Compliance Blog

Posted by Anthony Demangone

NCUA Board members members are often invited to speak at credit union conferences.  These speeches often are made available after the fact.  It is always worth it to scan the speech from a compliance officer's point of view.  You might find the following hidden gem in this speech by Chairman Debbie Matz back in December.  She said:

Speaking of red flags, we are seeing more of them on the latest call reports. As a result, our examiners are taking a hard look at four key areas of risk:

First, we’re looking at credit unions that hold fixed-rate long term mortgages on their books. Across our industry, 55% of the fixed-rate loans are sold. The problem is, fixed-rate loans that are not sold are concentrated in certain institutions. I know that the impulse of credit unions is to be close to their members, and that this improves the loan-to-share ratio – but it is a risk. When interest rates go up – notice I said "when, not "if" – those fixed-rate mortgages that are earning relatively high rates now could slip underwater. And then it would be too late to sell them.

Second, we’re looking at indirect lending. Credit unions need to drive their own indirect lending relationships, not simply outsource their loan decisions to auto dealers or third-party vendors. That means your credit union really needs to be doing your own due diligence, pulling the credit reports and practicing sound underwriting. If it’s done properly, this is a fine way to grow business. If not, it can be a fine way to steer credit unions into insolvency.

I have an unfortunate example of what I’m talking about. Not far from here in the southwest, there was a credit union that served primarily minority communities, and it got in over its head with an indirect auto lending program. A combination of inadequate due diligence, lack of monitoring of their third-party vendors, and extremely poor underwriting led to a situation where they ended up with over 1,000 repossessed vehicles on their lot. In just 3 years, repossessed assets grew from $160,000 to over $6 million. As a result, that once-healthy credit union had to be purchased and assumed by another credit union. By any reckoning, the situation at that credit union was unacceptable. My job is to make sure that it’s un-repeatable.

Third, loan participations. So much of this industry is built on trust. We don’t want to lose that. But when it comes to loan participation, that attitude needs to be modified a bit: Trust, but verify. These are the cases where a handshake isn’t enough. Even if someone else claims to have done it, you need to do your own due diligence.

Fourth and finally, we’re looking at member business lending. I support increasing the cap on member business lending. It makes no sense to me that Congress put an arbitrary cap on the percentage of assets credit unions can lend in this way. Still, we all need to recognize that commercial loans are risky. Member business loan delinquencies are higher than any other type of loans – including real estate loans. Worse yet, MBL delinquencies are rising much faster than delinquencies on all other loans. So, if you are not doing your own due diligence – particularly on loan participations – you can expect a visit from your examiner.

I'd compare her remarks to your credit union's operations.  If you fall into one or more of the four categories of focus, I'd prepare to discuss the issues during your next exam.

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April 1, 2010 is quickly approaching.  And that will mean escrowing for higher priced mortgage loans under Section 226.35 of Regulation Z.  (October 1, 2010 is the escrow deadline for manufactured homes.)  The escrow requirement, though, only applies HPML secured by a first lien.  But remember: that might include some of your home equity products.  Even those such loans general are secured by subordinate liens, they very well could be secured by a first-lien at times.  If you follow the link above, you'll see that the HPML escrow requirement extends to first-lien loans, regardless of how you classify the product within your shop.  Keep this in mind as April approaches.

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We have a webcast today focusing on Reg E and Reg Z.  We're in final "prep" mode.  Your best bet to reach us today is via email via compliance@nafcu.org.