On December 27, 2011, NCUA released the much-delayed December 31, 2010, KPMG audit for the Temporary Corporate Credit Union Stabilization Fund (TCCUSF). According to the TCCUSF audit, the contingent liability for losses increased from $6.4 billion as of December 2009 to $7.8 billion one year earlier. That’s a $1.467 billion increase (page 3).
The only explanation for this unexpected 23% increase in the un-audited footnotes that appear on page 24: “The increase in the aggregate contingent liability from 2009 to 2010 of approximately $1.4 billion is primarily a result of increased losses in the previously conserved CCUs [corporate credit unions] and three additional CCUs, all five of which were placed in AME status during 2010.”
For more than 18 months the NCUA had presented the $6.4 billion contingent liability for the TCCUSF in the financial statements released in open board meetings. In public comments during the campaign to have credit unions voluntarily prepay TCCUSF assessments, NCUA board and staff reaffirmed this estimate.
At the December 15, 2011 open Board meeting (seven days before the audit’s release), NCUA published its TCCUSF statement from November 30, 2011, which showed the $6.365 billion figure. The KPMG audit showed this amount had increased by almost $1.5 billion.
Was NCUA’s Chief Financial Officer unaware of the audit? Did the board knowingly releasing incorrect financial statements in the December open Board meeting? How long has the board known and presented this misinformation?
The audit included NCUA’s response to the significant audit deficiency so the entire NCUA leadership must have been aware of the audit’s findings. What assurance do credit unions have now that future information will be any more reliable? Who will explain this misrepresentation and take responsibility that it will not occur in the future?
Prior to being placed in AME status in September 2010, the five conserved corporate credit unions – US Central, WesCorp, Southwest, Members United, and Constitution – provided monthly financial statements with updated investment valuation estimates throughout 2010. Their financials received independent outside audits for all prior year-ends. Their monthly regulatory reports showed improving financial conditions both in terms of operating results and market valuations of securities up to the date of the NCUA takeover. (For more, see pages 36-37 of the special Callahan Report on the corporate crisis.)
The only event that could have increased the costs, which had been fully disclosed and reserved for, was NCUA’s corporate takeovers in September of 2010. These actions, themselves, increased the projected losses by 23%, not declines in security values or OTTI adjustments. Is this why board released the report without explanation?
This additional expense is nearly seven times NCUA’s credit union-funded annual budget, whose yearly increases are drawing heightened scrutiny. Do credit unions, not to mention Congress and the Administration, deserve a full accounting for this $1.5 billion loss.
NCUA’s Fiduciary Role: The Responsibility To Not Waste Assets
When NCUA took possession of the corporates’ assets in September 2010, it assumed a new legal role as a fiduciary. Two of the corporates it took over were solvent with positive equity. As a steward of assets, NCUA’s responsibility is to ensure it receives the maximum value of the assets for the benefit of credit union members. As the liquidating agent, NCUA’s Mike Barton acknowledged this responsibility in the issuance of Claim Certificates he gave to the members of the corporate credit unions as well as the corporate members of US Central.
One of the primary responsibilities of a fiduciary is to NOT waste assets. This fiduciary role is more than a regulatory responsibility and is explicitly acknowledged in the audit’s footnotes under “Fiduciary Responsibilities” (page 6). This new legal responsibility by NCUA and its employees makes an explanation for the $1.5 billion increase even more imperative.
The absence of critical financial information that any similarly situated trustee would provide to claimants is glaring. NCUA has publicly indicated that it acquired more than $50 billion in assets; however there is no information about:
The value of assets acquired (book or current market) or the status of the almost $12 billion OTTI reserves, that is future projected losses already expensed, for those assets.
Major fund flows, including the sale of $10 billion of securities in October 2010 and the consolidated financing activities for the borrowings and repayments such as the Treasury borrowings, the NGN financing, and the loans with bridge corporates.
Expense details for any asset management activities including fees for brokers, advisors, consultants, contract managers, etc.
An explanation for and the use of NCUA-guarantee fees of 35 basis points, which is taken from the revenues of assets securing the NCUA Guaranteed Notes (NGNs). This fee multiplied by the $28 billion now outstanding in notes generates almost $100 million per year or almost 50% of NCUA’s operating budget. Who receives these funds? How are they used?
The financing of the legacy assets. There is no straightforward financial presentation that addresses the cost of funds versus the yields and how the spread is being allocated to expenses and recoveries.
A fiduciary role is a special status. It requires more than an assertion that best efforts are being made; it entails full and timely reporting to ensure all parties are being fairly served and competently managed. Timely reporting ensures conflicting claims are evenly handled.
Regulatory Moral Hazard
Moral hazard is where a party insulated from risk behaves differently from how it would behave if it were fully exposed to the risk. Regulatory moral hazard occurs when the party responsible for events does not disclose the basis for its actions and instead asserts only its authority to act.
To minimize this hazard, public reporting in an open and timely manner is a critical responsibility for all regulators, even more so when cooperative funds are at stake. NCUA is managing members’ money, not the government.
The lack of information in the audit is compounded by the “significant deficiency” that was reported in the audit (page 30) under the title “lack of sufficient preparation for the accounting and reporting of the Corporate System Resolution Program.” This circumstance, the auditor states, resulted in the inability of “planning, managing, and executing the requisite co-ordination amongst NCUA departments to satisfy accounting and reporting requirements for the TCCUSF in a timely manner” (Page 31).
The excuse presented in the report for the delay in the audit is even more damning: “The delivery of the valuation reports took significantly longer than the agency had forecasted after due diligence efforts over the third party vendors identified additional questions for the valuation process. Further, it took until May 2011, to engage valuation specialists needed to calculate December 31, 2010, values of assets underlying the securitization program” (page 30).
In other words, for almost eight months after the NCUA seized the corporate assets and had issued more than $28 billion of NGNs, it was not able to calculate the value of the assets it acquired or used to underwrite the NGNs. How does the NCUA board and the staff responsible for these assets, as well as all other stakeholders, know whether it made proper funding decisions about these assets?
Would credit unions, or any other public institution, be permitted to continue with this the kind of vendor management and lack of management oversight? To reduce the moral hazard that can arise with regulatory authority, it is imperative that accountability and full disclosure accompany all of a NCUA’s fiduciary actions.
The Roles Of The “Independent” Auditor And The OIG
Given the auditor’s finding about the documented lack of proper “accounting and reporting requirements,” where should credit unions look for assurance and information that their interests are being properly managed? Is the $1.5 billion additional loss just the beginning of annual adjustments to these estimates?
There are two troubling aspects from the audit that suggest a full outside review of NCUA’s corporate actions would be beneficial for all parties, including the NCUA board and especially credit unions who pay the bills.
The KPMG audit is at best confusing to any reader and, at worst, misleading. One of the most glaring deficiencies in auditing history was the Arthur Andersen review of Enron. In that case, the firm used special purpose entities to record off balance sheet exposures that eventually caused its insolvency. KPMG’s extended footnotes with complex internal referencing and the inability, or unwillingness, to present a consolidated financial set of numbers is troubling to any reader.
KPMFG wants to excuse its presentation by referring to management’s deficiencies, but in doing so, the firm comes across as an apologist for the NCUA. For example, it states in its deficiency finding: “During 2010 the operating environment for NCUA was presented with what arguably was the culmination of developments without precedent. It is challenging to identify one predominant factor among the variety of potential contributory causes that include government interventions in the housing market, continued price instability in certain asset classes, and pre-planned corporate initiatives” (Page 31).
Before the September 2010 conservatorships, none of the five corporates had any difficulty reporting on, managing, and serving members with full and timely reports on these very same assets. Eight other corporates reported OTTI reserves and have never had difficulty providing monthly updates for these valuations. The auditor’s job is not to make excuses for the client but to serve the needs of all stakeholders for objective, timely, and full disclosure of relevant facts, especially for those who are paying the bills.
The Inspector General for NCUA, William DeSarno, contracted for this audit report and notes that NCUA’s other four audits for its other funds were issued on May 12, 2011 by KPMG. DeSarno states his role is to be the contracting officer. What were the performance criteria for this contract? For the 2009 audit, KPMG delivered the report in July 2010, or six months earlier than the December 2010 audit. Is this acceptable vendor performance?
Secondly, does the OIG have any responsibility for the content of the report or is it just a contracting party, a government go-between, so there is an appearance of independence from the NCUA board?
The OIG is supposed to review any loss that exceeds $10 million for an insurance fund. The NCUA board received a report that had a $1.5 billion increase in the loss provision. Did any alarm bells go off, or is the OIG just a paper pusher? Can the OIG inspect itself? Does it read and act on its own reports?
Next Steps: What Would Your Board Do?
One of the most important features of a cooperative structure is democratic governance, participation by the owners in the cooperative’s major decisions. Credit unions have a unique regulatory financial structure based on cooperative principles and cooperative funding.
One of NCUA’s initiatives last year was to mandate financial literacy training for all credit union boards. With this heightened awareness of the importance of reviewing financial statements, the following are some suggested next steps for credit union CEOs to take with their boards:
Download the 36-page report and give directors the opportunity to review it.
Ask if they understand the four pages of financial statements. Is the explanation and presentation clear, especially for the increase in the loss contingency to $7.8 billion?
Summarize the board’s questions and send them via Freedom of Information Act (FOIA) request to the OIG; copy the NCUA board.
Finally, ask your board what actions they would take if their management were to give them the report they had just reviewed.
Now you have your action steps! Unfortunately, a review of the information released would suggest that the $50 billion in assets NCUA took from the corporate system are still un-accounted for.