This is a story about Jack and Diane; two American kids who lost touch after a sordid affair in High School. Each of them go to college, get a job, and are now ready to claim their piece of suburbia by buying their first house.
Jack gets his mortgage from a credit union with assets over $2 billion dollars. Diane gets hers from a small credit union with assets over $25 million. Both of the credit unions make qualified mortgages (QM) to enthusiastic first time homebuyers. This means, among other things, that Jack’s mortgage doesn’t exceed a 43% debt- to-income ratio and his credit union adhered to the prescribed underwriting requirements mandated by Appendix Q. Jack’s credit union had its mortgage department document the borrowers information (remember, the days of the liar loan are over).
Our small credit union gives a QM mortgage to Diane. It also does everything right. It’s a lot easier for it to make a QM loan. For example, Diane had a debt to income ratio around 50%, but the D-T-I cap doesn’t apply to small lenders. Student loans for a Masters in Acting can pile up, but the credit union knows Diane and has made similar loans in the past. Besides, the credit union’s “mortgage department” consists of Bill, a 30 year veteran of making mortgages in the area who has internalized the credit union’s lending parameters but has never had the time or seen the need to translate this knowledge into policies or procedures.
Eighteen months go by and both credit unions have had to start foreclosures. Dodd-Frank has made foreclosure defense a profitable legal specialty, so both Jack and Diane have retained counsel. Both borrowers claim that they have a valid defense to foreclosure because both credit Unions violated Dodd-Frank in being foolish enough to give either of them a loan.
If the law works as envisioned, neither credit union will have anything to worry about. Once they prove they have made Qualified Mortgages the foreclosure defenses fail, right? In theory, yes, but here is my concern. Given the more stringent requirements imposed on larger credit unions, it may actually be easier for larger credit unions to get QM protections than smaller credit unions. The idea behind the safe harbor is that a judge can see by the terms of the mortgage and the mortgage file that a member had the ability to repay a mortgage loan. Given the more stringent limitations placed on our larger credit union, it will be obvious by the terms of the mortgage and the underwriting in the file that Jack had the Ability to Repay the loan when it was made.
In contrast, the same can’t be said of our smaller credit union. For example, was the 50% D-T-I ratio reasonable? Diane’s credit union says it was consistent with past practice, but its underwriting policy simply says it will underwrite to secondary market standards and there is nothing in the file to indicate why an exception was made in this case.
Don’t get me wrong, our small credit union did make a QM loan, but it didn’t have (a) the documentation to prove it and (b) policies explaining its underwriting standards. QM mortgage or not, judges are going to want proof and defense lawyers are going to raise as many questions about the credit union’s policies as they can.
As explained by an extremely smart lawyer in September 2012: “Even a safe harbor isn’t safe. You can always be sued for whether you meet the criteria or not to get into the safe harbor. It’s a bit of a marketing concept there. The more important point is, are we drawing bright lines? If someone were to say to me safe harbor or anything else, I would go with a safe harbor. But I don’t think safe harbor is truly safe. And I think it oversimplifies the issue.” I couldn’t agree more, Mr. Cordray.
The comment period on the Risk Based Net Worth proposal officially kicks in today with the regulation’s posting in today’s Federal Register. I’ll have more on this tomorrow.
Well, it’s all but official that no major tax reform, let alone tax reform putting the credit union tax exemption at risk, will take place this year. Not only is the credit union tax exemption not to be included in draft legislation but no lesser an authority than Senate Minority Leader Mitch McConnell took tax reform off the table for this year. While this is, of course, good news, given the amount of time and energy that the industry has devoted to the issue over the last several months, the bankers have still scored a partial victory. We’re in a mid-term election year and we have yet to get serious traction on what I consider the single most important issue facing the industry: the need for secondary capital.
Why is secondary capital so important? Let me count the ways. First, it simply makes no sense for credit unions to be penalized while growing in popularity. This is precisely what happens every time a member opens an account in this low interest, moderate growth economy where it is extremely difficult to make money off other people’s money. If credit unions are going to grow then they need the ability every other financial institution has to seek out investors.
Second, any doubt as to the crucial need for secondary capital has been dispelled by the NCUA’s Risk Based Net Worth regulatory reform proposal. In its simplest form, there are two ways a credit union can improve its risk weighting. It can either reduce its assets or increase its capital. But unlike the nation’s largest banks, our largest credit unions don’t have the opportunity to seek out additional capital. In short, if NCUA’s proposal goes forward it will put the brakes on the growth of credit unions whose only sin is to be large.
I understand how divisive the secondary capital debate is within the industry. Credit unions are, at their core, mutual institutions. They have to remain that way if they are going to continue providing members a unique financial experience. But secondary capital reform can be introduced in ways that maintain the essence of the credit union movement, which is one person one vote. If an institution is willing to invest in a credit union it would only do so against the backdrop of restrictions that give it no more or less influence than any other member of a given credit union.
Let’s keep in mind that low income credit unions can already take secondary capital and no one can seriously suggest that these institutions, in the aggregate, do not advance the core missions of the credit union movement.
Tax reform is like one of those Friday the 13th movies. The villain never really dies. The industry must, of course, remain vigilant. But, we don’t want to win the battle and lose the war by letting concerns over the credit union tax exemption crowd out other important pieces of the credit union agenda.
What really caught my eye about the National Association of Realtors’ (NAR)quarterly report on the State of US Housing was not the familiar litany of excuses for why, even though optimists continue to see robust economic growth right around the corner, the housing market continues to underwhelm (the weather was bad, credit is tight and the first time homebuyer isn’t buying, yada, yada, yada). No, what really caught my eye was the Association’s assertion that spiking flood insurance premiums are beginning to take a bite out of housing.
According to NAR President Steve Brown, “Thirty percent of transactions in flood zones were cancelled or delayed in January as a result of sharply higher flood insurance rates,” he said. “Since going into effect on October 1, 2013, about 40,000 home sales were either delayed or canceled because of increases and confusion over significantly higher flood insurance rates. The volume could accelerate as the market picks up this spring.”
If part of what is going on here is political gamesmanship, it’s gamesmanship of the best kind. The Senate has already passed legislation that would delay reforms mandated by the Bigget-Waters Reform Act of 2012. One of the primary goals of the Act is to entice private insures into the flood insurance business by phasing out government subsidies that insurers argue make it impossible to accurately and cost effectively price insurance in areas where it is necessary.
While the argument appeals to the free market guy in me, members of both sides of the aisle are justifiably concerned by the evidence that without amendments to this legislation, individuals who live in areas prone to flooding will see huge spikes in their flood insurance premiums. No surprise then that Congressman Michael Grimm of Staten Island is one of the primary proponents of legislation (HR3511) to keep insurance premiums from rising. It appears that House action on the bill is imminent, but the bill has already faced unexpected delays. At the end of the day, this is one of those bills that shows that ideology won’t trump legislation to help constituents stay in their homes.
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A Failure to Communicate?
I was more than a little surprised when I read Chairman Matz’s speech before CUNA’s Government Affairs Conference yesterday. With some credit union officials describing the Risk Based Net Worth proposal as Armageddon for the industry, I figured Matz would use the opportunity to explain why NCUA feels its proposal is medicine worth taking for the industry as a whole. I was wrong.
Given the fact that the industry itself pushed for net-worth reform for several years before seeing NCUA’s proposal, the agency undoubtedly has some arguments to make in its favor. But its failure to mount any kind of a defense of its idea is becoming a real problem. The proposal itself lacks the kind of detail that credit unions deserve when their regulator puts forward a proposal of this magnitude. Matz’s silence in the face of mounting credit union concerns does nothing to address legitimate credit union jitters on this issue.
I am a transparency kind of guy, so it has taken me a while to decide whether or not NCUA did the right thing coupling its Risk Based Net Worth proposal with a calculator with which you can see how a given credit union would fair under the proposal. On the one hand, the calculator has given individual credit unions and Associations a useful and important tool with which to get a handle on a crucially important but complicated proposal. On the other hand, the proposal is just that and to put out for public viewing the consequences of a proposed rule that suggests that many credit unions are less financially secure than they were just a few weeks ago crosses the line between encouraging public debate and peddling inaccurate information in the name of openness. Put a password on the calculator and let credit unions decide for themselves how much of this information they want to make available to the public and when.
It’s strange and more than a little bit curious to see NCUA’s sudden commitment to transparency. It’s as if President Obama decided to pardon Edward Snowden so he could become the head of the National Security Agency. It wasn’t too long ago that NCUA was making all of North Carolina’s state chartered credit unions undergo separate federal examinations because one of the state’s charters had the audacity to make its CAMEL ratings available to the public. It argued than that if one credit union exposed the Holy Grail of CAMEL ratings, pretty soon other credit unions would be pressured into revealing the same information to their members. After that, the industry, followed closely by civilization, would end as we know it. Things would get so bad that the Russians, led by a Kleptocratic thug, would be allowed to hold the Winter Olympics in one of that country’s warmest locations. Okay, that last one actually happened but you get what I mean.
Perhaps NCUA understands it went a little far in its North Carolina inquisition, but I find it a little suspicious, and at the very least inconsistent, for that same regulator to suddenly put such a high premium on transparency. It wants to let any member of the public take a look at a credit unions finances and get a snapshot of how it would fair under a very rough, dangerously simplistic RBNW formula that is years from taking effect if it ever does. Never mind the fact that the information is of very limited value to the general public at this point. It seems to me that Joe Six Pack or a disgruntled member is more likely to understand a risk weighted number than a CAMEL rating. This is a great example of a little knowledge being a dangerous thing.
Ultimately, confidences belong to the party on whose behalf information is provided. That’s why a credit union should be allowed to disclose its CAMEL rating to whomever it wants. Similarly, let’s password protect the NCUA calculator and give each credit union access to its own information. That way, individual institutions could decide how best to handle the RBNW proposal and NCUA can be satisfied that it has provided industry stakeholders with a valuable tool with which to assess one of its most important proposals.
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With the economy still stumbling along, policy officials, including Fed Chairman Janet Yellen, have stressed that the official unemployment rate is not the only gauge to use when assessing how good a job the economy is doing absorbing people into the workforce. This is a vitally important issue because the lower unemployment the more likely the Fed is to start raising short term interest rates. To me, all you have to do is look at the nation’s historically low level of workforce participation and the number of long term unemployed to realize that this is no time to be raising interest rates. So I was surprised when I read the Fed minutes and accompanying articles pointing out that at least some members of the Open Market Committee think it is time to raise rates. What could they be thinking? A possible answer comes from this passage in the Economist:
“recent research suggests the unemployment rate is saying something important. It’s just that the message is a depressing one: America’s laborr supply may be permanently stunted. If so that would mean that the economy is operating closer to potential—using all available capital and labor—than generally thought, and that there is less downward pressure on inflation than the Fed has assumed.”
Under this depressing view, stunted economic growth is the new normal and the Fed has to be quicker to raise interest rates than would have historically been the case. If it doesn’t, then we will have a sluggish economy with high inflation.
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NCUA’s monthly board meeting was yesterday. Unless you’re planning to liquidate sometime soon, there’s not all that much to get excited about. Have a great weekend – remember to break out the sun screen, jump in the pool and have a barbeque, it’s going to be in the 40s.
I’ve always loved the expression that if you give a man a fish he eats for a day, but if you teach a man to fish he eats for the rest of his life. But let’s remember that no matter how good the teacher or how eager the student , if no one can afford to buy a fishing pole the best training in the world will go to waste.
Can cell phones help solve this dilemma? According to researchers at the Bill and Melinda Gates Foundation, yes. They argue in the most recent issue of Foreign Affairs that mobile phones have the potential to drive down the costs of serving the poor in developing nations; help these citizens save by ending their reliance on cash and, most intriguingly, by providing data on the unbanked and under banked that will enable financial institutions to develop products that cater to their unique needs and create underwriting models that will allow financial institutions and burgeoning financial cooperatives to lend to the poor with more confidence. Although the analysis deals with world’s poorest nations, there are lessons for both credit unions and bureaucrats seeking to serve people of modest means in this country.
According to the researchers, many of the 2.5 billon persons who live on no more than $2.00 a day have capital they would like to save but no institutions in which to deposit it. Branches are expensive and reaching out to the poor can be prohibitive. As a result, 77 percent of the world’s poor have no access to basic banking services. This means that if they have to get money to a sick relative or hope to send money earned working away from home back to their family they have to rely on someone to physically deliver their money.
It doesn’t have to be this way. The World Bank estimates that 89% of people in developing nations have access to mobile technology. Properly harnessed the sick relative can have money digitally delivered to her hospital, money from a far away job can be quickly and safely sent home and financial institutions can cost effectively offer bank accounts and other products as they gain knowledge about these new customers.
In Kenya, a mobile banking product called M-Pesa allows its members to transfer money electronically. 62 percent of Kenyans now participate in the program in comparison to the 10 percent typical of micro lending programs.
Are there lessons for this country? You bet. First, let’s keep in mind that many of the underserved in this country are going to have cell phones long before they have bank accounts.
Secondly, let’s not put regulations in the way of serving the underserved by imposing costs that don’t have to be there. As technology gets more sophisticated NCUA should continue to scale back physical branch requirements for underserved areas.
Third, technology is moving so fast that if you have a robust online presence and nothing else, you better literally get on the phone quickly. The poor person deciding which financial institution will best protect his savings and help them grow is going to choose based on the quality of a financial institution’s app.
Finally, the researchers relate how cell phones have helped spawn cooperatives of members who like to meet periodically as a way of using group pressure to impose financial discipline. My guess is that none of these savers had to have a common bond beyond a commitment to saving for the future. As technology changes the definition of community, credit unions must be given the opportunity to change, as well.
Just as James Carville encapsulated the theme of Bill Clinton’s 1992 campaign by reminding people “it’s all about the economy, stupid,” an increasingly strong case can be made that your present and future lending growth is increasingly dependent on how you attract and manage young people.
The headlines in today’s paper proclaim the news that consumer borrowing, as measured by the New York Federal Reserve, shot up to its highest level since 2007. Given the fact that consumer spending drives about two-thirds of our nation’s economic growth, this is good news even if an excessive reliance on debt is what got us into the mess in the first place.
But look a little further behind these results and the lessons become murkier and a little disturbing, as pointed out in an excellent blog post (see below) analyzing the latest numbers on the New York Fed’s Liberty Street Blog . Specifically, people are doubling down on higher education as a means of securing their future and how these educational investments are managed will say a lot about economic growth in the coming years.
As the post points out, there’s been a tremendous amount of attention given to the growth of student loans in recent years, and looking at these numbers indicate why “first, student loans grew the most of any debt product in both periods (in percentage terms). Second, the growth in educational debt, like that of auto loans, is concentrated among the lower and middle credit score groups.”
Student debt is even getting blamed for squeezing the housing market as explained in the article link below from the Albany Business review. The argument being made is that lower credit scores and higher debt are making it more difficult for young people to fuel the mortgage market in their traditional role as first-time homebuyers. The New York Fed’s report adds credence to this theory since originations dropped in the fourth quarter and credit standards are still a heck of a lot tougher than they used to be.
If student debt is such an important component of consumer spending, does that mean that NCUA is right to propose a high risk weighting for student loans? Should credit unions just shy away from the private student loan business completely? Of course not. One of the problems with risk weightings as proposed by the NCUA is that they don’t allow for nuances such as sound underwriting. For example, commonsense would tell you that helping the daughter of a longtime member go to SUNY Binghamton is a better investment than lending to a desperate under-employed kid in her mid-twenties signing up for a for-profit school with a high default rate – but the weightings don’t allow for these types of distinctions.
And let’s keep in mind that today’s struggling college grads are tomorrow’s heirs. As pointed out by a CUNA Mutual Group Analysis, if you don’t go after Gen X and Gen Y, you will missing out on a $30 trillion wealth transfer that is going to take place over the coming years.
By the way, I’m trying something a little different today by putting the links for this post on the bottom of the page as a way of encouraging easy access to the material.
Rising student debt threatens housing recovery
I don’t know what it says about the state of the credit union industry that my most popular blog in recent weeks was about the legal grey area confronting credit unions and banks in the 20 states and the District of Columbia that have legalized, to varying degrees, the possession and distribution of marijuana, even though such laws violate federal statute.
So, I thought you might all be interested in knowing that our good friends at FinCEN issued a thoughtful guidance on Friday afternoon clarifying just how financial institutions can comply with the Bank Secrecy Act and provide banking services to marijuana businesses operating legally under state law. FinCEN’s solution is not directly relevant to states like New York that have yet to legalize marijuana, but given the fact that the pot-legalization movement is moving quicker than Bob Costas’ eye infection, I would keep this guidance in your electronic files. Here are some of the highlights, but remember if any of you are in the 21 jurisdictions directly impacted by this guidance, this is no substitute for reading the entire ruling.
1. In states where marijuana use is not legal, nothing has changed. You would still file a traditional suspicious activity report (SAR) if you have reason to believe that a member is using his or her account to run a pot selling business.
2. In jurisdictions where pot businesses are legal, financial institutions will be expected to do appropriate due diligence when opening an account. For example, they will have to find out whether or not the business is properly licensed and they should also analyze the store’s business model.
3. Let’s assume that we are dealing with a licensed, legal pot business. Under this guidance, even though your credit union is authorized to open the account, it would still be obligated to file SARS on a regular basis. Consistent with existing regulations, financial institutions with SARS requirements may file SARS for continuing activity. These reports are not new. However, when the SAR relates to a marijuana business for which nothing has changed, the filing would include the notation that it is “marijuana limited” in the SARS narrative section. FinCEN has taken the logical position that even though the business might be legal under state law, its activity still violates federal law and it wants to know about it.
Here’s where it gets a little tricky:
4. The Justice Department has decided that it will not prosecute marijuana-related businesses in jurisdictions where they are legal, provided the businesses do not engage in certain types of activity highlighted in the so-called Cole Memorandum such as selling drugs to minors or assisting in money laundering. Consequently, credit unions will have to monitor these businesses and when they suspect that they are engaging in activity red-flagged by the Justice Department, they would have to file a traditional SAR. For example, like any other business, it would be mighty suspicious if a business started doubling its cash deposits. Where a financial institution files a SAR on a marijuana related business that it reasonably believes “implicates one of the Cole Memo priorities. . .” it would file a “marijuana priority SAR” indicating which one of the Cole priorities are implicated.