ALEXANDRIA, Va. — The NCUA’s proposed derivatives rule includes a possible fee structure for credit unions applying for and using the authority that could discourage them, say those involved with the regulator’s pilot program. And one credit union chief financial officer said she won’t apply if the final rule includes the fee.
Denise Boutross McGlone, chief financial officer at the $2.4 billion Affinity FCU of Basking Ridge, N.J.,, has been using derivatives through the pilot to hedge against the interest rate risk presented by Affinity’s large 30-year fixed-rate mortgage portfolio. McGlone said she’s glad the NCUA proposed the rule, but said the fee structure suggested would be a deal breaker.
“When I read about the fees, my response was that Affinity will not be applying for derivatives authority,” she said. “The concept that we would have to pay fees to reduce risk to the fund is alien to me in any other regulatory regime.”
When introducing the proposed rule, the NCUA also included in its board action memorandum a potential fee structure that would levy a $75,000 to $125,000 application fee on credit unions seeking Level II authority. Level I authority application fees would vary from $25,000 to $50,000. Both could additionally be subjected to ongoing fees to cover additional exam costs as well.
During the board meeting, both NCUA Chairman Debbie Matz and Board Member Michael Fryzel urged comments on the fee structure, acknowledging that such an addition to the final rule would be a historic one.
McGlone, who worked in investment banking before joining the Affinity executive team in 2007, was previously chief financial officer and executive vice president of Sallie Mae where she managed a large derivatives program.
“You have to understand, this is very different for me because I’ve managed very large portfolio on Wall Street,” she said, “and then I come here and have to go through a third party for a plain vanilla swap.”
She questioned the NCUA’s estimated costs presented with the rule, which included between $3.8 million and $6.5 million for contractors and an additional six to 12 full-time equivalent employees to assist with exams.
“If NCUA can not cover this application of a simple product in its audit, that should give us all pause,” she said. “Certainly the NCUA auditors that we have encountered are more than capable.”
McGlone also said the fees would in effect be double taxation on large credit unions. Because the NCUA already collects operating fees from credit unions as a percentage of assets, she said, large credit unions pay 80% of operating fees and assessments, so they would already bear much of the cost resulting from operating budget increases.
Vincent Pennisi, executive vice president at the $54 billion Navy Federal Credit Union, said a fee structure wouldn’t prevent his 4.3 million-member cooperative from applying for the Level II authority if the rule is finalized. But, he did say it could be a problem for smaller credit unions.
“Credit unions could benefit from derivatives, but the fees could create a barrier to entry for some credit unions to enter the program,” he said. “And, the fee negatively impacts the value of the transactions. It’s a potential disincentive.”
Robert Perry, financial adviser at investment firm ALM First, said the potential fee structure was part of every conversation he’s had with a credit union about the proposed rule, and added, “It’s not sitting well with a few of them.”
ALM First conducted the pilot program for the NCUA, making the transactions for eight of the 10 credit unions. The Dallas-based firm, which had perviously gained NCUA authority to make derivatives transactions for its clients, inherited credit unions participation in the pilot program through Western Bridge Corporate FCU after it was liquidated.
“The breakeven point is further out now,” he said. “You have to get in big enough to make sense, and the more up-front costs, the bigger than number will be.”
If credit union managers and boards take the time to put together a well-thought out derivatives program that grows over time, the application fee doesn’t seem out of line, he said.
However, he added that the proposed rule’s limits on the size of the derivatives portfolio constrains some institutions to the point where the spread wouldn’t be worth the fees.
According to the proposed rule, Level I authority would be limited to a book value of up to 10% of net worth in caps and swaps valued at up to 100% of net worth; however, the swaps have a total fair value loss limit of 10% of net worth. A $250 million institution with 10% net worth would be limited to just $25 million. Up-front costs between $25,000 and $50,000 would eat up the spread, he said.
It’s not just credit unions with long-term mortgages on the books that could benefit from derivatives, he said. Credit unions that make member business loans, especially those with low-income designation that aren’t restricted by the 12.25% of assets cap, are already thinking ahead to the interest rate risk management.
If interest rates rise and members demand higher dividends, a credit union with enough low-rate, long-term assets could be priced out of a yield curve, Perry said, and most don’t have a natural way to fund that.
McGlone and Pennisi both said they thought the proposed rule puts too short of a limit on swap maturities. The proposed rule limits transactions for Level II authority to maturities of just 10 years for individual transactions, or a weighted average life of all derivatives in the portfolio to seven years. Level I authority would be limited to individual maturity limits of seven years and a portfolio weighted average life of five years.
The two said longer maturities are needed to match portfolios of 30-year mortgages, and McGlone added, “now is the time you want to go out 10 years, with rates being as low as they’ve ever been.”
Fees and technical aspects aside, all three said the pilot program was a success, and the plain vanilla swaps and caps proposed in the rule would effectively help qualified credit unions hedge interest rate risk.
NCUA Public Affairs Specialist John Fairbanks said the eight credit unions participating in the program through ALM First include both Navy and Affinity, as well as the $3.8 billion ENTFCU of Colorado Springs, Colo.; the $2.9 billion San Antonio FCU of San Antonio; the $2.5 billion Wescom Credit Union of Pasadena, Calif.; the $1 billion Meriwest Credit Union of San Jose, Calif.; the $1 billion Sharonview FCU of Fort Mill, S.C.; and the $405 million Verity Credit Union of Seattle. The $4.5 billion ESL FCU of Rochester, N.Y. and the $2.3 billion Chevron FCU of Oakland, Calif. participated in the NCUA’s pilot with their own direct authority.
Larry Fazio, director of the NCUA’s Office of Examination and Insurance, said 44 credit unions went through the application process, but only 10 actually performed transactions.