Now Is The Time To End The NCUA's Secrecy Over The Corporate Bailout

While credit unions await payback, a look at the agency’s audit numbers for the past six years show its secretive rescue plan might have cost more than it saved.

 
 

Seven years after the corporate credit union system takeover amidst the worst financial crisis since the Great Depression, the NCUA says it could be six more years before the credit union shareholder-owners get any money back themselves.

The NCUA says there has been $3.1 billion in legal recoveries from the Wall Street bankers who sliced and diced their way to financial disaster for millions of Americans. But that money remains in NCUA coffers, minus the hundreds of millions of dollars NCUA spent paying lawyers and other advisers.

Each time there was a settlement announced, the regulator would issue a chest-pounding press release. That culminated with showering hosannas on Debbie Matz as the longtime board chair made her exit while crediting herself and the agency for saving the corporates and the entire credit union industry.

What she leaves behind are serious questions about why the regulator took the actions it did, actions that — while shrouded in regulator secrecy —  analysis shows made the the situation worse and the imposed solutions much costlier.

There is some positive news out of this — shareholders of receiver’s certificates for three liquidated corporates and all the remaining corporates will receive payback, close to 100% in one case, but there are still some significant unanswered questions, including how much the plan cost, how much benefit it really provided, and how much and when the natural person credit unions who paid over $5 billion in premiums will be compensated for these “investments.”

The serious questions include what were the added costs of the resolution plan; how does the outcome compare with the state of the corporates when conserved; and how do credit unions monitor the critical allocation decisions now being made from surplus funds and especially legal recovery allocations?

Here are three more of those questions:

What are the sources and uses per each Asset Managed Estate of all the legal recoveries?
Nowhere have the details of what happened to these funds been provided. The agency has refused to answer questions about it. This should be the easiest of all cash flows to explain.

What talent and representation is needed for oversight in the payback phase to provide shareholder-owners confidence that all the recovery decisions and expenses are being made in their best interests?
Throughout the crisis the NCUA has relied on outside consultants, financial modeling companies, and Wall Street bankers. Everyone except the credit unions themselves. The NCUA has stated that aspects of the crisis plan were developed internally and other functions outsourced at the cost of tens of millions of dollars. And that’s not counting legal fees. Cooperative governance relies on democratic representation of collective assets.

How do we re-establish a system-wide liquidity solution using the cooperative systems resources in partnership with the Federal Financing Bank?
The resolution plan resulted in the dismantlement of the unique CLF-corporate cooperative liquidity safety net; it substituted more expensive Wall Street funding via the guaranteed notes program for the much less costly credit union-funded share-holdings; and it mandated by rule that credit unions seek liquidity sources outside the cooperative network.  

Today the Central Liquidity Fund has Treasury access of $5.6 billion versus $41 billion during the crisis.  Only 259 credit unions with $88 billion in assets belong today out of a $1.2 trillion cooperative system of 6,000 organizations.

This miniscule participation undermines the independent cooperative financial system and creates systemic vulnerability should another crisis occur.  Can’t a better solution be designed?

This is the fourth in a series of columns by Callahan & Associates chairman Chip Filson looking at the NCUA and credit unions as the regulator enters a new era of leadership.

Also read:

First, Do No Harm

With Matz’s departure, the board has the opportunity to take a new direction, one that hopefully will, among other priorities, maximize payouts to membership capital shareholders of the corporates.

One glaring fact is that almost 75% of the recovery within the corporates’ assets is simply from the gain of those investments themselves, and that, in fact, the agency’s funding and sale decisions hurt more than it helped. (It’s worth noting here that the largest corporates had been under direct NCUA supervision, including resident examiners, for more than a decade before their collapse.)

One of the dictums of medical care is: First do no harm. It’s the same with conserving financial institutions. The NCUA, unfortunately, may have fallen short of that base line of responsibility, instead costing the corporates’ owners more through its convoluted, secretive corporate restructuring and asset recovery process than it would have cost to simply wind down the corporates’ operations.

Another inescapable conclusion is that the liquidation of these corporates damaged the industry’s ability to self-fund its own liquidity, making it dependent on the very outside capital sources the corporate system and CLF were created to avoid.

Additionally, the agency has not explained how the $3.1 billion of Wall Street settlements will be distributed, although it has reported nearly $600 million in “professional and legal fees” while rebuffing requests for how the recoveries were allocated to specific corporate estates.

It has not been upfront about how it estimated losses the $7.2 billion net losses in the first place, and has forced stakeholders to file Freedom of Information Act requests to even find out how the conserved assets performance affected the financial statues of each corporate’s AME.

Fear-Driven Regulatory Overkill

Even with incomplete data, it’s hard not to conclude that this convoluted program is a classic example of regulatory overkill driven by “fear,” or false evidence appearing real. It also shows how NCUA secrecy hid vital details from those whom the regulator was supposed to serve.

The NCUA, now under new leadership, has the opportunity to restore confidence and properly serve credit union members across the country who own their cooperatives. They should be the beneficiaries of this process. That could begin immediately by expanding direct oversight of the corporate recovery process beyond the three current inside employees. New representatives from active corporates, large credit union shareholders of liquidated corporates, and an expert party perhaps from a trade association or accounting firm should be added to the group.  That is how a cooperative system functions best.

Some background is required to understand how we got where are now.

A Remarkable Recovery

The corporate credit union system staged a remarkable recovery from the low point of the financial crisis that followed the Lehman bankruptcy in September 2008. In just the 12 months ending June 30, 2010, this collective recovery included a $9 billion (37%) improvement in market valuation of assets and a $12 billion decline in leverage (shares and borrowings).

Significant progress had been made by all corporates to reduce expenses. Total unused OTTI reserves, which had been expensed and thus deducted from net worth, were $10.6 billion. The December 2009 TCCUSF audit by KPMG (issued July 21, 2010) said the shortfall in the corporate network would be $6.4 billion on top of the OTTI reserves already expensed— but not pointing out that virtually all of that was due to anticipated losses at WesCorp. 

Since March 2009 the two largest corporates — US Central and WesCorp — had been conserved and subsequently under NCUA’s management direction. A conservatorship is supposed to be temporary and, when feasible, restorative. Instead on Sept. 24, 2010, the NCUA seized three more corporates and combined their assets with the first two in a complex resolution plan.

The plan was to liquidate the assets of all five— approximately $66.8 billion as of June 2010 — which comprised 68% of all corporate assets.   The total liquidation was over three times the amount of assets left in the corporate network today.   

The liquidation process included setting up five bridge corporates, five Asset Management Estates (AMEs), and 13 NCUA Guaranteed Notes issuances (October 2010 – June 2011), each a separate trust collateralized with corporate assets.

None of this plan was ever discussed with the affected credit unions or their member-owners. The corporates were not offered any opportunity to respond to the projected new corporate rules. The deed was all planned in secret. Its complexity and opaqueness only added to the sense of unconstrained regulatory behavior.

Behind Closed Doors

None of this plan was ever discussed with the affected credit unions or their member-owners. The corporates were not offered any opportunity to respond to the proposed new corporate rules. The deed was all planned in secret. Its complexity and opaqueness only added to the sense of unconstrained regulatory behavior.

One immediate result was that the KMPG audit as of yearend 2010 raised the loss estimate from $6.4 billion one year earlier to $7.4 billion in the year the seizures occurred. In the final three months following the September takeovers the purported “loss” beyond the OTTI-remaining capital reserves had increased by almost $1.0 billion. This loss increase was contrary to the significant positive recoveries the system itself had reported on a monthly basis for over 18 months. 

Since the September 2010 takeovers, the NCUA has released audits, individual AME financials, and NGN projections but without clear explanations that would tie these multiple summary reports together. Moreover, the financial status of individual AMEs was not part of the releases, but rather had to be requested under FOIA.

Thus, documenting the true condition of each corporate and additional costs caused by the takeovers has been hard to establish. With six years of TCCUSF audits however, some of the pieces of the puzzle are clearer. But major information gaps remain. 

First Some Good News

From the five corporate December 2015 AME financial statements the NCUA projects that there is a substantial surplus for three, Constitution AME is almost whole, and that only WesCorp shareholders will be unlikely to receive any return of membership shares.

Here are the regulator’s projections at December 2015 versus the November 2008 capital account balances which is the date NCUA used when issuing receivers’ certificates:

    NCUA's 12/15 % Payout of
Corp AME Total Capital (11/08) Est Payout Nov 08 Capital
Southwest Corp $403.6 million $328.1 million 81.3%
Members United $572.1 million $181.3 million 31.7%
US Central $1,985.7 million $320 million* 16.1%
Subtotal $2,961.4 million $829.4 million 28.0%
Constitution Corp $66.8 million ($19.4 million) n/a
WesCorp $1,144.7 million ($4,108.4 million) n/a
Totals for five $4,172.6 million ($3,298.4 million) n/a

*Balance after payment of $1.0 billion share account to the TCCUSF. US Central payments will all go to member corporates, which will increase their individual recoveries. For example, Members United held 17.5% of US Central’s membership capital shares, which would result in an additional payment of $56 million to their shareholders.

What do the numbers mean? Shareholders of three corporates will receive a payout. Since the shareholders of US Central were the other “retail” corporates, the payouts for Southwest and Members United will be more. Also the prospect of a positive outcome for Constitution Corporate (a 1.8% shareholder of US Central) is highly probable. 

That is the good news. Payouts should only get better except for shareholders of WesCorp. Its deficit is currently estimated at $4.1 billion, a shortfall which becomes an unpaid liability to the TCCUSF account. That shortfall is a cost all credit unions must absorb before there is any return of TCCUSF’s $4.8 billion in premiums.

A Cure Worse Than The Disease

When liquidating the five corporates, NCUA set up multiple organizations and accounts. There was first the Temporary Corporate Guarantee Fund, and its successor TCCUSF. There were five bridge corporates established to guarantee uninterrupted corporate services and five AMEs.

The Central Liquidity Fund also loaned money for a short time, and there were three years of payments from the NCUSIF totaling $462 million when the operating ratio exceeded 1.3%. Add to this the 13 NGN trusts and note underwritings — each collateralized with specific AME assets.

With multiple sets of books and myriad cash flows inside and between all these entities, it is difficult to track what actually happened and the total costs. But there is adequate evidence in the numbers the agency has reported that suggest that its liquidation process cost far more than simply winding down the corporates as they were, without creating this elaborate new infrastructure developed by advisers from Wall Street.

How NCUA Hurt More Than Help

The financial condition of the five corporates at June 2010 as presented in their 5310 call reports showed the following:

  June 2010 June 2010 June 2010-5310 Current (January '16)
Name Capital Unused OTTI Total Capital & Res Legacy Asset Losses*
Constitution ($24.5 m) $153.7 m $129.2 million $ 71.3 million
Southwest $86.1 m $415.4 m $501.5 million $244.3 m
Members Un $23.2 m $505.0 m $528.2 million $205.5 m
WesCorp ($4,963.2 m) $6,2770 m $1,313.8 million $5,112.8 m
US Central $310.2 m $ 3,148.1 m $3458.3 million $1,356.8 m
TOTALS ($4,568.2 m) $10,499.2 m $5,536 million $6,990.7 m

*From legacy assets spread sheets posted on NCUA website-losses,  through January 2016

The data above shed some light on the costs of the liquidations that are in addition to the realized losses on the securities. 

The TCCUSF audits after 2009 consistently report that “the AMEs had an aggregate deficit of approximately $7.2 billion which represents the difference between the value of the AMEs’ assets and the contractual or settlement amount of the claims and member shares recognized by the NCUA board as the liquidating agent.”  

But this “deficit” would have required losses on securities much greater than had already been accounted for in the OTTI reserves shown above; or from other liquidation expenses.

At the time of takeover, there was unused OTTI of $10.5 billion. Even updating the losses from the legacy spread sheets, today only WesCorp would have a capital deficit beyond its June 2010 reserves — $3.8 billion. This $7.2 billion loss estimate set up in December 2010-if based on higher loss projections, should only be incurred after actual losses depleted the reserves already established. But even now the realized losses on NCUA’s published spread sheets of the corporates legacy assets are only $6.9 billion.

The four non-WesCorp AMEs should still have a positive balance remaining from their OTTI reserve and capital account totals when taken over in September 2010. What then are the additional liquidation expenses that increased the TCCUSF loss estimate by over a billion dollars in just the one year between the audits of 2009 and 2010?

Obviously, significant sums were spent or lost once the five corporates were taken over. One major cause may be losses on sales of investments and/or other assets. The NCUA says in its FAQs that the realized losses on legacy assets are $8.9 billion versus the $6.9 in the spread sheets. Yet the losses the NCUA itself reports on its own NGN performance update total only $8.1 billion.

The first step of conservatorship is to do no harm. So how did a total liability of $7.2 billion occur?  Only  WesCorp has a known, actual deficit today beyond the reserves set up when taken over? What were the actual costs when the AMEs and bridge corporates were established? What were the immediate expenses to set up the NGN program and where were these charged?

Total Liquidation Expenses — Excluding Legacy Losses — Reach $2,592.6 billion (2010-2015)

Apart from the $7.2 billion initial deficit, however created, there have been ongoing expenses charged to the five AMEs. The three major categories and six-year expense totals are as follows:

NCUA NGN guarantee fee:
$345.2 million
Interest paid on NGN notes:
$1,4538.2 million
Professional/legal fees:
$588.8 million
TOTAL
$2, 592.6 million

Offsetting these expenses are three “revenue” categories as follows:

% Total Revenue

NII after Guarantee Fee $  443.0 million 6.5% ($788.2 gross spread less $345.2m NCUA fee)
Net Legal Recoveries $1,842.6 million 27.1%
Increase in assets value $4,519.6 million 66.4%
TOTAL $6,805.2 million 100%

Two thirds of the “revenue” recoveries in the AMEs are from increases in the value of legacy assets which collateralize the NGNs. Or viewed from another standpoint,  the initial loss write-downs have been “reduced” by over $4.5 billion.

Four Questions That Need Answered

With billions in cash flowing between multiple entities, it’s easy to lose track of what is being spent and who is paying for these costs. As shown below, there were hundreds of millions of dollars being allocated to different stakeholders each year with no explanation as to how these decisions were made.

Here are four critical questions for which shareholders should have answers:

Question 1: How were the legal settlements paid out? The NCUA states that more than $3.1 billion has been recovered. However, the individual AMEs show a total of only $2.524 billion fees over the past six years. Where’s is the other $600 million? More importantly how was the net recovery of $1.843 billion, after deducting $589 million in legal fees, distributed among the five AMEs? Who made this decision and on what basis?

Question 2:  Why is there such a wide discrepancy between the improvement in reported market values for the legacy assets in the NGN Performance Matrix and the increase in “Estimated future residual value of legacy assets” for the AMEs?

The market value increase reported in the NGN is $506 million for 2015 and $1,520 million for the prior year. Yet the audit says that the “Net Change in the Recovery Value of Assets and Liabilities was $70 million in 2015, and $743.5 million in 2014.” (the total six-year change recognized is $4.5 billion in the revenue table above). 

Why is there such a wide difference between the reported improvement in market value (NGN matrix report) and accounting estimates used from the cash flow model?  (Note: if one looks at the full four years ending 2015 in the NGN matrix, the gain in market value is $11.8 billion, more than twice the amount recorded in the AME statements)

Question 3:  Who oversees the decision making for the TCCUSF allocations and how are these decisions reported? While the summary TCCUSF financial statements are provided the NCUA board, the real issue is how expenses are monitored and paid, and how income is allocated. For example, a significant income item for the TCCUSF for 2015 was a reported $107.3 million “Gain on the Disposition of Assets.” But why is that income to the TCCUSF? It owns no assets. The asset must have come from one of the corporate AMEs. If there was a gain, shouldn’t that go to the AME which owned the asset? Who make this decision?

Question 4:  The five seized corporates reported capital and unused OTTI reserves of $5.5 billion at June 30, 2010 (table 2). The two largest, WesCorp and US Central, were under direct NCUA management so one can assume their financial reports are accurate. But barely six months after this date, the auditors said the collective capital shortfall for all five was $7.2 billion, or a $12.7 billion change from the position each corporate reported separately in June. If assets were sold at a loss to pay out shares, how much loss did each AME incur? 

A Better Way Forward: A Cooperative Oversight Committee

No matter which forecast one chooses, the trend is for payouts to AME capital holders of at least $1 billion or more. However, there are  many gaps in tracking even this outcome. Without substantive answers to the four questions above, this positive event will be viewed with distrust.

Here are some straightforward ways to begin a more transparent, accountable oversight:

  • The NCUA board should specify where all of the legal dollars went and how the allocation of recoveries to corporates was made.

  • It should also direct that the expenses incurred during liquidation that created a $7.2 billion TCCUSF deficit as the AME’s were set up be detailed.

All of potentially 4,000 credit unions, or their successors, holding receiver’s certificates now have a clear stake in the outcome of the resolution program.

To increase confidence in ongoing resolution steps, the NCUA board should expand the current oversight by three internal NCUA employees to include three outside stakeholders and an expert third party. The representatives could come from an active corporate, large shareholders of liquidated corporates, and an expert party perhaps from a trade association or accounting firm.  

Transparency and credibility are essential to credit union confidence for current decisions plus designing options for 2021 when the final NGN expires. The cooperative model is based on participation by owners. This growing surplus belongs to members, not the NCUA nor anyone else in the federal government. The members’ interests should be represented.

Even after all recoveries, WesCorp’s AME will likely still be insolvent. That shortfall currently projected at $4.1 billion would be paid by the system. So far credit unions have paid $4.8 billion in premiums plus $462 million transferred from the NCSIF. That’s $1.0 billion more than the NCUA’s estimated deficit from WesCorp.  What is the source of the TCCUSF’s expenses other than WesCorp’s shortfall?

The data so far provided suggest that the OTTI reserves for the other four corporates were more than sufficient to cover their actual legacy losses. Each of these AMEs would also have benefitted from legal recoveries over the past three years.   But the estimated surpluses do not yet show those gains.

The before and after situation of the AME’s imply additional significant expenses, other than legacy investment losses, were incurred.  These must have been” netted from the TCCUSF books or the AME’s. creating the initial deficit negative starting point of $7.2 billion at yearend 2010.

Just when the benefit of having stable liquidity resources was being structured with the NGN refunding of credit union shares, the NCUA ironically and inexplicably destroyed the unique cooperative liquidity safety net that the credit union system may well need in a future crisis.

The Biggest Lesson Yet To Learn

While the TCCUSF premiums and losses incurred were historically unprecedented, the most important lesson isn’t the actual or projected amount of the losses. It’s the demonstration of how vital liquidity is in a crisis.

The NCUA made the NGN resolution plan a long-term funding solution with the assumption that the cycle of value inherent in most asset classes could be recovered from crisis-induced low points. To do this, the regulator needed a sure source of liquidity. So relying on Wall Street advisers, it issued new collateralized securities with U.S. government/NCUA guarantees at spreads over the Treasury yield curve that were much costlier than credit union-funded shares that were in place. The NGN funds were used to pay off these less expensive credit union shares.

The liquidation of these five corporates, and especially US Central, resulted in the elimination of the cooperative system’s self-funded liquidity safety net. This CLF-corporate partnership was a unique cooperative design that provided more than $41 billion in backup funding from the US Treasury’s Federal Financing Bank before its dismantlement. 

Just when the benefit of having stable liquidity resources was being structured with the NGN refunding of credit union shares, the NCUA ironically and inexplicably destroyed the unique cooperative liquidity safety net that the credit union system may well need in a future crisis.

A Shadow Of Its Former Self

The corporate credit union system now plays a much smaller role than before the crisis.

Data # Corporates $ Assets # Members $ Lines of Credit $ Shares
6-30-2010 27 $98.3 bn 10,934 $67.3 bn $94.9 bn
2-29-2016 12 $22.5 bn 5,000 $30.1 bn $20.4 bn + $9.4 bn EBA*

*EBA=Excess Balance Accounts swept to the Federal Reserve daily

Not only has the corporate network’s financial role diminished, but also  its reputation is tarnished so badly that credit unions now doubt the  corporate system’s capabilities and NCUA’s support of their role in   preserving the financial integrity of the cooperative model.

Instead, the agency issued a liquidity rule forcing credit unions to set up back up lines with either the Federal Reserve Bank or the CLF.  After the corporate network, the FHLB has been the most important liquidity option for credit unions; but neither of these organizations was included in the liquidity rule.

Moreover, confidence in NCUA’s role as a liquidity provider is so shaken that the CLF is a shadow of its former self. The CLF has only a $5.6 billion borrowing capability from the Federal Financing Bank today, versus $41 billion during and after the crisis. There now are 259 CLF member-owners with $88 billion in assets, instead of the 6,000 members and $1.0 trillion in CLF member assets participating before the crisis. Virtually all credit unions benefitted from this prior corporate-CLF partnership.

In a crisis liquidity matters more than capital. It allows credit unions to continue to fund loan requests when other financial intermediaries must hoard liquidity. Just as important, as shown by the corporate resolution plan, it enables a credit union to continue to hold onto assets that may have temporary declines in value because of external market conditions. 

Liquidity enables patience, that is holding rather than selling at a loss when markets become “dislocated.”  More often than not, crisis induced asset declines in value sooner or later recover or “normalize.”  

Estimates of investment losses for securities in the midst of a crisis will overstate outcomes when viewed over a longer economic cycle. Depending on which report one uses from the NCUA’s resolution plan, this loss miss-estimate ranges from $8 billion reviewing the resolution costs projections table to an approximate $12 billion “gain” in market value calculated from the NGN performance matrix report.  

Unfortunately, these flawed forecasts created immediate losses that were imposed on corporates and then on credit unions via TCCUSF premiums. There are no future facts, only probabilities. Models merely extrapolate years forward using assumptions drawn from current conditions.

The Critical Unfinished Business

Even with a billion dollars or more of members’ money tied up in the NGN trusts/AME nexus, what is more urgent is the restoration of the cooperative liquidity safety net. Without the ability to aggregate cooperative resources, credit unions will become dependent on outside lenders whose priorities in a crisis are likely to be elsewhere.  

Without a cooperative solution, credit unions countercyclical role is jeopardized. The result can be forced sales of assets or liquidations that create unnecessary losses, whereas the traditional cooperative advantage is the ability to take the long view in a crisis.

With a new NCUA board outlook, there is still time to pull aside the curtain of opaqueness and provide a complete picture of the corporate resolution program. This could create a new starting point in NCUA’s relations with the credit unions.

One of the dictums of medical care is: First do no harm. It’s the same with conserving financial institutions. The NCUA, unfortunately, may have fallen short of that base line of responsibility, instead costing the corporates’ owners more through its convoluted, secretive corporate restructuring and asset recovery process than it would have cost to simply wind down the corporates’ operations.