NCUA Owes Credit Unions $2 Billion In TCCUSF Refunds

Investment gains of more than $700 million prove the three liquidated corporates have always had positive capital.

 
 

NCUA’s release of June 2014 data on the NCUA Guaranteed Notes (NGN) program shows estimates of potential losses have fallen almost $8.0 billion from the agency's initial loss projection of $16.1 billion in July of 2010.

Credit unions should pay attention to this issue today for two reasons:

  1. Because the TCCUSF owes credit unions up to $2.0 billion in refunds.
  2. Because these kinds of errors in modeling capital levels could easily occur again under NCUA’s proposed risk-based capital regulations.

In just the first nine months of 2014, the Asset Management Estates (AMEs) that NCUA established to track each corporate’s assets gained in value. Or, more accurately, NCUA has reversed its initial loss estimates by $728 million. The bottom line from NCUA’s individual AME financial statements, as of Sept. 30, 2014, show that three of the fiduciary estates have positive capital accounts, led by U.S. Central’s $1.005 billion. In other words, NCUA’s modeling projections that showed negative net assets at these corporates were wrong.

The table below shows these changes in net worth for the nine-month period from December 2013 to September 2014 for each corporate’s estate.

SCHEDULE OF 5 AMEs’ FIDUCIARY NET CAPTIAL ($000s)
December 2013 - September 2014
© Callahan & Associates | www.creditunions.com

AMEs 12.31.13 9.30.14 Change In $
U.S. Central $686,265 $1,005,061 $318,796
WesCorp (4,515,967) (4,232,016) 283,951
Members United (8,658) 49,567 58,225
Southwest 65,863 125,547 59,684
Constitution (24,961) (17,284) 7,677
Total ($3,797,458) ($3,069,125) $728,333

Source: NCUA AME Financial Statements

Although Constitution Corporate still shows a negative capital balance, updating the status of the individual securities taken from it during NCUA’s seizure shows only $66.4 million of losses have been incurred as of Oct. 1, 2014. This is just 42% of the corporate’s total OTTI reserve writedowns of $159.8 million. If this year’s investment valuation gains continue, then Constitution’s AME capital balance should become positive as well. (Click here to view a spreadsheet detailing the legacy assets by CUSIP number of the five corporates closed by NCUA.)

Questions About NCUA’s Management Of The Corporate Crisis

NCUA’s initial projected collective loss estimate from July 2010 has now been shown to be in error by more than 50%. This incorrect estimation was the basis for seizing and liquidating the five corporates, securitizing and reselling their assets, and subsequently dismantling the Central Liquidity Fund liquidity safety net. Yet, NCUA continues to use the same methodology and, apparently, the same modeling resources that provided this initial gross overestimation.

The agency says its future projections are still “generated using projected legacy asset flows.” In addition to relying on a process that has been demonstrably inaccurate, the approach obscures accurate information NCUA should disclose to provide meaningful data for actions. For example, NCUA should post the actual losses for each of the five securities portfolios monthly so credit unions can compare real losses with the OTTI provisions the corporates initially expensed. 

Moreover, the information NCUA has released does not cross-foot. For example, in the TCCUSF Revenue and Expense statement as of Sept. 30, 2014, NCUA shows the “provision for insurance loss reduction” as only $294 million in this nine-month accounting period. However, in NCUA’s NGN Balance table updated only through June, the increase in the market value of the legacy assets is actually $781 million from year-end December 2013 through June 2014. (Click here to see the NCUA table of NGNs and legacy assets balances at different points in time.)

This is the same order of magnitude improvement as the $728 million in NCUA’s individual AME summaries shown above for the first nine months of the year. 

Why The Numbers Matter

By itself, the $7.9 billion discrepancy in legacy asset value between the July 2010 estimates — which NCUA used to justify the takeover and liquidation of the five corporates — and today’s values raises critical questions about NCUA’s supervisory and fiduciary roles. The added current differences of almost $500 million in the TCCUSF financial statements and the data for the changes in legacy assets in the NGN table raises more red flags about the agency’s oversight.

NCUA’s latest numbers show that credit unions are due as much as $2.0 billion in refunds from their TCCUSF premiums. Additionally, the member-owners of at least three corporates holding receiver’s certificates are also due payouts from the capital accounts.   

The information published by NCUA suggests that the agency is still not sure what it plans to do — except to hold onto this surplus until 2021. This inaction and delaying the return of refunds wrongly increases the cost of the incorrectly assessed premiums.

Shouldn’t the affected member-owner credit unions be involved in decisions about distributing their funds?

At a minimum, NCUA should increase the transparency of information on the TCCUSF. This would demonstrate awareness of its accountability to the credit unions whose funds are being held as well as  stimulate dialogue for returning these funds.

The following would be a good-faith start toward a new, candid policy instead of continuing to defend earlier missteps:

  1. Publish the quarterly AME balance sheets and distribution schedules on its website.
  2. At least quarterly, update the legacy asset spreadsheets with the realized losses for each AME’s security portfolio. Compare actual losses with the corporates’ OTTI reserves when they were taken over.
  3. Show the full cash flows, as well as income and expense for the TCCUSF each quarter. For example, what was the source of the funds for the $300 million paid to Treasury in June 2014? How much expense, if any, is being charged to the AMEs or the TCCUSF accounts to cover external lawsuits?
  4. Publish the name of the firm NCUA is using to model its cash-flow projections and the assumptions it used in each subsequent projection. 

The corporates’ AME data — now released only in part and often late — shows enormous flaws in NCUA’s initial decisions. It also calls into question NCUA’s continued reliance on models, firms, or individuals providing these highly inaccurate forecasts — not only in the past but also as recently as in the past six months.

Models And Implications For The Future

The urgency for NCUA to become more responsive on these corporate issues isn’t a singular concern. It has enormous implications for NCUA's future supervisory interaction with all credit unions.

NCUA already has the power to challenge the capital adequacy modeling results of credit unions with more than $10 billion in assets through the stress-test rule. Currently, that includes just four credit unions. But NCUA's proposed authority to impose, of its own accord, a higher capital requirement on any individual credit union threatens every credit union subject to the proposed risk-based capital rule. 

How could any credit union carry out plans to enhance or add financial services for the good of its member-owners not knowing that its capital level could be challenged at any time?

NCUA's use of and confidence in external firms’ alleged modeling expertise in deciding the fate of the corporate credit unions is proving to be misplaced. Asset liability management, including the modeling of interest-rate risk and net economic value (NEV), is a useful tool for assessing prudent levels of capital. All models use assumptions based on an institution’s experience, market position, and business strategy. 

However, NCUA’s regulatory practice of overriding management’s judgments of reserve adequacy has not been positive. NCUA’s liquidations of solvent corporates had fully reserved for all probable losses — as verified by independent auditors — is a timely reminder of the errors that can occur when using models and outside so-called "experts" to predict the future.

Yet, the rush to judgment in the corporate liquidations, based on faulty modeling and incorrect assumptions, appears to be a critical lesson not yet learned. If the agency were to be open with the data it asserts to have, and would be more forthcoming about its responsibility to the member-owners whose funds  it now holds, this would be an encouraging sign of an intent to not repeat past errors.

Without this openness, it will be difficult for credit unions to feel confident that the best interests of their members are being served — especially when the Agency’s judgments and examiner requirements are imposed using models and assumptions that conflict with the documented experiences  of a credit union’s board and management.

 
 

Jan. 5, 2015


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Comments

 
 
 
  • Assuming around the same level of earnings as Catalyst has experienced since the conservatorship, it appears by the numbers in the article that Southwest Corporate could have just as much capital in it today as Catalyst maintains. Credit unions would never have needed to capitalize Catalyst ($90 million initially as I recall). NCUA confiscated the remaining capital of Southwest Corporate, forcing member credit unions to absorb the losses and to capitalize a replacement corporate, all on weak projections, not actual losses. I am sure NCUA has charged all kinds of expenses to the corporate fund which could have been avoided as well, at least in the case of Southwest. Doesn't seem that Southwest was quite as "insolvent" or "failed" as the agency likes to repeatedly assert.
    Concerned SWC Member
     
     
     
  • So Mr. Filson, using your scenario, if a credit union has foreclosed on a real estate owner in a down market where property values were below the loan balance, does the credit union need to refund the former real estate owner it's money plus any gain when the market values recover and the credit union books a gain at sale? It was the homeowner's investment and the lender now has a sweet deal. All valuations are at a point in time and are generally very poor at predicting future systemic crashes or recoveries.
    Anonymous
     
     
     
  • The NCUA "foreclosed" on these corporates because they projected, using models, that at some point in the future these securities would default causing losses. In your analogy, this would be similar to a cu foreclosing on a borrower who is completely current in payments just because of a fluctuation in the value of the underlying collateral. Instead of recognizing losses when delinquency or defaults occured, NCUA modeled projected defaults over the entire lives of the securities and required reserves for this projection now. Not only were these loss projections in error by at least 50%, using NCUA's own numbers, each of the corporates had fully reserved for these incorrect estimates and in three of the cases still reported positive net worth after this over-reserving. Apart from the modeling errors causing incorrect financial projections that resulted in very poor and costly supervisory decisions, the precedent of projecting future scenarios onto current balance sheets is a lesson yet to be learned as NCUA enforces its stress test assumptions on larger credit unions and the Individual Minimum Capital Requirements on all others.
    Chip Filson
  • The article refers to "OCCI" ("reserves" & "provision") at least twice. Can someone tell me what "OCCI" is referring to?
    Mark Kaufmann
     
     
     
  • Editor's Note: The OCCI abbreviation was a typo; it should read OTTI for "other than temporary impairment." I have corrected the abbreviation in the text.
    Rebecca Wessler
  • The sad truth is that any credit union and/or CEO that bucks NCUA will be punished or run out of business. The declining number of credit unions speaks for itself. They don't have to be right - they are in charge and will make sure everyone knows it.
    S. W. Fontenot