Wednesday, April 8, 2020

Are you ready for the move away from the LIBOR standard?

WASHINGTON—The coronavirus pandemic is dominating the agendas of every credit union decision-maker, but there is another change on the horizon that deserves attention: the move away from the LIBOR standard.
With the long-time pricing standard, the London Interbank Offer Rate (LIBOR), being phased out and a new financial reference rate taking its place, one expert says the biggest concern is not knowing how big the CU exposure may be.
LIBOR, the global benchmark short-term interest rate, which has governed global financial transactions since the 1970s, will be discontinued by the end of 2021.
Samira Salem, a CUNA senior policy analyst, said she is worried over the degree to which credit unions will have to invest both time and money in making the shift to a new reference rate, simply because no one has yet to quantify how many credit unions and how much of their products are tied to LIBOR. 
And that exposure, too, could lead to potential lawsuits, she suggested, due to a lack of fallback language in many credit unions’ current contracts that include language referencing LIBOR.
“The thing is we really don't have a good handle on credit unions’ exposure,” said Salem. “It's important to get a handle on this. There is no language that explains the difference between LIBOR and an alternative rate and how that's going to be calculated.
“There certainly is legal risk,” Salem continued. “It is not clear how this situation will be resolved yet, but I am certain there is work being done now looking at this very issue. As I said, there is legal risk if neither party is willing to accept the change—either the credit union agrees to reduce its margin or the borrower pays a higher rate. This is the financial risk.”
LIBOR’s Replacement
Replacing LIBOR will be a new abbreviation, SOFR, for Secured Overnight Financing Rate. SOFR was officially adopted by the Federal Reserve in December 2017 as a replacement for the LIBOR standard, which has been widely used by financial institutions as a basis for setting—among other things—variable rate loans. The Consumer Financial Protection Bureau has estimated there is $1.3 trillion in consumer loans with an interest rate based on LIBOR, the bulk which are for residential mortgages.
According to the CFPB, LIBOR is being phased out, because the rate is based on transactions among banks that don’t occur as often as they did in prior years, making the index less reliable and credible.
Salem emphasized NCUA is paying close attention to the transition away from LIBOR within credit unions, making it one of the agency’s supervisory priorities in 2020. Board Member Mark McWatters, during a recent open board meeting, shared his concerns.
“The reason it’s high on our list is credit unions may not be paying attention to this issue; that could be the source of some embarrassment if LIBOR is to go away and the credit union community isn’t aware of it,” stated McWatters. “So, we have questions out to credit unions about how often they use LIBOR and how might they be affected by the transition.”
Earlier this year in remarks to a credit union meeting in Hawaii, McWatters added, “To me, the interesting issue isn’t the transition issue. For years people who worked with LIBOR intuitively understood the risk. You could price it in your head and had a feel for the underwriting in your head. When it becomes something else, how does that translate? How are you going to price your credit with the confidence you are properly accounting for the risk involved. In the world of pricing risk on credit, a few basis points can be the difference between a good loan and a bad loan.”

Salem said there are significant changes credit unions will have to make to their operation systems and loan documentation to accommodate an alternative base rate.

Significant Changes
“It's going to be expensive,” said Salem. “So, how many credit unions will get hit by this and how expensive it will be over the entire system is not known today. If we can clearly determine the level of exposure we’ll get a better sense of the total cost and the total amount of work that needs to be done. There is a financial risk here, as there are a wide range of consumer products that can be affected—such as adjustable rate mortgages, student loans, home equity lines, and credit cards.”
CUNA, Salem said, has completed a “back-of-the-envelope calculation” to obtain some sense of CUs’ exposure.
“We determined around 17% the entire credit union loan portfolio is made up of adjustable-rate loans, and you can adjust that percentage up or down,” Salem said. “However, what we really don’t know is how many credit unions have loans tied to LIBOR.”
Slow Adoption
Salem reminded NCUA is encouraging credit unions to transition away from anything that uses LIBOR as a reference rate.
“The Federal Reserve has been publishing SOFR for a while, but its adoption has been slow,” Salem said. “Right now we're in the transition phase—the end of 2021 is the end date, the Federal Reserve is encouraging the use of SOFR, and financial institutions are looking at integrating fallback language into existing contracts. We're right in the middle of all this. Overall, I’d say this is a hazy area right now.”
New FSAB Guidance
To help ease some of the burdens in the move away from LIBOR, the Financial Accounting Standards Board (FASB) has released new guidance designed to “ease the process of” migrating away from reference rates that include LIBOR as well as a migration to new reference rates.
According to FASB, the guidance addresses operational challenges that are designed to “simplify matters going forward and help reduce transition-related costs.” 
The update will also help reduce transition-related costs, FASB said.
The guidance will be in effect through Dec. 31, 2022, FASB said, to help various parties during the reference-rate transition period. 
FASB said the new guidance provides optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued.
The guidance can be found here.

Tuesday, April 7, 2020

NCUA Summary of the Coronavirus Aid, Relief, and Economic Security (CARES) Act

Letter to Credit Unions (20-CU-07)
Summary of the Coronavirus Aid, Relief, and
Economic Security (CARES) Act

Dear Boards of Directors and Chief Executive Officers:

This letter provides vital information about key changes affecting your credit union due to the recently enacted Coronavirus Aid, Relief, and Economic Security (CARES) Act.

Read the Letter to Credit Unions

The Coronavirus Aid, Relief, and Economic Security Act was signed into law by President Trump on March 27, 2020. The CARES Act contains numerous provisions to help workers, families, and businesses, including unemployment insurance benefits and loan guarantee programs. It also contains provisions that assist severely distressed sectors of the economy. Some of the CARES Act provisions that affect credit unions are described herein.

CUNA's Recession Forecast Deepens - Steven Rick

CUNA has forecast a recession twice as deep as the one it predicted just two weeks ago as unprecedented jobless claims signaled the American economy had come to a near standstill.
The forecast is part of the report, “The Coronavirus (COVID-19) Recession & its Impact on Credit Unions,” which CUNA economists began drafting more than a week ago, and were forced to continue revising before the ink dried on previous drafts.
Jordan van Rijn
“It is increasingly looking like the recession could take longer than originally anticipated,” CUNA economist and chief author Jordan van Rijn said in an interview. “It’s hard to imagine social distancing will just stop in May, June or July.”
“Many businesses may not be able to come back, and those jobs will disappear permanently,” he said.
Steven Rick
CUNA economists met Friday, April 3 with CUNA Mutual Group Chief Economist Steven Rick to revise their March 24 forecast, when they switched course from mid-February’s prediction of a 1.8% gain in real U.S. gross domestic product this year to a brief recession sending U.S. GDP down 2.25%, unemployment peaking at 6.5% and credit union loan growth slowing to 3.5%.
On Friday, they forecast a 5% drop in GDP for the year, with a slight downturn in the first quarter and “a historically unprecedented” 20% annualized drop for the current quarter.
“Assuming the coronavirus peaks in the second quarter and the U.S. gradually resumes economic activity shortly thereafter, economic growth should bounce back slightly in the third and fourth quarters,” the report said. “Growth, however, is likely to remain muted throughout 2020 as supply chains rebuild, many businesses close indefinitely and consumers remain cautious.”
The report also forecast:
  • The unemployment rate to reach 15% by September, representing the loss of approximately 18 million jobs. “However, unemployment could easily climb higher.”
  • Credit union loan growth is now expected to be only 2% this year and 3.5% in 2021 — both well below growth of 6.5% in 2019.
  • Loan quality will weaken. At the end of 2019, payments were only 60 days or more late on 0.70% of balances; this year delinquencies will spike to 1.25%. Charge-off rates, which were only 0.56% of average loans for the 12 months ending Dec. 31, will rise to 0.87% this year.
The economy will grow 3% in 2021, “with production and service-sector activity resuming, and pent up consumer demand driving growth,” the report said.
Van Rijn said in an interview that the economic team will be meeting and reporting more often because of the swiftly changing conditions.
Beyond common boilerplate caveats about uncertainty, CUNA economists stressed that conditions are truly fluid and predictions could change for the worse if any of their assumptions fall short.
“For example, ‘stay at home’ orders and social distancing could remain in place longer than the second quarter, and the coronavirus could dissipate during the warmer summer months only to return in the fall. Also, policymakers could make errors in fiscal and monetary policy, or in countering the pandemic,” the report said.
Despite this, credit unions will not see conditions as bad as they were during the Great Recession of 2007 to 2009. Loan delinquencies peaked at 1.82% and charge-offs at 1.20% in 2009. Loan portfolios fell 1.2% in 2010, the year after the recovery began.
“This is because credit and housing markets remain relatively healthy, credit unions are larger and more diversified today, mortgage lending is a bigger part of credit union loan portfolios, and the effects of the pandemic are expected to be relatively short-lived,” the report said.
Loans for cars and businesses will see the greatest impact, while low-interest rates will continue to feed refinance volume and home equity lines of credit.
Auto lending was already trending down. While cars account for about 30% of credit union loan balances, they have been responsible for about 40% of growth, mainly because of indirect lending. About 17 million new cars and light trucks were sold in 2019, but this year about 15% fewer will be sold.
While households are still reaching out to credit unions to refinance first mortgages and take out second mortgages, purchase mortgages will “take a hit, at least for a little while,” van Rijn said.

“It may be harder to go out and purchase a home with all of the social distancing,” he said. “In general, we expect credit unions will get creative so they can still do lending in these tough times.”
| April 06, 2020 at 01:43 PM

FYI, FAQs on PPP Ready to Read ASAP

ARLINGTON, Va.—In conjunction with the release by the Small Business Administration (SBA) of an interim final rule to implement the $349 billion Paycheck Protection Program, NAFCU has published a series of FAQs on the program and what it mean for credit unions.
Previous guidance from the Treasury Department indicated all federally-insured credit unions will be able to offer loans under the program, but those that are not currently SBA-approved lenders must submit an application to become one.
NAFCU's FAQ document answers 22 questions. Of note, while credit unions are not qualified to apply for a loan under the paycheck protection program, credit unions can receive economic injury disaster loans (EIDLs).
Among the issues discussed in the FAQs:
  • What paycheck protection loans can be used for
  • Terms of the loans
  • Who is eligible to apply
  • Who are eligible lenders, including how to apply to offer loans if not already an SBA-approved lender
  • Loan forgiveness
  • Ability to apply for other emergency coronavirus loans
  • Who can act as agents
  • Underwriting requirements
  • What documents lenders need to provide SBA for loan applications
  • How to determine a borrower's eligibility
  • Which documents lenders need to provide for loan forgiveness requests
  • If any fees are owed to SBA
Additional questions related to borrowers are also addressed in NAFCU's FAQs. The application period for small businesses opened Friday; independent contractors, self-employed individuals, and sole proprietors can begin applying April 10.

NAFCU is offering a free webinar today on PPP

ARLINGTON, Va.—NAFCU is offering a free webinar today to help credit unions better understand the process for offering loans through the Small Business Administration's new Paycheck Protection Program (PPP).
Just a day ahead of the launch of the program itself, the SBA last week released an interim final rule to implement the program. In response, NAFCU developed an FAQ document answering 22 questions credit unions are likely to face as they consider participating in the program (see related story).
Previous guidance from the Treasury Department indicated all federally-insured credit unions will be able to offer loans under the program, but those that are not currently SBA-approved lenders must submit an application to become one.
During today’s webinar, set to begin at 4 p.m. ET, credit unions will hear from Steve Meirink, executive vice president and general manager of compliance solutions in the Governance, Risk & Compliance division at Wolters Kluwer.
Meirink will provide guidance related to the Paycheck Protection Program, highlight the most pressing market needs, and explain the best ways credit unions can make the program work for members in need of small business loans during the coronavirus pandemic, NAFCU said.
While the webinar is free, registration is required.

Monday, April 6, 2020

Federal and State Agencies Encourage Mortgage Servicers to Work With Struggling Homeowners Affected by COVID-19

(April 6, 2020) — On Friday, April 3, the federal financial institution regulatory agencies and the state financial regulators issued a joint-policy statement providing needed regulatory flexibility to enable the mortgage servicers to work with struggling consumers affected by the Coronavirus Disease (referred to as COVID-19) emergency. The actions announced by the agencies inform servicers of the agencies’ flexible supervisory and enforcement approach during the COVID-19 emergency regarding certain communications to consumers required by the mortgage servicing rules. The policy statement and guidance issued today will facilitate mortgage servicers’ ability to place consumers in short-term payment forbearance programs such as the one required by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). 

Under the CARES Act, borrowers in a federally backed mortgage loan experiencing financial hardship due, directly or indirectly, to the COVID-19 emergency, may request forbearance by making a request to their mortgage servicer and affirming that they are experiencing financial hardship during the COVID–19 emergency. In response, servicers must provide a CARES Act forbearance that allows borrowers to defer their mortgage payments for up to 180-days and possibly longer. 

View the entire press release​

Banking During and After COVID-19

Before COVID-19, the banking industry was experiencing an unprecedented period of growth and prosperity. Despite increasing consumer expectations and increased competition from non-traditional financial institutions, most banks and credit unions were stronger than at any period since the financial crisis of 2008.
In a matter of only a few weeks, the world of banking has experienced a level of disruption that will change everything that had been the norm in financial services. There has not only been a major change in the way financial institutions conduct business but in the way, employees do their work and the way consumers manage their finances.
Banks and credit unions must use this time of disruption to consider reinventing themselves from the inside out. It is a time when we need to better understand the way consumers expect their financial institution to support their financial needs. This includes the way banks and credit unions use data, AI, technology and human resources to impact marketing, innovation and the digital delivery of products and services.
Some organizations may retrench and try to save costs because of the financial stress that results from the massive shutdowns caused by COVID-19. Other organizations will go beyond looking for efficiencies to create completely new business models that will impact all components of performance. Right now, there is an opportunity to reevaluate how technology, insight, and analytics can accelerate the future growth and competitiveness of financial institutions globally. To move forward will require a new perspective from most C-suites regarding priorities and deployment of resources.
To better understand the impact of COVID-19 on financial services, we interviewed three senior executives on the Banking Transformed podcast. Each executive discussed where banking was before the coronavirus crisis and the impact recent events will have on the future of marketing, innovation and digital delivery. Our guests for our “Banking Responds to COVID-19” series were:
A portion of each interview is provided below. The complete interview is available on The Financial Brand website or can be downloaded on your favorite podcast app.
Read More:
By Jim Marous, Co-Publisher of The Financial Brand, Owner/CEO of the Digital Banking Report and host of the Banking Transformed podcast.