Credit Unions: Financial Condition Has Improved, but Opportunities Exist to Enhance Oversight and Share Insurance Management
Published: 2003-10-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Recent legislative and regulatory changes have blurred some distinctions between credit unions and other depository institutions such as banks. The 1998 Credit Union Membership Access Act (CUMAA) allowed for an expansion of membership and mandated safety and soundness controls similar to those of other depository institutions. In light of these changes and the evolution of the credit union industry, GAO evaluated (1) the financial condition of the industry and the deposit (share) insurance fund, (2) the impact of CUMAA on the industry, and (3) how the National Credit Union Administration (NCUA) had changed its safety and soundness processes.
section_title: What GAO Found
paragraphs: The financial condition of the credit union industry has improved since GAO's last report in 1991, and the federal share insurance fund appears financially stable. However, a growing concentration of industry assets in large credit unions creates the need for greater risk management on the part of NCUA. The question of who benefits from credit unions' services has also been widely debated. While it has been generally accepted that credit unions have a historical emphasis on serving people of modest means, our analysis of limited available data suggested that credit unions served a slightly lower proportion of low- and moderate-income households than banks. CUMAA and subsequent NCUA regulations enabled federally chartered credit unions to expand their membership, serve larger geographic areas, and add underserved areas. According to NCUA officials, these changes were necessary to maintain the competitiveness of the federal charter with respect to state-chartered credit unions. While NCUA has stated its commitment to ensuring that credit unions provide financial services to all segments of society, NCUA has not developed indicators to determine if credit union services have reached the underserved. In response to the growing concentration of industry assets and increased services offered by credit unions, NCUA recently adopted a risk-focused examination and supervision program but still faces a number of challenges, including lack of access to third-party vendors that are providing more services to credit unions. Further, credit unions are not subject to internal control and attestation reporting requirements applicable to banks and thrifts. GAO also found that the insurance fund's rate structure does not reflect risks that individual credit unions pose to the fund, and NCUA's estimation of fund losses is based on broad historical analysis rather than a current risk profile of insured institutions.

section_title: Letter
paragraphs: Credit unions have historically occupied a unique niche among depository  institutions. Credit unions are not-for-profit, member-owned cooperatives  that are exempt from paying federal income taxes on their earnings. Unlike  banks, credit unions are subject to limits on their membership because  members must have a “common bond”—for example, working for the same  employer or living in the same community. However, over the years, these  membership requirements have loosened considerably and credit unions  have received expanded powers, which have raised questions about the  extent that credit unions remain unique and serve a different population  than banks. We last conducted a comprehensive review of the credit union  industry, including the National Credit Union Administration (NCUA), in  1991. Since that time, the credit union industry has experienced  substantial growth and expansion of activities. In addition, recent  legislative and regulatory changes have blurred some distinctions between  credit unions and other depository institutions—banks and thrifts. For  example, the 1998 Credit Union Membership Access Act (CUMAA)  expanded the definition of common bond and provided for reforms  intended to strengthen the safety and soundness of credit unions, including  instituting procedures for prompt corrective action (PCA) when credit  unions’ capital levels fall below a certain threshold.
In 2002, there were about 10,000 credit unions with approximately 82  million members. Credit unions, like banks and thrifts, are chartered by  both the federal government and state governments, also referred to as the  dual-chartering system. NCUA has oversight authority for federally  chartered credit unions and requires its credit unions to obtain federal  share (deposit) insurance for their members’ deposits from the National  Credit Union Share Insurance Fund (NCUSIF). This fund, administered by  NCUA, also provides share insurance to most state-chartered credit unions.  Some states permit their credit unions to purchase private share insurance  as an alternative to federal insurance.
In light of the evolution of the credit union industry and the passage of  CUMAA, you asked us to review a variety of issues involving the credit  union industry and NCUA. In response, we provided your staff information  on how NCUA responded to recommendations made in our 1991 report and  conducted preliminary research on the industry and NCUA. After  discussing this information with your staff, we agreed that the objectives of  this study were to evaluate (1) the financial condition of the credit union  industry; (2) the extent to which credit unions “make more available to  people of small means credit for provident purposes”; (3) the impact, if  any, of CUMAA on credit union field of membership requirements for  federally chartered credit unions; (4) how NCUA’s examination and  supervision processes have changed in response to changes in the industry;  (5) the financial condition of NCUSIF; and (6) the risks associated with the  use of private share insurance. You also asked us to review issues  associated with corporate credit unions, which we plan to address in a  separate report.
To evaluate the financial condition of the credit union industry we  performed quantitative analyses on credit union call report data for 1992–  2002. Since NCUA lacked readily available data to assess the extent to  which credit unions serve people of low and moderate incomes, we  analyzed data from the 2001 Federal Reserve Survey of Consumer Finances  (SCF) to identify the characteristics of credit union members. This survey  is the only comprehensive source of publicly available data on financial  institutions and consumer demographics that we could identify that is  national in scope. We also analyzed 2001 mortgage data from the Home  Mortgage Disclosure Act (HMDA) database, which allowed us to categorize  the income levels of households receiving mortgages from credit unions  and banks, and reviewed other industry studies. To determine how CUMAA  affected field of membership requirements for federally chartered credit  unions, we analyzed NCUA regulations and obtained data on field of  membership trends from NCUA. In addition, we surveyed state regulators  to obtain information about their chartering provisions, particularly for  credit unions serving geographic areas. To determine how NCUA’s  examination and supervision process has changed, we reviewed NCUA  documentation on its risk-focused program and conducted structured  interviews of NCUA regional directors and examiners, as well as selected  state credit union supervisors. We also analyzed NCUA data on examiner  resources provided to states and progress in implementing PCA. To  determine the financial condition of NCUSIF, we obtained and analyzed  key financial data about the fund from NCUA’s annual audited financial  statements for 1991–2002. Finally, to assess the risks associated with the  use of private share insurance, we identified and analyzed relevant federal  and state statutes and regulations and surveyed the 50 state credit union  regulators to determine which states permitted private share insurance. In  addition, we conducted interviews with state supervisors from states  where credit unions are permitted to choose private insurance—Alabama,  California, Idaho, Illinois, Indiana, Maryland, Nevada, and Ohio. We also  interviewed and obtained relevant documentation from representatives of  American Share Insurance (ASI)—the remaining provider of private share  insurance. Appendix I provides additional details on our scope and  methodology. We conducted our review from August 2002 through  September 2003 in accordance with generally accepted government  auditing standards.
subsections: section_title: Background
paragraphs: Credit unions differ from other depository institutions because of their  cooperative structure and tax exemption. Credit unions are member-owned  cooperatives run by boards elected by their members. They do not issue  capital stock; rather, they are not-for-profit entities that build capital by  retaining earnings. However, like banks and thrifts, credit unions have  either federal or state charters. Federal charters have been available since  1934 when the Federal Credit Union Act was passed. States have their own  chartering requirements. As of December 2002, the federal government  chartered about 60 percent of the nearly 10,000 credit unions, and about 40  percent were chartered by their respective states. Both federally and state- chartered credit unions are exempt from federal income taxes, with  federally chartered and most state-chartered credit unions also exempt  from state income and franchise taxes.
Another distinguishing feature of credit unions is that they may serve only  an identifiable group of people with a common bond. A common bond is  the characteristic that distinguishes a particular group from the general  public. For example, a group of people with a common profession or living  in the same community could share a common bond. Over the years,  common-bond requirements at the state and federal levels have become  less restrictive, permitting credit unions consisting of more than one group  having a common bond to form “multiple-bond” credit unions. The term  “field of membership” is used to describe all the people, including  organizations, that a credit union is permitted to accept for membership. As  previously noted, the loosening of common-bond restrictions, as well as  expanded powers, have brought credit unions into more direct competition  with other depository institutions, such as banks. In addition, credit unions  can offer members additional services made available by third-party  vendors and by certain profit-making entities with which they are  associated, referred to as credit union service organizations (CUSO).
CUMAA was the last statute that enacted major provisions affecting,  among other things, how federally chartered credit unions could define  their fields of membership and how federally insured credit unions  demonstrate the safety and soundness of their operations. In February  1998, the Supreme Court ruled that NCUA lacked authority to permit  federal credit unions to serve multiple membership groups. In response,  CUMAA authorized multiple-group chartering, subject to limitations NCUA  must consider when granting charters. Also, the act limited new  community charter applications to well-defined “local” communities.  Moreover, CUMAA placed several additional restrictions on federally  insured credit unions. It tightened audit requirements, established PCA  requirements when capital standards were not met, and placed a cap on the  percentage of funds that a credit union could expend for member business  loans.
NCUA has oversight responsibility for federally chartered credit unions and  has issued regulations that, among other things, guide their field of  membership and the scope of services they can offer. NCUA also has  responsibility for overseeing the safety and soundness of federally insured  credit unions through examinations and off-site monitoring. In addition,  NCUA administers NCUSIF, which provides primary share (deposit)  insurance for 98 percent of the nation’s credit unions.NCUA, in its role as  administrator of NCUSIF, is responsible for overseeing federally insured,  state-chartered credit unions to ensure that they pose no risk to NCUSIF.
State governments have responsibility for regulating state-chartered credit  unions. State regulators oversee the safety and soundness of state- chartered credit unions; although, as mentioned above, NCUA also has  responsibility for ensuring that state-chartered credit unions that are  federally insured pose no risk to NCUSIF. States set their own rules  regarding field of membership and the services credit unions can provide.  In addition, some states allow the credit unions in their states the option of  obtaining private primary share insurance. Currently, 212 credit unions in  eight states have primary share insurance from a private company, ASI,  located in Ohio. Primary share insurance for these privately insured credit  unions covers up to $250,000.
section_title: Financial Condition of the Credit Union Industry Has Improved Since 1991
paragraphs: Between 1992 and 2002, the capital ratios of federally insured credit unions  improved and remained higher than those of other depository institutions.  The industry’s assets also grew over this period, coincident with an  increased emphasis on mortgage loans. Credit union industry profitability,  after declining from 1992 to 1999, has since stabilized. In addition, since  1991 there has been a significant drop in the number of problem credit  unions as measured by regulatory ratings. Consolidation in the industry has  continued while total industry assets have grown, which has in part  resulted in two distinct groups of federally insured credit unions—larger  credit unions, which are fewer in number and provide a wider range of  services that more closely resemble those offered by banks, and smaller  credit unions, which are larger in number and provide more basic financial  services.
subsections: section_title: Credit Union Capital Ratios Have Improved Since 1991 and Remain Higher Than Those of Banks
paragraphs: The capital of federally insured credit unions as a percent of total industry  assets—the capital ratio—increased steadily between 1992 and 1997 and  has since remained mostly level. As shown in figure 1, the capital ratio of  the industry was 8.1 percent in 1992, increased to 11.1 percent in 1997, and  was 10.9 percent in 2002. As a point of comparison, the capital ratio of  credit unions has remained higher than that of banks and thrifts since  1992. As a result, credit unions have a greater proportion of assets  available to cover potential losses than banks and thrifts. This may be  appropriate since credit unions, unlike banks, are unable to raise capital in  the capital markets but must instead rely on retained earnings to build and  maintain their capital levels.
section_title: Industry Assets Have Grown and Asset Composition Has Changed
paragraphs: Total loans as a percent of total assets of federally insured credit unions  grew between 1992 and 2002. In 1992, 54 percent of credit union assets  were made up of loans and 16 percent were in U.S. government and agency  securities, while in 2002 loans represented 62 percent of industry assets,  and U.S. government and agency securities represented 14 percent of total  assets. The largest category of credit union loans was consumer loans (a  broad category consisting of unsecured credit card loans, new and used  vehicle loans, and certain other loans to members, but excluding real estate  loans such as mortgage or home equity loans), followed by real estate  loans. For example, in 2002, 31 percent of credit union total assets were  classified as consumer loans and 26 percent were classified as real estate  loans.
However, over time, holdings of real estate loans have grown more than  holdings of consumer loans. For example, real estate loans grew from 19  percent of total assets in 1992 to 26 percent in 2002, while consumer loans  grew from 30 percent to 31 percent over the same period. Despite a larger  increase in real estate lending relative to consumer lending, credit unions  still had a significantly larger percentage of consumer loans relative to total  assets compared with their peer group banks and thrifts: consumer loan  balances of peer group banks and thrifts were less than 8 percent of total  assets in 2002. To provide context, in terms of dollar amounts, credit  unions had $175 billion in consumer loans while peer group banks and  thrifts had $190 billion in consumer loans. However, these banks and thrifts  held a greater percentage of real estate loans than credit unions. See  appendix III for additional details.
section_title: Credit Union Profitability Has Been Relatively Stable in Recent Years
paragraphs: The profitability of credit unions, as measured by the return on average  assets, has been relatively stable in recent years. The industry’s return on  average assets was higher in the early to mid-1990s than in the late 1990s  and early 2000s. While declining from 1.39 in 1993 to 0.94 in 1999, the return  on average assets has since stabilized. It has generally hovered around 1,  which, by historical banking standards, is a performance benchmark, and it  was reported at 1.07 as of December 31, 2002. For comparative purposes,  the return on average assets for peer group banks and thrifts was 1.24 in  2002. Earnings, or profits, are an important source of capital for financial  institutions in general and are especially important for credit unions, as  they are mutually owned institutions that cannot sell equity to raise capital.  As previously mentioned, credit unions create capital, or net worth, by  retaining earnings. Most credit unions begin with no net worth and  gradually build it over time.
section_title: Regulatory Ratings Have Improved
paragraphs: Since we last reported on the financial condition of credit unions, there has  been a significant drop in the number of problem credit unions as  measured by the regulatory ratings of individual credit unions. Regulatory  ratings are a measure of the safety and soundness of credit union  operations, and credit unions with an overall CAMEL rating of 4 (poor) or 5  (unsatisfactory) are considered problem credit unions. The number of  problem credit unions declined by 63 percent from 578 (5 percent of all  credit unions) in 1992 to 211 (2 percent of total) in 2002.
section_title: Consolidation in Industry Has Widened the Gap between Larger and Smaller Credit Unions
paragraphs: Total assets in federally insured credit unions grew from $258 billion in  1992 to $557 billion in 2002, an increase of 116 percent. During this same  period, total member shares in these credit unions grew from $233 billion  to $484 billion, an increase of 108 percent. At the same time, the number of  federally insured credit unions fell from 12,595 to 9,688. As a result of the  increase in total assets and the decline in the number of federally insured  credit unions, the credit union industry has seen an increase in the average  size of its institutions and a slight increase in the concentration of assets.  At year-end 1992, credit unions with more than $100 million in assets  represented 4 percent of all credit unions and 52 percent of total assets; at  year-end 2002, credit unions with more than $100 million in assets  represented about 11 percent of all credit unions and 75 percent of total  assets. From 1992 to 2002, the 50 largest credit unions by asset size went  from holding around 18 percent of industry assets to around 23 percent of  industry assets. Despite the slight increase in concentration of assets in the  credit union industry, it was neither as concentrated as the banking  industry, nor did it witness the same degree of increased concentration.  From 1992 to 2002, the 50 largest banks by asset size went from holding  around 34 percent of industry assets to around 58 percent of industry  assets. Appendix IV has additional information on assets in federally  insured credit unions and banks.
This consolidation in the credit union industry has in part widened the gap  between two distinct groups of federally insured credit unions—larger  credit unions, which are relatively few in number and provide a wider  range of services, and smaller credit unions, which are greater in number  and provide more basic banking services. Figure 2 illustrates institution  size and asset distribution in the credit union industry as of 2002, with  institutions classified by asset ranges; smaller credit unions are captured in  the first category, while credit unions with assets in excess of $100 million  are separated into additional asset ranges for illustrative purposes. For  example, as of December 31, 2002, the 8,642 smaller credit unions—those  with $100 million or less in total assets—constituted nearly 90 percent of all  credit unions but held only 25 percent of the industry’s total assets (see  right-hand axis of fig. 2). Conversely, the 71 credit unions with assets of  between $1 billion and $18 billion, held 27 percent of total industry assets  (see right-hand axis of fig. 2) but represented less than 1 percent of all  credit unions.
We observed that larger credit unions tended to hold a wider variety of  loans than did smaller credit unions, and larger credit unions emphasized  different loan types than smaller credit unions. For example, new and used  vehicle loans have represented a relatively greater proportion of total  assets for smaller credit unions, and nearly all smaller credit unions held  such loans. However, while nearly all of the larger credit unions held new  and used car loans, first mortgage loans represented a relatively greater  proportion of total assets for larger credit unions. In fact, nearly all larger  credit unions held first mortgage loans, junior mortgage and home equity  loans, and credit card loans, while in general less than half of the smaller  credit unions held these loans. Larger credit unions also tended to be more  likely to provide more sophisticated services, such as financial services  through the Internet and electronic applications for new loans. While  nearly all larger credit unions offered automatic teller machines, less than  half of smaller credit unions did. In fact, when compared with similarly  sized peer group banks and thrifts, larger credit unions tended to appear  very similar to their bank peers in terms of loan holdings. Appendixes IV  and V provide further details.
section_title: Limited Comprehensive Data Are Available to Evaluate Income of Credit Union Members
paragraphs: As credit unions have become larger and offer a wider variety of services,  questions have been raised about whether credit unions are more likely to  serve households with low and moderate incomes than banks. However,  limited comprehensive data are available to evaluate income of credit  union members. Our assessment of available data—the Federal Reserve’s  2001 SCF, 2001 HMDA data, and other studies—provided some indication  that credit unions served a slightly lower proportion of households with  low and moderate incomes than banks. Industry experts suggested that  credit union membership characteristics—occupationally based fields of  membership and traditionally full-time employment status—could have  contributed to this outcome. However, limitations in the available data  preclude drawing definite conclusions about the income characteristics of  credit union members. Additional information, especially with respect to  the income levels of credit unions’ members receiving consumer loans,  would be required to assess more completely whom credit unions serve.
subsections: section_title: Data Lacking on Income Characteristics of Credit Union Members and Users
paragraphs: It has been generally accepted, particularly by NCUA and credit union  trade groups, that credit unions have a historical emphasis of serving  people with modest means. However, there are currently no  comprehensive data on the income characteristics of credit union  members, particularly those who actually receive loans and other services.  As credit unions have become larger and expanded their offerings of  financial services, industry groups, as well as consumer advocates, have  debated which economic groups benefit from credit unions’ services.  Additionally, questions have been raised about credit unions’ exemption  from federal income taxes. As stated in our 1991 report, and still true, none  of the common-bond criteria available to federally chartered credit unions  refers to the economic status of their members or potential members.
Information on the extent to which credit unions are lending and providing  services to households with various incomes is scarce because NCUA,  industry trade groups, and most states (with the exception of  Massachusetts and Connecticut) have not collected specific information  describing the economic status of credit union members who obtain loans  or benefit from other credit union services. Credit unions, even those  serving geographic areas, are not subject to the federal Community  Reinvestment Act (CRA), which requires banking regulators to examine  and rate banks and thrifts on lending and service to low- and moderate- income neighborhoods in their assessment area. As a consequence, credit  unions are not required by NCUA or other regulators to maintain data on  the extent to which loans and other services are being provided to  households with various incomes.
However, two states—Massachusetts and Connecticut—collect  information on the distribution of credit union lending by household  income and the availability of services because their state-chartered credit  unions are subject to examinations similar to those of federally regulated  institutions. Modeled on the federal examination procedures for large  banks, the state regulators apply lending and service tests to assess  whether credit unions are meeting the needs of the communities they have  set out to serve, including low- and moderate-income neighborhoods.  Massachusetts established its examination procedures in 1982, and  Connecticut in 2001.All credit unions in Massachusetts are subject to  these examinations, including those whose field of membership is  community-based. In contrast, in Connecticut, only state-chartered credit  unions serving communities with more than $10 million in assets are  subject to the examination. According to a Connecticut state official, the  Connecticut legislature established its examination due to an increasing  trend of multiple-bond credit unions to convert to community-chartered  bonds, and the $10-million threshold was chosen because the legislature  believed credit unions of that size would normally have the personnel and  technological resources to appropriately identify and serve their market. In  May 2003, Connecticut started to examine community-chartered credit  unions with assets of more than $10 million.
Consumer and industry groups have debated if information that  demonstrates whether credit unions serve low- and-moderate income  households is necessary. Some consumer groups believe that credit unions  should supply information that indicates they serve all segments of their  potential membership. The Woodstock Institute—an organization whose  purpose is to promote community reinvestment and economic  development in lower-income and minority communities—recommended,  among other things, that the CRA requirement should be extended to  include credit unions, based on a study they believe demonstrated that  credit unions are not adequately serving low-income households.Woodstock Institute officials noted that they would prefer to see CRA  requirements applied to larger credit unions, those with assets over $10  million. The National Federation of Community Development Credit  Unions (NFCDCU) has recommended that credit unions whose fields of  membership cover large communities should be affirmatively held  accountable for providing services to all segments of those communities,  and that NCUA publish annual reports on the progress and status of these  expanded credit unions. In contrast, NCUA and industry trade groups  have opposed these and related requirements largely because they state  that no evidence suggests that credit unions do not serve their members.
section_title: Federal Reserve Board Data Suggest That Credit Unions Serve a Slightly Lower Proportion of Low- and Moderate-income Households
paragraphs: Our analysis of the Federal Reserve Board’s 2001 SCF suggested that credit  unions overall served a lower percentage of households of modest means  (low- and moderate-income households combined) than banks. More  specifically, while credit unions served a slightly higher percentage of  moderate-income households than banks, they served a much lower  percentage of low-income households. The SCF is an interview survey of  U.S. households conducted by the Federal Reserve Board that includes  questions about household income and specifically asks whether  households use credit unions or banks. Our analysis of the SCF indicated  the following percentages for those households that used a financial  institution:
8 percent of households only used credit unions,
13 percent of households primarily used credit unions,
17 percent of households primarily used banks, and
62 percent of households only used banks.
To provide a more consistent understanding of our survey results, we used  the same income categories used by financial regulators—low, moderate,  middle, and upper—in their application of federal CRA examinations.
To determine the extent to which credit unions served people of “modest  means,” we first combined households with low or moderate incomes into  one group and combined households with middle or upper incomes into  another group. We then combined the SCF data into two main groups—  households that only and primarily used credit unions versus households  that only and primarily used banks. As shown in figure 3, this analysis  indicated that about 36 percent of households that only or primarily used  credit unions had low or moderate incomes, compared with 42 percent of  households that used banks. Moreover, our analysis suggested that a  greater percentage of households that only and primarily used credit  unions were in the middle- and upper-income grouping than the proportion  of households that only and primarily used banks.
To better understand the distribution of households by income category,  we also looked at each of the four income categories separately. As shown  in figure 4, this analysis suggested that the percentage of households that  only and primarily used credit unions in the low-income category was  lower than the percentage of households that used banks in the same  category (16 percent versus 26 percent). In contrast, households that only  and primarily used credit unions were more likely to be moderate- and  middle-income (19 percent and 22 percent) than those that only and  primarily used banks (16 and 17 percent). Given that credit union  membership has traditionally been tied to occupational- or employer-based  fields of membership, the higher percentage of moderate- and middle- income households served by credit unions is not surprising.
We also attempted to further explore the income distribution of credit  unions’ members by separately analyzing households that only used credit  unions or banks from those that primarily used credit unions or banks.  However, the results were subject to multiple interpretations due to  characteristics of the households in the SCF database. For example, when  user groups are combined and compared, the results may look different  than when the groups are separated and compared. Because such a high  percentage of the U.S. population only uses banks (62 percent), the data  obtained from the SCF is particularly useful for describing characteristics  of bank users but much less precise for describing smaller population  groups, such as those that only used credit unions (8 percent).
In addition to assessing the income characteristics of households using  credit unions and banks, we also performed additional analysis by  education, race, and age. The results of these analyses can be found in  appendix VI.
section_title: Credit Unions Made a Slightly Lower Proportion of Mortgage Loans to Households with Low and Moderate Incomes Than Banks
paragraphs: As an indicator of the income levels of households that utilize credit union  services, we used 2001 HMDA loan application records to analyze the  income of households receiving mortgages for the purchase of one-to-four  family homes from credit unions and peer-group banks. Our analysis  indicated that credit unions reporting HMDA data made a lower proportion  of mortgage loans to households with low and moderate incomes than  peer group banks reporting HMDA data—27 percent compared with  34 percent. More specifically, credit unions made 7 percent of their loans  to low-income households compared with 12 percent for banks, and credit  unions made 20 percent of their loans to moderate-income households  compared with 22 percent for banks (see fig. 5).
We also analyzed and compared the proportion of mortgage loans reported  by peer group banks and credit unions for the purchase of homes by the  median family income of the census tracts in which the homes were  located. We found that credit unions made roughly the same proportion of  loans for the purchase of homes, by census tract income category, as  banks. For example, we found that both credit unions and banks made 1  percent of their loans for the purchase of homes in low-income census  tracts and that credit unions made 9 percent of their loans for the purchase  of properties in moderate-income census tracts compared with 10 percent  by banks (see fig. 6). In addition, we found that both credit unions and  banks made 54 percent of their loans for the purchase of homes in middle- income census tracts, and that credit unions made about 37 percent of their  loans in upper-income census tracts compared with 35 percent by banks.  This analysis is a measure of whether all neighborhoods (census tracts  within an assessment area) are receiving financial services, including low- and moderate-income ones.
Because each HMDA loan record identified the income of the mortgage  loan recipient and the location of the property, the HMDA database allowed  us to determine the proportion of mortgages made within the four income  categories—low, moderate, middle, and upper—used by financial  regulators for CRA examinations. However, not all financial institutions are  required to report HMDA data—for example, depository institutions were  exempt from reporting data in 2001 if they had assets less than $31 million  as of December 31, 2000, and if they did not have a home or branch office in  an MSA. Further, not all credit unions, including those that had more than  $31 million in assets, made home purchase loans. As a result, most credit  unions did not meet HMDA’s reporting criteria—only about 14 percent of all  credit unions submitted data included in our analysis. On the other hand,  the credit unions that did report their loans to HMDA held about 70 percent  of credit union assets and included about 62 percent of all credit union  members.
section_title: HMDA Analysis Has Certain Limitations
paragraphs: Our analysis of HMDA data allowed us to determine the overall proportion  of mortgage loans credit unions and peer group banks made to households  and neighborhoods with low and moderate incomes. However, we would  need information on the proportion of low- and moderate-income  households within credit union fields of membership to actually make an  evaluation of whether credit unions, collectively or individually, have met  the credit needs of their entire field of membership. Similar to analyses  used in federal CRA lending tests, this information could then be used as a  baseline from which to evaluate an individual credit union’s actual lending  record. In addition, information on factors (for example, a community’s  economic condition, local housing costs) that could affect the ability of a  credit union to make loans consistent with safe and sound lending would  be necessary to evaluate an institution’s lending record. If regulators were  to make these types of evaluations for credit unions, they would be easier  to implement for those serving geographic areas because demographic  information (for example, on census tract median income levels) would be  available to describe credit union field of membership. For credit unions  with an occupational or associational membership, other ways of  characterizing their field of membership would need to be determined.
In addition, as previously mentioned, using HMDA data to analyze credit  union mortgage lending to members does not provide any information on  smaller credit unions, because in 2001 credit unions with less than $31  million in assets as of December 31, 2000, were not required to report  HMDA data. Because smaller credit unions did not report HMDA data, one  group of credit unions—the roughly 3,800 credit unions that qualified for  NCUA’s Small Credit Union Program in December 2002—were largely  excluded from our HMDA analysis. Credit unions qualifying for assistance  from this program must have less than $10 million in assets or have  received a “low-income” designation from NCUA. In addition, low-income  credit unions must demonstrate that more than half of their current  members meet one of NCUA’s low-income criteria. Further, smaller credit  unions are more likely than larger credit unions to make consumer loans  than mortgages, making an evaluation of mortgage lending more relevant  to larger credit unions than smaller ones. Because most credit unions can  be classified as small, analyzing the distribution of consumer loans by  household income would provide a more complete picture of credit union  lending.
section_title: Other Studies Indicate That Credit Unions Serve Households with Higher Incomes Than Banks
paragraphs: Other recently published studies—CUNA and the Woodstock Institute—  generally concluded that credit unions served a somewhat higher-income  population. The studies noted that the higher income levels could be due to  the full-time employment status of credit union members.
The CUNA 2002 National Member Survey reported that credit union  members had higher average income households than nonmembers—  $55,000 compared with $46,000. The report provided several reasons for  the income differential, including the full-time employment status of credit  union members, credit union affiliation with businesses or companies, and  weak credit union penetration among some of the lowest-income age  groups—18 to 24 and 65 and older. However, the report noted that  additional analyses, specifically those grouping consumers based on the  extent to which they rely on banks and credit unions as their primary  provider should also be considered. In addition, a study sponsored by the  Woodstock Institute, based on an analysis of 1999 and 2000 survey  responses obtained from households in the Chicago, Illinois, metropolitan  area concluded that credit unions in the Chicago region served a lower  percentage of lower-income households than they did middle- and upper- income ones. For example, while 40 percent of surveyed households with  incomes between $60,000–$70,000 contained a credit union member, only  23 percent of households earning between $30,000–$40,000 contained a  credit union member. The study also noted that household members  working for larger firms, and those who were members of a labor union,  were significantly more likely to be credit union members.
Officials from NCUA and the Federal Reserve Board also noted that credit  union members were likely to have higher incomes than nonmembers  because credit unions are occupationally based. An NFCDCU  representative noted that because credit union membership is largely  based on employment, relatively few credit unions are located in low- income communities. However, without additional research, especially on  the extent to which credit unions with a community base serve all of their  potential members, it is difficult to know whether full-time employment is  the sole explanatory factor.
section_title: CUMAA Authorized NCUA to Continue Preexisting Policies That Expanded Field of Membership
paragraphs: The Credit Union Membership Access Act of 1998 authorized preexisting  NCUA policies that had allowed credit unions to expand field of  membership. In 1998, the Supreme Court ruled against NCUA’s practice of  permitting federally chartered credit unions to consist of more than one  common bond.In CUMAA, Congress specifically permitted credit unions  to form multiple-bond credit unions and allowed these credit unions to  serve underserved areas. CUMAA also specified that community- chartered credit unions serve a “local” area.However, after the passage of  CUMAA, NCUA revised its regulations to make it easier for credit unions to  serve communities larger than before CUMAA. To some extent, these  NCUA policies appear to have been triggered by concerns about competing  with the states to charter credit unions. While CUMAA permitted multiple- bond credit unions to add underserved areas to their membership, the  impact of this provision will be difficult to assess because NCUA does not  track credit union progress in extending service to these communities.
subsections: section_title: CUMAA Permitted NCUA Policies Expanding Field of Membership
paragraphs: CUMAA authorized several preexisting NCUA field of membership policies  that had enabled federally chartered credit unions to expand their fields of  membership. These policies had allowed credit unions to consist of more  than one membership group and expand their membership to include  underserved areas. In addition, CUMAA permitted credit unions to retain  their existing membership.
Specifically, CUMAA affirmed NCUA’s 1982 policy of permitting credit  unions to form multiple-bond credit unions, allowing these credit unions to  retain their current membership and authorizing their future formation. A  credit union with a single common bond has members sharing a single  characteristic, for example, employment by the same company. In contrast,  multiple-bond credit unions consist of more than one distinct group. Congressional affirmation of NCUA’s policy of permitting multiple-bond  credit unions was important because earlier in 1998 the Supreme Court had  ruled that federally chartered, occupationally based credit unions were  required to consist of a single common bond. Figure 7 provides additional  information since 2000 on the percent of federally chartered credit unions  by charter type.
In addition, CUMAA affirmed other preexisting NCUA policies. For  example, CUMAA authorized multiple-bond credit unions to add  individuals or organizations in “underserved areas” to their field of  membership. This provision was similar to an NCUA policy that permitted  multiple-bond credit unions, as well other federally chartered, single-bond,  and community-chartered credit unions, to add low-income communities   to their field of membership. In addition, CUMAA affirmed NCUA’s “once  a member, always a member policy,” which had been in effect since 1968.  CUMAA authorized this policy such that credit union members may retain  their membership even after the basis for the original bond ended.However, CUMAA still contained provisions encouraging the creation of  new credit unions whenever possible.
section_title: NCUA Eased Requirements for Permitting Credit Unions to Serve Larger Geographic Areas
paragraphs: Despite the qualification in CUMAA that a community-chartered credit  union’s members be within a well-defined “local” community,  neighborhood, or rural district, NCUA eased requirements for permitting  credit unions to serve larger geographic areas. CUMAA added the word  “local” to the preexisting requirement that community-chartered credit  unions serve a “well-defined community, neighborhood, or rural district,”  but provided no guidance with respect to how the word “local” or any other  part of this requirement should be defined.
Following passage of CUMAA, NCUA expanded the ability of credit unions  to serve larger geographic areas through its regulatory rulings.Interpretive Ruling and Policy Statement (IRPS) 99-1, issued soon after  CUMAA, was the first regulation to set standards for what could be  considered a “local” area. It required credit unions to document that  residents of a proposed community area interact or have common  interests. Credit unions seeking to serve a single political jurisdiction (for  example, a city or a county) with more than 300,000 residents were  required to submit more extensive documentation than jurisdictions with  fewer than 300,000 residents. However, IRPS 03-1, which replaced IRPS  99-1, eliminated these documentation requirements, regardless of the  number of residents. Further, IRPS 03-1 allowed credit unions to propose  MSAs with less than 1 million residents for qualification as local areas. See  table 1 for changes in “local” requirements. NCUA adopted these  definitions of local community based on its experience in determining what  constituted a local community charter.
Specifically, NCUA officials said that they decided single political  jurisdictions should automatically qualify as “local” areas based on their  review of applications by credit unions for community charters. They  reported that they came to this conclusion because credit unions  converting to a community charter or expanding their service areas had  generally been able to successfully supply the documentation required by  NCUA. We asked NCUA officials what kind of relationships community- chartered credit union members could have if, for example, a local  community were to be defined as all of New York City. NCUA officials said  that the defining factors for them were that people lived in the same  political jurisdiction—thus providing, for example, a common government  and educational system—and noted that credit unions applying to serve  these larger jurisdictions still had to meet other requirements related to  safety and soundness. The officials also said that had CUMAA not  introduced the word “local,” NCUA could have considered providing credit  unions permission to expand their field of memberships statewide.
The regulatory changes in IRPS-03-1 pertaining to the definition of local  community have made it easier for federally chartered credit unions to  serve larger communities. Under IRPS-03-1, NCUA approved the largest  community yet—the 2.3 million residents of Miami-Dade County, Florida.NCUA had disapproved this same credit union’s request about 2 years  earlier, under IRPS 99-1, as amended by IRPS 01-1. Prior to IRPS-03-1, some  of the largest community field of memberships approved by NCUA  included service to 836,231 residents on Oahu, Hawaii, and service to  710,540 residents in Montgomery County and Greene County, Ohio. In  addition, over the last 3 years, potential membership––an estimate of the  maximum number of members that could join a credit union––in  community-chartered credit unions has come to exceed that in multiple- bond credit unions. According to NCUA estimates, in March 2003,  community-chartered credit unions had 98 million potential members  compared with multiple-bond credit unions with 92 million potential  members (see fig. 8).
section_title: Dual Chartering System May Have Created Pressure for Less Restrictive Field of Membership Regulations
paragraphs: According to NCUA, a major reason for NCUA’s recent regulatory changes  was to maintain the competitiveness of the federal charter in a dual  chartering system. They also characterized NCUA’s field of membership  regulations as more restrictive than those in some states. Officials in three  of the states in which we conducted interviews—California, Texas, and  Washington—said that the ability to expand field of membership more  readily under state rules was a reason that federally chartered credit unions  had converted to state charters.
Consistent with this assertion, we found that state-chartered credit unions  have experienced greater membership growth, although federally  chartered credit unions still had more members. Between 1990 and March  2003, state-chartered credit union membership increased by 88 percent,  from 19.5 million to 36.6 million, while membership in federally chartered  credit unions increased by 24 percent, from 36.2 million to 44.9 million. In  addition, if estimates of potential membership serve even as an  approximation of future membership, state-chartered credit unions could  be positioned to experience greater growth (see fig. 9). In March 2003,  state-chartered credit unions had about 405 million potential members,  almost twice the 208 million for federally chartered credit unions.
We also found that states had chartered a higher percentage of their credit  unions to serve geographic areas (communities) than NCUA. In 2002, we  estimated that about 1,146 state-chartered credit unions, 30 percent of all  state-chartered credit unions, served geographic areas compared with 848  federally chartered credit unions, 14 percent of all federally chartered  credit unions. However, this number increases to 1,096, 18 percent of all  federally chartered credit unions, once federally chartered credit unions  serving underserved areas are included. State-chartered credit unions  serving geographic areas held about 59 percent of state-chartered credit  unions assets compared with 17 percent held by federally chartered credit  union serving geographic areas, or 29 percent when the assets of credit  unions with underserved areas were included.
section_title: Credit Unions Have Added Underserved Areas, but No Information Available to Evaluate Actual Service
paragraphs: An NCUA objective is to ensure that credit unions provide financial  services to all segments of society, including the underserved, but NCUA  has not developed indicators to evaluate credit union progress in reaching  the underserved. This type of evaluation could require information similar  to that provided as part of CRA examinations—for example, information  on the distribution of loans made by the income levels of households  receiving mortgage and consumer loans—and provide comprehensive  information on how credit unions have utilized opportunities to extend  their services to underserved areas, including low- and moderate-income  households.  CUMAA had specifically provided that multiple-bond credit  unions could serve underserved areas, and NCUA permitted single-bond  and community-bond credit unions to add them as well. However, neither  CUMAA nor NCUA required that credit unions report on services to these  areas once they had been added. Figure 10 shows the number of  underserved areas added before and after CUMAA.
Instead of developing indicators to evaluate credit union progress in  reaching the underserved, NCUA officials have claimed success based on  the increase in the number of potential members added by credit unions in  underserved areas and, recently, on the membership growth rate of  federally chartered credit unions that have added underserved areas. As of  March 2003, credit unions had added 48 million potential members in  underserved areas. As noted previously, potential membership is an  estimate of the maximum number of people who could be eligible to join a  credit union. However, NCUA officials believe that potential membership is  an appropriate measure because they view NCUA’s role as expanding  membership opportunities for credit unions as opposed to the credit  unions’ role of actually extending services to new members. In addition,  in June 2003, NCUA claimed success based on estimates indicating that  annual membership growth in credit unions that expanded into  underserved areas has been higher than that of all federally chartered  credit unions—4.8 percent compared with 2.49 percent. However, they  could not identify whether the increase in membership actually came from  the underserved areas or provide any descriptive information (for example,  the income level) about the new members.
Because NCUA does not collect information on credit union service to  underserved areas, it would be difficult for NCUA or others to demonstrate  that these credit unions are actually extending their services to those who  have lower incomes or do not have access to financial services. As the  number of credit unions adding underserved areas increases, this question  becomes more important. For example, in 1999, the year after CUMAA, 13  credit unions added 16 underserved areas to their membership. In 2002, 223  credit unions added about 424 underserved areas. Further, the size of these  communities can be substantial. For example, in May 2003, NCUA  permitted one multiple-bond credit union to add an additional 300,000  residents within Los Angeles County, California, for a total of almost 1  million added residents in the last 2 years. In the same month, NCUA also  approved a multiple-bond credit union’s (headquartered in Dallas, Texas)  addition of 600,000 residents in underserved communities in Louisiana.
section_title: NCUA Adopted Risk- focused Examination and Supervision Program, but Faces Challenges in Implementation
paragraphs: Industry consolidation and changes in products and services offered by  credit unions prompted NCUA to move from an examination and  supervision approach that was primarily focused on reviewing transactions  to an approach that focuses NCUA resources on high-risk areas within a  credit union. Prior to implementing its risk-focused program in August  2002, NCUA sought guidance from other depository institution regulators  that had several years of experience with risk-focused programs. While this  consultative approach helped NCUA, it still faces a number of challenges  that create additional opportunities for NCUA to leverage off the  experience of the other depository institution regulators. These challenges  include ensuring that examiners have sufficient expertise in areas such as  information systems, monitoring the risks posed by expansion into  nontraditional credit union activities such as business lending, and  monitoring the risks posed to the federal deposit (share) insurance fund by  institutions for which states are the primary regulator. Moreover, unlike  other depository institution regulators, NCUA currently lacks authority to  inspect third-party vendors, which credit unions increasingly rely on to  provide services such as electronic banking. Further, credit unions are not  subject to the internal control reporting requirements that banks and thrifts  are subject to under FDICIA. NCUA adopted prompt corrective action, a  system of supervisory actions tied to the capital levels of an institution, in  August 2000, as required by CUMAA; few actions have been taken to date  due to a generally favorable economic climate for credit unions.
subsections: section_title: Changes in the Credit Union Industry Prompted NCUA to Revise Its Approach to Examination and Supervision
paragraphs: The credit union industry has undergone a variety of changes that  prompted NCUA to revise its approach to examining and supervising credit  unions. As described earlier, the credit union industry is consolidating, and  more industry assets are concentrated in larger credit unions, those with  assets in excess of $100 million. For example, in December 1992, credit  unions with over $100 million in assets held 52 percent of total industry  assets, but by December 2002, they held 75 percent of total industry assets.  Furthermore, credit unions are providing more complex electronic services  such as Internet account access and on-line loan applications to meet the  demands of their members. Thirty-five percent of the industry offered  financial services through the Internet as of December 2002; however, the  rate increased to over 90 percent for larger credit unions. In addition, the  composition of credit union assets has changed over time, with credit  unions engaging in more real estate loans (see fig. 11). For example, the  number of first mortgage loans about doubled from 589,000 loans as of  December 1992 to 1.2 million loans as of December 2002. During this same  period, the amount of first mortgage loans more than tripled from $29  billion to $101 billion. From 1992 to 2002, the percentage of real estate  loans to total assets grew from 19 percent to 26 percent, a greater rate of  growth than that of consumer loans over the same time period. The longer- term real estate loans introduced a greater level of interest rate risk than  that introduced through the shorter-term consumer loans credit unions  traditionally made.
As a result of these changes, NCUA found that its old approach of  reviewing the entire operation of credit unions and conducting extensive  transaction testing no longer sufficed, particularly for larger credit unions,  because of the number of transactions in which they engaged and the  variety of products and services they tended to provide. In contrast, under  the risk-focused approach, NCUA examiners are expected to identify those  activities that pose the highest risk to a credit union and to concentrate  their efforts on those activities. For example, as credit unions engage in  more complex electronic services, examiners are to focus their efforts on  reviewing information systems and technology to ensure that credit unions  have sufficient controls in place to manage operations risk.In addition, as  credit unions engage in more real estate lending, examiners are to focus on  ensuring that these credit unions have sophisticated asset-liability  management models in place to properly manage interest rate risk. When  transaction testing is used under the risk-focused approach, it is used to  validate the effectiveness of internal control and other risk-management  systems. Further, the risk-focused approach places more emphasis on  preplanning and off-site monitoring of credit union activities, which helps  ensure that once examiners arrive on site, they already will have identified  those areas of the greatest risk in a credit union and where to focus their  resources.
To compliment the risk-focused approach and allow NCUA to better  allocate its resources, the agency adopted a risk-based examination  program in July 2001. This program eliminates the requirement to perform  annual examinations on low-risk credit unions, replacing annual exams  with two examinations in a 3-year period.
section_title: NCUA Took Various Steps to Ensure Successful Implementation of the Risk- focused Program
paragraphs: NCUA consulted with its Office of Corporate Credit Unions to inquire  about their experiences with their risk-focused program that was  implemented in 1998. As a result of this consultation, NCUA incorporated a  greater level of examiner judgment in its risk-focused approach,  specifically allowing examiners to determine the appropriate level of on- site versus off-site supervision. For example, if an examiner discovered a  problem during off-site monitoring of a credit union, the examiner might  adjust the schedule of the on-site examination to directly address the  problem. In addition, in recognition that examiners would be required to  assess the future risks that credit unions might be undertaking, NCUA,  after consulting with its Office of Corporate Credit Unions, required that  examiners review information beyond the financial statements. For  example, under the risk-focused program, examiners might analyze due  diligence reviews by management for new and existing products and  services, internal controls, and measurements of actual performance  against forecasted results, to determine what future risks a particular  credit union might be undertaking.
NCUA’s consultations with FDIC and its review of two FDIC Inspector  General reports prompted NCUA to develop programs to address  challenges that FDIC experienced in implementing its risk-focused  program. For example, according to NCUA, FDIC did not conduct much  training for its examiners prior to implementing its risk-focused program.  NCUA, on the other hand, held training for all examiners, including state  examiners, and once the risk-focused program was implemented, NCUA  also provided additional training to help examiners assess risks more  effectively. NCUA’s review of the FDIC Inspector General reports found  that some FDIC examiners resisted the move to the risk-focused program.  NCUA’s response was to develop a quality control program to ensure that  examiners and supervisors were adopting the risk-focused approach and  that documentation was completed consistently across NCUA’s regions.  Under the quality control program, NCUA officials reviewed a sample of  examinations from each region for scope, conciseness of reports,  appropriateness of completed work papers and application of risk-focused  concepts. NCUA’s development of the quality control program was timely  and appropriate, because we found some NCUA examiners and state  supervisors were reluctant to move to the risk-focused program. The  examiners and supervisors were concerned that they would be blamed if a  credit union later had a problem in an area they had not initially identified  as high-risk.
NCUA’s consultations with the Office of the Comptroller of the Currency  (OCC) enabled NCUA to consider a different approach to improve its  oversight of large credit unions under the risk-focused program. OCC had  implemented a large bank program in recognition of the need for an  alternative approach to oversight of large and sophisticated banks. NCUA  likewise found the need for an alternative approach to oversight of large  credit unions because its examiners traditionally examined a large number  of small credit unions and very few larger ones and, thus, had been unable  to gain sufficient comfort and expertise in examining the larger, more  complex institutions. As a result of consultations with OCC, NCUA  implemented its Large Credit Union Pilot Program in January 2003 to,  among other things, develop a core of examiners with experience  overseeing these larger credit unions. Under this program, NCUA has also  experimented with different examination approaches, including targeted  examinations, which focus on certain aspects of credit union operations  such as the loans, investments, or asset-liability management. NCUA  officials told us that they received some preliminary feedback from credit  unions that found the pilot to be beneficial. However, because the pilot  ended recently, NCUA officials stressed that it was too early to tell how  effective this program will be in helping NCUA improve its examinations of  large credit unions.
In recognition that the risk-focused program was a significant departure  from NCUA’s old approach to examination and supervision, NCUA also  sought feedback from the industry on the risk-focused program by  developing a survey for credit unions to complete once they had gone  through their first risk-focused examination. NCUA reported that it had  received preliminary results from the survey that indicated that the risk- focused program has been well received. Specifically, NCUA received the  highest marks for examiners’ courteous and professional conduct, effective  overall examination process, and effective communication with  management and officials throughout the examination. Officials from some  of the large credit unions we interviewed were pleased with the program  because they felt that the examination was focused on the high-risk areas  that credit union officials needed to monitor. Likewise, examiners with  whom we spoke told us that adopting a risk-focused approach had made a  bigger difference in their oversight activities at the larger credit unions  because they could focus their resources on the high-risk areas of these  institutions. In contrast, the examiners relied on the old approach of  extensive transaction testing at the smaller credit unions that lacked  sufficient resources to implement robust internal control structures and  tended to limit their activities to the basic or traditional services offered by  credit unions.
section_title: NCUA Has Further Opportunities to Leverage the Experiences of Other Regulators to Address Existing Challenges
paragraphs: NCUA faces a number of challenges in implementing its risk-focused  approach that create additional opportunities for it to leverage the  experiences of the other regulators that have been using risk-focused  programs for several years. These challenges include ensuring that  examiners have sufficient training to keep pace with changes in industry  technologies and methods, adequately preparing for monitoring credit  unions as they expand more heavily into nontraditional credit union  activities such as business lending, and overseeing state-chartered  institutions in states that lack sufficient examiner resources and expertise.
subsections: section_title: NCUA Faces Challenges in Ensuring That Examiners Are Adequately Trained to Assess Changing Technology
paragraphs: According to NCUA examiners who had recently implemented the risk- focused program, NCUA faces challenges in training its examiners in  specialized areas such as information systems and technology. Likewise, as  we found in prior reviews, other depository institution regulators also  faced these challenges in implementing risk-focused programs. Some  NCUA examiners with whom we spoke indicated that NCUA’s formal and  on-the-job training of subject matter examiners, particularly in the areas of  information systems and technology, payment systems, and specialized  lending, was insufficient and did not help them keep pace with the  changing technology in the industry. As a result, some examiners were not  confident that they could assess the adequacy of information systems that  were vital to the operations of some credit unions.
NCUA officials sought to address concerns about specialist training by  modifying their training manual to more clearly state what classes were  appropriate for the different specialized areas. Further, as a member of the  Federal Financial Institutions Examination Council (FFIEC), NCUA was  aware of specialized training offered by other depository institution  regulators under the auspices of FFIEC, and encouraged NCUA examiners  to take advantage of this training.However, NCUA had not specifically  consulted with other depository institution regulators on how these  regulators addressed the challenge of training their specialists as banks and  thrifts had become more complex over time.
section_title: NCUA Faces Challenge of Ensuring That It Is Adequately Prepared to Monitor Credit Unions as They Expand into Nontraditional Activities
paragraphs: NCUA’s revised regulation on member business loans also presents NCUA  with the challenge of ensuring that it is adequately prepared to monitor this  growing area of lending. A recent NCUA final rule on member business  loans relaxed certain requirements (allowing well-capitalized, federally  insured credit unions to offer unsecured business loans) and introduced a  new risk area for NCUA to monitor.(Appendix VII provides a detailed  description of changes to this and other NCUA rules and regulations since  1992.)
While member business loans are still a relatively small percentage of  credit union loans (2 percent) and there are statutory limits placed on these  loans, NCUA’s recently revised rules could result in credit unions making  more of these loans.The Department of the Treasury has raised concerns  that allowing credit unions to engage in unsecured member business loans  would increase risks to safety and soundness. Since member business  loans constitute only a small percentage of credit union lending, most  NCUA examiners will not have significant experience looking at this type  of lending activity. In contrast, banks and thrifts offer these loans to a much  greater extent than credit unions and their regulators do have experience in  this area.
section_title: Variability in State Oversight May Constrain NCUA’s Ability to Monitor Risks to NCUSIF Posed by Federally Insured, State- chartered Credit Unions
paragraphs: Due to variability in levels of state oversight and resources, NCUA may face  challenges in implementing the risk-focused program at the state level.  Lack of examiner resources and expertise in some states, high state  examiner turnover, and weakness of enforcement by some state regulators  may affect oversight of federally insured, state-chartered credit unions,  according to NCUA officials.
While state officials with whom we met had adopted NCUA’s risk-focused  program and indicated they were generally pleased with NCUA’s support,  some of these officials indicated that they faced challenges related to  oversight of their credit unions. For example, they indicated that budget  problems had made it difficult to hire additional staff. In addition, some  state officials indicated that they could not compete on pay with the  industry, which led to high examiner turnover. A state official from a large  state indicated that the increase in credit unions converting from federal to  state charters had stretched her examiner resources.
The challenges faced by states are of particular concern given that state  supervisors have primary responsibility for examining federally insured,  state-chartered credit unions, which as of December 31, 2002, held 46  percent of industry assets. Inadequate oversight of these state-chartered  institutions could have a negative impact on the financial condition of  NCUSIF. The FDIC and Federal Reserve share oversight responsibility with  state supervisors for state-chartered banks, and these regulators also face  challenges similar to those faced by NCUA with regard to variability in  state oversight.
In commenting on how it addressed some of the issues facing states, NCUA  officials told us that in cases where states lacked examiner resources or  expertise, NCUA provided its own staff to ensure that federally insured,  state-chartered credit unions were adequately examined. In addition,  NCUA conducted joint examinations with state supervisors on selected  federally insured, state-chartered credit unions to assess the risk they  posed to NCUSIF. Some state officials with whom we met raised concerns  over joint examinations, claiming that NCUA examiners tried to impose  federal regulations on these state-chartered credit unions. These state  officials also expressed concern over NCUA’s process for developing its  overhead transfer rate, which they claimed was not transparent. We  discuss the overhead transfer rate more fully later in this report.
section_title: NCUA Lacks Authority to Examine Third-party Vendors
paragraphs: As we reported in July 1999, NCUA does not have the third-party oversight  authority provided to other federal banking regulators, and the lack of such  authority could limit NCUA’s effectiveness in ensuring the safety and  soundness of credit unions.Credit unions are increasingly relying on  third-party vendors to support technology-related functions such as  Internet banking, transaction processing, and funds transfers. While these  third-party arrangements can help credit unions manage costs, provide  expertise, and improve services to members, they also present risks such  as threats to security of systems, availability and integrity of systems, and  confidentiality of information. With greater reliance on third-party vendors,  credit unions subject themselves to operational and reputation risks if they  do not manage these vendors appropriately. Although NCUA received  authority to examine third-party vendors as part of the year 2000 readiness  effort, this authority was temporary and expired on December 31, 2001.
While NCUA has issued guidance regarding due diligence that credit unions  should be applying to third-party vendors, NCUA must ask for permission  to examine third-party vendors. Without vendor examination authority,  NCUA has no enforcement powers to ensure full and accurate disclosure.  For instance, in one case NCUA was denied access by a third-party vendor  that provides record-keeping services for 99 federally insured credit unions  with $1.4 billion in assets. NCUA notified the credit unions to heighten their  due diligence to ensure that appropriate controls were in place at the third- party vendor. In another case, NCUA was given access to a third-party  vendor, but the vendor withheld financial statements from NCUA  examiners. The third-party vendor served 113 credit unions representing  almost $750 million in assets.
section_title: Credit Unions Not Subject to Internal Control Reporting Requirements of FDICIA
paragraphs: Credit unions with assets over $500 million are required to obtain an annual  independent audit of financial statements by an independent certified  public accountant, but unlike banks and thrifts, these credit unions are not  required to report on the effectiveness of their internal controls for  financial reporting. Under FDICIA and its implementing regulations, banks  and thrifts with assets over $500 million are required to prepare an annual  management report that contains a statement of management’s responsibility for preparing the  institution’s annual financial statements, for establishing and  maintaining an adequate internal control structure and procedures for  financial reporting, and for complying with designated laws and  regulations relating to safety and soundness; and management’s assessment of the effectiveness of the institution’s  internal control structure and procedures for financial reporting as of  the end of the fiscal year and the institution’s compliance with the  designated safety and soundness laws and regulations during the fiscal  year.
Additionally, the institution’s independent accountants are required to  attest to management’s assertions concerning the effectiveness of the  institution’s internal control structure and procedures for financial  reporting. The institution’s management report and the accountant’s  attestation report must be filed with the institution’s primary federal  regulator and any appropriate state depository institution supervisor and  must be available for public inspection. These reports allow depository  institution regulators to gain increased assurance about the reliability of  financial reporting.
Banks reporting requirements under FDICIA are similar to the reporting  requirement included in the Sarbanes-Oxley Act of 2002. Under Sarbanes- Oxley, public companies are required to establish and maintain adequate  internal control structures and procedures for financial reporting and the  company’s auditor is required to attest to, and report on, the assessment  made by company management on the effectiveness of internal controls.  As a result of FDICIA and Sarbanes-Oxley, reports on management’s  assessment of the effectiveness of internal controls over financial reporting  and the independent auditor’s attestation on management’s assessment  have become normal business practice for financial institutions and many  companies. Extension of the internal control reporting requirement to  credit unions with assets over $500 million could provide NCUA with an  additional tool to assess the reliability of internal controls over financial  reporting.
section_title: NCUA Implemented PCA as Mandated by CUMAA, but Few Actions Taken to Date
paragraphs: In August 2000, NCUA initially implemented PCA for credit unions. CUMAA  mandated that NCUA implement a PCA program in order to minimize  losses to NCUSIF. Under the program, credit unions and NCUA are to take  certain actions based on a credit union’s net worth. Other depository  institution regulators were required to implement PCA in December 1992.  PCA was intended to be an additional tool in NCUA’s arsenal and did not  preclude NCUA from taking administrative actions, such as cease and  desist orders, civil money penalties, conservatorship, or liquidation of  credit unions.
CUMAA requires credit unions to take up to four mandatory supervisory  actions—an earnings transfer, submission of an acceptable net worth  restoration plan, a restriction on asset growth, and a restriction on member  business lending—depending on their net worth ratios.Credit unions that  are adequately capitalized (net worth ratio from 6.0 to 6.99 percent) are  required to take an earnings transfer. Credit unions that are  undercapitalized (net worth ratio from 4.0 to 5.99 percent), significantly  undercapitalized (net worth ratio from 2.0 to 3.99 percent), or critically  undercapitalized (net worth ratio of less than 2 percent) are required to  take all four mandatory supervisory actions.
CUMAA also required NCUA to develop discretionary supervisory actions,  such as dismissing officers or directors of an undercapitalized credit union,  to complement the prescribed actions under the PCA program. CUMAA  also authorized NCUA to implement an alternative system for new credit  unions in recognition that these credit unions typically start off with zero  net worth and gradually build their net worth through retained earnings.Appendix IX provides more detail on NCUA’s implementation of PCA.
To date, NCUA has taken few actions against credit unions under the PCA  program due to a generally favorable economic climate for credit unions.  As of December 31, 2002, NCUA took mandatory supervisory actions  against 2.8 percent (276 of 9,688) of federally insured credit unions. Of  these credit unions, the vast majority—92 percent or 253—had under $50  million in assets. Further, 41 percent (113 of 276) of these credit unions  were required to develop net worth restoration plans. However, it is too  early to tell how effective these plans will be in improving the condition of  the credit unions or minimizing losses to NCUSIF.
Credit unions were similar to banks and thrifts with respect to PCA capital  categorization with 97.6 percent of credit unions considered well- capitalized compared to 98.5 percent of banks and thrifts (see table 2).  However, a slightly higher percentage of credit unions were  undercapitalized, significantly undercapitalized, and critically  undercapitalized than banks and thrifts.
Some NCUA, state, and industry officials claimed that PCA was beneficial  because it provided standard criteria for taking supervisory actions and  was a good way to restrain rapid growth of assets relative to capital.  However, many state officials expressed concern over PCA due to the  limited ability of credit unions to increase their net worth quickly, because  they can only do so through retained earnings. They indicated that if a  credit union were subject to PCA, it would be difficult for that credit union,  particularly a smaller one, to increase capital and graduate out of PCA. In  contrast, other financial institutions are able to raise capital more quickly  through the sale of stock.
Some of these state officials raised the issue of whether credit unions  should likewise have a means to raise capital quickly by allowing credit  unions to use secondary capital toward their capital requirement under  PCA.Texas allowed its state-chartered credit unions to raise secondary  capital even though the secondary capital could not count towards PCA.
According to the Texas credit union regulator, no credit unions had taken  advantage of the state’s secondary capital provision. Currently there is a  debate in the industry on whether secondary capital is appropriate for  credit unions. While some in the industry favor secondary capital as a way  to help credit union avoid actions under PCA, others have raised the  concern that allowing credit unions to raise secondary capital (for  example, in the form of nonmember deposits) could change the structure  and character of credit unions by changing the mutual ownership. As of  September 2003, NCUA had not taken a position on secondary capital.
Another concern raised by NCUA officials is in regard to the most  appropriate measure of the net worth ratio for PCA purposes. NCUA  officials have suggested using risk-based assets, rather than total assets, to  calculate the net worth ratio of credit unions because they believe risk- based assets more clearly reflect the risks inherent in credit unions’  portfolios. NCUA officials recognize that, similar to banks, a minimum net  worth ratio based on total assets (tangible equity for banks and thrifts)  would still be needed for those institutions that are critically  undercapitalized. For most credit unions, risk-based assets are less than  total assets; therefore, a given amount of capital would have a higher net  worth ratio if risk-based assets were used. While there may be some merit  in using risk-based assets, credit unions have been subject to PCA  programs for a short time, and the advantages and disadvantages of the  current programs are not yet evident.
Finally, some NCUA officials raised the concern that PCA has led to more  liquidations of problem credit unions. In the past, NCUA sought merger  partners for problem credit unions. However, NCUA officials told us that it  was more difficult to find merger partners because stronger credit unions  were concerned that their net worth ratio would be lowered by merging  with problem credit unions, thereby putting them closer to the 7.0 percent  net worth ratio that triggers PCA. As a result, the cost of mergers has  increased under PCA because NCUA would have to provide greater  incentives to a potential partner, and that has forced the agency to liquidate  credit unions to a greater extent than prior to PCA. While the initial costs of  liquidations appear to be high, the purpose of PCA is to reduce the  likelihood of regulatory forbearance and protect the federal deposit (share)  insurance funds through early resolution of problem institutions; thus, in  the long run, the overall costs to NCUSIF should be less because of PCA.
section_title: NCUSIF’s Financial Condition Appears Satisfactory, but Methodologies for Overhead Transfer Rate, Insurance Pricing, and Estimated Loss Reserve Need Improvement
paragraphs: NCUSIF appears to be in satisfactory financial condition. For most of the  past 10 years, NCUSIF’s financial condition has been stable as indicated by  the fund’s equity ratio, earnings, and net income. However, while remaining  positive as of December 31, 2002, NCUSIF’s net income declined in 2001  and 2002. Among the factors contributing to the decline was a drop in  investment revenues, a sharp increase in the overhead transfer rate, which  is the amount paid to NCUA’s Operating Fund for administrative expenses,  and an increase in losses to the insurance fund. Moreover, NCUA’s methods  for pricing NCUSIF insurance and for estimating losses to the fund did not  consider important factors such as current credit union risk. NCUA’s flat- rate insurance pricing does not allow for the fact that some credit unions  are at greater risk of failure than others, and the historical analysis NCUA  uses for determining estimated losses does not reflect current economic  conditions or consider the loss exposure of credit unions with varying risk.  As a result of the current weaknesses in the methodologies used by NCUA,  information reported on the financial condition of the fund may not  accurately reflect the current risks to the fund.
subsections: section_title: NCUSIF Has Met Statutory Fund Equity Ratio Requirements, but Concerns Exist over Transfers of Expenses to the Fund
paragraphs: Indicators of the financial condition and performance of NCUSIF have  generally been stable over the past decade. NCUSIF’s fund equity ratio—a  measure of the fund’s equity available to cover losses on insured deposits—  was within statutory requirements at December 31, 2002, as it has been  over the past decade.
CUMAA defines the “normal operating level” for the fund’s equity ratio as a  range from 1.20 percent to 1.50 percent. CUMAA has designated the NCUA  board to evaluate and set the specific operating level for the fund equity  ratio. In setting the level, the board considers current industry and fund  conditions, as well as the future economic outlook. For 2002, NCUA’s board  set the specific operating level at 1.30 percent. If the equity ratio exceeds  the board’s determined operating level, CUMAA requires NCUA to  distribute to contributing credit unions an amount sufficient to reduce the  equity ratio to the operating level. Also, should the equity ratio fall below  the minimum rate of 1.20 percent, under CUMAA, NCUA’s board must  assess a premium until the equity ratio is restored to and can be maintained  at 1.20 percent. (See appendix X for a more detailed discussion of the  funding process and accounting for NCUSIF.)
Between 1991 and 2002, the equity ratio has fluctuated between 1.23  percent and 1.30 percent, a rate that has remained in line with legal  requirements (see fig. 12). As of December 31, 2002, the ratio of fund equity  to insured shares for NCUSIF as reported by NCUA was 1.27 percent.
NCUSIF’s ratio can be usefully compared with the only other share or  deposit insurance funds in the United States currently—FDIC’s Bank  Insurance Fund (BIF), which insures banks, and its Savings Association  Insurance Fund (SAIF), which insures thrifts; and ASI, which insures state- chartered credit unions that are not federally insured. The NCUSIF ratio  was comparable with the other share and deposit insurance funds as of  December 31, 2002 (see fig. 13).
NCUSIF’s earnings—principally derived from its investment portfolio,  which has increased significantly since 1991—have been sufficient to cover operating expenses and losses from insured credit union failures; make additions to its equity with the net income that is retained by the maintain its equity in accordance with legal requirements; maintain its allowance for anticipated losses on insured deposits; avoid assessing premiums, except for 1991 and 1992; and make, in some years, distributions to insured credit unions.
NCUSIF’s net income has remained positive through 2002 and had  generally been increasing since 1993, until significant declines occurred in  2001 and 2002 (see fig. 14). The declines were due to a combination of  decreased yields from the investment portfolio, an increase in the overhead  transfer rate, and larger insurance losses on failed credit unions. The  investment portfolio of NCUSIF consists entirely of U.S. Treasury  securities. Yields on these securities have declined—for example, from 6.07  percent in 2000 to 5.10 percent in 2001 and to 3.18 percent in 2002 on its 1- to 5-year maturities—following similar general declines in market yields for  Treasury securities. Of the $40.2 million net income decline between 2000  and 2001, $22.2 million of the decline was attributable to increases in the  overhead transfer rate, and $15.3 million was attributable to declines in  investment income. Of the $47.5 million decline in net income between  2001 and 2002, $39.6 million was attributable to declines in investment  income, while $12.5 million was attributable to provision for insurance  losses. At the same time, operating expenses decreased by $5.1 million. For  2003, interest rates have continued to decline, which will likely continue to  negatively affect investment earnings.
The sharp increase in the overhead transfer rate and its negative impact on  NCUSIF’s net income have raised questions about NCUA’s process for  determining the transfer rate. The Federal Credit Union Act of 1934 created  the Operating Fund for the purpose of providing administration and service  to the credit union system—for example, the supervision and regulation of  the federally chartered credit unions.
NCUA’s Operating Fund is financed through assessment of annual fees to  federally chartered credit unions as well as the overhead transfer from  NCUSIF (see fig. 15). Federally chartered credit unions are assessed an  annual fee by the Operating Fund based on the credit union’s asset size as  of the prior December 31. The fee is designed to cover the costs of  providing administration and service, as well as regulatory examinations to  the Federal Credit Union System. NCUA’s board reviews the fee structure  annually. The overhead transfer from NCUSIF for administrative services  provides a substantial portion of funding for the Operating Fund. The  annual rate for the overhead transfer is set by NCUA’s board based on  periodic surveys of NCUA staff time spent on insurance-related activities  compared with noninsurance-related, or regulatory, activities. An amount  of overhead or administrative expense is transferred to NCUSIF in  proportion to staff time spent on insurance-related activities. The overhead  transfer is intended to account for NCUA staff being responsible for both  insurance and supervisory-related activities.
Between 1986 and 2000, the transfer rate was 50 percent, which, according  to NCUA management, was based on surveys that indicated staff time was  equally split between insurance and regulatory activities. For example, 50  percent of the Operating Fund’s $127.6 million, or $63.8 million, in expenses  for 2000 were allocated to and paid by NCUSIF. For 2001, NCUA’s Board of  Directors increased the overhead transfer rate to 67 percent on the basis  that Operating Fund staff had increased their insurance-related activities.  This resulted in a $24.7 million increase (almost 40 percent) from 2000 in  the amount being allocated to NCUSIF. For 2002 and 2003, the NCUA board  lowered the 67-percent overhead transfer rate to 62 percent by adjusting  downward its allocation of what it considered “nonproductive” time factors  such as employee administrative and education time used in the 2001  survey because it was reflective of regulatory rather than insurance-related  activities.
In September 2001, NCUA management engaged its financial audit firm,  Deloitte & Touche, to review the basis on which the transfer rate was  determined. The auditor’s report contained several recommendations that  indicated that NCUA’s 2001 survey of staff time spent on insurance-related  functions—the primary basis on which NCUA allocates administrative  expenses—may not have resulted in an accurate allocation. The lack of a  clear separation of the insurance and supervisory functions had also been  the focus of a recommendation in our 1991 report (still unimplemented)  that NCUA should establish separate supervision and insurance offices.The 2001 recommendations from NCUA’s financial audit firm included  improvements in communication with staff on the survey process and  results, frequency and timing of the survey, methods of survey distribution,  and updated documentation of survey definitions and purpose. The  auditors also noted that individuals were allocating time after the fact,  when recollection may have been faulty, rather than tracking their time  concurrently as would be possible if provided the survey and guidelines  prior to an assignment. Additionally, the auditors reported that, to provide  reliable results, the survey should cover a greater period of time. The  limited period used could significantly skew the resulting proportion of  activities devoted to insurance versus regulatory activities. The auditor’s  recommendations indicated that the survey’s lack of consistency and  reliability may have resulted in a misallocation of overhead expenses  between the operating and insurance funds. Any misallocation would affect  NCUSIF’s financial condition because any increase in the overhead transfer  rate results in a decrease of NCUSIF’s net income. Misallocations also can  significantly affect the financial results of the Operating Fund. In addition  to the auditor’s findings, some federally insured, state-chartered credit  unions and trade groups have expressed concerns about NCUA’s  calculation of its overhead transfer rate. Primarily, they say that NCUA has  not clearly defined insurance and regulatory functions, and its  methodology for determining the overhead transfer rate is not transparent  or understandable to participating credit unions.
According to NCUA’s management, NCUA has begun implementing  Deloitte & Touche’s recommendations. For example, selected field  examiners are now completing surveys in a timely manner for periods  covering a full year. However, headquarters staff are not required to  complete the surveys as management asserts the split of their time mirrors  that of field examiners. In addition, the transfer rate is calculated and  approved by management every few years. However conditions can change  that may result in the transfer rate not representing the current condition.  Changing workloads and conditions can also cause a significant change in  future rates.
section_title: Federal Credit Union Insurance Pricing Is Not Based on Risk to Insurer
paragraphs: The Federal Credit Union Act requires all federally insured credit unions to  allocate 1 percent of their insured shares to NCUSIF. This flat rate does not  take into consideration variations in risk posed by individual credit unions.  Although FDIC had implemented a version of risk-based pricing in 1993,  FDIC has continued to study options for improving deposit insurance  funding. FDIC’s suggestions for improvement were issued in a 2001 report  that noted the cost of insurance, regardless of type (property, casualty, or  life), in the private sector is priced based upon the risk assumed by the  insurer. Premiums and loss experience are generally actuarially  determined, such that increased risk equates to increased cost. Since  passage of FDICIA in 1991, deposit insurance for banks and thrifts are  adjusted for some risk, and since December 31, 2000, private-sector  insurance for credit union shares has been adjusted for risk. (See  appendix X for additional information on accounting for insurance.) While  BIF and SAIF are adjusted for some risk, FDIC has made additional  proposals for enhancing the risk-based nature of its insurance pricing. For  instance, the current BIF and SAIF funding does not require a fast-growing  institution to pay premiums if it is well capitalized and CAMEL-rated 1 or 2.  As a result, FDIC has proposed that the pricing structure for BIF and SAIF  be amended so that fast-growing institutions would be required to pay  premiums.
NCUSIF is the only share or deposit insurer that has not adopted a risk- based insurance structure. Therefore, some credit unions could be  overpaying while others could be underpaying if their current rates were  compared to their risk profiles—with the cost of insurance not being  equitable based on the level of risk posed to NCUSIF by individual credit  unions. In contrast, FDIC’s BIF and SAIF and ASI currently operate on a  risk-based capitalization structure. Depository institutions insured by BIF  and SAIF pay a premium twice a year based upon their capital levels and  supervisory ratings, with institutions with the lowest capital levels and  worst supervisory ratings paying higher premiums. ASI’s insurance fund  requires its insured credit unions to maintain deposits between 1.0 and 1.3  percent of their insured shares. The amount for each credit union is  determined based upon its supervisory rating, with lower-rated credit  unions maintaining higher deposits.
The risk-based structure has certain advantages. First, by varying pricing  according to risk, more of the burden is distributed to those members that  put an insurance fund at greater risk of loss. Second, risk-based pricing  provides an incentive for member owners and managers of credit unions to  control their risk. Finally, risk-based pricing helps regulators focus on  higher-risk credit unions by enabling them to allocate their insurance  activities in proportion to the price charged. During our review, members  of NCUA’s management told us that they believe that risk-based pricing  would adversely affect small credit unions and suggested that an option  would be to add risk-based pricing only for credit unions over a certain  size. By not having risk-based insurance structure, NCUSIF puts a  disproportionate share of the pricing burden on less-risky credit unions and  does not provide an incentive through pricing for owners and managers to  control their risk.
section_title: Management’s Estimation of Insured Share Losses Does Not Reflect Specific Loss Rates
paragraphs: NCUA’s process for determining estimated losses from insured credit  unions—the largest potential liability of the fund—does not reflect current  economic conditions and loss exposures of credit unions with varying risk.  The estimated liability balance is established to cover probable and  estimable losses as a result of federally insured credit union failures. The  estimated liability balance is reduced when the insurance claims are  actually paid. NCUSIF’s estimated liability for losses was $48 million at  December 31, 2002.
In 2002, NCUA’s management analyzed historical loss trends over varying  periods of time in order to assess whether the estimated liability for losses  was adequate. It analyzed historical rates of insurance payouts for the past  3-year, 5-year, 10-year, and 15-year averages. The 15-year analysis  encompassed an economic period of dramatic losses, which management  contends may be cyclical and indicative of future exposure, although not  necessarily indicative of current economic conditions. As a result of this  analysis, in July 2002, management began building the estimated losses  account balance by $1.5 million a month to $60 million (from $48 million at  December 31, 2002), the amount the analysis determined would be needed  to cover identified and anticipated losses.
NCUA’s estimation method does not identify specific historical failure rates  and related loss rates for the group of credit unions that had been identified  as troubled, but instead specifically calculates expected losses for each  problem credit union, if it is determined that a particular credit union is  likely to fail. This methodology essentially assigns a probability of failure of  either zero or 100 percent to each individual credit union considered to be  troubled. By not considering specific historical failure rates and loss rates  in its methodology, NCUA is using an over-simplified estimation method. As  a result, NCUA may not be achieving the best estimate of probable losses.  Therefore, NCUA may be over or underestimating its probable losses  because it does not apply more targeted and specific loss rates to currently  identified problem institutions, but instead, makes a determination that  essentially selects from two probabilities: zero or 100-percent probability  of failure.
From 2000 to 2002, the amount of insured shares in problem credit unions  doubled, going from $1.5 billion insured shares in 2000 to nearly $3 billion  insured shares in 2002. The increase in insured shares of problem credit  unions may be an indicator of larger future losses to the fund, since  problem credit unions are more likely to fail. In addition, recent increases  the share payouts show that the insurance fund is suffering from increasing  losses that totaled $40 million in 2002. At the same time, the estimated loss  reserve, which is intended to cover actual losses, has been declining since  1994. As a result the cushion between payouts for insurance losses and the  reserve balance became increasingly smaller between 2001 and 2002 (see  fig. 16). Given the recent trends, it is especially important to utilize specific  data on failure rates for troubled institutions.
In contrast to NCUA’s method, FDIC’s method records estimated bank and  thrift insurance losses based on a detailed analysis of institutions in five  risk-based groups. The first group consists of institutions classified as  having a 100-percent expected failure rate. This determination is based on  the scheduled closing date for the institution, the classification of the  institution as “critically undercapitalized,” or identification of the  institution as an imminent failure. The remaining four risk groups are based  on federal and state supervisory ratings and the institutions’ projected  capitalization levels. Every quarter, FDIC meets with representatives from  other federal financial regulatory agencies to discuss these groupings and  ensure that each institution is appropriately grouped based on the most  recent supervisory information. Also on a quarterly basis, FDIC’s Financial  Risk Committee (FRC), an interdivisional committee, meets to discuss and  determine the appropriate projected failure rates to be applied to each of  the four remaining risk-based groups. The projected failure rate for each  risk-based group is multiplied by the assets of each institution in that  group, which results in expected failed assets. Expected failed assets are  then multiplied by an expected loss experience rate, the product of which  results in the loss estimate for anticipated failures. The projected failure  rates for the remaining four risk-based groups are based on historical  failure rates for those categories. However, FRC has the responsibility for  determining if the historical failure rates for each group are appropriate  given the current and expected condition of the industry and may adjust  failure rates, if necessary. The expected loss experience rates have been  based on asset size and reflect FDIC’s historical loss experience for banks  of different sizes. FRC may also use loss rates based on institution-specific  supervisory information rather than the historical rates. This process, as  implemented by FDIC, results in a more targeted estimation process that  specifically captures current changes in the risk profile of insured  institutions.
section_title: System Risk That May Be Associated with Private Share Insurance Appears to Have Decreased, but Some Concerns Remain
paragraphs: The amount of insured shares and the number of privately insured credit  unions and providers of private primary share insurance have declined  significantly since 1990. Specifically, 1,462 credit unions purchased private  share insurance in 1990 compared with 212 credit unions as of December  2002. During the same period, the total amount of privately insured shares  decreased by 42 percent ($18.6 billion to about $10.8 billion). Although the  use of private share insurance has declined, some circumstances of the  remaining private insurer, ASI, raise concerns. First, ASI’s risks are  concentrated in a few large credit unions and in certain states. Second, ASI  has a limited ability to absorb catastrophic losses because it does not have  the backing of any governmental entity and its lines of credit are limited in  the aggregate as to the amount and available collateral. To mitigate its  risks, ASI has implemented a number of risk-management strategies, such  as increased monitoring of its largest credit unions. State oversight  mechanisms of the remaining private share insurer and privately insured  credit unions also provide some additional assurance that ASI and the  credit unions it insures operate in a safe and sound manner. One additional  concern, as we recently reported, is that many privately insured credit  unions failed to make required disclosures about not being federally  insured and, therefore, the members of these credit unions may not have  been adequately informed that their deposits lacked federal deposit  insurance.
subsections: section_title: Few Credit Unions Are Privately Insured
paragraphs: Compared with federally insured credit unions, relatively few credit unions  are privately insured. As of December 2002, 212 credit unions—about 2  percent of all credit unions—chose to purchase private primary share  insurance. These privately insured credit unions were located in eight  states and had about 1.1 million members with shares totaling about $10.8  billion, as of December 2002—a little over 1 percent of all credit union  members and 2 percent of all credit union shares. In contrast, as of  December 2002, there were 9,688 federally insured credit unions with about  81 million members and shares totaling $483 billion.
Through a survey of 50 state regulators and related follow-on discussions  with the regulators, we identified nine additional states that could permit  credit unions to purchase private share insurance.Figure 17 illustrates  the states that permit or could permit private share insurance as of March  2003 and the number of privately insured credit unions as of December  2002.
The number of privately insured credit unions and private share insurers  has declined significantly since 1990. In 1990, 1,462 credit unions in 23  states purchased private share insurance from 10 different nonfederal,  private insurers, with shares at these credit unions totaling $18.6 billion.  Between 1990 and 2002, the amount of privately insured shares decreased  42 percent to about $10.8 billion. Shortly after the failure of Rhode Island  Share and Depositors Indemnity Corporation (RISDIC), a private share  insurer in Rhode Island in 1991, almost half of all privately insured credit  unions converted to federal share insurance voluntarily or by state mandate.As a result of the conversions from private to federal share  insurance, most private share insurers have gone out of business due to the  loss of their membership since 1990; only one company, ASI, currently  offers private primary share insurance.
In states that currently permit private share insurance, a comparable  number of credit unions have converted from federal to private share  insurance and from private to federal share insurance since 1990—31 and  26, respectively. Most of the conversions from federal to private share  insurance (26 of 31) occurred since 1997. According to management at  many privately insured credit unions, they converted to private share  insurance to obtain higher coverage and avoid federal rules and regulation.  Additionally, management at these credit unions noted that they were  satisfied with the service they received from the private share insurer and  all but one planned to remain privately insured. According to NCUA—in  states that currently permit private share insurance—since 1990, 26 credit  unions converted from private to federal share insurance; the majority did  so in the early 1990s, following the RISDIC failure and widespread concern  over the safety and soundness of private share insurance.Most of the 26  credit unions planned to continue to purchase federal share insurance  either because they were reasonably satisfied or because they viewed  having their share insurance backed by the federal government as a benefit.
section_title: Risks Exist at Remaining Private Share Insurer, but Certain Factors Help to Mitigate Concerns
paragraphs: Although the use of private share insurance has declined, we found two  aspects of the remaining private insurer that raise potential safety and  soundness concerns. First, ASI faces a concentration of risk in a few large  credit unions and certain states. Second, ASI has limited borrowing  capacity and could find it difficult to cover catastrophic losses under  extreme economic conditions because it does not have the backing of any  governmental agency, its lines of credit are limited in the aggregate as to  the amount and available collateral, and it has no reinsurance for its  primary share insurance. To help mitigate these risks, ASI has taken steps  to increase its monitoring of its largest credit unions and is using other  strategies to limit its risks. In addition, as a regulated entity, state regulation  of ASI and the credit unions it insures provides some additional assurance  that ASI and the credit unions operate in a safe and sound manner.
subsections: section_title: Risks of Remaining Private Insurer Concentrated in a Few Credit Unions and States
paragraphs: ASI is chartered in Ohio statute as a credit union share guaranty  corporation. As specified in Ohio statute, the purpose of such a  corporation includes guaranteeing payment of all or a part of a  participating credit union share account. Although ASI is commonly  referred to as a provider of insurance, it is not subject to all of Ohio’s  insurance laws. For example, ASI is not subject to Ohio’s insurance law  that limits the risk exposure of an insurance company. Specifically, while  Ohio insurance companies are subject to a “maximum single risk”  requirement—“no insured institution’s coverage should comprise more  than 20 percent of the admitted assets, or three times the average risk or 1  percent of insured shares, whichever is greater”—Ohio has not imposed  this requirement on ASI. Although ASI is not subject to this requirement,  we found that ASI exceeded this concentration limit. For example, one  credit union made up about 25 percent of ASI’s total insured shares, as of  December 2002. In contrast, the largest federally insured credit union  accounted for only 3 percent of NCUSIF’s total insured shares. Other  concentration risks exist; for example, we found that 45 percent of ASI’s  total insured shares were located in one state (California). Further, all of  ASI’s insured credit unions were located in only eight states, with almost  half being located in one state (Ohio), which represents 14 percent of all  ASI-insured shares. In contrast, 14.3 percent of federally insured credit  union shares were located in one state (California). The credit unions that  NCUSIF insures are located in 50 states and the District of Columbia, with  the largest percentage (8 percent) of credit unions located in one state  (Pennsylvania), which represents about 4 percent of NCUSIF’s insured  shares.
While we remain concerned about ASI’s concentration of risks, ASI  employs a number of risk-management strategies—intended to mitigate its  risk exposure in individual institutions—including being selective about  which credit unions it insures, conducting regular on- and off-site  monitoring of all its insured institutions, implementing a partially adjusted,  risk-based insurance pricing policy, and establishing a 30-day termination  policy. More specifically, ASI employs the following risk-management  strategies:
To qualify for primary share insurance with ASI, a credit union must  meet ASI’s insurance eligibility criteria, which include an analysis of the  financial performance of the credit union over a 3-year period and an  evaluation of the institution’s operating policies. For example, to qualify  for ASI coverage, a credit union’s fixed assets must be limited to 5  percent of the institution’s total assets or the amount permitted by its  supervisory authority, whichever is greater, and credit unions must  maintain a minimum net capital-to-asset ratio of 4 percent of total  assets. In contrast, federal PCA requirements compel federally insured  credit unions to maintain a minimum capital to assets ratio of 7 percent  of total assets. The credit union also must submit its investment, asset- liability management, and loan policies for ASI’s review. In addition, ASI  obtains and reviews the most recent reports from the credit union’s  regulator and certified public accountant (CPA) or supervisory  committee. Between 1994 and July 2003, ASI denied share insurance  coverage to eight credit unions while approving coverage for 31 credit  unions.
ASI also regularly monitors all credit unions it insures. ASI routinely  conducts off-site monitoring and conducts on-site examinations of  privately insured credit unions at least once every 3 years. It also  reviews state examination reports for the credit unions it insures and  imposes strict audit requirements. For example, ASI requires an annual  CPA audit for credit unions with $20 million or more in assets, while  NCUA only requires the annual CPA audit for credit unions with more  than $500 million in assets. Further, after insuring a large credit union,  ASI implemented a special monitoring plan for its largest credit unions  in light of its increased risk exposure. For larger credit unions (those  with more than 10 percent of ASI’s total insured shares or the top 5  credit unions in asset size), ASI increased its monitoring by conducting  semiannual, on-site examinations, as well as monthly and quarterly off- site monitoring, which included a review of the credit unions’ most  recent audits (monthly) and financial information (quarterly). ASI also  annually reviews the audited financial statements of these large credit  unions. In January 2003, five credit unions with about 40 percent of ASI’s  total insured assets qualified for this special monitoring.ASI also  began a monitoring strategy intended to increase its oversight of smaller  credit unions, due in part to experiencing larger-than-expected losses at   a small credit union in 2002. ASI determined that 98 smaller credit  unions qualified for increased monitoring, with shares from the largest  of these smaller credit unions totaling about $23 million.
ASI also has implemented a partially adjusted, risk-based insurance  pricing policy, which produces an incentive for the institutions insured  by ASI to obtain a better CAMEL rating, which in turn lowers the risk to  ASI’s insurance fund. Like NCUSIF, ASI’s insurance fund is deposit- based; that is, ASI requires credit unions it insures to deposit a specified  amount with ASI.As of December 2002, these deposits with ASI  totaled $112 million. Unlike NCUSIF, ASI’s insurance fund is partially  adjusted for risk, which acts as a positive, risk-management strategy to  mitigate against losses. Specifically, a credit union with a higher, or  worse, CAMEL rating is required to deposit more into ASI’s insurance  fund. Conversely, NCUA requires federally insured credit unions to  deposit 1.0 percent of insured shares into NCUSIF regardless of their  CAMEL ratings. According to ASI, it also has the contractual ability to  reassess all member credit unions up to 3 percent of their total assets to  raise additional funds to cover catastrophic loss.
ASI’s credit union termination policy provides another risk-mitigating  strategy that ASI can use to manage its risk exposure to an individual  credit union. ASI’s insurance contract identifies several circumstances  that would enable ASI to terminate insurance coverage. For example,  ASI may terminate a credit union’s insurance with 30 days notice to the  credit union and its state regulator, if the credit union fails to comply  with ASI requirements to remedy any unsafe or unsound conditions or  remedy an audit qualification in a timely manner. According to ASI  management, it has not terminated a credit union’s share insurance,  although ASI has used its termination policy as leverage to force  changes at a credit union.
When its largest insured credit union applied for primary share insurance,  ASI undertook an assessment of its financial and underwriting  considerations for insuring this institution. ASI had previously provided  excess share insurance to the credit union and was familiar with its  financial condition. ASI’s independent actuaries determined that the ASI  fund could withstand losses sustained during adverse economic conditions  for up to 5 years, with or without insuring this large credit union.  Ultimately, ASI’s assessment concluded that the credit union’s financial  condition was strong and, although it would increase ASI’s concentration  of risks, insuring the credit union would have a favorable financial impact  on ASI. According to regulators from the Ohio Department of Commerce,  Division of Financial Institutions (Ohio Division of Financial Institutions),  they did not take exception to ASI insuring the large credit union and had  reviewed ASI’s underwriting assessment and asked to be updated  periodically.
section_title: Remaining Private Insurer Has Limited Borrowing Capacity and May Find It Difficult to Cover Losses from Its Largest Insured Credit Unions under Extreme Economic Conditions
paragraphs: Unlike federal share insurance, which is backed by the full faith and credit  of the United States, ASI’s insurance fund is not backed by any government  entity. Therefore, losses on member deposits in excess of available cash,  investments, and other assets of ASI-insured institutions would only be  covered up to ASI’s available resources and its secured lines of credit,  which serve as a back-up source of funds. According to ASI documents, the  terms of ASI’s secured lines of credit required collateralization between 80  and 115 percent of current market value of the U.S. government or agency  securities ASI holds. As a result, ASI’s borrowing capacity is essentially  limited to the securities it holds. ASI officials also explained that due to the  high cost of reinsurance, it has not purchased reinsurance on its primary  share insurance, although it has reinsurance for its excess share insurance.
ASI has not had large losses since 1975. ASI has expended funds for 118  claims and its loss experience—from the credit unions that have made  claims—has averaged 3.95 percent of the total assets of these credit unions.  If ASI’s historical loss average of 3.95 percent was tested and proved true  for a failure at the largest credit union ASI insured, as of December 2002,  the loss amount would be about $119 million. While this would be a  major loss, ASI would most likely be able to sustain this loss. ASI’s  historical loss rate is nearly 60 percent less than the loss rate experienced  by NCUSIF for the same period. However, under more stressful conditions,  ASI could have difficulty fulfilling its obligations. For example, ASI’s five  largest credit unions represent nearly 40 percent of insured shares, for  which a collective loss at 3.95 percent of the assets of these credit unions  would exceed ASI’s equity by approximately $30 million. According to ASI,  it could raise additional funds to cover catastrophic loss by reassessing all  member credit unions up to 3 percent of their total assets, which excluding  the top five credit unions, would generate approximately $214 million of  additional capital, while maintaining minimum capital levels at 4 percent of  total assets. Further, by Ohio statute, the Superintendent of the Division of  Financial Institutions can order ASI to reassess its insured credit unions up  to the full amount of their capital, which, excluding the top five credit  unions, would generate approximately $794 million of funds for ASI with  which to pay claims. This recapitalization process is generally similar to  that required of NCUSIF before accessing its Treasury line of credit.  However, if ASI reassessed its member credit unions during a catastrophic  failure, it would further negatively affect these credit unions at a time that  they were already facing stressful economic conditions.
State Oversight of ASI and the  Credit Unions It Insures Provides  provides some additional assurance that ASI and privately insured credit  Additional Assurance unions operate in a safe and sound manner. As a share guaranty  State regulation of ASI and the privately insured credit unions it insures  corporation, ASI is subject to state oversight and regulation in those states  where ASI insures credit unions. ASI was chartered in Ohio statute, with  the Ohio Division of Financial Institutions and the Ohio Department of  Insurance dually regulating it. ASI is licensed by the Ohio Superintendent  of Insurance and is subject to routine oversight by that department and  Ohio’s Superintendent of Credit Unions. The Ohio Division of Financial  Institutions conducts annual assessments of ASI, which evaluate ASI’s  underwriting and monitoring procedures, financial soundness, and  compliance with Ohio laws. Under Ohio law, its Department of Insurance  also is required to examine ASI at least once every 5 years. The last Ohio  Department of Insurance exam of ASI was completed in March 1999, which  covered January 1995 through December 1997. When we met with Ohio  officials in June 2003, they told us that the Ohio Department of Insurance  planned to examine ASI in the third quarter of calendar year 2003. ASI is  also required to submit annual audited financial statements, including  management’s attestation, and quarterly unaudited financial statements to  Ohio insurance and credit union regulators. Ohio law also requires ASI to  provide copies of written communication with regulatory significance to  Ohio regulators, obtain the opinion of an actuary attesting to the adequacy  of loss reserves established, and apply annually for a license to do business  in Ohio. In our discussions with officials from the Ohio Division of  Financial Institutions and the Ohio Department of Insurance, we found  that, to date, ASI has complied with all requirements and regulations, and  no regulators have taken corrective actions against ASI or limited ASI’s  ability to do business in Ohio.
Generally, state financial regulators have taken the primary lead for  monitoring ASI’s actions, while state insurance regulators were not as  involved in overseeing ASI’s operations. All states where ASI insures credit  unions have, at some point, formally certified ASI to conduct business in  that state. Ohio and Maryland have certified ASI in the past year—as  required by governing statutes in those states. Regarding the other states in  which ASI operates, while they have not formally recertified ASI, Ohio’s  annual examination process of ASI involves regulators from most states.  State credit union regulators from Idaho, Illinois, Indiana, and Nevada  commonly participate in this assessment; according to ASI officials, their  acceptance of the final examination report infers that they approve of ASI’s  continuing operation in their respective states. State credit union  regulators from California and Alabama, however, have not participated in  the annual on-site assessment of ASI. Regarding monitoring efforts by state  insurance regulators, according to ASI, the Ohio Department of Insurance  is the only state insurance department that imposes requirements and  insurance regulators from Idaho, Illinois, and Nevada only request  information.
Most state credit union regulators with whom we met told us they had  regular communication with ASI about the credit unions ASI insured. ASI  officials reported that they commonly conducted joint, on-site exams of  credit unions with state regulators. State credit union regulators imposed  safety and soundness standards and carried out examinations of state- chartered credit unions in a way similar to how the federal government  oversees federally insured credit unions. According to state regulators,  state regulations, standards, and examinations apply to all state-chartered  credit unions, regardless of their insurance status (whether federal, private,  or noninsured). State credit union regulators reported that they had  adopted NCUA’s examination program, and their examiners had received  training from NCUA. However, as previously discussed, some state officials  with whom we met indicated that they faced challenges related to oversight  of their credit unions; for example, some states lacked examiner resources  and had high examiner turnover.
Additionally, privately insured credit unions—as compared with federally  insured credit unions—are not subject to identical requirements and  regulations. For example, while federally insured, state-chartered credit  unions are subject to PCA—as discussed earlier, privately insured, state- chartered credit unions are not subject to these federally mandated  supervisory actions. Although, as a matter of practice, many state  regulators reported that they have the authority to impose capital  requirements on privately insured credit unions and could take action  when a credit union’s capital levels are not safe and sound. However, state  officials in California, Idaho, Illinois, Indiana, Ohio, and Nevada said that  their states required privately insured credit unions to maintain specified  reserve levels, which were codified in statute or regulation. Additionally,  Alabama requires credit unions seeking private insurance to meet certain  capital levels.
While some states had specific requirements for credit unions seeking to  purchase private share insurance, many states regulators reported that  they have the authority to “not approve” the conversion of credit unions to  private share insurance. Alabama, Illinois, and Ohio have written guidelines  for credit unions seeking to purchase private share insurance and  regulators reported that they have the authority to “not approve” a credit  union’s purchase of private insurance. The other five states that permitted  private share insurance do not have written guidelines for credit unions  seeking to purchase private share insurance, but Idaho, Indiana, and  Nevada state regulators also noted that they have the authority to “not  approve” a credit union’s purchase of private share insurance.
Moreover, NCUA supervised the conversions of federally insured credit  unions to private share insurance. Specifically, NCUA has imposed  notification requirements on federally insured credit unions seeking to  convert to private share insurance and requires an affirmative vote of a  majority of the credit union members on the conversion from federal to  private share insurance. NCUA has required these credit unions to notify  their members, in a disclosure, that if the conversion were approved, the  federal government would not insure shares. We reviewed six recent  conversions to private share insurance, and found that, prior to NCUA’s  termination of the credit union’s federal share insurance, these credit  unions, including the large credit union that recently converted to ASI, had  generally complied with NCUA’s notification requirements for conversion.
section_title: Members of Many Privately Insured Credit Unions Are Not Receiving Required Disclosures about the Lack of Federal Share Insurance
paragraphs: Although actions taken by ASI and some state regulators provide some  assurances that ASI is operating in a safe and sound manner, ASI’s  concentration risks and limited borrowing capacity raise concerns that  under stressful economic conditions it may not be able to fulfill its responsibilities to its membership. Congress determined that it was important for members of privately insured credit unions to be informed  that their deposits in such institutions were not federally insured.  Specifically, among other things, section 43 of the Federal Deposit  Insurance Act requires depository institutions lacking federal deposit  insurance, which includes privately insured credit unions, to conspicuously  disclose to their membership that deposits at these institutions are (1) not  federally insured and (2) if the institution fails, the federal government  does not guarantee that depositors will get back their money. These  institutions are required to conspicuously disclose this information on  periodic statements of account, signature cards, and passbooks, and on  certificates of deposit, or instruments evidencing a deposit (deposit slips).  These institutions are also required to conspicuously disclose that the  institution is not federally insured at places where deposits are normally  received (lobbies) and in advertising (brochures and newsletters).
The Federal Trade Commission (FTC) is responsible for enforcing  compliance with section 43. However, FTC has never taken action to  enforce these requirements, and has sought and obtained in its  appropriations authority a prohibition against spending appropriated funds  to carry out these provisions. We recently reported that because of a lack of  federal enforcement of this section, many privately insured credit unions  did not always make required disclosures. We conducted unannounced  site visits to 57 locations of privately insured credit unions (49 main and 8  branch locations) in five states—Alabama, California, Illinois, Indiana, and  Ohio and found that 37 percent of the locations we visited did not  conspicuously post signage in the lobby of the credit union. During these  site visits, we also obtained other available credit union materials  (brochures, membership agreements, signature cards, deposit slips, and  newsletters) that did not include language to notify consumers that the  credit union was not federally insured—as required by section 43. Overall,  134 of the 227 pieces of materials we obtained from 57 credit union  locations—or 59 percent—did not include specified language. As part of  our review, we also reviewed 78 Web sites of privately insured credit  unions and found that many Web sites were not fully compliant with  section 43 disclosure requirements. For example, 39 of the 78 sites  reviewed had not included language to notify consumers that the credit  union was not federally insured.
Our primary concern, resulting from the lack of enforcement of section 43  provisions, was the possibility that members of privately insured, state- chartered credit unions might not be adequately informed that their  deposits are not federally insured and should their institution fail, the  federal government does not guarantee that they will get their money back.  The fact that many privately insured credit unions we visited did not  conspicuously disclose this information raised concerns that the  congressional interest in this regard was not being fully satisfied. In our  August 2003 report, we concluded that FTC was the best among candidates  to enforce and implement section 43 and provided suggestions on how to  provide additional flexibility to FTC to enforce section 43 disclosure  requirements. The House Committee on Appropriations, Subcommittee on  Commerce, Justice, State, the Judiciary, and Related Agencies, is currently  considering adding language in FTC’s 2004 appropriations bill that would  require FTC to enforce and implement section 43 disclosure provisions.
section_title: Conclusions
paragraphs: The financial condition of the credit union industry has improved since  1991. Between 1992 and 2002, changes in the industry have resulted in two  distinct groups of credit unions—smaller credit unions providing their  members with basic banking services and larger credit unions that seek to  provide their members with a full range of financial services similar to  other depository institutions. These larger credit unions control a larger  percent of industry assets than they did in 1991. This concentration of  industry assets creates the need for greater risk management on the part of  credit union management and NCUA with respect to monitoring and  controlling risks to the federal share insurance fund.
Among the more significant changes that have occurred in the credit union  industry over the past two decades have been the weakening or blurring of  the common bond that traditionally existed between credit union  members. The movement toward geographic-based fields of membership,  and other expansions of the common-bond restrictions in conjunction with  expanded lines of financial services, have made credit unions more  competitive with banks. These changes have raised questions about the  extent to which credit unions are fulfilling their perceived historic mission  of serving individuals of modest means. However, no comprehensive data  are available to determine the income characteristics of those who receive  credit unions services, especially with respect to consumer loans and other  financial services. Available data, such as that provided by the SCF and  HMDA, provide some indication that credit unions serve low- and  moderate-income households but not to the same extent as banks. If credit  unions, as indicated by NCUA and the credit union industry, place a special  emphasis on serving low- and moderate-income households, more  extensive data would be needed to support this conclusion. These data  would need to include information on the distribution of consumer loans  because smaller credit unions are more likely to make consumer than  mortgage loans. Lack of data especially impairs NCUA’s ability to  determine if credit unions that have adopted underserved areas are  reaching the households in the communities most in need of financial  services.
As the industry has changed and larger credit unions have become more  like banks in the services they have provided, NCUA has adopted a  supervisory and examination approach that more closely parallels that of  the other depository institution regulators. While it is too soon to  determine whether the risk-focused approach being implemented by NCUA  will allow it to more effectively monitor and control the risks being  assumed by credit unions, our work suggests that further opportunities  exist for NCUA to further leverage off the approaches and experiences of  the other federal depository institution regulators. For example, as NCUA  is addressing challenges in implementation of its risk-focused program, it  has the opportunity to use forums such as the FFIEC to learn how other  depository institution regulators dealt with similar challenges in  implementing their risk-focused programs. Also, NCUA might gain an  evaluation of an institution’s internal controls, comparable to other  depository institution regulators, if credit unions were required, like banks  and thrifts, to provide management evaluations of internal controls and  their auditor’s assessments of such evaluations. Finally, NCUA could gain  better oversight of third-party vendors if it had the same ability to examine  the activities of third-party vendors as do other depository institution  regulators.
As of December 2002, NCUSIF’s financial condition appeared satisfactory  based on its fund-equity ratio and positive net income. However, it is not  clear whether or to what extent NCUSIF’s recent decline in net income will  continue. Improvements in NCUA’s processes for determining the overhead  transfer rate, pricing, and estimated losses could help to promote future  financial stability by providing more accurate information for financial  management. As currently determined by NCUA, the overhead transfer rate  may not have accurately reflected the actual time spent by NCUA staff on  insurance-related activities. Recent fluctuations are the result of  adjustments being made because of surveys that had not been conducted  regularly or over sufficient periods of time. In addition, NCUSIF’s pricing  for federal share insurance coverage does not reflect the risk that an  individual credit union poses to the fund. Moreover, the process used by  NCUA to estimated losses to the insurance fund—the fund’s most  significant liability and management estimate—has been based on overly  broad historical analysis. The risk-based pricing structure that is the norm  across the insurance industry and, for loss estimates, the more detailed,  risk-based historical analysis used by FDIC in insuring banks and thrifts  may provide useful lessons for NCUA in improving its management of  insurance for credit unions.
While systemic risks that might be created by private share insurance  appear to have decreased since 1990, the recent conversion of a large credit  union from federal to private share insurance has introduced new  concerns. Because the remaining private insurer’s (ASI) insured shares are  overly concentrated in one large credit union and in certain states, and  because it does not have the backing of any governmental entity and it has  limited borrowing capacity, ASI may have a limited ability to absorb  catastrophic losses. This raises questions about the ability of ASI, under  severe economic conditions, to fulfill its obligations if its largest credit  unions were to fail. Given this risk, we believe it is important that the  members of privately insured credit unions are made aware that their  shares are not federally insured. As we previously reported, since no  federal entity currently enforces compliance with federal disclosure  requirements for privately insured credit unions, and with the high level of  noncompliance that we found in on-site visits to privately insured credit  unions, we believe that members of privately insured credit unions might  not be adequately informed that their shares are not federally insured. As a  result, we have previously recommended that Congress consider providing  additional flexibility to FTC to ensure compliance with the federal  disclosure requirements.
Recommendations for 	 To promote NCUA’s ability to meet its goal of assisting credit unions in  Executive Action  safely providing financial services to all segments of society, to enable more consistent federal oversight of financial institutions, and to enhance  share insurance management (for example, improving allocation costs,  providing insurance according to risk, and improving the loss estimation  process), we recommend that the Chairman of the National Credit Union  Administration use tangible indicators, other than “potential membership,” to determine  whether credit unions have provided greater access to credit union  services in underserved areas; consult with other regulators through FFIEC more consistently about  risk-focused programs to learn how these regulators have dealt with  past challenges (for example, training of information technology  specialists); continuously improve the process for and documentation of the  overhead transfer rate by consistently calculating and applying those  rates, updating the rates annually, and completing the survey with full  representation; evaluate options for implementing risk-based insurance pricing. In its  evaluation, the NCUA Chairman should consider the potential impact of  risk-based insurance pricing to the ability of credit unions to provide  services to various constituencies; and evaluate options for stratifying the industry by risk profile and applying  probable failure rates and loss rates, based in part on historical data, for  each risk profile category when estimating future losses from  institutions.
section_title: Matters for Congressional Consideration
paragraphs: Should Congress be concerned that federally insured credit unions,  especially those serving geographical areas, are not adequately serving low- and moderate-income households, Congress may wish to consider  requiring NCUA to obtain data on the proportion of mortgage and  consumer loans provided to low- and moderate-income households within  each federally insured credit union’s field of membership and obtain  descriptions of services specifically targeted to low- and moderate-income  households.
To ensure the safety and soundness of the credit union industry, Congress  may wish to consider making credit unions with assets of $500 million or  more subject to the FDICIA requirement that management and external  auditors report on the internal control structure and procedures for  financial reporting, as well as compliance with designated safety and  soundness laws.
To improve oversight of third-party vendors, Congress may wish to  consider granting NCUA legislative authority to examine third-party  vendors that provide services to credit unions and are not examined  through FFIEC.
section_title: Agency Comments and Our Evaluation
paragraphs: We requested comments on a draft of this report from the Chairman of the  National Credit Union Administration and the President and Chief  Executive Officer of American Share Insurance. We received written  comments from NCUA and ASI that are summarized below and reprinted in  appendixes XI and XII respectively. In addition, we received technical  comments from NCUA and ASI that we incorporated into the report as  appropriate.
NCUA concurred with most of the report’s assessment regarding the  challenges facing NCUA and credit unions since 1991. For example, NCUA  concurred with the report’s assessment that overall the financial health and  stability of the credit union industry has improved since 1991. NCUA also  agreed with our recommendation to consult with other regulators through  FFIEC more consistently to leverage the knowledge and experience the  other regulators have gained in administering risk-focused programs.  NCUA stated that it plans to continue its coordination with its FFIEC  counterparts as it makes ongoing improvements to its approach to  supervising federally insured credit unions.
NCUA also concurred with our matter for congressional consideration that  credit unions with assets of $500 million or more should provide annual  management reports assessing the effectiveness of their internal controls  over financial reporting and their external auditor’s attestation to  management’s assertions. NCUA stated that it is providing guidance for  credit unions on the principles of the Sarbanes-Oxley Act that will, among  other things, strongly encourage large credit unions to voluntarily provide  this reporting on internal controls. However, NCUA believed that  legislation was not necessary because NCUA has the authority to  implement regulations requiring credit unions to provide these reports  should it become necessary. While we acknowledge NCUA’s authority to  issue regulations on this issue, we note that regulations can be changed  unilaterally by the agency, whereas legislation is binding unless changed by  Congress. Our intent in developing this matter for congressional  consideration was to ensure parity between credit unions, banks, and  thrifts with regard to internal control reporting requirements; therefore, we  have left this as a matter for congressional consideration in our report.
NCUA also indicated that it did not oppose our recommendation that it be  given statutory authority to examine third-party vendors that provide  services to credit unions and are not examined through FFIEC, provided  that appropriate discretion was extended to the agency in the allocation of  agency resources and evaluation of risk parameters in using this authority.  NCUA stated that given that many of these third-party vendors service  numerous credit unions, a failure of a vendor poses systemic risk issues.  However, NCUA suggested that it be changed to a matter for congressional  consideration because it was a statutory issue rather than one involving the  use of existing NCUA regulatory authority. We agreed with NCUA’s  assessment and have modified the report accordingly.
NCUA concurred with the report’s recommendation to make improvements  to the process for determining the overhead transfer rate and indicated that  management is in the process of improving the methodology for calculating  this rate. NCUA also concurred in part with our report’s conclusion that the  NCUSIF loss reserve methodology warrants study, in order to further refine  NCUSIF’s estimates. Regarding our recommendation that NCUA study  options for improving its estimates of future insurance losses, NCUA stated  that it is awaiting the receipt of recommendations that FDIC received on  revising its insurance process, and NCUA will review the details of the  revised FDIC process and how to integrate those practices within NCUA’s  system.
In its response, NCUA proposed an alternative to risk-based insurance  pricing by using the adoption of a PCA approach where required net worth  levels would be tied to an institution’s risk profile. While NCUA’s proposal  may be one option to consider, we continue to recommend that NCUA  evaluate and study various options for achieving a risk-based pricing of  insurance to fairly distribute risk, provide incentives for member credit  unions to control their risk, and focus regulators on higher-risk credit  unions. While it is possible that the option suggested by NCUA would  achieve the objectives, we believe that NCUA should study the costs,  benefits, and risks associated with various options in order to determine  the most effective and cost-beneficial means of achieving a risk-based  system of insurance.
NCUA disagreed with our recommendation that it should use indicators,  other than “potential membership,” to determine whether credit unions  have provided greater access to credit union services in underserved areas.  NCUA officials stated that they believe that their data indicated that credit  unions have reached out to underserved communities; implementation of  this recommendation could result in significant and unnecessary data  collection; and Congress has not imposed CRA-like requirements on credit  unions in the past. We agree that federally chartered credit unions have  added underserved areas in record numbers, increasing the numbers of  potential members in these areas, and that membership growth in credit  unions with underserved areas has been greater than for credit unions  overall. However, this information does not indicate whether underserved  individuals or households have received greater access to services (for  example, by using check-cashing services, opening no-fee checking  accounts, or receiving loans) as a result of these field of membership  expansions. Further, while we agree that documenting service to the  underserved would result in additional administrative requirements, the  magnitude and scale of this effort does not necessarily require imposition  of CRA as implemented for banks and thrifts, and could result in  information benefitting future credit union expansion efforts. At a  minimum, it would be useful to know whether membership growth in  credit unions that have added underserved areas has come from the  underserved areas themselves and the extent to which those census tracts  within these areas have been identified as low- or moderate-income. This  type of information, collected uniformly by a federal agency like NCUA,  could serve as first step towards documenting the extent to which credit  unions have reached for members outside of their traditional membership  base. Finally, without this information, it will be difficult for NCUA or  others that are interested to determine whether credit unions have  extended services of any kind to underserved individuals as authorized in  CUMAA.
Finally, NCUA also concurred with the report’s identification of possible  systemic risk that could be associated with private share insurance that  lacks the full faith and credit backing of a state or the federal government.  NCUA believed that the asset concentration, limited borrowing capacity,  and the lack of any reinsurance of the private insurer present unique  challenges for the eight state supervisory authorities where private  insurance exists today.
In commenting on the private share insurance section of a draft of this  report, ASI stated that we failed to adequately assess the private share  insurance industry. In summary, as discussed below, ASI raised objections  to the report statements that ASI’s risks are concentrated in a few large  credit unions and a few states; ASI has limited ability to absorb large losses  because it does not have the backing of any governmental agency; and  ASI’s lines of credit are limited in the aggregate as to amount and available  collateral. In response, we considered ASI’s positions and materials  provided, including ASI’s actuarial assumptions and ASI’s past  performance, and believe our report addresses these issues correctly as  originally presented.
First, in regard to ASI’s concentration risks, ASI stated that the inclusion of  a single large, high-quality credit union provided financial resources that  improved, not diminished, the financial integrity of ASI. Our report  acknowledges this fact. However, our report also notes that this credit  union made up about 25 percent of ASI’s total insured shares, and that ASI’s  five largest credit unions represent nearly 40 percent of ASI’s insured  shares, as of December 2002. While not disputing that the large credit union  would improve ASI’s current financial position, we continue to believe that  this level of concentration in a few credit unions, under adverse economic  conditions, could expose ASI to a potentially high level of losses. ASI also  stated that ASI’s coverage and the geographic distribution of ASI’s insured  credit unions is a matter of state law. The report points out this fact, and we  acknowledge that it limits ASI’s ability to diversify its risks. However, the  fact remains that ASI’s risks are currently concentrated in eight states.
Second, in response to our report’s assessment of ASI’s limited ability to  absorb catastrophic losses, ASI noted “its sound private deposit insurance  program builds on a solid foundation of careful underwriting, continuous  risk management and the financial backing of its mutual member credit  unions, capable of absorbing large (catastrophic) losses.” In addition, ASI  noted that over its 29-year history, it has paid over 110 claims on failed  credit unions, and that no member of an ASI-insured credit union has ever  lost money. ASI also noted that it could assess its member credit unions up  to 3 percent of their total assets in order to obtain more capital. We  acknowledge these facts in this report; however, our point remains that ASI  has limited borrowing capacity and, under stressful economic conditions,  may have difficulty securing funds from others to meet its obligations. ASI  also objected to the report’s comparison of private share insurance to the  federal insurance program. As the last remaining private share insurer, ASI  has no peer on which to base a comparison and the only alternative to  private share insurance for credit unions is NCUSIF.
Third, ASI commented that the draft report incorrectly views the  company’s lines of credit as a source of capital. ASI noted that their lines of  credit are solely in place to provide emergency liquidity. We do not disagree  with ASI’s statement. When incorporating ASI’s previously received  technical comments, we clarified in the report that losses on member  deposits, in excess of available cash, investments, and other assets of ASI- insured institutions, would only be covered up to ASI’s available resources  and its secured lines of credit, which serve as a back-up source of funds.  Further, the report notes that ASI’s lines of credit required collaterization  between 80 and 115 percent of current market value of the U.S. government  or agency securities ASI holds. As a result, ASI’s borrowing capacity is  essentially limited to the securities it holds and therefore, in a time of  stressful economic conditions, ASI may have difficulty maintaining its own  liquidity if its insured credit unions were failing and unable to meet the  withdrawal requests of depositors.
Lastly, ASI supported our previous conclusion that FTC is the appropriate  agency for monitoring and defining private share insurance consumer  disclosure requirements and believed that privately insured credit unions  would benefit from FTC’s enforcement of such provisions. In our  concluding discussions with ASI officials, they emphasized that they were  undertaking efforts to educate their member credit unions on the required  consumer disclosures and taking steps, in conjunction with state credit  union leagues, to ensure compliance.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies of this report to the Chairman  of the Senate Committee on Banking, Housing, and Urban Affairs, the  Chairman and Ranking Minority Member of the House Committee on  Financial Services, and other congressional committees. We also will send  copies to the National Credit Union Administration and American Share  Insurance and make copies available to others upon request. In addition,  the report will be available at no charge on the GAO Web site at  http://www.gao.gov.
This report was prepared under the direction of Debra R. Johnson and  Harry Medina, Assistant Directors. If you or your staff have any questions  regarding this report, please contact the Assistant Directors or me at  (202) 512-8678. Key contributors are acknowledged in appendix XIII.
section_title: Objectives, Scope, and Methodology
paragraphs: Our report objectives were evaluate (1) the financial condition of the credit  union industry; (2) the extent to which credit unions “make more available  to people of small means credit for provident purposes;” (3) the impact, if  any, of the Credit Union Membership Access Act of 1998 (CUMAA) on the  credit union industry with respect to membership provisions; (4) how the  National Credit Union Administration’s (NCUA) examination and  supervision processes have changed in response to changes in the industry;  (5) the financial condition of the National Credit Union Share Insurance  Fund (NCUSIF); and (6) issues concerning the use of private share  (deposit) insurance.
subsections: section_title: Financial Condition of Industry
paragraphs: To assess the financial condition of the credit union industry, we obtained  and analyzed annual call report financial data (Form 5300) and regulatory  ratings (CAMEL scores) for all federally insured credit unions from 1992 to  2002. NCUA requires federally insured credit unions to submit a quarterly  call report, which contains information on the financial condition and  operations of the institution. Using the call reports, we calculated  descriptive statistics and key financial ratios and determined trends in  financial performance. NCUA provided us with a copy of the electronic  Form 5300 database for our analysis. The database contained year-end  information for December 1992–December 2002. We reviewed NCUA  established procedures for verifying the accuracy of the Form 5300  database and found that the data that forms this database are verified on an  annual basis, either during each credit union’s examination, or through off- site supervision. We determined that the data were sufficiently reliable for  the purposes of this report. In addition we received a database of  regulatory ratings (CAMEL) from NCUA for 1992–2002, on which we (1)  reviewed the data by performing electronic testing of required data  elements, (2) reviewed existing information about the data and the system  that produced them, and (3) interviewed agency officials knowledgeable  about the data. We determined that the data were sufficiently reliable for  the purposes of this report.
In addition to using call report data for credit unions, we also used data  collected by the Federal Financial Institutions Examination Council  (FFIEC) and Office of Thrift Supervision (OTS) to compare the financial  condition of and services offered by credit unions with those of other  depository institutions insured by the Federal Deposit Insurance  Corporation (FDIC). We used call report (reporting forms FFIEC 031 and  FFIEC 041 for banks and OTS Form 1313 for thrifts) data obtained from  FDIC’s Statistics on Depository Institutions Web site, which contains  consolidated bank and thrift data stored on FDIC’s Research Information  System database. To assess the reliability of these data, we randomly  cross-checked selected data obtained from this Web site with selected  individual call reports and compared our calculations with aggregate  figures provided by FDIC. Given the context of the analyses, we  determined that these data were sufficiently reliable for the purposes of  our report. For broad, industrywide comparisons with banks involving  industry concentration and capital ratios, we used total assets and equity  capital data for all FDIC-insured institutions, excluding insured branches of  foreign-chartered banks. In order to determine bank and thrift institutions  for our more detailed review, we constructed five peer groups in terms of  institution size as measured by total assets, reported as of December 31,  2002. See table 3 for the definitions we used to create peer groups.
We specified the maximum total assets of $18 billion by rounding up the  total assets of the largest credit union in our database as of December 31,  2002, to the nearest billion dollars. We also classified bank and thrift  institutions as to whether they emphasized credit card or mortgage loans;  this was done by determining if a given bank had (1) a total loans to total  assets ratio of at least 0.5 and (2) either a credit card loans to total loans  ratio of at least 0.5 or a mortgage loans to total loans ratio of at least 0.5.  The call report data that we used for our financial condition and services  analyses consisted of information on total assets and total loans, as well as  more specific loan holdings data (for example, consumer loans and real  estate loans). We also obtained additional data to calculate bank capital  ratios and return on average assets, including equity capital, net income,  and average assets.
section_title: Service to People with Low and Moderate Incomes
paragraphs: To evaluate the extent to which credit unions serve people with low and  moderate incomes, we analyzed existing data on the income levels of credit  union members, reviewed available literature, and interviewed regulatory  and industry officials. We analyzed 2001 Home Mortgage Disclosure Act  (HMDA) data, the Federal Reserve’s 2001 Survey of Consumer Finances  (SCF), NCUA program literature, and statistical reports of industry trade  and consumer groups. To present our findings, we relied on the combined  message of all these studies and data sources because we found no single  source that contained data on the incomes of credit union and other  depository institution consumers. To compare the income characteristics  of households and neighborhoods that obtain mortgages from credit unions  and banks, we used four income categories—-low, moderate, middle, and  upper—used by financial regulators as part of the Community  Reinvestment Act (CRA) exams. See table 4 for definitions.
We analyzed loan application records (LAR) from the HMDA database to  compare the proportion of mortgage loans made by credit unions and peer  group banks with households and communities with various income levels.  We used 2001 HMDA data, the most recent data set available from the  Federal Reserve Bank at the time of our review. For the purposes of  comparing credit union lending with that of banks, we included only those  banks with assets of $16 billion or less on December 31, 2001, which was  the size of the largest credit union in 2001, rounded up to the nearest  billion. In addition, we excluded lending institutions that only made  mortgages. Our HMDA analysis included records from 4,195 peer group  banks. We obtained the asset size and total membership for credit unions  reporting to HMDA from NCUA's 2001 call report database and obtained  the asset size of other lenders (to identify the peer group banks) from the  HMDA Lender File, which contains data on the characteristics of  institutions reporting to HMDA, supplied to us by the Federal Reserve.
Our HMDA analysis did not include all credit unions and banks because  only institutions that meet HMDA’s reporting criteria, such as having a  certain amount of assets, must report their mortgage loans to HMDA. For  example, in 2001, depository institutions with more than $31 million in  assets as of December 31, 2000, were required to report loans to HMDA.  Largely because of this criterion, most credit unions—86 percent—were  not required to report mortgage loans to HMDA and, thus, were excluded  from our analysis. However, we believe our analysis is still of value  because, in 2001, reporting credit unions held about 70 percent of credit  union assets and included 62 percent of credit unions’ members.
For our analysis, we only analyzed LARs for originated loans for the  purchase of one-to-four family homes that served as the purchaser’s  primary dwelling. Our analysis included about 71,000 loans reported by  credit unions and about 807,000 loans reported by peer group banks. We  determined that the data were sufficiently reliable for the purposes of this  report by performing electronic testing of the required data elements,  reviewing existing information about the data and the system that  produced them, and interviewing agency officials knowledgeable about the  data. We did not independently verify the accuracy of the contents of the  LARs reported to the HMDA database or the accompanying lender file.
After selecting the records, we determined what proportion of credit union  and bank loans were made to purchasers with low, moderate, middle, and  upper incomes. To do so, we categorized the purchaser's gross annual  income, as identified on the LAR, into one of four income categories based  on the median family income of the MSA in which the purchased home was  located. We did this by matching the Metropolitan Statistical Area (MSA)  on the HMDA LAR with the appropriate Department of Housing and Urban  Development (HUD)-estimated 2001 median family income. We used SAS  version 8.02 version, which is a computer-based data analysis and reporting  software application, to perform all of these analyses. We did not analyze  about 16 percent of the credit union and bank LARs because they did not  contain a MSA. While it is possible that this information was simply not  recorded, lenders must only report MSAs for properties located in MSAs  where their institution has a home or branch office.
In addition, we determined what proportion of credit union and bank loans  were made for the purchase of properties in census tracts by the median  family income of the census tract. The Federal Reserve Board, in  categorizing each census tract level, used the four income categories used  by the financial regulators (low, moderate, middle, and upper) and used  definitions corresponding to the ones identified in table 4. Because the  median income of each census tract is labeled within HMDA, we did not  have to determine the income category ourselves. We did not analyze about  16 percent of the credit union and bank LARs because they did not contain  a census tract. While it is possible that this information was simply not  recorded, lenders are not responsible for identifying census tract  information if the property is located in a county with less than 30,000  people or if the property was located in an area that did not have census  tracts for the 1990 census.
Finally, we analyzed the race and ethnicity data in HMDA to compare the  lending records of credit unions and banks whose loans met our criteria. As  noted in appendix VI, about 15 percent of records for credit unions lacked  race and ethnicity data and 6 percent of records for banks. While it is  possible that this information was simply not recorded, applicants filing  loan applications by mail or by telephone are not obligated to provide this  information.
We also analyzed the Federal Reserve’s 2001 SCF, a triennial survey of U.S.  households sponsored by the Board of Governors of the Federal Reserve  System with the cooperation of Treasury, and reviewed secondary sources  to identify the characteristics of credit union members. We analyzed the  SCF because it is a respected source of publicly available data on financial  institution and consumer demographics that is nationally representative  and because it was the only comprehensive source of publicly available  data with information on financial institutions and consumer demographics  that we could identify. We analyzed the SCF to develop statistics on the  income, race, age, and education of credit union members and bank  customers. Because some customers use both credit unions and banks, we  performed our income analysis based on the assumption that households  can be divided into four user categories—those who use credit unions only,  those who primarily use credit unions, those who use banks only, and those  who primarily use banks. Dr. Jinkook Lee of Ohio State University  developed these categories. In addition, to identify existing research on  credit union research, we asked officials at NCUA and industry groups (for  example, the Credit Union National Association (CUNA) to identify  relevant studies and performed a literature search.
section_title: Impact of CUMAA
paragraphs: To study the impact of CUMAA on credit union field of membership  regulations, we reviewed and analyzed CUMAA and compared its  provisions with NCUA interpretive rulings and policy statements (IRPS) in  effect before and after CUMAA. In addition, we interviewed NCUA officials  and industry representatives to obtain their viewpoints on how NCUA  interpreted CUMAA's membership provisions. To obtain information about  state field of membership regulations in general and how many state- chartered credit unions serve geographical areas, we surveyed regulators  in the 50 states and received responses from the 46 that actively charter  credit unions. This allowed us to compare the number of federally  chartered and state-chartered credit unions serving geographical areas.  Finally, we obtained historical trend data from NCUA on the charter types  of federally chartered credit unions, “potential” (that is, people within a  credit union’s field of membership but not members of the credit union)  and actual membership, and service to underserved areas.
section_title: Regulatory Oversight
paragraphs: To evaluate how NCUA’s supervision and examination of credit unions has  evolved in response to changes in the industry since 1991, we identified  changes in the types of products, services, and activities in which credit  unions engage as well as key changes to NCUA regulations. We also  identified changes to NCUA’s examination and supervision approach, and  evaluated oversight procedures of federally insured, state-chartered credit  unions. Finally, we studied NCUA’s implementation of prompt corrective  action (PCA).
To identify changes in the types of products, services, and activities in  which credit unions engage, we analyzed 1992–2002 Form 5300 call report  data and conducted structured interviews with NCUA examiners, state  supervisory officials, and officials from seven large credit unions. To  identify key regulatory changes, we (1) reviewed the Federal Credit Union  Act and amendments made by Congress since 1991; (2) interviewed NCUA  officials, including NCUA’s General Counsel and officials from NCUA’s  Division of Examination and Insurance, NCUA and state examiners, and  officials from seven large credit unions; (3) reviewed NCUA legal opinions  and letters to credit unions; and (4) reviewed final rules published in the  Federal Register.
To identify changes to NCUA’s examination and supervision approach, we  reviewed NCUA’s examiner guide for key elements of the risk-focused  examination approach and compared current exam documentation  requirements with previous requirements. We conducted structured  interviews with six of NCUA’s regional directors, 23 NCUA examiners  covering all NCUA regions, and 13 state supervisory officials from  Alabama, California, Idaho, Illinois, Indiana, Maryland, Massachusetts,  Michigan, Nevada, Ohio, Texas, Washington, and Wisconsin. These states  contained 51 percent of the total number of federally insured, state- chartered credit unions and 58 percent of the total assets of federally  insured, state-chartered credit unions as of December 31, 2002. In addition,  we interviewed officials from seven large credit unions; selecting at least  one credit union from NCUA’s six regions. To obtain information on the  experiences of other depository institution regulators with the risk-focused  examination and supervision approach, we interviewed officials from the  FDIC, OTS, Office of the Comptroller of the Currency, and the Federal  Reserve Bank. Finally, to obtain information on other NCUA initiatives  intended to compliment the risk-focused program, we reviewed NCUA  documents on the large credit union pilot program, and the subject matter  examiner program.
To evaluate oversight procedures of federally insured, state-chartered  credit unions, we obtained information about the oversight procedures  during our structured interviews with the 13 states supervisory officials  and NCUA examiners. We also reviewed NCUA’s examiner guide and  memorandum of understanding between NCUA and states describing  NCUA’s procedures for conducting joint examinations of federally insured,  state-chartered credit unions with state regulators.
Finally, to study NCUA’s implementation of PCA, we reviewed CUMAA,  NCUA rules and regulations pertaining to PCA, and NCUA’s examiner  guide. We also analyzed data from NCUA on the number of credit unions  subject to PCA as of December 31, 2002. We interviewed agency officials  knowledgeable about this data and found that NCUA headquarters, as well  as the region, conducted reasonableness checks against the Form 5300  database, which contains the net-worth ratio used for PCA. When data  outliers were found, examiners were required to review the data for  accuracy and make any necessary corrections. We determined that the data  were sufficiently reliable for the purposes of this report. In addition, we  interviewed NCUA officials and examiners, state supervisory officials,  credit union officials, and officials of other federal financial regulatory  agencies to obtain their perspectives on PCA.
section_title: Status of NCUSIF
paragraphs: To evaluate the financial condition of NCUSIF, we obtained key financial  data about the fund from NCUA’s annual audited financial statements for  1991–2002. For 2002, we compared NCUSIF’s key performance measure,  which is the ratio of fund equity to insured shares (deposits), to key  performance measures of the Bank Insurance Fund, Savings Association  Insurance Fund, and American Share Insurance, the remaining private  insurer. We also reviewed NCUSIF’s estimated loss and overhead  administrative expenses transfer process and applicable internal controls.  We reviewed other relevant industry studies on deposit-insurance pricing  and loan-loss allowance. In addition, we interviewed NCUA officials,  industry trade groups, and officials of other federal financial regulatory  agencies to obtain their perspectives on the funding of NCUSIF, the  overhead transfer rate, and the loan-loss allowance.
section_title: Private Share Insurance
paragraphs: To better understand the issues around share (deposit) insurance, we  reviewed and analyzed relevant studies on federal and private insurers for  both credit unions and other depository institutions.In addition, we  interviewed officials at NCUA, the Department of the Treasury, and FDIC to  obtain perspectives specific to private share insurance. We also obtained  views from credit union industry groups including the National Association  of Federal Credit Unions, National Association of State Credit Union  Supervisors, and CUNA.
To determine the extent to which private share insurance is permitted and  utilized by state-chartered credit unions, we conducted a survey of state  credit union regulators in all 50 states. Our survey had a 100-percent  response rate. In addition to the survey, we obtained and analyzed financial  and membership data of privately insured credit unions from a variety of  sources (NCUA, Credit Union Insurance Corporation, CUNA, and ASI—the  only remaining provider of primary share insurance). We found this  universe difficult to confirm because in our discussions with state  regulators, NCUA and ASI officials, and our review of state laws, we  identified other states that could permit credit unions to purchase private  share insurance.
To determine the regulatory differences between privately insured credit  unions and federally insured, state-chartered credit unions, we identified  and analyzed statutes and regulations related to share insurance at the  state and federal levels. In addition, we interviewed officials at NCUA and  conducted interviews with officials at the state credit union regulatory  agencies from Alabama, California, Idaho, Indiana, Illinois, Maryland,  Nevada, New Hampshire, and Ohio. Finally, we analyzed NCUA’s  application of its conversion policies and looked at the cases of six credit  unions that terminated their federal share insurance and converted to  private share insurance in 2002 and 2003.
To identify factors influencing a credit union's decision to obtain private or  federal share insurance, we conducted structured interviews with officials  of both federally insured and privately insured credit unions. Specifically,  we interviewed management at 29 credit unions that, since 1990, had  converted from federal to private share insurance and management at 26  credit unions that had converted from private to federal share insurance.  We did not interview credit union management in states that did not permit  private insurance.
To determine the extent to which privately insured credit unions met  federal disclosure requirements, we identified and analyzed federal  consumer disclosure provisions in section 43 of the Federal Deposit  Insurance Act, as amended, and conducted unannounced site visits to 57  privately insured credit unions (49 main and 8 branch locations) in  Alabama, California, Illinois, Indiana, and Ohio. The credit union locations  were selected based on a convenience sample using state and city location  coupled with random selection of main or branch locations within each  city. About 90 percent of the locations we visited were the main institution  rather than a branch institution. This decision was based on the  assumption that if the main locations were not in compliance, then the  branch locations would probably not be in compliance either. Although  neither these site visits, nor the findings they produced, render a  statistically valid sample of all possible main and branch locations of  privately insured credit unions necessary in order to determine the “extent”  of compliance, we believe that what we found is robust enough, both in the  aggregate and within each state, to raise concern about lack of disclosure  in privately insured credit unions. During each site visit, using a systematic  check sheet, we noted whether or not the credit union had conspicuously  displayed the fact that the institution was not federally insured (on signs or  stickers, for example).
In addition, from these same 57 sites visited, we collected a total of 227  credit union documents that we analyzed for disclosure compliance. While  section 43 requires depository institutions lacking federal deposit  insurance to disclose they are not federally insured in personal documents,  such as periodic statements, we did not collect them. We also conducted an  analysis of the Web sites of 78 privately insured credit unions, in all eight  states where credit unions are privately insured, to determine whether  disclosures required by section 43 were included. To identify these Web  sites, we conducted a Web search. We attempted to locate Web sites for all  212 privately insured credit unions; however, we were able to identify only  78 Web sites. We analyzed all Web sites identified. Finally, we interviewed  FTC staff to understand their role in enforcement of requirements of  section 43 for depository institutions lacking federal deposit insurance.
To understand how private share insurers operate, we conducted  interviews with officials at three private share insurers for credit unions—  ASI (Ohio), Credit Union Insurance Corporation (Maryland), and  Massachusetts Credit Union Share Insurance Corporation (Massachusetts).  Because ASI was the only fully operating provider of private primary share  insurance, ASI was the focus of our review. We obtained documents  related to ASI operations such as financial statements and annual audits  and analyzed them for the auditor’s opinion noting adherence with  accounting principles generally accepted in the United States. Additionally,  to understand the state regulatory framework for this remaining private  share insurer, we interviewed officials at the Ohio Department of  Insurance.
section_title: Status of Recommendations from GAO’s 1991 Report
paragraphs: We made 52 recommendations to Congress and the National Credit Union  Administration (NCUA) in our 1991 report on the credit union industry and  NCUAOf these, 28 were made to Congress, of which 8 were implemented  or partially implemented as of September 2003. We made 24  recommendations to NCUA, and 19 were implemented as of September  2003. In addition, we issued one matter for congressional consideration.  Congress partially addressed this matter.
Our recommendations spanned the range of issues addressed in our 1991  report, including the condition of the credit union industry and the National Credit Union  Share Insurance Fund (NCUSIF), credit union law and regulation, supervision of credit unions,
NCUA’s management of failed credit unions, corporate credit unions, share insurance issues, structural changes in NCUA, and the evolution of credit unions’ role in the financial marketplace.
NCUA implemented most of our recommendations to the agency. The key  changes implemented by NCUA affected (1) corporate credit unions, (2)  reporting requirements for credit unions, and (3) supervision of state- chartered credit unions. With respect to corporate credit unions, NCUA  implemented various recommendations that established minimum capital  requirements, limited investment powers of state-chartered corporate  credit unions, increased detail and frequency of reporting requirements,  and established a new unit in NCUA that is responsible for oversight,  examination, and enforcement of corporate credit unions. We expect to  review corporate credit unions following this study and to report in greater  depth on issues affecting corporate credit unions. In the area of reporting  requirements, NCUA implemented a requirement in 1993 that all federally  insured credit unions with assets greater than $50 million file financial and  statistical reports (call reports) on a quarterly basis and as of July 1, 2002,  required all federally insured credit unions to file quarterly call reports.  Finally, NCUA affirmed its supervision of state-chartered and federally  insured credit unions by establishing examination goals, as well as  conducting examinations, at almost 16 percent of all state-chartered and  federally insured credit unions in 2002.
NCUA told us that it chose not to implement five of our recommendations  because it either disagreed with the recommendations (see  recommendation 24 in table 5), or believed it had already addressed the  recommendations (see recommendations 9, 11, 16, 17 in table 5). For  example, NCUA disagreed with our recommendation to separate its  supervision and insurance functions (see recommendation 24) and  believed it was unnecessary for credit unions to submit copies of their  supervisory committee audit reports to NCUA, as NCUA examiners  routinely review the reports as part of the examination process (see  recommendation 9).
Congress implemented or partially implemented 8 of the 28  recommendations we made, which (1) established minimum capital levels  for credit unions, (2) tightened commercial lending, and (3) established  annual audit requirements for credit unions with assets greater than $500  million. As discussed in table 5, among those not implemented are  recommendations dealing with NCUA’s Central Liquidity Facility (CLF)  (see recommendations 49-52) and the structure of NCUA (see  recommendations 43-48).
See table 5 for our recommendations to NCUA and Congress and their  status as of August 31, 2003.
section_title: Financial Condition of Federally Insured Credit Unions
paragraphs: As we reported earlier, the financial condition of federally insured credit  unions—the industry—has improved since 1991, based on various  measures such as capital ratios, assets, and regulatory ratings. This  appendix provides greater detail on these measures. We used annual call  reports from December 31, 1992, to December 31, 2002, as well as a  database of regulatory ratings from the National Credit Union  Administration (NCUA) for the same time period. In addition, we used  consolidated data based on annual call reports for banks and thrifts in  order to compare them with credit unions.
subsections: section_title: Industry Capital Ratios Have Increased over Time
paragraphs: The capital of federally insured credit unions as a percentage of total  industry assets—the capital ratio—grew from 8.10 to 10.86 percent from  December 31, 1992, to December 31, 2002 (see fig. 18). Over this period,  larger credit unions had consistently higher capital ratios than smaller  credit unions.
section_title: Growth of the Industry
paragraphs: The credit union industry grew dramatically since December 31, 1992, as  measured by assets and the value of shares (see table 6). From December  31, 1992, to December 31, 2002, assets in federally insured credit unions  increased from $258 billion to $557 billion, or 116 percent, while shares  increased from $233 billion to $484 billion, or 108 percent. From December  31, 1992, to December 31, 2000, the annual percentage growth rates of  assets and shares generally fluctuated from around 3 percent to around 7  percent, with a significant rise in 1998 to over 10 percent. In the last 2 years  (2001–2002), however, the annual percentage growth in assets and shares  again rose sharply. According to NCUA officials, the more recent growth in  assets and shares reflected a “flight to safety” on the part of consumers  seeking low-risk investments in reaction to the generally depressed  condition of the securities market.
As noted earlier, the industry has consolidated and become slightly more  concentrated. As of December 31, 1992, there were 12,595 credit unions,  but by December 31, 2002, that number had declined to 9,688 (see table 7).  The number of credit unions with less than $10 million in assets declined  during this period, while the number of credit unions with more than $30  million in assets grew. Those credit unions with over $100 million in assets  had around 52 percent of total industry assets as of December 31, 1992, but  by December 31, 2002, credit unions of this size had around 75 percent of  total industry assets. The 50 largest credit unions held 18 percent of  industry assets in 1992, but by 2002 the 50 largest credit unions held 23  percent of industry assets.
As industry assets have increased, the composition of these assets has  changed. Total loans as a percentage of total assets increased from 54  percent as of December 31, 1992, to 62 percent as of December 31, 2002  (see table 8). While consumer loans, which broadly consist of unsecured  credit card loans, new and used vehicle loans, and certain other loans to  members, remained the largest category of credit union loans, the most  significant growth in credit union loan portfolios was in real estate loans.  These loans grew from 19 percent of total assets as of December 31, 1992,  to 26 percent of total assets as of December 31, 2002.
Despite the growth in credit union real estate loans, credit unions had a  lower percentage of real estate loans to total assets (26 percent) than their  peer group banks and thrifts, which had 37 percent of real estate loans to  total assets (see table 9). Credit unions had a significantly higher  percentage of consumer loans to total assets (31 percent) compared with  their peer group banks and thrifts (8 percent). These banks and thrifts,  however, had a significantly higher percentage of agricultural and  commercial loans to total assets (12 percent) compared with credit unions  (slightly more than 1 percent).
section_title: Credit Union Profits Have Been Relatively Stable in Recent Years
paragraphs: The profitability of credit unions, as measured by the return on average  assets, has been relatively stable in recent years. According to this  measure, credit union profitability was higher in the early to mid-1990s  than in the late 1990s and early 2000s. While declining from 1993 through  1999, the return on average assets has since stabilized. It has generally  hovered around 1 percent, which, by historical banking standards, is a  performance benchmark, and it was reported at 1.07 as of December 31,  2002 (see fig. 19). Profits are an especially important source of capital for  credit unions because they are mutually owned institutions that cannot sell  equity to raise capital.
section_title: Credit Unions’ Regulatory Ratings Have Improved Since December 1992
paragraphs: The number of credit unions with a CAMEL rating of 1 (strong) increased  from 1,082 (9 percent) in 1992 to 2,186 (23 percent) in 2002 (see fig. 20).  During the same time period, institutions classified as problem credit  unions—those with CAMEL ratings of 4 (poor) or 5 (unsatisfactory)—  decreased from 578 (5 percent) in 1992 to 211 (2 percent) in 2002.
section_title: Comparison of Bank and Credit Union Distribution of Assets
paragraphs: Figures 21, 22, and 23 illustrate the marked size disparity between credit  unions and institutions insured by the Federal Deposit Insurance  Corporation (FDIC), with figure 21 highlighting how small most credit  unions are. At the end of 2002, the largest credit union had less than $18  billion in assets, while the largest bank, with over $600 billion in assets, was  larger than the entire credit union industry.
Given the disproportionate size of the banking industry relative to the  credit union industry, peer groups were defined to mitigate the effects of  this discrepancy. Therefore, for our more detailed reviews, we constructed  five peer groups in terms of institution size as measured by total assets,  reported as of December 31, 2002. We further refined the sample of FDIC- insured institutions to exclude those banks and thrifts we determined had  emphases in credit card or mortgage loans. The largest bank included in  our analyses had total assets of nearly $18 billion in 2002. See appendix I  for details.
Figures 24, 25, 26, and 27 illustrate that differences in services (as  measured by the number of institutions holding various consumer,  mortgage, and business loans) between credit unions and peer group banks  are manifested in terms of institution size. Overall, the credit union  industry in aggregate did not appear to be that similar to the banking  industry (as captured by our sample of peer group banks) in terms of  services; however, when broken out by size, the larger credit unions (those  with more than $100 million in assets, or credit unions in Groups II, III, IV,  and V) appeared to be offering very similar services to peer banks.  Moreover, as nearly 90 percent of all credit unions had less than $100  million in assets as of December 31, 2002, the results depicted in Figure 24  are influenced more heavily by these institutions.
section_title: Credit Union Services, 1992–2002
paragraphs: In the absence of detailed time series data on the provision of services by  credit unions, we used holdings of various loans, including mortgage and  consumer loans, as well as other variables, as rough measures of credit  union services over time. We also separated credit unions by asset size to  illustrate any differences in provision of services by this criterion. For  illustrative purposes, we compared the smallest credit unions (those with  assets of $100 million or less) with the largest credit unions (those with  more than $1 billion in assets).
The percentage of all credit unions holding first mortgage loans has  increased every year since 1992 (see fig. 28). However, nearly twice as  many credit unions hold new and used vehicle loans as first mortgage  loans.
Calculating the percentage of loan amounts held to total assets can reveal  the relative importance of each type of loan to credit unions. Figure 29  shows that first mortgage loans have increased in importance, surpassing  each of the other loan holdings.
Although nearly all credit unions have offered regular shares (savings  accounts), over the years, the percentage of those offering share drafts  (checking accounts) and money market shares has increased, as illustrated  in figure 30.
The number of employees could have an effect on the provision of services  as well. Figure 31 shows that industry consolidation has not adversely  affected employment. Even though the industry shrank in terms of the  number of institutions from 12,595 in 1992 to 9,688 in 2002, a decline of 23  percent, the number of full-time employees went from 119,480 in 1992 to  180,401 in 2002, an increase of 51 percent.
The differences between the smallest credit unions (those with $100  million or less in assets) and the largest credit unions (those with more  than $1 billion in assets) are also apparent in the types of loans held and  their relative importance for each group over time (see figs. 32 and 33).  Nearly all of the smallest credit unions have emphasized new and used  vehicle loans, but typically less than one-half of these credit unions have  held other loan types. As of December 31, 2002, used vehicle loans were the  relatively most important loan holding for the smallest credit unions,  surpassing new vehicle loans. Almost all of the largest credit unions have  held most types of loans over the past decade, with the exception of  member business loans—but the percentage of the largest credit unions  holding these has been steadily growing and, as of December 31, 2002,  roughly three out of four of these credit unions held them. First mortgage  loans have consistently been the most important loan holding of the largest  credit unions, and they now represent nearly one-quarter of the asset mix  of these credit unions.
As of December 31, 2002, we observed a gap in services offered by smaller  credit unions and larger credit unions (see fig. 34). While larger credit  unions—those with assets of more than $100 million—accounted for just  over 10 percent of all credit unions, they offered more services than smaller  credit unions. For example, nearly all of the larger credit unions held  mortgage loans and credit card loans, while only around one-half of the  smaller credit unions held these loans.
The discrepancy in the services offered by smaller and larger credit unions  is more accurately illustrated through an analysis of more recently  collected data on more sophisticated product and service offerings, such as  the availability of automatic teller machines (ATM) and electronic banking  (see fig. 35). While less than half of the smallest credit unions offered ATMs  and one-third offered financial services through the Internet, nearly all  larger credit unions offered these services.
section_title: Characteristics of Credit Union and Bank Users
paragraphs: This appendix provides additional information on the characteristics—age,  education, and race/ethnicity—of households that use banks and credit  unions. For figures 36, 37, and 38, we analyzed data from the Federal  Reserve's 2001 Survey of Consumer Finances (SCF). The categories we  used to describe these households—credit union users and bank users—  included those who only and primarily used each of these institutions. To  supplement our analyses of households by race, we also analyzed 2001 loan  application records from the Home Mortgage Disclosure Act database  (HMDA) (see fig. 39). As we did with our analysis of HMDA income data,  we only analyzed records for home purchase loans actually made for the  purchase of one-to-four family homes.
Fifteen percent of the HMDA data reported by credit unions and 6 percent  of the HMDA data reported by banks lacked race and ethnicity data. As  such, the data in this figure may not represent the exact proportion of  mortgage loans by race. We also found that the proportion of loans without  data varied by the asset size of institutions. For example, race data were  missing for 23 percent of credit unions with assets of more than $500  million compared with about 3 percent for credit unions with less than $50  million in assets. Similarly, race data were missing for about 8 percent of  peer group banks with more than $500 million in assets compared with  about 4 percent of banks with less than $50 million in assets. However,  since these larger institutions made most of the loans, missing data from  these institutions account for more than 80 percent of all the missing data.
section_title: Key Changes in NCUA Rules and Regulations, 1992–2003
paragraphs: Since 1992, changes to the National Credit Union Administration’s (NCUA)  rules and regulations governing credit unions generally expanded the  powers of credit unions to offer products and services, and broadened the  activities in which they could engage.  With the exception of member  business lending, which NCUA constrained during the 1990s, federally  chartered credit unions gained authority to, among other things, (1) invest  in a wider variety of financial instruments, (2) offer services through the  Internet, and (3) profit from referring members to products, such as  insurance and investments, sold by third parties.  Also, NCUA increased the  number of activities in which credit union service organizations (CUSO)  could engage, including student loan and business loan origination.  In  September 2003, NCUA expanded credit union powers in member business  lending to permit well-capitalized credit unions to make unsecured  member business loans within certain limits, among other things.  See table  10 for a timeline of key changes to NCUA rules and regulations.
section_title: NCUA’s Budget Process and Industry Role
paragraphs: The National Credit Union Administration (NCUA) changed its budget  process in 2001 to allow outside parties, including credit unions and trade  organizations, to submit comments on the budget. While outside parties  can submit their budget suggestions and concerns at any time, NCUA has a  formal budget briefing where these parties can officially submit their  comments. This briefing takes place at the latter stage of NCUA’s budget  process. The changes NCUA has made to its budget process come during a  period in which NCUA has been reducing the growth in its budgets.
NCUA has two main sources of funding for its operating costs. According  to NCUA, 62 percent of the funds for operating costs in their 2002 budget  came from the National Credit Union Share Insurance Fund (NCUSIF),  administered by NCUA. NCUSIF is principally financed from earnings  (income) on investments purchased using the deposits of federally insured  credit unions. Funds are transferred from the insurance fund through a  monthly accounting procedure known as the overhead transfer to cover  costs associated with ensuring that insured deposits are safe and sound.  The remaining 38 percent of NCUA’s funds for its operating costs came  primarily from operating fees assessed on federally chartered credit  unions, for which NCUA has oversight responsibility.
subsections: section_title: NCUA Budget Process Now Includes Step for Outside Parties to Submit Comments
paragraphs: NCUA budgets on a calendar-year basis, and its board sets the policies and  overall direction for the budget. In July and August prior to the next budget  year, the NCUA regional offices submit their workload and program needs.  NCUA’s examination and insurance officials in headquarters assess the  information and formulate proposed program hours, which along with  historical actual expenditures are the basis for the proposed budget. In  September and October, the Chief Financial Officer (CFO) reviews and  analyzes the figures, conducts briefings with office directors, and makes  adjustments. In November, NCUA holds a public briefing where interested  parties, including credit unions and trade associations, have the  opportunity to comment. Later in November, the CFO briefs the board prior  to final budget adjustments. Additionally, in July of the budget year, there is  a midyear budget review to determine if any adjustments need to be made  to the budget. According to NCUA officials, NCUA also conducts a variance  analysis on the budget on a monthly basis and a more comprehensive  review at the end of the year.
According to NCUA, credit unions and other stakeholders can submit their  budget suggestions and concerns at any time. Normally, suggestions come  between August and November while NCUA is working on the budget. For  the public budget hearing, credit unions can address the board for 5  minutes or submit a written document.
Recent budget concerns by credit unions have centered on lessening the  costs to credit unions for NCUA oversight. Credit unions have raised  specific concerns about the number of NCUA staff or full-time equivalents,  the salaries of NCUA staff, and the overhead transfer rate from the  insurance fund. According to NCUA data, its average full-time equivalent  cost is less than that of the Federal Deposit Insurance Corporation (FDIC)  and the Office of the Comptroller of the Currency (OCC) and equal to that  of the Office of Thrift Supervision (OTS). Nevertheless, NCUA has  responded to concerns over its salary levels by deciding to undertake a pay  study.
section_title: NCUA Has Reduced Its Budget Growth in Recent Years
paragraphs: In recent years, NCUA has been successful in slowing its budget growth.  After 10-percent annual growth from 1998 to 2000, NCUA budget growth  has decreased to an average of about 3 percent in 2000–2003 (see fig. 40).  The NCUA board’s budget priorities have been to streamline business  processes, increase efficiencies, control budget growth, and match  resources to mission requirements, while maintaining effective  examination processes and products. NCUA is seeking budget savings by  adopting a risk-focused examination approach, extending the examination  cycle, adopting more flexible rules and regulations, increasing efficiencies  from technology (such as videoconferencing), and consolidating two of  their regions into one.
NCUA’s authorized full-time equivalent staff level decreased over 7 percent  from 1,049 in 2000 to 971 in 2003 (see fig. 41). This level of staff reductions  has been partly in response to changes in the industry. Since 1998, the  number of federally insured credit unions has decreased steadily by about 3  percent per year.
section_title: NCUA’s Implementation of Prompt Corrective Action
paragraphs: Section 301 of the Credit Union Membership Access Act (CUMAA)  amended the Federal Credit Union Act to require the National Credit Union  Administration (NCUA) to adopt a system of prompt corrective action  (PCA) for use on credit unions experiencing capitalization problems. The  goal of requiring PCA is to resolve the problems of insured credit unions  with the least possible long-term loss to the National Credit Union Share  Insurance Fund (NCUSIF). In that regard, NCUA was required to prescribe  a system of PCA consisting of three principal components: (1) a  comprehensive framework of mandatory supervisory actions and  discretionary supervisory actions, (2) an alternative system of PCA for  “new” credit unions, and (3) a risk-based net worth (RBNW) requirement  for “complex” credit unions. Furthermore, section 301 also required NCUA  to report to Congress on how PCA was implemented and how PCA for  credit unions differs from PCA for other depository institutions. NCUA  submitted this report in May 2000. In addition, NCUA submitted a further  report to Congress that described how NCUA carried out the RBNW  requirements for credit unions and how these requirements differed from  RBNW requirements of other depository institutions (see table 11).
After NCUA implemented the initial PCA and RBNW regulations, it formed  a PCA Oversight Task Force to review at least a full year of PCA  implementation and recommend necessary modifications. The task force  reviewed the first six quarters of PCA implementation. It made several  recommendations to improve PCA, including revising definitions of terms  and clarifying implementation issues. In June 2002, NCUA issued a  proposed rule setting forth revisions and adjustments to improve and  simplify PCA. In November 2002, after incorporating public comments on  the proposed rule, NCUA issued the final PCA rule adopting the proposed  revisions and adjustments. The final rule became effective on January 1,  2003.
subsections: section_title: PCA Incorporates a Comprehensive Framework of Mandatory and Discretionary Supervisory Actions
paragraphs: The PCA rule consists of a comprehensive framework of mandatory and  discretionary supervisory actions for all federally insured credit unions  except “new” credit unions. The PCA system includes the following five  statutory categories and their associated net worth ratios: well-capitalized—7.0 percent or greater net worth, adequately capitalized—6.0 to 6.99 percent net worth, undercapitalized—4.0 to 5.99 percent net worth, significantly undercapitalized—2.0 to 3.99 percent net worth, and critically undercapitalized—less than 2.0 percent net worth.
As noted earlier in the report, mandatory supervisory actions apply to  credit unions that are classified adequately capitalized or lower. The PCA  system also includes conditions triggering mandatory conservatorship and  liquidation.
CUMAA also authorized NCUA to develop a comprehensive series of  discretionary supervisory actions to complement the mandatory  supervisory actions. Some or all of these 14 discretionary supervisory  actions can be applied to credit unions that are classified undercapitalized  or lower (see table 12).
The discretionary supervisory actions are tailored to suit the distinctive  characteristics of credit unions.
section_title: An Alternative System for New Credit Unions
paragraphs: CUMAA required NCUA to develop an alternative PCA system for “new”  credit unions. In doing so, NCUA recognized that new credit unions (1)  initially have no net worth, (2) need reasonable time to accumulate net  worth, and (3) need incentives to become adequately capitalized by the  time they are no longer new. Accordingly, the PCA system for new credit  unions has relaxed net worth ratios, allows regulatory forbearance, and  offers incentives to build net worth. The PCA system for new credit unions  includes six net worth categories and their associated net worth ratios (see  table 13).
section_title: Risk-based Net Worth Requirement for “Complex” Credit Unions
paragraphs: CUMAA also required NCUA to formulate the definition of a “complex”  credit union according to the risk level of its portfolios of assets and  liabilities. Well-capitalized and adequately capitalized credit unions  classified as complex are subject to an additional RBNW requirement to  compensate for material risks against which a 6.0 percent net worth ratio  may not provide adequate protection. (We describe the RBNW requirement  in more detail elsewhere in this appendix.)
section_title: NCUA Submitted Required PCA Report to Congress
paragraphs: CUMAA mandated that NCUA submit a report to Congress addressing PCA.  The report, dated May 22, 2000, explains how the new PCA rules account  for the cooperative character of credit unions and how the PCA rules differ  from the Federal Deposit Insurance Act’s (FDIA) “discretionary  safeguards” for other depository institutions as well as the reasons for the  differences.
The report discusses how the PCA rules account for credit unions’  cooperative character in three areas: their not-for-profit nature, their  inability to issue stock, and their board of directors consisting primarily of  volunteers. First, the final rule accounts for credit unions’ not-for-profit  nature by permitting a less-than-well-capitalized credit union to seek a  reduction in the statutory earnings retention requirement to allow the  continued payment of dividends sufficient to discourage an outflow of  shares. In addition, a well-capitalized credit union whose earnings are  depleted may be permitted to pay dividends from its regular reserve  provided that such payment would not cause the credit union to fall below  the adequately capitalized level. Secondly, to account for the inability of  credit unions to issue capital stock, the final rule relies on the Net Worth  Restoration Plan, which must be submitted by credit unions classified as  undercapitalized or lower. Finally, to recognize that credit unions’ boards  of directors consist primarily of volunteers, the rule exempts credit unions  that are near to being adequately capitalized from the discretionary  supervisory action authorizing NCUA to order a new election of the board  of directors.
NCUA reported that the final rule established discretionary supervisory  actions that are essentially comparable to section 38 of FDIA, which  specifies “discretionary safeguards” for other depository institutions. The  report notes that NCUA adopted discretionary supervisory actions that are  similar to all but two of FDIA’s 14 discretionary safeguards.
NCUA did not adopt FDIA’s safeguards requiring selling new shares of  stock and prior approval of capital distributions by a bank holding  company. NCUA’s rationale for these exclusions was that, unlike banks,  credit unions cannot sell stock to raise capital and are not controlled by  holding companies.
NCUA departed from FDIA discretionary safeguards in fashioning three of  the discretionary supervisory actions: (1) dismissals of senior officers or  directors, (2) exemption of officers from discretionary supervisory actions,  and (3) ordering a new election of the boards of directors. NCUA reported  that the discretionary supervisory action for director dismissals departs  significantly from its FDIA counterpart. The FDIA safeguard protects from  dismissal of officials with office tenures of 180 days or less, when an  institution becomes undercapitalized. In contrast, NCUA contends that  such a “safe harbor” is unnecessary for credit unions. Moreover, NCUA  field experience supports the view that short-tenured officers can be as  responsible as others for rapidly declining net worth.
With regard to exempting officers from discretionary supervisory actions,  NCUA provides conditional relief to credit unions in contrast to the FDIA.  For example, the report notes that FDIA allows 11 discretionary safeguards  to be imposed on undercapitalized institutions. On the other hand, NCUA’s  comparable discretionary supervisory actions can be imposed against  undercapitalized credit unions in the first tier of that category only when  they fail to comply with any of CUMAA’s four mandatory supervisory  actions or fail to implement an approved Net Worth Restoration Plan.NCUA’s rationale for granting relief from the relevant discretionary  supervisory actions is to avoid treating credit unions that are just short of  adequately capitalized as harshly as those that are almost significantly  undercapitalized.
NCUA’s report states that it modified the discretionary supervisory action  ordering a new election of the board of directors. Specifically, NCUA  excludes undercapitalized credit unions from this requirement but applies  it to significantly undercapitalized and critically undercapitalized credit  unions. NCUA’s exception was based on the belief that the safeguard would  undermine a defining characteristic of credit unions—membership election  of directors—and possibly discourage members from volunteering to serve  as directors. Moreover, NCUA noted that its discretionary supervisory  action does not compel a credit union to replace its board with a NCUA- designated slate; it simply requires the membership to reconsider its  original choice of directors. Finally, the report states that ordering a  wholesale election of the board of directors may be an overreaction when a  credit union’s net worth is within reach of becoming adequately capitalized.
section_title: NCUA Submitted RBNW Report to Congress
paragraphs: NCUA submitted a report to Congress addressing its RBNW provisions on  November 3, 2000. In general, the report describes NCUA’s comprehensive  approach to evaluating a credit union’s individual risk exposure. It explains  the RBNW requirement that applies to complex credit unions. The RBNW  requirement takes into account whether credit unions classified as  adequately capitalized provide adequate protection against risks posed by  contingent liabilities, among other risks. According to the RBNW report,  NCUA’s approach (1) targets credit unions that carry an above-average  level of exposure to material risk, (2) allows an alternative method to  calculate the amount of net worth needed to remain adequately capitalized  or well-capitalized, and (3) makes available a risk mitigation credit to  reflect quantitative evidence of risk mitigation.
NCUA reported that its final rule targets credit unions that have higher  material risk levels, thus warranting an extra measure of capital to protect  them and NCUSIF from losses. As noted previously, credit unions do not  issue stocks that create shareholder equity. Without shareholder equity to  absorb losses, the RBNW requirement serves to mitigate most forms of risk  in a complex credit union’s portfolio. Specifically, the RBNW measures the  risk level of on- and off-balance sheet items in the credit union’s “risk  portfolios.” The requirement applies only if a credit union’s total assets at  the end of a quarter exceed $10 million, and its RBNW requirement under  the standard calculation exceeds 6 percent. The $10 million asset floor  eliminates the burden on credit unions that are unlikely to impose a  material risk.
NCUA uses two methods to determine whether a complex credit union  meets its RBNW requirement. Under the “standard calculation,” each of  eight risk portfolios is multiplied by one or more corresponding risk  weightings to produce eight “standard components.” The sum of the eight  standard components yields the RBNW requirement that the credit union’s  net worth ratio must meet for it to remain either adequately capitalized or  well-capitalized. If the RBNW requirement is not met, the credit union falls  into the undercapitalized net worth category. NCUA allows a credit union  that does not meet its RBNW requirement under the standard calculation to  substitute for any of the three standard components, a corresponding  “alternative component” that may reduce the RBNW requirement. The  alternative components recognize finer increments of risk in real estate  loans, member business loans, and investments.
Finally, in reporting on the RBNW requirement, NCUA recognized that  credit unions, which failed under the standard calculation and with the  alternative components, nonetheless might individually be able to mitigate  material risk. In such instances, a risk mitigation credit is available to credit  unions that succeed in demonstrating mitigation of interest rate or  credit risk.If approved, a risk mitigation credit will reduce the RBNW  requirement a credit union must satisfy to remain classified as adequately  capitalized or above.
section_title: Accounting for Share Insurance
paragraphs: The National Credit Union Share Insurance Fund (NCUSIF) capitalizes its  insurance fund differently than the Federal Deposit Insurance Corporation  (FDIC) capitalizes the Bank Insurance Fund (BIF) and the Savings  Association Insurance Fund (SAIF). For NCUSIF, a cash deposit in the fund  equal to 1 percent of insured shares, adjusted at least annually, must remain  on deposit with the fund for the period a credit union remains federally  insured. This deposit is treated as an asset on the credit union’s financial  statements, and as part of equity on NCUSIF’s financial statements in an  account entitled “Insured credit unions’ accumulated contributions.” If a  credit union leaves federal insurance, for example to become privately  insured, the deposit with NCUSIF is refunded. However, if the National  Credit Union Administration’s (NCUA) board assesses additional premiums  in order to maintain the minimum required equity ratio, the premiums are  treated as an operating expense on the credit unions’ financial statements  and would not be refunded. Since 2000, NCUA has not made any  distributions to contributing credit unions because the fund did not exceed  the NCUA board’s specific operating level. And, between 1990 and 2002,  federally insured credit unions were assessed premiums only in 1991 and  1992, when the fund’s equity declined below the mandated minimum  normal o rcent of insured shares. 1.20 pep erating l evel ofHowever, unlike federally insured credit unions, federally insured banks  and thrifts operate exclusively under a premium-based insurance system.  This system requires banks and thrifts to remit a premium payment of a  specified percent of their balance of insured deposits twice a year to FDIC  to obtain federal deposit insurance. Each bank or thrift treats the premium  as an expense in its financial statements, while FDIC recognizes the  premium as income in its financial statements. If a bank or thrift elects to  not continue its federal deposit insurance, its premiums are, unlike the  NCUSIF insurance deposit, nonrefundable. or 3) and a supervisory subgroup (A, B, or C).This resulted in the best- rated institutions being categorized as 1-A and the worst institutions as 3-C.  These categorizations result in a range of premium costs, with the best- rated institutions paying the lowest premium and the worst-rated  institutions paying the highest premium.
In August 2000, FDIC issued a report that discussed the current deposit  insurance system, including the existence of two separate funds, an  insurance pricing system that may provide inappropriate incentives for risk  and growth, and issues of fairness and equitable insurance coverage, and  offered possible solutions. The report warned that this system might  require banks to fund insurance losses when they can least afford it.  Solutions offered in the report included (1) merging BIF and SAIF, (2)  improving the pricing of insurance premiums through a number of options,  and (3) setting a “soft” target for the reserve ratio, which would allow the  deposit insurance fund balances to grow during favorable economic  periods, thereby smoothing premium costs over a longer period of time. As  a result of FDIC’s report, legislation is pending that may provide additional  reforms of the deposit insurance system, including pricing of insurance. percent up to a maximum of 1.3 percent for each credit union depending on  the credit union’s CAMEL rating.
The FDIC study of risk-based pricing indicated that one of the negative  aspects of not pricing to risk is that new institutions and fast-growing  institutions are benefiting at the expense of their older and slower-growing  competitors. Rapid deposit growth lowers a fund’s equity ratio and  increases the probability that additional failures will push a fund’s equity  ratio below the minimum requirements, resulting in a rapid increase in  premiums for all institutions.
section_title: Comments from the National Credit Union Administration
section_title: Comments from American Share Insurance
paragraphs: B.
ASI  has  limited  ability  to  absorb  large  (catastrophic)  losses  because  it  does  not  have  the  backing of any government entity.
In  its  29-year  history,  ASI  has  paid  over  110  claims  on  failed  credit  unions,  and  more  importantly,  no  member of a privately insured credit union has ever lost money in an ASI-insured account. Also, ASI’s  statutory ability to reassess its member credit unions provides a significant amount of committed equity  for  catastrophic  losses.  Further,  the  company  employs  numerous  programs  to  mitigate  the  risk  of  large  losses and field examines more than 60% of its insured risk annually.  Therefore, a sound private deposit  insurance  program,  built  upon  a  solid  foundation  of  careful  underwriting,  continuous  risk  management  and the financial backing of its mutual member credit unions, can absorb large (catastrophic) losses.
With regard to the government backing, the GAO fails to consider that ASI is a private business, licensed  at the state level; owned by the credit unions it insures; and, managed by a board of directors elected by  such  member  credit  unions.  Private  share  insurance  was  never  intended  to  have  any  state  or  federal  guarantees.
C.
ASI’s lines of credit are limited in the aggregate as to amount and available collateral.
The Study Section erroneously views the company’s lines of credit as a source of capital, when they are  solely in place to provide emergency liquidity. Proportionately, ASI’s committed lines of credit with third  parties,  as  a  percentage  of  fund  assets,  are  greater  than  that  of  the  federal  share  insurer.  Comparisons  throughout the Study Section are often provided on an absolute basis, not a proportionate basis, which we  believe skews many of the results included in the Study Section.
D.  	 Many  privately  insured  credit  unions  have  failed  to  make  required  consumer  disclosures  about the absence of federal insurance of member accounts as required under the Federal  Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), and the Federal Trade  Commission (FTC) is the appropriate federal agency to enforce such compliance.
FDICIA  was  passed  in  December  1991,  and  not  long  thereafter,  the  FTC  sought  and  received  an  exemption  from  Congress  from  enforcing  the  consumer  disclosure  provisions  of  FDICIA.  We  concur  with  the  Study  Section’s  observations  in  this  regard,  and  believe  privately  insured  credit  unions  would  benefit from FTC’s enforcement of such provisions.
Detailed comments supporting and supplementing our above comments are attached as Exhibit A.
A.
ASI’s risks are concentrated in a few large credit unions and in certain states.
All  businesses  face  some  degree  of  concentration  risk.  For  example,  55%  of  all  federally  insured  shares  are  on  deposit  at  only  230  NCUSIF-insured  credit  unions  --  this  represents  less  than  3%  of  all  federally  insured  credit  unions nationally. Despite this natural phenomena, the GAO proceeds to raise concern over ASI’s risk distribution.
The  Study  Section  states  that  compared  to  federally  insured  credit  unions,  “…relatively  few  credit  unions  are  privately insured.” As of December 31, 2002, about 2% of all credit unions are privately insured. ASI is currently  authorized  in  nine  states  and  insuring  credit  unions  in  eight  nationally,  and  is  limited  to  insuring  only  state- chartered  credit  unions  in  those  states  in  which  the  company  is  authorized  to  do  business.  In  its  current  states  of  operation,  the  company  insures  212  credit  unions,  comprising  $10.8  billion  in  insured  shares.  What  the  Study  Section fails to report is that these credit unions represent 19% of all 1,095 state-chartered credit unions within that  limited  market,  and  13.67%  of  the  $80  billion in  shares  in  those  same  1,095  credit  unions.  Clearly,  private  share  insurance is more significant to those affected states than the Study Section’s 2% statistic infers.
The Study Section also reports that 45% of all shares insured by ASI are in credit unions chartered in California, as  compared to 14.7% for the NCUSIF. These facts can be misleading given that ASI has a  limited  market, and the  NCUSIF operates in all 50 states. An entirely different, but more comparable, result is achieved when one isolates  the relative risk in these eight states only. Under an assumption that both entities are limited to doing business in  just the eight ASI states, ASI’s 45% concentration in California looks significantly less daunting when compared to  55% for the NCUSIF. This should offer evidence that when placed on equal footing, the relative risk concentration  variances are reduced materially.
While eight states represent a limited market, they do not necessarily represent a geographic concentration risk, as  inferred by the Study Section. We argue that the company’s states of operation represent a diverse cross-section of  our nation, for example: East Coast – Maryland; Midwest – Ohio, Indiana and Illinois; West Coast – California and  Nevada; Northwest – Idaho; and, Southeast – Alabama.
As a private company, ASI faces various admission obstacles when seeking new markets. First, a state must have a  state statute that allows for an option in share insurance. According to the Study Section, a total of approximately  20 state statutes currently allow for the share insurance option for their state-chartered credit unions. Based on this  data, ASI is operating in about 40%-50% of the available markets. Furthermore, the actual power to approve such  coverage,  when  permitted  by  statute,  is  generally  resident  with  the  specific  state’s  credit  union  supervisory  authority. So, as a private company, to do business in any state requires that three basic conditions exist: (1) credit  union demand; (2) a permissible statute; and, (3) regulatory acceptance of the option.
Based on these legislative and regulatory barriers, we take exception to the GAO constantly using the federal share  insurer, the NCUSIF, as a benchmark in evaluating a private company’s geographic concentration risk. Due to the  agency’s federal franchise, none of the above conditions need be present for the NCUSIF to do business in a state.
The business of insuring credit union member deposits is a business of risk assumption. Accordingly, the type of  risk  one  assumes  drives  the  cost  of  the  program  and  the  risk  of  ultimate  loss  to  the  fund.  ASI  has  been  very  selective in assuming the risk it underwrites, and does a thorough job of monitoring and field examining its insured  institutions  on  a  recurring  basis  as  reported  in  the  Study  Section.  In  addition,  the  Study  Section  reports  that  the  company  has  denied  insurance  coverage  to  certain  credit  unions  representing  inordinate  risk  to  the  fund,  and  conversely has approved many that satisfy the company’s Risk Eligibility Standards. Of the 29 credit unions that  have converted to private share insurance during the past decade, all were at the time, and are now, safe and sound  credit unions, and all strictly complied with the federal requirements to convert insurance. These were not problem  credit unions fleeing federal supervision. Included in these federal requirements is a mail ballot vote of the credit  union’s entire membership.
Risk in a Few Large Credit Unions  The Study Section reports that ASI has one insured institution that represents approximately 25% of its total insured  shares,  and  that  its  “Top  Five”  credit  unions  represent  40%  of  total  insured  shares.  The  first  statistic  compares  unfavorably  to  the  NCUSIF’s  reported  concentration  risk  in  a  single  institution  of  3%,  to  which  we  take  no  exception. The risk of a single institution, however, has been significantly misrepresented in the Study Section. A  large, well managed credit union contributes significantly to the financial stability of a share insurance program.
When  underwriting  its  current  largest  institution  in  2002,  ASI  considered  several  risk-mitigating  factors,  and,  as  with all applicant credit unions, performed a careful analysis of the institution. First, the subject institution received  (and  continues  to  receive)  the  highest  rating  available  for  credit  unions.  Second,  ASI’s  independent  actuaries  evaluated  the  adequacy  of  ASI’s  capital  prior  to,  and  following,  the  underwriting  of  this  credit  union,  and  determined that ASI would continue to have a sufficiently high probability of sustaining runs even with this credit  union  in  its  insurance  fund.  Lastly,  the  federal  insurer  and  state  regulator  both  approved  of  the  credit  union’s  insurance conversion, but only after the credit union took a full mail ballot vote of its almost 200,000 members and  agreed to satisfy all the requirements of consumer disclosure under FDICIA.
With regard to the risk concentrated in a few large credit unions, the Study Section fails to report the concentration  risk in what would be the equivalent of the NCUSIF’s “Top Five” federally insured credit unions. Proportionately,  this would equate to the NCUSIF’s top 230 federally insured credit unions. In terms of asset size, this group of 230  credit unions represents 45% of the NCUSIF’s total insured shares. Clearly, the two funds compare on this statistic,  when measured on a proportionate, not absolute basis.
B.
ASI has limited ability to absorb large (catastrophic) losses because it does not have the backing of  any government entity.
The credit union movement introduced share insurance on the state level long before Title II of the Federal Credit  Union  Act  was  enacted  in  1971,  providing  the  first  federal  deposit  insurance  for  credit  unions.  However,  private  share insurance didn’t come of age until the mid 1970s, as states began to realize the loss of sovereignty in a state  charter under an all-federal insurance setting.
It  was  never  envisioned  that  private  share  insurance  would  seek,  or  need,  any  guarantee  from  a  state  or  federal  government to operate. In the cooperative spirit of the credit union movement, private share insurance was designed  to  be  a  credit  union-owned  and  credit  union-operated  private  fund.  Nor  was  it  ever  the  intent  of  the  framers  of  private share insurance for it to operate without supervision, or financial capacity. Accordingly, various state laws  were proactively sought and passed to permit the private share insurance option, subject to admission standards and  required approvals. Private share insurance was designed to provide credit unions with a comparable – not identical  --  alternative  means  for  protecting  member  share  accounts.  Accordingly,  a  government  backing  for  private  share  insurance was never  anticipated, and to use the lack  of such a guarantee as  a criticism of private share insurance  does not take into account its legislative intent, past performance or founding principles.
To  our  knowledge,  no  private  insurance  company,  licensed  by  individual  states,  has  a  guarantee  from  the  federal  government. Further, no private insurance company in the U.S. would be able to meet the “deep pockets” test of the  federal or state governments inferred in the Study Section. As evidence of this, the largest insurance company in the  country reports just under $32 billion in capital from all of its various insurance product lines. This is barely 50% of  sheet capital plus the off-balance sheet recapitalization liability of its insured credit unions).
Credit union-only insurance funds have a stable history that does not track with insurers of thrifts or a combination  of thrifts and credit unions. Funds that have insured only credit unions (like ASI and the NCUSIF) have had very  successful  track  records  when  it  comes  to  loss  and  risk  management.  In  over  29  years,  ASI’s  loss  ratio  has  been  significantly below that of its federal counterpart, and ASI has never had a year with an operating loss, nor has it  ever had to seek any form of recapitalization from its member credit unions to bolster the fund due to losses.
The  reality  is  that  a  sound  deposit  insurance  program,  built  upon  a  solid  foundation  of  careful  underwriting,  continuous  risk  management  and  the  financial  backing  of  its  mutual  member  credit  unions,  can  exist  as  long  as  consideration is given to an actuarial analysis of the capital adequacy of the program in terms of sufficiently high  probabilities  (over  90%)  of  being  able  to  withstand  runs  and  multiple  runs  on  the  system.   This  is  a  common  analysis that is accepted in the insurance industry for various kinds of low frequency, high-severity risk programs  and  is  the  foundation  that  the  ASI  insurance  program  is  built  upon.  Our  actuarial  analyses  and  independent  actuarial reports were provided to the GAO during its investigation. Alternative share insurance can be comparable  to the NCUSIF, and still not have a government backing.
C.
ASI’s lines of credit are limited in the aggregate as to amount and available collateral.
With regard to ASI’s committed bank lines of credit, the Study Section infers that ASI’s ability to absorb losses is  reduced since its lines of credit are limited in the aggregate as to amount and available collateral.  We disagree with  this  inference.  The  company’s  lines  of  credit  are  designed  to  be  solely  a  liquidity  facility.  The  committed  lines  ensure liquidity of ASI’s invested funds; i.e., they provide a mechanism for ASI to quickly generate cash to meet  liquidity needs, without having to liquidate the portfolio.  Resources available for funding losses are not the same as  resources  available  for  providing  liquidity.  Lines  of  credit  are  not  intended  to  be  a  source  for  funding  insurance  losses. In fact, banks would not provide a loan for such a purpose.  ASI’s assets and its off-balance sheet sources of  funding  (i.e.,  the  power  to  recapitalize  the  fund  by  insured  credit  unions  under  the  ASI’s  governing  statute  and  insurance policy) are its capital sources for funding losses, not the bank lines of credit.
Proportionately, ASI’s lines of credits are greater than that of the NCUSIF.  ASI’s $90 million in committed lines  of credit equates to approximately 47% of the company’s total assets.  NCUSIF’s $1.6 billion maximum borrowing  capacity ($100 million from the U.S. Treasury and $1.5 billion from the Central Liquidity Facility, as disclosed in  the  NCUSIF’s  and  CLF’s  audited  financial  statements  for  the  year  ended  December  31,  2002),  equates  to  approximately 28% of its total assets.
ASI has other sources of liquidity when it liquidates a credit union -- that is the credit union’s own liquid assets.
Approximately 42% of ASI’s primary insured credit unions’ total assets are comprised of cash and investments –  we  believe  this  is  significant.   In  addition,  the  non-liquid  assets  (namely  loans  and  fixed  assets)  of  a  failed  institution  can  be  pledged  as  collateral  for  additional  borrowings  to  generate  short-term  liquidity  until  such  loans  and  other  assets  can  be  collected  and/or  sold.  In  essence,  a  failed  credit  union’s  total  assets  over  time  often  generate sufficient liquidity to pay shareholders. Any shortage (historically less than 4% of total assets of the failed  institution) is usually funded as a loss by ASI’s assets.  This is the same principle under which NCUSIF operates.
D. 	 Many privately insured credit unions  have failed to make required consumer disclosures about the  absence  of  federal  insurance  of  member  accounts  as  required  under  the  Federal  Deposit  Insurance  Corporation  Improvement  Act  of  1991  (FDICIA),  and  the  Federal  Trade  Commission  (FTC)  is  the  appropriate federal agency to enforce such compliance.
The Study Section reference to the GAO’s August 20, 2003 study titled: Federal Deposit Insurance Act: FTC Best  Among Candidates to Enforce Consumer Protection Provisions (GAO-03-971) reiterates the GAO’s earlier concern  that  “…members  of  privately  insured  credit  unions  might  not  be  adequately  informed  that  their  deposits  are  not  federally insured…”
Although the statement  may be accurate, any implication that ASI and its member credit unions are purposefully  misleading consumers fails to directly implicate the Federal Trade Commission (FTC) who, with the concurrence  of Congress, has totally disregarded its statutory responsibility to regulate the disclosure requirements as defined by  Section 151 (g) of FDICIA, codified at 12 U.S.C. § 1831 (t)(g).
We  believe  that  the  GAO’s  earlier  study  brought  to  light  the  problems  that  arise  when  a  federal  law  effectively  lacks  an  enforcement  agency,  and  we  support  the  GAO’s  previous  conclusion  that  the  FTC  is  the  appropriate  agency for monitoring and defining private share insurance consumer disclosure requirements.
This  concludes  ASI’s  detailed  comments  in  response  to  the  GAO’s  draft  report  on  its  study  of  private  share  insurance  in  the  credit  union  movement  --  a  component  of  the  GAO’s  broader  study  titled,  Credit  Unions:  Financial  Condition  Has  Improved  But  Opportunities  Exist  to  Enhance  Oversight  and  Share  Insurance  Management.
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