NCUA Securitization Rule Offers Opportunities
In June, the NCUA issued a proposed regulation that would authorize federal credit unions to securitize loans that they have originated and that meet certain requirements set forth in the rule. The proposed amendment would also apply its securitization requirements to federally insured, state-chartered credit unions that are permitted to securitize their assets by state law. The NCUA is currently seeking comments on the amendment, and a final rule is expected later this year.
We believe this is a terrific opportunity for credit unions going forward. Banks have been using securitizations for quite some time, and we expect credit unions to follow suit.
Simply put, a securitization is the isolation of identifiable cash flows and sale of the assets that generate those cash flows [such as loans to credit union members] from a sponsor/credit union to a bankruptcy-remote special purpose entity. The special purpose entity uses the cash flows generated by the transferred asset to collateralize and generate principal and interest payments on debt securities it issues to investors. The investors in these debt securities generally have limited recourse only to the securitized assets and the cash flows they generate.
Although federal credit unions have long been explicitly authorized to sell their loans, until now credit unions have not been explicitly authorized to securitize those loans. But in the proposed rule, the NCUA has made clear that it now views securitizations of loans originated by a sponsoring credit union to its members as an incidental power necessary to enable it to effectively carry on its business, and as such it is authorizing such activities under the Federal Credit Union Act.
Upon adoption of the proposed rule, securitizations will allow federal credit unions to make loans and then sell or transfer such loans to a special purpose entity; the funds generated from such sales can then be made available for more loans to members.
Additionally, securitizations may be used to reduce a credit union’s interest rate risk by converting its loans—fixed-rate assets—into cash. And the sale of these loans can accelerate the originating credit union’s receipt of cash from its assets as securitization permits the originating credit union to receive the discounted present value of the loans more immediately than waiting for those loans to mature.
The proposed rule limits federal credit unions to securitizing only those loans it has originated. To securitize assets, a sponsoring credit union must create an issuing entity, commonly known as a special purpose entity or special purpose vehicle, to purchase and hold the assets collateralizing the asset-backed security.
The special purpose entity created by the sponsoring credit union for securitizations must be “bankruptcy remote” from the credit union, meaning the special purpose entity’s assets are isolated from any creditors of the credit union should the credit union become insolvent. A special purpose CUSO might address this regulatory requirement.
The proposed rule establishes the following seven minimum requirements for securitizations:
i Compliance with all federal and state laws and regulations, including registration, disclosure, reporting, and other legal requirements.
ii Risk management. Credit unions must have in place independent risk management controls to ensure proper policies and operating procedures, including appropriate risk limits, are in place.
iii An annual audit of its financial statements performed in accordance with generally accepted auditing standards (GAAP) by an independent auditor.
iv The credit union’s board of directors must have a general understanding of the risks and benefits of its securitization activities.
v Senior management responsible for a credit union’s securitizations must possess sufficient expertise to oversee those activities, and select and oversee the various third parties engaged to support the securitization.
vi The credit union’s board must approve an asset securitization policy that includes or addresses, at a minimum, the following items:
- A statement of the business purpose for engaging in securitization activities, including scope and level of acceptable risk;
- Governance of securitization activities;
- Written and consistently applied accounting methodology;
- Regulatory reporting requirements;
- Valuation methods;
- Management reporting process; and
- Exposure limits and requirements for both aggregate and individual transaction monitoring.
vii Effective internal controls.
Undoubtedly, the benefits of securitizations for credit unions are many, but the transactions can be quite complex, and they invariably involve numerous parties and extensive legal documentation. But these transactions have been going on for years. I don’t think it will take long for credit unions to grow comfortable with them.