NCUA’s proposal asking credit unions to prepay assessments to cover cash shortfalls in its management of the legacy assets taken from corporates represents a unique opportunity for credit unions. By supporting the request and forwarding up to $3 billion, or 38 basis points of future premiums, credit unions can show their confidence in the Agency’s management of the corporate situation. If the minimum amount of $300 million is not raised, the result would indicate the opposite in NCUA’s handling of the corporate stabilization.
Why is there a cash shortfall?
In both written and public explanations, NCUA spokespersons say the need for cash is not because any loss estimates have changed. The loss estimate in the audited statement published in July 2010 for the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) was $6.4 billion.
The cash shortfall has occurred because NCUA has been unable to manage the most basic of ALM tasks, which is matching assets with liabilities. In September, NCUA nationalized three additional corporates and then stripped the five corporates under their control of $50-$60 billion of their highest yielding investments, the so-called legacy assets. Some $10 billion of these assets were sold outright, even though that sale locked in losses that should have been recovered over the economic lives of these securities.
The additional assets taken were to be funded by NCUA’s guaranteed note program. The problem is that assets taken and funding provided do not match. Wall Street requires over-collateralization so that each dollar of funding requires $1.10 to $1.30 of assets at book value. Having sold or already pledged all of the assets, NCUA has no more earning assets to borrow against, so it must ask credit unions to help out by covering its cash shortfall as its funding liabilities come due.
Corporates Managed the Funding Match
As long as these assets were managed by individual corporates, the problem did not exist. Each corporate managed its own ALM matching. Additionally, the spread between the cost of funds and investment yields helped the corporate system record the most successful year ever in 2010 — until NCUA’s September takeover.
The corporates did not have to over-collateralize their investments. Rather, corporates had set up loss reserves, called OTTI, to fund any projected investment defaults. This total of $12 billion in OTTI estimates appears to have overestimated future losses as securities had steadily recovered from their valuation low points. Moreover, realized cash defaults were a fraction of these total reserves. That is, the investments were still paying as required even though projected loss estimates had already been expensed.
Both the potential losses and the dollar-for-dollar funding for the investments had been provided by each corporate. The situation was not only under control, but corporates also reported monthly on their earnings, cash flow, and the value of the securities they held. The process was transparent; open and net income, even in the most severe cases such as WesCorp, was positive. The entire network had started to rebuild its retained earnings base.
When NCUA seized the highest yielding assets from the corporates, it also had the funding responsibility but no balance sheet to use. NCUA spent $33 million on Wall Street advisors to implement the NGN funding, pool by pool. The program, which is barely six months old, now comes up cash short. By comparison, the corporate funding was in place, producing net income and providing full coverage for estimated losses.
In addition NCUA is reportedly charging 30 basis points to manage the liquidation estates set up for the NGN funding. This expense, paid from credit union pockets, in effect duplicates the corporate system and adds an additional expense tier.
NCUA’s Liquidity Options
The NCUA is not the FDIC. The FDIC assessed three years of prepaid premiums in the fall of 2009 because it was running out of cash. This precedent was referred to in NCUA’s description of its proposed program. FDIC is strictly an insurance resolution fund with a financial structure financed only by premiums. There is no 1% deposit as in the NCUSIF. The FDIC’s balance sheet was increasingly filled with illiquid assets acquired from failed institutions and it was reporting a negative net worth of more than $21 billion.
NCUA has multiple sources of liquidity because credit unions created a unitary regulatory structure under the NCUA board (chartering, liquidity, and insurance), not a stand-alone insurance solution. The liquidity sources available today include:
- The TCCUSF, with borrowing authority of up to $30 billion. (S 896)
- The CLF, with no outstanding loans and borrowing authority of up to $41 billion.
- The NCUSIF, which has more than $10 billion invested in cash at the U.S. Treasury.
All of these funding sources would be at the lowest rate available in any market, which is the U.S. Treasury’s rate. These institutions were established just for this purpose. In the “old” corporate system, managing system liquidity needs was the role of U.S. Central with the corporates. But that structure has been dismantled. By appealing directly for credit union funding support, NCUA is in effect creating a shadow U.S. Central function.
The Need for Transparency and Disclosure
NCUA has proposed borrowing from credit unions through “voluntary” prepayments. However, there has been no financial information presented that would allow credit unions to understand or to evaluate the request.
There have been no financial statements that show the status or the cash flows from the NGN programs. There have been no disclosures of any of the costs or losses, or how the estates have been managed.
Between $50-60 billion in total assets were stripped from the corporate system. Some were sold outright. The assets now in liquidation estates, funded by NGNs, would have a current book value of at least $30 billion. This amount exceeds the combined balance sheets of all of NCUA’s other funds. But no numbers were presented, there were no discussions of costs or revenue, and most importantly, no cash flow projections from the investments have been shown.
A Tenfold Funding Range?
If a borrower makes a request with a tenfold range from the minimum to the maximum amount needed ($300 million to $3 billion are NCUA’s program parameters), one has to question the underlying financial projections being used. If $300 million is all that is raised, where does the $2.7 billion come from? Why not get the $300 million there?
When these assets were part of the corporate network, full financial disclosures and projections were reported monthly. Credit unions had completely funded corporate investments. Now there is nothing to monitor except NCUA requests for more cash.
Credit unions have already supported funding of the corporate network on at least five different occasions. The first was their support for the increase in the CLF borrowing authority to $41.5 billion in September 2008. The most recent was the continuing commitment of total direct funding with share deposits of $94 billion, an amount equal to all corporate investments in the fall of 2010.
The Confidence Opportunity
NCUA has warned that if credit unions don’t agree to the voluntary prepayment, then NCUA will be forced to assess higher premiums. Even though the cash outlay would be similar, credit unions would be forced to “expense” such a premium now but apparently not if a voluntary prepayment of the same dollars were sent. It should be noted that the GAAP accounting for voluntary prepayments is not clear.
A large upfront expense was exactly the situation that the May 2008 TCCUSF legislation was passed to avoid. Specifically, S 896 provided funding so that credit unions could spread the costs out over seven years. Now, NCUA is using the threat of a large expense to make up for its liquidity, not loss, shortfalls.
It is critical to distinguish cash flow requirements from losses. Premium assessments were designed to cover losses, which is the role of insurance. The role of insurance is not to fund liquidity requirements. Liquidity needs were to be met from other resources authorized in the CLF and the TCCUSF.
Credit unions may choose to support the voluntary prepayment of assessments, but it should be clear that this has nothing to do with the corporate losses. NCUA said repeatedly those estimates have not changed.
NCUA’s September 2010 nationalization of the corporate system was characterized in the press as a government “bailout.” The credit union system objected to this term because no government funds were involved. Ironically, this proposal is a bailout –but by credit unions of their regulator!
Instead of settling any uncertainty that may have existed in the corporates, NCUA has just created a whole new set of financial and funding issues without any disclosures for support. How many more financial surprises will follow this one?