By Harvey L. Johnson, CPA, Manager
As Published in Credit Union Management
An NCUA opinion letter allows CUSOs to help move bad debt off CU books
In today’s economy, non-performing loans continue to be a critical issue for many credit unions. Non-performing loans combined with capital impairments in the corporate system have left many credit unions financially unstable, causing federal regulators to take over 15 credit unions because they were deemed not financially viable.
The National Credit Union Administration’s increased emphasis on safety and soundness could actually benefit many credit unions, encouraging them to re-evaluate current operating strategies and possible ways to improve their financial condition. One strategy credit unions could leverage to help improve their financial conditions is to establish a credit union service organization to reduce the time and money they spend on collections. In addition, credit unions can essentially use a CUSO as a legal “shelter” selling their non-performing, “troubled” loans to the CUSO – and, in turn, removing those loans from their books.
Unfortunately, there are not many CUSOs out there that have been formed to buy, sell and collect delinquent loans. Some credit unions might be hesitant to undertake such a large and substantial program. Others simply may not have been aware that CUSOs have the ability to purchase and own non-performing loans.
NCUA’s Clarification for CUSOs on Purchasing and Servicing Delinquent Loans
In 2005, NCUA determined that the purchase of non-performing loans was a permissible part of a CUSO’s debt collection activity. The interpretation provided at this point in time, however, did not fully address the authority of a CUSO to engage in debt restructuring when purchasing non-performing loans.
As a result of the upheaval in the financial industry, NCUA was asked in early 2009 to clarify what restrictions would apply to a CUSO engaging in the purchasing and servicing of delinquent loans. NCUA issued Opinion Letter 09-0349 in May 2009, concluding that CUSOs can restructure loans to aid in their collection activity. NCUA’s CUSO rule was then amended to provide several new examples of permissible CUSO activities related to the operation of credit unions, including the purchase and servicing of non-performing loans.
The new ruling clarified that CUSOs may purchase non-performing loans to restructure delinquent debt, so long as CUSOs don’t increase the borrower’s original note.
Further, NCUA stated that CUSOs can restructure loans by changing the term, payment schedules and/or interest rates, but cannot advance new principal. NCUA also cautions that CUSOs should not restructure a loan under their authority to purchase and service non-performing loans in an effort to circumvent lending restrictions applicable to federal credit unions (for example, restructuring a loan with maturity terms longer or interest rates higher than permitted by regulation).
Other permissible loan support services for a CUSO include:
- debt collection services;
- loan processing, servicing, and sales;
- sale of repossessed collateral;
- real estate settlement services;
- purchase and servicing of non-performing loans; and
- referral and processing of loan applications for members whose loan applications have been denied by the credit union.
Avoiding the Pitfalls
Part of what a credit union needs to consider before forming a CUSO – which, frankly, is not always easy – are potential pitfalls relating to legal and accounting-related errors and restrictions. One of these restrictions, for example, prevents credit unions from exceeding 1 percent of their capital when investing in a CUSO.
The primary pitfall for credit unions to consider and avoid at all costs has to do with the structure and ownership of a CUSO. The whole point of establishing a CUSO is to improve the credit union’s financial stability by getting non-performing loans off the books. If the CUSO is not structured properly, either by establishing a wholly owned CUSO or by having a controlling interest (51 percent ownership), accounting rules require the entities to be consolidated, meaning the very loans the credit union wanted off its books are now right back on them.
To avoid these pitfalls, strategic planning is extremely important. In addition to considering the structure, the credit union also needs to consider fee arrangements, back-office functions and other logistical issues. A credit union should consult its legal counsel and a qualified accountant before finalizing its plans for a CUSO.
While NCUA issued its CUSO opinion letter over a year ago, delinquent loans continue to be a critical issue for many credit unions. They may have not yet recognized that CUSOs can purchase and service delinquent loans, serving as another way for them to get troubled loans off their books to help improve their financial condition. As long as credit unions pay careful attention to avoid any pitfalls and carefully follow a strategic plan, a CUSO can be used for the benefit of a credit union, improving both the financial stability of the credit union and potentially saving significant time and resources by having the CUSO purchase and service its non-performing loans.
Harvey Johnson is an audit manager and is an active member of the Financial Institution Services Team at Witt Mares PLC, a regional accounting and consulting firm serving clients throughout the mid-Atlantic. Contact him at hjohnson@wittmares.com or visit www.wittmares.com.