Chattel Lien Fund

Robert M. Windsor, President
First Financial Federal Credit Union of Maryland
1215 York Road
Lutherville, Maryland 21093

Re: Chattel Lien Fund.

Dear Mr. Windsor:

You have asked whether a federal credit union (FCU) may establish a fund for expenditures incurred in improving repossessed vehicles used to secure member loans that are damaged and uninsured. Your credit union policy refers to this fund as a "chattel lien fund." An FCU has the power to "exercise such incidental powers as shall be necessary or requisite to enable it to carry on effectively the business for which it is incorporated." 12 U.S.C. §1757(17). Under the Federal Credit Union Act and generally accepted accounting practices, an FCU may not create a reserve or fund of money for improving damaged collateral. However, an FCU may improve damaged repossessed uninsured collateral as an incidental power.

Your FCU formerly maintained a blanket collateral protection insurance policy to protect the credit union on uninsured physical damage loss to repossessed property. The FCU passed the twenty-five dollar premium to the member on each vehicle loan. When the credit union repossessed uninsured damaged collateral, it filed a claim with its insurer. For business reasons, the FCU decided to cancel the policy and establish a fund to absorb these losses on member loans. As a result, member costs reduced to twelve dollars per loan. After repossessing a damaged uninsured vehicle, the FCU pays for the necessary repairs and sells the vehicle at auction. This allows the FCU to recover more of its losses at the vehicle's sale.

We have prohibited FCUs from establishing various forms of self-insurance. However, we have determined that your credit union’s program to provide protection for its chattel liens does not establish a form of self-insurance because it does not cover liability losses. The purpose of the credit union’s policy is to reduce losses the FCU will sustain if it attempts to sell a damaged repossessed vehicle.

In reviewing the incidental powers of FCUs, NCUA has relied on the test courts have applied to the incidental power authority of banks as introduced in Arnold Tours, Inc. v. Camp, 472 F.2d 427 (1st Cir. 1972): an activity is authorized as an incidental power if it is convenient or useful in connection with the FCU’s performance of one of its express powers under the Federal Credit Union Act. More recent case law has broadened the analysis under the incidental powers test. Nationsbank of North Carolina v. Variable Annuity Life Insurance Co., 513 U.S. 251, 259 n.2 (1995); Norwest Bank Minnesota, N.A. v. Sween Corporation, 118 F.3d 1255, 1260 (8th Cir. 1997; and First National Bank of Eastern Arkansas v. Taylor, 907 F.2d 775, 778 (8th Cir. 1990). Applying the rationale of these cases, FCUs may engage in activities that are closely related to the express powers enumerated in 12 U.S.C. § 1757 and are useful in carrying out the business of credit unions.

Charging loan fees for an internal collateral protection program is a logical outgrowth of an FCU’s express authority to lend to its members. The FCU Act does not require FCUs to obtain collateral protection insurance to cover losses resulting from repossessed damaged collateral. Yet, it is essential to the business of credit unions to reduce the risk of loss resulting from lending activities. If an FCU’s board of directors adopts a policy for a collateral protection program that comports with safety and soundness considerations and is accounted for properly, an FCU can limit losses and benefit members. Reasonable expenditures to improve damaged collateral in preparation for its sale should reduce losses resulting from an uncollectable loan. In contrast to a blanket collateral protection insurance policy, loan fees tacked to a collateral protection program may be cheaper for members because the FCU does not pass along insurance company overhead and profits. Therefore, charging fees to cover chattel lien losses through appropriate accounting measures is closely related to an FCU’s express lending authority and is useful in carrying out the business of credit unions.

In reviewing your proposal, however, the Office of Examination and Insurance determined that the credit union must adjust its accounting procedures for the "chattel lien fund." As required, the FCU board of directors has adopted a policy for establishing a fund. However, the fund currently allows the credit union to bypass the monthly profit and loss statement. The member loan fees collected increase the fund; credit union payments to improve collateral reduce the fund. The $12 fee collected from the member is not reflected in income until the reserve reaches $100,000, the board established cap.

It is inconsistent with generally accepted accounting principles (GAAP) and the FCU Act to create a distinct fund or reserve, separate and apart from regular or special reserves authorized by 12 C.F.R. Part 702. The fees collected for collateral protection coverage and the money spent for improving damaged collateral cannot bypass the income statement. Members’ fees are income. Credit union payments to improve collateral are expenses. These amounts should figure into operations and affect periodic net income. The credit union board may authorize that an amount from accumulated excess undivided earnings, after required regulatory transfers and the payment of dividends, be appropriated (set aside) for collateral protection coverage. Such an appropriation, however, would not alter the accounting requirement for all collateral protection coverage related transactions to flow through the income statement. You should seek the advice of an independent accountant practitioner to determine the specific application of GAAP in these circumstances and provide that opinion to the examiner at the FCU’s regularly scheduled examination.