In June, the NCUAissued a proposed regulation that would authorize federal creditunions to securitize loans that they have originated and that meetcertain requirements set forth in the rule. The proposed amendmentwould also apply its securitization requirements to federallyinsured, state-chartered credit unions that are permitted tosecuritize their assets by state law. The NCUA is currently seekingcomments on the amendment, and a final rule is expected later thisyear.

We believe this is a terrific opportunity for credit unionsgoing forward. Banks have been using securitizations for quite sometime, and we expect credit unions to follow suit.

Simply put, a securitization is the isolation of identifiablecash flows and sale of the assets that generate those cash flows[such as loans to credit union members] from a sponsor/credit unionto a bankruptcy-remote special purpose entity. The special purposeentity uses the cash flows generated by the transferred asset tocollateralize and generate principal and interest payments on debtsecurities it issues to investors. The investors in these debtsecurities generally have limited recourse only to the securitizedassets and the cash flows they generate.

Although federal credit unions have long been explicitlyauthorized to sell their loans, until now credit unions have notbeen explicitly authorized to securitize those loans. But in theproposed rule, the NCUA has made clear that it now viewssecuritizations of loans originated by a sponsoring credit union toits members as an incidental power necessary to enable it toeffectively carry on its business, and as such it is authorizingsuch activities under the Federal Credit Union Act.

Upon adoption of the proposed rule, securitizations will allowfederal credit unions to make loans and then sell or transfer suchloans to a special purpose entity; the funds generated from suchsales can then be made available for more loans to members.

Additionally, securitizations may be used to reduce a creditunion's interest rate risk by converting its loans—fixed-rateassets—into cash. And the sale of these loans can accelerate theoriginating credit union's receipt of cash from its assets assecuritization permits the originating credit union to receive thediscounted present value of the loans more immediately than waitingfor those loans to mature.

The proposed rule limits federal credit unions to securitizingonly those loans it has originated. To securitize assets, asponsoring credit union must create an issuing entity, commonlyknown as a special purpose entity or special purpose vehicle, topurchase and hold the assets collateralizing the asset-backedsecurity.

The special purpose entity created by the sponsoring creditunion for securitizations must be “bankruptcy remote” from thecredit union, meaning the special purpose entity's assets areisolated from any creditors of the credit union should the creditunion become insolvent. A special purpose CUSO might address thisregulatory requirement.

The proposed rule establishes the following seven minimumrequirements for securitizations:

i Compliance with all federal and state laws and regulations,including registration, disclosure, reporting, and other legalrequirements.

ii Risk management. Credit unions must have in place independent riskmanagement controls to ensure proper policies and operatingprocedures, including appropriate risk limits, are in place.

iii An annual audit of its financial statements performed in accordancewith generally accepted auditing standards (GAAP) by an independentauditor.

iv The credit union's board of directors must have a generalunderstanding of the risks and benefits of its securitizationactivities.

v Senior management responsible for a credit union's securitizationsmust possess sufficient expertise to oversee those activities, andselect and oversee the various third parties engaged to support thesecuritization.

vi The credit union's board must approve an asset securitizationpolicy that includes or addresses, at a minimum, the followingitems:

• A statement of the business purpose for engaging insecuritization activities, including scope and level of acceptablerisk;
• 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 andindividual transaction monitoring.

vii Effective internal controls.

Undoubtedly, the benefits of securitizations for credit unionsare many, but the transactions can be quite complex, and theyinvariably involve numerous parties and extensive legaldocumentation. But these transactions have been going on for years.I don't think it will take long for credit unions to growcomfortable with them.

AndyKeeney is co-chair of the Kaufman & Canoles Credit UnionTeam in Norfolk, Va. CONTACT: [email protected]or (757) 624-3153.