TODAY’S NCUA BOARD MEETING HAD NO FIREWORKS BUT WAS SUBSTANTIVE NONETHELESS 

The NCUA Board met today with two actions on real estate appraisals that were quite substantive and a report on the financial condition of the National Credit Union Share Insurance Fund (NCUSIF) that should cause federally-insured credit unions to take note of the possibility of a deposit insurance premium in their future.

FIRST, LET’S LOOK AT THE APPRAISAL RULES

The first of two appraisal rules finalized by the NCUA Board today raises the real estate appraisal threshold from $250,000 to $400,000 as to the regulatory requirement that a credit union get an appraisal on a residential mortgage.  This action, originally proposed and put out for a public comment period in November 2019, brings NCUA’s appraisal threshold into parity with the $400,000 figure granted to banks by the FDIC and OCC.

Last year the NCUA Board on a 2-1 vote (with Board Member Todd Harper in opposition) raised the threshold for requiring an appraisal on a business loan from $250,000 to $1 million.  It then followed with this proposal to raise the residential loan appraisal threshold to $400,000 on a unanimous vote.

Today’s vote was also unanimous, thus indicating that Board Member Harper’s concerns were obviously more focused on member business loans than mortgage loans.  Either way, both increases have now been finalized by the NCUA Board.  And both were very positive steps in removing regulatory burden on credit unions that directly impact their members.

Remember that the appraisal threshold, either for mortgages or for business loans, is a regulatory requirement that there must be an appraisal above that amount.  It is in the discretion of the credit union, through its own underwriting standards and lending policies, as to whether they will require an appraisal below the threshold.

A credit union can still require an appraisal below $400,000 on a residential mortgage and below $1 million on a business loan.  However, with the new rule changes, they are not required by regulation to do so if they do not feel it is essential to the effective and proper underwriting of the loan.

The second rule finalized today was a temporary deferral of the requirement to obtain an appraisal or an evaluation for up to 120 days following the closing of a real estate loan transaction.  This is a temporary extension authority due to the COVID pandemic which has created a dramatic backlog in appraisals and property evaluations in proportion to the dramatic growth in purchase loans and refinancing of mortgages at today’s record low interest rates.

Many members were having their loans delayed significantly because they could not close without an appraisal – but the appraisers could not get to them until three months from now.  This rule, even though temporary, is a positive member service change that benefits both members and their credit unions.

It does not remove the requirement for an appraisal where one is required, either by regulation or by the credit union’s own underwriting policy.  Nor does it require a credit union to close a mortgage loan without an appraisal if the credit union’s underwriting policies stipulate that a particular loan needs an appraisal before closing.

It is simply a flexibility extension due to the disruption in the appraisal and valuation industry as a result of COVID.  The NCUA Board is to be commended for their unanimous votes in support of both of these rules.

After several months of 2-1 votes and obvious lack of consensus about the direction the NCUA Board should be taking on certain issues, it was refreshing to see a meeting without any fireworks or agendas other than good regulatory practice and policy.

HOW ABOUT THE NCUA EQUITY LEVEL FALLING TO 1.22% AND WHAT COULD THAT MEAN ABOUT POSSIBLE PREMIUMS GOING FORWARD?

First, let’s look at the law.  The equity level in the National Credit Union Share Insurance Fund (NCUSIF) must be kept above 1.2%.  That is, essentially, the 1% of total insured deposits that is required to be submitted to the NCUSIF by every federally-insured credit union – plus earnings on that 1% deposit sufficient to always have another .20% in reserve along with the initial credit union deposit of 1% of insured deposits.

Historically, the NCUA Board has set a “normal operating level” well above 1.2% in order to always have a cushion above the legal required equity level in order to cover losses to the insurance fund through credit union losses above their retained capital to cover those losses themselves.

That normal operating level (NOL) has increased and decreased over the years.  When I was at NCUA the NOL was 1.27%.  It was increased subsequently to 1.30%, then up to 1.33% and 1.39% and now down to 1.38%.  The NOL is established by the NCUA Board and can be changed according to the board’s concern about potential losses to the fund.

When the equity level gets above the NOL, a dividend is sometimes declared and some of the excess funds in the NCUSIF are returned to credit unions.  The losses were so minimal during the seven years I served on the NCUA Board that we returned a dividend in five of the seven years.

Well, following the financial crisis, corporate losses and now with concerns over potential losses from the impact of the COVID era, those days of regular dividends have passed.

The challenge has become to set an NOL at the proper level to cover the losses and to provide a cushion for future losses from an unexpected source (such as the taxi medallion loans that had always performed at a high level before the Uber-fication of the taxi industry).  Or, most recently, concerns about the impact from COVID.

At today’s NCUA Board meeting, the board received a status report that showed the equity level in the NCUSIF to have fallen to its lowest level in decades at 1.22%.  That is only two basis points above the level required by law for the NCUSIF to have in order to be in compliance with Congress’ mandate.

Why the marked drop?  Was it from COVID losses?  No.

While there may indeed be some losses from credit unions unable to survive the disruption COVID and the economic fallout have caused, at this point those losses have not materialized in any measurable form.

But what has changed during COVID is the dramatic and almost uncontrolled influx of insured deposits that have flowed into credit union coffers.  With over 16% deposit growth year to date in 2020, this flight-to-safety – when coupled with over $3 trillion in stimulus funds into the economy for individuals and businesses – has raised the numerator in the NCUSIF equity level calculation so much that the same equity the NCUSIF has built up to reach 1.38% at the end of 2019 is now only 1.22% of the new total of insured deposits.

This ratio will almost certainly improve at year end 2020 when credit unions have to make additional deposits to equal 1% of their insured shares; however, no one knows if the deposit growth will continue.  Or how long.  Or how much.  And when will those deposits begin their outflow.  And how long will that outflow take.

A lot of uncertainties.

Combine this with the fact that there will be some credit union losses from the COVID disruption.  These losses will likely not be nearly as much as feared back in April and May when the economy was shut down and unemployment reached near 20%.

But there will be some losses, particularly from credit unions without the scale to survive the COVID downturn.  Again, scale matters.

Depending upon what those losses are and depending upon how long the deposit influx stays with us or grows further, it is possible that the NCUSIF equity level could fall below 1.2%.

My guess is that such a drop below 1.2% is unlikely.  But it is certainly within the range of a reasonable possibility.

If the equity level falls below 1.2%, the NCUA Board will be required by law to assess a premium on all federally-insured credit unions to bring the equity level back to at least 1.2%.  And the probability is that, if a premium is required, the board will almost certainly assess a premium large enough to build back to the NOL of around 1.38% or thereabouts.

So, with 2021 budgets being prepared now, I know you are thinking – should I budget for a 2021 premium?

Again, the likelihood is that the end of year 1% catch up deposits from credit unions into the NCUSIF will be sufficient to get the equity level back near or above 1.3% – provided there are no dramatic increases in credit union losses from COVID.

However, it would not be wise to totally discount the possibility of a 2021 premium if the deposits continue to flow in and the economic disruption as a result of COVID creates more credit union losses than expected.

Just be mindful that the possibility is out there.  Board Member Harper, who could well become NCUA Chairman if Joe Biden becomes president after the 2020 election and changes the designated chairmanship as he will have the authority and precedent to do, has already publicly called for serious consideration of both a 2021 premium and a risk-basing of the premium structure which would weigh the premium more toward larger and growing credit unions – just as did Risk-Based Capital.

While risk-based premiums would not be allowed under current law and would require literally an act of Congress to authorize, the NCUA Board itself can declare a premium.

It bears keeping your credit union eyes on this.

Until next time. Stay safe.