Charting the Corporate Role of the Future

The impetus for change in certain aspects of Corporate operations needs to be kept in perspective with the role Corporates serve in the daily functions of credit unions. It also needs to be considered in light of recent changes in the investment markets.

 
 
The announcement of large credit related losses and NCUA actions to stabilize the Corporate System in recent weeks shocked the credit union community. Indeed, the historical stability of Corporates has been called into question. Several alternatives, including the elimination of the Corporate System, have already been proposed. I believe we sit at a crossroads.

How did we get here? Simply put, the Corporate System underestimated credit risk. The spike in credit losses experienced on mortgagebacked securities, particularly in the last half of 2008, overwhelmed many of the credit enhancements built into the securities purchased by Corporates and U. S. Central. The value of these securities had been in decline since 2007. Much of this decline was previously attributed to the lack of demand for or the illiquid secondary market for these securities. This was occurring while credit unions were experiencing increased loan demand as well as competition for term deposits from banks. Liquidity levels at credit unions and Corporates tightened as 2008 progressed. The situation became tenuous when credit loss estimates accelerated.

The announcement of significantly higher than anticipated credit losses at U. S. Central in January 2009 would have likely created further liquidity pressure on an already strained Corporate System. This prompted the NCUA to act aggressively. The situation highlights a need for change in the Corporate business model and its regulation.

What should change? What should remain in place?

The impetus for change in certain aspects of Corporate operations needs to be kept in perspective with the role Corporates serve in the daily functions of credit unions. It also needs to be considered in light of recent changes in the investment markets.

Corporates were created by credit unions decades ago. They exclusively serve and are governed by credit unions. The Corporate role has evolved from managing overnight liquidity to a broader array of services ranging from payment systems to term investment and borrowing. Corporates are now aggregators of collective credit union volumes and are an integral part of the “back-office” functions of many credit unions. Over ninety percent of CenCorp’s members use CenCorp for one or more of these functions.

Investment markets changed significantly in 2008. Previously AAA-rated investments are no longer rated so highly. Swift government actions in the autumn brought both benefits and unintended consequences. Changes for financial institutions included the greater availability of federally insured investments, payment of interest on FRB balances, and the increase in deposit insurance to $250,000. At the same time, the issuance of securities in the markets in which Corporates have traditionally invested (principally mortgage-or asset-backed securities) has declined.

A Turning Point

I suspect that the combined result of the factors noted above will result in reduced Corporate balance sheets, particularly due to fewer term deposits from credit unions. This should occur regardless of any regulatory change. The challenge will be to manage the reduction in deposits in relation to the paydown of existing investment securities.

The larger near-term issue is the magnitude of credit losses that will ultimately be incurred on the investment securities in the Corporate System. A deterioration in credit quality beyond what is already estimated would lead to further write-downs. This uncertainty will likely be present until the securities pay down over the next several years.

In the meantime, Corporates will need to deliver the day-to-day operational functions demanded by members. Corporates were created to harness the collective strength of members for their mutual benefit. Open access, customized product offerings, cooperative pricing and returns, and credit union governance are hallmarks of the Corporate System. These things can’t be allowed to change.

I can say with certainty that the path forward for CenCorp will be determined by what is in the best interest of members. The Advance Notice of Proposed Rulemaking (ANPR) for Corporates provides an open forum for credit union voices to be heard. I plan on listening and participating in this process. I believe other Corporates will be doing the same. I encourage everyone to let your thoughts be known. Let’s make the outcome a stronger credit union system.
 

 

 

Feb. 23, 2009


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