California’s $3.1 billion Kinecta Federal Credit Union, party to a delayed mega-merger with the $1.1 billion NuVision CU, is in recovery mode this month, tending to a battered mortgage portfolio.
Update, March 1, 2012: Kinecta, NuVision Cancel Merger Plans
Two years ago the planned consolidation, once described as the largest ever, was the talk of the industry, but as of last week, final regulatory and membership approval is not expected until at least mid-2013.
It is perhaps a setback for Kinecta of Manhattan Beach, which posted a $30.6 million loss for 2011 and was among those southern California CUs that suffered the worst of the mortgage meltdown tied to the 2007-2009 housing bust.
From a management perspective, Kinecta and NuVision of Huntington Beach are in a special class. The president/CEO of both credit unions is Roger Ballard, heading up two CUs located 35 miles apart in fairly prosperous suburbs south of Los Angeles.
Ballard originally held the NuVision post and was given Kinecta reins following a long period of management turmoil at that CU. On the financial side, NuVision has fared better during the state’s deep recession, posting a $2.6 million profit for 2010.
Both CUs share aerospace legacies, serving a large SEG employee base in both Los Angeles and Orange counties and hold a combined membership of 300,000.
In an interview, Ballard called the year-end loss and write-downs disappointing but reflective of reverses in the wholesale and resale mortgage market. He added, “We have already made major strides toward recovery.”
Analysts expressed surprise that Kinecta, compared to other CUs, has not improved its balance sheet faster in dealing with mortgages. Ballard contends his CU was buffeted by a variety of factors and perhaps misjudged the booming refinance market in 2011 and was too optimistic about loan volume.
The president/CEO of the California Credit Union League, Diana Dykstra, downplayed any alarm bells surrounding Kinecta since the CU has “an unusual and national mortgage business that is subject to circumstantial market swings.”
And those refinancing shifts “could easily move the other direction just as quickly,” said Dykstra, who maintained both CUs are strong, growing and well-capitalized with a capable senior staff. She praised Ballard as a talented executive, able to run two large CUs despite the setback.
For his part, Ballard, in a statement, blamed part of Kinecta’s difficulties on regulation of wholesale mortgages and “significant slowing by new federally mandated loan officer compensation rules.”
The imposition of those rules, he said, “was compounded by a much slower than anticipated purchase market due to the prolonged weakness” in the real estate sector. In addition, said Ballard, “high inventory of REOs caused home values to decline, negatively impacting revenue” from the CU’s 35-state mortgage operation.”
In considering economic conditions, the California CEO maintained “historically low interest rates created an unprecedented level of loan prepayments due to heavy refinance activity in the latter half of 2011.” And that, he continued, led to a lower market value for mortgage servicing rights.
“Along with many other mortgage industry participants, we established a nearly $10 million impairment reserve against our MSR asset as a result,” he continued. “Our MSR impairment charges can be recaptured in subsequent periods as interest rates rise and the asset value recovers.”
Ballard said the internal decision to delay implementation of the NuVision merger was made late last year with a formal notice issued as 2011 earnings results were released.
He said boards of both CUs felt it prudent to put off the final merger filing, and so a member vote may not take place until the latter half of 2013.
Regarding the mortgage business, Kinecta retains a large percentage of its portfolio–63%– in real estate, though that is down from 68% at year end. “NCUA has been so concerned about concentration risk recently that it stands to reason that Kinecta might have decided to let certain loans leave in favor of driving portfolio growth in other areas,” observed analyst Tom Glatt Jr., head of his own Wilmington, N.C., consulting firm.
The Kinecta-NuVision combination was initially announced in June 2010 and paralleled another high profile merger of California’s Addison Avenue FCU and First Tech CU of Portland, Ore., to form the $5.1 billion First Tech FCU now with headquarters in Palo Alto, Calif.
That merger was completed last year, but Dykstra, like others, said there was no rush by the boards of Kinecta-NuVision to culminate their union.
“The truth is the merger of Kinecta and NuVision was much harder to put together” because of different business lines as compared to First Tech and Addison, “which were more of the same,” said Dykstra.
Glatt also said the delay may fit into an overall strategic design, which means that both boards would have been fully aware of the loss details and “even if the loss was unexpected, it largely seems to stem mainly from balloon resets. And given interest rates that may not be a bad thing, especially given NCUA's other concern of the day–interest rate risk.”
As for Ballard running two CUs simultaneously, another analyst and merger consultant, Michael Bell, a Niles, Mich., attorney of Detroit-based Kotz Sangster, said that a dual CEO role is certainly not entirely unique or unheard of, particularly in a pending merger. But “it certainly brings a series of risks to the forefront” and in these cases he advises clients “to utilize their boards and their supervisory committees to evaluate and put plans in place to deal with the risks.”
“Proper analysis and planning can eliminate a great majority of the risks, including continuity of leadership,” said Bell, suggesting CUs should already have the necessary policies and plans in place “to deal with the unique risks of a dual CEO.”
In elaborating on Kinecta’s finances, Ballard maintained the CU’s residential mortgages “will continue to be a strong business driver for us. Our purchase production increased over 60% in 2011 in a very difficult market and we expect this growth to continue.”
He said Kinecta hopes to generate a higher mix of retail mortgage origination in 2012, which offers higher margins. In addition, he does not anticipate any regulatory changes in 2012 and with MSR valuations at very conservative levels, he does not anticipate additional impairment.