How The NCUA Can Speed Up Bailout Returns

Merging the corporate credit union fund with the share insurance fund is an idea worth considering.

NCUA board chair Mark McWatters has raised the possibility of a more effective way to end the bailout of the corporate credit unions and return the money that’s left to the credit unions and their members —the rightful owners.

At a December briefing, McWatters said the agency should consider merging the Temporary Corporate Credit Union Stability Fund into the NCUSIF, the insurance fund that ensures the existence of the movement itself, closing the TCCUSF.

A TCCUSF Primer

Natural person credit unions funded the corporate credit unions the NCUA seized and shut down in September 2010. Those same credit unions then funded the recovery through assessments the NCUA imposed to fund the TCCUSF. The NCUA replaced those five shuttered corporates with five Asset Managed Estates funded through the NCUA Guaranteed Notes program.

Merging the funds would allow rebates of excess TCCUSF premiums earlier than June 2021, when the TCCUSF is scheduled to shut down. It also would simplify the management and reporting of the AMEs, reduce costs, and provide much-needed flexibility in windingdown the program.

The corporate bailout fund itself is to shut down in 2021, but a payout earlier than that is vital given the several billion dollars in surplus funds the NCUA now holds on behalf of the corporate shareholders and credit union members.

That includes surplus funds arise because of two major inflows:

  • The net, to date, of $3.2 billion in legal recoveries.
  • The $3.4 projected surplus in legacy asset values versus NGN liabilities.

The NCUA December board update was based on September 2016 financial data. The presentation projected as much as $4.9 billion in surplus by 2021. The funds would go into two different payouts.

One, at current estimates, would rebate $3.2 billion in TCCUSF insurance assessments to all credit unions. The second would return $1.7 billion to the capital shareholders, except WesCorp, of the corporate AMEs. This second payment would also be to activecorporate credit unions who were U.S. Central member shareholders and hold receiver’s certificates.

The Benefits Of A Faster Payment

McWatters’ discussion of future options highlighted the benefits of earlier action. Every year the NCUA does not return surplus funds is another year of lost earnings for credit unions. At approximately $5.0 billion surplus, and assuming a 4% opportunitycost, this amounts to $200 million per year, or a pro rata amount if partial distributions, of lost revenue for credit unions, compounded year after year for every delay.

In addition to accelerating the return of funds to members, merging the TCCUSF into the NCUSIF would reduce administrative complexity, simplify reporting about the AMEs, and provide flexibility for future resolution options.

Since the share fund’s financial condition is reported monthly to the NCUA board and credit unions, this would increase both the timeliness and transparency of the management of the legacy assets.

Critical Questions Left Unaddressed

The December update focused primarily on explaining and defending earlier decisions, such as the need for premiums made in the initial years.

Absent from the update was any effort to explore what the NCUA has learned since it developed the plan in 2009, and why a crisis begun in 2007 cannot be fully resolved until 14 years later, in 2021, if then.

One clear takeaway is that the TCCUSF’s funding of the legacy assets is so rigid that there is little flexibility for events to unfold markedly differently from the plan’s assumptions. For example, the plan assumed there would be no legacyasset surplus. In fact, there’s several billion dollars of that. And if combined cash flows from those assets were incorrectly estimated, the NGN notes included no early call features except for a 10% cleanup provision as assetspaid down.

Here is the NCUA’s presentation from the December meeting.

After 70 minutes and 43 presentation slides, the NCUA staff failed to address many key questions, including:

  1. How is the NCUA allocated legal recoveries among the five AMEs? What is the process or criteria for allocation? For example, one slide showed three estates receiving a total of $1.101 billion in recoveries from the Royal Bank of Scotland. How did the NCUA determine this allocation? And how did the NCUA credit to the five estates earlier recoveries of more than $3.0 billion? These allocations have a major impact onthe distribution of funds between the corporate shareholders or to all credit unions through assessment rebates.
  2. How does the NCUA recognize the $3.8 billion legacy asset surplus in the financial statements of the AMEs? Does the agency recognize this value in full or partially? Does the NCUA assign values directly to the estate from which the asset was takenor by other criteria?
  3. There was no discussion of the liquiditation expenses charged to the TCCUSF fund program. In addition to the $1 billion in legal payments to lawyers, the NCUA has charged more than $1 billion in additional expenses to the five AMEs. Just as the NCUAdetailed payments to lawyers in a spread sheet, shouldn’t it detail these expenses per AME as well?
  4. The presentation noted the NCUA has incurred more than $1.0 billion in losses on non-securitized assets held by the corporates. Since the regulator’s policy and advisor Barclays’ recommendation was to hold assets, how was this loss incurredand to which estates did the NCUA assign the losses?

Recommended Reading: NCUA Shows Nobody The Money, Except For The Attorneys

The Longest, Costliest Resolution Ever

These questions aren’t academic. The liquidation of the five corporates has been the costliest regulatory action the NCUA has ever taken. These liquidation costs are distinct from the losses on investments. These administrative expenses, non-legacyasset sales, and legal fees are already at $3 billion; and they’re still growing.

There’s also collateral damage. The simultaneous liquidation of five corporates holding more than $100 billion in assets reduced the corporate system’s roles to the margin of the credit union network and shrank its collective liquidity safetynet with the Central Liquidity Fund to irrelevance.

Without a thorough evaluation of assumptions and decisions, the ability to learn from this enormous regulatory purge of the corporate system is lost.

For example, a recurring theme through the entire sequence of events, repeated at the December board session, was how apocalyptic the corporate circumstances were.

Larry Fazio, director of the Office of Examination and Insurance, opened by asserting that in December 2009, the five corporates held securities with a book value of $52.7 billion but a market value of only $22 billion. He maintained that if the NCUAhad not taken action in September 2010, 18 months later, then the alternative would have been a $30 billion catastrophic loss to the credit union system.

Alternative Facts

This alternative fact is not a meaningful discussion of other options, whether considered or not.

Moreover, Fazio’s statement contradicts the staff’s assessment given to the NCUA’s closed board meeting earlier that year of an estimated $4.8 billion expense to the NCUSIF, subject to the participation rate in the voluntary excessshare guarantee program in the review of the six corporates, one was not conserved, holding the majority of legacy assets.

The NCUA has used this hypothetical catastrophic alternative to justify its actions from the beginning and in subsequent statements. This dire vision has substituted for timely information, detailed updates on the bonds’ performance, and, ultimately,the willingness to work collaboratively with the industry for seeking the least costly response both in dollars and in time.

Once the NCUA developed its NGN liquidation plan with Barclays entirely in secret, there was no second evaluation or assessment even after an increase of more than $10 billion in market valuations between Dec. 9, 2009, and Sept. 10, 2010.

One Problem Corporate, Not Five

Most importantly, by bundling five separate corporates into one combined liquidation, the NCUA disguised an important fact: The problem of solvency losses was concentrated primarily in one corporate WesCorp.

Four of the corporates had fully reserved for all projected losses and three of the four had meaningful regulatory capital the month before their seizure.

CORPORATE CALL REPORT INFORMATION

FOR FIVE CORPORATE CREDIT UNIONS | DATA AS OF 08.2010
Callahan & Associates | CreditUnions.com
Name Aug. 2010 Reg Capital Unused OTTI Reserves (deducted from capital)
US Central $321.6 million $3.545 billion
Members United $29.5 million $600 million
Southwest $90.4 million $453.4 million
Constitution ($23.5 million) $159.1 million
WesCorp ($4.938 billion) $6.874 billion
TOTAL $11.632 billion

shows 5310 Corporate Call Report data as of August 2010, a month before liquidation, along with the unused OTTI reserves that had already been subtracted from regulatory capital.

Source: Callahan & Associates.

Scapegoats And Regulatory Animus

It’s no secret the NCUA’s liquidation actions were driven by an animus fueled by the belief it was necessary to diminish the corporate system.

The legal efforts to sue corporate boards and managers furthered this effort to define scapegoats that would allow the NCUA to absolve itself from any culpability for the problem. These attitudes have diverted regulatory attention away from the broaderstructural issues confronting the cooperative system’s integrity and, ultimately, its independent survival.

Understanding the full costs and decisions that caused this crisis to turn into a workout of 14 years or more is vital to restore credit unions’ confidence in regulatory judgments and to identify how the cooperative system can be restored to greatersoundness.

A Liquidity Challenge, Not A Solvency One

The data in the chart above shows the corporate challenge was not primarily a solvency issue, it was liquidity. The corporates had more than fully expensed the losses, and the actual credit losses that were the focus of the problem now appear to havebeen undervalued or written down by $3.4 billion too much or more.

The OTTI write-downs of these five corporates were all too high. Even with these overestimates, the only corporate that had a significant impairment was WesCorp.

By the date of the corporate seizures in September 2010, all the internal corporate financial trends and external market data showed the resolution was a liquidity funding challenge. Before the liquidation seizure, credit unions had provided $60.2 billionin deposits that were stable and paying low rates at the very short end of the curve. The remaining funding of $17.5 billion was for FHLB borrowings, about one-third of which were more than three years.

By liquidating the corporates, the NCUA had to replace these two sources with a partial funding using the rigid NGN structure with 135% overcollateralization and NCUA guarantees. The higher rates on the NGN funding plus the 35 basis point fee chargedthe AMEs was significantly higher than the existing credit union deposits were costing.

Because the $28 billion in NGN funds was significantly less than the in-place deposits, the NCUA needed to sell off the best-performing assets, undo derivative contracts at costs estimated in the hundreds of millions of dollars, and assess premiums tocover cash shortfalls greater than the $6 billion TCCUSF line of credit.

Funding Mismash

This complex funding mishmash to replace the stable credit union deposits in these five corporates added costs in the billions charged to the AMEs on top of the OTTI losses the corporates had already expensed.

Once liquidation began, limiting the additional administrative costs of the program was not an NCUA priority. Ironically, as learned at the December session, the challenge of how to manage and sell the assets is still here and will not be resolved evenat June 2021, when the NGN notes go away. A significant amount of legacy assets will still remain.

So, how does NCUA intend to manage these left over legacy assets? In its own words, the agency said in one of the slides at the December meeting: (Our) role as a liquidating agent is to conduct an orderly liquidation, not function as a long-termasset manager trying to maximize return on a portfolio.

Yet that is exactly the strategy of the NGN program: a long-term asset manager. Even after a 10-year resolution program, the NCUA anticipates holding billions of legacy assets that will not pay down until years ahead. It is disappointing to learn NCUAstaffers view their only role as an orderly liquidation and not maximizing return to the members.

If this is indeed their view, then McWatters’ discussion of getting the money back more quickly to its rightful owners has even more importance

An Empowering Discussion

McWatters’ interest in merging the NCUSIF and TCCUSF is empowering because it opens more options to manage and speed up return to credit unions.

If the NCUA can complete this modification in the open with credit union input and design, that might set the stage for rebuilding the CLF as a meaningful liquidity backstop for the cooperative system.

Instead of holding to decisions made years ago, in very different circumstances, the movement now have the chance to rethink workout options and identify constructive ways for recovering substantial losses it once assumed were gone forever.

You Might Also Enjoy

  • Billions More Reasons For The NCUA To End The Deepening Secrecy

  • NCUA Shows Nobody The Money, Except For The Attorneys

  • Money Indeed Changes Everything: An Open Letter To The NCUA Board

  • Five Corporate Estates Gain $570.1 Million In Second Quarter, But NCUA Secrecy Remains

  • The Corporate Bailout Fund Grows While Credit Unions Wait

February 21, 2017

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