earnings.
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\13\ Basel 1 is a risk-based capital framework developed by the
Basel Committee, a group of 11 industrialized nations, including the
U.S., formed to harmonize banking standards and regulations among
member nations.
\14\ Both the old and new corporate rules also require that a
corporate maintain a minimum net economic value ratio of 2 percent.
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The rule also contains new Prompt Corrective Action (PCA) standards
for enforcement of the capital requirements. The consequences of
failing to retain adequate capitalization can include restrictions on
activities, restrictions on investments and asset growth, restrictions
on the payment of dividends, restrictions on executive compensation,
requirements to elect new directors or dismiss management, and the
possibility of conservatorship, liquidation, or a supervisory merger.
These new capital and PCA requirements will ensure that corporates hold
adequate capital commensurate with the risks of both their balance
sheet assets and off-balance sheet activities.
Corporate Governance Provisions
As a result of the recent corporate crisis, NCUA identified certain
weaknesses in corporate governance. The new corporate rule improves
upon the existing governance provisions in several ways. All board
members will be required to hold either a CEO, CFO, or COO position at
their member credit union or other member entity. A majority of a
corporate's board of directors will have to be representatives of
consumer credit unions. No person will be permitted to sit on the
boards of two or more corporates at the same time, nor will a single
organizational member be permitted to have more than one individual
representative on the board of any given corporate.
Other governance changes relate to transparency. The new rule
requires that each corporate disclose to its members the compensation
of its most highly compensated employees. \15\ In the case of merger
involving a federally chartered corporate, the corporate must disclose
to both its members and NCUA any material merger-related increase in
compensation for any senior executive or director as a result of the
merger.
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\15\ The disclosure includes the three, four, or five most highly
compensated employees at each corporate, with the exact number of
employees depending on the size of the corporate. The compensation of
the corporate credit union's CEO must also be disclosed, even if the
CEO is not among the most highly compensated at the corporate.
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The new rule also prohibits ``golden parachutes,'' defined as
payments made to an institution-affiliated party that are contingent on
the termination of that person's employment and received when the
corporate making the payment is either troubled, undercapitalized, or
insolvent.
Additional Proposed Amendments to NCUA's Corporate Rule
During the rulemaking process leading to NCUA's recent final
amendments to its corporate rule, NCUA received many suggestions for
further amending the rule that deserved consideration. Some of these
suggestions were beyond the scope of the proposed rule, and so legally
could not be included in the final rule. Other suggestions were within
the scope of the first proposal, but deserving of additional public
comment before adoption.
Accordingly, on November 18, 2010, NCUA issued seven additional
proposed amendments to the corporate rule for public comment. Briefly,
these proposed amendments, if adopted by NCUA, would:
Increase the transparency of corporate credit union
decision making by requiring corporates conduct all board of
director votes as recorded votes and include the votes of
individual directors in the meeting minutes;
Require that corporate credit unions follow certain audit,
reporting, and audit committee practices required of commercial
banks by the Federal Deposit Insurance Act, Part 363 of the
Federal Deposit Insurance Corporation Regulations, and the
Sarbanes-Oxley Act of 2002;
Provide for the equitable sharing of Stabilization Fund
expenses among all members of corporate credit unions,
including both credit union and non- credit union members, by
establishing procedures for requesting members not insured by
the NCUSIF to make premium payments to the Stabilization Fund;
Protect against unnecessary competition between corporates
by limiting consumer credit unions to membership in one
corporate of the consumer credit union's choice at any one
time;
Improve risk management at corporates by requiring
corporates to establish enterprise-wide risk management
committees staffed with at least one independent risk
management expert;
Provide corporates with more options to grow retained
earnings by allowing corporates to charge their members
reasonable one-time or periodic membership fees; and
Require the disclosure of compensation received from a
corporate credit union service organization (CUSO) by highly
compensated corporate credit union executives who are also
employees of the CUSO.
The public comment period on these proposals ends January 28, 2011.
Current State of Corporate Credit Unions
The corporate credit union system is in a state of transition,
which is going according to plan. To date, that transition process has
been extremely successful. The four bridge corporates continue to
deliver the critical payment and settlement services on which their
members depend. The 22 corporates operating independent of NCUA control
are in the process of implementing critical operational changes to
conform with the new regulatory framework.
NCUA's number one priority in launching the corporate resolution
efforts was to ensure that the critical payment, settlement, and
liquidity services corporates provide their member credit unions would
continue uninterrupted. That goal has been met. At no time over the
past 2 years was there a lapse in services to the 90 million consumers
served by credit unions.
The future of the corporate credit union system will ultimately be
decided by the consumer credit unions they serve. If consumer credit
unions are committed to a corporate system for their financial service
needs, the system must conform to the new more rigorous regulatory
framework NCUA has established. If credit unions choose not to obtain
services from corporates going forward, NCUA will ensure an orderly
transition for credit unions to new service providers. Under either
circumstance, NCUA's primary goal is to ensure uninterrupted financial
services to the 90 million credit union consumers.
NCUA is working closely with consumer credit unions to provide as
much guidance as possible in making the critical decisions related to
their future service needs. NCUA has assured credit unions that they do
not need to make an immediate decision. However, NCUA has also been
clear in communicating that the decision process is complex and that
credit unions need to begin evaluating their options now.
III. Status of Consumer Credit Unions
Despite the stresses on credit union earnings, the industry remains
very well capitalized. As of September 30, 2010, aggregate net worth
totaled $90.6 billion, representing the highest dollar level in credit
union history. This equates to a net worth ratio of 9.97 percent of
total assets. Ninety-eight percent of all credit unions were at least
``adequately capitalized'' or better, with 94.8 percent of all credit
unions ``well capitalized.'' \16\
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\16\ See, 12 C.F.R. Part 702.
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During the past several years, credit unions have experienced
strong membership and deposit growth, indicating they continue to
provide valuable services to members. They currently serve 90.8 million
members, an increase of 5 million since 2006. Over the same period,
shares have grown by $178 billion, or 30 percent, to $780 billion.
Credit Unions Continue To Meet Member Lending Needs
Even during the height of the recent recession, credit unions
continued to lend to their members as demonstrated by 15 percent growth
in loans originated since 2008. Loans account for 62 percent of all
credit union assets, with more than half secured by real estate.
Focusing more closely on credit union mortgage lending, 68 percent
of credit unions offer mortgage loans to their members, originating $55
billion in first mortgage loans through the third quarter of 2010. In
the first nine months of 2010, total mortgage loans held on credit
union balance sheets increased $667 million, to a new high of 54.6
percent of total loans.
All other consumer loans, such as auto loans and credit cards, make
up 40 percent of credit unions' loan portfolios. Used vehicle loans are
the fastest-growing segment of consumer lending.
Regarding member business loans (MBLs), currently, 2,210 or
approximately 30 percent of all credit unions offer these types of
loans. MBLs comprise 6.5 percent of all outstanding loans, or $36.7
billion. The majority of these MBLs are secured by real estate. The
average size of an MBL is $249,000, indicating credit unions are
largely serving the needs of small businesses.
Loan Portfolio Quality
Despite overall adherence to sound underwriting practices, the
credit union industry was not immune to the macroeconomic impact of
high unemployment and home value declines. Since the end of 2006, the
aggregate delinquent loan ratio and net charge-off ratios more than
doubled to highs of 1.84 percent and 1.21 percent respectively as of
year-end 2009. However, aggregate delinquency and net charge-offs have
stabilized in 2010. While historically high for credit unions, these
figures still compare favorably to other types of lenders.
Real Estate Loan Delinquency
At more than half of total loans, real estate is the predominant
factor in overall portfolio performance. Rising delinquency rates and
losses present a challenge for credit unions. Real estate loan
delinquency has been steadily increasing as the economic crisis has
unfolded, from 0.34 percent in 2006 to 2.06 percent as of September
2010. For this same time period, net charge-offs for real estate loans
demonstrate a similar trend, increasing to 0.63 percent as of the third
quarter 2010.
Loan Modifications and Foreclosures
NCUA continues to support loan modifications to resolve credit
union member issues. For borrowers experiencing financial difficulties,
in lieu of foreclosures, it may be in the best interest of credit
unions and their members to develop prudent workout arrangements or
loan modifications. Credit unions have shown a willingness to work with
their members experiencing financial difficulty as noted by the rapid
growth in loan modifications. They have increased from $1.5 billion in
2008 to $8.4 billion, which is approximately 2 percent of total real
estate loans.
Foreclosed assets represent only a small fraction (0.49 percent) of
total real estate loans outstanding in credit unions, but have been
rising since 2007. In light of the recent concerns over marketwide real
estate foreclosure practices and documentation, NCUA is examining a
sample of the largest credit unions selling mortgages to ensure
adequate controls are in place.
Member Business Loan Delinquency
While MBLs represent only 4 percent of total credit union industry
assets and approximately 1 percent of total commercial loans in the
financial markets, \17\ the levels of delinquent member business loans
have increased from 0.53 percent to 4.29 percent from 2006 to September
2010 (compared to total loan delinquency of 1.74 percent). A similar
trend during this period was noted in net MBL charge-offs, which
increased to 0.71 percent. Presently, at 270 of the 633 credit unions
which have a 3, 4, or 5 CAMEL rating \18\ and make member business
loans, MBLs are the primary or secondary contributing factor for the
supervisory concern.
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\17\ Mortgage Bankers Association Commercial and Multifamily
Mortgage Debt Outstanding Report as of 6/30/2010. (http://
www.mortgagebankers.org/NewsandMedia/PressCenter/74019.htm)
\18\ Credit unions with a CAMEL rating of 3 have supervisory
concerns; credit unions with a CAMEL rating of 4 or 5 are considered
``troubled.''
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Investment Portfolio Quality
Credit union investments account for a third of total assets. These
are generally short-term in nature, with nearly half maturing in less
than 1 year, and the majority are conservatively invested in Federal
Government obligations.
Earnings Have Been Stressed
Earnings have been depressed over the last several years and will
likely continue to be stressed in the near future. As of September
2010, credit unions reported a return on average assets of 0.45 percent
compared to 0.82 percent in 2006. This has reduced credit unions'
ability to build net worth. Credit union earnings are under stress due
to compressed net interest margins in the current interest rate
environment, NCUSIF premiums and Stabilization Fund assessments, and
higher provision for loan loss expenses. Also, any future rise in
interest rates will likely further reduce margins. NCUA's ability to
better manage the timing of Stabilization Fund assessments improves the
credit union system's capacity to absorb these costs, continue to
provide needed member services, and remain well capitalized.
The Number of Troubled Credit Unions Is Increasing
The level of troubled credit unions \19\ is highly correlated to
the state of the economy. As of October 31, 2010, there were 363
troubled credit unions holding $44.4 billion in assets and $39.1
billion in shares. These credit unions represent 5.0 percent of all
credit unions and total shares. The number of troubled credit unions
has increased in the current year, from 328 at year-end 2009.
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\19\ NCUA defines a troubled credit union as rated either a CAMEL
Code 4 or 5.
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Similarly, CAMEL code 3 credit unions, which exhibit some degree of
supervisory concern due to less than satisfactory risk management
practices, increased from 1,648 to 1,779 over the same period. The
following charts illustrate the changes in the number of troubled and
CAMEL code 3 credit unions and the dollars in total shares held by
these credit unions since year-end 2007.
As Chart 2 illustrates, the majority of shares are held in CAMEL 1
and 2 credit unions. While NCUA is working diligently with affected
credit unions to resolve problems in weaker institutions, the level of
troubled credit unions will also depend heavily on the pace of the
economic recovery.
Impact on the NCUSIF
One of the primary factors impacting the NCUSIF equity level is
losses due to credit union failures. As a result of the above stresses
on the credit union system and the corresponding increase in troubled
credit unions, the NCUSIF has experienced increased losses during the
past 2 years.
For proper financial statement reporting, the shifting of credit
union assets to more adverse CAMEL codes results in an increase in the
amount of NCUSIF reserves for credit union failures. The increase in
reserves lowered the equity ratio \20\ of the NCUSIF below 1.2 percent
during the summer of 2010. Thus, in September the NCUA Board approved a
restoration plan consisting of a premium of 0.124 percent of insured
shares to return the equity ratio to near 1.3 percent. The September
2010 premium was slightly more than the 2009 premium of 0.10 percent of
insured shares. As of October 31, 2010, the NCUSIF's equity ratio was
restored to 1.29 percent and is projected to remain above 1.2 percent
through at least June 2011.
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\20\ Equity ratio means the ratio of the amount of NCUSIF's
capitalization, meaning insured credit unions' 1 percent capitalization
deposits plus the retained earnings balance of the NCUSIF (less
contingent liabilities for which no provision for losses has been made)
to the aggregate amount of the insured shares in all insured credit
unions.
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NCUA regularly conducts stress tests to measure the resilience of
the NCUSIF. The most recent tests included analyzing the impact of
further declines in real estate values and other economic conditions.
The results of this year's stress tests indicate the risk profile of
the NCUSIF has not changed. The amount of losses at modeled stress
levels remain within the ability of the NCUSIF to absorb. NCUA will
continue to assess the risk profile of the NCUSIF and take appropriate
actions based on the results.
Potential Future Risks
While credit unions are financially strong and well positioned to
weather the continuing impact of the economic recession, NCUA has
identified the following potential future risks.
Interest Rate Risk
As of September 2010, fixed-rate mortgages represent 63 percent of
total mortgage loans, indicating a clear preference by credit union
members for this product in the current economic environment. While
NCUA recognizes the benefit to consumers of refinancing higher-rate
real estate loans into lower fixed-rate loans, NCUA is concerned with
the interest rate and liquidity risk associated with a high level of
fixed-rate, long-term assets should rates rise rapidly.
Credit unions are taking some positive steps to mitigate interest
rate risk. Credit unions sold $27.6 billion in first mortgage real
estate loans to date in 2010. These sales represent nearly 50 percent
of first mortgages granted. However, significant exposure to rapidly
rising rates remains.
Credit Union Service Organizations
A Credit Union Service Organization (CUSO) is a corporation,
limited partnership, or limited liability company that provides
services primarily to credit unions or members of affiliated credit
unions. These entities can be wholly owned by a single credit union or
owned by a group of credit unions with or without other investors. A
credit union's invested interest in a CUSO is subject to NCUA
regulations. \21\
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\21\ See, 12 C.F.R. Part 712.
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Credit unions are increasingly using CUSOs to perform various
functions and achieve economies of scale by partnering with other
financial institutions. This partnering is especially critical to the
2,833 credit unions with less than $10 million in assets. Credit unions
currently have $1.3 billion invested in CUSOs and approximately 33
percent of all credit unions reported using CUSO services. While this
arrangement can be beneficial from an efficiency standpoint, especially
for smaller credit unions, it places the systemic risk inherent in the
delivery of these services outside of NCUA's direct regulatory and
supervisory domain. NCUA is the only Federal financial institution
regulator that does not have oversight authority of third-party
vendors.
Privately Insured Credit Unions
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. \22\ ASI has geographic concentration in
two States particularly hard hit by the recent recession: California
and Nevada.
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\22\ ASI provides primary insurance directly in nine States
(Alabama, California, Idaho, Illinois, Indiana, Maryland, Nevada, Ohio,
and Texas), excess insurance directly in Arizona and California, and
excess insurance indirectly through ESI in 30 other States. ASI and ESI
both operate Web sites that list their respective States of operation.
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IV. NCUA Supervisory Improvements
The last several years have provided clear evidence of the
importance of a strong regulatory and supervisory approach. The depth
and severity of the recent economic crisis has provided new insight to
all regulatory agencies. NCUA is committed to proactively identifying
areas of concern and implementing corrective action in a timely manner.
To better accomplish this, NCUA modified its risk-based examination
program to require annual examinations of every Federal credit union
and increased on-site reviews of State-chartered credit unions. Annual
examinations provide more frequent onsite contacts at credit unions,
enabling NCUA to more effectively stay ahead of developing problems
than the previous 18-month examination schedule allowed. Full
implementation of the annual exam cycle is anticipated in 2011 as NCUA
hires and trains additional staff.
In addition to more frequent contacts at credit unions, NCUA is
also taking stronger resolution action earlier in the process when
problems are identified. In 2010 NCUA issued a supervisory letter and
increased training for field staff directing more rapid escalation of
administrative remedies to resolve problems that had been left
uncorrected by credit union management.
NCUA has increased the resources provided for credit union
supervision to ensure problem areas are brought to a timely and
appropriate resolution. A particular focus going forward will be strong
regulation and supervision relative to interest rate risk management.
NCUA has also been acquiring additional specialized expertise and
incorporating an enhanced training program for examination staff.
NCUA has made necessary adjustments over the past 2 years to
address the increased challenges associated with the financial crisis
and implement additional proactive risk mitigation programs.
While NCUA remains a highly effective regulator and insurer, NCUA
is also operating more efficiently. For every $1,000 in federally
insured credit union assets, NCUA is currently spending just 22 cents--
compared with 31 cents in the year 2000.
V. Legislative Remedies
Current Legislative Requests
Due to the financial environment and the evolving nature of
financial reporting rules, NCUA is requesting statutory changes to its
enabling statute, the Federal Credit Union Act (Act), to enhance its
ability to serve as an effective safety and soundness regulator of over
7,400 credit unions and deposit insurer for 90 million members. While
these amendments are technical and noncontroversial, they are
nonetheless critical to NCUA's role as regulator and insurer. \23\
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\23\ See, Appendix 1 for applicable proposed legislative text.
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NCUA requests the following statutory changes to the Act.
Change the ``Net Worth'' definition to allow certain loans
and accounts established by the NCUA Board to count as net
worth. NCUA's ability to resolve problem credit unions at the
least cost to the NCUSIF has been limited by the Financial
Accounting Standard Board's changes in accounting standards, in
combination with the existing statutory definition of net
worth. Since NCUA does not have the ability to adjust the
definition of net worth similar to the Federal Deposit
Insurance Corporation's authority, this results in the dilution
of a credit union's net worth when it acquires another credit
union, regardless of whether or not NCUSIF assistance is
provided to facilitate the acquisition. This increases costs to
resolve failed institutions and necessitates more outright
liquidations instead of mergers. Liquidations immediately cut
members off from credit union services.
Amend the Act to clarify that the equity ratio of the
NCUSIF is based on NCUSIF-only, unconsolidated financial
statements. Evolving accounting standards could result in the
consolidation of the financial statements of the NCUSIF with
regulated entities when NCUA exercises its role as the
Government regulator and insurer by conserving failed
institutions. The requested amendment would be consistent with
Congress' original intent in defining the NCUSIF equity ratio,
and prevent insured credit unions from being assessed
artificially inflated insurance premiums resulting from the
consolidation of financial statements with failed institutions.
Streamline the operation of the Stabilization Fund. As
currently written, the Stabilization Fund must borrow from the
U.S. Treasury to obtain funds to make expenditures related to
losses in the corporate credit union system. The Stabilization
Fund then assesses federally insured credit unions to repay the
U.S. Treasury borrowing over time. Relevant amendments to
Section 217(d) of the Act would give NCUA the option of making
premium assessments on federally insured credit unions in
advance of anticipated expenditures, thereby avoiding borrowing
directly from the U.S. Treasury. In addition, while the
existing statutory language includes the implicit authority for
ongoing advances, a clarification of this in the statute is
recommended.
Anticipated Requests for Next Congress
The following are important legislative initiatives for further
improving the regulation of the credit union industry.
Statute of Limitations. NCUA proposes that Congress amend
the Act to extend the statute of limitations \24\ provision
applicable to actions filed by NCUA as conservator/liquidating
agent of a credit union. This would provide parity with similar
authority already provided to FDIC, clarify other ambiguities
in the statute, and allow the NCUSIF to better mitigate losses.
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\24\ 12 U.S.C. 1787(b)(14)
Third-Party Vendor Authority. NCUA is the only regulator
subject to the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 that does not have authority to perform
examinations of vendors which provide services to insured
institutions. Credit unions are increasingly relying on third-
party vendors to support technology-related functions such as
Internet banking, transaction processing, and funds transfers.
Vendors are also providing important loan underwriting and
management services for credit unions. The third-party
arrangements present risks such as threats to credit risk,
security of systems, availability and integrity of systems, and
confidentiality of information. Without vendor examination
authority, NCUA has limited authority to minimize risks
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presented by vendors.
Supplemental Capital. Some financially healthy, well-
capitalized credit unions that offer desirable products and
services are discouraged from marketing them too vigorously out
of concern that attracting share deposits from new and existing
members will inflate the credit union's asset base, thus
diluting its net worth for purposes of PCA. In effect, the
reward for their success in attracting new shares is the risk
of a demotion to a lower net worth category if accepting those
shares drives down the credit union's net worth ratio. NCUA
believes two legislative remedies would help reverse the
disincentive to accept new share deposits--one that addresses
the ``total assets'' denominator of the net worth ratio, and
another that addresses the ``retained earnings'' numerator. For
more information on the specific remedy proposed, refer to
NCUA's letter to the Honorable Barney Frank (appended to this
testimony document as Appendix 2).
Member Business Lending Statutory Limit. The Act limits the
amount of member business loans the vast majority of credit
unions can grant to the lesser of 1.75 percent of net worth or
12.25 percent of assets. NCUA recognizes the importance of
small businesses in our Nation's economy. As such, NCUA
supports efforts to allow credit unions to provide businesses
additional avenues of credit when appropriate under a
comprehensive regulatory framework, by increasing or
eliminating the current statutory MBL limitation. Given such a
change, NCUA would promptly revise MBL regulations to
appropriately mitigate any additional risk. For more
information on the specific remedy proposed, refer to NCUA's
letter to the Honorable Timothy Geithner (appended to this
testimony document as Appendix 3).
VI. Conclusion
Over the last 24 months, the credit union industry has faced
profound and unprecedented threats to its stability. A steep plunge in
global financial markets triggered the most severe economic downturn in
recent memory. The resulting cascade of job losses, home foreclosures,
and bankruptcies exerted significant pressure on the entire American
financial services sector, including credit unions.
NCUA's experience during these years of crisis demonstrated the
value of rigorous regulation, diligent oversight, and a robust
insurance fund. NCUA's increased supervision contributed significantly
to the credit union system's ability to withstand the extraordinary
economic shocks over the past 2 years.
Going forward, NCUA has also implemented proactive measures to
address the ongoing strains and emerging risks to consumer credit
unions. Coming out of this extraordinary economic downturn, the credit
union industry remains financially stable and well positioned to emerge
from the current economic downturn as a leader in the delivery of
financial products and services to more than 90 million consumers.
Additional Material Supplied for the Record
LETTER SUBMITTED BY FRED R. BECKER, JR., PRESIDENT AND CHIEF EXECUTIVE
OFFICER, NATIONAL ASSOCIATION OF FEDERAL CREDIT UNIONS
LETTER SUBMITTED BY BILL CHENEY, PRESIDENT AND CHIEF EXECUTIVE OFFICER,
CREDIT UNION NATIONAL ASSOCIATION
STATEMENT SUBMITTED BY THE CREDIT UNION NATIONAL ASSOCIATION
STATEMENT SUBMITTED BY THE AMERICAN BANKERS ASSOCIATION
Chairman Dodd, Ranking Member Shelby, and Members of the Committee,
the American Bankers Association appreciates the opportunity to submit
this statement for the record--for the December 9, 2010, Senate Banking
Committee hearing entitled ``The State of the Credit Union Industry.''
The American Bankers Association (ABA) represents banks of all sizes
and charters and is the voice for the Nation's $13 trillion banking
industry and its two million employees.
There are several key points we would like to make in this
statement:
Even though credit unions pay no Federal taxes, the
industry received taxpayer assistance to resolve insolvent
corporate credit unions.
Raising the credit unions legal business lending cap is not
necessary for credit unions to meet members' credit needs.
Moreover, expanding the lending cap is inconsistent with the
credit union mission and raises serious safety and soundness
concerns.
Alternative or secondary capital is not appropriate for
credit unions. It would dramatically change the focus of credit
unions away from member-owned to a market-driven capital
structure, and would force credit unions to generate a level of
return necessary to attract such capital--all of which will
negatively impact credit union members.
Credit unions, like many in the banking industry, have suffered
losses as the recession took hold and unemployment dramatically
increased. For the credit union industry, several multi- billion-dollar
corporate credit unions (which were designed to provide investments and
financial services to smaller, ``natural person'' credit unions)
dramatically increased their level of risk and ended up failing. This
caused severe losses to the National Credit Union Share Insurance Fund
and created an environment where many smaller credit unions could fail.
Even though credit unions pay no Federal taxes--a privilege bestowed on
credit unions in order to focus their lending on ``people of small
means''--the credit union industry sought taxpayer help to facilitate
the repayment of these losses. \1\
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\1\ See, Appendix B for details on the taxpayer assistance which
benefited the credit union industry. The mission of credit unions to
serve people of small means was articulated in the preamble to the 1934
Federal Credit Union Act.
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This assistance, like many other special programs related to
banking and financial institutions, was appropriate for that time. It
appears that now, however, some credit unions are using the financial
crisis and the recession to argue for more business lending authority
and access to alternative sources of capital. Credit unions argue that
these greater authorities would enable them to meet the needs of small
businesses seeking credit. Such arguments are simply not true. Under
current law, business loans under $50,000 do not count against the
aggregate business loan cap of 12.25 percent of assets. Moreover, the
guaranteed portion of Small Business Administration loans does not
count against the aggregate business loan limit. Thus, there is
considerable opportunity under current law for credit unions to meet
the needs of small business.
In addition, only a small percentage of credit unions--one-half of
one-percent--are at or near the congressionally mandated cap. Thus,
even for larger business loans in excess of $50,000, there is little
constraint on credit union lending except for these small numbers of
large, fast-growing, profit-seeking credit unions.
The real goal of expanded business lending is for some aggressive
credit unions to make even more large dollar loans--such as loans for
luxury golf and condominium developments. For some aggressive credit
unions, it is not unusual for them to make multimillion dollar loans. A
dramatic example of just how far these credit unions have gone is the
financing of Thumper Pond, a resort development in Minnesota that went
bankrupt. This luxury resort featured a golf course, spa, water park,
hotels, and a planned condominium community. The resort was financed by
a large commercial loan made by Spire Federal Credit Union. Not only is
this far beyond any sensible definition of modest means, but the resort
is located over 200 miles from the credit union's headquarters. Is this
the kind of loan that should be tax-subsidized?
Such loans are clearly counter to the chartered mission of serving
people of small means. It is leveraging the tax-exemption to provide
loans to large businesses that have plenty of credit options available
through taxpaying banks. This credit union tax expenditure is neither
focused nor contained; it takes revenue from banks that compete for
these same loans--revenue that would be taxed and would help to offset
some of the current Federal budget deficit.
Lifting the business lending cap also raises serious safety and
soundness concerns. As credit unions have aggressively pursued business
lending options, business loan delinquencies have risen and some credit
unions have failed. In fact, just a few weeks ago (November 23), the
NCUA's Office of the Inspector General (OIG) released a report
summarizing the 10 costliest natural person credit union failures. In 7
of these 10 failures, business lending contributed to the failure. \2\
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\2\ Appendix A provides more details about what the Inspector
General discovered.
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Moreover, the General Accountability Office in 2003 warned about
the danger of business lending by credit unions and it was skeptical
that NCUA was up to the challenge to monitor the expansion of credit
union business lending. \3\ It should be no surprise that the Inspector
General's Material Loss Review found adequate oversight often missing:
business loans were made to nonmembers; credit unions exceeded the
legal Member Business Loan cap of 12.25 percent; credit unions violated
the loan-to-one borrower limit; and credit unions made business loans
without a Member Business Loan policy. Expanding credit union business
lending only encourages larger, riskier loans, without any assurance of
adequate oversight.
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\3\ Credit Unions: Financial Condition Has Improved, but
Opportunities Exist to Enhance Oversight and Share Insurance
Management. General Accounting Office, October 2003 (GAO-04-91), p. 49.
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Just as business lending is not the answer to the misfortunes of
credit unions, neither is access to alternative or secondary capital.
In fact, it will blur the line between credit unions and other
depository institutions. By granting credit unions the ability to issue
secondary capital, the capital structure of the credit union industry
would fundamentally change. This would potentially permit any credit
union to issue secondary capital to members and nonmembers alike. By
moving away from the concept of ``member-owned'' equity towards a
reliance on capital contributions from nonmembers and the broader
marketplace, the very essence of a credit union's ownership structure
is called into question. It would force credit unions to generate a
level of returns necessary to attract such capital and therefore would
be a costlier source of funds. Not only does this dramatically change
the focus of credit unions away from serving their membership towards a
market-driven capital structure, it also raises a host of corporate
governance concerns, such as voting rights of holders of such ownership
stakes, board composition, etc.
Moreover, granting all credit unions the ability to raise
alternative capital may negatively impact the ability of low-income
credit unions to attract capital. Low-income credit unions would have
to compete with other credit unions for this additional capital, thus,
raising their cost of capital and making it more difficult to fulfill
their social mission.
NCUA will point to where credit unions in Australia and Canada have
the ability to issue alternative capital. It should also be noted that
credit unions in Australia and Canada are taxed. The lack of taxation
of credit unions in the United States is the key difference.
Finally, Congress, Treasury, and the GAO have questioned the need
for alternative capital. In 1998, Congress specifically reinforced its
view that credit unions, in maintaining their distinct character,
should rely upon retained earnings to build net worth, while not
issuing capital stock. For example, the report of the Senate Banking
Committee [Rept. No. 105-193, p. 12] states that the ``NCUA [National
Credit Union Administration] must design the system of prompt
corrective action to take into account that credit unions are not-for-
profit cooperatives that (1) do not issue capital stock, and (2) must
rely on retained earnings to build net worth.'' This was reinforced by
Emil Henry, former Assistant Secretary of the Treasury for Financial
Institutions, who noted in 2006 that the ability to ``raise equity
capital by increasing retained earnings . . . is an important feature
that is grounded in the cooperative nature of credit unions.'' And in
2004, GAO found that there was no compelling evidence for alternative
or secondary capital for credit unions.
In conclusion, while the common perception about credit unions is
that they are small mom-and-pop operations, the reality is that there
are 167 credit unions that have over $1 billion in assets. To put that
in perspective, these credit unions are larger than 91 percent of the
taxpaying banks in this country. Moreover, the traditional credit
unions are being squeezed out by the invasive tactics of these growth-
oriented credit unions. It is no surprise that over 2,600 credit unions
have been absorbed into larger credit unions since the beginning of
2001.
While the rhetoric suggests that without greater business lending
or capital authority there are no options for these institutions to
grow and better serve their customers, the reality is that a very
viable option is available today through switching to a mutual savings
bank charter--a route that some credit unions have already taken. This
charter provides greater flexibility, still preserves the mutual-member
focus that credit unions find desirable, and is accompanied by the
effective and experienced supervision of traditional banking
regulators. This savings bank charter would give these credit unions
the ability to expand their business lending and retain their mutual
structure. However, NCUA actively impedes the ability of credit unions
to engage in charter choice. Removal of NCUA's obstructionism is a far
better alternative to enabling more business lending and access to
alternative capital than a wholesale change in powers that will benefit
only a small proportion of large credit unions. Facilitating conversion
to a mutual savings bank charter will benefit those credit unions that
have outgrown their charter, and will also improve the fiscal position
of the United States as these entities pay their fair share of taxes.
Congress is rightfully concerned about the state of the corporate
credit unions in receivership and the significant costs their rescue
imposes on the rest of the credit union industry. While the taxpayer
assistance was appropriate for the circumstances, it is ironic that
taxpayer dollars would be used to support an industry that has not paid
a single dollar in Federal taxes. The answer to the stresses currently
suffered by credit unions is not to increase business lending powers or
allow alternative forms of capital. Nor are these necessary to meet the
credit needs of businesses. The fact is that there is ample authority
under existing law to meet credit unions small business member needs.
Equally important is that expanding the lending cap is inconsistent
with the credit union mission and raises serious safety and soundness
concerns. Similarly, alternative capital may sound appealing, but it
would dramatically change the member-owned focus of credit unions to a
market-driven one, which ultimately will negatively impact credit union
members.
Against a backdrop where nontraditional credit unions forsake the
common bond in favor of fast growth, and where energies are diverted to
favoring the well-off and businesses rather than meeting their
chartered obligation to serve people of modest means, it is no surprise
that ABA opposes expansion of credit union powers. To allow such
expansion will only move the new breed of credit unions further and
further away from their mandated mission.
STATEMENT SUBMITTED BY MARY MARTHA FORTNEY, PRESIDENT AND CHIEF
EXECUTIVE OFFICER, NATIONAL ASSOCIATION OF STATE CREDIT UNION
SUPERVISORS
The National Association of State Credit Union Supervisors (NASCUS)
appreciates the opportunity to provide a submission for the record of
the December 9, 2010, Senate Banking Committee hearing ``The State of
the Credit Union Industry.''
NASCUS, the professional association of State credit union
regulators, has been committed to enhancing State credit union
supervision and advocating for a safe and sound State credit union
system since its inception in 1965. NASCUS and State regulators would
like to take this opportunity to brief the Committee on a needed
critical reform: natural person credit union access to supplemental
capital.
As this Committee knows, the credit union capital structure is
unique among financial institutions. Credit unions can only rely on
retained earnings for capital growth, an archaic structure that does
not allow credit unions to raise capital in times of need. The current
economic environment facing credit unions only reinforces NASCUS and
State regulators' steadfast support of supplemental capital access for
natural person credit unions. NASCUS and State regulators have believed
for years that supplemental capital is appropriate for credit unions, a
necessary tool for safety and soundness and critical to the credit
union system's long term health and sustainability.
In addition to the general economic impact, credit unions are
paying for the deterioration of the corporate credit union network
through assessments to the Temporary Corporate Credit Union
Stabilization Fund (TCCUSF) at an estimated total cost of $13.9-16.1
billion spread across 10 years. This is putting additional stress on
credit union balance sheets already challenged by a restrictive capital
regime.
As evidenced by the development of the third iteration of Basel
standards, international regulators are capital planning far into the
future and addressing prospective capital considerations for banks and
other financial institutions. What are U.S. credit unions doing as far
as capital planning for the future? Unfortunately, relying on just
retained earnings for net worth does not provide needed flexibility for
capital planning. Credit unions cannot thrive and compete under these
archaic capital standards.
Non- low income, natural person credit unions remain virtually the
only class of depository institutions denied access to supplemental
capital. This distinction carries enormous implications for natural
person credit unions' ability to manage both the current economic
climate, but also the eventual economic recovery. Further, from a
regulatory standpoint, a well managed supplemental capital program can
provide increased systemic stability, additional balance sheet
management tools and an extra buffer to mutualized losses.
NASCUS encourages this Committee to make the necessary changes to
the definition of net worth in the Federal Credit Union Act to allow
access to supplemental capital. Following the legislative change, State
and Federal regulators would establish prudent regulatory standards for
supplemental capital. However, State and Federal regulators would not
be starting from scratch--there are supplemental capital models in use
around the world, and NCUA and State regulators have studied the
regulatory considerations for its use in the United States.
For NASCUS and State regulators (many of whom are familiar with
supplemental capital through bank regulatory responsibilities)
achieving capital reform has long been a matter of safety and
soundness. Increased capital and investor discipline can provide
critical buffers during economic downturns. We believe credit unions
can manage the complexities of supplemental capital. We know that State
regulators can manage its regulation.
NASCUS urges this Committee to make credit union access to
supplemental capital a priority in the upcoming Congress. NASCUS and
State regulators welcome questions from the Committee on this issue.