ALEXANDRIA, Va. - Extensive losses by some credit unions have led to conservatorships, NCUA management, and ultimately, losses to the National Credit Union Share Insurance Fund. NCUA Chairman Joann Johnson, below, tells Credit Union Journal how those losses came to be and some of the agency’s strategies for dealing with them.
CUJ: How did a situation as large as that affecting Norlarco Credit Union and others that have failed due to risky lending bets in Florida come about so quickly? Was the agency aware of any warning signs there?
Johnson: In general the business model of the credit unions presenting recent significant risk to the NCUSIF includes rapid growth in a concentration of high-risk assets with limited management controls and oversight in place.
Credit unions have the ability to book significant levels of growth in loans and shares using means other than their traditional reliance on existing members, including the establishment of third party processor relationships and participation lending. As a result, credit unions can, and in some cases have, materially changed their balance sheet and risk profile in a matter of months.
Historically, increased risk and associated operating weaknesses occur over an extended period with adequate time for NCUA supervision efforts to be effective. The recent cases show a different model, where the risk can develop over a period of months, versus years. In cases where the development of the concentration of high-risk assets occurred within relatively short periods, it is difficult for NCUA to respond and bring the activities to a stop before failure becomes likely. As a result, we have placed additional emphasis on our off-site monitoring of credit union activity, and made adjustments to the type of information we monitor in order to help identify the credit unions with rising risk levels.
CUJ: The agency’s first priority is safety and soundness and the NCUSIF. Do you have a sense of how large the losses will be to the NCUSIF from some of these failed investments?
Johnson: The agency’s first priority is the safety and soundness of the entire credit union system with the strength of the NCUSIF being a major part of the objective.
Our risk profile consists of the risk within all of the credit unions in the federally insured system. NCUA staff regularly measures the risk of loss to the NCUSIF within the system.
The Provision for CU Losses included on the balance sheet of the NCUSIF reflects the amount of anticipated losses from credit union failures. The balance of this account increased from $70 million as of Dec. 31, 2006 to nearly $216 million as of Dec. 31, 2007. This loss reserve includes the reserves for all CU failures, not just those related to the Florida loans. The NCUSIF remains very strong with an equity level of 1.29% at yearend 2007, even after considering the reserve increase.
CUJ: What percentage of the loans NCUA has acquired from the failed CUs does the agency anticipate it will recover? In other words, how many pennies on the dollar?
Johnson: While we have established reserves based upon our computation of a range of loss estimates for different types of assets, the actual loss level is unknown until the assets are actually disposed. All assets retained by the NCSUIF are actively managed and marketed by the Asset Management and Assistance Center (AMAC) with the goal to maximize the value of the assets. The recovery level will be dependent upon many factors including local market trends and the general economy.
CUJ: What steps have you instituted with examiners, and in conjunction with NASCUS, as a result of this situation?
Johnson: The breadth and severity of this particular situation underscores the need for careful oversight and monitoring of third party relationships. To this end, NCUA has a long-standing history of providing guidance to the industry on proper due diligence of third-party arrangements. We recently issued a Supervisory Letter to staff on Evaluating Third-Party Relationships, and also issued this letter to all federally insured credit unions late last year. I am also confident my staff and NASCUS will continue working closely together to highlight to our examiners the importance of reviewing quarterly 5300 call reports to help identify red flags or detect potential adverse trends.
CUJ: The slowing economy raises other challenges for CUs, including loan quality. What are your concerns there?
Johnson: Credit unions haven’t been as involved in subprime adjustable rate or non-traditional mortgage lending as other financial institutions. While that made the credit union industry somewhat insulated from the initial impact of the subprime and non-traditional mortgage crisis, credit unions are now facing larger economic issues stemming from it. It’s likely that some members may have consumer loans, such as unsecured or auto loans, at a credit union which may be adversely impacted by high payment resets of these mortgages held elsewhere.
NCUA and the federal banking regulators have issued guidance to the industry to encourage financial institutions to work constructively with borrowers who may experience payment shock as adjustable rate mortgages reprice. The principles outlined in this guidance could be applied to other loan products which may become stressed during this challenging time.
CUJ: Aside from these issues, what other goals do you have before your term ends?
Johnson: I have strived to create a member-centric focus in each issue that I have dealt with at NCUA. This has been manifested in a wide variety of ways, including the new conversion regulation as well as the attention we are paying to transparency issues and member access to records and other pertinent information.
One initiative that I am particularly interested in is reform of Prompt Corrective Action and the attendant creation of a risk-based capital system for credit unions. This would represent an important step to put more member capital in their hands, while maintaining a robust and thorough safety and soundness regime. A provision to do this is currently under consideration by Congress as part of the Credit Union Regulatory Improvements Act, and I continue to take every opportunity to encourage its enactment.
In my time with NCUA we have addressed numerous challenging issues, such as identity theft, the Bank Secrecy Act, specialized lending, and even natural disasters, just to name a few. We’ve also been able to decrease NCUA’s regulatory footprint on the industry by providing a framework of regulations with inherent flexibility to allow credit unions to carry out their member service mission.
