oversight

Credit Unions: Financial Condition Has Improved, but Opportunities Exist to Enhance Oversight and Share Insurance Management

Published by the Government Accountability Office on 2003-10-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to the Ranking Minority Member,
               Committee on Banking, Housing, and
               Urban Affairs, U.S. Senate


October 2003
               CREDIT UNIONS
               Financial Condition
               Has Improved, but
               Opportunities Exist to
               Enhance Oversight
               and Share Insurance
               Management




GAO-04-91

               a

                                                October 2003


                                                CREDIT UNIONS

                                                Financial Condition Has Improved, but
Highlights of GAO-04-91, a report to the        Opportunities Exist to Enhance Oversight
Ranking Minority Member, Committee on
Banking, Housing, and Urban Affairs, U.S.       and Share Insurance Management
Senate.




Recent legislative and regulatory               The financial condition of the credit union industry has improved since
changes have blurred some                       GAO’s last report in 1991, and the federal share insurance fund appears
distinctions between credit unions              financially stable. However, a growing concentration of industry assets in
and other depository institutions               large credit unions creates the need for greater risk management on the part
such as banks. The 1998 Credit                  of NCUA. The question of who benefits from credit unions’ services has also
Union Membership Access Act
(CUMAA) allowed for an expansion
                                                been widely debated. While it has been generally accepted that credit unions
of membership and mandated                      have a historical emphasis on serving people of modest means, our analysis
safety and soundness controls                   of limited available data suggested that credit unions served a slightly lower
similar to those of other depository            proportion of low- and moderate-income households than banks.
institutions. In light of these
changes and the evolution of the                CUMAA and subsequent NCUA regulations enabled federally chartered
credit union industry, GAO                      credit unions to expand their membership, serve larger geographic areas,
evaluated (1) the financial                     and add underserved areas. According to NCUA officials, these changes
condition of the industry and the               were necessary to maintain the competitiveness of the federal charter with
deposit (share) insurance fund, (2)             respect to state-chartered credit unions. While NCUA has stated its
the impact of CUMAA on the                      commitment to ensuring that credit unions provide financial services to all
industry, and (3) how the National
Credit Union Administration
                                                segments of society, NCUA has not developed indicators to determine if
(NCUA) had changed its safety and               credit union services have reached the underserved.
soundness processes.
                                                In response to the growing concentration of industry assets and increased
                                                services offered by credit unions, NCUA recently adopted a risk-focused
                                                examination and supervision program but still faces a number of challenges,
With respect to the share insurance             including lack of access to third-party vendors that are providing more
fund, GAO recommends that the                   services to credit unions. Further, credit unions are not subject to internal
Chairman of NCUA explore
                                                control and attestation reporting requirements applicable to banks and
developing a risk-based funding
system, improve the process for                 thrifts. GAO also found that the insurance fund’s rate structure does not
allocating overhead expenses, and               reflect risks that individual credit unions pose to the fund, and NCUA’s
refine the process for estimating               estimation of fund losses is based on broad historical analysis rather than a
future losses. To improve                       current risk profile of insured institutions.
reporting, the Chairman should
also use tangible indicators to                 Mortgages Made by Credit Unions and Banks, by Income Level of Purchaser, 2001
determine whether credit unions
are serving people in underserved
areas. To help ensure safety and
soundness, Congress may wish to
consider making credit unions
subject to internal control
reporting and attestation
requirements applicable to banks
and thrifts and providing NCUA
legislative authority to examine
third-party vendors.
www.gao.gov/cgi-bin/getrpt?GAO-04-91.

To view the full product, including the scope
and methodology, click on the link above.
For more information, contact Richard J.
Hillman at (202) 512-9073 or
hillmanr@gao.gov.
Contents




Letter
                                                                                                   1
                              Results in Brief 
                                                          4
                              Background                                                                  8

                              Financial Condition of the Credit Union Industry Has Improved 

                                Since 1991                                                               10
                              Limited Comprehensive Data Are Available to Evaluate Income of
                                Credit Union Members                                                     16
                              CUMAA Authorized NCUA to Continue Preexisting Policies That
                                Expanded Field of Membership                                             29
                              NCUA Adopted Risk-Focused Examination and Supervision
                                Program, but Faces Challenges in Implementation                          42
                              NCUSIF’s Financial Condition Appears Satisfactory, but
                                Methodologies for Overhead Transfer Rate, Insurance Pricing,
                                and Estimated Loss Reserve Need Improvement                              56
                              System Risk That May Be Associated with Private Share Insurance
                                Appears to Have Decreased, but Some Concerns Remain                      66
                              Conclusions                                                                80
                              Recommendations for Executive Action                                       82
                              Matters for Congressional Consideration                                    83
                              Agency Comments and Our Evaluation                                         84


Appendixes
               Appendix I:    Objectives, Scope, and Methodology                                         90
               Appendix II:   Status of Recommendations from GAO’s 1991 Report                         101
              Appendix III:   Financial Condition of Federally Insured Credit Unions                   113
              Appendix IV:    Comparison of Bank and Credit Union Distribution of 

                              Assets                                                                   121

               Appendix V:    Credit Union Services, 1992–2002                                         128

              Appendix VI:    Characteristics of Credit Union and Bank Users                           140

             Appendix VII:    Key Changes in NCUA Rules and Regulations, 1992–2003                     144

             Appendix VIII:   NCUA’s Budget Process and Industry Role                                  146

              Appendix IX:    NCUA’s Implementation of Prompt Corrective Action                        150

               Appendix X:    Accounting for Share Insurance                                           159

              Appendix XI:    Comments from the National Credit Union 

                              Administration                                                           162

             Appendix XII:    Comments from American Share Insurance                                   168




                              Page i                              GAO-04-91 Changes in Credit Union Industry
                          Contents




           Appendix XIII:	 GAO Contacts and Staff Acknowledgments                                     174
                           GAO Contacts                                                               174
                           Staff Acknowledgments                                                      174


Tables	                   Table 1: Regulatory Definitions of Local Community, 2000 and 

                                    2003
                                                               34
                          Table 2: Federally Insured Credit Unions Were Similar to Banks and

                                    Thrifts with Respect to Capital Categories, as of December

                                    31, 2002
                                                           54
                          Table 3: Peer Group Definitions
                                              92
                          Table 4: Definition of Income Categories
                                     93
                          Table 5: Status of GAO Recommendations to NCUA and Congress, 

                                    as of August 31, 2003
                                            103
                          Table 6: Federally Insured Credit Union Growth in Assets and 

                                    Shares, 1992–2002
                                                115
                          Table 7: Distribution of Credit Unions by Asset Size, 1992 and

                                    2002
                                                             116
                          Table 8: Asset Composition of Credit Unions as a Percentage of 

                                    Total Assets, 1992–2002
                                          117
                          Table 9: Comparison of the Loan Portfolios of Federally Insured 

                                    Credit Unions with Peer Group Banks and Thrifts, as of 

                                    2002
                                                             118
                          Table 10: Timeline of Key Changes to NCUA Rules and Regulations,
                                    January 1992–September 2003                                       144
                          Table 11: CUMAA Mandates and NCUA Actions on PCA Regulation
                                    Implementation                                                    151
                          Table 12: Discretionary Supervisory Actions                                 153
                          Table 13: Net Worth Category Classification for New Credit
                                    Unions                                                            154


Figures	                  Figure 1: Comparison of Credit Union and Bank Capital Ratios,
                                    1992–2002                                                           11
                          Figure 2: Credit Union Industry Size and Total Assets Distribution,
                                    as of December 31, 2002                                             15
                          Figure 3: Income Characteristics of Households Using Credit
                                    Unions versus Banks, Low and Moderate Income versus
                                    Middle and High Income                                              21
                          Figure 4: Income Characteristics of Households Using Credit
                                    Unions versus Banks, by Four Income Categories                      22
                          Figure 5: Mortgages Made by Credit Unions and Banks, by Income
                                    Level of Purchaser, 2001                                            24



                          Page ii                                GAO-04-91 Changes in Credit Union Industry
Contents




Figure 6: Loans Made by Credit Unions and Banks, by Average 

           Income in the Purchased Home’s Census Tract, 2001                  25

Figure 7: Percentage of Federally Chartered Credit Unions, by 

           Charter Type, 2000–2003                                            31

Figure 8: Actual and Potential Members in Federally Chartered 

           Credit Unions, by Charter Type, 2000–2003                          36

Figure 9: Actual and Potential Members in Federally and

           State-chartered Credit Unions, 1990–2003                           37

Figure 10: Underserved Areas Added before and after CUMAA, by 

           Federal Charter Type, 1997–2002                                    40

Figure 11: Credit Union Mortgage Loans Have Grown Significantly 

           Since 1992                                                         43

Figure 12: NCUSIF’s Equity Ratio, 1991–2002                                   57

Figure 13: Equity to Insured Shares or Deposits of the Various 

           Insurance Funds                                                    58

Figure 14: Net Income of NCUSIF, 1990–2002                                    59

Figure 15: Financing Sources of NCUSIF and NCUA’s Operating 

           Fund                                                               60

Figure 16: Share Payouts and Reserve Balance, 1990–2002                       65

Figure 17: States Permitting Private Share Insurance (March 2003) 

           and Number of Privately Insured Credit Unions 

           (December 2002)                                                    68

Figure 18: Capital Ratios in Federally Insured Credit Unions, 1992–

           2002                                                             114

Figure 19: Profitability of Federally Insured Credit Unions, 1992–

           2002                                                             119

Figure 20: Federally Insured Credit Unions, by CAMEL Rating, 

           1992–2002                                                        120

Figure 21: Total Assets of All Credit Unions and All Banks, as of 

           2002                                                             121

Figure 22: Total Assets of Credit Unions and Banks with Less Than

           $100 Million in Assets, as of 2002                               122

Figure 23: Total Assets of Credit Unions with Less Than $5 Million in

           Assets, as of 2002                                               123

Figure 24: Percentage of All Credit Unions and All Banks Holding 

           Various Loans, as of 2002                                        124

Figure 25: Percentage of Credit Unions and Banks with Assets of 

           $100 Million or Less Holding Various Loans, as of 

           2002                                                             125

Figure 26: Percentage of Credit Unions and Banks with Assets 

           between $1 Billion and $18 Billion Holding Various Loans, 

           as of 2002                                                       126




Page iii                               GAO-04-91 Changes in Credit Union Industry
Contents




Figure 27: Percentages of Credit Unions and Banks Holding Various 

           Loans, by Institution Size, as of 2002                           127

Figure 28: Percentage of Credit Unions Holding Various Loans, 

           1992–2002                                                        129

Figure 29: Percentage of Assets Held in Various Loans by All Credit 

           Unions, 1992-2002                                                131

Figure 30: Percentage of Credit Unions Offering Various Accounts,

           1992–2002                                                        133

Figure 31: Credit Union Employees and Number of Credit Unions, 

           1992–2002                                                        134

Figure 32: Percentage of Credit Unions, Smallest versus Largest, 

           Holding Various Loans, 1992–2002                                 136

Figure 33: Percentage of Assets Held in Various Loans, Smallest 

           versus Largest Credit Unions, 1992–2002                          137

Figure 34: Differences among Services Offered by Smaller and

           Larger Credit Unions, as of 2002                                 138

Figure 35: Credit Union Size and Offerings of More Sophisticated 

           Services, as of 2002                                             139

Figure 36: Households Using Credit Unions and Banks, by 

           Education Level, 2001                                            140

Figure 37: Households Using Credit Unions and Banks, by Age 

           Group, 2001                                                      141

Figure 38: Households Using Credit Unions and Banks, by Race and 

           Ethnicity, 2001                                                  142

Figure 39: Mortgages Made by Credit Unions and Banks, by Race 

           and ethnicity, 2001                                              143

Figure 40: NCUA Budget Levels, 1992–2004                                    148

Figure 41: NCUA-authorized Staffing Levels, 1992–2003                       149





Abbreviations

ASI               American Share Insurance

ATM               Automatic Teller Machines

BIF               Bank Insurance Fund

BSA               Bank Secrecy Act

CLF               Central Liquidity Facility 

CPA               Certified Public Accountant

CRA               Community Reinvestment Act

CUIC              Credit Union Insurance Corporation

CUMAA             Credit Union Membership Access Act of 1998




Page iv                                GAO-04-91 Changes in Credit Union Industry
Contents




CUNA                  Credit Union National Association

CUSO                  Credit Union Service Organization

FCUA                  Federal Credit Union Act

FDIA                  Federal Deposit Insurance Act

FDIC                  Federal Deposit Insurance Corporation

FDICIA                Federal Deposit Insurance Corporation Improvement Act of 

                      1991
FFIEC                 Federal Financial Institutions Examination Council
FRC                   Financial Risk Committee
FTC                   Federal Trade Commission
HMDA                  Home Mortgage Disclosure Act
HUD                   Department of Housing and Urban Development
IRPS                  Interpretive Ruling and Policy Statement
LAR                   Loan Application Records
MCIC                  Metro Chicago Information Center
MSA                   Metropolitan Statistical Area
NCUA                  National Credit Union Administration
NCUSIF                National Credit Union Share Insurance Fund
NFCDCU                National Federation of Community Development Credit
                      Unions
OCC                   Office of the Comptroller of the Currency
OTS                   Office of Thrift Supervision
PCA                   Prompt Corrective Action
RISDIC                Rhode Island Share and Depositors Indemnity
                      Corporation
SAIF                  Savings Association Insurance Fund
SCF                   Survey of Consumer Finances




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Page v                                        GAO-04-91 Changes in Credit Union Industry
A

United States General Accounting Office
Washington, D.C. 20548



                                    October 27, 2003

                                    The Honorable Paul S. Sarbanes
                                    Ranking Minority Member
                                    Committee on Banking, Housing,
                                     and Urban Affairs
                                    United States Senate

                                    Dear Senator Sarbanes:

                                    Credit unions have historically occupied a unique niche among depository
                                    institutions. Credit unions are not-for-profit, member-owned cooperatives
                                    that are exempt from paying federal income taxes on their earnings. Unlike
                                    banks, credit unions are subject to limits on their membership because
                                    members must have a “common bond”—for example, working for the same
                                    employer or living in the same community. However, over the years, these
                                    membership requirements have loosened considerably and credit unions
                                    have received expanded powers, which have raised questions about the
                                    extent that credit unions remain unique and serve a different population
                                    than banks. We last conducted a comprehensive review of the credit union
                                    industry, including the National Credit Union Administration (NCUA), in
                                    1991.1 Since that time, the credit union industry has experienced
                                    substantial growth and expansion of activities. In addition, recent
                                    legislative and regulatory changes have blurred some distinctions between
                                    credit unions and other depository institutions—banks and thrifts. For
                                    example, the 1998 Credit Union Membership Access Act (CUMAA)
                                    expanded the definition of common bond and provided for reforms
                                    intended to strengthen the safety and soundness of credit unions, including
                                    instituting procedures for prompt corrective action (PCA) when credit
                                    unions’ capital levels fall below a certain threshold.2

                                    In 2002, there were about 10,000 credit unions with approximately 82
                                    million members. Credit unions, like banks and thrifts, are chartered by
                                    both the federal government and state governments, also referred to as the
                                    dual-chartering system. NCUA has oversight authority for federally


                                    1
                                     U.S. General Accounting Office, Credit Unions: Reforms for Ensuring Future Soundness,
                                    GAO/GGD-91-85 (Washington, D.C.: July 10, 1991). This report contained a variety of
                                    recommendations to Congress and NCUA. See appendix II for information on the
                                    implementation of these recommendations.
                                    2
                                     See Pub. L. No. 105-219 (Aug. 7, 1998).




                                    Page 1                                      GAO-04-91 Changes in Credit Union Industry
chartered credit unions and requires its credit unions to obtain federal
share (deposit) insurance for their members’ deposits from the National
Credit Union Share Insurance Fund (NCUSIF). This fund, administered by
NCUA, also provides share insurance to most state-chartered credit unions.
Some states permit their credit unions to purchase private share insurance
as an alternative to federal insurance.

In light of the evolution of the credit union industry and the passage of
CUMAA, you asked us to review a variety of issues involving the credit
union industry and NCUA. In response, we provided your staff information
on how NCUA responded to recommendations made in our 1991 report and
conducted preliminary research on the industry and NCUA.3 After
discussing this information with your staff, we agreed that the objectives of
this study were to evaluate (1) the financial condition of the credit union
industry; (2) the extent to which credit unions “make more available to
people of small means credit for provident purposes”;4 (3) the impact, if
any, of CUMAA on credit union field of membership requirements for
federally chartered credit unions; (4) how NCUA’s examination and
supervision processes have changed in response to changes in the industry;
(5) the financial condition of NCUSIF; and (6) the risks associated with the
use of private share insurance. You also asked us to review issues
associated with corporate credit unions, which we plan to address in a
separate report.5




3
In addition, we recently completed a separate review of private insurance issues. See U.S.
General Accounting Office, Federal Deposit Insurance Act: FTC Best Among Candidates to
Enforce Consumer Protection Provisions, GAO-03-971 (Washington, D.C.: Aug. 20, 2003).
4
 This quotation is taken from the title of the Federal Credit Union Act of June 26, 1934. In
addition, in CUMAA the congressional findings stated among other things that credit unions
“have the specified mission of meeting the credit and savings needs of consumers,
especially persons of modest means (Pub. L. No. 105-219 § 2 (1998)). While these statutes
have used “small means” and “modest means” to describe the type of people who credit
unions might serve, in this report we used “low- and moderate-income,” as defined by
banking regulators.
5
 A corporate credit union is one whose members are credit unions, not individuals.
Corporate credit unions provide credit unions with services, investment opportunities,
loans, and other forms of credit should credit unions face liquidity problems. See 12 C.F.R.
Part 704 (2003).




Page 2                                          GAO-04-91 Changes in Credit Union Industry
To evaluate the financial condition of the credit union industry we
performed quantitative analyses on credit union call report data for 1992–
2002.6 Since NCUA lacked readily available data to assess the extent to
which credit unions serve people of low and moderate incomes, we
analyzed data from the 2001 Federal Reserve Survey of Consumer Finances
(SCF) to identify the characteristics of credit union members. This survey
is the only comprehensive source of publicly available data on financial
institutions and consumer demographics that we could identify that is
national in scope. We also analyzed 2001 mortgage data from the Home
Mortgage Disclosure Act (HMDA) database, which allowed us to categorize
the income levels of households receiving mortgages from credit unions
and banks, and reviewed other industry studies. To determine how CUMAA
affected field of membership requirements for federally chartered credit
unions, we analyzed NCUA regulations and obtained data on field of
membership trends from NCUA. In addition, we surveyed state regulators
to obtain information about their chartering provisions, particularly for
credit unions serving geographic areas. To determine how NCUA’s
examination and supervision process has changed, we reviewed NCUA
documentation on its risk-focused program and conducted structured
interviews of NCUA regional directors and examiners, as well as selected
state credit union supervisors. We also analyzed NCUA data on examiner
resources provided to states and progress in implementing PCA. To
determine the financial condition of NCUSIF, we obtained and analyzed
key financial data about the fund from NCUA’s annual audited financial
statements for 1991–2002. Finally, to assess the risks associated with the
use of private share insurance, we identified and analyzed relevant federal
and state statutes and regulations and surveyed the 50 state credit union
regulators to determine which states permitted private share insurance. In
addition, we conducted interviews with state supervisors from states
where credit unions are permitted to choose private insurance—Alabama,
California, Idaho, Illinois, Indiana, Maryland, Nevada, and Ohio. We also
interviewed and obtained relevant documentation from representatives of
American Share Insurance (ASI)—the remaining provider of private share
insurance. Appendix I provides additional details on our scope and


6
 We only reviewed federally insured credit unions—about 98 percent of all credit unions—
because they were all required to submit call report data to NCUA, while not all privately
insured credit union call report data were reported to NCUA. Call reports are submitted by
credit unions to NCUA and contain data on a credit union’s financial condition and other
operating statistics. Throughout the report, when we use the term “industry,” we are
referring to federally insured credit unions and exclude the 212 privately insured credit
unions.




Page 3                                        GAO-04-91 Changes in Credit Union Industry
                    methodology. We conducted our review from August 2002 through
                    September 2003 in accordance with generally accepted government
                    auditing standards.



Results in Brief	   The overall financial condition of the credit union industry, as measured by
                    capital ratios, asset growth, and regulatory ratings, has improved since our
                    last report in 1991. An example of the improved condition of the credit
                    union industry is the decline in the number of credit unions identified by
                    NCUA as being in weak or unsatisfactory condition—578 (about 5 percent
                    of all credit unions) in 1992 compared with 211 (about 2 percent of all
                    credit unions) in 2002.7 While credit union profitability, as measured by the
                    return on assets ratio, generally declined between 1992 and 1999, it has
                    since stabilized. The number of credit unions declined between 1992 and
                    2002 while total industry assets have grown. This has resulted in two
                    distinct groups of credit unions—larger credit unions, which are fewer in
                    number and provide a wider range of services that more closely resemble
                    those offered by banks, and smaller credit unions, which are greater in
                    number and provide more basic financial services. Credit unions with over
                    $100 million in assets represented about 4 percent of all credit unions and
                    52 percent of total credit union assets in 1992 compared with about 11
                    percent of all credit unions and 75 percent of total credit union assets in
                    2002. These larger credit unions were more likely to provide sophisticated
                    financial services, such as Internet banking and electronic loan
                    applications, and engage in mortgage lending than smaller credit unions.

                    As credit unions have become larger and expanded the range of services
                    they offer, the question of who receives services from credit unions has
                    been widely debated. While it has been generally accepted that credit
                    unions have a historical emphasis on serving people of modest means,
                    limited data exist that can be used to assess the income characteristics of
                    credit union members. Our analysis of available data suggested that the
                    income of credit union members is similar to that of bank customers;
                    although credit unions may serve a slightly lower proportion of low- and
                    moderate-income households than banks. Our analysis of the Federal
                    Reserve’s 2001 Survey of Consumer Finances indicates that 36 percent of
                    households that primarily or only used credit unions had low and moderate


                    7
                     NCUA rates credit unions using the CAMEL system, which stands for capital adequacy,
                    asset quality, management, earnings, and liquidity. The ratings are 1 (strong), 2
                    (satisfactory), 3 (flawed), 4 (poor), and 5 (unsatisfactory).




                    Page 4                                       GAO-04-91 Changes in Credit Union Industry
incomes compared with 42 percent of households that used banks. Our
analysis of HMDA 2001 loan application records indicated that credit
unions provided a slightly lower percentage of their mortgages to low- and
moderate-income households than banks—27 percent compared with 34
percent—of comparable asset size. However, relying on HMDA data to
evaluate credit union service to low- and moderate-income households has
limitations because most credit unions are (1) small and, therefore, not
required to report HMDA data and (2) generally make more consumer
loans (for example, for cars) than residential mortgage loans. An analysis
of consumer loans or other services by household income would provide a
more complete picture of credit union service to low- and moderate-
income households. Other industry studies concluded that credit union
members tended to have higher incomes than nonmembers, but indicated
that this was likely due to credit union membership being primarily
occupationally based.

CUMAA authorized preexisting NCUA policies that had enabled federally
chartered credit unions to expand their membership over the last two
decades. In response to a Supreme Court decision, Congress enacted
provisions of CUMAA permitting federally chartered credit unions to form
multiple-bond credit unions—consisting of groups, such as for
employment, each with their own distinguishing characteristics—and
permitted these credit unions to add communities underserved by financial
institutions to their membership. NCUA permitted single- and community-
bond, federally chartered credit unions to add underserved communities to
their field of membership as well. CUMAA also amended a chartering
provision authorizing community credit unions by specifying that the area
in which their members are located should be “local.” However, NCUA
regulations have made it easier for credit unions to qualify to serve larger
geographic areas (for example, entire cities). According to NCUA officials,
these changes were necessary to maintain the competitiveness of the
federal charter with respect to what they perceived as less restrictive field
of membership requirements allowed for state-chartered credit unions in
some states. While CUMAA permitted multiple-bond credit unions to add
underserved areas, and NCUA has stated its commitment to ensuring that
credit unions provide financial services to all segments of society, NCUA
has not developed indicators to determine if credit union services have
reached the underserved. Instead, NCUA uses “potential membership,” the
number of people who could join credit unions, as an indirect measure of
credit union success in penetrating these areas.




Page 5                                 GAO-04-91 Changes in Credit Union Industry
In response to the growing concentration of assets in the credit union
industry and increased services and activities offered by credit unions,
NCUA adopted a risk-focused examination and supervision program
similar to that of other depository institution regulators. While NCUA has
taken a number of steps to ensure the successful implementation of its risk-
focused program, it faces a number of challenges. NCUA has met with the
other depository institution regulators, such as the Federal Deposit
Insurance Corporation (FDIC), to learn about how they implemented their
risk-focused programs. However, opportunities exist to further leverage the
experiences of other depository institution regulators to more effectively
deal with ongoing challenges such as ensuring that examiners have
sufficient training and expertise to evaluate the more sophisticated
activities of credit unions, such as Internet banking and member business
lending. Furthermore, unlike the other depository institution regulators,
NCUA lacks authority to review the operations of third-party vendors,
which credit unions increasingly rely on to provide services such as
Internet banking. However, these third-party arrangements present risks
such as threats to security of information systems, availability and integrity
of systems, and confidentiality of information. In addition, credit unions
are not subject to the internal control reporting requirements that the
Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
imposed on banks and thrifts. NCUA implemented PCA, in 2000 as
mandated by CUMAA, as another control for safety and soundness of the
industry. To date, there have been very few credit unions subject to PCA
partially because of a generally favorable economic climate for credit
unions.

Indicators of the financial condition and performance of NCUSIF have
generally been stable over the past decade. For example, the ratio of fund
equity to insured shares—a measure of the fund’s equity available to cover
losses on insured deposits—was within statutory requirements at
December 31, 2002, as it has been over the past decade. While NCUSIF’s net
income has remained positive through 2002, it experienced significant
declines in 2001 and 2002 due to decreased yields from the investment
portfolio, increases in the amount paid to NCUA’s Operating Fund for
administrative expenses (overhead transfer rate), and increasing insurance
losses on failed credit unions. NCUA’s external auditors reviewed the basis
on which the transfer rate was determined and made several
recommendations for improvement that, according to NCUA officials, are
being assessed and implemented. While financial indicators have generally
remained satisfactory, NCUSIF is the only share or deposit insurance fund
that has not adopted a risk-based insurance structure. Currently, credit



Page 6                                  GAO-04-91 Changes in Credit Union Industry
unions are assessed a flat rate that does not reflect the risk that individual
credit unions pose to the fund. Moreover, NCUA’s process for estimating
anticipated losses to the fund lacks precision, as it does not identify
specific historical failure rates and related loss rates for the group of credit
unions that have been identified as being in troubled condition. As a result,
NCUA may be over or underestimating probable losses to the fund.

The overall system risk to the credit union industry that may be created by
private primary share insurance appears to have decreased since 1990,
although some concerns remain. The number of privately insured credit
unions and providers of private primary share insurance have declined
significantly since 1990. Specifically, in 1990, there were 1,462 privately
insured credit unions—with $18.6 billion in insured shares—compared
with 212 privately insured credit unions—with about $10.8 billion in
insured shares, as of December 2002. This represented a 42 percent
decrease in privately insured shares. Moreover, during the same period the
number of private primary share insurers decreased from 10 to 1—ASI.
Although the use of private share insurance has declined, some
circumstances of the remaining private insurer raise concerns. First, ASI’s
insured risks are overly concentrated in a few large credit unions and in
certain states. Second, ASI may have a limited ability to absorb
catastrophic losses because it does not have the backing of any
governmental entity and its lines of credit are limited. However, ASI has
implemented a number of risk-management strategies, including increased
monitoring of its largest credit unions to help mitigate concentration risk.
In addition, state regulation of ASI and the privately insured credit unions it
insures provides some additional assurance that ASI and the credit unions
operate in a safe and sound manner. One additional concern, as we recently
reported, is that many privately insured credit unions failed to make
required disclosures about not being federally insured and, therefore, the
members of these credit unions may not have been adequately informed
that their deposits lacked federal deposit insurance.

This report contains recommendations to NCUA and matters for
congressional consideration that, if implemented, would better ensure
NCUA’s ability to achieve its goal of ensuring that credit unions can safely
provide financial services to all segments of society, promote greater
consistency in federal oversight of depository institutions, and enhance
share insurance management.

We requested comments on a draft of this report from the Chairman of the
National Credit Union Administration and the President and Chief



Page 7                                   GAO-04-91 Changes in Credit Union Industry
              Executive Officer of American Share Insurance. We received written
              comments from NCUA and ASI that are discussed in this report and
              reprinted in appendixes XI and XII respectively. NCUA generally agreed
              with most of the report’s assessment regarding the challenges facing NCUA
              and credit unions since 1991 and planned to implement the majority of the
              report’s recommendations. In commenting on a draft of the private share
              insurance section, ASI stated that this report did not adequately assess the
              private share insurance industry and objected to our conclusions that ASI’s
              risks are concentrated in a few large credit unions and a few states; it has
              limited ability to absorb large losses because it does not have the backing
              of any governmental agency; and its lines of credit are limited in the
              aggregate as to amount and available collateral. In response, we considered
              ASI’s positions and materials provided, including ASI’s actuarial
              assumptions and ASI’s past performance, and believe our report addresses
              these issues correctly as originally presented.



Background	   Credit unions differ from other depository institutions because of their
              cooperative structure and tax exemption. Credit unions are member-owned
              cooperatives run by boards elected by their members. They do not issue
              capital stock; rather, they are not-for-profit entities that build capital by
              retaining earnings. However, like banks and thrifts, credit unions have
              either federal or state charters. Federal charters have been available since
              1934 when the Federal Credit Union Act was passed. States have their own
              chartering requirements. As of December 2002, the federal government
              chartered about 60 percent of the nearly 10,000 credit unions, and about 40
              percent were chartered by their respective states. Both federally and state-
              chartered credit unions are exempt from federal income taxes, with
              federally chartered and most state-chartered credit unions also exempt
              from state income and franchise taxes.

              Another distinguishing feature of credit unions is that they may serve only
              an identifiable group of people with a common bond. A common bond is
              the characteristic that distinguishes a particular group from the general
              public. For example, a group of people with a common profession or living
              in the same community could share a common bond. Over the years,
              common-bond requirements at the state and federal levels have become
              less restrictive, permitting credit unions consisting of more than one group




              Page 8                                 GAO-04-91 Changes in Credit Union Industry
having a common bond to form “multiple-bond” credit unions.8 The term
“field of membership” is used to describe all the people, including
organizations, that a credit union is permitted to accept for membership. As
previously noted, the loosening of common-bond restrictions, as well as
expanded powers, have brought credit unions into more direct competition
with other depository institutions, such as banks. In addition, credit unions
can offer members additional services made available by third-party
vendors and by certain profit-making entities with which they are
associated, referred to as credit union service organizations (CUSO).9

CUMAA was the last statute that enacted major provisions affecting,
among other things, how federally chartered credit unions could define
their fields of membership and how federally insured credit unions
demonstrate the safety and soundness of their operations. In February
1998, the Supreme Court ruled that NCUA lacked authority to permit
federal credit unions to serve multiple membership groups.10 In response,
CUMAA authorized multiple-group chartering, subject to limitations NCUA
must consider when granting charters. Also, the act limited new
community charter applications to well-defined “local” communities.
Moreover, CUMAA placed several additional restrictions on federally
insured credit unions. It tightened audit requirements, established PCA
requirements when capital standards were not met, and placed a cap on the
percentage of funds that a credit union could expend for member business
loans.

NCUA has oversight responsibility for federally chartered credit unions and
has issued regulations that, among other things, guide their field of
membership and the scope of services they can offer. NCUA also has
responsibility for overseeing the safety and soundness of federally insured
credit unions through examinations and off-site monitoring. In addition,

8
See GAO/GGD-91-85 for additional background on the history of NCUA and state field of
membership regulatory policies.
9
 A CUSO is a corporation, limited liability corporation, or limited partnership that provides
services such as insurance, securities, or real estate brokerage, primarily to credit unions or
members of affiliated credit unions. NCUA specifies which types of activities a CUSO may
undertake. Credit unions can invest up to 1 percent of paid–in and unimpaired capital and
surplus in CUSOs. Credit unions can loan up to an aggregate of 1 percent of paid–in and
unimpaired capital and surplus to CUSOs. The CUSO must maintain a separate identity from
the credit union. See 12 C.F.R. Part 712 (2003).
10
 National Credit Union Administration v. First National Bank & Trust Co., 522 U.S. 479
(1998).




Page 9                                           GAO-04-91 Changes in Credit Union Industry
                         NCUA administers NCUSIF, which provides primary share (deposit)
                         insurance for 98 percent of the nation’s credit unions.11 NCUA, in its role as
                         administrator of NCUSIF, is responsible for overseeing federally insured,
                         state-chartered credit unions to ensure that they pose no risk to NCUSIF.

                         State governments have responsibility for regulating state-chartered credit
                         unions. State regulators oversee the safety and soundness of state-
                         chartered credit unions; although, as mentioned above, NCUA also has
                         responsibility for ensuring that state-chartered credit unions that are
                         federally insured pose no risk to NCUSIF. States set their own rules
                         regarding field of membership and the services credit unions can provide.
                         In addition, some states allow the credit unions in their states the option of
                         obtaining private primary share insurance. Currently, 212 credit unions in
                         eight states have primary share insurance from a private company, ASI,
                         located in Ohio. Primary share insurance for these privately insured credit
                         unions covers up to $250,000.



Financial Condition of   Between 1992 and 2002, the capital ratios of federally insured credit unions
                         improved and remained higher than those of other depository institutions.
the Credit Union         The industry’s assets also grew over this period, coincident with an
Industry Has Improved    increased emphasis on mortgage loans. Credit union industry profitability,
                         after declining from 1992 to 1999, has since stabilized. In addition, since
Since 1991               1991 there has been a significant drop in the number of problem credit
                         unions as measured by regulatory ratings. Consolidation in the industry has
                         continued while total industry assets have grown, which has in part
                         resulted in two distinct groups of federally insured credit unions—larger
                         credit unions, which are fewer in number and provide a wider range of
                         services that more closely resemble those offered by banks, and smaller
                         credit unions, which are larger in number and provide more basic financial
                         services.




                         11
                            Generally, primary deposit insurance covers the first portion of members' deposits up to a
                         specified amount. For example, NCUSIF provides primary deposit insurance up to $100,000
                         per member per qualifying account. In contrast, excess deposit insurance is optional
                         coverage above the amount provided by primary deposit insurance that credit unions may
                         purchase from private insurers.




                         Page 10                                         GAO-04-91 Changes in Credit Union Industry
Credit Union Capital Ratios   The capital of federally insured credit unions as a percent of total industry
Have Improved Since 1991      assets—the capital ratio—increased steadily between 1992 and 1997 and
                              has since remained mostly level. As shown in figure 1, the capital ratio of
and Remain Higher Than        the industry was 8.1 percent in 1992, increased to 11.1 percent in 1997, and
Those of Banks                was 10.9 percent in 2002. As a point of comparison, the capital ratio of
                              credit unions has remained higher than that of banks and thrifts since
                              1992.12 As a result, credit unions have a greater proportion of assets
                              available to cover potential losses than banks and thrifts. This may be
                              appropriate since credit unions, unlike banks, are unable to raise capital in
                              the capital markets but must instead rely on retained earnings to build and
                              maintain their capital levels.



                              Figure 1: Comparison of Credit Union and Bank Capital Ratios, 1992–2002
                              Capital ratio

                              12



                              10



                               8



                               6



                               4



                               2



                               0
                                   1992        1993       1994    1995   1996     1997      1998      1999     2000      2001      2002

                                              Credit unions

                                              Banks and thrifts
                              Source: Call report data.

                              Note: Bank and thrift data are from all FDIC-insured institutions filing call reports, excluding insured
                              branches of foreign institutions.



                              12
                                Throughout the report we use the terms “banks,” “banks and thrifts,” and “FDIC-insured
                              institutions” interchangeably.




                              Page 11                                                GAO-04-91 Changes in Credit Union Industry
Industry Assets Have Grown   Total loans as a percent of total assets of federally insured credit unions
and Asset Composition Has    grew between 1992 and 2002. In 1992, 54 percent of credit union assets
                             were made up of loans and 16 percent were in U.S. government and agency
Changed                      securities, while in 2002 loans represented 62 percent of industry assets,
                             and U.S. government and agency securities represented 14 percent of total
                             assets. The largest category of credit union loans was consumer loans (a
                             broad category consisting of unsecured credit card loans, new and used
                             vehicle loans, and certain other loans to members, but excluding real estate
                             loans such as mortgage or home equity loans), followed by real estate
                             loans. For example, in 2002, 31 percent of credit union total assets were
                             classified as consumer loans and 26 percent were classified as real estate
                             loans.

                             However, over time, holdings of real estate loans have grown more than
                             holdings of consumer loans. For example, real estate loans grew from 19
                             percent of total assets in 1992 to 26 percent in 2002, while consumer loans
                             grew from 30 percent to 31 percent over the same period. Despite a larger
                             increase in real estate lending relative to consumer lending, credit unions
                             still had a significantly larger percentage of consumer loans relative to total
                             assets compared with their peer group banks and thrifts: consumer loan
                             balances of peer group banks and thrifts were less than 8 percent of total
                             assets in 2002. To provide context, in terms of dollar amounts, credit
                             unions had $175 billion in consumer loans while peer group banks and
                             thrifts had $190 billion in consumer loans. However, these banks and thrifts
                             held a greater percentage of real estate loans than credit unions. See
                             appendix III for additional details.



Credit Union Profitability   The profitability of credit unions, as measured by the return on average
Has Been Relatively Stable   assets, has been relatively stable in recent years.13 The industry’s return on
                             average assets was higher in the early to mid-1990s than in the late 1990s
in Recent Years
                             and early 2000s. While declining from 1.39 in 1993 to 0.94 in 1999, the return
                             on average assets has since stabilized. It has generally hovered around 1,
                             which, by historical banking standards, is a performance benchmark, and it
                             was reported at 1.07 as of December 31, 2002. For comparative purposes,
                             the return on average assets for peer group banks and thrifts was 1.24 in
                             2002. Earnings, or profits, are an important source of capital for financial


                             13
                              The return on average assets is calculated as the current period’s net income divided by the
                             average of current period assets and prior year-end assets.




                             Page 12                                         GAO-04-91 Changes in Credit Union Industry
                             institutions in general and are especially important for credit unions, as
                             they are mutually owned institutions that cannot sell equity to raise capital.
                             As previously mentioned, credit unions create capital, or net worth, by
                             retaining earnings. Most credit unions begin with no net worth and
                             gradually build it over time.



Regulatory Ratings Have      Since we last reported on the financial condition of credit unions, there has
Improved                     been a significant drop in the number of problem credit unions as
                             measured by the regulatory ratings of individual credit unions. Regulatory
                             ratings are a measure of the safety and soundness of credit union
                             operations, and credit unions with an overall CAMEL rating of 4 (poor) or 5
                             (unsatisfactory) are considered problem credit unions. The number of
                             problem credit unions declined by 63 percent from 578 (5 percent of all
                             credit unions) in 1992 to 211 (2 percent of total) in 2002.



Consolidation in Industry    Total assets in federally insured credit unions grew from $258 billion in
Has Widened the Gap          1992 to $557 billion in 2002, an increase of 116 percent. During this same
                             period, total member shares in these credit unions grew from $233 billion
between Larger and Smaller
                             to $484 billion, an increase of 108 percent. At the same time, the number of
Credit Unions                federally insured credit unions fell from 12,595 to 9,688. As a result of the
                             increase in total assets and the decline in the number of federally insured
                             credit unions, the credit union industry has seen an increase in the average
                             size of its institutions and a slight increase in the concentration of assets.
                             At year-end 1992, credit unions with more than $100 million in assets
                             represented 4 percent of all credit unions and 52 percent of total assets; at
                             year-end 2002, credit unions with more than $100 million in assets
                             represented about 11 percent of all credit unions and 75 percent of total
                             assets. From 1992 to 2002, the 50 largest credit unions by asset size went
                             from holding around 18 percent of industry assets to around 23 percent of
                             industry assets. Despite the slight increase in concentration of assets in the
                             credit union industry, it was neither as concentrated as the banking
                             industry, nor did it witness the same degree of increased concentration.
                             From 1992 to 2002, the 50 largest banks by asset size went from holding
                             around 34 percent of industry assets to around 58 percent of industry
                             assets. Appendix IV has additional information on assets in federally
                             insured credit unions and banks.

                             This consolidation in the credit union industry has in part widened the gap
                             between two distinct groups of federally insured credit unions—larger
                             credit unions, which are relatively few in number and provide a wider


                             Page 13                                 GAO-04-91 Changes in Credit Union Industry
range of services, and smaller credit unions, which are greater in number
and provide more basic banking services. Figure 2 illustrates institution
size and asset distribution in the credit union industry as of 2002, with
institutions classified by asset ranges; smaller credit unions are captured in
the first category, while credit unions with assets in excess of $100 million
are separated into additional asset ranges for illustrative purposes. For
example, as of December 31, 2002, the 8,642 smaller credit unions—those
with $100 million or less in total assets—constituted nearly 90 percent of all
credit unions but held only 25 percent of the industry’s total assets (see
right-hand axis of fig. 2). Conversely, the 71 credit unions with assets of
between $1 billion and $18 billion, held 27 percent of total industry assets
(see right-hand axis of fig. 2) but represented less than 1 percent of all
credit unions.14




14
 There were 68 credit unions with assets between $1 billion and $5 billion, which held 21
percent of industry assets, and three credit unions with assets in excess of $5 billion, which
held 6 percent of industry assets. As of December 31, 2002, the largest credit union held
$17.6 billion in assets.




Page 14                                         GAO-04-91 Changes in Credit Union Industry
Figure 2: Credit Union Industry Size and Total Assets Distribution, as of December
31, 2002
Number of credit unions                    Percentage of total assets

10,000                                                             30

            8,642
                                                                   25
 8,000


                                                                   20
 6,000

                                                                   15

 4,000
                                                                   10


 2,000
                                                                   5
                            602
                                    240          133       71
      0                                                            0
            $100            $250    $500        $1,000   $18,000
          Total assets (in millions)

                      Number of credit unions

                      Percentage of total assets

Source: Call report data.


Note: This figure depicts credit union industry distribution both in terms of the number of federally
insured institutions in a particular size category as well as the percentage of industry assets that are
held by institutions in that category. Group I credit unions had assets of $100 million or less; Group II
credit unions had assets greater than $100 million and less than or equal to $250 million; Group III
credit unions had assets greater than $250 million and less than or equal to $500 million; Group IV
credit unions had assets greater than $500 million and less than or equal to $1 billion; and Group V
credit unions had assets greater than $1 billion and less than or equal to $18 billion, which is the asset
size, rounded up to the nearest billion dollars, of the largest credit union as of December 31, 2002.
Thus, Group I represents smaller credit unions and Groups II, III, IV, and V represent larger credit
unions.


We observed that larger credit unions tended to hold a wider variety of
loans than did smaller credit unions, and larger credit unions emphasized
different loan types than smaller credit unions. For example, new and used
vehicle loans have represented a relatively greater proportion of total
assets for smaller credit unions, and nearly all smaller credit unions held
such loans. However, while nearly all of the larger credit unions held new
and used car loans, first mortgage loans represented a relatively greater
proportion of total assets for larger credit unions. In fact, nearly all larger
credit unions held first mortgage loans, junior mortgage and home equity



Page 15                                                         GAO-04-91 Changes in Credit Union Industry
                            loans, and credit card loans, while in general less than half of the smaller
                            credit unions held these loans. Larger credit unions also tended to be more
                            likely to provide more sophisticated services, such as financial services
                            through the Internet and electronic applications for new loans. While
                            nearly all larger credit unions offered automatic teller machines, less than
                            half of smaller credit unions did. In fact, when compared with similarly
                            sized peer group banks and thrifts, larger credit unions tended to appear
                            very similar to their bank peers in terms of loan holdings. Appendixes IV
                            and V provide further details.



Limited                     As credit unions have become larger and offer a wider variety of services,
                            questions have been raised about whether credit unions are more likely to
Comprehensive Data          serve households with low and moderate incomes than banks. However,
Are Available to            limited comprehensive data are available to evaluate income of credit
                            union members. Our assessment of available data—the Federal Reserve’s
Evaluate Income of          2001 SCF, 2001 HMDA data, and other studies—provided some indication
Credit Union Members        that credit unions served a slightly lower proportion of households with
                            low and moderate incomes than banks. Industry experts suggested that
                            credit union membership characteristics—occupationally based fields of
                            membership and traditionally full-time employment status—could have
                            contributed to this outcome. However, limitations in the available data
                            preclude drawing definite conclusions about the income characteristics of
                            credit union members. Additional information, especially with respect to
                            the income levels of credit unions’ members receiving consumer loans,
                            would be required to assess more completely whom credit unions serve.



Data Lacking on Income      It has been generally accepted, particularly by NCUA and credit union
Characteristics of Credit   trade groups, that credit unions have a historical emphasis of serving
                            people with modest means. However, there are currently no
Union Members and Users
                            comprehensive data on the income characteristics of credit union
                            members, particularly those who actually receive loans and other services.
                            As credit unions have become larger and expanded their offerings of
                            financial services, industry groups, as well as consumer advocates, have
                            debated which economic groups benefit from credit unions’ services.
                            Additionally, questions have been raised about credit unions’ exemption
                            from federal income taxes. As stated in our 1991 report, and still true, none
                            of the common-bond criteria available to federally chartered credit unions
                            refers to the economic status of their members or potential members.




                            Page 16                                GAO-04-91 Changes in Credit Union Industry
Information on the extent to which credit unions are lending and providing
services to households with various incomes is scarce because NCUA,
industry trade groups, and most states (with the exception of
Massachusetts and Connecticut) have not collected specific information
describing the economic status of credit union members who obtain loans
or benefit from other credit union services.15 Credit unions, even those
serving geographic areas, are not subject to the federal Community
Reinvestment Act (CRA), which requires banking regulators to examine
and rate banks and thrifts on lending and service to low- and moderate-
income neighborhoods in their assessment area.16 As a consequence, credit
unions are not required by NCUA or other regulators to maintain data on
the extent to which loans and other services are being provided to
households with various incomes.

However, two states—Massachusetts and Connecticut—collect
information on the distribution of credit union lending by household
income and the availability of services because their state-chartered credit
unions are subject to examinations similar to those of federally regulated
institutions. Modeled on the federal examination procedures for large
banks, the state regulators apply lending and service tests to assess
whether credit unions are meeting the needs of the communities they have
set out to serve, including low- and moderate-income neighborhoods.
Massachusetts established its examination procedures in 1982, and




15
  The Credit Union National Association (CUNA) collects information about the
characteristics (for example, income, race, and age) of credit union members but not
specifically the income levels of members who actually receive mortgage and consumer
loans or use other services.
16
   The CRA requires all federal bank and thrift regulators to encourage depository
institutions under their jurisdiction to help meet the credit needs of the local communities in
which they are chartered, consistent with safe and sound operations. See 12 U.S.C. §§ 2901,
2903, and 2906 (2000). CRA requires that the appropriate federal supervisory authority
assess the institution’s record of meeting the credit needs of its entire community, including
low- and moderate-income areas. Federal bank and thrift regulators perform what are
commonly known as CRA examinations to evaluate services to low- and-moderate income
neighborhoods. Assessment areas, also called delineated areas, represent the communities
for which the regulators are to evaluate an institution’s CRA performance.




Page 17                                          GAO-04-91 Changes in Credit Union Industry
Connecticut in 2001.17 All credit unions in Massachusetts are subject to
these examinations, including those whose field of membership is
community-based.18 In contrast, in Connecticut, only state-chartered credit
unions serving communities with more than $10 million in assets are
subject to the examination. According to a Connecticut state official, the
Connecticut legislature established its examination due to an increasing
trend of multiple-bond credit unions to convert to community-chartered
bonds, and the $10-million threshold was chosen because the legislature
believed credit unions of that size would normally have the personnel and
technological resources to appropriately identify and serve their market. In
May 2003, Connecticut started to examine community-chartered credit
unions with assets of more than $10 million.

Consumer and industry groups have debated if information that
demonstrates whether credit unions serve low- and-moderate income
households is necessary. Some consumer groups believe that credit unions
should supply information that indicates they serve all segments of their
potential membership. The Woodstock Institute—an organization whose
purpose is to promote community reinvestment and economic
development in lower-income and minority communities—recommended,
among other things, that the CRA requirement should be extended to
include credit unions, based on a study they believe demonstrated that
credit unions are not adequately serving low-income households.19
Woodstock Institute officials noted that they would prefer to see CRA
requirements applied to larger credit unions, those with assets over $10
million. The National Federation of Community Development Credit
Unions (NFCDCU) has recommended that credit unions whose fields of


17
   Overall, State officials reported that credit union examination ratings have been similar to
those of banks, except that credit unions have received a somewhat lower percentage of
“outstanding,” the highest rating. As of July 2003, no Massachusetts credit union had a rating
lower than “satisfactory” for Massachusetts’s version of the CRA examination. The officials
also noted that analysis of HMDA data by itself is inadequate because loan application
records do not capture all the information available in an application.
18
 The State of Massachusetts permits a credit union not serving geographic areas to
designate its membership as its assessment area. For example, one credit union, serving a
major communications company, designated its membership as those who are employees or
retired employees of the credit union itself; retirees and employees of other communication
companies, including their affiliates and subsidiaries; and family members of eligible
employees and retirees.
19
 Woodstock Institute, “Rhetoric and Reality: An Analysis of Mainstream Credit Unions’
Record of Serving Low Income People” (Chicago: February 2002).




Page 18                                          GAO-04-91 Changes in Credit Union Industry
                             membership cover large communities should be affirmatively held
                             accountable for providing services to all segments of those communities,
                             and that NCUA publish annual reports on the progress and status of these
                             expanded credit unions.20 In contrast, NCUA and industry trade groups
                             have opposed these and related requirements largely because they state
                             that no evidence suggests that credit unions do not serve their members.21



Federal Reserve Board Data   Our analysis of the Federal Reserve Board’s 2001 SCF suggested that credit
Suggest That Credit Unions   unions overall served a lower percentage of households of modest means
                             (low- and moderate-income households combined) than banks.22 More
Serve a Slightly Lower
                             specifically, while credit unions served a slightly higher percentage of
Proportion of Low- and       moderate-income households than banks, they served a much lower
Moderate-income              percentage of low-income households. The SCF is an interview survey of
Households                   U.S. households conducted by the Federal Reserve Board that includes
                             questions about household income and specifically asks whether
                             households use credit unions or banks. Our analysis of the SCF indicated
                             the following percentages for those households that used a financial
                             institution:23

                             • 8 percent of households only used credit unions,



                             20
                                NFCDCU represents and provides, among other things, financial assistance, technical
                             assistance, and human resources to about 215 community development credit unions for the
                             purpose of reaching low-income consumers.
                             21
                                In 2000, NCUA required that any type of application related to expanding, converting, or
                             chartering a community credit union include information known as a “community action
                             plan,” which described the credit union’s plan for serving the entire community. In interim
                             rules issued in December 2001 and final rules adopted in May 2002, NCUA repealed this
                             requirement. In discussion of the final rule, NCUA stated: “It is an unreasonable practice to
                             require only certain credit unions to adopt specific written policies addressing service to the
                             entire community, without any evidence that these credit unions are failing to serve their
                             entire communities.” CUNA and the National Federation of Credit Unions concurred with
                             this decision. CUNA further noted that the imposition of this requirement could encourage
                             federally chartered credit unions to convert to a state charter.
                             22
                              The SCF is conducted every 3 years and is intended to provide detailed information on the
                             balance sheet, pension, income, and other demographic characteristics of U.S. households
                             and their use of financial institutions. See appendix I for details.
                             23
                              These percentages reflect the percent of households using financial institutions as a
                             percent of all financial institution users and does not include those households that are
                             sometime referred to as unbanked.




                             Page 19                                          GAO-04-91 Changes in Credit Union Industry
• 13 percent of households primarily used credit unions,24

• 17 percent of households primarily used banks, and

• 62 percent of households only used banks.

To provide a more consistent understanding of our survey results, we used
the same income categories used by financial regulators—low, moderate,
middle, and upper—in their application of federal CRA examinations.25

To determine the extent to which credit unions served people of “modest
means,” we first combined households with low or moderate incomes into
one group and combined households with middle or upper incomes into
another group. We then combined the SCF data into two main groups—
households that only and primarily used credit unions versus households
that only and primarily used banks. As shown in figure 3, this analysis
indicated that about 36 percent of households that only or primarily used
credit unions had low or moderate incomes, compared with 42 percent of
households that used banks. Moreover, our analysis suggested that a
greater percentage of households that only and primarily used credit
unions were in the middle- and upper-income grouping than the proportion
of households that only and primarily used banks.




24
   Those who “primarily” used credit unions placed more than 50 percent of their assets in
credit unions and those who “primarily” used banks placed more than 50 percent of their
assets in banks. The term “use” refers to a household’s placement of assets in a checking,
savings, or money market account. Our methodology for determining these classifications
was based on work performed by Dr. Jinkook Lee, a professor and researcher at Ohio State
University. See Jinkook Lee and William A. Kelly Jr., in “Who Uses Credit Unions?”
(Prepared for the Filene Research Institute and the Center for Credit Union Research, 1999,
2001).
25
     See appendix I for the income category definitions.




Page 20                                           GAO-04-91 Changes in Credit Union Industry
Figure 3: Income Characteristics of Households Using Credit Unions versus Banks,
Low and Moderate Income versus Middle and High Income
Percentage of households

70
                    64

60                                          58


50
                                    42
40       36

30


20


10


 0
         Households                Households
      only and primarily        only and primarily
     using credit unions           using banks


               Low and moderate income

               Middle and upper income

Source: 2001 SCF.



To better understand the distribution of households by income category,
we also looked at each of the four income categories separately. As shown
in figure 4, this analysis suggested that the percentage of households that
only and primarily used credit unions in the low-income category was
lower than the percentage of households that used banks in the same
category (16 percent versus 26 percent). In contrast, households that only
and primarily used credit unions were more likely to be moderate- and
middle-income (19 percent and 22 percent) than those that only and
primarily used banks (16 and 17 percent). Given that credit union
membership has traditionally been tied to occupational- or employer-based
fields of membership, the higher percentage of moderate- and middle-
income households served by credit unions is not surprising.




Page 21                                              GAO-04-91 Changes in Credit Union Industry
Figure 4: Income Characteristics of Households Using Credit Unions versus Banks,
by Four Income Categories
Percentage

50

                                      43
                                                                                  41
40




30
                                                     26

                              22

20                  19
                                                                        17
       16                                                     16



10




 0
              Households only and                         Households only and
          primarily using credit unions                   primarily using banks


              Low income

              Moderate income

              Middle income

              Upper income

Source: 2001 SCF.


Note: We found no statistical difference in the percentage of upper-income households when the only
and primarily using credit union group and the only and primarily using bank group were compared.


We also attempted to further explore the income distribution of credit
unions’ members by separately analyzing households that only used credit
unions or banks from those that primarily used credit unions or banks.
However, the results were subject to multiple interpretations due to
characteristics of the households in the SCF database. For example, when
user groups are combined and compared, the results may look different
than when the groups are separated and compared. Because such a high
percentage of the U.S. population only uses banks (62 percent), the data
obtained from the SCF is particularly useful for describing characteristics
of bank users but much less precise for describing smaller population
groups, such as those that only used credit unions (8 percent).




Page 22                                            GAO-04-91 Changes in Credit Union Industry
                               In addition to assessing the income characteristics of households using
                               credit unions and banks, we also performed additional analysis by
                               education, race, and age. The results of these analyses can be found in
                               appendix VI.



Credit Unions Made a           As an indicator of the income levels of households that utilize credit union
Slightly Lower Proportion of   services, we used 2001 HMDA loan application records to analyze the
                               income of households receiving mortgages for the purchase of one-to-four
Mortgage Loans to
                               family homes from credit unions and peer-group banks.26 Our analysis
Households with Low and        indicated that credit unions reporting HMDA data made a lower proportion
Moderate Incomes Than          of mortgage loans to households with low and moderate incomes than
Banks                          peer group banks reporting HMDA data—27 percent compared with
                               34 percent.27 More specifically, credit unions made 7 percent of their loans
                               to low-income households compared with 12 percent for banks, and credit
                               unions made 20 percent of their loans to moderate-income households
                               compared with 22 percent for banks (see fig. 5).28




                               26
                                 HMDA, 12 U.S.C. §§ 2801-2811 (2000), was enacted to provide regulators and the public
                               with information on home mortgage lending so that both could determine whether
                               institutions were serving the credit needs of their communities. As required by the Federal
                               Reserve Board's Regulation C (12 C.F.R. Part 203), lenders subject to HMDA are required to
                               collect data containing information about the loan and the loan applicant. This information
                               is submitted on files known as loan application registers (loan records). HMDA-reportable
                               mortgages include those for home purchase, home improvement, and refinancing of home
                               purchase loans, but we analyzed only those made for home purchases because these loans
                               are a gateway to homeownership and other loans are easier to obtain. See appendix I for
                               more information.
                               27
                                We created a bank peer group that consisted of financial institutions with less than $16
                               billion in assets because the largest credit union held assets between $15 billion and $16
                               billion as of December 2001. We excluded financial institutions that only made mortgages.
                               Our analysis included 4,195 peer group banks.
                               28
                                 To categorize the home purchaser’s income, we used the 2001 HUD-estimated median
                               income estimates for each Metropolitan Statistical Area (MSA) based on the 1990 U.S.
                               Census, as supplied by the Federal Reserve Board. Results may have been more accurate if
                               these estimates were based on the 2000 U.S. Census. In 2003, HUD must begin basing their
                               median income estimates on the 2000 U.S. Census.




                               Page 23                                        GAO-04-91 Changes in Credit Union Industry
Figure 5: Mortgages Made by Credit Unions and Banks, by Income Level of
Purchaser, 2001
Percentage of loans

50

                                        44


40                                                                                39



                              30
30
                                                                        27

                                                               22
                   20
20


                                                     12

10
        7



 0
                  Credit unions                             Peer group banks


              Low-income purchasers

              Moderate-income purchasers

              Middle-income-purchasers

              Upper-income purchasers

Source: 2001 HMDA database.

Note: About 16 percent of all credit union and peer group bank loans reported to HMDA were excluded
from this analysis because their loan records did not identify the MSA of the purchased property.
Because we did not know the MSA, we could not calculate a MSA median income to categorize the
loan. HMDA reporting requirements allow for the omission of the MSA when the property is not located
in an MSA where the institution has a home or branch office. Also, percentages of loans made by
credit unions do not add up to 100 percent due to rounding.


We also analyzed and compared the proportion of mortgage loans reported
by peer group banks and credit unions for the purchase of homes by the
median family income of the census tracts in which the homes were
located. We found that credit unions made roughly the same proportion of
loans for the purchase of homes, by census tract income category, as
banks. For example, we found that both credit unions and banks made 1
percent of their loans for the purchase of homes in low-income census
tracts and that credit unions made 9 percent of their loans for the purchase
of properties in moderate-income census tracts compared with 10 percent
by banks (see fig. 6). In addition, we found that both credit unions and
banks made 54 percent of their loans for the purchase of homes in middle-



Page 24                                            GAO-04-91 Changes in Credit Union Industry
income census tracts, and that credit unions made about 37 percent of their
loans in upper-income census tracts compared with 35 percent by banks.
This analysis is a measure of whether all neighborhoods (census tracts
within an assessment area) are receiving financial services, including low-
and moderate-income ones.



Figure 6: Loans Made by Credit Unions and Banks, by Average Income in the
Purchased Home's Census Tract, 2001
Percentage of loans

60
                              54                                          54

50



40                                    37
                                                                                    35


30



20


                   9                                            10
10

        1                                              1
 0
                  Credit unions                               Peer group banks


              Low-income tract

              Moderate-income tract

              Middle-income-tract

              Upper-income tract

Source: 2001 HMDA database.

Note: About 16 percent of the credit union and peer group bank loans reported to HMDA were
excluded from this analysis because their loan records did not identify the census tract of the
purchased property. Because we did not know the census tract, no census tract median income was
available to categorize the loan. HMDA reporting requirements allow for the omission of the census
tract locations under certain conditions; for example, when the property did not have an identified
census tract for the 1990 census or was located in a county with a population of 30,000 or less. Also,
percentages of loans made by credit unions do not add up to 100 percent due to rounding.


Because each HMDA loan record identified the income of the mortgage
loan recipient and the location of the property, the HMDA database allowed
us to determine the proportion of mortgages made within the four income



Page 25                                              GAO-04-91 Changes in Credit Union Industry
                            categories—low, moderate, middle, and upper—used by financial
                            regulators for CRA examinations. However, not all financial institutions are
                            required to report HMDA data—for example, depository institutions were
                            exempt from reporting data in 2001 if they had assets less than $31 million
                            as of December 31, 2000, and if they did not have a home or branch office in
                            an MSA. Further, not all credit unions, including those that had more than
                            $31 million in assets, made home purchase loans.29 As a result, most credit
                            unions did not meet HMDA’s reporting criteria—only about 14 percent of all
                            credit unions submitted data included in our analysis.30 On the other hand,
                            the credit unions that did report their loans to HMDA held about 70 percent
                            of credit union assets and included about 62 percent of all credit union
                            members.



HMDA Analysis Has Certain   Our analysis of HMDA data allowed us to determine the overall proportion
Limitations                 of mortgage loans credit unions and peer group banks made to households
                            and neighborhoods with low and moderate incomes. However, we would
                            need information on the proportion of low- and moderate-income
                            households within credit union fields of membership to actually make an
                            evaluation of whether credit unions, collectively or individually, have met
                            the credit needs of their entire field of membership. Similar to analyses
                            used in federal CRA lending tests, this information could then be used as a
                            baseline from which to evaluate an individual credit union’s actual lending
                            record.31 In addition, information on factors (for example, a community’s
                            economic condition, local housing costs) that could affect the ability of a

                            29
                               Our analysis of NCUA call report data indicated that 93 percent of credit unions with more
                            than $31 million in assets, as of December 31, 2000, made first mortgage loans, loans that
                            include home purchase loans, compared with only 34 percent of credit unions with fewer
                            assets.
                            30
                              In total, for 2001, 1,717 credit unions reported data to HMDA, but our analyses only
                            included the 1,446 that made mortgage loans that met our criteria. For example, we only
                            included mortgage loans for home purchases rather than refinancing.
                            31
                               For larger institutions, those with more than $250 million in assets, CRA examinations
                            generally consist of three parts—a lending test, a service test, and an investment test. The
                            lending test entails a review of an institution’s lending record, including originations and
                            purchases of home mortgages, small business, small farm, and, at the institution’s option,
                            consumer loans throughout the institution's assessment area, including low- and moderate-
                            income areas. The lending test is weighted more heavily than the investment and service
                            tests in the institution’s overall CRA rating. The service test requires the examiner to analyze
                            an institution’s system for delivering retail banking services and the extent and
                            innovativeness of its community development services. The investment test evaluates an
                            institution’s investment in community development activities.




                            Page 26                                          GAO-04-91 Changes in Credit Union Industry
credit union to make loans consistent with safe and sound lending would
be necessary to evaluate an institution’s lending record. If regulators were
to make these types of evaluations for credit unions, they would be easier
to implement for those serving geographic areas because demographic
information (for example, on census tract median income levels) would be
available to describe credit union field of membership. For credit unions
with an occupational or associational membership, other ways of
characterizing their field of membership would need to be determined.

In addition, as previously mentioned, using HMDA data to analyze credit
union mortgage lending to members does not provide any information on
smaller credit unions, because in 2001 credit unions with less than $31
million in assets as of December 31, 2000, were not required to report
HMDA data. Because smaller credit unions did not report HMDA data, one
group of credit unions—the roughly 3,800 credit unions that qualified for
NCUA’s Small Credit Union Program in December 2002—were largely
excluded from our HMDA analysis. Credit unions qualifying for assistance
from this program must have less than $10 million in assets or have
received a “low-income” designation from NCUA.32 In addition, low-income
credit unions must demonstrate that more than half of their current
members meet one of NCUA’s low-income criteria.33 Further, smaller credit
unions are more likely than larger credit unions to make consumer loans
than mortgages, making an evaluation of mortgage lending more relevant
to larger credit unions than smaller ones. Because most credit unions can
be classified as small, analyzing the distribution of consumer loans by
household income would provide a more complete picture of credit union
lending.34




32
 These credit unions receive special help from NCUA regional staff, including assistance in
completing business plans and maintaining financial records. Low-income credit unions
also qualify for low-interest loans and technical assistance grants and are permitted to
accept nonmember deposits and secondary capital accounts. According to NCUA estimates,
as of December 31, 2002, the median asset level of these credit unions was about $3.4
million. About 107 of these credit unions had more than $32 million in assets, the threshold
for reporting lending data to HMDA in 2003.
33
  As of December 31, 2002, there were 907 low-income credit unions. Credit unions can use a
number of methods to document their low-income eligibility, such as reviewing loans to
identify members’ wages or household incomes, or written membership surveys that
request the members’ total household income and annual wages.
34
     See appendix V for more detailed information on credit union services by asset size.




Page 27                                           GAO-04-91 Changes in Credit Union Industry
Other Studies Indicate That   Other recently published studies—CUNA and the Woodstock Institute—
Credit Unions Serve           generally concluded that credit unions served a somewhat higher-income
                              population. The studies noted that the higher income levels could be due to
Households with Higher        the full-time employment status of credit union members.
Incomes Than Banks
                              The CUNA 2002 National Member Survey reported that credit union
                              members had higher average income households than nonmembers—
                              $55,000 compared with $46,000.35 The report provided several reasons for
                              the income differential, including the full-time employment status of credit
                              union members, credit union affiliation with businesses or companies, and
                              weak credit union penetration among some of the lowest-income age
                              groups—18 to 24 and 65 and older. However, the report noted that
                              additional analyses, specifically those grouping consumers based on the
                              extent to which they rely on banks and credit unions as their primary
                              provider should also be considered.36 In addition, a study sponsored by the
                              Woodstock Institute, based on an analysis of 1999 and 2000 survey
                              responses obtained from households in the Chicago, Illinois, metropolitan
                              area concluded that credit unions in the Chicago region served a lower
                              percentage of lower-income households than they did middle- and upper-
                              income ones.37 For example, while 40 percent of surveyed households with
                              incomes between $60,000–$70,000 contained a credit union member, only
                              23 percent of households earning between $30,000–$40,000 contained a


                              35
                                 CUNA 2002 National Member Survey and research and information from CUNA and
                              affiliates. CUNA based its statistics on average household income on a survey of 1,000
                              randomly selected households conducted in February 2002. The data from this survey were
                              weighted to accurately represent U.S. consumers age 18 and older.
                              36
                                CUNA supplemented its average income analysis of members and nonmembers with one
                              that divided consumers into four institution user groups—as similarly done by Jinkook Lee,
                              in “Who Uses Credit Unions” in her analysis of the SCF and in our previous analysis—and
                              calculated the average household income of each institution user group. CUNA determined
                              that consumers who only used banks and only used credit unions had a lower average
                              income than consumers who used both institutions. In addition, when comparing the
                              average income of consumers who used both institutions, the analysis concluded that those
                              who primarily used credit unions had a slightly lower average income than those who
                              primarily used banks.
                              37
                               The study cited is “Rhetoric and Reality: An Analysis of Mainstream Credit Unions’ Record
                              of Serving Low Income People” (February 2002). To determine the characteristics of credit
                              union members, the Woodstock Institute analyzed 1999 and 2000 survey data collected by
                              the Metro Chicago Information Center (MCIC). MCIC surveyed roughly 3,000 households in
                              the Chicago area and asked respondents whether they were members of a credit union.
                              However, the survey did not specifically ask whether the respondents held accounts at a
                              bank or credit union.




                              Page 28                                       GAO-04-91 Changes in Credit Union Industry
                         credit union member. The study also noted that household members
                         working for larger firms, and those who were members of a labor union,
                         were significantly more likely to be credit union members.

                         Officials from NCUA and the Federal Reserve Board also noted that credit
                         union members were likely to have higher incomes than nonmembers
                         because credit unions are occupationally based. An NFCDCU
                         representative noted that because credit union membership is largely
                         based on employment, relatively few credit unions are located in low-
                         income communities. However, without additional research, especially on
                         the extent to which credit unions with a community base serve all of their
                         potential members, it is difficult to know whether full-time employment is
                         the sole explanatory factor.



CUMAA Authorized         The Credit Union Membership Access Act of 1998 authorized preexisting
                         NCUA policies that had allowed credit unions to expand field of
NCUA to Continue         membership. In 1998, the Supreme Court ruled against NCUA’s practice of
Preexisting Policies     permitting federally chartered credit unions to consist of more than one
                         common bond.38 In CUMAA, Congress specifically permitted credit unions
That Expanded Field of   to form multiple-bond credit unions and allowed these credit unions to
Membership               serve underserved areas.39 CUMAA also specified that community-
                         chartered credit unions serve a “local” area.40 However, after the passage of
                         CUMAA, NCUA revised its regulations to make it easier for credit unions to
                         serve communities larger than before CUMAA. To some extent, these
                         NCUA policies appear to have been triggered by concerns about competing
                         with the states to charter credit unions. While CUMAA permitted multiple-
                         bond credit unions to add underserved areas to their membership, the
                         impact of this provision will be difficult to assess because NCUA does not
                         track credit union progress in extending service to these communities.




                         38
                          National Credit Union Administration v. First National Bank & Trust Co., 522 U.S. 479
                         (1998).
                         39
                              Pub. L. No. 105-219 § 101(2).
                         40
                              Id.




                         Page 29                                     GAO-04-91 Changes in Credit Union Industry
CUMAA Permitted NCUA          CUMAA authorized several preexisting NCUA field of membership policies
Policies Expanding Field of   that had enabled federally chartered credit unions to expand their fields of
                              membership. These policies had allowed credit unions to consist of more
Membership                    than one membership group and expand their membership to include
                              underserved areas. In addition, CUMAA permitted credit unions to retain
                              their existing membership.

                              Specifically, CUMAA affirmed NCUA’s 1982 policy of permitting credit
                              unions to form multiple-bond credit unions, allowing these credit unions to
                              retain their current membership and authorizing their future formation.41 A
                              credit union with a single common bond has members sharing a single
                              characteristic, for example, employment by the same company. In contrast,
                              multiple-bond credit unions consist of more than one distinct group. 42
                              Congressional affirmation of NCUA’s policy of permitting multiple-bond
                              credit unions was important because earlier in 1998 the Supreme Court had
                              ruled that federally chartered, occupationally based credit unions were
                              required to consist of a single common bond.43 Figure 7 provides additional
                              information since 2000 on the percent of federally chartered credit unions
                              by charter type.44




                              41
                                 CUMAA permitted the following common bonds: (1) the single common bond, defined as
                              one group with a common bond of occupation or association; (2) the multiple common
                              bond, defined as including more than one group, each with a common bond of occupation
                              or association; and (3) the community bond, defined as persons or organizations within a
                              well-defined local community, neighborhood, or rural district. Formation of multiple
                              common-bond credit unions is limited to groups having fewer than 3,000 members unless
                              NCUA grants an exception based on criteria contained in CUMAA. See 12 U.S.C. § 1759(b),
                              (d), as amended.
                              42
                                 According to NCUA officials, single-bond credit unions are more susceptible to failure
                              because they are reliant on one type of occupational group. For example, if an occupational
                              group were subject to layoffs, the credit union could lose its membership base or
                              experience a decline in assets.
                              43
                                 National Credit Union Administration v. First National Bank & Trust Co., 522 U.S. 479
                              (1998).
                              44
                               Although single-bond credit unions included about 38 to 40 percent of all federally
                              chartered credit unions between 2000 and March 2003, during this time period they only
                              held about 18 percent of all assets of federally chartered credit unions. In contrast, federally
                              chartered multiple-bond credit unions held about 70 percent of federal assets in March 2000,
                              and this percentage dropped to about 65 percent in 2003. Federally chartered community
                              credit unions held about 13 percent of federal assets in 2000, and this percentage increased
                              to about 17 percent of assets in March 2003.




                              Page 30                                          GAO-04-91 Changes in Credit Union Industry
Figure 7: Percentage of Federally Chartered Credit Unions, by Charter Type, 2000–

2003

Percentage of credit unions


50                   48                     48               48
                                                                              47


            40
40                                   39
                                                      38                38




30




20
                                                                   15
                                                 14
                                13
      12

10




 0
           2000                      2001             2002              2003
                                                                  (through March)


                Community

                Single bond

                Multiple bond

Source: NCUA.

Note: With the exception of the statistics provided for multiple-bond credit unions for 1996, NCUA
cannot provide us data on federal chartering trends before 2000. However, NCUA was able to report
that by 1996, about half of all federally chartered credit unions were multiple-bond credit unions.


In addition, CUMAA affirmed other preexisting NCUA policies. For
example, CUMAA authorized multiple-bond credit unions to add
individuals or organizations in “underserved areas” to their field of
membership. This provision was similar to an NCUA policy that permitted
multiple-bond credit unions, as well other federally chartered, single-bond,
and community-chartered credit unions, to add low-income communities




Page 31                                                    GAO-04-91 Changes in Credit Union Industry
                                to their field of membership.45 In addition, CUMAA affirmed NCUA’s “once
                               a member, always a member policy,” which had been in effect since 1968.
                               CUMAA authorized this policy such that credit union members may retain
                               their membership even after the basis for the original bond ended.46
                               However, CUMAA still contained provisions encouraging the creation of
                               new credit unions whenever possible.47



NCUA Eased Requirements        Despite the qualification in CUMAA that a community-chartered credit
for Permitting Credit Unions   union’s members be within a well-defined “local” community,
                               neighborhood, or rural district, NCUA eased requirements for permitting
to Serve Larger Geographic
                               credit unions to serve larger geographic areas. CUMAA added the word
Areas                          “local” to the preexisting requirement that community-chartered credit
                               unions serve a “well-defined community, neighborhood, or rural district,”
                               but provided no guidance with respect to how the word “local” or any other
                               part of this requirement should be defined.48




                               45
                                  In 1994, NCUA’s Interpretive Ruling and Policy Statement (IRPS) 94-1 authorized all
                               federally chartered credit unions, regardless of bond, to include in their membership,
                               without regard to location, communities and associational groups satisfying the definition
                               of low income. This program should not be confused with NCUA’s “low-income designated
                               program,” which permits credit unions who exclusively serve low-income areas to maintain
                               secondary capital and accept nonmember deposits.
                               46
                                Pub. L. No. 105-219 § 101 (2), 12 U.S.C. § 1759 (e)(2), as amended. Under this provision,
                               once a person becomes a member of a credit union, that person or organization may remain
                               a member of that credit union until the person or organization chooses to withdraw from
                               membership in the credit union.
                               47
                                The Federal Credit Union Act requires NCUA to encourage the formation of separately
                               chartered credit unions instead of approving the inclusion of an additional common-bond
                               group within the field of membership of an existing credit union. 12 U.S.C. § 1759(f)(1).
                               From 1991 to March 2003, only 143 new federally insured credit unions were chartered, an
                               average of about 11 to 12 new credit unions per year. NCUA said that small groups are
                               generally not economically sustainable and prefer to join multiple-bond credit unions.
                               48
                                    Pub. L. No. 105-219 § 101; See 12 U.S.C. § 1759(c)(2), as amended.




                               Page 32                                            GAO-04-91 Changes in Credit Union Industry
Following passage of CUMAA, NCUA expanded the ability of credit unions
to serve larger geographic areas through its regulatory rulings.49
Interpretive Ruling and Policy Statement (IRPS) 99-1, issued soon after
CUMAA, was the first regulation to set standards for what could be
considered a “local” area. It required credit unions to document that
residents of a proposed community area interact or have common
interests. Credit unions seeking to serve a single political jurisdiction (for
example, a city or a county) with more than 300,000 residents were
required to submit more extensive documentation than jurisdictions with
fewer than 300,000 residents.50 However, IRPS 03-1, which replaced IRPS
99-1, eliminated these documentation requirements, regardless of the
number of residents. Further, IRPS 03-1 allowed credit unions to propose
MSAs with less than 1 million residents for qualification as local areas. See
table 1 for changes in “local” requirements. NCUA adopted these
definitions of local community based on its experience in determining what
constituted a local community charter.




49
 Prior to CUMAA, NCUA regulations did not limit the size of the community a credit union
could serve. However, NCUA required extensive documentation to establish the existence
of a community. For example, up until March 1, 1998, credit unions were required to provide
written evidence of community support for their applications, such as letters of support,
petitions, or surveys. In March 1998, in IRPS 98-1, NCUA deleted the information
requirement but noted that credit unions still had to demonstrate that residents of the
proposed community interacted.
50
 For example, in IRPS 99-1, if the population of a single political jurisdiction was less than
300,000, the credit union was only obligated to submit a letter describing how the area met
standards for community interaction or common interests. However, if the population
exceeded 300,000, the credit union would have to submit additional documentation;
demonstrating, for example, the existence of major trade areas or shared facilities (such as
educational).




Page 33                                         GAO-04-91 Changes in Credit Union Industry
Table 1: Regulatory Definitions of Local Community, 2000 and 2003

IRPS 99-1, effective in November 2000, 

(as amended by IRPS 00-1)                          IRPS 03-1, effective in May 2003

1. Areas in single political jurisdictions (for    1. Any city, county, or political equivalent in
example, counties or cities) qualified as a        a single political jurisdiction, regardless of
local community if the number of residents         population size, automatically meets the
did not exceed 300,000.                            definition of a local community.

2. States, noncontiguous jurisdictions, and        2. MSAs may meet the definition of local
MSAs did not meet the definition of a local        community provided the population does
community.                                         not exceed 1 million.

3. Contiguous political jurisdictions qualified 3. Contiguous political jurisdictions qualify
as a local community if they contained          as a local community if they contain
200,000 or fewer residents.                     500,000 or fewer residents.

4. A letter describing community interaction       4. A letter describing community interaction
or common interests was required for               or common interests is required for
conditions (1) and (3) above. Otherwise, the       conditions (2) and (3) above. Otherwise, the
credit union had to provide additional             credit union must provide additional
documentation.                                     documentation.
Source: IRPS 99-1 and IRPS 03-1.

Note: NCUA amended IRPS 99-1, the first field of membership regulation issued by NCUA after
CUMAA, several times (IRPS 00-1 on Oct. 27, 2000; IRPS 01-1 on March 2001; and IRPS 02-2 on
April 24, 2002.) This table only highlights key changes pertaining to the geographic and population
criteria used by NCUA to approve community charters.


Specifically, NCUA officials said that they decided single political
jurisdictions should automatically qualify as “local” areas based on their
review of applications by credit unions for community charters. They
reported that they came to this conclusion because credit unions
converting to a community charter or expanding their service areas had
generally been able to successfully supply the documentation required by
NCUA. We asked NCUA officials what kind of relationships community-
chartered credit union members could have if, for example, a local
community were to be defined as all of New York City. NCUA officials said
that the defining factors for them were that people lived in the same
political jurisdiction—thus providing, for example, a common government
and educational system—and noted that credit unions applying to serve
these larger jurisdictions still had to meet other requirements related to
safety and soundness. The officials also said that had CUMAA not
introduced the word “local,” NCUA could have considered providing credit
unions permission to expand their field of memberships statewide.




Page 34                                             GAO-04-91 Changes in Credit Union Industry
The regulatory changes in IRPS-03-1 pertaining to the definition of local
community have made it easier for federally chartered credit unions to
serve larger communities. Under IRPS-03-1, NCUA approved the largest
community yet—the 2.3 million residents of Miami-Dade County, Florida.51
NCUA had disapproved this same credit union’s request about 2 years
earlier, under IRPS 99-1, as amended by IRPS 01-1. Prior to IRPS-03-1, some
of the largest community field of memberships approved by NCUA
included service to 836,231 residents on Oahu, Hawaii, and service to
710,540 residents in Montgomery County and Greene County, Ohio.52 In
addition, over the last 3 years, potential membership––an estimate of the
maximum number of members that could join a credit union––in
community-chartered credit unions has come to exceed that in multiple-
bond credit unions.53 According to NCUA estimates, in March 2003,
community-chartered credit unions had 98 million potential members
compared with multiple-bond credit unions with 92 million potential
members (see fig. 8).




51
  This multiple-bond credit union, located in Miami, Florida, originally applied to serve
Miami-Dade County, Florida, in April 2001. However, NCUA officials denied both the
original application and subsequent appeal on the grounds that the residents of this area
(including two large cities and 28 other municipalities) did not have common interests or
interactions. As required by IRPS 99-1 (as amended by IRPS 01-1), the credit union was
required to supply documentation that residents within this area interacted but the
evidence, while described as “voluminous” by NCUA officials, did not meet with their
approval. Under the new rule (IRPS 03-1), approved in May 2003, this level of evidence was
no longer required.
52
  While the examples in this paragraph represent some of the largest community-charter
field of memberships approved by NCUA, the population sizes of these communities can
vary tremendously. For example, in 2002, NCUA field of membership approvals ranged from
a population of 695 in Delta County, Colorado, to a population of 1.1 million residents in the
area surrounding Maple Grove, Minnesota. Since 1999, the average population of approved
communities has increased—in 1999, this average was 134,000 and as of June 25, 2003,
357,000.
53
 Federally insured credit unions are required to report their potential membership on
NCUA’s call report. This number is expected to include current membership as well as
potential members. While the instructions require that the estimates must be reasonable and
supportable, no further instructions are provided. Two or more credit unions whose field of
membership overlaps can count the same person as a potential member.




Page 35                                         GAO-04-91 Changes in Credit Union Industry
                             Figure 8: Actual and Potential Members in Federally Chartered Credit Unions, by
                             Charter Type, 2000–2003
                             Number of members in millions

                             100




                              80




                              60




                              40




                              20




                               0
                                     Actual           Potential       Actual    Potential       Actual      Potential
                                      Single-bond charter             Community charter         Multiple-bond charter


                                              2000

                                              2001

                                              2002


                                              2003 (through March)


                             Source: NCUA.




Dual Chartering System May   According to NCUA, a major reason for NCUA’s recent regulatory changes
Have Created Pressure for    was to maintain the competitiveness of the federal charter in a dual
                             chartering system. They also characterized NCUA’s field of membership
Less Restrictive Field of
                             regulations as more restrictive than those in some states. Officials in three
Membership Regulations       of the states in which we conducted interviews—California, Texas, and
                             Washington—said that the ability to expand field of membership more
                             readily under state rules was a reason that federally chartered credit unions
                             had converted to state charters.

                             Consistent with this assertion, we found that state-chartered credit unions
                             have experienced greater membership growth, although federally
                             chartered credit unions still had more members. Between 1990 and March
                             2003, state-chartered credit union membership increased by 88 percent,



                             Page 36                                             GAO-04-91 Changes in Credit Union Industry
from 19.5 million to 36.6 million, while membership in federally chartered
credit unions increased by 24 percent, from 36.2 million to 44.9 million. In
addition, if estimates of potential membership serve even as an
approximation of future membership, state-chartered credit unions could
be positioned to experience greater growth (see fig. 9). In March 2003,
state-chartered credit unions had about 405 million potential members,
almost twice the 208 million for federally chartered credit unions.



Figure 9: Actual and Potential Members in Federally and State-chartered Credit
Unions, 1990–2003
Number of members in millions

450

400

350

300

250

200

150

100

 50

  0
      1990      1991   1992   1993   1994     1995   1996    1997   1998   1999   2000   2001   2002     2003
                                                                                                       (through
                                                                                                        March)

                 State actual membership
                 Federal actual membership
                 State potential membership
                 Federal potential membership
Source: NCUA.

Note: In 2001, the total population of the United States was about 285 million people. In contrast,
between 2001 and 2003, the total number of potential credit union members ranged from 446 million to
about 613 million. The total number of potential members exceeds the total population of the United
States because credit unions can count the same individuals as potential members when their field of
membership overlaps.




Page 37                                                     GAO-04-91 Changes in Credit Union Industry
                            We also found that states had chartered a higher percentage of their credit
                            unions to serve geographic areas (communities) than NCUA.54 In 2002, we
                            estimated that about 1,146 state-chartered credit unions, 30 percent of all
                            state-chartered credit unions, served geographic areas compared with 848
                            federally chartered credit unions, 14 percent of all federally chartered
                            credit unions.55 However, this number increases to 1,096, 18 percent of all
                            federally chartered credit unions, once federally chartered credit unions
                            serving underserved areas are included. State-chartered credit unions
                            serving geographic areas held about 59 percent of state-chartered credit
                            unions assets compared with 17 percent held by federally chartered credit
                            union serving geographic areas, or 29 percent when the assets of credit
                            unions with underserved areas were included.56



Credit Unions Have Added    An NCUA objective is to ensure that credit unions provide financial
Underserved Areas, but No   services to all segments of society, including the underserved, but NCUA
                            has not developed indicators to evaluate credit union progress in reaching
Information Available to    the underserved.57 This type of evaluation could require information similar
Evaluate Actual Service

                            54
                             We use the term “serving geographic areas” because some states (for example, California
                            and Texas) permit their credit unions to serve a mix of occupational and associational
                            groups and communities. Because NCUA could not provide us information on the number
                            of state-chartered credit unions serving communities, we surveyed state regulators to obtain
                            this information.
                            55
                             The number of credit unions serving geographic areas varied by state. For example, in
                            California, state-chartered credit unions serving geographic areas represented about 48
                            percent of state-chartered credit unions and held about 82 percent of state-chartered assets.
                            In comparison, in New York, state-chartered credit unions serving geographic areas
                            represented about 5 percent of state-chartered credit unions and held about 11 percent of
                            state-chartered assets.
                            56
                               Because chartering provisions among the states and the federal government vary, we
                            would like to emphasize that these numbers are estimates only. For example, we had no way
                            of knowing, short of contacting individual credit unions, whether state-chartered credit
                            unions relied more extensively on a community or an occupational group for their
                            membership. In addition, some state-chartered credit unions were excluded from our
                            calculations, including those that were privately insured, because we could not identify
                            them in the NCUA call report data.
                            57
                              Part of NCUA’s vision statement, included as part of its 2003-2008 Strategic Plan, is:
                            “Ensure the cooperative credit union movement can safely provide financial services to all
                            segments of American society.” Further, in NCUA’s 2003 Annual Performance Plan, NCUA
                            states as a specific goal that it plans to “Facilitate credit union efforts to increase credit
                            union membership and accessibility to continue to serve the underserved, and enhance
                            financial services.”




                            Page 38                                          GAO-04-91 Changes in Credit Union Industry
to that provided as part of CRA examinations—for example, information
on the distribution of loans made by the income levels of households
receiving mortgage and consumer loans—and provide comprehensive
information on how credit unions have utilized opportunities to extend
their services to underserved areas, including low- and moderate-income
households. 58 CUMAA had specifically provided that multiple-bond credit
unions could serve underserved areas, and NCUA permitted single-bond
and community-bond credit unions to add them as well. However, neither
CUMAA nor NCUA required that credit unions report on services to these
areas once they had been added. Figure 10 shows the number of
underserved areas added before and after CUMAA.




58
   The Federal Credit Union Act, as amended by CUMAA, provides NCUA criteria to use to
determine if an area is “underserved.” See 12 U.S.C. § 1759 (c)(2). Among other things, these
areas must qualify as “investment areas” as defined by section 103 (16) of the Community
Development Banking and Financial Institutions Act of 1994 (12 U.S.C. § 4703(16)). Areas
could qualify, for example, by having at least 20 percent of their population living in poverty.
Second, areas must qualify as underserved based on data from the NCUA board and the
federal banking agencies. NCUA officials, however, apply only the first criterion, presuming
that areas qualifying as an investment area automatically qualify as underserved.




Page 39                                          GAO-04-91 Changes in Credit Union Industry
Figure 10: Underserved Areas Added before and after CUMAA, by Federal Charter
Type, 1997–2002
Number of underserved areas

350

                                 CUMAA enacted
300                              in August 1998


250


200


150


100


 50


  0
      1997               1998        1999            2000             2001            2002

                Single bond

                Multiple bond

                Community
Source: NCUA.

Note: Between 1997 and 1999, credit unions were adding communities under NCUA's low income
standards. While CUMAA did not specifically permit single-bond and community-chartered credit
unions to add underserved areas, NCUA permitted them to do so.


Instead of developing indicators to evaluate credit union progress in
reaching the underserved, NCUA officials have claimed success based on
the increase in the number of potential members added by credit unions in
underserved areas and, recently, on the membership growth rate of
federally chartered credit unions that have added underserved areas. As of
March 2003, credit unions had added 48 million potential members in
underserved areas. As noted previously, potential membership is an
estimate of the maximum number of people who could be eligible to join a
credit union. However, NCUA officials believe that potential membership is
an appropriate measure because they view NCUA’s role as expanding
membership opportunities for credit unions as opposed to the credit




Page 40                                           GAO-04-91 Changes in Credit Union Industry
unions’ role of actually extending services to new members.59 In addition,
in June 2003, NCUA claimed success based on estimates indicating that
annual membership growth in credit unions that expanded into
underserved areas has been higher than that of all federally chartered
credit unions—4.8 percent compared with 2.49 percent. However, they
could not identify whether the increase in membership actually came from
the underserved areas or provide any descriptive information (for example,
the income level) about the new members.

Because NCUA does not collect information on credit union service to
underserved areas, it would be difficult for NCUA or others to demonstrate
that these credit unions are actually extending their services to those who
have lower incomes or do not have access to financial services.60 As the
number of credit unions adding underserved areas increases, this question
becomes more important. For example, in 1999, the year after CUMAA, 13
credit unions added 16 underserved areas to their membership. In 2002, 223
credit unions added about 424 underserved areas. Further, the size of these
communities can be substantial. For example, in May 2003, NCUA
permitted one multiple-bond credit union to add an additional 300,000
residents within Los Angeles County, California, for a total of almost 1
million added residents in the last 2 years. In the same month, NCUA also
approved a multiple-bond credit union’s (headquartered in Dallas, Texas)
addition of 600,000 residents in underserved communities in Louisiana.




59
 To promote adoption of these areas, NCUA developed a public relations program called
“Access to America” that promotes awareness of NCUA programs that provide resources, or
other support, to credit unions to expand their financial services to the underserved.
60
   CUNA published a study, 2003 “Serving Members of Modest Means” Survey Report, on
how credit unions served consumers having annual household incomes of $40,000 or less.
While the survey findings cannot be generalized to all credit unions, the survey results
indicated that most credit unions responding to the survey targeted at least one service (for
example, money orders, check-cashing services) to lower- and moderate-income members,
and that credit unions with underserved areas were likely to offer more of these services.
About 35 percent of the credit unions responding to the survey indicated they would grant a
loan for $100 or less and about 30 percent indicated they would open a certificate account
for less than $100. The study noted that credit unions had difficulty responding to questions
that asked them to estimate members’ or potential members’ income distributions.




Page 41                                         GAO-04-91 Changes in Credit Union Industry
NCUA Adopted Risk-            Industry consolidation and changes in products and services offered by
                              credit unions prompted NCUA to move from an examination and
focused Examination           supervision approach that was primarily focused on reviewing transactions
and Supervision               to an approach that focuses NCUA resources on high-risk areas within a
                              credit union. Prior to implementing its risk-focused program in August
Program, but Faces            2002, NCUA sought guidance from other depository institution regulators
Challenges in                 that had several years of experience with risk-focused programs. While this
Implementation                consultative approach helped NCUA, it still faces a number of challenges
                              that create additional opportunities for NCUA to leverage off the
                              experience of the other depository institution regulators. These challenges
                              include ensuring that examiners have sufficient expertise in areas such as
                              information systems, monitoring the risks posed by expansion into
                              nontraditional credit union activities such as business lending, and
                              monitoring the risks posed to the federal deposit (share) insurance fund by
                              institutions for which states are the primary regulator. Moreover, unlike
                              other depository institution regulators, NCUA currently lacks authority to
                              inspect third-party vendors, which credit unions increasingly rely on to
                              provide services such as electronic banking. Further, credit unions are not
                              subject to the internal control reporting requirements that banks and thrifts
                              are subject to under FDICIA.61 NCUA adopted prompt corrective action, a
                              system of supervisory actions tied to the capital levels of an institution, in
                              August 2000, as required by CUMAA; few actions have been taken to date
                              due to a generally favorable economic climate for credit unions.



Changes in the Credit Union   The credit union industry has undergone a variety of changes that
Industry Prompted NCUA to     prompted NCUA to revise its approach to examining and supervising credit
                              unions. As described earlier, the credit union industry is consolidating, and
Revise Its Approach to
                              more industry assets are concentrated in larger credit unions, those with
Examination and               assets in excess of $100 million. For example, in December 1992, credit
Supervision                   unions with over $100 million in assets held 52 percent of total industry
                              assets, but by December 2002, they held 75 percent of total industry assets.
                              Furthermore, credit unions are providing more complex electronic services
                              such as Internet account access and on-line loan applications to meet the
                              demands of their members. Thirty-five percent of the industry offered
                              financial services through the Internet as of December 2002; however, the
                              rate increased to over 90 percent for larger credit unions. In addition, the
                              composition of credit union assets has changed over time, with credit

                              61
                                   Pub. L. No. 102-242 § 112, 12 U.S.C. § 1831m (2000).




                              Page 42                                            GAO-04-91 Changes in Credit Union Industry
unions engaging in more real estate loans (see fig. 11). For example, the
number of first mortgage loans about doubled from 589,000 loans as of
December 1992 to 1.2 million loans as of December 2002. During this same
period, the amount of first mortgage loans more than tripled from $29
billion to $101 billion. From 1992 to 2002, the percentage of real estate
loans to total assets grew from 19 percent to 26 percent, a greater rate of
growth than that of consumer loans over the same time period. The longer-
term real estate loans introduced a greater level of interest rate risk than
that introduced through the shorter-term consumer loans credit unions
traditionally made.62



Figure 11: Credit Union Mortgage Loans Have Grown Significantly Since 1992
Number of loans (in millions)                              Amount of loans held (dollars in billions)

1.2                                                                                              100



1.0
                                                                                                 80


0.8
                                                                                                 60

0.6

                                                                                                 40
0.4


                                                                                                 20
0.2



0.0                                                                                              0
      1992       1993       1994   1995    1996   1997   1998   1999     2000    2001     2002


                 Number of loans

                 Total dollar amount of loans
Source: Call report data.

Note: Only first mortgage loans represented.




62
   Interest rate risk is the risk that changes in market rates will have a negative impact on
capital and earnings. In September 2003, NCUA issued Letter to Credit Unions 03-CU-15,
which discusses the interest rate risk for credit unions with large concentrations of fixed-
rate mortgages.




Page 43                                                   GAO-04-91 Changes in Credit Union Industry
As a result of these changes, NCUA found that its old approach of
reviewing the entire operation of credit unions and conducting extensive
transaction testing no longer sufficed, particularly for larger credit unions,
because of the number of transactions in which they engaged and the
variety of products and services they tended to provide. In contrast, under
the risk-focused approach, NCUA examiners are expected to identify those
activities that pose the highest risk to a credit union and to concentrate
their efforts on those activities. For example, as credit unions engage in
more complex electronic services, examiners are to focus their efforts on
reviewing information systems and technology to ensure that credit unions
have sufficient controls in place to manage operations risk.63 In addition, as
credit unions engage in more real estate lending, examiners are to focus on
ensuring that these credit unions have sophisticated asset-liability
management models in place to properly manage interest rate risk.64 When
transaction testing is used under the risk-focused approach, it is used to
validate the effectiveness of internal control and other risk-management
systems. Further, the risk-focused approach places more emphasis on
preplanning and off-site monitoring of credit union activities, which helps
ensure that once examiners arrive on site, they already will have identified
those areas of the greatest risk in a credit union and where to focus their
resources.

To compliment the risk-focused approach and allow NCUA to better
allocate its resources, the agency adopted a risk-based examination
program in July 2001. This program eliminates the requirement to perform
annual examinations on low-risk credit unions, replacing annual exams
with two examinations in a 3-year period.65




63
 Operations risk is the risk that fraud or operational problems could result in an inability to
deliver products, remain competitive, or manage information.
64
   Asset-liability management is the process of evaluating balance sheet risk (interest rate
and liquidity risk) and making prudent decisions, which enable a credit union to remain
financially viable as economic conditions change.
65
 These credit unions are defined as those with a CAMEL rating of 1 or 2 for the prior two
examinations, and those exhibiting additional characteristics, such as having been in
operation for at least 10 years, having a positive return on assets, having adequate internal
controls, and having added no recent high-risk programs.




Page 44                                          GAO-04-91 Changes in Credit Union Industry
NCUA Took Various Steps       NCUA consulted with its Office of Corporate Credit Unions to inquire
to Ensure Successful          about their experiences with their risk-focused program that was
                              implemented in 1998. As a result of this consultation, NCUA incorporated a
Implementation of the Risk-   greater level of examiner judgment in its risk-focused approach,
focused Program               specifically allowing examiners to determine the appropriate level of on-
                              site versus off-site supervision. For example, if an examiner discovered a
                              problem during off-site monitoring of a credit union, the examiner might
                              adjust the schedule of the on-site examination to directly address the
                              problem. In addition, in recognition that examiners would be required to
                              assess the future risks that credit unions might be undertaking, NCUA,
                              after consulting with its Office of Corporate Credit Unions, required that
                              examiners review information beyond the financial statements. For
                              example, under the risk-focused program, examiners might analyze due
                              diligence reviews by management for new and existing products and
                              services, internal controls, and measurements of actual performance
                              against forecasted results, to determine what future risks a particular
                              credit union might be undertaking.

                              NCUA’s consultations with FDIC and its review of two FDIC Inspector
                              General reports prompted NCUA to develop programs to address
                              challenges that FDIC experienced in implementing its risk-focused
                              program. For example, according to NCUA, FDIC did not conduct much
                              training for its examiners prior to implementing its risk-focused program.
                              NCUA, on the other hand, held training for all examiners, including state
                              examiners, and once the risk-focused program was implemented, NCUA
                              also provided additional training to help examiners assess risks more
                              effectively. NCUA’s review of the FDIC Inspector General reports found
                              that some FDIC examiners resisted the move to the risk-focused program.
                              NCUA’s response was to develop a quality control program to ensure that
                              examiners and supervisors were adopting the risk-focused approach and
                              that documentation was completed consistently across NCUA’s regions.
                              Under the quality control program, NCUA officials reviewed a sample of
                              examinations from each region for scope, conciseness of reports,
                              appropriateness of completed work papers and application of risk-focused
                              concepts. NCUA’s development of the quality control program was timely
                              and appropriate, because we found some NCUA examiners and state
                              supervisors were reluctant to move to the risk-focused program. The
                              examiners and supervisors were concerned that they would be blamed if a
                              credit union later had a problem in an area they had not initially identified
                              as high-risk.




                              Page 45                                GAO-04-91 Changes in Credit Union Industry
NCUA’s consultations with the Office of the Comptroller of the Currency
(OCC) enabled NCUA to consider a different approach to improve its
oversight of large credit unions under the risk-focused program. OCC had
implemented a large bank program in recognition of the need for an
alternative approach to oversight of large and sophisticated banks. NCUA
likewise found the need for an alternative approach to oversight of large
credit unions because its examiners traditionally examined a large number
of small credit unions and very few larger ones and, thus, had been unable
to gain sufficient comfort and expertise in examining the larger, more
complex institutions. As a result of consultations with OCC, NCUA
implemented its Large Credit Union Pilot Program in January 2003 to,
among other things, develop a core of examiners with experience
overseeing these larger credit unions. Under this program, NCUA has also
experimented with different examination approaches, including targeted
examinations, which focus on certain aspects of credit union operations
such as the loans, investments, or asset-liability management. NCUA
officials told us that they received some preliminary feedback from credit
unions that found the pilot to be beneficial. However, because the pilot
ended recently, NCUA officials stressed that it was too early to tell how
effective this program will be in helping NCUA improve its examinations of
large credit unions.

In recognition that the risk-focused program was a significant departure
from NCUA’s old approach to examination and supervision, NCUA also
sought feedback from the industry on the risk-focused program by
developing a survey for credit unions to complete once they had gone
through their first risk-focused examination. NCUA reported that it had
received preliminary results from the survey that indicated that the risk-
focused program has been well received. Specifically, NCUA received the
highest marks for examiners’ courteous and professional conduct, effective
overall examination process, and effective communication with
management and officials throughout the examination. Officials from some
of the large credit unions we interviewed were pleased with the program
because they felt that the examination was focused on the high-risk areas
that credit union officials needed to monitor. Likewise, examiners with
whom we spoke told us that adopting a risk-focused approach had made a
bigger difference in their oversight activities at the larger credit unions
because they could focus their resources on the high-risk areas of these
institutions. In contrast, the examiners relied on the old approach of
extensive transaction testing at the smaller credit unions that lacked
sufficient resources to implement robust internal control structures and




Page 46                               GAO-04-91 Changes in Credit Union Industry
                               tended to limit their activities to the basic or traditional services offered by
                               credit unions.



NCUA Has Further               NCUA faces a number of challenges in implementing its risk-focused
Opportunities to Leverage      approach that create additional opportunities for it to leverage the
                               experiences of the other regulators that have been using risk-focused
the Experiences of Other       programs for several years. These challenges include ensuring that
Regulators to Address          examiners have sufficient training to keep pace with changes in industry
Existing Challenges            technologies and methods, adequately preparing for monitoring credit
                               unions as they expand more heavily into nontraditional credit union
                               activities such as business lending, and overseeing state-chartered
                               institutions in states that lack sufficient examiner resources and expertise.

NCUA Faces Challenges in       According to NCUA examiners who had recently implemented the risk-
Ensuring That Examiners Are    focused program, NCUA faces challenges in training its examiners in
Adequately Trained to Assess   specialized areas such as information systems and technology. Likewise, as
Changing Technology            we found in prior reviews, other depository institution regulators also
                               faced these challenges in implementing risk-focused programs.66 Some
                               NCUA examiners with whom we spoke indicated that NCUA’s formal and
                               on-the-job training of subject matter examiners, particularly in the areas of
                               information systems and technology, payment systems, and specialized
                               lending, was insufficient and did not help them keep pace with the
                               changing technology in the industry.67 As a result, some examiners were not
                               confident that they could assess the adequacy of information systems that
                               were vital to the operations of some credit unions.

                               NCUA officials sought to address concerns about specialist training by
                               modifying their training manual to more clearly state what classes were
                               appropriate for the different specialized areas. Further, as a member of the
                               Federal Financial Institutions Examination Council (FFIEC), NCUA was
                               aware of specialized training offered by other depository institution
                               regulators under the auspices of FFIEC, and encouraged NCUA examiners


                               66
                                  U.S. General Accounting Office, Risk-focused Bank Examinations: Regulators of Large
                               Banking Organizations Face Challenges, GAO/GGD-00-48 (Washington, D.C.: Jan. 24,
                               2000).
                               67
                                 NCUA’s subject matter examiner program was created in February 2002 to train
                               experienced and knowledgeable examiners in specialized areas, such as capital markets and
                               information systems, to help examiners assess risks more effectively. The program also was
                               designed to augment NCUA’s existing core of specialist examiners.




                               Page 47                                       GAO-04-91 Changes in Credit Union Industry
                                 to take advantage of this training.68 However, NCUA had not specifically
                                 consulted with other depository institution regulators on how these
                                 regulators addressed the challenge of training their specialists as banks and
                                 thrifts had become more complex over time.

NCUA Faces Challenge of          NCUA’s revised regulation on member business loans also presents NCUA
Ensuring That It Is Adequately   with the challenge of ensuring that it is adequately prepared to monitor this
Prepared to Monitor Credit       growing area of lending. A recent NCUA final rule on member business
Unions as They Expand into       loans relaxed certain requirements (allowing well-capitalized, federally
Nontraditional Activities        insured credit unions to offer unsecured business loans) and introduced a
                                 new risk area for NCUA to monitor.69 (Appendix VII provides a detailed
                                 description of changes to this and other NCUA rules and regulations since
                                 1992.)

                                 While member business loans are still a relatively small percentage of
                                 credit union loans (2 percent) and there are statutory limits placed on these
                                 loans, NCUA’s recently revised rules could result in credit unions making
                                 more of these loans.70 The Department of the Treasury has raised concerns
                                 that allowing credit unions to engage in unsecured member business loans




                                 68
                                  FFIEC is a formal interagency body empowered to prescribe uniform principles,
                                 standards, and report forms for the federal examination of financial institutions by the
                                 Board of Governors of the Federal Reserve System, the Federal Deposit Insurance
                                 Corporation, the National Credit Union Administration, the Office of the Comptroller of the
                                 Currency, and the Office of Thrift Supervision. FFIEC also serves to make recommendations
                                 to promote uniformity in the supervision of financial institutions.
                                 69
                                    See 68 Fed. Reg. 56537 (Oct. 1, 2003). Under NCUA’s prior regulations, all business loans to
                                 members had to be secured by collateral. Under the revised rule, NCUA now allows well-
                                 capitalized credit unions that have addressed unsecured loans in their member business
                                 loan policies to make unsecured business loans to members. These loans are subject to the
                                 limit that (1) the aggregate unsecured business loans to one borrower not exceed the lesser
                                 of $100,000 or 2.5 percent of a credit union’s net worth and (2) the aggregate of all unsecured
                                 business loans not exceed 10 percent of a credit union’s net worth. The revised rule also
                                 permits the exclusion of participation interests—credit union purchases of an interest in a
                                 loan originated by another credit union—in member business loans from the aggregate
                                 business loan limit, provided that the loan was for a nonmember of the purchasing credit
                                 union. However, the total of nonmember and member business loans may only exceed the
                                 aggregate business loan limit if approved by NCUA regional directors. Finally, the revised
                                 rule expands preapproved CUSO activities to include business loan originations.
                                 70
                                    Under CUMAA, credit unions had an aggregate business loan limit of the lesser of 1.75
                                 times the credit union’s net worth or 12.25 percent of the credit union’s total assets.




                                 Page 48                                          GAO-04-91 Changes in Credit Union Industry
                                     would increase risks to safety and soundness.71 Since member business
                                     loans constitute only a small percentage of credit union lending, most
                                     NCUA examiners will not have significant experience looking at this type
                                     of lending activity. In contrast, banks and thrifts offer these loans to a much
                                     greater extent than credit unions and their regulators do have experience in
                                     this area.

Variability in State Oversight May   Due to variability in levels of state oversight and resources, NCUA may face
Constrain NCUA’s Ability to          challenges in implementing the risk-focused program at the state level.
Monitor Risks to NCUSIF Posed        Lack of examiner resources and expertise in some states, high state
by Federally Insured, State-         examiner turnover, and weakness of enforcement by some state regulators
chartered Credit Unions              may affect oversight of federally insured, state-chartered credit unions,
                                     according to NCUA officials.

                                     While state officials with whom we met had adopted NCUA’s risk-focused
                                     program and indicated they were generally pleased with NCUA’s support,
                                     some of these officials indicated that they faced challenges related to
                                     oversight of their credit unions. For example, they indicated that budget
                                     problems had made it difficult to hire additional staff. In addition, some
                                     state officials indicated that they could not compete on pay with the
                                     industry, which led to high examiner turnover. A state official from a large
                                     state indicated that the increase in credit unions converting from federal to
                                     state charters had stretched her examiner resources.

                                     The challenges faced by states are of particular concern given that state
                                     supervisors have primary responsibility for examining federally insured,
                                     state-chartered credit unions, which as of December 31, 2002, held 46
                                     percent of industry assets. Inadequate oversight of these state-chartered
                                     institutions could have a negative impact on the financial condition of
                                     NCUSIF. The FDIC and Federal Reserve share oversight responsibility with
                                     state supervisors for state-chartered banks, and these regulators also face
                                     challenges similar to those faced by NCUA with regard to variability in
                                     state oversight.




                                     71
                                       Department of the Treasury comment letter concerning NCUA’s proposed rule on member
                                     business lending, dated June 2, 2003. Further, Treasury stated that excluding business
                                     participation loans and business loans originated by CUSOs from member business loan
                                     limits would undermine the intent of congressional limitations on credit union business
                                     loans established in CUMAA.




                                     Page 49                                      GAO-04-91 Changes in Credit Union Industry
                          In commenting on how it addressed some of the issues facing states, NCUA
                          officials told us that in cases where states lacked examiner resources or
                          expertise, NCUA provided its own staff to ensure that federally insured,
                          state-chartered credit unions were adequately examined. In addition,
                          NCUA conducted joint examinations with state supervisors on selected
                          federally insured, state-chartered credit unions to assess the risk they
                          posed to NCUSIF. Some state officials with whom we met raised concerns
                          over joint examinations, claiming that NCUA examiners tried to impose
                          federal regulations on these state-chartered credit unions. These state
                          officials also expressed concern over NCUA’s process for developing its
                          overhead transfer rate, which they claimed was not transparent.72 We
                          discuss the overhead transfer rate more fully later in this report.



NCUA Lacks Authority to   As we reported in July 1999, NCUA does not have the third-party oversight
Examine Third-party       authority provided to other federal banking regulators, and the lack of such
                          authority could limit NCUA’s effectiveness in ensuring the safety and
Vendors                   soundness of credit unions.73 Credit unions are increasingly relying on
                          third-party vendors to support technology-related functions such as
                          Internet banking, transaction processing, and funds transfers. While these
                          third-party arrangements can help credit unions manage costs, provide
                          expertise, and improve services to members, they also present risks such
                          as threats to security of systems, availability and integrity of systems, and
                          confidentiality of information. With greater reliance on third-party vendors,
                          credit unions subject themselves to operational and reputation risks if they
                          do not manage these vendors appropriately. Although NCUA received
                          authority to examine third-party vendors as part of the year 2000 readiness
                          effort, this authority was temporary and expired on December 31, 2001.

                          While NCUA has issued guidance regarding due diligence that credit unions
                          should be applying to third-party vendors, NCUA must ask for permission
                          to examine third-party vendors. Without vendor examination authority,
                          NCUA has no enforcement powers to ensure full and accurate disclosure.
                          For instance, in one case NCUA was denied access by a third-party vendor
                          that provides record-keeping services for 99 federally insured credit unions


                          72
                             The overhead transfer rate is the percentage of NCUA’s share insurance fund (NCUSIF)
                          that is transferred to support the agency’s expenses (operating fund).
                          73
                             U.S. General Accounting Office, Electronic Banking: Enhancing Oversight of Internet
                          Banking Activities, GAO/GGD-99-91 (Washington, D.C.: July 6, 1999).




                          Page 50                                       GAO-04-91 Changes in Credit Union Industry
                            with $1.4 billion in assets. NCUA notified the credit unions to heighten their
                            due diligence to ensure that appropriate controls were in place at the third-
                            party vendor. In another case, NCUA was given access to a third-party
                            vendor, but the vendor withheld financial statements from NCUA
                            examiners. The third-party vendor served 113 credit unions representing
                            almost $750 million in assets.



Credit Unions Not Subject   Credit unions with assets over $500 million are required to obtain an annual
to Internal Control         independent audit of financial statements by an independent certified
                            public accountant, but unlike banks and thrifts, these credit unions are not
Reporting Requirements of
                            required to report on the effectiveness of their internal controls for
FDICIA                      financial reporting. Under FDICIA and its implementing regulations, banks
                            and thrifts with assets over $500 million are required to prepare an annual
                            management report that contains

                            •	 a statement of management’s responsibility for preparing the
                               institution’s annual financial statements, for establishing and
                               maintaining an adequate internal control structure and procedures for
                               financial reporting, and for complying with designated laws and
                               regulations relating to safety and soundness; and

                            •	 management’s assessment of the effectiveness of the institution’s
                               internal control structure and procedures for financial reporting as of
                               the end of the fiscal year and the institution’s compliance with the
                               designated safety and soundness laws and regulations during the fiscal
                               year.74

                            Additionally, the institution’s independent accountants are required to
                            attest to management’s assertions concerning the effectiveness of the
                            institution’s internal control structure and procedures for financial
                            reporting. The institution’s management report and the accountant’s
                            attestation report must be filed with the institution’s primary federal
                            regulator and any appropriate state depository institution supervisor and
                            must be available for public inspection. These reports allow depository
                            institution regulators to gain increased assurance about the reliability of
                            financial reporting.




                            74
                                 See 12 U.S.C. § 1831m; 12 C.F.R. Part 363 (2003).




                            Page 51                                            GAO-04-91 Changes in Credit Union Industry
                            Banks reporting requirements under FDICIA are similar to the reporting
                            requirement included in the Sarbanes-Oxley Act of 2002. Under Sarbanes-
                            Oxley, public companies are required to establish and maintain adequate
                            internal control structures and procedures for financial reporting and the
                            company’s auditor is required to attest to, and report on, the assessment
                            made by company management on the effectiveness of internal controls.
                            As a result of FDICIA and Sarbanes-Oxley, reports on management’s
                            assessment of the effectiveness of internal controls over financial reporting
                            and the independent auditor’s attestation on management’s assessment
                            have become normal business practice for financial institutions and many
                            companies. Extension of the internal control reporting requirement to
                            credit unions with assets over $500 million could provide NCUA with an
                            additional tool to assess the reliability of internal controls over financial
                            reporting.



NCUA Implemented PCA as     In August 2000, NCUA initially implemented PCA for credit unions. CUMAA
Mandated by CUMAA, but      mandated that NCUA implement a PCA program in order to minimize
                            losses to NCUSIF. Under the program, credit unions and NCUA are to take
Few Actions Taken to Date
                            certain actions based on a credit union’s net worth.75 Other depository
                            institution regulators were required to implement PCA in December 1992.
                            PCA was intended to be an additional tool in NCUA’s arsenal and did not
                            preclude NCUA from taking administrative actions, such as cease and
                            desist orders, civil money penalties, conservatorship, or liquidation of
                            credit unions.

                            CUMAA requires credit unions to take up to four mandatory supervisory
                            actions—an earnings transfer, submission of an acceptable net worth
                            restoration plan, a restriction on asset growth, and a restriction on member
                            business lending—depending on their net worth ratios.76 Credit unions that
                            are adequately capitalized (net worth ratio from 6.0 to 6.99 percent) are




                            75
                              A credit union’s net worth represents the sum of the various reserve accounts—undivided
                            earnings, regular reserves, and any other appropriations designated by management or
                            regulatory authorities—and reflect the cumulative net retained earnings of the credit union
                            since its inception.
                            76
                                 The net worth ratio is defined as net worth divided by total assets.




                            Page 52                                             GAO-04-91 Changes in Credit Union Industry
required to take an earnings transfer.77 Credit unions that are
undercapitalized (net worth ratio from 4.0 to 5.99 percent), significantly
undercapitalized (net worth ratio from 2.0 to 3.99 percent), or critically
undercapitalized (net worth ratio of less than 2 percent) are required to
take all four mandatory supervisory actions.78

CUMAA also required NCUA to develop discretionary supervisory actions,
such as dismissing officers or directors of an undercapitalized credit union,
to complement the prescribed actions under the PCA program. CUMAA
also authorized NCUA to implement an alternative system for new credit
unions in recognition that these credit unions typically start off with zero
net worth and gradually build their net worth through retained earnings.79
Appendix IX provides more detail on NCUA’s implementation of PCA.

To date, NCUA has taken few actions against credit unions under the PCA
program due to a generally favorable economic climate for credit unions.
As of December 31, 2002, NCUA took mandatory supervisory actions
against 2.8 percent (276 of 9,688) of federally insured credit unions. Of
these credit unions, the vast majority—92 percent or 253—had under $50
million in assets. Further, 41 percent (113 of 276) of these credit unions
were required to develop net worth restoration plans. However, it is too
early to tell how effective these plans will be in improving the condition of
the credit unions or minimizing losses to NCUSIF.

Credit unions were similar to banks and thrifts with respect to PCA capital
categorization with 97.6 percent of credit unions considered well-
capitalized compared to 98.5 percent of banks and thrifts (see table 2).
However, a slightly higher percentage of credit unions were
undercapitalized, significantly undercapitalized, and critically
undercapitalized than banks and thrifts.

77
   Credit unions that are less than well-capitalized—that is, have less than a 7.0 percent net
worth ratio—are required to increase the dollar amount of their net worth quarterly by
transferring at least 0.1 percent of their total assets to the regular reserve account. These
credit unions must meet applicable risk-based net worth requirements if they are complex,
which under PCA is defined as a credit union having more than $10 million in assets and a
risk-based net worth ratio that exceeds 6.0 percent. The ratio is a calculation that assigns
risk weightings to different types of assets and investments.
78
   The net worth restoration plan is a blueprint for credit union officials and staff for
restoring the credit union’s net worth ratio to 6.0 percent or higher.
79
 Credit unions are defined as new if they have been in operation for less than 10 years and
have less than $10 million in assets.




Page 53                                           GAO-04-91 Changes in Credit Union Industry
Table 2: Federally Insured Credit Unions Were Similar to Banks and Thrifts with
Respect to Capital Categories, as of December 31, 2002

                                                 Credit                       Banks/
                                                unions                         thrifts
Capital categorya                            (number)b        Percent       (number)      Percent
Well-capitalized                                   9,363          97.6          9,210         98.5
Adequately capitalized                               153           1.6            134           1.4
Undercapitalized                                      61           0.6               6          0.1
Significantly undercapitalized                        10           0.1               2          0.0
Critically undercapitalized                           10           0.1               2          0.0
Total                                              9,597        100.0           9,354        100.0
Sources: NCUA and FDIC.

Note: Does not include new credit unions.
a
 Although the categories triggering PCA actions are the same for both the bank regulators and NCUA,
the capital requirements underlying these categories are different.
b
Numbers reported by NCUA as of May 2003.


Some NCUA, state, and industry officials claimed that PCA was beneficial
because it provided standard criteria for taking supervisory actions and
was a good way to restrain rapid growth of assets relative to capital.
However, many state officials expressed concern over PCA due to the
limited ability of credit unions to increase their net worth quickly, because
they can only do so through retained earnings. They indicated that if a
credit union were subject to PCA, it would be difficult for that credit union,
particularly a smaller one, to increase capital and graduate out of PCA. In
contrast, other financial institutions are able to raise capital more quickly
through the sale of stock.

Some of these state officials raised the issue of whether credit unions
should likewise have a means to raise capital quickly by allowing credit
unions to use secondary capital toward their capital requirement under
PCA.80 Texas allowed its state-chartered credit unions to raise secondary
capital even though the secondary capital could not count towards PCA.81


80
  Secondary capital can take the form of investments in an institution by nonmembers. The
investments are subordinated to all other credit union debt. Currently, only credit unions
designated as “low-income” by NCUA are eligible to raise secondary capital.
81
   This secondary capital must be in accordance with generally accepted accounting
principles.




Page 54                                            GAO-04-91 Changes in Credit Union Industry
According to the Texas credit union regulator, no credit unions had taken
advantage of the state’s secondary capital provision. Currently there is a
debate in the industry on whether secondary capital is appropriate for
credit unions. While some in the industry favor secondary capital as a way
to help credit union avoid actions under PCA, others have raised the
concern that allowing credit unions to raise secondary capital (for
example, in the form of nonmember deposits) could change the structure
and character of credit unions by changing the mutual ownership. As of
September 2003, NCUA had not taken a position on secondary capital.

Another concern raised by NCUA officials is in regard to the most
appropriate measure of the net worth ratio for PCA purposes. NCUA
officials have suggested using risk-based assets, rather than total assets, to
calculate the net worth ratio of credit unions because they believe risk-
based assets more clearly reflect the risks inherent in credit unions’
portfolios. NCUA officials recognize that, similar to banks, a minimum net
worth ratio based on total assets (tangible equity for banks and thrifts)
would still be needed for those institutions that are critically
undercapitalized. For most credit unions, risk-based assets are less than
total assets; therefore, a given amount of capital would have a higher net
worth ratio if risk-based assets were used. While there may be some merit
in using risk-based assets, credit unions have been subject to PCA
programs for a short time, and the advantages and disadvantages of the
current programs are not yet evident.

Finally, some NCUA officials raised the concern that PCA has led to more
liquidations of problem credit unions. In the past, NCUA sought merger
partners for problem credit unions. However, NCUA officials told us that it
was more difficult to find merger partners because stronger credit unions
were concerned that their net worth ratio would be lowered by merging
with problem credit unions, thereby putting them closer to the 7.0 percent
net worth ratio that triggers PCA. As a result, the cost of mergers has
increased under PCA because NCUA would have to provide greater
incentives to a potential partner, and that has forced the agency to liquidate
credit unions to a greater extent than prior to PCA. While the initial costs of
liquidations appear to be high, the purpose of PCA is to reduce the
likelihood of regulatory forbearance and protect the federal deposit (share)




Page 55                                 GAO-04-91 Changes in Credit Union Industry
                             insurance funds through early resolution of problem institutions; thus, in
                             the long run, the overall costs to NCUSIF should be less because of PCA.82



NCUSIF’s Financial           NCUSIF appears to be in satisfactory financial condition. For most of the
                             past 10 years, NCUSIF’s financial condition has been stable as indicated by
Condition Appears            the fund’s equity ratio, earnings, and net income. However, while remaining
Satisfactory, but            positive as of December 31, 2002, NCUSIF’s net income declined in 2001
                             and 2002. Among the factors contributing to the decline was a drop in
Methodologies for            investment revenues, a sharp increase in the overhead transfer rate, which
Overhead Transfer            is the amount paid to NCUA’s Operating Fund for administrative expenses,
Rate, Insurance              and an increase in losses to the insurance fund. Moreover, NCUA’s methods
                             for pricing NCUSIF insurance and for estimating losses to the fund did not
Pricing, and Estimated       consider important factors such as current credit union risk. NCUA’s flat-
Loss Reserve Need            rate insurance pricing does not allow for the fact that some credit unions
Improvement                  are at greater risk of failure than others, and the historical analysis NCUA
                             uses for determining estimated losses does not reflect current economic
                             conditions or consider the loss exposure of credit unions with varying risk.
                             As a result of the current weaknesses in the methodologies used by NCUA,
                             information reported on the financial condition of the fund may not
                             accurately reflect the current risks to the fund.



NCUSIF Has Met Statutory     Indicators of the financial condition and performance of NCUSIF have
Fund Equity Ratio            generally been stable over the past decade. NCUSIF’s fund equity ratio—a
                             measure of the fund’s equity available to cover losses on insured deposits—
Requirements, but Concerns
                             was within statutory requirements at December 31, 2002, as it has been
Exist over Transfers of      over the past decade.83
Expenses to the Fund
                             CUMAA defines the “normal operating level” for the fund’s equity ratio as a
                             range from 1.20 percent to 1.50 percent. CUMAA has designated the NCUA
                             board to evaluate and set the specific operating level for the fund equity
                             ratio. In setting the level, the board considers current industry and fund
                             conditions, as well as the future economic outlook. For 2002, NCUA’s board


                             82
                                Regulatory forbearance occurs when regulators delay taking corrective action, assuming
                             that problems will not occur in the short-term, or that economic conditions may change in a
                             way favorable to the troubled institution.
                             83
                              The ratio is calculated as the fund balance (assets minus liabilities) of NCUSIF divided by
                             the sum of all credit union members’ shares insured by the fund.




                             Page 56                                        GAO-04-91 Changes in Credit Union Industry
set the specific operating level at 1.30 percent. If the equity ratio exceeds
the board’s determined operating level, CUMAA requires NCUA to
distribute to contributing credit unions an amount sufficient to reduce the
equity ratio to the operating level. Also, should the equity ratio fall below
the minimum rate of 1.20 percent, under CUMAA, NCUA’s board must
assess a premium until the equity ratio is restored to and can be maintained
at 1.20 percent. (See appendix X for a more detailed discussion of the
funding process and accounting for NCUSIF.)

Between 1991 and 2002, the equity ratio has fluctuated between 1.23
percent and 1.30 percent, a rate that has remained in line with legal
requirements (see fig. 12). As of December 31, 2002, the ratio of fund equity
to insured shares for NCUSIF as reported by NCUA was 1.27 percent.



Figure 12: NCUSIF’s Equity Ratio, 1991–2002
Equity ratio

1.30



1.28



1.26



1.24



1.22



1.20



1.18
       1991     1992   1993    1994   1995   1996   1997   1998   1999   2000   2001   2002

                Statutory minimum
Source: NCUA.



NCUSIF’s ratio can be usefully compared with the only other share or
deposit insurance funds in the United States currently—FDIC’s Bank
Insurance Fund (BIF), which insures banks, and its Savings Association
Insurance Fund (SAIF), which insures thrifts; and ASI, which insures state-
chartered credit unions that are not federally insured. The NCUSIF ratio


Page 57                                             GAO-04-91 Changes in Credit Union Industry
was comparable with the other share and deposit insurance funds as of
December 31, 2002 (see fig. 13).



Figure 13: Equity to Insured Shares or Deposits of the Various Insurance Funds
Percentage equity to insured shares or deposits

1.5

                                1.37
                                       1.31
       1.27        1.27


1.0




0.5




0.0
      NCUSIF       BIF          SAIF   ASI
Sources: NCUA, FDIC, and ASI.



NCUSIF’s earnings—principally derived from its investment portfolio,
which has increased significantly since 1991—have been sufficient to

• cover operating expenses and losses from insured credit union failures;

•	 make additions to its equity with the net income that is retained by the
   fund;

• maintain its equity in accordance with legal requirements;

• maintain its allowance for anticipated losses on insured deposits;

• avoid assessing premiums, except for 1991 and 1992; and

• make, in some years, distributions to insured credit unions.

NCUSIF’s net income has remained positive through 2002 and had
generally been increasing since 1993, until significant declines occurred in
2001 and 2002 (see fig. 14). The declines were due to a combination of



Page 58                                           GAO-04-91 Changes in Credit Union Industry
decreased yields from the investment portfolio, an increase in the overhead
transfer rate, and larger insurance losses on failed credit unions. The
investment portfolio of NCUSIF consists entirely of U.S. Treasury
securities. Yields on these securities have declined—for example, from 6.07
percent in 2000 to 5.10 percent in 2001 and to 3.18 percent in 2002 on its 1-
to 5-year maturities—following similar general declines in market yields for
Treasury securities. Of the $40.2 million net income decline between 2000
and 2001, $22.2 million of the decline was attributable to increases in the
overhead transfer rate, and $15.3 million was attributable to declines in
investment income. Of the $47.5 million decline in net income between
2001 and 2002, $39.6 million was attributable to declines in investment
income, while $12.5 million was attributable to provision for insurance
losses. At the same time, operating expenses decreased by $5.1 million. For
2003, interest rates have continued to decline, which will likely continue to
negatively affect investment earnings.



Figure 14: Net Income of NCUSIF, 1990–2002
Dollars in thousands

250,000




200,000




150,000




100,000




 50,000




      0
          1990   1991   1992   1993   1994   1995   1996   1997   1998   1999   2000   2001   2002
Source: NCUA.



The sharp increase in the overhead transfer rate and its negative impact on
NCUSIF’s net income have raised questions about NCUA’s process for
determining the transfer rate. The Federal Credit Union Act of 1934 created
the Operating Fund for the purpose of providing administration and service



Page 59                                             GAO-04-91 Changes in Credit Union Industry
to the credit union system—for example, the supervision and regulation of
the federally chartered credit unions.

NCUA’s Operating Fund is financed through assessment of annual fees to
federally chartered credit unions as well as the overhead transfer from
NCUSIF (see fig. 15). Federally chartered credit unions are assessed an
annual fee by the Operating Fund based on the credit union’s asset size as
of the prior December 31. The fee is designed to cover the costs of
providing administration and service, as well as regulatory examinations to
the Federal Credit Union System. NCUA’s board reviews the fee structure
annually. The overhead transfer from NCUSIF for administrative services
provides a substantial portion of funding for the Operating Fund. The
annual rate for the overhead transfer is set by NCUA’s board based on
periodic surveys of NCUA staff time spent on insurance-related activities
compared with noninsurance-related, or regulatory, activities. An amount
of overhead or administrative expense is transferred to NCUSIF in
proportion to staff time spent on insurance-related activities. The overhead
transfer is intended to account for NCUA staff being responsible for both
insurance and supervisory-related activities.



Figure 15: Financing Sources of NCUSIF and NCUA’s Operating Fund


                 State-chartered,                                  Federally
                federally insured                                  chartered
                  credit unions                                  credit unions




   Deposit of 1%                                                        Annual
   of insured shares                                                    operating
   (premium, if needed)                                                 fee assessed



                                    Overhead transfer rate         NCUA
                    NCUSIF                                        Operating
                                                                    Fund



Source: NCUA.


Between 1986 and 2000, the transfer rate was 50 percent, which, according
to NCUA management, was based on surveys that indicated staff time was
equally split between insurance and regulatory activities. For example, 50



Page 60                                       GAO-04-91 Changes in Credit Union Industry
percent of the Operating Fund’s $127.6 million, or $63.8 million, in expenses
for 2000 were allocated to and paid by NCUSIF. For 2001, NCUA’s Board of
Directors increased the overhead transfer rate to 67 percent on the basis
that Operating Fund staff had increased their insurance-related activities.
This resulted in a $24.7 million increase (almost 40 percent) from 2000 in
the amount being allocated to NCUSIF. For 2002 and 2003, the NCUA board
lowered the 67-percent overhead transfer rate to 62 percent by adjusting
downward its allocation of what it considered “nonproductive” time factors
such as employee administrative and education time used in the 2001
survey because it was reflective of regulatory rather than insurance-related
activities.

In September 2001, NCUA management engaged its financial audit firm,
Deloitte & Touche, to review the basis on which the transfer rate was
determined. The auditor’s report contained several recommendations that
indicated that NCUA’s 2001 survey of staff time spent on insurance-related
functions—the primary basis on which NCUA allocates administrative
expenses—may not have resulted in an accurate allocation. The lack of a
clear separation of the insurance and supervisory functions had also been
the focus of a recommendation in our 1991 report (still unimplemented)
that NCUA should establish separate supervision and insurance offices.84
The 2001 recommendations from NCUA’s financial audit firm included
improvements in communication with staff on the survey process and
results, frequency and timing of the survey, methods of survey distribution,
and updated documentation of survey definitions and purpose. The
auditors also noted that individuals were allocating time after the fact,
when recollection may have been faulty, rather than tracking their time
concurrently as would be possible if provided the survey and guidelines
prior to an assignment. Additionally, the auditors reported that, to provide
reliable results, the survey should cover a greater period of time. The
limited period used could significantly skew the resulting proportion of
activities devoted to insurance versus regulatory activities. The auditor’s
recommendations indicated that the survey’s lack of consistency and
reliability may have resulted in a misallocation of overhead expenses
between the operating and insurance funds. Any misallocation would affect
NCUSIF’s financial condition because any increase in the overhead transfer
rate results in a decrease of NCUSIF’s net income. Misallocations also can
significantly affect the financial results of the Operating Fund. In addition
to the auditor’s findings, some federally insured, state-chartered credit


84
     GAO/GGD-91-85, p. 197.




Page 61                                GAO-04-91 Changes in Credit Union Industry
                           unions and trade groups have expressed concerns about NCUA’s
                           calculation of its overhead transfer rate. Primarily, they say that NCUA has
                           not clearly defined insurance and regulatory functions, and its
                           methodology for determining the overhead transfer rate is not transparent
                           or understandable to participating credit unions.

                           According to NCUA’s management, NCUA has begun implementing
                           Deloitte & Touche’s recommendations. For example, selected field
                           examiners are now completing surveys in a timely manner for periods
                           covering a full year. However, headquarters staff are not required to
                           complete the surveys as management asserts the split of their time mirrors
                           that of field examiners. In addition, the transfer rate is calculated and
                           approved by management every few years. However conditions can change
                           that may result in the transfer rate not representing the current condition.
                           Changing workloads and conditions can also cause a significant change in
                           future rates.



Federal Credit Union       The Federal Credit Union Act requires all federally insured credit unions to
Insurance Pricing Is Not   allocate 1 percent of their insured shares to NCUSIF. This flat rate does not
                           take into consideration variations in risk posed by individual credit unions.
Based on Risk to Insurer
                           Although FDIC had implemented a version of risk-based pricing in 1993,
                           FDIC has continued to study options for improving deposit insurance
                           funding. FDIC’s suggestions for improvement were issued in a 2001 report
                           that noted the cost of insurance, regardless of type (property, casualty, or
                           life), in the private sector is priced based upon the risk assumed by the
                           insurer.85 Premiums and loss experience are generally actuarially
                           determined, such that increased risk equates to increased cost. Since
                           passage of FDICIA in 1991, deposit insurance for banks and thrifts are
                           adjusted for some risk, and since December 31, 2000, private-sector
                           insurance for credit union shares has been adjusted for risk. (See
                           appendix X for additional information on accounting for insurance.) While
                           BIF and SAIF are adjusted for some risk, FDIC has made additional
                           proposals for enhancing the risk-based nature of its insurance pricing. For
                           instance, the current BIF and SAIF funding does not require a fast-growing
                           institution to pay premiums if it is well capitalized and CAMEL-rated 1 or 2.
                           As a result, FDIC has proposed that the pricing structure for BIF and SAIF



                           85
                              Federal Deposit Insurance Corporation, Keeping the Promise: Recommendations for
                           Deposit Insurance Reform (Washington, D.C.: April 2001).




                           Page 62                                     GAO-04-91 Changes in Credit Union Industry
                             be amended so that fast-growing institutions would be required to pay
                             premiums.

                             NCUSIF is the only share or deposit insurer that has not adopted a risk-
                             based insurance structure. Therefore, some credit unions could be
                             overpaying while others could be underpaying if their current rates were
                             compared to their risk profiles—with the cost of insurance not being
                             equitable based on the level of risk posed to NCUSIF by individual credit
                             unions. In contrast, FDIC’s BIF and SAIF and ASI currently operate on a
                             risk-based capitalization structure. Depository institutions insured by BIF
                             and SAIF pay a premium twice a year based upon their capital levels and
                             supervisory ratings, with institutions with the lowest capital levels and
                             worst supervisory ratings paying higher premiums. ASI’s insurance fund
                             requires its insured credit unions to maintain deposits between 1.0 and 1.3
                             percent of their insured shares. The amount for each credit union is
                             determined based upon its supervisory rating, with lower-rated credit
                             unions maintaining higher deposits.

                             The risk-based structure has certain advantages. First, by varying pricing
                             according to risk, more of the burden is distributed to those members that
                             put an insurance fund at greater risk of loss. Second, risk-based pricing
                             provides an incentive for member owners and managers of credit unions to
                             control their risk. Finally, risk-based pricing helps regulators focus on
                             higher-risk credit unions by enabling them to allocate their insurance
                             activities in proportion to the price charged. During our review, members
                             of NCUA’s management told us that they believe that risk-based pricing
                             would adversely affect small credit unions and suggested that an option
                             would be to add risk-based pricing only for credit unions over a certain
                             size. By not having risk-based insurance structure, NCUSIF puts a
                             disproportionate share of the pricing burden on less-risky credit unions and
                             does not provide an incentive through pricing for owners and managers to
                             control their risk.



Management’s Estimation of   NCUA’s process for determining estimated losses from insured credit
Insured Share Losses Does    unions—the largest potential liability of the fund—does not reflect current
                             economic conditions and loss exposures of credit unions with varying risk.
Not Reflect Specific Loss
                             The estimated liability balance is established to cover probable and
Rates                        estimable losses as a result of federally insured credit union failures. The
                             estimated liability balance is reduced when the insurance claims are
                             actually paid. NCUSIF’s estimated liability for losses was $48 million at
                             December 31, 2002.



                             Page 63                                GAO-04-91 Changes in Credit Union Industry
In 2002, NCUA’s management analyzed historical loss trends over varying
periods of time in order to assess whether the estimated liability for losses
was adequate. It analyzed historical rates of insurance payouts for the past
3-year, 5-year, 10-year, and 15-year averages. The 15-year analysis
encompassed an economic period of dramatic losses, which management
contends may be cyclical and indicative of future exposure, although not
necessarily indicative of current economic conditions. As a result of this
analysis, in July 2002, management began building the estimated losses
account balance by $1.5 million a month to $60 million (from $48 million at
December 31, 2002), the amount the analysis determined would be needed
to cover identified and anticipated losses.

NCUA’s estimation method does not identify specific historical failure rates
and related loss rates for the group of credit unions that had been identified
as troubled, but instead specifically calculates expected losses for each
problem credit union, if it is determined that a particular credit union is
likely to fail. This methodology essentially assigns a probability of failure of
either zero or 100 percent to each individual credit union considered to be
troubled. By not considering specific historical failure rates and loss rates
in its methodology, NCUA is using an over-simplified estimation method. As
a result, NCUA may not be achieving the best estimate of probable losses.
Therefore, NCUA may be over or underestimating its probable losses
because it does not apply more targeted and specific loss rates to currently
identified problem institutions, but instead, makes a determination that
essentially selects from two probabilities: zero or 100-percent probability
of failure.

From 2000 to 2002, the amount of insured shares in problem credit unions
doubled, going from $1.5 billion insured shares in 2000 to nearly $3 billion
insured shares in 2002. The increase in insured shares of problem credit
unions may be an indicator of larger future losses to the fund, since
problem credit unions are more likely to fail. In addition, recent increases
the share payouts show that the insurance fund is suffering from increasing
losses that totaled $40 million in 2002. At the same time, the estimated loss
reserve, which is intended to cover actual losses, has been declining since
1994. As a result the cushion between payouts for insurance losses and the
reserve balance became increasingly smaller between 2001 and 2002 (see
fig. 16). Given the recent trends, it is especially important to utilize specific
data on failure rates for troubled institutions.




Page 64                                  GAO-04-91 Changes in Credit Union Industry
Figure 16: Share Payouts and Reserve Balance,1990–2002
Dollars in millions

0.15




0.12




0.09




0.06




0.03




0.00
       1990       1991       1992   1993   1994   1995   1996   1997   1998   1999   2000   2001   2002


                  Share payouts

                  Reserves
Sources: Call report data.



In contrast to NCUA’s method, FDIC’s method records estimated bank and
thrift insurance losses based on a detailed analysis of institutions in five
risk-based groups. The first group consists of institutions classified as
having a 100-percent expected failure rate. This determination is based on
the scheduled closing date for the institution, the classification of the
institution as “critically undercapitalized,” or identification of the
institution as an imminent failure. The remaining four risk groups are based
on federal and state supervisory ratings and the institutions’ projected
capitalization levels. Every quarter, FDIC meets with representatives from
other federal financial regulatory agencies to discuss these groupings and
ensure that each institution is appropriately grouped based on the most
recent supervisory information. Also on a quarterly basis, FDIC’s Financial
Risk Committee (FRC), an interdivisional committee, meets to discuss and
determine the appropriate projected failure rates to be applied to each of




Page 65                                                   GAO-04-91 Changes in Credit Union Industry
                       the four remaining risk-based groups.86 The projected failure rate for each
                       risk-based group is multiplied by the assets of each institution in that
                       group, which results in expected failed assets. Expected failed assets are
                       then multiplied by an expected loss experience rate, the product of which
                       results in the loss estimate for anticipated failures. The projected failure
                       rates for the remaining four risk-based groups are based on historical
                       failure rates for those categories. However, FRC has the responsibility for
                       determining if the historical failure rates for each group are appropriate
                       given the current and expected condition of the industry and may adjust
                       failure rates, if necessary. The expected loss experience rates have been
                       based on asset size and reflect FDIC’s historical loss experience for banks
                       of different sizes. FRC may also use loss rates based on institution-specific
                       supervisory information rather than the historical rates. This process, as
                       implemented by FDIC, results in a more targeted estimation process that
                       specifically captures current changes in the risk profile of insured
                       institutions.



System Risk That May   The amount of insured shares and the number of privately insured credit
                       unions and providers of private primary share insurance have declined
Be Associated with     significantly since 1990. Specifically, 1,462 credit unions purchased private
Private Share          share insurance in 1990 compared with 212 credit unions as of December
                       2002. During the same period, the total amount of privately insured shares
Insurance Appears to   decreased by 42 percent ($18.6 billion to about $10.8 billion). Although the
Have Decreased, but    use of private share insurance has declined, some circumstances of the
Some Concerns          remaining private insurer, ASI, raise concerns. First, ASI’s risks are
                       concentrated in a few large credit unions and in certain states. Second, ASI
Remain                 has a limited ability to absorb catastrophic losses because it does not have
                       the backing of any governmental entity and its lines of credit are limited in
                       the aggregate as to the amount and available collateral. To mitigate its
                       risks, ASI has implemented a number of risk-management strategies, such
                       as increased monitoring of its largest credit unions. State oversight
                       mechanisms of the remaining private share insurer and privately insured
                       credit unions also provide some additional assurance that ASI and the


                       86
                        The Financial Risk Committee consists of representatives from four divisions within FDIC:
                       Insurance and Research, Resolutions and Receiverships, Supervision and Consumer
                       Protection, and Finance. FDIC maintains statistics on the percentage of institutions within
                       different risk categories that fail based on the ratio of failed institutions’ assets to total
                       assets. For purposes of this report the term “failure rate” is used to describe this statistic. A
                       100-percent projected failure rate is always applied to the first risk-based group.




                       Page 66                                           GAO-04-91 Changes in Credit Union Industry
                        credit unions it insures operate in a safe and sound manner. One additional
                        concern, as we recently reported, is that many privately insured credit
                        unions failed to make required disclosures about not being federally
                        insured and, therefore, the members of these credit unions may not have
                        been adequately informed that their deposits lacked federal deposit
                        insurance.



Few Credit Unions Are   Compared with federally insured credit unions, relatively few credit unions
Privately Insured       are privately insured. As of December 2002, 212 credit unions—about 2
                        percent of all credit unions—chose to purchase private primary share
                        insurance.87 These privately insured credit unions were located in eight
                        states and had about 1.1 million members with shares totaling about $10.8
                        billion, as of December 2002—a little over 1 percent of all credit union
                        members and 2 percent of all credit union shares. In contrast, as of
                        December 2002, there were 9,688 federally insured credit unions with about
                        81 million members and shares totaling $483 billion.

                        Through a survey of 50 state regulators and related follow-on discussions
                        with the regulators, we identified nine additional states that could permit
                        credit unions to purchase private share insurance.88 Figure 17 illustrates
                        the states that permit or could permit private share insurance as of March
                        2003 and the number of privately insured credit unions as of December
                        2002.




                        87
                          Our review focuses on primary share insurance. Generally, primary share (or deposit)
                        insurance is mandatory for all depository institutions and covers members’ deposits up to a
                        specified amount. Excess share (deposit) insurance is optional coverage above the amount
                        provided by primary share insurance. NCUSIF provides primary share insurance up to
                        $100,000 per member; while ASI provides primary share insurance up to $250,000 per
                        account and excess share insurance. ASI is chartered by Ohio statute. ASI’s coverage is
                        subject to a $250,000 statutory cap under Ohio law. Ohio Rev. Code Ann. § 1761.09(A),
                        (Anderson, 2003).
                        88
                           States that “could permit” private share insurance include those with state laws permitting
                        credit unions to purchase private share insurance, but that have no credit unions in the state
                        that currently carry private share insurance.




                        Page 67                                         GAO-04-91 Changes in Credit Union Industry
Figure 17: States Permitting Private Share Insurance (March 2003) and Number of Privately Insured Credit Unions (December
2002)

  Number of credit unions that
  purchase private share insurance

  100                                                                       93


   80


   60


                                                                      40
   40

                                   20         21          22
   20
                             8
          3         5

    0
        ma




                            a

                                  ho


                                              a

                                                        a

                                                                  is

                                                                            io
                  d

                             d




                                         ian


                                                       rni

                                                                no
               an




                                                                           Oh
                          va

                                 Ida
     ba




                                                   lifo
                                        Ind
              ryl




                                                               Illi
                        Ne
    Ala

             Ma




                                                  Ca




                                                                                       States that permit private share insurance but do not have privately insured credit unions

                                                                                       States that have credit unions that purchase private share insurance


Sources: GAO and state regulators.



                                                                                 The number of privately insured credit unions and private share insurers
                                                                                 has declined significantly since 1990. In 1990, 1,462 credit unions in 23
                                                                                 states purchased private share insurance from 10 different nonfederal,
                                                                                 private insurers, with shares at these credit unions totaling $18.6 billion.
                                                                                 Between 1990 and 2002, the amount of privately insured shares decreased
                                                                                 42 percent to about $10.8 billion. Shortly after the failure of Rhode Island
                                                                                 Share and Depositors Indemnity Corporation (RISDIC), a private share
                                                                                 insurer in Rhode Island in 1991, almost half of all privately insured credit
                                                                                 unions converted to federal share insurance voluntarily or by state




                                                                                 Page 68                                                  GAO-04-91 Changes in Credit Union Industry
mandate.89 As a result of the conversions from private to federal share
insurance, most private share insurers have gone out of business due to the
loss of their membership since 1990; only one company, ASI, currently
offers private primary share insurance.90

In states that currently permit private share insurance, a comparable
number of credit unions have converted from federal to private share
insurance and from private to federal share insurance since 1990—31 and
26, respectively. Most of the conversions from federal to private share
insurance (26 of 31) occurred since 1997. According to management at
many privately insured credit unions, they converted to private share
insurance to obtain higher coverage and avoid federal rules and regulation.
Additionally, management at these credit unions noted that they were
satisfied with the service they received from the private share insurer and
all but one planned to remain privately insured. According to NCUA—in
states that currently permit private share insurance—since 1990, 26 credit
unions converted from private to federal share insurance; the majority did
so in the early 1990s, following the RISDIC failure and widespread concern
over the safety and soundness of private share insurance.91 Most of the 26
credit unions planned to continue to purchase federal share insurance


89
  Several factors precipitated the closure of RISDIC in 1991. For example, weaknesses
existed in the Rhode Island bank regulator’s and RISDIC’s oversight of institutions.
Furthermore, some of the institutions insured by RISDIC engaged in high-risk activities. In
1991, RISDIC depleted its reserves because of the failure of one institution. As a result, runs
occurred at several other institutions insured by RISDIC; it was not able to meet its
insurance obligations and was forced to call in a conservator. The Governor of Rhode Island
closed all institutions insured by RISDIC and required institutions to purchase federal
deposit insurance. According to NCUA, it did not insure all Rhode Island credit unions
following the Governor’s closure of institutions insured by RISDIC.
90
   As of December 2002, we identified two companies that provided private primary share
insurance in the 50 states and the District of Columbia—ASI and Credit Union Insurance
Corporation (CUIC) in Maryland. However, CUIC was in the process of dissolution and,
therefore, we did not include it in our analysis. As of August 2003, of the five credit unions
that CUIC insured, four purchased private share insurance from ASI, and one converted to
federal share insurance.
91
  Generally, credit unions that converted from federal to private share insurance since 1990
were larger than credit unions that switched from private to federal share insurance during
the same period. Specifically, as of December 2002, about a third of the credit unions that
converted to private insurance had shares between $100 and $500 million; on the other
hand, the majority of credit unions that converted to federal insurance had shares totaling
up to $50 million. Only two of the 26 conversions occurred since 1995—one because the
private insurer went out of business and the other because of a merger with a federally
insured credit union.




Page 69                                          GAO-04-91 Changes in Credit Union Industry
                                either because they were reasonably satisfied or because they viewed
                                having their share insurance backed by the federal government as a benefit.



Risks Exist at Remaining        Although the use of private share insurance has declined, we found two
Private Share Insurer, but      aspects of the remaining private insurer that raise potential safety and
                                soundness concerns. First, ASI faces a concentration of risk in a few large
Certain Factors Help to         credit unions and certain states. Second, ASI has limited borrowing
Mitigate Concerns               capacity and could find it difficult to cover catastrophic losses under
                                extreme economic conditions because it does not have the backing of any
                                governmental agency, its lines of credit are limited in the aggregate as to
                                the amount and available collateral, and it has no reinsurance for its
                                primary share insurance. To help mitigate these risks, ASI has taken steps
                                to increase its monitoring of its largest credit unions and is using other
                                strategies to limit its risks. In addition, as a regulated entity, state regulation
                                of ASI and the credit unions it insures provides some additional assurance
                                that ASI and the credit unions operate in a safe and sound manner.

Risks of Remaining Private      ASI is chartered in Ohio statute as a credit union share guaranty
Insurer Concentrated in a Few   corporation.92 As specified in Ohio statute, the purpose of such a
Credit Unions and States        corporation includes guaranteeing payment of all or a part of a
                                participating credit union share account.93 Although ASI is commonly
                                referred to as a provider of insurance, it is not subject to all of Ohio’s
                                insurance laws.94 For example, ASI is not subject to Ohio’s insurance law
                                that limits the risk exposure of an insurance company. Specifically, while
                                Ohio insurance companies are subject to a “maximum single risk”
                                requirement—“no insured institution’s coverage should comprise more
                                than 20 percent of the admitted assets, or three times the average risk or 1


                                92
                                     Ohio Rev. Code Ann. Oh. 1761.
                                93
                                  Ohio Rev. Code Ann. § 1761.03. Under Ohio law, other purposes of a credit union share
                                guaranty corporation are to (1) aid and assist any participating credit union that is in
                                liquidation or incurs financial difficulty in order that the credit union share accounts are
                                protected or guaranteed against losses, and (2) cooperate with participating credit unions,
                                the superintendent of credit unions, the appropriate credit union supervisory authorities,
                                and the NCUA for the purpose of advancing the general welfare of credit unions in Ohio and
                                in other states where participating credit unions operate.
                                94
                                  In Ohio, credit union guaranty corporations are subject to many Ohio insurance laws;
                                however, they apply only to the extent that such laws are otherwise applicable and are not
                                in conflict with Ohio laws for credit union guaranty corporations. See Ohio Rev. Code Ann.
                                1761.04(A).




                                Page 70                                        GAO-04-91 Changes in Credit Union Industry
percent of insured shares, whichever is greater”—Ohio has not imposed
this requirement on ASI.95 Although ASI is not subject to this requirement,
we found that ASI exceeded this concentration limit. For example, one
credit union made up about 25 percent of ASI’s total insured shares, as of
December 2002. In contrast, the largest federally insured credit union
accounted for only 3 percent of NCUSIF’s total insured shares. Other
concentration risks exist; for example, we found that 45 percent of ASI’s
total insured shares were located in one state (California). Further, all of
ASI’s insured credit unions were located in only eight states, with almost
half being located in one state (Ohio), which represents 14 percent of all
ASI-insured shares. In contrast, 14.3 percent of federally insured credit
union shares were located in one state (California). The credit unions that
NCUSIF insures are located in 50 states and the District of Columbia, with
the largest percentage (8 percent) of credit unions located in one state
(Pennsylvania), which represents about 4 percent of NCUSIF’s insured
shares.

While we remain concerned about ASI’s concentration of risks, ASI
employs a number of risk-management strategies—intended to mitigate its
risk exposure in individual institutions—including being selective about
which credit unions it insures, conducting regular on- and off-site
monitoring of all its insured institutions, implementing a partially adjusted,
risk-based insurance pricing policy, and establishing a 30-day termination
policy. More specifically, ASI employs the following risk-management
strategies:

•	 To qualify for primary share insurance with ASI, a credit union must
   meet ASI’s insurance eligibility criteria, which include an analysis of the
   financial performance of the credit union over a 3-year period and an
   evaluation of the institution’s operating policies. For example, to qualify
   for ASI coverage, a credit union’s fixed assets must be limited to 5
   percent of the institution’s total assets or the amount permitted by its
   supervisory authority, whichever is greater, and credit unions must
   maintain a minimum net capital-to-asset ratio of 4 percent of total
   assets.96 In contrast, federal PCA requirements compel federally insured
   credit unions to maintain a minimum capital to assets ratio of 7 percent

95
   Under Ohio law, insurers licensed by the state are subject to a “maximum single risk”
requirement. See Ohio Rev. Code Ann. § 3941.06(B).
96
   According to ASI, the average net capital-to-assets ratio of all ASI’s primary insured credit
unions was 10.88 percent, as of December 31, 2002.




Page 71                                          GAO-04-91 Changes in Credit Union Industry
     of total assets.97 The credit union also must submit its investment, asset-
     liability management, and loan policies for ASI’s review. In addition, ASI
     obtains and reviews the most recent reports from the credit union’s
     regulator and certified public accountant (CPA) or supervisory
     committee. Between 1994 and July 2003, ASI denied share insurance
     coverage to eight credit unions while approving coverage for 31 credit
     unions.98

•	 ASI also regularly monitors all credit unions it insures. ASI routinely
   conducts off-site monitoring and conducts on-site examinations of
   privately insured credit unions at least once every 3 years. It also
   reviews state examination reports for the credit unions it insures and
   imposes strict audit requirements. For example, ASI requires an annual
   CPA audit for credit unions with $20 million or more in assets, while
   NCUA only requires the annual CPA audit for credit unions with more
   than $500 million in assets. Further, after insuring a large credit union,
   ASI implemented a special monitoring plan for its largest credit unions
   in light of its increased risk exposure. For larger credit unions (those
   with more than 10 percent of ASI’s total insured shares or the top 5
   credit unions in asset size), ASI increased its monitoring by conducting
   semiannual, on-site examinations, as well as monthly and quarterly off-
   site monitoring, which included a review of the credit unions’ most
   recent audits (monthly) and financial information (quarterly). ASI also
   annually reviews the audited financial statements of these large credit
   unions. In January 2003, five credit unions with about 40 percent of ASI’s
   total insured assets qualified for this special monitoring.99 ASI also
   began a monitoring strategy intended to increase its oversight of smaller
   credit unions, due in part to experiencing larger-than-expected losses at




97
   For example, federal PCA regulations require supervisory action when federally insured
credit unions’ capital to assets ratio is less than 6 percent of total assets.
98
   Twenty-eight of these credit unions converted from federal insurance, while two were
newly chartered credit unions and one was an uninsured credit union.
99
 As of June 2003, the total shares of these credit unions ranged from $297.6 million to $2.5
billion. Though the plan targeted only ASI’s five largest credit unions, ASI may increase the
number of monitored credit unions at any time so that it continually reviews at least 25
percent of total insured shares.




Page 72                                         GAO-04-91 Changes in Credit Union Industry
      a small credit union in 2002.100 ASI determined that 98 smaller credit
      unions qualified for increased monitoring, with shares from the largest
      of these smaller credit unions totaling about $23 million.

•	 ASI also has implemented a partially adjusted, risk-based insurance
   pricing policy, which produces an incentive for the institutions insured
   by ASI to obtain a better CAMEL rating, which in turn lowers the risk to
   ASI’s insurance fund. Like NCUSIF, ASI’s insurance fund is deposit-
   based; that is, ASI requires credit unions it insures to deposit a specified
   amount with ASI.101 As of December 2002, these deposits with ASI
   totaled $112 million. Unlike NCUSIF, ASI’s insurance fund is partially
   adjusted for risk, which acts as a positive, risk-management strategy to
   mitigate against losses. Specifically, a credit union with a higher, or
   worse, CAMEL rating is required to deposit more into ASI’s insurance
   fund.102 Conversely, NCUA requires federally insured credit unions to
   deposit 1.0 percent of insured shares into NCUSIF regardless of their
   CAMEL ratings.103 According to ASI, it also has the contractual ability to
   reassess all member credit unions up to 3 percent of their total assets to
   raise additional funds to cover catastrophic loss.

•	 ASI’s credit union termination policy provides another risk-mitigating
   strategy that ASI can use to manage its risk exposure to an individual
   credit union. ASI’s insurance contract identifies several circumstances
   that would enable ASI to terminate insurance coverage. For example,
   ASI may terminate a credit union’s insurance with 30 days notice to the


100
  ASI assigned a risk level to the credit unions it insured (low, moderate, or high) and then
used this assessment to determine the extent of oversight at the credit union, which might
include conducting face-to-face interviews with the chair of the supervisory audit
committee, confirming checks over $1,000 have cleared, or verifying the value of loans,
investments, and share accounts with credit union members in writing or over the phone.
101
   ASI deposit-based insurance fund is funded through capital contributions to ASI from
member credit unions. The member credit unions record this capital contribution as a
deposit (asset) on their financial statements.
102
  ASI’s insurance fund is funded through the credit unions it insures depositing between 1.0
and 1.3 percent of a credit union’s insured shares with ASI. The credit unions’ CAMEL
ratings determine the rate at which credit unions are assessed (the ratings are 1-strong, 2-
satisfactory, 3-flawed, 4-poor, and 5-unsatisfactory). For example, credit unions with a
CAMEL score of 1 must deposit 1.0 percent of total insured shares into ASI’s insurance fund;
credit unions with a CAMEL score of 4 or 5 must deposit 1.3 percent of their total insured
shares.
103
  12 U.S.C. § 1782a(c).




Page 73                                         GAO-04-91 Changes in Credit Union Industry
                                     credit union and its state regulator, if the credit union fails to comply
                                     with ASI requirements to remedy any unsafe or unsound conditions or
                                     remedy an audit qualification in a timely manner. According to ASI
                                     management, it has not terminated a credit union’s share insurance,
                                     although ASI has used its termination policy as leverage to force
                                     changes at a credit union.104

                                  When its largest insured credit union applied for primary share insurance,
                                  ASI undertook an assessment of its financial and underwriting
                                  considerations for insuring this institution.105 ASI had previously provided
                                  excess share insurance to the credit union and was familiar with its
                                  financial condition. ASI’s independent actuaries determined that the ASI
                                  fund could withstand losses sustained during adverse economic conditions
                                  for up to 5 years, with or without insuring this large credit union.
                                  Ultimately, ASI’s assessment concluded that the credit union’s financial
                                  condition was strong and, although it would increase ASI’s concentration
                                  of risks, insuring the credit union would have a favorable financial impact
                                  on ASI. According to regulators from the Ohio Department of Commerce,
                                  Division of Financial Institutions (Ohio Division of Financial Institutions),
                                  they did not take exception to ASI insuring the large credit union and had
                                  reviewed ASI’s underwriting assessment and asked to be updated
                                  periodically.

Remaining Private Insurer Has     Unlike federal share insurance, which is backed by the full faith and credit
Limited Borrowing Capacity and    of the United States, ASI’s insurance fund is not backed by any government
May Find It Difficult to Cover    entity. Therefore, losses on member deposits in excess of available cash,
Losses from Its Largest Insured   investments, and other assets of ASI-insured institutions would only be
Credit Unions under Extreme       covered up to ASI’s available resources and its secured lines of credit,
Economic Conditions               which serve as a back-up source of funds. According to ASI documents, the
                                  terms of ASI’s secured lines of credit required collateralization between 80
                                  and 115 percent of current market value of the U.S. government or agency


                                  104
                                     ASI’s involuntary termination procedure, unlike NCUA’s, does not require a credit union to
                                  notify its members that its share insurance has been terminated. According to ASI, because
                                  states generally prohibit credit unions from operating without share insurance, the states
                                  would require notification to credit union members of the change in the credit union’s
                                  insured status. NCUA’s involuntary termination policy, on the other hand, requires 30 days
                                  notice and also requires a credit union to issue “prompt and reasonable” notice to its
                                  members that it will cease to be insured. 12 U.S.C. §§1786(b), (c).
                                  105
                                     According to ASI documents, this credit union would have represented 22 percent of ASI’s
                                  insured shares; at the time of the assessment, ASI’s largest credit union represented only 6
                                  percent of the fund’s insured shares.




                                  Page 74                                         GAO-04-91 Changes in Credit Union Industry
                                    securities ASI holds. As a result, ASI’s borrowing capacity is essentially
                                    limited to the securities it holds. ASI officials also explained that due to the
                                    high cost of reinsurance, it has not purchased reinsurance on its primary
                                    share insurance, although it has reinsurance for its excess share insurance.

                                    ASI has not had large losses since 1975. ASI has expended funds for 118
                                    claims and its loss experience—from the credit unions that have made
                                    claims—has averaged 3.95 percent of the total assets of these credit unions.
                                    If ASI’s historical loss average of 3.95 percent was tested and proved true
                                    for a failure at the largest credit union ASI insured, as of December 2002,
                                    the loss amount would be about $119 million.106 While this would be a
                                    major loss, ASI would most likely be able to sustain this loss. ASI’s
                                    historical loss rate is nearly 60 percent less than the loss rate experienced
                                    by NCUSIF for the same period. However, under more stressful conditions,
                                    ASI could have difficulty fulfilling its obligations. For example, ASI’s five
                                    largest credit unions represent nearly 40 percent of insured shares, for
                                    which a collective loss at 3.95 percent of the assets of these credit unions
                                    would exceed ASI’s equity by approximately $30 million. According to ASI,
                                    it could raise additional funds to cover catastrophic loss by reassessing all
                                    member credit unions up to 3 percent of their total assets, which excluding
                                    the top five credit unions, would generate approximately $214 million of
                                    additional capital, while maintaining minimum capital levels at 4 percent of
                                    total assets. Further, by Ohio statute, the Superintendent of the Division of
                                    Financial Institutions can order ASI to reassess its insured credit unions up
                                    to the full amount of their capital, which, excluding the top five credit
                                    unions, would generate approximately $794 million of funds for ASI with
                                    which to pay claims. This recapitalization process is generally similar to
                                    that required of NCUSIF before accessing its Treasury line of credit.
                                    However, if ASI reassessed its member credit unions during a catastrophic
                                    failure, it would further negatively affect these credit unions at a time that
                                    they were already facing stressful economic conditions.

State Oversight of ASI and the      State regulation of ASI and the privately insured credit unions it insures
Credit Unions It Insures Provides   provides some additional assurance that ASI and privately insured credit
Additional Assurance                unions operate in a safe and sound manner. As a share guaranty


                                    106
                                       This estimate is based on using December 2002 financial data on the largest credit union
                                    insured by ASI. According to a capital adequacy analysis performed for ASI, ASI’s
                                    independent actuaries determined that the ASI fund could withstand losses sustained during
                                    adverse economic conditions for up to 5 years, with or without insuring this large credit
                                    union.




                                    Page 75                                        GAO-04-91 Changes in Credit Union Industry
corporation, ASI is subject to state oversight and regulation in those states
where ASI insures credit unions. ASI was chartered in Ohio statute, with
the Ohio Division of Financial Institutions and the Ohio Department of
Insurance dually regulating it. ASI is licensed by the Ohio Superintendent
of Insurance and is subject to routine oversight by that department and
Ohio’s Superintendent of Credit Unions.107 The Ohio Division of Financial
Institutions conducts annual assessments of ASI, which evaluate ASI’s
underwriting and monitoring procedures, financial soundness, and
compliance with Ohio laws. Under Ohio law, its Department of Insurance
also is required to examine ASI at least once every 5 years. The last Ohio
Department of Insurance exam of ASI was completed in March 1999, which
covered January 1995 through December 1997. When we met with Ohio
officials in June 2003, they told us that the Ohio Department of Insurance
planned to examine ASI in the third quarter of calendar year 2003. ASI is
also required to submit annual audited financial statements, including
management’s attestation, and quarterly unaudited financial statements to
Ohio insurance and credit union regulators.108 Ohio law also requires ASI to
provide copies of written communication with regulatory significance to
Ohio regulators, obtain the opinion of an actuary attesting to the adequacy
of loss reserves established, and apply annually for a license to do business
in Ohio. In our discussions with officials from the Ohio Division of
Financial Institutions and the Ohio Department of Insurance, we found
that, to date, ASI has complied with all requirements and regulations, and
no regulators have taken corrective actions against ASI or limited ASI’s
ability to do business in Ohio.

Generally, state financial regulators have taken the primary lead for
monitoring ASI’s actions, while state insurance regulators were not as
involved in overseeing ASI’s operations. All states where ASI insures credit
unions have, at some point, formally certified ASI to conduct business in
that state.109 Ohio and Maryland have certified ASI in the past year—as
required by governing statutes in those states. Regarding the other states in
which ASI operates, while they have not formally recertified ASI, Ohio’s


107
  See Ohio Rev. Code Ann. Ch. 1761.
108
   While Ohio law requires ASI to submit annual audited financial statements, Ohio law
permits the superintendent of insurance to require the submission of quarterly reports. The
superintendent of insurance imposes this requirement on ASI. See Ohio Rev. Code Ann. §§
1761.16 and 3901.42.
109
  The states are Alabama, California, Idaho, Illinois, Indiana, Maryland, Nevada, and Ohio.




Page 76                                        GAO-04-91 Changes in Credit Union Industry
annual examination process of ASI involves regulators from most states.
State credit union regulators from Idaho, Illinois, Indiana, and Nevada
commonly participate in this assessment; according to ASI officials, their
acceptance of the final examination report infers that they approve of ASI’s
continuing operation in their respective states. State credit union
regulators from California and Alabama, however, have not participated in
the annual on-site assessment of ASI. Regarding monitoring efforts by state
insurance regulators, according to ASI, the Ohio Department of Insurance
is the only state insurance department that imposes requirements and
insurance regulators from Idaho, Illinois, and Nevada only request
information.

Most state credit union regulators with whom we met told us they had
regular communication with ASI about the credit unions ASI insured. ASI
officials reported that they commonly conducted joint, on-site exams of
credit unions with state regulators. State credit union regulators imposed
safety and soundness standards and carried out examinations of state-
chartered credit unions in a way similar to how the federal government
oversees federally insured credit unions. According to state regulators,
state regulations, standards, and examinations apply to all state-chartered
credit unions, regardless of their insurance status (whether federal, private,
or noninsured). State credit union regulators reported that they had
adopted NCUA’s examination program, and their examiners had received
training from NCUA. However, as previously discussed, some state officials
with whom we met indicated that they faced challenges related to oversight
of their credit unions; for example, some states lacked examiner resources
and had high examiner turnover.

Additionally, privately insured credit unions—as compared with federally
insured credit unions—are not subject to identical requirements and
regulations. For example, while federally insured, state-chartered credit
unions are subject to PCA—as discussed earlier, privately insured, state-
chartered credit unions are not subject to these federally mandated
supervisory actions. Although, as a matter of practice, many state
regulators reported that they have the authority to impose capital
requirements on privately insured credit unions and could take action
when a credit union’s capital levels are not safe and sound. However, state
officials in California, Idaho, Illinois, Indiana, Ohio, and Nevada said that
their states required privately insured credit unions to maintain specified
reserve levels, which were codified in statute or regulation. Additionally,
Alabama requires credit unions seeking private insurance to meet certain
capital levels.



Page 77                                 GAO-04-91 Changes in Credit Union Industry
                             While some states had specific requirements for credit unions seeking to
                             purchase private share insurance, many states regulators reported that
                             they have the authority to “not approve” the conversion of credit unions to
                             private share insurance. Alabama, Illinois, and Ohio have written guidelines
                             for credit unions seeking to purchase private share insurance and
                             regulators reported that they have the authority to “not approve” a credit
                             union’s purchase of private insurance. The other five states that permitted
                             private share insurance do not have written guidelines for credit unions
                             seeking to purchase private share insurance, but Idaho, Indiana, and
                             Nevada state regulators also noted that they have the authority to “not
                             approve” a credit union’s purchase of private share insurance.

                             Moreover, NCUA supervised the conversions of federally insured credit
                             unions to private share insurance. Specifically, NCUA has imposed
                             notification requirements on federally insured credit unions seeking to
                             convert to private share insurance and requires an affirmative vote of a
                             majority of the credit union members on the conversion from federal to
                             private share insurance. NCUA has required these credit unions to notify
                             their members, in a disclosure, that if the conversion were approved, the
                             federal government would not insure shares.110 We reviewed six recent
                             conversions to private share insurance, and found that, prior to NCUA’s
                             termination of the credit union’s federal share insurance, these credit
                             unions, including the large credit union that recently converted to ASI, had
                             generally complied with NCUA’s notification requirements for conversion.



Members of Many Privately    Although actions taken by ASI and some state regulators provide some
Insured Credit Unions Are    assurances that ASI is operating in a safe and sound manner, ASI’s
                             concentration risks and limited borrowing capacity raise concerns that
Not Receiving Required       under stressful economic conditions it may not be able to fulfill its
Disclosures about the Lack   responsibilities to its membership. Congress determined that it was
of Federal Share Insurance   important for members of privately insured credit unions to be informed


                             110
                                Specifically, under the Federal Credit Union Act, if a federally insured credit union
                             terminates federal share insurance or converts to nonfederal (private) insurance, the
                             institution must give its members “prompt and reasonable notice” that the institution has
                             ceased to be federally insured. 12 U.S.C. § 1786(c). NCUA rules implement these provisions
                             by prescribing language to be used in (1) the notices of the credit union’s proposal to
                             terminate federal share insurance or convert to nonfederal (private) insurance, (2) an
                             acknowledgement on the voting ballot of the member’s understanding that federal share
                             insurance will terminate, and (3) the notice of the termination or conversion. See 12 C.F.R.
                             Part 708b (2003).




                             Page 78                                        GAO-04-91 Changes in Credit Union Industry
that their deposits in such institutions were not federally insured.
Specifically, among other things, section 43 of the Federal Deposit
Insurance Act requires depository institutions lacking federal deposit
insurance, which includes privately insured credit unions, to conspicuously
disclose to their membership that deposits at these institutions are (1) not
federally insured and (2) if the institution fails, the federal government
does not guarantee that depositors will get back their money.111 These
institutions are required to conspicuously disclose this information on
periodic statements of account, signature cards, and passbooks, and on
certificates of deposit, or instruments evidencing a deposit (deposit slips).
These institutions are also required to conspicuously disclose that the
institution is not federally insured at places where deposits are normally
received (lobbies) and in advertising (brochures and newsletters).

The Federal Trade Commission (FTC) is responsible for enforcing
compliance with section 43.112 However, FTC has never taken action to
enforce these requirements, and has sought and obtained in its
appropriations authority a prohibition against spending appropriated funds
to carry out these provisions. We recently reported that because of a lack of
federal enforcement of this section, many privately insured credit unions
did not always make required disclosures.113 We conducted unannounced
site visits to 57 locations of privately insured credit unions (49 main and 8
branch locations) in five states—Alabama, California, Illinois, Indiana, and
Ohio and found that 37 percent of the locations we visited did not
conspicuously post signage in the lobby of the credit union. During these
site visits, we also obtained other available credit union materials
(brochures, membership agreements, signature cards, deposit slips, and
newsletters) that did not include language to notify consumers that the
credit union was not federally insured—as required by section 43. Overall,
134 of the 227 pieces of materials we obtained from 57 credit union
locations—or 59 percent—did not include specified language. As part of
our review, we also reviewed 78 Web sites of privately insured credit
unions and found that many Web sites were not fully compliant with
section 43 disclosure requirements. For example, 39 of the 78 sites


111
  12 U.S.C. § 1831t (b).
112
  12 U.S.C. § 1831t (g).
113
   U.S. General Accounting Office, Federal Deposit Insurance Act: FTC Best Among
Candidates to Enforce Consumer Protection Provisions, GAO-03-971 (Washington, D.C.:
Aug. 20, 2003).




Page 79                                     GAO-04-91 Changes in Credit Union Industry
               reviewed had not included language to notify consumers that the credit
               union was not federally insured.

               Our primary concern, resulting from the lack of enforcement of section 43
               provisions, was the possibility that members of privately insured, state-
               chartered credit unions might not be adequately informed that their
               deposits are not federally insured and should their institution fail, the
               federal government does not guarantee that they will get their money back.
               The fact that many privately insured credit unions we visited did not
               conspicuously disclose this information raised concerns that the
               congressional interest in this regard was not being fully satisfied. In our
               August 2003 report, we concluded that FTC was the best among candidates
               to enforce and implement section 43 and provided suggestions on how to
               provide additional flexibility to FTC to enforce section 43 disclosure
               requirements. The House Committee on Appropriations, Subcommittee on
               Commerce, Justice, State, the Judiciary, and Related Agencies, is currently
               considering adding language in FTC’s 2004 appropriations bill that would
               require FTC to enforce and implement section 43 disclosure provisions.



Conclusions	   The financial condition of the credit union industry has improved since
               1991. Between 1992 and 2002, changes in the industry have resulted in two
               distinct groups of credit unions—smaller credit unions providing their
               members with basic banking services and larger credit unions that seek to
               provide their members with a full range of financial services similar to
               other depository institutions. These larger credit unions control a larger
               percent of industry assets than they did in 1991. This concentration of
               industry assets creates the need for greater risk management on the part of
               credit union management and NCUA with respect to monitoring and
               controlling risks to the federal share insurance fund.

               Among the more significant changes that have occurred in the credit union
               industry over the past two decades have been the weakening or blurring of
               the common bond that traditionally existed between credit union
               members. The movement toward geographic-based fields of membership,
               and other expansions of the common-bond restrictions in conjunction with
               expanded lines of financial services, have made credit unions more
               competitive with banks. These changes have raised questions about the
               extent to which credit unions are fulfilling their perceived historic mission
               of serving individuals of modest means. However, no comprehensive data
               are available to determine the income characteristics of those who receive
               credit unions services, especially with respect to consumer loans and other



               Page 80                                GAO-04-91 Changes in Credit Union Industry
financial services. Available data, such as that provided by the SCF and
HMDA, provide some indication that credit unions serve low- and
moderate-income households but not to the same extent as banks. If credit
unions, as indicated by NCUA and the credit union industry, place a special
emphasis on serving low- and moderate-income households, more
extensive data would be needed to support this conclusion. These data
would need to include information on the distribution of consumer loans
because smaller credit unions are more likely to make consumer than
mortgage loans. Lack of data especially impairs NCUA’s ability to
determine if credit unions that have adopted underserved areas are
reaching the households in the communities most in need of financial
services.

As the industry has changed and larger credit unions have become more
like banks in the services they have provided, NCUA has adopted a
supervisory and examination approach that more closely parallels that of
the other depository institution regulators. While it is too soon to
determine whether the risk-focused approach being implemented by NCUA
will allow it to more effectively monitor and control the risks being
assumed by credit unions, our work suggests that further opportunities
exist for NCUA to further leverage off the approaches and experiences of
the other federal depository institution regulators. For example, as NCUA
is addressing challenges in implementation of its risk-focused program, it
has the opportunity to use forums such as the FFIEC to learn how other
depository institution regulators dealt with similar challenges in
implementing their risk-focused programs. Also, NCUA might gain an
evaluation of an institution’s internal controls, comparable to other
depository institution regulators, if credit unions were required, like banks
and thrifts, to provide management evaluations of internal controls and
their auditor’s assessments of such evaluations. Finally, NCUA could gain
better oversight of third-party vendors if it had the same ability to examine
the activities of third-party vendors as do other depository institution
regulators.

As of December 2002, NCUSIF’s financial condition appeared satisfactory
based on its fund-equity ratio and positive net income. However, it is not
clear whether or to what extent NCUSIF’s recent decline in net income will
continue. Improvements in NCUA’s processes for determining the overhead
transfer rate, pricing, and estimated losses could help to promote future
financial stability by providing more accurate information for financial
management. As currently determined by NCUA, the overhead transfer rate
may not have accurately reflected the actual time spent by NCUA staff on



Page 81                                GAO-04-91 Changes in Credit Union Industry
                        insurance-related activities. Recent fluctuations are the result of
                        adjustments being made because of surveys that had not been conducted
                        regularly or over sufficient periods of time. In addition, NCUSIF’s pricing
                        for federal share insurance coverage does not reflect the risk that an
                        individual credit union poses to the fund. Moreover, the process used by
                        NCUA to estimated losses to the insurance fund—the fund’s most
                        significant liability and management estimate—has been based on overly
                        broad historical analysis. The risk-based pricing structure that is the norm
                        across the insurance industry and, for loss estimates, the more detailed,
                        risk-based historical analysis used by FDIC in insuring banks and thrifts
                        may provide useful lessons for NCUA in improving its management of
                        insurance for credit unions.

                        While systemic risks that might be created by private share insurance
                        appear to have decreased since 1990, the recent conversion of a large credit
                        union from federal to private share insurance has introduced new
                        concerns. Because the remaining private insurer’s (ASI) insured shares are
                        overly concentrated in one large credit union and in certain states, and
                        because it does not have the backing of any governmental entity and it has
                        limited borrowing capacity, ASI may have a limited ability to absorb
                        catastrophic losses. This raises questions about the ability of ASI, under
                        severe economic conditions, to fulfill its obligations if its largest credit
                        unions were to fail. Given this risk, we believe it is important that the
                        members of privately insured credit unions are made aware that their
                        shares are not federally insured. As we previously reported, since no
                        federal entity currently enforces compliance with federal disclosure
                        requirements for privately insured credit unions, and with the high level of
                        noncompliance that we found in on-site visits to privately insured credit
                        unions, we believe that members of privately insured credit unions might
                        not be adequately informed that their shares are not federally insured. As a
                        result, we have previously recommended that Congress consider providing
                        additional flexibility to FTC to ensure compliance with the federal
                        disclosure requirements.114



Recommendations for 	   To promote NCUA’s ability to meet its goal of assisting credit unions in
                        safely providing financial services to all segments of society, to enable
Executive Action        more consistent federal oversight of financial institutions, and to enhance


                        114
                              GAO-03-971.




                        Page 82                                GAO-04-91 Changes in Credit Union Industry
                share insurance management (for example, improving allocation costs,
                providing insurance according to risk, and improving the loss estimation
                process), we recommend that the Chairman of the National Credit Union
                Administration

                •	 use tangible indicators, other than “potential membership,” to determine
                   whether credit unions have provided greater access to credit union
                   services in underserved areas;

                •	 consult with other regulators through FFIEC more consistently about
                   risk-focused programs to learn how these regulators have dealt with
                   past challenges (for example, training of information technology
                   specialists);

                •	 continuously improve the process for and documentation of the
                   overhead transfer rate by consistently calculating and applying those
                   rates, updating the rates annually, and completing the survey with full
                   representation;

                •	 evaluate options for implementing risk-based insurance pricing. In its
                   evaluation, the NCUA Chairman should consider the potential impact of
                   risk-based insurance pricing to the ability of credit unions to provide
                   services to various constituencies; and

                •	 evaluate options for stratifying the industry by risk profile and applying
                   probable failure rates and loss rates, based in part on historical data, for
                   each risk profile category when estimating future losses from
                   institutions.



Matters for     Should Congress be concerned that federally insured credit unions,
                especially those serving geographical areas, are not adequately serving low-
Congressional   and moderate-income households, Congress may wish to consider
Consideration   requiring NCUA to obtain data on the proportion of mortgage and
                consumer loans provided to low- and moderate-income households within
                each federally insured credit union’s field of membership and obtain
                descriptions of services specifically targeted to low- and moderate-income
                households.

                To ensure the safety and soundness of the credit union industry, Congress
                may wish to consider making credit unions with assets of $500 million or
                more subject to the FDICIA requirement that management and external



                Page 83                                 GAO-04-91 Changes in Credit Union Industry
                      auditors report on the internal control structure and procedures for
                      financial reporting, as well as compliance with designated safety and
                      soundness laws.

                      To improve oversight of third-party vendors, Congress may wish to
                      consider granting NCUA legislative authority to examine third-party
                      vendors that provide services to credit unions and are not examined
                      through FFIEC.



Agency Comments and   We requested comments on a draft of this report from the Chairman of the
                      National Credit Union Administration and the President and Chief
Our Evaluation        Executive Officer of American Share Insurance. We received written
                      comments from NCUA and ASI that are summarized below and reprinted in
                      appendixes XI and XII respectively. In addition, we received technical
                      comments from NCUA and ASI that we incorporated into the report as
                      appropriate.

                      NCUA concurred with most of the report’s assessment regarding the
                      challenges facing NCUA and credit unions since 1991. For example, NCUA
                      concurred with the report’s assessment that overall the financial health and
                      stability of the credit union industry has improved since 1991. NCUA also
                      agreed with our recommendation to consult with other regulators through
                      FFIEC more consistently to leverage the knowledge and experience the
                      other regulators have gained in administering risk-focused programs.
                      NCUA stated that it plans to continue its coordination with its FFIEC
                      counterparts as it makes ongoing improvements to its approach to
                      supervising federally insured credit unions.

                      NCUA also concurred with our matter for congressional consideration that
                      credit unions with assets of $500 million or more should provide annual
                      management reports assessing the effectiveness of their internal controls
                      over financial reporting and their external auditor’s attestation to
                      management’s assertions. NCUA stated that it is providing guidance for
                      credit unions on the principles of the Sarbanes-Oxley Act that will, among
                      other things, strongly encourage large credit unions to voluntarily provide
                      this reporting on internal controls. However, NCUA believed that
                      legislation was not necessary because NCUA has the authority to
                      implement regulations requiring credit unions to provide these reports
                      should it become necessary. While we acknowledge NCUA’s authority to
                      issue regulations on this issue, we note that regulations can be changed
                      unilaterally by the agency, whereas legislation is binding unless changed by



                      Page 84                                GAO-04-91 Changes in Credit Union Industry
Congress. Our intent in developing this matter for congressional
consideration was to ensure parity between credit unions, banks, and
thrifts with regard to internal control reporting requirements; therefore, we
have left this as a matter for congressional consideration in our report.

NCUA also indicated that it did not oppose our recommendation that it be
given statutory authority to examine third-party vendors that provide
services to credit unions and are not examined through FFIEC, provided
that appropriate discretion was extended to the agency in the allocation of
agency resources and evaluation of risk parameters in using this authority.
NCUA stated that given that many of these third-party vendors service
numerous credit unions, a failure of a vendor poses systemic risk issues.
However, NCUA suggested that it be changed to a matter for congressional
consideration because it was a statutory issue rather than one involving the
use of existing NCUA regulatory authority. We agreed with NCUA’s
assessment and have modified the report accordingly.

NCUA concurred with the report’s recommendation to make improvements
to the process for determining the overhead transfer rate and indicated that
management is in the process of improving the methodology for calculating
this rate. NCUA also concurred in part with our report’s conclusion that the
NCUSIF loss reserve methodology warrants study, in order to further refine
NCUSIF’s estimates. Regarding our recommendation that NCUA study
options for improving its estimates of future insurance losses, NCUA stated
that it is awaiting the receipt of recommendations that FDIC received on
revising its insurance process, and NCUA will review the details of the
revised FDIC process and how to integrate those practices within NCUA’s
system.

In its response, NCUA proposed an alternative to risk-based insurance
pricing by using the adoption of a PCA approach where required net worth
levels would be tied to an institution’s risk profile. While NCUA’s proposal
may be one option to consider, we continue to recommend that NCUA
evaluate and study various options for achieving a risk-based pricing of
insurance to fairly distribute risk, provide incentives for member credit
unions to control their risk, and focus regulators on higher-risk credit
unions. While it is possible that the option suggested by NCUA would
achieve the objectives, we believe that NCUA should study the costs,
benefits, and risks associated with various options in order to determine
the most effective and cost-beneficial means of achieving a risk-based
system of insurance.




Page 85                                GAO-04-91 Changes in Credit Union Industry
NCUA disagreed with our recommendation that it should use indicators,
other than “potential membership,” to determine whether credit unions
have provided greater access to credit union services in underserved areas.
NCUA officials stated that they believe that their data indicated that credit
unions have reached out to underserved communities; implementation of
this recommendation could result in significant and unnecessary data
collection; and Congress has not imposed CRA-like requirements on credit
unions in the past. We agree that federally chartered credit unions have
added underserved areas in record numbers, increasing the numbers of
potential members in these areas, and that membership growth in credit
unions with underserved areas has been greater than for credit unions
overall. However, this information does not indicate whether underserved
individuals or households have received greater access to services (for
example, by using check-cashing services, opening no-fee checking
accounts, or receiving loans) as a result of these field of membership
expansions. Further, while we agree that documenting service to the
underserved would result in additional administrative requirements, the
magnitude and scale of this effort does not necessarily require imposition
of CRA as implemented for banks and thrifts, and could result in
information benefitting future credit union expansion efforts. At a
minimum, it would be useful to know whether membership growth in
credit unions that have added underserved areas has come from the
underserved areas themselves and the extent to which those census tracts
within these areas have been identified as low- or moderate-income. This
type of information, collected uniformly by a federal agency like NCUA,
could serve as first step towards documenting the extent to which credit
unions have reached for members outside of their traditional membership
base. Finally, without this information, it will be difficult for NCUA or
others that are interested to determine whether credit unions have
extended services of any kind to underserved individuals as authorized in
CUMAA.

Finally, NCUA also concurred with the report’s identification of possible
systemic risk that could be associated with private share insurance that
lacks the full faith and credit backing of a state or the federal government.
NCUA believed that the asset concentration, limited borrowing capacity,
and the lack of any reinsurance of the private insurer present unique
challenges for the eight state supervisory authorities where private
insurance exists today.

In commenting on the private share insurance section of a draft of this
report, ASI stated that we failed to adequately assess the private share



Page 86                                 GAO-04-91 Changes in Credit Union Industry
insurance industry. In summary, as discussed below, ASI raised objections
to the report statements that ASI’s risks are concentrated in a few large
credit unions and a few states; ASI has limited ability to absorb large losses
because it does not have the backing of any governmental agency; and
ASI’s lines of credit are limited in the aggregate as to amount and available
collateral. In response, we considered ASI’s positions and materials
provided, including ASI’s actuarial assumptions and ASI’s past
performance, and believe our report addresses these issues correctly as
originally presented.

First, in regard to ASI’s concentration risks, ASI stated that the inclusion of
a single large, high-quality credit union provided financial resources that
improved, not diminished, the financial integrity of ASI. Our report
acknowledges this fact. However, our report also notes that this credit
union made up about 25 percent of ASI’s total insured shares, and that ASI’s
five largest credit unions represent nearly 40 percent of ASI’s insured
shares, as of December 2002. While not disputing that the large credit union
would improve ASI’s current financial position, we continue to believe that
this level of concentration in a few credit unions, under adverse economic
conditions, could expose ASI to a potentially high level of losses. ASI also
stated that ASI’s coverage and the geographic distribution of ASI’s insured
credit unions is a matter of state law. The report points out this fact, and we
acknowledge that it limits ASI’s ability to diversify its risks. However, the
fact remains that ASI’s risks are currently concentrated in eight states.

Second, in response to our report’s assessment of ASI’s limited ability to
absorb catastrophic losses, ASI noted “its sound private deposit insurance
program builds on a solid foundation of careful underwriting, continuous
risk management and the financial backing of its mutual member credit
unions, capable of absorbing large (catastrophic) losses.” In addition, ASI
noted that over its 29-year history, it has paid over 110 claims on failed
credit unions, and that no member of an ASI-insured credit union has ever
lost money. ASI also noted that it could assess its member credit unions up
to 3 percent of their total assets in order to obtain more capital. We
acknowledge these facts in this report; however, our point remains that ASI
has limited borrowing capacity and, under stressful economic conditions,
may have difficulty securing funds from others to meet its obligations. ASI
also objected to the report’s comparison of private share insurance to the
federal insurance program. As the last remaining private share insurer, ASI
has no peer on which to base a comparison and the only alternative to
private share insurance for credit unions is NCUSIF.




Page 87                                 GAO-04-91 Changes in Credit Union Industry
Third, ASI commented that the draft report incorrectly views the
company’s lines of credit as a source of capital. ASI noted that their lines of
credit are solely in place to provide emergency liquidity. We do not disagree
with ASI’s statement. When incorporating ASI’s previously received
technical comments, we clarified in the report that losses on member
deposits, in excess of available cash, investments, and other assets of ASI-
insured institutions, would only be covered up to ASI’s available resources
and its secured lines of credit, which serve as a back-up source of funds.
Further, the report notes that ASI’s lines of credit required collaterization
between 80 and 115 percent of current market value of the U.S. government
or agency securities ASI holds. As a result, ASI’s borrowing capacity is
essentially limited to the securities it holds and therefore, in a time of
stressful economic conditions, ASI may have difficulty maintaining its own
liquidity if its insured credit unions were failing and unable to meet the
withdrawal requests of depositors.

Lastly, ASI supported our previous conclusion that FTC is the appropriate
agency for monitoring and defining private share insurance consumer
disclosure requirements and believed that privately insured credit unions
would benefit from FTC’s enforcement of such provisions. In our
concluding discussions with ASI officials, they emphasized that they were
undertaking efforts to educate their member credit unions on the required
consumer disclosures and taking steps, in conjunction with state credit
union leagues, to ensure compliance.


As agreed with your offices, unless you publicly announce the contents of
this report earlier, we plan no further distribution until 30 days from the
report date. At that time, we will send copies of this report to the Chairman
of the Senate Committee on Banking, Housing, and Urban Affairs, the
Chairman and Ranking Minority Member of the House Committee on
Financial Services, and other congressional committees. We also will send
copies to the National Credit Union Administration and American Share
Insurance and make copies available to others upon request. In addition,
the report will be available at no charge on the GAO Web site at
http://www.gao.gov.




Page 88                                 GAO-04-91 Changes in Credit Union Industry
This report was prepared under the direction of Debra R. Johnson and
Harry Medina, Assistant Directors. If you or your staff have any questions
regarding this report, please contact the Assistant Directors or me at
(202) 512-8678. Key contributors are acknowledged in appendix XIII.

Sincerely yours,




Richard J. Hillman
Director, Financial Markets
 and Community Investment




Page 89                               GAO-04-91 Changes in Credit Union Industry
Appendix I

Objectives, Scope, and Methodology



                         Our report objectives were evaluate (1) the financial condition of the credit
                         union industry; (2) the extent to which credit unions “make more available
                         to people of small means credit for provident purposes;”1 (3) the impact, if
                         any, of the Credit Union Membership Access Act of 1998 (CUMAA) on the
                         credit union industry with respect to membership provisions; (4) how the
                         National Credit Union Administration’s (NCUA) examination and
                         supervision processes have changed in response to changes in the industry;
                         (5) the financial condition of the National Credit Union Share Insurance
                         Fund (NCUSIF); and (6) issues concerning the use of private share
                         (deposit) insurance.



Financial Condition of   To assess the financial condition of the credit union industry, we obtained
Industry                 and analyzed annual call report financial data (Form 5300) and regulatory
                         ratings (CAMEL scores) for all federally insured credit unions from 1992 to
                         2002.2 NCUA requires federally insured credit unions to submit a quarterly
                         call report, which contains information on the financial condition and
                         operations of the institution. Using the call reports, we calculated
                         descriptive statistics and key financial ratios and determined trends in
                         financial performance. NCUA provided us with a copy of the electronic
                         Form 5300 database for our analysis. The database contained year-end
                         information for December 1992–December 2002. We reviewed NCUA
                         established procedures for verifying the accuracy of the Form 5300
                         database and found that the data that forms this database are verified on an
                         annual basis, either during each credit union’s examination, or through off-
                         site supervision. We determined that the data were sufficiently reliable for
                         the purposes of this report. In addition we received a database of
                         regulatory ratings (CAMEL) from NCUA for 1992–2002, on which we (1)
                         reviewed the data by performing electronic testing of required data
                         elements, (2) reviewed existing information about the data and the system
                         that produced them, and (3) interviewed agency officials knowledgeable



                         1
                          While credit union legislation (see the Federal Credit Union Act at 12 U.S.C. § 1751) uses
                         “small means” and the credit union industry has not defined the term, in this report, we used
                         “low- and moderate-income,” as defined by banking regulators, to describe the type of
                         people who credit unions might serve.
                         2
                          As do banking regulators, NCUA and state regulators use the “CAMEL” rating system, a
                         composite score, to help evaluate the safety and soundness of institutions. CAMEL scores
                         rate capital adequacy (C), asset quality (A), management (M), earnings (E), liquidity (L), and
                         overall condition.




                         Page 90                                         GAO-04-91 Changes in Credit Union Industry
Appendix I

Objectives, Scope, and Methodology





about the data. We determined that the data were sufficiently reliable for
the purposes of this report.

In addition to using call report data for credit unions, we also used data
collected by the Federal Financial Institutions Examination Council
(FFIEC) and Office of Thrift Supervision (OTS) to compare the financial
condition of and services offered by credit unions with those of other
depository institutions insured by the Federal Deposit Insurance
Corporation (FDIC).3 We used call report (reporting forms FFIEC 031 and
FFIEC 041 for banks and OTS Form 1313 for thrifts) data obtained from
FDIC’s Statistics on Depository Institutions Web site, which contains
consolidated bank and thrift data stored on FDIC’s Research Information
System database.4 To assess the reliability of these data, we randomly
cross-checked selected data obtained from this Web site with selected
individual call reports and compared our calculations with aggregate
figures provided by FDIC. Given the context of the analyses, we
determined that these data were sufficiently reliable for the purposes of
our report. For broad, industrywide comparisons with banks involving
industry concentration and capital ratios, we used total assets and equity
capital data for all FDIC-insured institutions, excluding insured branches of
foreign-chartered banks. In order to determine bank and thrift institutions
for our more detailed review, we constructed five peer groups in terms of
institution size as measured by total assets, reported as of December 31,
2002. See table 3 for the definitions we used to create peer groups.




3
 FDIC is responsible for overseeing insured financial institution adherence to FFIEC’s
reporting requirements, including the observance of all bank regulatory agency rules and
regulations, accounting principles, and pronouncements adopted by the Financial
Accounting Standards Board and all other matters relating to call report submission. Call
reports are required by statute and collected by FDIC under the provision of Section
1817(a)(1) of the Federal Deposit Insurance Act. FDIC collects, corrects, updates, and
stores call report data submitted to it by all insured national and state nonmember
commercial banks and state-chartered savings banks on a quarterly basis. Throughout the
report, we use the terms, “banks,” “banks and thrifts,” and “FDIC-insured institutions”
interchangeably.
4
As of August 31, 2003, the address for this Web site was www3.fdic.gov/sdi/.




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                             Table 3: Peer Group Definitions

                             Group           Asset size of institution
                             I               Total assets of $100 million or less
                             II	             Total assets greater than $100 million, but less than or equal to $250
                                             million
                             III	            Total assets greater than $250 million, but less than or equal to $500
                                             million
                             IV              Total assets greater than $500 million, but less than or equal to $1 billion
                             V	              Total assets greater than $1 billion, but less than or equal to the asset
                                             size, rounded up to the nearest billion dollars, of the largest credit union
                                             (for example, $16 billion for 2001 and $18 billion for 2002)
                             Source: GAO.


                             We specified the maximum total assets of $18 billion by rounding up the
                             total assets of the largest credit union in our database as of December 31,
                             2002, to the nearest billion dollars. We also classified bank and thrift
                             institutions as to whether they emphasized credit card or mortgage loans;
                             this was done by determining if a given bank had (1) a total loans to total
                             assets ratio of at least 0.5 and (2) either a credit card loans to total loans
                             ratio of at least 0.5 or a mortgage loans to total loans ratio of at least 0.5.
                             The call report data that we used for our financial condition and services
                             analyses consisted of information on total assets and total loans, as well as
                             more specific loan holdings data (for example, consumer loans and real
                             estate loans). We also obtained additional data to calculate bank capital
                             ratios and return on average assets, including equity capital, net income,
                             and average assets.



Service to People with Low   To evaluate the extent to which credit unions serve people with low and
and Moderate Incomes         moderate incomes, we analyzed existing data on the income levels of credit
                             union members, reviewed available literature, and interviewed regulatory
                             and industry officials. We analyzed 2001 Home Mortgage Disclosure Act
                             (HMDA) data, the Federal Reserve’s 2001 Survey of Consumer Finances
                             (SCF), NCUA program literature, and statistical reports of industry trade
                             and consumer groups. To present our findings, we relied on the combined
                             message of all these studies and data sources because we found no single
                             source that contained data on the incomes of credit union and other
                             depository institution consumers. To compare the income characteristics
                             of households and neighborhoods that obtain mortgages from credit unions
                             and banks, we used four income categories—-low, moderate, middle, and



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upper—used by financial regulators as part of the Community
Reinvestment Act (CRA) exams.5 See table 4 for definitions.



Table 4: Definition of Income Categories

Categories                      Definitions
Low income	                     For an individual income, when income is less than 50 percent of
                                the metropolitan statistical area’s (MSA) median family income,
                                and for a geographic area, when the median family income is
                                less than 50 percent
Moderate income	                For an individual income, when income is at least 50 percent and
                                less than 80 percent of the MSA's median family income, and for
                                a geographic area, when the median family income is at least 50
                                percent and less than 80 percent
Middle income	                  For an individual income, when income is at least 80 percent and
                                less than 120 percent of the MSA's median family income, and
                                for a geographic area, when the median family income is at least
                                80 percent and less than 120 percent
Upper income	                   For an individual income, when income is at least 120 percent or
                                more of the MSA's median family income, and for a geographic
                                area, when the median family income is 120 percent or more
Source: 12 C.F.R. 228.12 (n).


We analyzed loan application records (LAR) from the HMDA database to
compare the proportion of mortgage loans made by credit unions and peer
group banks with households and communities with various income levels.
We used 2001 HMDA data, the most recent data set available from the
Federal Reserve Bank at the time of our review. For the purposes of
comparing credit union lending with that of banks, we included only those
banks with assets of $16 billion or less on December 31, 2001, which was
the size of the largest credit union in 2001, rounded up to the nearest
billion. In addition, we excluded lending institutions that only made
mortgages. Our HMDA analysis included records from 4,195 peer group
banks. We obtained the asset size and total membership for credit unions
reporting to HMDA from NCUA's 2001 call report database and obtained
the asset size of other lenders (to identify the peer group banks) from the




5
 In passing the CRA, Congress required federal financial supervisory agencies, except
NCUA, to assess an institution’s record of helping to meet the credit needs of the local
communities in which the institution is chartered.




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HMDA Lender File, which contains data on the characteristics of
institutions reporting to HMDA, supplied to us by the Federal Reserve.

Our HMDA analysis did not include all credit unions and banks because
only institutions that meet HMDA’s reporting criteria, such as having a
certain amount of assets, must report their mortgage loans to HMDA. For
example, in 2001, depository institutions with more than $31 million in
assets as of December 31, 2000, were required to report loans to HMDA.
Largely because of this criterion, most credit unions—86 percent—were
not required to report mortgage loans to HMDA and, thus, were excluded
from our analysis. However, we believe our analysis is still of value
because, in 2001, reporting credit unions held about 70 percent of credit
union assets and included 62 percent of credit unions’ members.

For our analysis, we only analyzed LARs for originated loans for the
purchase of one-to-four family homes that served as the purchaser’s
primary dwelling. Our analysis included about 71,000 loans reported by
credit unions and about 807,000 loans reported by peer group banks. We
determined that the data were sufficiently reliable for the purposes of this
report by performing electronic testing of the required data elements,
reviewing existing information about the data and the system that
produced them, and interviewing agency officials knowledgeable about the
data. We did not independently verify the accuracy of the contents of the
LARs reported to the HMDA database or the accompanying lender file.

After selecting the records, we determined what proportion of credit union
and bank loans were made to purchasers with low, moderate, middle, and
upper incomes. To do so, we categorized the purchaser's gross annual
income, as identified on the LAR, into one of four income categories based
on the median family income of the MSA in which the purchased home was
located. We did this by matching the Metropolitan Statistical Area (MSA)
on the HMDA LAR with the appropriate Department of Housing and Urban
Development (HUD)-estimated 2001 median family income. We used SAS
version 8.02 version, which is a computer-based data analysis and reporting
software application, to perform all of these analyses. We did not analyze
about 16 percent of the credit union and bank LARs because they did not
contain a MSA. While it is possible that this information was simply not
recorded, lenders must only report MSAs for properties located in MSAs
where their institution has a home or branch office.

In addition, we determined what proportion of credit union and bank loans
were made for the purchase of properties in census tracts by the median



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family income of the census tract. The Federal Reserve Board, in
categorizing each census tract level, used the four income categories used
by the financial regulators (low, moderate, middle, and upper) and used
definitions corresponding to the ones identified in table 4. Because the
median income of each census tract is labeled within HMDA, we did not
have to determine the income category ourselves. We did not analyze about
16 percent of the credit union and bank LARs because they did not contain
a census tract. While it is possible that this information was simply not
recorded, lenders are not responsible for identifying census tract
information if the property is located in a county with less than 30,000
people or if the property was located in an area that did not have census
tracts for the 1990 census.

Finally, we analyzed the race and ethnicity data in HMDA to compare the
lending records of credit unions and banks whose loans met our criteria. As
noted in appendix VI, about 15 percent of records for credit unions lacked
race and ethnicity data and 6 percent of records for banks. While it is
possible that this information was simply not recorded, applicants filing
loan applications by mail or by telephone are not obligated to provide this
information.

We also analyzed the Federal Reserve’s 2001 SCF, a triennial survey of U.S.
households sponsored by the Board of Governors of the Federal Reserve
System with the cooperation of Treasury, and reviewed secondary sources
to identify the characteristics of credit union members. We analyzed the
SCF because it is a respected source of publicly available data on financial
institution and consumer demographics that is nationally representative
and because it was the only comprehensive source of publicly available
data with information on financial institutions and consumer demographics
that we could identify. We analyzed the SCF to develop statistics on the
income, race, age, and education of credit union members and bank
customers. Because some customers use both credit unions and banks, we
performed our income analysis based on the assumption that households
can be divided into four user categories—those who use credit unions only,
those who primarily use credit unions, those who use banks only, and those
who primarily use banks. Dr. Jinkook Lee of Ohio State University
developed these categories. In addition, to identify existing research on
credit union research, we asked officials at NCUA and industry groups (for
example, the Credit Union National Association (CUNA) to identify
relevant studies and performed a literature search.




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Impact of CUMAA	        To study the impact of CUMAA on credit union field of membership
                        regulations, we reviewed and analyzed CUMAA and compared its
                        provisions with NCUA interpretive rulings and policy statements (IRPS) in
                        effect before and after CUMAA. In addition, we interviewed NCUA officials
                        and industry representatives to obtain their viewpoints on how NCUA
                        interpreted CUMAA's membership provisions. To obtain information about
                        state field of membership regulations in general and how many state-
                        chartered credit unions serve geographical areas, we surveyed regulators
                        in the 50 states and received responses from the 46 that actively charter
                        credit unions. This allowed us to compare the number of federally
                        chartered and state-chartered credit unions serving geographical areas.
                        Finally, we obtained historical trend data from NCUA on the charter types
                        of federally chartered credit unions, “potential” (that is, people within a
                        credit union’s field of membership but not members of the credit union)
                        and actual membership, and service to underserved areas.



Regulatory Oversight	   To evaluate how NCUA’s supervision and examination of credit unions has
                        evolved in response to changes in the industry since 1991, we identified
                        changes in the types of products, services, and activities in which credit
                        unions engage as well as key changes to NCUA regulations. We also
                        identified changes to NCUA’s examination and supervision approach, and
                        evaluated oversight procedures of federally insured, state-chartered credit
                        unions. Finally, we studied NCUA’s implementation of prompt corrective
                        action (PCA).

                        To identify changes in the types of products, services, and activities in
                        which credit unions engage, we analyzed 1992–2002 Form 5300 call report
                        data and conducted structured interviews with NCUA examiners, state
                        supervisory officials, and officials from seven large credit unions. To
                        identify key regulatory changes, we (1) reviewed the Federal Credit Union
                        Act and amendments made by Congress since 1991; (2) interviewed NCUA
                        officials, including NCUA’s General Counsel and officials from NCUA’s
                        Division of Examination and Insurance, NCUA and state examiners, and
                        officials from seven large credit unions; (3) reviewed NCUA legal opinions
                        and letters to credit unions; and (4) reviewed final rules published in the
                        Federal Register.

                        To identify changes to NCUA’s examination and supervision approach, we
                        reviewed NCUA’s examiner guide for key elements of the risk-focused
                        examination approach and compared current exam documentation



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requirements with previous requirements. We conducted structured
interviews with six of NCUA’s regional directors, 23 NCUA examiners
covering all NCUA regions, and 13 state supervisory officials from
Alabama, California, Idaho, Illinois, Indiana, Maryland, Massachusetts,
Michigan, Nevada, Ohio, Texas, Washington, and Wisconsin. These states
contained 51 percent of the total number of federally insured, state-
chartered credit unions and 58 percent of the total assets of federally
insured, state-chartered credit unions as of December 31, 2002. In addition,
we interviewed officials from seven large credit unions; selecting at least
one credit union from NCUA’s six regions. To obtain information on the
experiences of other depository institution regulators with the risk-focused
examination and supervision approach, we interviewed officials from the
FDIC, OTS, Office of the Comptroller of the Currency, and the Federal
Reserve Bank. Finally, to obtain information on other NCUA initiatives
intended to compliment the risk-focused program, we reviewed NCUA
documents on the large credit union pilot program, and the subject matter
examiner program.

To evaluate oversight procedures of federally insured, state-chartered
credit unions, we obtained information about the oversight procedures
during our structured interviews with the 13 states supervisory officials
and NCUA examiners. We also reviewed NCUA’s examiner guide and
memorandum of understanding between NCUA and states describing
NCUA’s procedures for conducting joint examinations of federally insured,
state-chartered credit unions with state regulators.

Finally, to study NCUA’s implementation of PCA, we reviewed CUMAA,
NCUA rules and regulations pertaining to PCA, and NCUA’s examiner
guide. We also analyzed data from NCUA on the number of credit unions
subject to PCA as of December 31, 2002. We interviewed agency officials
knowledgeable about this data and found that NCUA headquarters, as well
as the region, conducted reasonableness checks against the Form 5300
database, which contains the net-worth ratio used for PCA. When data
outliers were found, examiners were required to review the data for
accuracy and make any necessary corrections. We determined that the data
were sufficiently reliable for the purposes of this report. In addition, we
interviewed NCUA officials and examiners, state supervisory officials,
credit union officials, and officials of other federal financial regulatory
agencies to obtain their perspectives on PCA.




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Status of NCUSIF	          To evaluate the financial condition of NCUSIF, we obtained key financial
                           data about the fund from NCUA’s annual audited financial statements for
                           1991–2002. For 2002, we compared NCUSIF’s key performance measure,
                           which is the ratio of fund equity to insured shares (deposits), to key
                           performance measures of the Bank Insurance Fund, Savings Association
                           Insurance Fund, and American Share Insurance, the remaining private
                           insurer. We also reviewed NCUSIF’s estimated loss and overhead
                           administrative expenses transfer process and applicable internal controls.
                           We reviewed other relevant industry studies on deposit-insurance pricing
                           and loan-loss allowance. In addition, we interviewed NCUA officials,
                           industry trade groups, and officials of other federal financial regulatory
                           agencies to obtain their perspectives on the funding of NCUSIF, the
                           overhead transfer rate, and the loan-loss allowance.



Private Share Insurance	   To better understand the issues around share (deposit) insurance, we
                           reviewed and analyzed relevant studies on federal and private insurers for
                           both credit unions and other depository institutions.6 In addition, we
                           interviewed officials at NCUA, the Department of the Treasury, and FDIC to
                           obtain perspectives specific to private share insurance. We also obtained
                           views from credit union industry groups including the National Association
                           of Federal Credit Unions, National Association of State Credit Union
                           Supervisors, and CUNA.

                           To determine the extent to which private share insurance is permitted and
                           utilized by state-chartered credit unions, we conducted a survey of state
                           credit union regulators in all 50 states. Our survey had a 100-percent
                           response rate. In addition to the survey, we obtained and analyzed financial
                           and membership data of privately insured credit unions from a variety of
                           sources (NCUA, Credit Union Insurance Corporation, CUNA, and ASI—the
                           only remaining provider of primary share insurance). We found this
                           universe difficult to confirm because in our discussions with state
                           regulators, NCUA and ASI officials, and our review of state laws, we
                           identified other states that could permit credit unions to purchase private
                           share insurance.



                           6
                            The scope of our work was limited to primary share insurance, which is generally
                           mandatory for all credit unions (whereas excess share insurance is optional coverage above
                           primary share insurance).




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To determine the regulatory differences between privately insured credit
unions and federally insured, state-chartered credit unions, we identified
and analyzed statutes and regulations related to share insurance at the
state and federal levels.7 In addition, we interviewed officials at NCUA and
conducted interviews with officials at the state credit union regulatory
agencies from Alabama, California, Idaho, Indiana, Illinois, Maryland,
Nevada, New Hampshire, and Ohio. Finally, we analyzed NCUA’s
application of its conversion policies and looked at the cases of six credit
unions that terminated their federal share insurance and converted to
private share insurance in 2002 and 2003.

To identify factors influencing a credit union's decision to obtain private or
federal share insurance, we conducted structured interviews with officials
of both federally insured and privately insured credit unions. Specifically,
we interviewed management at 29 credit unions that, since 1990, had
converted from federal to private share insurance and management at 26
credit unions that had converted from private to federal share insurance.
We did not interview credit union management in states that did not permit
private insurance.

To determine the extent to which privately insured credit unions met
federal disclosure requirements, we identified and analyzed federal
consumer disclosure provisions in section 43 of the Federal Deposit
Insurance Act, as amended, and conducted unannounced site visits to 57
privately insured credit unions (49 main and 8 branch locations) in
Alabama, California, Illinois, Indiana, and Ohio.8 The credit union locations
were selected based on a convenience sample using state and city location
coupled with random selection of main or branch locations within each
city. About 90 percent of the locations we visited were the main institution
rather than a branch institution. This decision was based on the
assumption that if the main locations were not in compliance, then the
branch locations would probably not be in compliance either. Although
neither these site visits, nor the findings they produced, render a
statistically valid sample of all possible main and branch locations of
privately insured credit unions necessary in order to determine the “extent”
of compliance, we believe that what we found is robust enough, both in the


7
 We limited our analysis to those states with privately insured credit unions—Alabama,
California, Idaho, Indiana, Illinois, Maryland, Nevada, and Ohio.

12 U.S.C. § 1831t.
8




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aggregate and within each state, to raise concern about lack of disclosure
in privately insured credit unions. During each site visit, using a systematic
check sheet, we noted whether or not the credit union had conspicuously
displayed the fact that the institution was not federally insured (on signs or
stickers, for example).

In addition, from these same 57 sites visited, we collected a total of 227
credit union documents that we analyzed for disclosure compliance. While
section 43 requires depository institutions lacking federal deposit
insurance to disclose they are not federally insured in personal documents,
such as periodic statements, we did not collect them. We also conducted an
analysis of the Web sites of 78 privately insured credit unions, in all eight
states where credit unions are privately insured, to determine whether
disclosures required by section 43 were included. To identify these Web
sites, we conducted a Web search. We attempted to locate Web sites for all
212 privately insured credit unions; however, we were able to identify only
78 Web sites. We analyzed all Web sites identified. Finally, we interviewed
FTC staff to understand their role in enforcement of requirements of
section 43 for depository institutions lacking federal deposit insurance.

To understand how private share insurers operate, we conducted
interviews with officials at three private share insurers for credit unions—
ASI (Ohio), Credit Union Insurance Corporation (Maryland), and
Massachusetts Credit Union Share Insurance Corporation (Massachusetts).
Because ASI was the only fully operating provider of private primary share
insurance, ASI was the focus of our review.9 We obtained documents
related to ASI operations such as financial statements and annual audits
and analyzed them for the auditor’s opinion noting adherence with
accounting principles generally accepted in the United States. Additionally,
to understand the state regulatory framework for this remaining private
share insurer, we interviewed officials at the Ohio Department of
Insurance.




9
 As of December 2002, we identified two entities that provide private primary share
insurance to credit unions in the 50 states and the District of Columbia—ASI and Credit
Union Insurance Corporation (CUIC). However, CUIC in Maryland was in the process of
dissolution and, therefore, we did not include it in our analysis. During our review, we
learned that Massachusetts Credit Union Share Insurance Corporation only provides excess
deposit insurance, and therefore we did not include it in our analysis.




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Appendix II

Status of Recommendations from GAO’s 1991
Report

              We made 52 recommendations to Congress and the National Credit Union
              Administration (NCUA) in our 1991 report on the credit union industry and
              NCUA1 Of these, 28 were made to Congress, of which 8 were implemented
              or partially implemented as of September 2003. We made 24
              recommendations to NCUA, and 19 were implemented as of September
              2003. In addition, we issued one matter for congressional consideration.
              Congress partially addressed this matter.

              Our recommendations spanned the range of issues addressed in our 1991
              report, including

              •	 the condition of the credit union industry and the National Credit Union
                 Share Insurance Fund (NCUSIF),

              • credit union law and regulation,

              • supervision of credit unions,

              • NCUA’s management of failed credit unions,

              • corporate credit unions,

              • share insurance issues,

              • structural changes in NCUA, and

              • the evolution of credit unions’ role in the financial marketplace.

              NCUA implemented most of our recommendations to the agency. The key
              changes implemented by NCUA affected (1) corporate credit unions, (2)
              reporting requirements for credit unions, and (3) supervision of state-
              chartered credit unions. With respect to corporate credit unions, NCUA
              implemented various recommendations that established minimum capital
              requirements, limited investment powers of state-chartered corporate
              credit unions, increased detail and frequency of reporting requirements,
              and established a new unit in NCUA that is responsible for oversight,
              examination, and enforcement of corporate credit unions. We expect to
              review corporate credit unions following this study and to report in greater


              1
              U.S. General Accounting Office, Credit Unions: Reforms for Ensuring Future Soundness,
              GAO/GGD-91-85 (Washington, D.C.: July 10, 1991).




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Report





depth on issues affecting corporate credit unions. In the area of reporting
requirements, NCUA implemented a requirement in 1993 that all federally
insured credit unions with assets greater than $50 million file financial and
statistical reports (call reports) on a quarterly basis and as of July 1, 2002,
required all federally insured credit unions to file quarterly call reports.
Finally, NCUA affirmed its supervision of state-chartered and federally
insured credit unions by establishing examination goals, as well as
conducting examinations, at almost 16 percent of all state-chartered and
federally insured credit unions in 2002.

NCUA told us that it chose not to implement five of our recommendations
because it either disagreed with the recommendations (see
recommendation 24 in table 5), or believed it had already addressed the
recommendations (see recommendations 9, 11, 16, 17 in table 5). For
example, NCUA disagreed with our recommendation to separate its
supervision and insurance functions (see recommendation 24) and
believed it was unnecessary for credit unions to submit copies of their
supervisory committee audit reports to NCUA, as NCUA examiners
routinely review the reports as part of the examination process (see
recommendation 9).

Congress implemented or partially implemented 8 of the 28
recommendations we made, which (1) established minimum capital levels
for credit unions, (2) tightened commercial lending, and (3) established
annual audit requirements for credit unions with assets greater than $500
million. As discussed in table 5, among those not implemented are
recommendations dealing with NCUA’s Central Liquidity Facility (CLF)
(see recommendations 49-52) and the structure of NCUA (see
recommendations 43-48).2

See table 5 for our recommendations to NCUA and Congress and their
status as of August 31, 2003.




2
 CLF was created in 1978 to improve the general financial stability of credit unions by
serving as a liquidity lender to credit unions experiencing unusual or unexpected liquidity
shortfalls. The NCUA board oversees the CLF.




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                                              Appendix II

                                              Status of Recommendations from GAO’s 1991 

                                              Report





Table 5: Status of GAO Recommendations to NCUA and Congress, as of August 31, 2003

Issue                   GAO Recommendation to NCUA                   Status             Comments
1       Condition of    Require credit unions with assets greater    Implemented        Implemented in the March 31, 1993,
        credit unions   than $50 million to file financial and                          quarterly call reports for federally insured
        and NCUSIF      statistical reports quarterly.                                  credit unions with assets greater than $50
                                                                                        million. Effective July 1, 2002, NCUA
                                                                                        expanded rule to cover all federally insured
                                                                                        credit unions.
2                       Expand the information required from credit Implemented	        According to NCUA, it established a
                        unions with assets greater than $50 million                     reporting system for common bond data in
                        on the financial and statistical reports in the                 January 2002. The system monitors the
                        areas of asset quality, interest rate                           approvals of field of membership and is
                        sensitivity, management, and common                             called Generated Efficient National
                        bond.                                                           Information System for Insurances Services.
                                                                                        Also, NCUA investment rules require credit
                                                                                        unions that make certain investments to
                                                                                        perform shock tests on interest rate
                                                                                        sensitivity. According to NCUA, it performs
                                                                                        shock tests of credit unions using call report
                                                                                        data and expects examiners to make contact
                                                                                        with credit unions if potential problems are
                                                                                        identified.
3       Law and         Assess its real estate regulation and           Implemented     In June 1991, NCUA issued comprehensive
        regulation      strengthen it to help ensure the sound                          guidelines and since then issued a series of
                        underwriting of loans and their suitability for                 letters to credit unions to address this issue.
                        sale in the secondary market.
4                       Restrict the exclusions from its commercial Implemented         A final rule addressing all of our concerns
                        lending limit established in 1987 to help                       and recommendations went into effect in
                        ensure that credit unions are not used as                       January 1992. The rule established a limit on
                        vehicles underwriting large commercial                          the amount of loans that may be made to
                        ventures.                                                       one borrower to the greater of 15 percent of
                                                                                        reserves or $75,000.
5       Supervision     Clarify the purposes, unique values, and     Implemented        According to NCUA, the Office of
                        requirements for use of each of its off-site                    Examination and Insurance completed the
                        monitoring tools. Determine the appropriate                     requirements for the use of off-site
                        recipients of the tools and distribute them                     monitoring tools, such as the use of risk
                        accordingly, within each region.                                reports, in fiscal year 1995. Since then,
                                                                                        NCUA has adopted additional off-site
                                                                                        monitoring tools, such as the consolidated
                                                                                        balance sheet and scope workbook.
6                       Require documentation at the regional        Implemented        NCUA requires this review as part of the
                        office level of examiners’ reviews of all                       examination process and requires
                        credit union call reports.                                      documentation of the review in the
                                                                                        examination report.




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                                              Appendix II

                                              Status of Recommendations from GAO’s 1991 

                                              Report





(Continued From Previous Page)
Issue                   GAO Recommendation to NCUA                    Status            Comments
7                       Invoke its statutory authority to refuse to   Implemented	      According to NCUA, its examiner guide
                        accept state supervisors’ examinations                          addresses oversight of federally insured,
                        when a state regulatory authority lacks                         state-chartered credit unions, including
                        adequate independence from the credit                           processes to make an independent
                        union industry. Examine all NCUSIF-                             assessment of these credit unions. NCUA
                        insured credit unions in such states.                           affirms it is empowered by the Federal Credit
                                                                                        Union Act to examine any federally insured
                                                                                        credit union, including those where
                                                                                        questions are raised regarding the
                                                                                        independence of the state from the industry.
                                                                                        NCUA claims that use of this authority is
                                                                                        evidenced by having conducted exams at
                                                                                        15.6 percent of all federally insured, state-
                                                                                        chartered credit unions in 2002.
8                       Establish a policy goal for examination      Implemented        NCUA affirms that its regions have
                        frequency of state-chartered credit unions.	                    established goals that include monitoring the
                                                                                        examination cycles and supervision efforts of
                                                                                        each state. State examinations not
                                                                                        conducted within 18 months are tracked and
                                                                                        agreements are made and followed to bring
                                                                                        the state into compliance.
9                       Require all credit unions to submit copies of Not implemented   This recommendation pertains to federally
                        their supervisory committee audit reports to                    insured credit unions with less than $500
                        NCUA upon completion.	                                          million in assets. NCUA believes that the
                                                                                        1991 recommendation is unnecessary.
                                                                                        NCUA claims it reviews the supervisory
                                                                                        committee audits as a required step during
                                                                                        the risk-focused examination process.
10                      Conduct an Inspector General review            Implemented      The Inspector General completed quality 

                        focusing on NCUA’s handling of problem                          assurance reviews of each NCUA region as 

                        credit unions since mid-1990, specifically its                  of July 1994.

                        use of enforcement powers, and submit a 

                        report to the NCUA board.

11      NCUA’s          Require that waivers and special charges    Not implemented	    Under prompt corrective action, NCUA is
        management of   be authorized by the Director of the Office                     required to take various mandatory
        failed credit   of Examination and Insurance, the General                       supervisory actions against credit unions
        unions          Counsel, and the regional director.                             depending on their net worth ratio, including
                                                                                        requiring earnings transfers for credit unions
                                                                                        that are less than well capitalized—7 percent
                                                                                        net worth ratio or less. NCUA has
                                                                                        established guidelines under which regional
                                                                                        directors can grant earnings retention
                                                                                        waivers as well as charges to the reserve.
                                                                                        NCUA claims that its regional offices track
                                                                                        approval of waivers and charges.
12	                     Develop policy guidance concerning the        Implemented       NCUA maintains rules regarding waivers and
                        use of these provisions and monitor their                       special charges in Section 702 of its rules
                        use.                                                            and regulations.




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(Continued From Previous Page)
Issue                   GAO Recommendation to NCUA                      Status            Comments
13                      Adhere to the criteria for assisting credit     Implemented	      NCUA claims that the implementation of
                        unions.                                                           prompt corrective action in February 2000
                                                                                          greatly changed its ability to assist credit
                                                                                          unions. To address the issue of assistance to
                                                                                          credit unions, NCUA affirms that the board
                                                                                          approved a Special Assistance Program in
                                                                                          February 2001, and that it maintains a
                                                                                          Special Assistance Manual regarding the
                                                                                          documentation and quality of requests for
                                                                                          assistance. Finally, NCUA claims it has
                                                                                          implemented an approval process for
                                                                                          different levels of assistance to credit unions.
14      Corporate       Establish minimum capital requirements for Implemented            Section 704 of NCUA regulations requires a
        credit unions   corporate credit unions and U.S. Central                          minimum 4 percent capital ratio for retail, as
                        Credit Union, taking all risks into account.a                     well as wholesale, corporate credit unions,
                        In the interim, establish a minimum level                         such as U.S. Central Credit Union.
                        based on assets, and set a time frame for
                        achieving this level. This could be achieved
                        by increasing reserving requirements and
                        using subordinated debt arrangements,
                        such as membership capital share
                        deposits.
15                      Restrict the investment powers of state-        Implemented       NCUA’s corporate credit union rules apply to
                        chartered corporate credit unions to the                          all federally insured corporate credit unions.
                        limits imposed on federal corporate credit                        NCUA requires all nonfederally insured
                        unions.                                                           corporate credit unions to adhere to the
                                                                                          same rules as a condition of receiving
                                                                                          shares or deposits from federally insured
                                                                                          credit unions.
16                      Limit the investments of corporate credit       Not implemented   NCUA believes it is more appropriate to

                        unions and U.S. Central Credit Union in a                         establish concentration limits on capital 

                        single obligor to 1 percent of the investor’s                     rather than assets and established a 

                        total assets. Exceptions should include                           regulation limiting aggregate investments in

                        obligations of the U.S. Government,                               any single obligor to the greater of 50 

                        repurchase agreements that equal up to 2                          percent of capital or $5 million.

                        percent of assets, and all investments by

                        corporate credit unions in U.S. Central 

                        Credit Union.

17                      Limit loans to one borrower by corporate    Not implemented       NCUA believes it is more appropriate to set
                        credit unions and U.S. Central Credit Union                       limits based on capital instead of assets. In
                        to 1 percent of the lender’s assets. NCUA                         October 1997, the loan limit was 10 percent
                        should be authorized to make exceptions                           of capital—an amount we determined could
                        on a loan-by-loan basis.                                          exceed 1 percent of assets. As of January
                                                                                          2003, NCUA rules capped the maximum
                                                                                          aggregate loan amount to any one member
                                                                                          to 50 percent of capital for unsecured loans,
                                                                                          and 100 percent of capital for secured loans,
                                                                                          with exceptions. We view this as a departure
                                                                                          from the 1991 recommendation.




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(Continued From Previous Page)
Issue                  GAO Recommendation to NCUA                  Status             Comments
18                     Obtain more complete and timely             Implemented        According to NCUA, it requires corporate
                       information about corporate financial                          credit unions to submit monthly call reports
                       operations.                                                    to NCUA as well as information to
                                                                                      examiners. Also, NCUA affirms that it revises
                                                                                      the corporate call reports annually to ensure
                                                                                      proper supervision of corporate credit
                                                                                      unions.
19                     Establish a unit at NCUA headquarters that Implemented         According to NCUA, the NCUA board
                       would be responsible for corporate                             separated corporate credit union supervisory
                       oversight, examination, and enforcement                        responsibility from the Office of Examination
                       actions.                                                       and Insurance and created the Office of
                                                                                      Corporate Credit Unions in August 1994.
20                     Review the CAMEL rating system for          Implemented        In January 1999, NCUA implemented a
                       corporate credit unions to reduce the                          system for evaluating the risk associated
                       inconsistencies and focus more clearly on                      with corporate credit unions that is different
                       the component being rated.                                     from the CAMEL ratings used for other credit
                                                                                      unions. The system, known as the Corporate
                                                                                      Risk Information System, has 12 component
                                                                                      ratings regarding financial risk and risk
                                                                                      management.
21      Share          Place NCUSIF’s fiscal year on a calendar    Implemented        In November 1993, the NCUA Board of
        insurance      year.                                                          Directors approved the change to a fiscal
                                                                                      year based on the calendar year (January–
                                                                                      December), which became effective January
                                                                                      1, 1995.
22                     Reduce the time lag in adjusting NCUSIF’s   Implemented        According to NCUA, establishing a fiscal
                       financing.	                                                    year based on the calendar year for NCUSIF
                                                                                      reduced time lags in collection of
                                                                                      assessments from 7 to 3 months.
23                     Require credit unions to exclude their 1  Implemented          Action taken by Congress addressed our 

                       percent deposit in NCUSIF from both sides                      concern. Minimum net worth ratios

                       of their balance sheet when assessing                          established in the 1998 Credit Union

                       capital adequacy. Then, that amount would                      Membership Access Act (CUMAA), which is 

                       not be counted as credit union capital.                        7 percent for well-capitalized credit unions,

                                                                                      compensated for the NCUSIF deposit (1
                                                                                      percent of assets) that credit unions account
                                                                                      for on their balance sheet. The minimum
                                                                                      capital ratio for banks insured by FDIC is 6
                                                                                      percent.
24	     NCUA           Immediately establish separate supervision Not implemented     NCUA disagrees with this recommendation.
        structural     and insurance offices that report directly to
        changes        the board.




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(Continued From Previous Page)
Issue                   GAO Recommendation to Congress              Status              Comments
25      Condition of    Hold annual oversight hearings at which the Not implemented     As of September 1994, the Senate did not
        credit unions   NCUA board testifies on the condition of                        hold hearings, but the House Banking
        and NCUSIF      credit unions and NCUSIF and assesses                           Committee had. NCUA has no objections to
                        risk areas and reports on NCUA’s                                this recommendation.
                        responses.
26      Law and         Amend Federal Credit Union Act (FCUA) to Implemented            Implemented as part of prompt corrective
        regulation      require NCUA to establish minimum capital                       action in CUMAA (August 1998) and
                        levels for credit unions no less stringent                      promulgated as NCUA regulation in
                        than those applicable to other insured                          February 2000.
                        depository institutions, providing for an
                        appropriate phase-in period.
27                      Amend the FCUA to limit the amount that      Not implemented	   NCUA’s position has changed since 1994,
                        credit unions can loan or invest in a single                    when it believed a 5 percent of assets
                        obligor, other than investments in direct or                    limitation on exposure to single obligors
                        guaranteed obligations of the U.S.                              would be satisfactory. According to NCUA,
                        Government or in the credit union’s                             the 5-percent limitation is too restrictive for
                        corporate credit union, to not more than 1                      some credit unions, especially for smaller
                        percent of the credit union’s total assets.                     credit unions. According to NCUA, its
                        Limits permitted in 1991 with respect to                        current regulations for credit unions do not
                        credit union service organizations should                       provide specific limits, but provides flexibility
                        continue, and exposures of not more than 2                      to well-run and managed credit unions.
                        percent of assets should be provided for in                     NCUA believes that setting obligor limitations
                        repurchase agreement transactions.                              is better handled through the agency’s
                        Authorize NCUA to set a higher limit for                        regulation process because it permits
                        secured consumer loans made by small                            prompt changes, is considerate of the fluid
                        credit unions and for overnight funds                           financial environment, and maintains
                        deposited with correspondent institutions.                      emphasis on overall risk.

28                      Amend the FCUA to require NCUA to           Implemented         Implemented as part of CUMAA in 1998 and
                        tighten the commercial lending regulation                       promulgated as NCUA regulation in May
                        and include an overall limit.                                   1999. NCUA established the aggregate limit
                                                                                        on a credit union’s outstanding member
                                                                                        business loans to the lesser of 1.75 times the
                                                                                        credit unions’ net worth or 12.25 percent of
                                                                                        total assets.
29                      Amend the FCUA to modify borrowing           Not implemented	   NCUA believes that this recommendation is
                        authority and specify that credit unions may                    not necessary because Congress indirectly
                        not borrow for the purpose of growth,                           addressed this issue through PCA provisions
                        unless prior approval of NCUA is obtained.                      in CUMAA in 1998. According to NCUA, if a
                                                                                        credit union is undercapitalized under PCA,
                                                                                        then growth can be restricted. Also
                                                                                        according to NCUA, PCA requirements
                                                                                        indirectly influence borrowing because
                                                                                        borrowing could impact net worth
                                                                                        classification.

                                                                                        For clarification, we intended this
                                                                                        recommendation to apply to all credit unions,
                                                                                        not just those under PCA.




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(Continued From Previous Page)
Issue                  GAO Recommendation to Congress            Status             Comments
30                     Amend the FCUA to require credit unions to Implemented       Implemented as part of comprehensive

                       adequately disclose that dividends on                        banking reforms in 1991. NCUA issued a 

                       shares and other accounts cannot be                          regulation under the Truth in Savings Act.

                       guaranteed in advance but are dependent 

                       on earnings.

31                     Amend the FCUA to require all insured     Not implemented    NCUA is opposed to this recommendation
                       credit unions to obtain NCUA permission                      and believes that current regulations are
                       before opening a new branch.	                                appropriate. NCUA’s regulations require
                                                                                    federally insured credit unions with over $1
                                                                                    million in assets to obtain NCUA approval to
                                                                                    invest in fixed assets, including branch
                                                                                    offices, if the aggregate of all such
                                                                                    investments exceeds 5 percent of shares
                                                                                    and retained earnings. Credit unions eligible
                                                                                    under NCUA’s Regulatory Flexibility
                                                                                    Program are exempt from this requirement.
32                     Amend the FCUA to require credit unions     Partially        Implemented as part of CUMAA in 1998 and
                       above a minimum size to obtain annual       implemented      promulgated as NCUA regulation in July
                       independent certified public accountant                      1999. Credit unions with assets greater than
                       audits and to make annual management                         $500 million are required to obtain annual
                       reports on internal controls and compliance                  independent certified public accountant
                       with laws and regulations.                                   audits. However, no requirement has been
                                                                                    made requiring annual management reports
                                                                                    on internal controls and compliance with
                                                                                    laws and regulations.
33                     Amend the FCUA to authorize and require Not implemented      NCUA agrees with this recommendation.

                       NCUA to compel a federally insured, state-

                       chartered union to follow the federal

                       regulations in any area in which the credit 

                       union’s powers go beyond those permitted

                       federally chartered credit unions and are 

                       considered to constitute a safety and 

                       soundness risk.

34      NCUA’s        Amend FCUA to authorize NCUA to provide Not implemented       According to NCUA, it maintains a policy of
        management of assistance in resolving a failing credit union                assisting failing credit unions at the least
        failures      only when it is less costly than liquidation or               cost. Also, NCUA believes that changes to
                      essential to provide adequate depository                      the FCUA are unnecessary because NCUA
                      services in the community.                                    has enough flexibility to assist failing credit
                                                                                    unions when the benefits of preserving the
                                                                                    credit union outweigh the cost.
35                     Require NCUA to maintain documentation    Not implemented    According to NCUA, its policies and
                       supporting its resolution decisions,                         practices emphasize the importance of
                       including the statistical and economic                       maintaining documentation of resolutions
                       assumptions made.                                            and that decisions are supported. In
                                                                                    addition, and according to NCUA, it actively
                                                                                    updates expectations and processes for
                                                                                    retrieving and maintaining data through the
                                                                                    revision of the Examiner’s Guide, Accounting
                                                                                    Manual, Directives, Special Actions Manual,
                                                                                    and Guidance to Credit Unions.



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(Continued From Previous Page)
Issue                   GAO Recommendation to Congress            Status             Comments
36      Corporate       Amend the FCUA to confine insured credit Not implemented     While not expressly implemented, NCUA has
        credit unions   union investments in corporate credit                        taken some action in this area. NCUA
                        unions and U.S. Central Credit Union to                      regulations require nonfederally insured
                        those that have obtained deposit insurance                   corporate credit unions to agree to adhere to
                        from NCUSIF.                                                 its corporate credit union rule and to submit
                                                                                     to NCUA examinations as a condition of
                                                                                     receiving shares or deposits from federally
                                                                                     insured credit unions. According to NCUA,
                                                                                     there is only one corporate credit union that
                                                                                     is not federally insured.
37                      Require NCUA to establish a program to      Implemented	     NCUA’s regulations require corporate credit
                        promptly increase the capital of corporate                   unions to maintain a minimum capital ratio of
                        credit unions and establish minimum capital                  4 percent. In addition, NCUA may issue a
                        standards.                                                   capital directive to corporate credit unions to
                                                                                     achieve adequate capitalization within a
                                                                                     specified time frame by taking any action
                                                                                     deemed necessary, including increasing the
                                                                                     amount of capital to specific levels. NCUA’s
                                                                                     corporate credit union rule also imposes an
                                                                                     earnings retention requirement of either 10
                                                                                     or 15 basis points per annum if a corporate
                                                                                     credit union’s retained earnings ratio falls
                                                                                     below 2 percent.
38      Share           Require credit unions to expense the 1     Implemented	      We determined that Congress’ passage of
        insurance       percent deposit in NCUSIF over a                             CUMAA, which set net worth levels for credit
                        reasonable period of time—to be                              unions 1 percent higher to compensate for
                        determined by NCUA. At the same time,                        NCUSIF’s accounting of the deposit as an
                        emphasize that the assets represented by a                   asset, addressed our concerns about the
                        failed credit union’s insurance deposit                      double counting of capital at NCUSIF and
                        should be available first to NCUSIF. This                    credit unions. We determined that the
                        action should be coordinated with and                        recommendation regarding NCUSIF’s
                        consistent with any legislation to                           access to the assets of a failed credit union
                        recapitalize the Bank Insurance Fund in                      has not been implemented, but we
                        order to avoid placing credit unions at a                    determined that this recommendation is
                        competitive disadvantage.                                    implemented because our greatest concern
                                                                                     was addressed regarding the double
                                                                                     counting of capital between NCUSIF and
                                                                                     credit unions.




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                                            Status of Recommendations from GAO’s 1991 

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(Continued From Previous Page)
Issue                  GAO Recommendation to Congress                Status            Comments
39                     Amend the FCUA to establish an available      Implemented	      In passing CUMAA in August 1998,
                       assets ratio for NCUSIF.                                        Congress amended the FCUA to establish a
                                                                                       minimum 1.0 percent available assets ratio
                                                                                       for NCUSIF. In addition, the NCUA board is
                                                                                       to make a distribution to insured credit
                                                                                       unions after each calendar year if, at the end
                                                                                       of the calendar year: the NCUSIF’s available
                                                                                       assets ratio exceeds 1.0 percent, any loans
                                                                                       from the federal government as well as
                                                                                       interest on those loans have been repaid,
                                                                                       and NCUSIF’s equity ratio exceeds the
                                                                                       normal operating level.
40                     Amend the FCUA to authorize NCUA to           Implemented	      Under CUMAA, Congress authorized NCUA
                       raise the basic NCUSIF equity ratio,                            to assess a premium charge on insured
                       available assets ratio, and premiums, and                       credit unions if NCUSIF’s equity ratio was
                       delete NCUSIF ability to set a normal                           less than 1.3 percent and the premium
                       operating level below the statutory                             charge would not exceed the amount
                       minimum.                                                        necessary to restore the equity ratio to 1.3
                                                                                       percent. Congress also defined NCUSIF’s
                                                                                       normal operating level as an equity ratio to
                                                                                       be specified by the NCUA board between 1.2
                                                                                       and 1.5 percent. However, Congress set the
                                                                                       available assets ratio at 1.0 percent with no
                                                                                       authority given to NCUA to change it.

41                     Amend the FCUA to provide for additional  Not implemented       NCUA believes that borrowing authority is
                       NCUA borrowing from Treasury on behalf of                       appropriate so long as the CLF and NCUSIF
                       NCUSIF.                                                         continue to have borrowing authority.

42                     Amend the FCUA to place NCUSIF in a           Not implemented   NCUA sees no compelling reason to make

                       position second to general creditors but                        this change.

                       rank this position ahead of uninsured

                       shares.

43      NCUA           Amend the FCUA to require that NCUA, in       Not implemented   NCUA believes there is no need for
        structural     consultation with Congress and the credit                       legislative change, as PCA provisions in
        changes        union industry, to identify specific unsafe                     CUMAA address declining net worth levels in
                       and unsound practices and conditions that                       credit unions.
                       merit enforcement action, identify the
                       appropriate corrective action, and
                       promulgate these requirements by
                       regulation.
44                     Amend the FCUA to require NCUA to take        Not implemented   Same as above.
                       appropriate enforcement action when
                       unsafe and unsound conditions or
                       practices, as specified in law or NCUA
                       regulations, are identified.




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(Continued From Previous Page)
Issue                  GAO Recommendation to Congress              Status              Comments
45                     Amend the FCUA to provide for a five-        Not implemented    NCUA is opposed to this recommendation.

                       member NCUA board, with two members 

                       ex officio, (the Chairman of the Federal

                       Reserve Board and the Secretary of the

                       Treasury). Authorize the two ex officio 

                       members to delegate their authority to 

                       another member of the Federal Reserve 

                       Board or to another official of the

                       Department of the Treasury who is 

                       appointed by the President with the advice 

                       and consent of the Senate.

46                     Consider placing credit union’s examination Not implemented     NCUA opposes this recommendation 

                       and supervision functions under a single                        because it believes the change would affect 

                       federal regulator once such an entity is                        the identity of credit unions, limit the financial

                       operating effectively, if there is broad reform                 choices for consumers, create competing 

                       of the depository institution regulatory                        and conflicting priorities for the single 

                       structure. The insurance function could                         regulator, and stifle the financial

                       then be placed under FDIC or under a                            marketplace.

                       separate entity.

47                     Remove the power of federally chartered     Not implemented     NCUA has no objection to this
                       credit unions to borrow from Farm Credit                        recommendation.
                       Banks, as provided for in FCUA.
48                     Amend the Community Development Credit Not implemented          NCUA opposes this recommendation
                       Union Revolving Fund Transfer Act to                            because such a change would create
                       designate an entity other than NCUA as                          additional bureaucratic requirements for
                       administrator of the revolving fund.	                           small financial institutions. According to
                                                                                       NCUA, the agency does not receive
                                                                                       appropriations for administering the program
                                                                                       and funds the program through the operating
                                                                                       and overhead transfer fees collected from
                                                                                       both federally chartered and federally
                                                                                       insured credit unions.
49                     Dissolve the CLF, as established by Title III Not implemented   NCUA opposes this recommendation.
                       of the FCUA.
50                     If CLF continues to operate, sharply reduce Not implemented     NCUA opposes this recommendation and 

                       CLF borrowing authority from the current                        believes that restricting CLF’s capacity could 

                       level of 12 times subscribed capital and                        undermine its purpose.

                       surplus.

51                     If CLF continues to operate, require the   Not implemented      NCUA believes that the rates of CLF loans
                       terms and conditions of CLF loans to be no                      are prudent. According to NCUA, rates on
                       more liberal than those made by the                             CLF loans to credit unions are based on the
                       Federal Reserve.                                                Federal Financing Bank (FFB) fixed rate, as
                                                                                       the CLF borrows from the FFB. Furthermore,
                                                                                       according to NCUA, FFB rates are related to
                                                                                       U.S. Treasury rates.




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(Continued From Previous Page)
Issue                              GAO Recommendation to Congress                         Status                Comments
52                                 If CLF continues to operate, prohibit CLF      Not implemented               According to NCUA, CLF and NCUSIF are 

                                   loans or guarantees of any kind to NCUSIF,                                   distinct entities and CLF does not extend

                                   and, in the event the NCUA board certifies                                   loans or guarantees to NCUSIF.

                                   that CLF does not have sufficient funds to 

                                   meet liquidity needs of credit unions, 

                                   authorize the Department of the Treasury to 

                                   lend to NCUSIF, rather than to CLF, in order 

                                   to meet such needs.

Matter for congressional consideration
           Credit unions’          If credit unions are to remain distinct from  Partially 
                    In passing CUMAA in August 1998,
           role in the             other depository institutions because, in     implemented
                   Congress established membership limits for
           financial               part, of their common-bond membership 
                                      federally chartered credit unions with respect
           marketplace             requirement, and if this requirement is 
                                    to common-bond and community-chartered
                                   intended to further the safe and sound 
                                     credit unions. Furthermore, Congress
                                   operation of credit unions, consider stating
                                established numerical limitations for groups
                                   this general intent in legislation and 
                                     to be eligible for inclusion in multiple
                                   establish guidelines on the limits of 
                                      common-bond credit unions and established
                                   occupational, associational, and community 
                                 geographical guidelines for community credit
                                   common bonds as well as the purpose and 
                                    unions.
                                   limits of multiple group charters. These 

                                   guidelines should apply to all federally 
                                   However, the legislation only applied to
                                   insured credit unions.
                                                      federally chartered credit unions. It did not
                                                                                                                apply to federally insured,state-chartered
                                                                                                                credit unions, which held 46 percent of total
                                                                                                                industry assets as of December 31, 2002.
                                                                                                                Therefore, this recommendation is partially
                                                                                                                implemented.
Sources: GAO; NCUA; Department of Treasury; Federal Register; CUMAA.
                                                               a
                                                                U.S. Central Credit Union, founded in 1974, solely assists corporate credit unions with financial
                                                               services, including investment, liquidity, and cash management products and services; risk
                                                               management and analytic capabilities; settlement, funds transfer and payment services; and
                                                               safekeeping and custody services. It is owned and directed by its member corporate credit unions.




                                                               Page 112                                            GAO-04-91 Changes in Credit Union Industry
Appendix III

Financial Condition of Federally Insured
Credit Unions

                            As we reported earlier, the financial condition of federally insured credit
                            unions—the industry—has improved since 1991, based on various
                            measures such as capital ratios, assets, and regulatory ratings. This
                            appendix provides greater detail on these measures. We used annual call
                            reports from December 31, 1992, to December 31, 2002, as well as a
                            database of regulatory ratings from the National Credit Union
                            Administration (NCUA) for the same time period. In addition, we used
                            consolidated data based on annual call reports for banks and thrifts in
                            order to compare them with credit unions.



Industry Capital Ratios     The capital of federally insured credit unions as a percentage of total
Have Increased over Time	   industry assets—the capital ratio—grew from 8.10 to 10.86 percent from
                            December 31, 1992, to December 31, 2002 (see fig. 18). Over this period,
                            larger credit unions had consistently higher capital ratios than smaller
                            credit unions.




                            Page 113                               GAO-04-91 Changes in Credit Union Industry
                          Appendix III
                          Financial Condition of Federally Insured
                          Credit Unions




                          Figure 18: Capital Ratios in Federally Insured Credit Unions, 1992–2002
                          Capital ratios

                          16


                          14


                          12


                          10


                           8


                           6


                           4


                           2


                           0
                               1992         1993      1994    1995   1996     1997      1998      1999     2000      2001      2002

                                          Small

                                          Medium

                                          Large

                                          All credit unions
                          Source: Call report data.

                          Note: In this figure, small credit unions are defined as those with less than $10 million in assets;
                          medium credit unions are those with assets ranging from $10 million to less than $50 million in assets;
                          and large credit unions are those with $50 million or more in assets. The capital ratio of a given size
                          category is calculated as the total equity of all credit unions in that size category divided by the total
                          assets of all credit unions in that size category.




Growth of the Industry	   The credit union industry grew dramatically since December 31, 1992, as
                          measured by assets and the value of shares (see table 6). From December
                          31, 1992, to December 31, 2002, assets in federally insured credit unions
                          increased from $258 billion to $557 billion, or 116 percent, while shares
                          increased from $233 billion to $484 billion, or 108 percent. From December
                          31, 1992, to December 31, 2000, the annual percentage growth rates of
                          assets and shares generally fluctuated from around 3 percent to around 7
                          percent, with a significant rise in 1998 to over 10 percent. In the last 2 years
                          (2001–2002), however, the annual percentage growth in assets and shares
                          again rose sharply. According to NCUA officials, the more recent growth in
                          assets and shares reflected a “flight to safety” on the part of consumers



                          Page 114                                              GAO-04-91 Changes in Credit Union Industry
Appendix III
Financial Condition of Federally Insured
Credit Unions




seeking low-risk investments in reaction to the generally depressed
condition of the securities market.



Table 6: Federally Insured Credit Union Growth in Assets and Shares, 1992–2002

Dollars in billions
                                   Assets                             Shares
                                            Percentage                         Percentage
 December 31                Dollar value        growth        Dollar value         growth
1992                            $258.37                           $233.01
1993                             277.13           7.26             246.96             5.99
1994                             289.45           4.45             255.02             3.26
1995                             306.64           5.94             270.14             5.93
1996                             326.89           6.60             286.71             6.13
1997                             351.17           7.43             307.18             7.14
1998                             388.70          10.69             340.00            10.68
1999                             411.42           5.84             356.92             4.98
2000                             438.22           6.51             379.24             6.25
2001                             501.54          14.45             437.13            15.27
2002                             557.07          11.07             484.19            10.77
Source: Call report data.


As noted earlier, the industry has consolidated and become slightly more
concentrated. As of December 31, 1992, there were 12,595 credit unions,
but by December 31, 2002, that number had declined to 9,688 (see table 7).
The number of credit unions with less than $10 million in assets declined
during this period, while the number of credit unions with more than $30
million in assets grew. Those credit unions with over $100 million in assets
had around 52 percent of total industry assets as of December 31, 1992, but
by December 31, 2002, credit unions of this size had around 75 percent of
total industry assets. The 50 largest credit unions held 18 percent of
industry assets in 1992, but by 2002 the 50 largest credit unions held 23
percent of industry assets.




Page 115                                         GAO-04-91 Changes in Credit Union Industry
                                                     Appendix III
                                                     Financial Condition of Federally Insured
                                                     Credit Unions




Table 7: Distribution of Credit Unions by Asset Size, 1992 and 2002

                                                                  Asset size (dollars in millions)
December                               Less than    .5 to less   2 to less   10 to less    30 to less    50 to less          100
31                                             .5       than 2    than 10      than 30       than 50      than 100       or more          Total
1992
                      Number of
                      credit unions        1,696        2,818       4,304         2,121          625           519           512         12,595
                      Percent of
                      credit unions        13.47        22.37       34.17         16.84         4.96          4.12           4.07           100
                      Total assets 

                      (dollars in

                      millions)         $433,203 $3,243,850 $21,230,518 $37,355,589 $24,331,358 $36,133,301 $135,637,393 $258,365,211

                      Percent of 

                      total assets          0.17         1.26         8.22        14.46         9.42         13.99         52.50
           100
2002
                      Number of
                      credit unions          620        1,327       3,022         2,121          801           751         1,046          9,688
                      Percent of
                      credit unions         6.40        13.70       31.19         21.89         8.27          7.75         10.80            100
                      Total assets 

                      (dollars in

                      millions)         $165,054 $1,543,306 $16,181,104 $37,913,707 $31,135,123 $52,762,245 $417,374,026 $557,074,565

                      Percent of 

                      total assets          0.03         0.28          2.9         6.81         5.59          9.47         74.92
           100
Source: Call report data.


                                                     As industry assets have increased, the composition of these assets has
                                                     changed. Total loans as a percentage of total assets increased from 54
                                                     percent as of December 31, 1992, to 62 percent as of December 31, 2002
                                                     (see table 8). While consumer loans, which broadly consist of unsecured
                                                     credit card loans, new and used vehicle loans, and certain other loans to
                                                     members, remained the largest category of credit union loans, the most
                                                     significant growth in credit union loan portfolios was in real estate loans.
                                                     These loans grew from 19 percent of total assets as of December 31, 1992,
                                                     to 26 percent of total assets as of December 31, 2002.




                                                     Page 116                                        GAO-04-91 Changes in Credit Union Industry
                                                     Appendix III
                                                     Financial Condition of Federally Insured
                                                     Credit Unions




Table 8: Asset Composition of Credit Unions as a Percentage of Total Assets, 1992–2002

Figures in percent
                            Dec. 31,   Dec. 31,   Dec. 31, Dec. 31, Dec. 31,      Dec. 31, Dec. 31, Dec. 31,      Dec. 31,   Dec.31,   Dec. 31,
                              1992       1993       1994     1995     1996          1997     1998     1999           2000      2001      2002
Cash                           2.42       2.27       2.18        2.32      2.22      2.25        2.28      6.39      7.64      10.09      9.62
Consumer
loans                         29.77      31.35      35.83       37.70     39.01     38.57       35.59     36.31     37.61      33.91     31.47
Real estate
loans                         19.05      18.67      19.96       20.14     21.63     22.92       23.35     25.28     26.61      26.27     26.41
Other loans                    5.19       4.94       4.97        4.82      4.76      4.66        4.30      4.43      4.55       4.11      3.63
Total loans                   54.01      54.96      60.76       62.66     65.40     66.15       63.24     66.02     68.77      64.29     61.51
U.S.

government 

and agency 

securities                    16.26      18.05      18.33       16.41     15.63     14.52       13.67     13.19     11.99      12.32     13.89

Investments in 

corporate credit

unions                        13.33      11.41       8.28        8.07      6.97      7.41        9.29      5.15      3.36       3.85      4.77

Bank and thrift 

deposits                       0.00       0.00       5.52        5.43      4.87      4.71        5.46      3.78      2.85       3.71      4.18

Other 

investments                    1.05       1.13       1.08        1.02      0.85      0.92        1.29      1.44      1.35       1.47      1.56

Fixed and other 

assets                        12.93      12.17       3.85        4.09      4.06      4.04        4.77      4.03      4.04       4.27      4.47

Total assets ($ 

in billions)                $258.37    $277.13    $289.45   $306.64     $326.89   $351.17   $388.70     $411.42   $438.22    $501.54   $557.07

Source: Call report data.




                                                     Page 117                                       GAO-04-91 Changes in Credit Union Industry
                                          Appendix III
                                          Financial Condition of Federally Insured
                                          Credit Unions




                                          Despite the growth in credit union real estate loans, credit unions had a
                                          lower percentage of real estate loans to total assets (26 percent) than their
                                          peer group banks and thrifts, which had 37 percent of real estate loans to
                                          total assets (see table 9). Credit unions had a significantly higher
                                          percentage of consumer loans to total assets (31 percent) compared with
                                          their peer group banks and thrifts (8 percent). These banks and thrifts,
                                          however, had a significantly higher percentage of agricultural and
                                          commercial loans to total assets (12 percent) compared with credit unions
                                          (slightly more than 1 percent).



Table 9: Comparison of the Loan Portfolios of Federally Insured Credit Unions with Peer Group Banks and Thrifts, as of 2002


                                               Credit unions                                                     Banks
Loan types                                           Dollar value           Percent                               Dollar value           Percent
Consumer loans                                $175,300,187,240                 31.47                        $189,841,654,000                 7.53
Real estate loans                               147,131,474,868                26.41                         944,031,005,000                37.44
Agricultural and commercial
loans                                              6,644,982,024                1.19                         303,205,739,000                12.03
Other loans                                      13,571,878,174                 2.44                           65,472,408,000                2.60
Total loans                                   $342,648,522,306                 61.51                      $1,502,550,806,000                59.60
Other assets                                    214,426,042,531                38.49                       1,018,695,188,000                40.40
Total assets                                  $557,074,564,837                   100                      $2,521,245,994,000                  100
Number of institutions                                       9,688                                                         7,829
Source: Call report data.

                                          Note: Data are as of December 31, 2002, and are based on all federally insured credit unions and
                                          banks and thrifts filing call reports. Insured U.S. branches of foreign-chartered banks, banks with more
                                          than $18 billion in assets, and banks we determined had emphases in credit card or mortgage loans
                                          are excluded.




Credit Union Profits Have                 The profitability of credit unions, as measured by the return on average
Been Relatively Stable in                 assets, has been relatively stable in recent years. According to this
                                          measure, credit union profitability was higher in the early to mid-1990s
Recent Years
                                          than in the late 1990s and early 2000s. While declining from 1993 through
                                          1999, the return on average assets has since stabilized. It has generally
                                          hovered around 1 percent, which, by historical banking standards, is a
                                          performance benchmark, and it was reported at 1.07 as of December 31,
                                          2002 (see fig. 19). Profits are an especially important source of capital for
                                          credit unions because they are mutually owned institutions that cannot sell
                                          equity to raise capital.



                                          Page 118                                             GAO-04-91 Changes in Credit Union Industry
                            Appendix III
                            Financial Condition of Federally Insured
                            Credit Unions




                            Figure 19: Profitability of Federally Insured Credit Unions, 1992–2002
                            Percentage

                            1.6


                            1.4


                            1.2


                            1.0


                            0.8


                            0.6


                            0.4


                            0.2


                            0.0
                                  1992        1993      1994   1995   1996     1997      1998     1999      2000     2001     2002
                            Source: Call report data.


                            Notes: Profitability is measured by the return on average assets, in which average assets are the
                            simple average of total assets as of the current period and prior yearend. The return on average assets
                            was not available for 1992 since we did not have 1991 total assets data.




Credit Unions’ Regulatory   The number of credit unions with a CAMEL rating of 1 (strong) increased
Ratings Have Improved       from 1,082 (9 percent) in 1992 to 2,186 (23 percent) in 2002 (see fig. 20).
                            During the same time period, institutions classified as problem credit
Since December 1992
                            unions—those with CAMEL ratings of 4 (poor) or 5 (unsatisfactory)—
                            decreased from 578 (5 percent) in 1992 to 211 (2 percent) in 2002.




                            Page 119                                             GAO-04-91 Changes in Credit Union Industry
                                                       Appendix III
                                                       Financial Condition of Federally Insured
                                                       Credit Unions




Figure 20: Federally Insured Credit Unions, by CAMEL Rating, 1992–2002

        CAMEL rating

Year    Strong                          Satisfactory                                          Flawed                             Poor          Unsatisfactory


1992        8.59                                                               54.65                                     32.17          4.18    0.41


1993            9.46                                                             57.42                               29.87          3.14       0.11


1994            11.53                                                              58.86                            27.1           2.45        0.06


1995               13.69                                                               58.9                      25.10             2.18        0.14


1996                    17.91                                                     57.63                    22.00                   2.34        0.11


1997                       20.44                                                56.15                    20.62                      2.7        0.10


1998                       21.17                                                55.85                    20.26                     2.57         0.16


1999                       20.56                                                 56.51                   19.87                      2.86        0.20


2000                         22.91                                               57.54                 17.61                       1.85        0.09


2001                            24.17                                           55.74                  18.04                       1.97        0.08


2002                         22.57                                              55.67                   19.58                      2.08        0.10


Source: NCUA.




                                                       Page 120                                        GAO-04-91 Changes in Credit Union Industry
Appendix IV

Comparison of Bank and Credit Union
Distribution of Assets

                                                                     Figures 21, 22, and 23 illustrate the marked size disparity between credit
                                                                     unions and institutions insured by the Federal Deposit Insurance
                                                                     Corporation (FDIC), with figure 21 highlighting how small most credit
                                                                     unions are.1 At the end of 2002, the largest credit union had less than $18
                                                                     billion in assets, while the largest bank, with over $600 billion in assets, was
                                                                     larger than the entire credit union industry.



Figure 21: Total Assets of All Credit Unions and All Banks, as of 2002
Number of institutions
                                                                                    70             67
                                                                                                              Institutions with more than $5 billion in total assets
10,000                                                                                                                                                                        credit unions- 3
                                                                                    60                                                                                        banks-        173
          8,642

                                                                                    50
 8,000

                                                                                    40                                                         37

                                                                                                                  29
 6,000                                                                              30

                4,681                                                               20                                          16
                                                                                                                                                             14

 4,000                                                                              10                                                                                    8
                                                                                           2                            1                                                               2
                                                                                                          0                           0              0            0                0
                                  2,538                                                0
                                                                                               $10        $15           $20           $50            $100         $500             $750
 2,000
                                                1,073
                            602                               506
                                          240                            383
                                                        133         68         2    67         0     29       1    16       0    37       0     14       0    8       0       2
      0
             $0.1            $0.25         $0.5           $1         $5          $10           $15            $20           $50           $100           $500         $750
          Total assets (in billions)


                                                                               Credit unions

                                                                               Banks

Source: Call report data.

                                                                     Note: Data are as of December 31, 2002, and include all federally insured credit unions and banks and
                                                                     thrifts filing call reports. Insured U.S. branches of foreign-chartered institutions are excluded. This
                                                                     figure depicts the number of institutions in a particular asset size category. Each category represents a
                                                                     range—for example, the first category includes all institutions with assets of $100 million or less, while
                                                                     the second category includes all institutions with assets greater than $100 million and less than or
                                                                     equal to $250 million, up to the last category, which includes all institutions with assets greater than
                                                                     $500 million and less than or equal to $750 billion.




                                                                     1
                                                                      Throughout the report, we refer to institutions insured by the FDIC interchangeably as
                                                                     “banks,” “banks and thrifts,” and “FDIC-insured institutions.”




                                                                     Page 121                                                                 GAO-04-91 Changes in Credit Union Industry
                                                                         Appendix IV

                                                                         Comparison of Bank and Credit Union 

                                                                         Distribution of Assets





Figure 22: Total Assets of Credit Unions and Banks with Less Than $100 Million in Assets, as of 2002
Number of institutions

3,500


3,000


2,500


2,000


1,500


1,000


  500


     0
              0


                       00


                                 00


                                           00


                                                     00


                                                               00


                                                                         00


                                                                                   00


                                                                                              00


                                                                                                        00


                                                                                                                  00


                                                                                                                            00


                                                                                                                                      00


                                                                                                                                                00


                                                                                                                                                          00


                                                                                                                                                                    00


                                                                                                                                                                              00


                                                                                                                                                                                        00


                                                                                                                                                                                                  00



                                                                                                                                                                                                            0
         ,00




                                                                                                                                                                                                        ,00
                  0,0


                            5,0


                                      0,0


                                                5,0


                                                          0,0


                                                                    5,0


                                                                              0,0


                                                                                          5,0


                                                                                                   0,0


                                                                                                             5,0


                                                                                                                       0,0


                                                                                                                                 5,0


                                                                                                                                           0,0


                                                                                                                                                     5,0


                                                                                                                                                               0,0


                                                                                                                                                                         5,0


                                                                                                                                                                                   0,0


                                                                                                                                                                                             5,0
         $5




                                                                                                                                                                                                       00
                  $1


                            $1


                                      $2


                                                $2


                                                          $3


                                                                    $3


                                                                              $4


                                                                                         $4


                                                                                                   $5


                                                                                                             $5


                                                                                                                       $6


                                                                                                                                 $6


                                                                                                                                           $7


                                                                                                                                                     $7


                                                                                                                                                               $8


                                                                                                                                                                         $8


                                                                                                                                                                                   $9


                                                                                                                                                                                             $9


                                                                                                                                                                                                       $1
         Total assets (in thousands)


                                                                                        Credit unions

                                                                                        Banks

Source: Call report data.

                                                                         Note: Data are as of December 31, 2002, and include all federally insured credit unions and banks and
                                                                         thrifts filing call reports. Insured U.S. branches of foreign-chartered institutions are excluded. This
                                                                         figure depicts the number of institutions in a particular asset size category. Each category represents a
                                                                         range—for example, the first category includes all institutions with assets of $5 million or less, while the
                                                                         second category includes all institutions with assets greater than $5 million and less than or equal to
                                                                         $10 million, up to the last category, which includes all institutions with assets greater than $95 million
                                                                         and less than or equal to $100 million.




                                                                         Page 122                                                                GAO-04-91 Changes in Credit Union Industry
                                                                                 Appendix IV

                                                                                 Comparison of Bank and Credit Union 

                                                                                 Distribution of Assets





Figure 23: Total Assets of Credit Unions with Less Than $5 Million in Assets, as of 2002
Number of credit unions

350


300


250


200


150


100


 50


  0
           0


                    0


                                 0


                                           00


                                                      00


                                                                 00


                                                                            00


                                                                                          00


                                                                                                     00


                                                                                                                00


                                                                                                                           00


                                                                                                                                      00


                                                                                                                                                 00


                                                                                                                                                            00


                                                                                                                                                                         00


                                                                                                                                                                                    00


                                                                                                                                                                                               00


                                                                                                                                                                                                          00


                                                                                                                                                                                                                     00


                                                                                                                                                                                                                                00
      ,00


                 ,00


                            ,00


                                          0,0


                                                     0,0


                                                                0,0


                                                                           0,0


                                                                                        0,0


                                                                                                    0,0


                                                                                                               0,0


                                                                                                                          0,0


                                                                                                                                     0,0


                                                                                                                                                0,0


                                                                                                                                                           0,0


                                                                                                                                                                       0,0


                                                                                                                                                                                   0,0


                                                                                                                                                                                              0,0


                                                                                                                                                                                                         0,0


                                                                                                                                                                                                                    0,0


                                                                                                                                                                                                                               0,0
      50


               00


                            50


                                     ,00


                                                ,25


                                                           ,50


                                                                      ,75


                                                                                    ,00


                                                                                               ,25


                                                                                                          ,50


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                                                                                                                                                                              ,00


                                                                                                                                                                                         ,25


                                                                                                                                                                                                    ,50


                                                                                                                                                                                                               ,75


                                                                                                                                                                                                                          ,00
   $2


               $5


                        $7


                                     $1


                                                $1


                                                           $1


                                                                      $1


                                                                                   $2


                                                                                               $2


                                                                                                          $2


                                                                                                                     $2


                                                                                                                                $3


                                                                                                                                           $3


                                                                                                                                                      $3


                                                                                                                                                                  $3


                                                                                                                                                                              $4


                                                                                                                                                                                         $4


                                                                                                                                                                                                    $4


                                                                                                                                                                                                               $4


                                                                                                                                                                                                                          $5
      Total assets
Source: Call report data.

                                                                                 Note: Data are as of December 31, 2002, and include all federally insured credit unions filing call
                                                                                 reports. This figure depicts the number of institutions in a particular asset size category. Each category
                                                                                 represents a range—for example, the first category includes all institutions with assets of $250,000 or
                                                                                 less, while the second category includes all institutions with assets greater than $250,000 and less
                                                                                 than or equal to $500,000, up to the last category, which includes all institutions with assets greater
                                                                                 than $4.75 million and less than or equal to $5 million.


                                                                                 Given the disproportionate size of the banking industry relative to the
                                                                                 credit union industry, peer groups were defined to mitigate the effects of
                                                                                 this discrepancy. Therefore, for our more detailed reviews, we constructed
                                                                                 five peer groups in terms of institution size as measured by total assets,
                                                                                 reported as of December 31, 2002. We further refined the sample of FDIC-
                                                                                 insured institutions to exclude those banks and thrifts we determined had
                                                                                 emphases in credit card or mortgage loans. The largest bank included in
                                                                                 our analyses had total assets of nearly $18 billion in 2002. See appendix I
                                                                                 for details.

                                                                                 Figures 24, 25, 26, and 27 illustrate that differences in services (as
                                                                                 measured by the number of institutions holding various consumer,
                                                                                 mortgage, and business loans) between credit unions and peer group banks




                                                                                 Page 123                                                                        GAO-04-91 Changes in Credit Union Industry
Appendix IV

Comparison of Bank and Credit Union 

Distribution of Assets





are manifested in terms of institution size. Overall, the credit union
industry in aggregate did not appear to be that similar to the banking
industry (as captured by our sample of peer group banks) in terms of
services; however, when broken out by size, the larger credit unions (those
with more than $100 million in assets, or credit unions in Groups II, III, IV,
and V) appeared to be offering very similar services to peer banks.
Moreover, as nearly 90 percent of all credit unions had less than $100
million in assets as of December 31, 2002, the results depicted in Figure 24
are influenced more heavily by these institutions.



Figure 24: Percentage of All Credit Unions and All Banks Holding Various Loans, as
of 2002
Percentage of institutions
                                                                  100
100                 98                                                   98              98


                                      86

 80



                               59
 60
          50                                  50


 40
                                                        29


 20                                                                              16




  0
            First           Junior mortgage    Credit                Other       Agricultural
          mortgage             and home         card               consumer     and business
           loans              equity loans     loans                 loans         loans


                  Credit unions

                  Banks

Source: Call report data.

Note: Data are as of December 31, 2002, and are based on all federally insured credit unions and
banks and thrifts filing call reports. Insured U.S. branches of foreign-chartered institutions and banks
we determined had emphases in credit card or mortgage loans are excluded. Bank data on mortgages
exclude thrifts. Credit union data on other consumer loans may include member business and
agricultural loans.




Page 124                                                     GAO-04-91 Changes in Credit Union Industry
Appendix IV

Comparison of Bank and Credit Union 

Distribution of Assets





Figure 25: Percentage of Credit Unions and Banks with Assets of $100 Million or
Less Holding Various Loans, as of 2002
Percentage of institutions
                                                                  100
100                 97                                                   97              96




 80                                   78




 60                            55

          44                                  45

 40




 20                                                     18
                                                                                 12



  0
            First           Junior mortgage    Credit                Other       Agricultural
          mortgage             and home         card               consumer     and business
           loans              equity loans     loans                 loans         loans


                  Credit unions

                  Banks

Source: Call report data.


Note: Data are as of December 31, 2002, and are based on all federally insured credit unions and
banks and thrifts filing call reports. Insured U.S. branches of foreign-chartered institutions and banks
we determined had emphases in credit card or mortgage loans are excluded. Bank data on mortgages
exclude thrifts. Credit union data on other consumer loans may include member business and
agricultural loans.




Page 125                                                     GAO-04-91 Changes in Credit Union Industry
Appendix IV

Comparison of Bank and Credit Union 

Distribution of Assets





Figure 26: Percentage of Credit Unions and Banks with Assets between $1 Billion
and $18 Billion Holding Various Loans, as of 2002
Percentage of institutions
       100                 100                                    100
100             96                                                       97              96
                                      95
                                              90


 80                                                                              76




 60
                                                        52



 40




 20




  0
            First           Junior mortgage    Credit                Other       Agricultural
          mortgage             and home         card               consumer     and business
           loans              equity loans     loans                 loans         loans


                  Credit unions

                  Banks

Source: Call report data.

Note: Data are as of December 31, 2002, and are based on all federally insured credit unions and
banks and thrifts filing call reports. Insured U.S. branches of foreign-chartered institutions and banks
we determined had emphases in credit card or mortgage loans are excluded. Bank data on mortgages
exclude thrifts. Credit union data on other consumer loans may include member business and
agricultural loans.




Page 126                                                     GAO-04-91 Changes in Credit Union Industry
                                                               Appendix IV

                                                               Comparison of Bank and Credit Union 

                                                               Distribution of Assets





Figure 27: Percentages of Credit Unions and Banks Holding Various Loans, by Institution Size, as of 2002

Group Number Total                      Percentage of institutions with the following holdings:
             assets
             (dollars                                              Junior mortgage                                                              Agricultural and
             in billions)               First mortgage loans       and home equity loans       Credit card loans        Other consumer loans    business loans

             8,642           $139.70       43.6%                          54.5%                   44.7%                                 99.9%       12.3%
    I
             4,083           $205.98                     97.3%                 77.6%                17.5%                               97.5%                      96.3%

               602            $93.57                     97.2%                      98.5%                      91.7%                     100%      43.5%
   II
             2,086           $327.96                     98.9%                     95.9%         35.7%                                  98.8%                      97.4%

               240            $83.83                     99.2%                     98.3%                      91.3%                      100%          57.1%
   III
               858           $297.79                     97.8%                     96.9%           45.8%                                98.1%                      97.1%

               133            $89.73                      100%                         99.2%                   93.2%                     100%          57.1%
   IV
               418           $289.54                     97.6%                      97.6%          44.5%                                98.1%                      96.7%

                 71          $150.24                     100%                          100%                   90.1%                      100%               76.1%
   V
               384          $1,399.98                    96.2%                     94.8%             51.8%                             96.9%                       95.8%

             9,688           $557.07        49.5%                         59.3%                     49.8%                               99.9%        16.4%
Total
             7,829          $2,521.25                    97.7%                    86.4%        28.6%                                    97.9%                      97.5%



                                                                       Credit unions

                                                                       Banks

Source: Call report data.

                                                               Note: Data are as of December 31, 2002, and are based on all federally insured credit unions and
                                                               banks and thrifts filing call reports. Insured U.S. branches of foreign-chartered institutions and banks
                                                               we determined had emphases in credit card or mortgage loans are excluded. Bank data on mortgages
                                                               exclude thrifts. Credit union data on other consumer loans may include member business and
                                                               agricultural loans. Group I credit unions had assets of $100 million or less; Group II credit unions had
                                                               assets greater than $100 million and less than or equal to $250 million; Group III credit unions had
                                                               assets greater than $250 million and less than or equal to $500 million; Group IV credit unions had
                                                               assets greater than $500 million and less than or equal to $1 billion; and Group V credit unions had
                                                               assets greater than $1 billion and less than or equal to $18 billion, which is the asset size, rounded up
                                                               to the nearest billion dollars, of the largest credit union as of December 31, 2002.




                                                               Page 127                                                GAO-04-91 Changes in Credit Union Industry
Appendix V

Credit Union Services, 1992–2002



               In the absence of detailed time series data on the provision of services by
               credit unions, we used holdings of various loans, including mortgage and
               consumer loans, as well as other variables, as rough measures of credit
               union services over time. We also separated credit unions by asset size to
               illustrate any differences in provision of services by this criterion. For
               illustrative purposes, we compared the smallest credit unions (those with
               assets of $100 million or less) with the largest credit unions (those with
               more than $1 billion in assets).

               The percentage of all credit unions holding first mortgage loans has
               increased every year since 1992 (see fig. 28). However, nearly twice as
               many credit unions hold new and used vehicle loans as first mortgage
               loans.




               Page 128                               GAO-04-91 Changes in Credit Union Industry
                                             Appendix V

                                             Credit Union Services, 1992–2002





Figure 28: Percentage of Credit Unions Holding Various Loans, 1992–2002
  Percentage of credit unions              New vehicle loans            Percentage of credit unions                      Used vehicle loans
  100                                                                   100


    80                                                                   80


    60                                                                   60


    40                                                                   40


    20                                                                   20


     0                                                                    0
         1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002               1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


  Percentage of credit unions              Other real estate loans      Percentage of credit unions                      First mortgage loans
  100                                                                   100


    80                                                                   80


    60                                                                   60


    40                                                                   40


    20                                                                   20


     0                                                                    0
         1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002               1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


  Percentage of credit unions              Credit card loans            Percentage of credit unions                      Member business loans
  100                                                                   100


    80                                                                   80


    60                                                                   60


    40                                                                   40


    20                                                                   20


     0                                                                    0
         1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002               1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Source: Call report data.

                                             Note: Data are as of December 31 and are based on all federally insured credit unions filing call
                                             reports.




                                             Page 129                                             GAO-04-91 Changes in Credit Union Industry
Appendix V

Credit Union Services, 1992–2002





Calculating the percentage of loan amounts held to total assets can reveal
the relative importance of each type of loan to credit unions. Figure 29
shows that first mortgage loans have increased in importance, surpassing
each of the other loan holdings.




Page 130                              GAO-04-91 Changes in Credit Union Industry
                                                Appendix V

                                                Credit Union Services, 1992–2002





Figure 29: Percentage of Assets Held in Various Loans by All Credit Unions, 1992–2002
    Percentage of total credit union assets   First mortgage loans           Percentage of total credit union assets       New vehicle loans
    25                                                                       25


    20                                                                       20


    15                                                                       15


    10                                                                       10


      5                                                                       5


      0                                                                       0
          1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                  1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

    Percentage of total credit union assets   Other real estate loans        Percentage of total credit union assets       Used vehicle loans
    25                                                                       25


    20                                                                       20


    15                                                                       15


    10                                                                       10


      5                                                                       5


      0                                                                       0
          1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                  1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

    Percentage of total credit union assets   Credit card loans              Percentage of total credit union assets       Member business loans
    25                                                                       25


    20                                                                       20


    15                                                                       15


    10                                                                       10


      5                                                                       5


      0                                                                       0
          1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                  1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Source: Call report data.

                                                Note: Data are as of December 31 and are based on all federally insured credit unions filing call
                                                reports.




                                                Page 131                                              GAO-04-91 Changes in Credit Union Industry
Appendix V

Credit Union Services, 1992–2002





Although nearly all credit unions have offered regular shares (savings
accounts), over the years, the percentage of those offering share drafts
(checking accounts) and money market shares has increased, as illustrated
in figure 30.




Page 132                             GAO-04-91 Changes in Credit Union Industry
Appendix V

Credit Union Services, 1992–2002





Figure 30: Percentage of Credit Unions Offering Various Accounts, 1992–2002
   Percentage of credit unions                                              Regular shares
   100


    80


    60


    40


    20


      0
           1992        1993   1994   1995   1996    1997    1998     1999     2000    2001     2002


   Percentage of credit unions                                              Share drafts
   100


    80


    60


    40


    20


      0
           1992        1993   1994   1995   1996    1997    1998     1999     2000    2001     2002


   Percentage of credit unions                                              Money market shares
   100


    80


    60


    40


    20


      0
           1992        1993   1994   1995   1996    1997    1998     1999     2000    2001     2002

Source: Call report data.

Note: Data are as of December 31 and are based on all federally insured credit unions filing call
reports. Regular shares are savings accounts and share drafts are checking accounts.




Page 133                                             GAO-04-91 Changes in Credit Union Industry
Appendix V

Credit Union Services, 1992–2002





The number of employees could have an effect on the provision of services
as well. Figure 31 shows that industry consolidation has not adversely
affected employment. Even though the industry shrank in terms of the
number of institutions from 12,595 in 1992 to 9,688 in 2002, a decline of 23
percent, the number of full-time employees went from 119,480 in 1992 to
180,401 in 2002, an increase of 51 percent.



Figure 31: Credit Union Employees and Number of Credit Unions, 1992–2002
Number of credit unions                                                                 Full-time employees

15,000                                                                                              200,000


                                                                                                    175,000
12,000
                                                                                                    150,000


                                                                                                    125,000
 9,000

                                                                                                    100,000

 6,000
                                                                                                    75,000


                                                                                                    50,000
 3,000
                                                                                                    25,000


      0                                                                                             0
            1992      1993     1994    1995      1996   1997     1998   1999   2000   2001   2002


                       Number of credit unions

                       Full-time employees

Source: Call report data.

Note: Data are as of December 31 and are based on all federally insured credit unions filing call
reports.


The differences between the smallest credit unions (those with $100
million or less in assets) and the largest credit unions (those with more
than $1 billion in assets) are also apparent in the types of loans held and
their relative importance for each group over time (see figs. 32 and 33).
Nearly all of the smallest credit unions have emphasized new and used
vehicle loans, but typically less than one-half of these credit unions have
held other loan types. As of December 31, 2002, used vehicle loans were the
relatively most important loan holding for the smallest credit unions,
surpassing new vehicle loans. Almost all of the largest credit unions have



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Appendix V

Credit Union Services, 1992–2002





held most types of loans over the past decade, with the exception of
member business loans—but the percentage of the largest credit unions
holding these has been steadily growing and, as of December 31, 2002,
roughly three out of four of these credit unions held them. First mortgage
loans have consistently been the most important loan holding of the largest
credit unions, and they now represent nearly one-quarter of the asset mix
of these credit unions.




Page 135                              GAO-04-91 Changes in Credit Union Industry
                                             Appendix V

                                             Credit Union Services, 1992–2002





Figure 32: Percentage of Credit Unions, Smallest versus Largest, Holding Various Loans, 1992–2002
   Percentage of credit unions             New vehicle loans             Percentage of credit unions                      Used vehicle loans
  100                                                                    100


    80                                                                    80


    60                                                                    60


    40                                                                    40


    20                                                                    20


     0                                                                     0
         1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


  Percentage of credit unions              Other real estate loans       Percentage of credit unions                      First mortgage loans
  100                                                                    100


    80                                                                    80


    60                                                                    60


    40                                                                    40


    20                                                                    20


     0                                                                     0
         1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


  Percentage of credit unions              Credit card loans             Percentage of credit unions                      Member business loans
  100                                                                    100           Group I credit unions

                                                                                       Group V credit unions
    80                                                                    80


    60                                                                    60


    40                                                                    40


    20                                                                    20


     0                                                                     0
         1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Source: Call report data.

                                             Note: Data are as of December 31 and are based on all federally insured credit unions filing call
                                             reports. The smallest credit unions (Group I) are those with $100 million or less in assets while the
                                             largest credit unions (Group V) are those with more than $1 billion in assets.




                                             Page 136                                               GAO-04-91 Changes in Credit Union Industry
                                                Appendix V

                                                Credit Union Services, 1992–2002





Figure 33: Percentage of Assets Held in Various Loans, Smallest versus Largest Credit Unions, 1992–2002
    Percentage of total credit union assets   New vehicle loans              Percentage of total credit union assets         Used vehicle loans
    25                                                                       25


    20                                                                       20


    15                                                                       15


    10                                                                       10


      5                                                                        5


      0                                                                        0
          1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                   1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


    Percentage of total credit union assets   First mortgage loans           Percentage of total credit union assets         Other real estate loans
    25                                                                       25


    20                                                                       20


    15                                                                       15


    10                                                                       10


      5                                                                        5


      0                                                                        0
          1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                   1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


    Percentage of total credit union assets   Credit card loans              Percentage of total credit union assets         Member business loans
    25                                                                       25           Group I credit unions

                                                                                          Group V credit unions
    20                                                                       20


    15                                                                       15


    10                                                                       10


      5                                                                        5


      0                                                                        0
          1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002                   1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Source: Call report data.

                                                Note: Data are as of December 31 and are based on all federally insured credit unions filing call
                                                reports. The smallest credit unions (Group I) are those with $100 million or less in assets while the
                                                largest credit unions (Group V) are those with more than $1 billion in assets.




                                                Page 137                                              GAO-04-91 Changes in Credit Union Industry
Appendix V

Credit Union Services, 1992–2002





As of December 31, 2002, we observed a gap in services offered by smaller
credit unions and larger credit unions (see fig. 34). While larger credit
unions—those with assets of more than $100 million—accounted for just
over 10 percent of all credit unions, they offered more services than smaller
credit unions. For example, nearly all of the larger credit unions held
mortgage loans and credit card loans, while only around one-half of the
smaller credit unions held these loans.



Figure 34: Differences among Services Offered by Smaller and Larger Credit
Unions, as of 2002
Percentage of institutions

               98.2                      98.7                   99.9   100

100
                                                       91.7



 80





 60
                          54.5
                                                                                        47.7
         43.6                                   44.7

 40





 20

                                                                                12.3



  0
            First           Junior mortgage       Credit           Other        Agricultural
          mortgage             and home            card          consumer      and business
           loans              equity loans        loans            loans          loans


                  Smaller credit unions

                  Larger credit unions

Source: Call report data.


Note: Data are as of December 31, 2002, and are based on all federally insured credit unions filing call
reports. In this figure, larger credit unions are those with more than $100 million in assets while smaller
credit unions are those with $100 million or less in assets.


The discrepancy in the services offered by smaller and larger credit unions
is more accurately illustrated through an analysis of more recently
collected data on more sophisticated product and service offerings, such as
the availability of automatic teller machines (ATM) and electronic banking
(see fig. 35). While less than half of the smallest credit unions offered ATMs



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                                                               Appendix V

                                                               Credit Union Services, 1992–2002





                                                               and one-third offered financial services through the Internet, nearly all
                                                               larger credit unions offered these services.



Figure 35: Credit Union Size and Offerings of More Sophisticated Services, as of 2002

  Group        Number of        Percentage of credit unions in the sample offering:
                  credit
                unions in       Financial services                  Financial services through audio                                   Electronic
               the sample       through the Internet                responses or phone-based system    ATMs                            applications for new loans

                    8,642
      I                          28.4%                                    41.5%                               45.2%                    19.7%
                 (89.2% of
               entire sample)

                     602
     II                                                91.7%                              97.7%                             96.7%                        79.1%
                  (6.2% of
               entire sample)

                     240
     III                                                97.1%                             97.5%                             98.8%                           88.3%
                  (2.5% of
               entire sample)

                     133
     IV
                                                        97.7%                             98.5%                              100%                           88.0%
                  (1.4% of
               entire sample)


                      71
     V                                                  98.6%                               100%                            98.6%                             94.4%
                  (0.7% of
               entire sample)

  Entire
                    9,688           35.5%                                   47.6%                              50.9%                    26.6%
 sample

Source: Call report data.

                                                               Note: Data are as of December 31, 2002, and are based on all federally insured credit unions filing call
                                                               reports. Group I credit unions had assets of $100 million or less; Group II credit unions had assets
                                                               greater than $100 million and less than or equal to $250 million; Group III credit unions had assets
                                                               greater than $250 million and less than or equal to $500 million; Group IV credit unions had assets
                                                               greater than $500 million and less than or equal to $1 billion; and Group V credit unions had assets
                                                               greater than $1 billion and less than or equal to $18 billion, which is the asset size, rounded up to the
                                                               nearest billion dollars, of the largest credit union as of December 31, 2002.




                                                               Page 139                                                GAO-04-91 Changes in Credit Union Industry
Appendix VI

Characteristics of Credit Union and Bank
Users

               This appendix provides additional information on the characteristics—age,
               education, and race/ethnicity—of households that use banks and credit
               unions. For figures 36, 37, and 38, we analyzed data from the Federal
               Reserve's 2001 Survey of Consumer Finances (SCF). The categories we
               used to describe these households—credit union users and bank users—
               included those who only and primarily used each of these institutions. To
               supplement our analyses of households by race, we also analyzed 2001 loan
               application records from the Home Mortgage Disclosure Act database
               (HMDA) (see fig. 39). As we did with our analysis of HMDA income data,
               we only analyzed records for home purchase loans actually made for the
               purchase of one-to-four family homes.



               Figure 36: Households Using Credit Unions and Banks, by Education Level, 2001
               Percentage of households

               35                  34

                                                        31                                 31
               30                                                      28
                                             27

               25                                                                23


               20                                             18


               15


               10      8


                5


                0
                               Households only and                 Households only and
                           primarily using credit unions           primarily using banks


                              Less than high school

                              High school graduate

                              Some college

                              College/graduate degree

               Source: 2001 SCF.




               Page 140                                      GAO-04-91 Changes in Credit Union Industry
Appendix VI

Characteristics of Credit Union and Bank

Users





Figure 37: Households Using Credit Unions and Banks, by Age Group, 2001

Percentage of households


50

                    46




40


                                                               33

30


        24                                                              24        24
                            22

20
                                                 19




10
                                       9




 0
              Households only and                         Households only and
          primarily using credit unions                   primarily using banks


              Ages 18-33


              Ages 34-49


              Ages 50-65


              Age 66+


Source: 2001 SCF.

Note: Percentages do not add to 100 percent due to rounding.




Page 141                                          GAO-04-91 Changes in Credit Union Industry
Appendix VI

Characteristics of Credit Union and Bank

Users





Figure 38: Households Using Credit Unions and Banks, by Race and Ethnicity, 2001
Percentage of households
                                                                                 79
80                                       76

70


60


50


40


30


20                             16
                                                                       11
10                                                             7
         3           4                               3
 0
                Households only and                      Households only and
             primarily using credit unions               primarily using banks


                Other

                Hispanic

                Black

                White

Source: 2001 SCF.

Note: Percentages do not add to 100 percent due to rounding.




Page 142                                          GAO-04-91 Changes in Credit Union Industry
Appendix VI

Characteristics of Credit Union and Bank

Users





Figure 39: Mortgages Made by Credit Unions and Banks, by Race and Ethnicity, 

2001

Percentage


80                                                                           77
                                                                73
70


60


50


40


30


20
                                                                                   15

10                                                     7                                   6
        4           4                     5   4
                              3
 0
            Other                 Black         Hispanic             White        Not provided
     Race


               Loans made by credit unions

               Loans made by peer group banks

Source: 2001 HMDA database.

Notes: The “other” category includes data reported for American Indians, Alaskan natives, Asian or
Pacific islanders, and those from the HMDA “other” category. We collapsed these categories to create
groups similar to the ones used by the SCF. However, in our HMDA analysis, we only included
mortgages made by peer group banks (banks with less than $16 billion in assets) whereas the SCF did
not exclude households using banks with more than $16 billion in assets.


Fifteen percent of the HMDA data reported by credit unions and 6 percent
of the HMDA data reported by banks lacked race and ethnicity data. As
such, the data in this figure may not represent the exact proportion of
mortgage loans by race. We also found that the proportion of loans without
data varied by the asset size of institutions. For example, race data were
missing for 23 percent of credit unions with assets of more than $500
million compared with about 3 percent for credit unions with less than $50
million in assets. Similarly, race data were missing for about 8 percent of
peer group banks with more than $500 million in assets compared with
about 4 percent of banks with less than $50 million in assets. However,
since these larger institutions made most of the loans, missing data from
these institutions account for more than 80 percent of all the missing data.



Page 143                                                   GAO-04-91 Changes in Credit Union Industry
Appendix VII

Key Changes in NCUA Rules and Regulations,
1992–2003

                                       Since 1992, changes to the National Credit Union Administration’s (NCUA)
                                       rules and regulations governing credit unions generally expanded the
                                       powers of credit unions to offer products and services, and broadened the
                                       activities in which they could engage. With the exception of member
                                       business lending, which NCUA constrained during the 1990s, federally
                                       chartered credit unions gained authority to, among other things, (1) invest
                                       in a wider variety of financial instruments, (2) offer services through the
                                       Internet, and (3) profit from referring members to products, such as
                                       insurance and investments, sold by third parties. Also, NCUA increased the
                                       number of activities in which credit union service organizations (CUSO)
                                       could engage, including student loan and business loan origination. In
                                       September 2003, NCUA expanded credit union powers in member business
                                       lending to permit well-capitalized credit unions to make unsecured
                                       member business loans within certain limits, among other things. See table
                                       10 for a timeline of key changes to NCUA rules and regulations.



Table 10: Timeline of Key Changes to NCUA Rules and Regulations, January 1992–September 2003

Effective date             Key change
January 1992	              NCUA limited member business loans in response to losses to credit unions, their members, and the
                           National Credit Union Share Insurance Fund. NCUA established loan security requirements, limits on
                           loans to one borrower, and an aggregate portfolio cap on construction and development loans at 15
                           percent of reserves for federally insured credit unions.
September 1996	            NCUA allowed credit unions serving predominantly low-income members to raise secondary capital
                           from foundations and other philanthropic-minded institutional investors, to help credit unions make
                           more loans, and improve services to low-income members.a NCUA required credit unions to establish
                           certain uninsured or other form of nonshare accounts for secondary capital.
January 1998	              NCUA codified additional powers of federally chartered credit unions to act as trustees and custodians
                           of Roth Individual Retirement Accounts (IRA) and Education IRAs, which is in addition to those trustee
                           and custodian services they had been authorized to provide for other kinds of pension and retirement
                           plans for approximately the previous 23 years.
                           NCUA changed its investment rule to focus on risk management (previous focus was on specific
                           financial instruments for federal credit unions). NCUA established new requirements for assessing
                           and managing risk associated with federally chartered credit union investment activities.
April 1998	                NCUA codified additional preapproved CUSO activities to include student loan origination, disaster
                           recovery services, additional checking and currency services, and electronic income tax filing
                           services, among others.
August 1998	               Credit Union Membership Access Act (CUMAA) became law. CUMAA provisions cap the aggregate
                           portfolio amount of member business loans for federally insured credit unions, with exceptions.
March 2000	                NCUA allowed federally chartered credit unions in specified locations outside the United States to
                           offer trustee or custodian services for IRAs.




                                       Page 144                                       GAO-04-91 Changes in Credit Union Industry
                                                    Appendix VII

                                                    Key Changes in NCUA Rules and Regulations, 

                                                    1992–2003





(Continued From Previous Page)
Effective date                          Key change
August 2001	                            NCUA issued legal opinion that permitted a federally chartered credit union employee to be a shared
                                        employee with a third party and, while acting in the capacity of an employee of the third party, to sell
                                        nondeposit investment products and provide investment advice. NCUA continued to restrict federally
                                        chartered credit union employees, acting as an employee of the credit union, from selling nondeposit
                                        investment products or providing investment advice.
September 2001	                         NCUA’s Incidental Powers Regulation became effective. This rule codified a broad range of activities,
                                        products, and services that federally chartered credit unions could offer directly to members, and
                                        which NCUA had previously recognized in legal opinions or had recognized in other regulations. One
                                        change, which permits federally chartered credit unions to earn income directly from finder activities
                                        (the referral of members to outside vendors, such as investment and insurance brokers), had the
                                        effect of making it unnecessary to use a CUSO in third-party networking arrangements in order to
                                        receive income. Key powers codified in the regulation include: electronic financial services, finder
                                        activities, loan-related products, such as debt suspension agreements, and trustee services.b There is
                                        overlap of the activities in which federally chartered credit unions and CUSOs may engage (for
                                        example, consumer mortgage origination), but there are also activities only permissible for CUSOs
                                        (for example, general trust services and travel agency services).
February 2002	                          NCUA issued a legal opinion on how federally chartered credit unions can provide nonmembers, such
                                        as agricultural workers with familial ties to foreign countries, with wire transfer services. While
                                        expressly restricting unlimited services to nonmembers, NCUA permitted federally chartered credit
                                        unions to (1) establish nondividend-bearing accounts for people within its field of membership, (2)
                                        provide wire transfer services as a promotional activity on a limited basis, and (3) provide services as
                                        a charitable activity, so long as the recipients of the charitable services were within the credit union’s
                                        field of membership.
March 2002	                             NCUA’s Regulatory Flexibility Program became effective. NCUA relieved eligible federally and state-
                                        chartered credit unions from certain NCUA regulations relating to permissible investments and
                                        investment management requirements, limits on share deposits from public entities and nonmembers,
                                        approval processes for charitable contributions, and limits on ownership of fixed assets.
July 2003	                              NCUA expanded investment powers of certain federally chartered credit unions to allow them to
                                        purchase financial instruments that were previously prohibited, including commercial mortgage-
                                        related securities and equity options.c
                                        NCUA permitted federally insured credit unions to open branches in foreign countries, with conditions.
September 2003                          NCUA amended its CUSO rule to permit CUSOs to originate business loans.
                                        NCUA amended its member business loan rule to allow eligible federally insured credit unions to make
                                        unsecured member business loans, with limits, and to permit the exclusion of purchased nonmember
                                        loans and nonmember participation interests from the aggregate business loan limit, among other
                                        things.
Sources: GAO, NCUA, Federal Register.

                                                    Note:
                                                    a
                                                     Secondary capital can take the form of investments into an institution by nonmembers, such as
                                                    foundations, corporations, and other financial institutions. The investments are subordinated to all
                                                    other credit union debt, and are used to absorb losses.
                                                    b
                                                     Debt suspension agreements are contracts between a lender and a borrower where the lender agrees
                                                    to suspend scheduled installment payments for an agreed period in the event the borrower
                                                    experiences financial hardship.
                                                    c
                                                     Equity options are limited to those that would be purchased for the sole purpose of offering dividends
                                                    based on the performance of an equity index.




                                                    Page 145                                             GAO-04-91 Changes in Credit Union Industry
Appendix VIII

NCUA’s Budget Process and Industry Role



                            The National Credit Union Administration (NCUA) changed its budget
                            process in 2001 to allow outside parties, including credit unions and trade
                            organizations, to submit comments on the budget. While outside parties
                            can submit their budget suggestions and concerns at any time, NCUA has a
                            formal budget briefing where these parties can officially submit their
                            comments. This briefing takes place at the latter stage of NCUA’s budget
                            process. The changes NCUA has made to its budget process come during a
                            period in which NCUA has been reducing the growth in its budgets.

                            NCUA has two main sources of funding for its operating costs. According
                            to NCUA, 62 percent of the funds for operating costs in their 2002 budget
                            came from the National Credit Union Share Insurance Fund (NCUSIF),
                            administered by NCUA. NCUSIF is principally financed from earnings
                            (income) on investments purchased using the deposits of federally insured
                            credit unions. Funds are transferred from the insurance fund through a
                            monthly accounting procedure known as the overhead transfer to cover
                            costs associated with ensuring that insured deposits are safe and sound.
                            The remaining 38 percent of NCUA’s funds for its operating costs came
                            primarily from operating fees assessed on federally chartered credit
                            unions, for which NCUA has oversight responsibility.



NCUA Budget Process Now     NCUA budgets on a calendar-year basis, and its board sets the policies and
Includes Step for Outside   overall direction for the budget. In July and August prior to the next budget
                            year, the NCUA regional offices submit their workload and program needs.
Parties to Submit
                            NCUA’s examination and insurance officials in headquarters assess the
Comments                    information and formulate proposed program hours, which along with
                            historical actual expenditures are the basis for the proposed budget. In
                            September and October, the Chief Financial Officer (CFO) reviews and
                            analyzes the figures, conducts briefings with office directors, and makes
                            adjustments. In November, NCUA holds a public briefing where interested
                            parties, including credit unions and trade associations, have the
                            opportunity to comment. Later in November, the CFO briefs the board prior
                            to final budget adjustments. Additionally, in July of the budget year, there is
                            a midyear budget review to determine if any adjustments need to be made
                            to the budget. According to NCUA officials, NCUA also conducts a variance
                            analysis on the budget on a monthly basis and a more comprehensive
                            review at the end of the year.

                            According to NCUA, credit unions and other stakeholders can submit their
                            budget suggestions and concerns at any time. Normally, suggestions come
                            between August and November while NCUA is working on the budget. For



                            Page 146                                GAO-04-91 Changes in Credit Union Industry
                          Appendix VIII
                          NCUA’s Budget Process and Industry Role




                          the public budget hearing, credit unions can address the board for 5
                          minutes or submit a written document.

                          Recent budget concerns by credit unions have centered on lessening the
                          costs to credit unions for NCUA oversight. Credit unions have raised
                          specific concerns about the number of NCUA staff or full-time equivalents,
                          the salaries of NCUA staff, and the overhead transfer rate from the
                          insurance fund. According to NCUA data, its average full-time equivalent
                          cost is less than that of the Federal Deposit Insurance Corporation (FDIC)
                          and the Office of the Comptroller of the Currency (OCC) and equal to that
                          of the Office of Thrift Supervision (OTS). Nevertheless, NCUA has
                          responded to concerns over its salary levels by deciding to undertake a pay
                          study.



NCUA Has Reduced Its      In recent years, NCUA has been successful in slowing its budget growth.
Budget Growth in Recent   After 10-percent annual growth from 1998 to 2000, NCUA budget growth
                          has decreased to an average of about 3 percent in 2000–2003 (see fig. 40).
Years
                          The NCUA board’s budget priorities have been to streamline business
                          processes, increase efficiencies, control budget growth, and match
                          resources to mission requirements, while maintaining effective
                          examination processes and products. NCUA is seeking budget savings by
                          adopting a risk-focused examination approach, extending the examination
                          cycle, adopting more flexible rules and regulations, increasing efficiencies
                          from technology (such as videoconferencing), and consolidating two of
                          their regions into one.




                          Page 147                                  GAO-04-91 Changes in Credit Union Industry
Appendix VIII
NCUA’s Budget Process and Industry Role




Figure 40: NCUA Budget Levels, 1992–2004
Percentage change                                                                       Dollars in millions

12                                                                                                     150



10
                                                                                                       120


 8
                                                                                                       90


 6
                                                                                                       60

 4

                                                                                                       30
 2


                                                                                                       0
 0


-2
     1992   1993      1994      1995   1996   1997   1998   1999   2000   2001   2002   2003 2004
                                                                                            (projected)
                Percentage change

                Total dollars

Source: NCUA.

Note: The 2004 projected budget is expected to increase between 4.0 and 4.5 percent from the 2003
budget level.


NCUA’s authorized full-time equivalent staff level decreased over 7 percent
from 1,049 in 2000 to 971 in 2003 (see fig. 41). This level of staff reductions
has been partly in response to changes in the industry. Since 1998, the
number of federally insured credit unions has decreased steadily by about 3
percent per year.




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Appendix VIII
NCUA’s Budget Process and Industry Role




Figure 41: NCUA-authorized Staffing Levels, 1992–2003
Number of staff

1,200

                                                             1,042   1,049   1,029
         996      996                                1,013                           995
                         978                                                                971
1,000                           944    951    953



 800




 600




 400




 200




    0

         1992     1993   1994   1995   1996   1997   1998    1999    2000    2001    2002   2003

Source: NCUA.




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NCUA’s Implementation of Prompt Corrective
Action

              Section 301 of the Credit Union Membership Access Act (CUMAA)
              amended the Federal Credit Union Act to require the National Credit Union
              Administration (NCUA) to adopt a system of prompt corrective action
              (PCA) for use on credit unions experiencing capitalization problems.1 The
              goal of requiring PCA is to resolve the problems of insured credit unions
              with the least possible long-term loss to the National Credit Union Share
              Insurance Fund (NCUSIF). In that regard, NCUA was required to prescribe
              a system of PCA consisting of three principal components: (1) a
              comprehensive framework of mandatory supervisory actions and
              discretionary supervisory actions, (2) an alternative system of PCA for
              “new” credit unions, and (3) a risk-based net worth (RBNW) requirement
              for “complex” credit unions.2 Furthermore, section 301 also required NCUA
              to report to Congress on how PCA was implemented and how PCA for
              credit unions differs from PCA for other depository institutions. NCUA
              submitted this report in May 2000. In addition, NCUA submitted a further
              report to Congress that described how NCUA carried out the RBNW
              requirements for credit unions and how these requirements differed from
              RBNW requirements of other depository institutions (see table 11).




              1
              Pub. L. No. 105-219 (Aug. 7, 1998).
              2
               CUMAA defines a “new” credit union as one that has been in operation for less than 10
              years and having less than $10 million in assets. 12 C.F.R. §702.2(h). NCUA defines a credit
              union as “complex” when its total assets at the end of a quarter exceed $10 million and its
              RBNW calculation exceeds 6 percent net worth. 12 C.F.R. §702.103.




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NCUA’s Implementation of Prompt
Corrective Action




Table 11: CUMAA Mandates and NCUA Actions on PCA Regulation Implementation

                                                        CUMAA
CUMAA mandates to NCUA                                  deadlines                  NCUA action dates
PCA actions:
      Issue PCA proposed rule                           May 1999                   Issued May 1999
      Issue the PCA final rule                          February 2000              Issued February 2000
      Issue PCA report to Congress                      February 2000              Issued May 2000
      Implement PCA                                     August 2000                Implemented August 2000 a
RBNW requirements actions:
      Issue RBNW requirements                           February 1999              Issued October 1998

      (Advance Notice of Proposed 

      Rulemaking) 

                                                        c
      Issue RBNW requirements                                                      Issued February 2000
      proposed ruleb
      Issue RBNW requirements final                     August 2000                Issued July 2000
      rule
                                                        c
      Issue RBNW requirements report                                               Issued November 2000
      to Congress b
      Implement RBNW requirements                       January 2001               Implemented January 2001
      final rule
Sources: Federal Register 64, no. 95 (18 May 1999): 27090; Federal Register 65, no. 34 (18 February 2000): 8560; Federal Register 63,
no. 209 (29 October 1998): 57938; Federal Register 65, no. 34 (18 February 2000): 8597; Federal Register 65, no. 140 (20 July 2000):
44950; and NCUA reports to Congress.

Note:
a
    The PCA final rule applied to credit unions beginning in the fourth quarter of 2000.
b
 CUMAA did not set any deadline for NCUA to issue the RBNW requirement proposed rule and did not
require NCUA to issue a RBNW report to Congress.
c
 Not mandated by CUMAA.


After NCUA implemented the initial PCA and RBNW regulations, it formed
a PCA Oversight Task Force to review at least a full year of PCA
implementation and recommend necessary modifications.3 The task force
reviewed the first six quarters of PCA implementation. It made several
recommendations to improve PCA, including revising definitions of terms
and clarifying implementation issues. In June 2002, NCUA issued a
proposed rule setting forth revisions and adjustments to improve and
simplify PCA. In November 2002, after incorporating public comments on
the proposed rule, NCUA issued the final PCA rule adopting the proposed

3
 NCUA established a PCA Oversight Task Force in February 2000. This task force consisted
of NCUA staff and state regulators. See Federal Register 65, no. 140 (20 July 2000): 44964.




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                            NCUA’s Implementation of Prompt
                            Corrective Action




                            revisions and adjustments.4 The final rule became effective on January 1,
                            2003.



PCA Incorporates a          The PCA rule consists of a comprehensive framework of mandatory and
Comprehensive Framework     discretionary supervisory actions for all federally insured credit unions
                            except “new” credit unions.5 The PCA system includes the following five
of Mandatory and            statutory categories and their associated net worth ratios:
Discretionary Supervisory
Actions                     • well-capitalized—7.0 percent or greater net worth,

                            • adequately capitalized—6.0 to 6.99 percent net worth,

                            • undercapitalized—4.0 to 5.99 percent net worth,

                            • significantly undercapitalized—2.0 to 3.99 percent net worth, and

                            • critically undercapitalized—less than 2.0 percent net worth.

                            As noted earlier in the report, mandatory supervisory actions apply to
                            credit unions that are classified adequately capitalized or lower. The PCA
                            system also includes conditions triggering mandatory conservatorship and
                            liquidation.

                            CUMAA also authorized NCUA to develop a comprehensive series of
                            discretionary supervisory actions to complement the mandatory
                            supervisory actions. Some or all of these 14 discretionary supervisory
                            actions can be applied to credit unions that are classified undercapitalized
                            or lower (see table 12).




                            4
                             The final PCA rule contains 17 revisions and adjustments. See Federal Register 67, no. 230
                            (29 November 2002): 71078.
                            5
                             NCUA issued staff instructions on discretionary supervisory actions in April 2003, but has
                            yet to impose a discretionary supervisory action against any credit union.




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                            NCUA’s Implementation of Prompt
                            Corrective Action




                            Table 12: Discretionary Supervisory Actions

                            Discretionary supervisory actions                                         Statutory net worth category
                            Require NCUA prior approval for acquisitions,                             “Undercapitalized” and lower
                            branching, new lines of business
                            Restrict transactions with and ownership of CUSOs                         “Undercapitalized” and lower
                            Restrict dividends paid                                                   “Undercapitalized” and lower
                            Prohibit or reduce asset growth                                           “Undercapitalized” and lower
                            Alter, reduce, or terminate any activity by credit union                  “Undercapitalized” and lower
                            or its CUSO
                            Prohibit nonmember deposits                                               “Undercapitalized” and lower
                            Other actions to further the purpose of part 702                          “Undercapitalized” and lower
                            Order new election of board of directors                                  “Undercapitalized” and lower
                            Dismiss directors or senior executive officers                            “Undercapitalized” and lower
                            Employ qualified senior executive officers                                “Undercapitalized” and lower
                            Restrict senior executive officers’ compensation and                      “Significantly Undercapitalized”
                            bonus                                                                     and lower
                            Require merger if grounds exist for conservatorship or “Significantly Undercapitalized”
                            liquidation                                            and lower
                            Restrict payments on uninsured secondary capital                          “Critically Undercapitalized”
                            Require NCUA prior approval for certain actions                           “Critically Undercapitalized”
                            Source: Federal Register 64, no. 95 (18 May 1999): 27096-27098.


                            The discretionary supervisory actions are tailored to suit the distinctive
                            characteristics of credit unions.



An Alternative System for   CUMAA required NCUA to develop an alternative PCA system for “new”
New Credit Unions           credit unions. In doing so, NCUA recognized that new credit unions (1)
                            initially have no net worth, (2) need reasonable time to accumulate net
                            worth, and (3) need incentives to become adequately capitalized by the
                            time they are no longer new. Accordingly, the PCA system for new credit
                            unions has relaxed net worth ratios, allows regulatory forbearance, and
                            offers incentives to build net worth. The PCA system for new credit unions
                            includes six net worth categories and their associated net worth ratios (see
                            table 13).




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                            NCUA’s Implementation of Prompt
                            Corrective Action




                            Table 13: Net Worth Category Classification for New Credit Unions

                            New credit union net worth category                                         Net worth ratio (Percent)
                            “Well-Capitalized”                                                                        7.0 or above
                            “Adequately Capitalized”                                                                   6.0 to 6.99
                            “Moderately Capitalized”                                                                   3.5 to 5.99
                            “Marginally Capitalized”                                                                   2.0 to 3.49
                            “Minimally Capitalized”                                                                    0.0 to 1.99
                            “Uncapitalized”                                                                           Less than 0
                            Source: Federal Register 64, no. 95 (18 May 1999): 27099.




Risk-based Net Worth        CUMAA also required NCUA to formulate the definition of a “complex”
Requirement for “Complex”   credit union according to the risk level of its portfolios of assets and
                            liabilities. Well-capitalized and adequately capitalized credit unions
Credit Unions
                            classified as complex are subject to an additional RBNW requirement to
                            compensate for material risks against which a 6.0 percent net worth ratio
                            may not provide adequate protection. (We describe the RBNW requirement
                            in more detail elsewhere in this appendix.)



NCUA Submitted Required     CUMAA mandated that NCUA submit a report to Congress addressing PCA.
PCA Report to Congress      The report, dated May 22, 2000, explains how the new PCA rules account
                            for the cooperative character of credit unions and how the PCA rules differ
                            from the Federal Deposit Insurance Act’s (FDIA) “discretionary
                            safeguards” for other depository institutions as well as the reasons for the
                            differences.

                            The report discusses how the PCA rules account for credit unions’
                            cooperative character in three areas: their not-for-profit nature, their
                            inability to issue stock, and their board of directors consisting primarily of
                            volunteers.6 First, the final rule accounts for credit unions’ not-for-profit
                            nature by permitting a less-than-well-capitalized credit union to seek a
                            reduction in the statutory earnings retention requirement to allow the
                            continued payment of dividends sufficient to discourage an outflow of
                            shares. In addition, a well-capitalized credit union whose earnings are

                            6
                             Credit unions cannot issue capital stock and, therefore, must rely on retained earnings to
                            build net worth.




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Corrective Action




depleted may be permitted to pay dividends from its regular reserve
provided that such payment would not cause the credit union to fall below
the adequately capitalized level. Secondly, to account for the inability of
credit unions to issue capital stock, the final rule relies on the Net Worth
Restoration Plan, which must be submitted by credit unions classified as
undercapitalized or lower. Finally, to recognize that credit unions’ boards
of directors consist primarily of volunteers, the rule exempts credit unions
that are near to being adequately capitalized from the discretionary
supervisory action authorizing NCUA to order a new election of the board
of directors.

NCUA reported that the final rule established discretionary supervisory
actions that are essentially comparable to section 38 of FDIA, which
specifies “discretionary safeguards” for other depository institutions. The
report notes that NCUA adopted discretionary supervisory actions that are
similar to all but two of FDIA’s 14 discretionary safeguards.

NCUA did not adopt FDIA’s safeguards requiring selling new shares of
stock and prior approval of capital distributions by a bank holding
company. NCUA’s rationale for these exclusions was that, unlike banks,
credit unions cannot sell stock to raise capital and are not controlled by
holding companies.

NCUA departed from FDIA discretionary safeguards in fashioning three of
the discretionary supervisory actions: (1) dismissals of senior officers or
directors, (2) exemption of officers from discretionary supervisory actions,
and (3) ordering a new election of the boards of directors. NCUA reported
that the discretionary supervisory action for director dismissals departs
significantly from its FDIA counterpart. The FDIA safeguard protects from
dismissal of officials with office tenures of 180 days or less, when an
institution becomes undercapitalized. In contrast, NCUA contends that
such a “safe harbor” is unnecessary for credit unions. Moreover, NCUA
field experience supports the view that short-tenured officers can be as
responsible as others for rapidly declining net worth.

With regard to exempting officers from discretionary supervisory actions,
NCUA provides conditional relief to credit unions in contrast to the FDIA.
For example, the report notes that FDIA allows 11 discretionary safeguards
to be imposed on undercapitalized institutions. On the other hand, NCUA’s
comparable discretionary supervisory actions can be imposed against
undercapitalized credit unions in the first tier of that category only when
they fail to comply with any of CUMAA’s four mandatory supervisory



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                      Appendix IX
                      NCUA’s Implementation of Prompt
                      Corrective Action




                      actions or fail to implement an approved Net Worth Restoration Plan.7
                      NCUA’s rationale for granting relief from the relevant discretionary
                      supervisory actions is to avoid treating credit unions that are just short of
                      adequately capitalized as harshly as those that are almost significantly
                      undercapitalized.

                      NCUA’s report states that it modified the discretionary supervisory action
                      ordering a new election of the board of directors. Specifically, NCUA
                      excludes undercapitalized credit unions from this requirement but applies
                      it to significantly undercapitalized and critically undercapitalized credit
                      unions. NCUA’s exception was based on the belief that the safeguard would
                      undermine a defining characteristic of credit unions—membership election
                      of directors—and possibly discourage members from volunteering to serve
                      as directors. Moreover, NCUA noted that its discretionary supervisory
                      action does not compel a credit union to replace its board with a NCUA-
                      designated slate; it simply requires the membership to reconsider its
                      original choice of directors. Finally, the report states that ordering a
                      wholesale election of the board of directors may be an overreaction when a
                      credit union’s net worth is within reach of becoming adequately capitalized.



NCUA Submitted RBNW   NCUA submitted a report to Congress addressing its RBNW provisions on
Report to Congress    November 3, 2000. In general, the report describes NCUA’s comprehensive
                      approach to evaluating a credit union’s individual risk exposure. It explains
                      the RBNW requirement that applies to complex credit unions. The RBNW
                      requirement takes into account whether credit unions classified as
                      adequately capitalized provide adequate protection against risks posed by
                      contingent liabilities, among other risks. According to the RBNW report,
                      NCUA’s approach (1) targets credit unions that carry an above-average
                      level of exposure to material risk, (2) allows an alternative method to
                      calculate the amount of net worth needed to remain adequately capitalized
                      or well-capitalized, and (3) makes available a risk mitigation credit to
                      reflect quantitative evidence of risk mitigation.

                      NCUA reported that its final rule targets credit unions that have higher
                      material risk levels, thus warranting an extra measure of capital to protect
                      them and NCUSIF from losses. As noted previously, credit unions do not


                      7
                       The net worth ratio of credit unions in the undercapitalized category is 4.0-5.99 percent.
                      The first tier of the undercapitalized net worth category is 5.0-5.99 percent, and the second
                      tier of that net worth category is 4.0-4.99 percent.




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issue stocks that create shareholder equity. Without shareholder equity to
absorb losses, the RBNW requirement serves to mitigate most forms of risk
in a complex credit union’s portfolio. Specifically, the RBNW measures the
risk level of on- and off-balance sheet items in the credit union’s “risk
portfolios.”8 The requirement applies only if a credit union’s total assets at
the end of a quarter exceed $10 million, and its RBNW requirement under
the standard calculation exceeds 6 percent. The $10 million asset floor
eliminates the burden on credit unions that are unlikely to impose a
material risk.9

NCUA uses two methods to determine whether a complex credit union
meets its RBNW requirement. Under the “standard calculation,” each of
eight risk portfolios is multiplied by one or more corresponding risk
weightings to produce eight “standard components.”10 The sum of the eight
standard components yields the RBNW requirement that the credit union’s
net worth ratio must meet for it to remain either adequately capitalized or
well-capitalized. If the RBNW requirement is not met, the credit union falls
into the undercapitalized net worth category. NCUA allows a credit union
that does not meet its RBNW requirement under the standard calculation to
substitute for any of the three standard components, a corresponding
“alternative component” that may reduce the RBNW requirement. The
alternative components recognize finer increments of risk in real estate
loans, member business loans, and investments.

Finally, in reporting on the RBNW requirement, NCUA recognized that
credit unions, which failed under the standard calculation and with the
alternative components, nonetheless might individually be able to mitigate
material risk. In such instances, a risk mitigation credit is available to credit
unions that succeed in demonstrating mitigation of interest rate or




8
 The RBNW report notes that the “risk portfolios” of balance sheet assets consist of long-
term real estate loans, member business loans outstanding, investments, low-risk assets,
and average-risk assets. The “risk portfolios” of off-balance sheet assets are loans sold with
recourse and unused member business loan commitments.
9
According to the report, the principal banking industry trade association advocated $10
million as an appropriate minimum asset “floor.”
10
  Risk portfolios include real estate loans, member business loans (MBL) outstanding,
investments, low-risk assets, average-risk assets, loans sold with recourse, unused MBL
commitments, and allowances. See Federal Register 65, no. 34 (18 February 2000): 8606.




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NCUA’s Implementation of Prompt
Corrective Action




credit risk.11 If approved, a risk mitigation credit will reduce the RBNW
requirement a credit union must satisfy to remain classified as adequately
capitalized or above.




11
 According to NCUA data, as of May 2003, no credit union failed to meet an RBNW
requirement under the standard calculation and with the alternative component, and so
none has applied for a risk mitigation credit to date.




Page 158                                     GAO-04-91 Changes in Credit Union Industry
Appendix X

Accounting for Share Insurance



               The National Credit Union Share Insurance Fund (NCUSIF) capitalizes its
               insurance fund differently than the Federal Deposit Insurance Corporation
               (FDIC) capitalizes the Bank Insurance Fund (BIF) and the Savings
               Association Insurance Fund (SAIF). For NCUSIF, a cash deposit in the fund
               equal to 1 percent of insured shares, adjusted at least annually, must remain
               on deposit with the fund for the period a credit union remains federally
               insured. This deposit is treated as an asset on the credit union’s financial
               statements, and as part of equity on NCUSIF’s financial statements in an
               account entitled “Insured credit unions’ accumulated contributions.” If a
               credit union leaves federal insurance, for example to become privately
               insured, the deposit with NCUSIF is refunded. However, if the National
               Credit Union Administration’s (NCUA) board assesses additional premiums
               in order to maintain the minimum required equity ratio, the premiums are
               treated as an operating expense on the credit unions’ financial statements
               and would not be refunded. Since 2000, NCUA has not made any
               distributions to contributing credit unions because the fund did not exceed
               the NCUA board’s specific operating level. And, between 1990 and 2002,
               federally insured credit unions were assessed premiums only in 1991 and
               1992, when the fund’s equity declined below the mandated minimum
               normal operating level of 1.20 percent of insured shares.1

               However, unlike federally insured credit unions, federally insured banks
               and thrifts operate exclusively under a premium-based insurance system.
               This system requires banks and thrifts to remit a premium payment of a
               specified percent of their balance of insured deposits twice a year to FDIC
               to obtain federal deposit insurance. Each bank or thrift treats the premium
               as an expense in its financial statements, while FDIC recognizes the
               premium as income in its financial statements. If a bank or thrift elects to
               not continue its federal deposit insurance, its premiums are, unlike the
               NCUSIF insurance deposit, nonrefundable.

               The Federal Deposit Insurance Corporation Improvement Act (FDICIA),
               enacted in December 1991, contained some important provisions including
               risk-based premiums for BIF and SAIF. FDIC developed and then
               implemented the risk-based premium system on January 1, 1993. Under the
               system, institutions were categorized according to a capital subgroup (1, 2,




               1
               Federal Credit Union Act.




               Page 159                               GAO-04-91 Changes in Credit Union Industry
Appendix X
Accounting for Share Insurance




or 3) and a supervisory subgroup (A, B, or C).2 This resulted in the best-
rated institutions being categorized as 1-A and the worst institutions as 3-C.
These categorizations result in a range of premium costs, with the best-
rated institutions paying the lowest premium and the worst-rated
institutions paying the highest premium.

In August 2000, FDIC issued a report that discussed the current deposit
insurance system, including the existence of two separate funds, an
insurance pricing system that may provide inappropriate incentives for risk
and growth, and issues of fairness and equitable insurance coverage, and
offered possible solutions. The report warned that this system might
require banks to fund insurance losses when they can least afford it.
Solutions offered in the report included (1) merging BIF and SAIF, (2)
improving the pricing of insurance premiums through a number of options,
and (3) setting a “soft” target for the reserve ratio, which would allow the
deposit insurance fund balances to grow during favorable economic
periods, thereby smoothing premium costs over a longer period of time. As
a result of FDIC’s report, legislation is pending that may provide additional
reforms of the deposit insurance system, including pricing of insurance.

As did BIF and SAIF, American Share Insurance (ASI), the private primary
share insurer, adopted a form of risk-based insurance plan at the end of
2000. As does NCUSIF, ASI’s member credit unions pay a deposit rather
than an annual premium assessment to purchase their insurance coverage.
Prior to December 31, 2000, all of ASI’s insured credit unions were required
to maintain a deposit of 1.3 percent of each member’s total insured share
amounts, compared with 1.0 percent that federally insured credit unions
maintain with NCUSIF. With its change to a risk-based system, ASI’s
insurance coverage now requires a range—a minimum deposit of 1.0


2
 The capital subgroup is assigned on the basis of the institution’s total risk-based capital
ratio, tier 1 risk-based capital ratio, and tier 1 leverage capital ratio. The institutions report
this data quarterly to FDIC on their Report of Income and Condition (call report). For
instance, according to FDIC Risk-Based Assessment System – Overview, Group 1 (“Well-
Capitalized”) has a “Total Risk-Based Capital Ratio equal to or greater than 10 percent, and
Tier 1 Risk-Based Capital Ratio equal to or greater than 6 percent, and Tier 1 Leverage
Capital Ratio equal to or greater than 5 percent.” Each semiannual period, FDIC assigns the
supervisory subgroup based on various factors including results of the most recent
examination report, the amount of time since the last examination, and statistical analysis of
call report data. For example, according to the FDIC’s Risk-Based Assessment System-
Overview, a subgroup A institution is “financially sound institution with only a few minor
weaknesses and generally corresponds to the primary federal regulator’s composite rating
of ‘1’or ‘2’.”




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Accounting for Share Insurance




percent up to a maximum of 1.3 percent for each credit union depending on
the credit union’s CAMEL rating.3

The FDIC study of risk-based pricing indicated that one of the negative
aspects of not pricing to risk is that new institutions and fast-growing
institutions are benefiting at the expense of their older and slower-growing
competitors. Rapid deposit growth lowers a fund’s equity ratio and
increases the probability that additional failures will push a fund’s equity
ratio below the minimum requirements, resulting in a rapid increase in
premiums for all institutions.




3
 Credit unions are rated on their condition by NCUA and state regulators using a “CAMEL”
system that evaluates their capital adequacy (C), asset quality (A), management (M),
earnings (E), liquidity (L), and their overall condition.




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Comments from the National Credit Union
Administration




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Administration





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Administration





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Administration





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Administration





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Comments from the National Credit Union

Administration





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Comments from American Share Insurance 





               Page 168     GAO-04-91 Changes in Credit Union Industry
     Appendix XII

     Comments from American Share Insurance 





Mr. Richard J. Hillman 

October 14, 2003 

Page 2 



B. 	    ASI has limited ability to absorb large (catastrophic) losses because it does not have the
        backing of any government entity.

In its 29-year history, ASI has paid over 110 claims on failed credit unions, and more importantly, no
member of a privately insured credit union has ever lost money in an ASI-insured account. Also, ASI’s
statutory ability to reassess its member credit unions provides a significant amount of committed equity
for catastrophic losses. Further, the company employs numerous programs to mitigate the risk of large
losses and field examines more than 60% of its insured risk annually. Therefore, a sound private deposit
insurance program, built upon a solid foundation of careful underwriting, continuous risk management
and the financial backing of its mutual member credit unions, can absorb large (catastrophic) losses.

With regard to the government backing, the GAO fails to consider that ASI is a private business, licensed
at the state level; owned by the credit unions it insures; and, managed by a board of directors elected by
such member credit unions. Private share insurance was never intended to have any state or federal
guarantees.

C.      ASI’s lines of credit are limited in the aggregate as to amount and available collateral.

The Study Section erroneously views the company’s lines of credit as a source of capital, when they are
solely in place to provide emergency liquidity. Proportionately, ASI’s committed lines of credit with third
parties, as a percentage of fund assets, are greater than that of the federal share insurer. Comparisons
throughout the Study Section are often provided on an absolute basis, not a proportionate basis, which we
believe skews many of the results included in the Study Section.

D. 	    Many privately insured credit unions have failed to make required consumer disclosures
        about the absence of federal insurance of member accounts as required under the Federal
        Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), and the Federal Trade
        Commission (FTC) is the appropriate federal agency to enforce such compliance.

FDICIA was passed in December 1991, and not long thereafter, the FTC sought and received an
exemption from Congress from enforcing the consumer disclosure provisions of FDICIA. We concur
with the Study Section’s observations in this regard, and believe privately insured credit unions would
benefit from FTC’s enforcement of such provisions.

Detailed comments supporting and supplementing our above comments are attached as Exhibit A.

Very truly yours,



DENNIS R. ADAMS
President/CEO

DRA/krb

Attachment




     Page 169                                                     GAO-04-91 Changes in Credit Union Industry
        Appendix XII

        Comments from American Share Insurance 





                                                   EXHIBIT A

          DETAILED COMMENTS ON THE GAO’S DRAFT STUDY OF PRIVATE SHARE INSURANCE

                                     A Component of the GAO’s Study Titled:
                     Credit Unions: Financial Condition Has Improved But Opportunities Exist
                             To Enhance Oversight and Share Insurance Management

                                                  Submitted By: 

                                              American Share Insurance 

                                                 October 14, 2003 



A.      ASI’s risks are concentrated in a few large credit unions and in certain states.

All businesses face some degree of concentration risk. For example, 55% of all federally insured shares are on
deposit at only 230 NCUSIF-insured credit unions -- this represents less than 3% of all federally insured credit
unions nationally. Despite this natural phenomena, the GAO proceeds to raise concern over ASI’s risk distribution.

Geographic Risk

The Study Section states that compared to federally insured credit unions, “…relatively few credit unions are
privately insured.” As of December 31, 2002, about 2% of all credit unions are privately insured. ASI is currently
authorized in nine states and insuring credit unions in eight nationally, and is limited to insuring only state-
chartered credit unions in those states in which the company is authorized to do business. In its current states of
operation, the company insures 212 credit unions, comprising $10.8 billion in insured shares. What the Study
Section fails to report is that these credit unions represent 19% of all 1,095 state-chartered credit unions within that
limited market, and 13.67% of the $80 billion in shares in those same 1,095 credit unions. Clearly, private share
insurance is more significant to those affected states than the Study Section’s 2% statistic infers.

The Study Section also reports that 45% of all shares insured by ASI are in credit unions chartered in California, as
compared to 14.7% for the NCUSIF. These facts can be misleading given that ASI has a limited market, and the
NCUSIF operates in all 50 states. An entirely different, but more comparable, result is achieved when one isolates
the relative risk in these eight states only. Under an assumption that both entities are limited to doing business in
just the eight ASI states, ASI’s 45% concentration in California looks significantly less daunting when compared to
55% for the NCUSIF. This should offer evidence that when placed on equal footing, the relative risk concentration
variances are reduced materially.

While eight states represent a limited market, they do not necessarily represent a geographic concentration risk, as
inferred by the Study Section. We argue that the company’s states of operation represent a diverse cross-section of
our nation, for example: East Coast – Maryland; Midwest – Ohio, Indiana and Illinois; West Coast – California and
Nevada; Northwest – Idaho; and, Southeast – Alabama.

Statutory Factors

As a private company, ASI faces various admission obstacles when seeking new markets. First, a state must have a
state statute that allows for an option in share insurance. According to the Study Section, a total of approximately
20 state statutes currently allow for the share insurance option for their state-chartered credit unions. Based on this
data, ASI is operating in about 40%-50% of the available markets. Furthermore, the actual power to approve such
coverage, when permitted by statute, is generally resident with the specific state’s credit union supervisory
authority. So, as a private company, to do business in any state requires that three basic conditions exist: (1) credit
union demand; (2) a permissible statute; and, (3) regulatory acceptance of the option.


                                                      Page 1 of 4




        Page 170                                                         GAO-04-91 Changes in Credit Union Industry
         Appendix XII

         Comments from American Share Insurance 





Based on these legislative and regulatory barriers, we take exception to the GAO constantly using the federal share
insurer, the NCUSIF, as a benchmark in evaluating a private company’s geographic concentration risk. Due to the
agency’s federal franchise, none of the above conditions need be present for the NCUSIF to do business in a state.

Mitigating Concentration Risk

The business of insuring credit union member deposits is a business of risk assumption. Accordingly, the type of
risk one assumes drives the cost of the program and the risk of ultimate loss to the fund. ASI has been very
selective in assuming the risk it underwrites, and does a thorough job of monitoring and field examining its insured
institutions on a recurring basis as reported in the Study Section. In addition, the Study Section reports that the
company has denied insurance coverage to certain credit unions representing inordinate risk to the fund, and
conversely has approved many that satisfy the company’s Risk Eligibility Standards. Of the 29 credit unions that
have converted to private share insurance during the past decade, all were at the time, and are now, safe and sound
credit unions, and all strictly complied with the federal requirements to convert insurance. These were not problem
credit unions fleeing federal supervision. Included in these federal requirements is a mail ballot vote of the credit
union’s entire membership.

Risk in a Few Large Credit Unions

The Study Section reports that ASI has one insured institution that represents approximately 25% of its total insured
shares, and that its “Top Five” credit unions represent 40% of total insured shares. The first statistic compares
unfavorably to the NCUSIF’s reported concentration risk in a single institution of 3%, to which we take no
exception. The risk of a single institution, however, has been significantly misrepresented in the Study Section. A
large, well managed credit union contributes significantly to the financial stability of a share insurance program.

When underwriting its current largest institution in 2002, ASI considered several risk-mitigating factors, and, as
with all applicant credit unions, performed a careful analysis of the institution. First, the subject institution received
(and continues to receive) the highest rating available for credit unions. Second, ASI’s independent actuaries
evaluated the adequacy of ASI’s capital prior to, and following, the underwriting of this credit union, and
determined that ASI would continue to have a sufficiently high probability of sustaining runs even with this credit
union in its insurance fund. Lastly, the federal insurer and state regulator both approved of the credit union’s
insurance conversion, but only after the credit union took a full mail ballot vote of its almost 200,000 members and
agreed to satisfy all the requirements of consumer disclosure under FDICIA.

With regard to the risk concentrated in a few large credit unions, the Study Section fails to report the concentration
risk in what would be the equivalent of the NCUSIF’s “Top Five” federally insured credit unions. Proportionately,
this would equate to the NCUSIF’s top 230 federally insured credit unions. In terms of asset size, this group of 230
credit unions represents 45% of the NCUSIF’s total insured shares. Clearly, the two funds compare on this statistic,
when measured on a proportionate, not absolute basis.

B. 	    ASI has limited ability to absorb large (catastrophic) losses because it does not have the backing of
        any government entity.

The credit union movement introduced share insurance on the state level long before Title II of the Federal Credit
Union Act was enacted in 1971, providing the first federal deposit insurance for credit unions. However, private
share insurance didn’t come of age until the mid 1970s, as states began to realize the loss of sovereignty in a state
charter under an all-federal insurance setting.




                                                       Page 2 of 4




         Page 171                                                         GAO-04-91 Changes in Credit Union Industry
        Appendix XII

        Comments from American Share Insurance 





It was never envisioned that private share insurance would seek, or need, any guarantee from a state or federal
government to operate. In the cooperative spirit of the credit union movement, private share insurance was designed
to be a credit union-owned and credit union-operated private fund. Nor was it ever the intent of the framers of
private share insurance for it to operate without supervision, or financial capacity. Accordingly, various state laws
were proactively sought and passed to permit the private share insurance option, subject to admission standards and
required approvals. Private share insurance was designed to provide credit unions with a comparable – not identical
-- alternative means for protecting member share accounts. Accordingly, a government backing for private share
insurance was never anticipated, and to use the lack of such a guarantee as a criticism of private share insurance
does not take into account its legislative intent, past performance or founding principles.

To our knowledge, no private insurance company, licensed by individual states, has a guarantee from the federal
government. Further, no private insurance company in the U.S. would be able to meet the “deep pockets” test of the
federal or state governments inferred in the Study Section. As evidence of this, the largest insurance company in the
country reports just under $32 billion in capital from all of its various insurance product lines. This is barely 50% of
the aggregate capital available to the NCUSIF. (Note: This amount is the estimated sum of the NCUSIF’s balance
sheet capital plus the off-balance sheet recapitalization liability of its insured credit unions).

Credit union-only insurance funds have a stable history that does not track with insurers of thrifts or a combination
of thrifts and credit unions. Funds that have insured only credit unions (like ASI and the NCUSIF) have had very
successful track records when it comes to loss and risk management. In over 29 years, ASI’s loss ratio has been
significantly below that of its federal counterpart, and ASI has never had a year with an operating loss, nor has it
ever had to seek any form of recapitalization from its member credit unions to bolster the fund due to losses.

The reality is that a sound deposit insurance program, built upon a solid foundation of careful underwriting,
continuous risk management and the financial backing of its mutual member credit unions, can exist as long as
consideration is given to an actuarial analysis of the capital adequacy of the program in terms of sufficiently high
probabilities (over 90%) of being able to withstand runs and multiple runs on the system. This is a common
analysis that is accepted in the insurance industry for various kinds of low frequency, high-severity risk programs
and is the foundation that the ASI insurance program is built upon. Our actuarial analyses and independent
actuarial reports were provided to the GAO during its investigation. Alternative share insurance can be comparable
to the NCUSIF, and still not have a government backing.

C.      ASI’s lines of credit are limited in the aggregate as to amount and available collateral.

With regard to ASI’s committed bank lines of credit, the Study Section infers that ASI’s ability to absorb losses is
reduced since its lines of credit are limited in the aggregate as to amount and available collateral. We disagree with
this inference. The company’s lines of credit are designed to be solely a liquidity facility. The committed lines
ensure liquidity of ASI’s invested funds; i.e., they provide a mechanism for ASI to quickly generate cash to meet
liquidity needs, without having to liquidate the portfolio. Resources available for funding losses are not the same as
resources available for providing liquidity. Lines of credit are not intended to be a source for funding insurance
losses. In fact, banks would not provide a loan for such a purpose. ASI’s assets and its off-balance sheet sources of
funding (i.e., the power to recapitalize the fund by insured credit unions under the ASI’s governing statute and
insurance policy) are its capital sources for funding losses, not the bank lines of credit.

Proportionately, ASI’s lines of credits are greater than that of the NCUSIF. ASI’s $90 million in committed lines
of credit equates to approximately 47% of the company’s total assets. NCUSIF’s $1.6 billion maximum borrowing
capacity ($100 million from the U.S. Treasury and $1.5 billion from the Central Liquidity Facility, as disclosed in
the NCUSIF’s and CLF’s audited financial statements for the year ended December 31, 2002), equates to
approximately 28% of its total assets.




                                                      Page 3 of 4




        Page 172                                                         GAO-04-91 Changes in Credit Union Industry
        Appendix XII

        Comments from American Share Insurance 





ASI has other sources of liquidity when it liquidates a credit union -- that is the credit union’s own liquid assets.
Approximately 42% of ASI’s primary insured credit unions’ total assets are comprised of cash and investments –
we believe this is significant. In addition, the non-liquid assets (namely loans and fixed assets) of a failed
institution can be pledged as collateral for additional borrowings to generate short-term liquidity until such loans
and other assets can be collected and/or sold. In essence, a failed credit union’s total assets over time often
generate sufficient liquidity to pay shareholders. Any shortage (historically less than 4% of total assets of the failed
institution) is usually funded as a loss by ASI’s assets. This is the same principle under which NCUSIF operates.

D. 	    Many privately insured credit unions have failed to make required consumer disclosures about the
        absence of federal insurance of member accounts as required under the Federal Deposit Insurance
        Corporation Improvement Act of 1991 (FDICIA), and the Federal Trade Commission (FTC) is the
        appropriate federal agency to enforce such compliance.

The Study Section reference to the GAO’s August 20, 2003 study titled: Federal Deposit Insurance Act: FTC Best
Among Candidates to Enforce Consumer Protection Provisions (GAO-03-971) reiterates the GAO’s earlier concern
that “…members of privately insured credit unions might not be adequately informed that their deposits are not
federally insured…”

Although the statement may be accurate, any implication that ASI and its member credit unions are purposefully
misleading consumers fails to directly implicate the Federal Trade Commission (FTC) who, with the concurrence
of Congress, has totally disregarded its statutory responsibility to regulate the disclosure requirements as defined by
Section 151 (g) of FDICIA, codified at 12 U.S.C. § 1831 (t)(g).

We believe that the GAO’s earlier study brought to light the problems that arise when a federal law effectively
lacks an enforcement agency, and we support the GAO’s previous conclusion that the FTC is the appropriate
agency for monitoring and defining private share insurance consumer disclosure requirements.

This concludes ASI’s detailed comments in response to the GAO’s draft report on its study of private share
insurance in the credit union movement -- a component of the GAO’s broader study titled, Credit Unions:
Financial Condition Has Improved But Opportunities Exist to Enhance Oversight and Share Insurance
Management.




                                                      Page 4 of 4




        Page 173                                                         GAO-04-91 Changes in Credit Union Industry
Appendix XIII

GAO Contacts and Staff Acknowledgments




GAO Contacts	     Richard J. Hillman (202) 512-8678
                  Debra R. Johnson (202) 512-8678
                  Harry Medina (415) 904-2220



Staff             In additional to those named in the body of this report, the following 

                  individuals made key contributions.

Acknowledgments
                  William Bates

                  Sonja Bensen

                  Anne Cangi

                  Theresa L. Chen

                  William Chatlos

                  Jeanette Franzel

                  Charla Gilbert

                  Paul Kinney

                  Jennifer Lai

                  May Lee

                  Kimberley McGatlin

                  Grant Mallie

                  José R. Peña

                  Donald Porteous

                  Mitch Rachlis

                  Emma Quach

                  Barbara Roesmann

                  Nicholas Satriano

                  Kathryn Supinski

                  Paul Thompson

                  Richard Vagnoni





(250097)          Page 174                               GAO-04-91 Changes in Credit Union Industry
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