The $5.6 billion loss attributed to WesCorp’s failure in the Office of the Inspector General’s (OIG) required review is the largest loss ever in the credit union system. One would expect the analysis, data, and documentation of the loss in the OIG review could be valuable. What are the lessons? What needs to be changed? What do we know two years later about the process and judgments during the run-up and in the heat of the crisis in 2009?
Unfortunately, answers to these questions are not in the report. Instead, much of the “analysis” is rerun material. The numerous explanations read as if NCUA is happy to slice up the blame as long as it gets the smallest piece.
What is it that makes this 41-page Review read, at best, like a whitewash and, at worst, like a prime example of the need for redesigning NCUA?
Who was responsible at the Agency?
The Director of Examination and Insurance during the corporate crisis was Dave Marquis. He spoke openly about the Agency’s corporate assessments in numerous meetings in 2008. Board member Gigi Hyland’s comments in her June 2008 presentation during FSCC’s annual meeting is typical: “We believe there is some market dislocation, but we’re on top of it.” The report in the press then continued: “Hyland said there is no need to panic and that any concerned CEO can contact NCUA’s Kent Buckham, who heads the office of corporate credit unions, or Dave Marquis, who oversees examination and insurance, if they need questions answered.”
The Agency’s response to the OIG Review is from Dave Marquis, in his capacity as Executive Director. Thus the person responsible for the corporates during the corporate crisis, undoubtedly interviewed about his role and Agency actions, is now the person who acts on the Review. The Agency person responsible during the crisis is now the person responsible for the review process.
Recusal would have been the minimum expectation for the person at the center of the crisis. We learned nothing new about this largest loss in NCUSIF history because there is no external accountability, let alone internal governance, for any Agency decisions, including this $5.6 billion estimated loss.
What was the primary problem; what happened?
The OIG surmised WesCorp did not implement appropriate risk management practices to control its high investment grade (AAA or AA) RMBS securities. And OCCU was slow to react to the increasing use of these highly rated RMBS securities in WesCorp’s portfolio.
Nothing new here. A lot of others made the same misjudgment. In fact, virtually no one foresaw the descent into financial cardiac arrest from these financial instruments even as late as mid-2008. Everyone believed because the facts were in sight, the problem was manageable.
But subsequent events, in fact worldwide panic, exceeded almost every market participant’s worst-case scenario. September 2008’s financial markets’ cardiac arrest became an outlier of extreme impact. But human nature makes us concoct explanations after the fact to make it explainable and predictable. This retrospective interpretation — some would call it 20/20 hindsight — can lead to significant misstatements about what was known and done at the time. This rewriting of events can lead to serious misunderstandings about the lessons to be learned for all involved, especially lessons about the role of the regulator.
NCUA has offered three interpretations of why WesCorp’s investment strategy failed:
- The large concentration in mezzanine securities
This was the primary explanation in the April 10, 2009 NCUA Analysis of Distressed Securities held by Corporate Credit Unions, shortly after the conservatorships. The OIG picks up this document almost verbatim 18 months later.
- The conspiracy theory
This is the legal basis for NCUA’s filing of a lawsuit against WesCorp’s Board and management seeking to recover billions: Management and the Board conspired to grow WesCorp to benefit themselves.
- The so-called the Countrywide concentration theory
This is a new element added by the OIG. As this one goes, RMBS by Countrywide were the second highest in the RMBS portfolio and “Countrywide was the servicer for over 220% of the underlying mortgage collateral within its investment portfolio.” None of these factors was mentioned in the April 2009 distressed securities analysis, or the conspiracy-Board-due-care suit, even though the OIG says these facts were in examination findings. There is no OIG attempt to link any of these observations to direct losses, OTTI or otherwise.
Full disclosure of all the exams is essential to understand what was said and done at the time. Exam quotes taken out of context with no disclosure of any CRIS ratings, both the empirical and qualitative 1-5 rankings are, at best, hearsay, and, at worst, irrelevant to the Agency’s actual supervisory role at the time.
What is the OIG recommendation for the future?
So, what is the OIG recommendation? In a nutshell, pass a new rule. The OIG’s logic is as follows: “OCCU examiners continually indicated WesCorp’s portfolio was well diversified and its exposures and credit limits within regulatory constraints. Also OCCU examiners informed us WesCorp management knew it was in compliance with NCUA requirements. Therefore, the examiners knew they had limited, if any options to address the risk concentrations” (page 33).
Marquis’s response to the OIG report picks up this same we-didn’t-have-the-authority excuse: “During the buildup of the concentration of RMBS, examiners expressed concerns but lacked regulatory leverage to enforce limits” (page 40).
Anyone who has followed NCUA regulatory and supervisory action over the past two years would find this statement disingenuous.
Even before the new 704 rule was passed in September 2010, NCUA’s options for addressing regulatory concerns in corporates were the same as in natural person credit unions: DOR, LUAs, cease and desist, removal of officers and officials, and orders to establish special reserves, in addition to the ultimate power to conserve, liquidate, and terminate insurance.
These powers all were present for corporate concerns, but there are special 704 authorities in existence then and now that apply only to corporates, including 704.3(e), which gives the Agency the power to impose higher or lower capital requirements; 704.3(f)(g), concerning 10-day reporting of capital ratio compliance and approval of capital ratio plans; and 740.3(i), retained earnings goals. Most important to the WesCorp situation is 1) 704.10, the Agency’s direct control and oversight of a corporate’s required plan when an investment fails to meet any part of 704; and 2) 704.8, the Agency’s requirement for a written action plan, subject to the approval, disapproval, or modification when any corporate fails its NEV limits.
NCUA had the authority and formal responsibility of overseeing WesCorp. But like everyone else, as the crisis grew, and as initial expectations were confounded and panic ensued, NCUA did not know what to do because the time of easy changes had passed.
What should the OIG have discussed?
What is there to be learned from an in-depth, independent analysis and appraisal two years after the WesCorp collapse? I suggest we should have learned the answers to the following questions:
- What were the critical judgments, especially as securities were downgraded and NEV limits passed, that might have provided other options? What tripwires were in place and waived? Were hedges against further loss evaluated? Were they thought too expensive?
- How was the OTTI reserve established by NCUA after conservatorship determined? WesCorp had reported to its Board, to NCUA on-site examiners, and to its larger members an initial OTTI estimate as part of its December 2008 audit with BDO Seidman. NCUA in its conservatorship maintained these estimates were not “honest numbers.” NCUA then provided its “management estimates — the honest numbers” that were four to six times the WesCorp draft numbers of early March. What did BDO Seidman do with this range — just bow to the stronger power? Was there a better analysis? If so, why was this not shown to WesCorp’s Board and management so they could react and take appropriate steps to correct misleading information?
- What is the status of the $6.8 billion credit loss reserve made largely two years ago at the depth of the crisis, compared to the status of the securities today? (SEE CHART) What would the OTTI valuation be today? What are the actual cash losses versus the reserves? What is the expected life, and how might this duration reduce some of the potential credit loss?
SOURCE: JPMorgan, Barclays Capital; all data as of October 31, 2010.
- The OIG states, “WesCorp was economically insolvent” (page 28). However, in 2010 WesCorp was reporting one of it best operating results ever, having positive earnings while presenting an accounting statement that showed it had a negative net equity of more than 24%. There was a disconnect between WesCorp’s real economic value and its accounting presentation. Its member credit unions continually received some of the highest dividend rates anywhere from their accounts and WesCorp still reported record levels of earnings.
- What other recovery plans and projections were made once NCUA was in control? Was the intent all along just to liquidate, regardless of changing and improving circumstances?
- Why have not the securities held at WesCorp been fully disclosed so members could make their own independent judgments — much the way other corporates routinely disclosed their individual securities and valuations to their members both monthly and in the annual reports?
OIG Review Confirms Systemic Flaw
The bottom line from the OIG’s largely rehash of prior information is that we still do not know what happened. No external parties were apparently interviewed; no details, facts, exam reports, or other contemporary documentation (which are available from participants) were shown. What we do have is a rationale for why the Agency passed a new rule, after the rule was in fact passed. For a $5.5 billion loss, this whitewash won’t do.
The real lesson from this perfunctory Review is there is no governance process controlling NCUA’s exercise of its authority. The issue is much bigger than billions of dollars of member’s funds, misused or not. It is whether the cooperative system can expect to have a system of accountable regulation. This is more than a credit union industry issue. It is also a vital responsibility for both Congress and the Administration. Because absolute power does corrupt, one can now add an OIG report to the mounting evidence of the systemic flaw in the credit union regulatory structure.