Sharp Rise in Loan-Loss Provisions Ravage Credit Unions' Capital Ratios
Mike Sacher, who left RSM McGladrey mid-January to start his own accounting consulting firm, said credit unions located in areas experiencing home value declines and job losses are seeing loan losses across the board.
"No matter what sector: real estate, indirect, commercial, unsecured, even participation loans, you're seeing the current economy having an impact," Sacher said.
Making matters worse, accounting standards require impaired loans to be provisioned, even if they're current. Loan to value has soared above 100% in many credit union home equity portfolios; members who pay on time but have experienced FICO score dips due to problems elsewhere is another example of required loan-impairment reporting.
"Credit unions who are properly meeting accounting standards are identifying those loans and putting them on the watch list, even if they're not delinquent, and some provision is being made," Sacher said.
Some credit unions have avoided loan losses due to tight underwriting policies during the mortgage boom. However, Sacher said he thinks most credit unions located in hard-hit areas like Southern California that didn't take enormous provisions last quarter probably aren't aware of the accounting requirement and will be hit with an exception come audit time.
"My guess is we'll continue to see large provision increases over next couple of quarters as everybody cycles through the exam list," he said.
The $3.2 billion Wescom Credit Union had a tough 2007 and even tougher 2008, posting a cumulative $88 million net loss those two years and setting aside nearly $83 million in provisions during 2008; however, Executive Vice President of Finance and Financial Services Keith Pipes has managed to keep Wescom's net worth above 7% by shedding assets previously leveraged for growth, ALM and credit risk.
Pipes said Wescom sold off some government guaranteed investments and has been selling all of its new first mortgages to keep assets low. Wescom is also trying to increase earnings and efficiency while reducing costs, laying off approximately 175 employees and closing two of its 42 branches effective March 6.
The $4.2 billion Kinecta Federal Credit Union ended the year with a 7.64% capital ratio, not far off the institution's 8% ideal, despite recording a historic $44 million net loss and setting aside nearly $83 million in loan-loss provisions.
Chief Financial Officer Karen Christensen said she also reduced assets, selling off some loans and cutting back on new loan production to the tune of $190 million, which helped alleviate capital pressure.
"Going into '09, our cost structure will be about $9 million less than in '08," she said. "Our '09 plan is based around our loan-loss reserves, and we think we'll be profitable in '09, and should get back to an 8% capital ratio by mid-year."
The $1.7 billion Arizona Federal Credit Union wasn't as lucky, losing nearly $116 million in 2008 and posting an undercapitalized 4.75% ratio as of Dec. 31.
AFCU began the year with almost 11% capital, and could have handled charge offs that rose from only $18 million in 2007 to nearly $102 million at year-end 2008. However, it was the additional $174.5 million in loan-loss provisions that broke the camel's back, said President/CEO Ron Westad.
"Our total capital still sits at roughly $170 million on a balance sheet of $1.7 billion," Westad said. "So, total capital is relatively significant, but in the process of moving reserves through the income statement, we now have only 4.75% net worth but over 5% in loan-loss reserves."
Going forward, Westad's strategy to avoid corrective action is basic: mitigate risk, ensure credit quality of new loans, boost revenue and reduce expenses.
Selling off assets previously used for leveraging isn't an option for the $92 million The Members Own Federal Credit Union, a Victorville, Calif., community credit union that saw its net worth fall to 5.88% at year-end.
It only took 12 nonperforming residential construction loans to turn a challenging year into an undercapitalized one, said CEO Mary Kassel.
However, Kassel said she managed to rework two of the loans into first mortgages. Even though the members have good repayment histories, the loans must nonetheless be accounted for in provisions for the standard six months, as required by the NCUA of all reworked mortgages. Kassel said the two will drop off her provisions list in June, raising net worth back above 6%.
"We laid off seven full-time staff in January, the credit union's first ever layoffs, so it was a very difficult decision," Kassel said. "But, with the changes in our economy, our lobby flow had changed so we cut branch hours and staff."
Kassel also negotiated free rent for her second retail location, will attempt to collect state tax refunds from repossessed vehicles and is encouraged by robust lending activity and several large employers who have relocated major operations to Victorville.
However, managing real estate losses is still a tall order for a sub-$100 million credit union.
"A credit union our size isn't even allowed to have the kind of reserves you need to cover what's happened in our real estate market," she said.