WASHINGTON — Federally insured credit unions have increased loan-loss provisions substantially during the past 12 months, according to the NCUA. Provision for loan-loss expense to average assets was 0.71 as of Sept. 30, 2008, up 92% from 0.37 just one year prior. Allowance for loan-loss accounts as a percentage of total loans is up, too, from 0.68% in September 2007 to 0.87% this past September, a nearly 30% increase.
However, delinquencies and charge offs for credit unions are up, too, and their rate of increase is as dramatic as both provisions and allocations. One eye catcher among the NCUA's statistics is that the historical parity between delinquencies to total loans and ALLL to total loans is converging: Delinquencies as of Sept. 30 rose to 1.13%, 25 basis points higher than the ALLL ratio of 0.87%. In September 2007, that spread was 13 basis points. On Sept. 30, 2006, the spread was only six basis points.
NCUA spokesman John McKechnie said there are trends emerging in the practice of provision budgeting. However, both he and industry balance sheet experts cautioned against making any false assumptions regarding the need for provisions and delinquencies to match dollar for dollar when they increase or decrease.
Why? Mike Sacher, director at accounting firm McGladrey & Pullen, said one factor is that real estate delinquencies are rising for the first time in credit union history, and their sheer size is having an effect on the makeup of delinquent portfolios.
"As real estate loans become delinquent, delinquency ratios can rise significantly, outstripping the amount set aside in the ALLL," Sacher said. "The challenge for credit unions is to analyze the loss exposure presented by delinquent real estate loans and ensure an appropriate amount has been allocated to the ALLL. Credit unions must also determine whether any impairment has occurred on certain real estate loans that may not yet even be delinquent and factor this into the ALLL calculation."
McKechnie said the NCUA has joined with the other FFIEC regulators to issue interagency guidance on ALLL funding and methodologies. However, the agency's new "contingency oriented and forward looking" methods of regulation also account for some of the trend. As promised by agency leaders during speaking engagements and interviews for the past few months, NCUA examiners have been advised to move away from standardized numbers and ratios when evaluating credit union balance sheets and to instead look at specific credit union factors, like field of membership and contingency plans, when evaluating loan loss risk.
Additionally, McKechnie said real estate loans that qualify for restructuring should fall within Statement of Financial Accounting Standard No. 114.
"The basis for funding the ALLL under FAS 114 would most likely be based on the discounted present value of expected future cash flows," he said.
Consultant and former NCUA Chair Dennis Dollar added that a credit union's recovery history is yet another consideration when determining provisions and allocation accounts.
"It cannot be assumed that all delinquencies will result in losses, and each credit union has a different history of how they have managed their delinquencies," Dollar said. "Yes, during a time of economic upheaval, the likelihood of provisions for loan loss increasing is very likely. However, the amount of provision that will be needed cannot be drawn solely from the delinquency ratios or total dollars of delinquent loans."
When asked if the NCUA was comfortable with industrywide ALLL coffers and provisioning ratios, McKechnie responded without hesitation, saying, "Yes." He added that the NCUA has hired 50 new regular and five new supervisory examiners, as well as decreasing the length of the exam cycle to 12 months, so the agency has plenty of troops on the ground. In fact, he said, examiners have turned up a couple of credit unions that weren't provisioning properly and that may also be skewing numbers a bit.
Sacher said it's important to note that the NCUA's numbers show that ALLL to total loans is still 12 basis points higher than the net charge-off ratio, which means credit unions should have enough set aside to account for next year's loan losses.
Furthermore, based on what his own consulting experiences over the past two months, Sacher said he expects both provisions and ALLL ratios to rise considerably in the fourth quarter.
"Directional consistency is what, as an auditor, I would expect to see," Sacher said. "I don't have enough information to know if the magnitude of the increase is enough, but it's certainly moving in right direction."
However, Peter Duffy, director at Sandler O'Neill & Partners, said unprecedented increases in consumer debt-more than tripling from $4 trillion to $13 trillion in the last 18 years-should offset at least some decrease in risk as a result of more real estate loans being counted among the delinquent.
It's not just his opinion, Duffy said. Plenty of banks and credit unions alike are putting aside more provision funds this year as compared to delinquencies and charge offs, not less.
"It makes complete sense to evaluate each situation based on individual environment, concentrations, field of membership … that makes complete sense," he said. "But on a general market basis, as much as household debt has increased in the last 18 years, and in an accelerated way during the last eight, one would think provisions would fall into line with delinquencies."
However, Dollar added that provisions only tell half the story of whether or not a credit union is adequately funded for loan losses.
"Many ALLL accounts were well-funded going into the recent crisis," Dollar said. "Therefore, they would not need as much provision for loan losses to go into the ALLL account, even if their charge offs do increase."
–handerson@cutimes.com

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Loan Provisions Shoot Up, But Have They Grown Enough to Cover Losses?

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