NCUA’s description of the corporate problem dramatically changed tone after the initial January announcement. In public statements following the March conservatorships, NCUA said it needed to conserve the two corporates to get “honest numbers.” In a later Reuters news story, the “senior managers” of Wescorp were accused of “preparing to report a credit loss significantly below what an external analysis had revealed.” Chairman Fryzel is quoted: “Some information was not as accurate as it could have been.”
Over the past several weeks, NCUA has published more high level summaries of its analysis. It has also gone back to rewrite the past. In April, the Agency reversed WesCorp’s March 2008 decision by reclassifying its $9 billion held-to-maturity portfolio back to available-for-sale effective December 31, 2008. This retroactive reclassification requires that an OTTI estimate be made in the year-end audit. However, NCUA goes on to state in the very same footnote, “it is our intent to hold these securities to maturity.”
In the same March 2009 financial summary, WesCorp is reporting a “credit loss” of $5.6 billion. Additional unrealized losses of $6.0 billion were also recorded “as an unrealized loss in other comprehensive income.” Of the $16 billion in bonds for which the $6.0 billion unrealized loss is recorded, the Agency also reports that $10.5 billion were rated AAA, $2.8 billion AA, and only $2.2 billion less than single A.
Managing the Numbers
At its highest level of financial summary, the Agency is now saying that WesCorp’s books were off by approximately $11 billion as of March 2009. This difference is magnified by backdating the reclassification of the held-to-maturity portfolio to December. For if the reclassification were done in March 2009 then the OTTI for market dislocation on these securities would not have to be booked due to the FASB change in OTTI accounting practice which took effect as of the first quarter 2009.
To arrive at these results the Agency first used its own internal models as of January, then hired PIMCO to reassess resulting in the conservatorship in March, and now is using Clayton Fixed Income Services to again justify its estimates.
No one knows the losses that could occur if the securities were held to maturity. These estimates using multiple models are based on assumptions that can vary literally week to week based on updated economic and financial data. However, even though these are estimates, subject to monthly change, credit unions are being asked to write off these future losses now, not as they are incurred.
One example of how fast estimates can change is the Agency’s original instruction in January that credit unions expense the capital infusion to US Central (an estimated 13 basis points of net worth). Two months later, the Agency’s estimates given to both the Corporates in a meeting with US Central and in their May 1, 2009 Corporate update, is that the capital infusion at US Central is not impaired. But that change has not been pointed out in any of their expensing requirements. That would just highlight the variability of all loss estimates.
Through its actions, NCUA is demonstrating the same behavior that it was ascribing to WesCorp—picking numbers to fit a preferred outcome. None of the underlying securities valuations have been released so that PIMCO could be compared with Clayton let alone the Agency’s own models—which would likely show how securities do fluctuate, both up and down, in value. With the vast majority of WesCorp’s mortgage backed $16 billion in AA and AAA rated securities, it is a reasonable assumption that as markets recover, value will return.
The System’s Dilemma
The credit union system is a single model. All capital is the members’, whether held by a corporate, the CLF, the NCUSIF, a CUSO or the FHLB’s. Because of that common interest, credit unions do not face the challenge of balancing the roles of private shareholders, depositors and the federal government.
An example of this common interest occurred in March when NCUA demonstrated that it indeed has the ability to use the CLF to lend to the Corporates without using the cumbersome marked-up process of SIP. In March the Agency “prepositioned” $10 billion in the NCUSIF for use with two large credit unions. When WesCorp published its March financials, it disclosed on its balance sheet an “NCUA CLF Loan” of $5.0 billion at .35% interest. By comparison, the rate on the SIP borrowing initiated in December was .91%. The Agency can therefore lend to Corporates using the CLF at significantly lower rates than the SIP structure, an option many had been pointing out since late in 2008. It is in everyone’s interest that this be done.
In trying to justify its conservatorship actions, the greatest risk run by the Agency is not the losses on the portfolio, but the loss of confidence in its own role. The Agency had examiners full time in US Central and WesCorp. All Corporates send detailed call reports monthly to NCUA showing their investment holdings and classifications. Most publish even greater detail on their web sites. These reports were sent for every event the Agency now wants to reverse—the March 2008 held to maturity reclassification, the December year-end filings, and every month thereafter.
By suggesting there is an $11 billion “adjustment” required in WesCorp’s balance sheet position, the Agency is opening itself up to one of two possibilities: its own oversight was not competent during this time but that today it is, even with the same leadership in place; or the professional integrity of the auditors, the portfolio managers, and the supervisory structure that reviewed these reports is suspect. Either outcome could create an enormous challenge to the unitary strength of the credit union system.
As one concerned CEO wrote me: “NCUA was privy to internal documents and had full access to all investment practices. The same portfolio evidence that damns WesCorp management will also damn NCUA.”
The Way Forward
Some credit unions just want the corporate problem to be over, so that they can get on with running their business. They, like most, have written off the 1% or more, and will survive. Others are saying never again, vowing to have no interaction with any corporate or proposed new structure. Some think there is a magic solution that will somehow make this all come out right, maybe some TARP or other government funding - forgetting what makes cooperatives different.
The one solution that unites everyone is for NCUA to commit to the least cost outcome by holding the bulk of securities as they are paid down or until there is clear evidence of default. No loss has yet been incurred on these securities. But there have been multiple estimates of what could happen.
The final die is not cast; however if security sales begin, it won’t be the financial losses that cause the crisis to flare up anew. It will be the realization that the members’ interests were not everyone’s true first, and final, concern.