A Cooperative Decision Over Assessments Facing The NCUA

Will the NCUA board do the right thing for credit unions? Can NCUA evolve with changing priorities?

 
 

The NCUA board will consider a possible assessment for the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) at its meeting on Tuesday. The decision is pivotal because it will indicate whether the NCUA board can recognize the progress of the program it conceived and refocus on the current opportunities for cooperative leadership, or whether it will remain locked in the crisis mindset from events four years ago.

NCUA recently updated its corporate data website and issued the KPMG TCCUSF audit for 2011 on June 22. These resources show positive net income of more than $1.9 billion in 2011, significant cash on hand and available credit, positive cash flows, and increasing value for the assets collateralizing the NGN borrowings.

The data shows there is no need for a current assessment. More importantly, with $12.2 billion of net assets in excess of liabilities, the need for future assessments is uncertain and, at best, unnecessary.

The NCUA board has an opportunity to recognize the positive trends of its corporate plan and align future TCCUSF assessments with actual losses incurred. The expected proposal to take funds imposing an additional expense on credit unions would occur amid declining margins and when the system’s best efforts are needed to help members in an uncertain economy.

Now is the time to realize that TCCUSF options are changing. The marketplace and economic conditions are different than when NCUA devloped the prior predictions and tactics more than  two years ago.

Priorities are different for credit unions. They are responding to consumers’ increasing interest in cooperatives and their desire to bring new funds to the system.  We are in an environment that urgently needs a business model that puts people first. That is what cooperatives do best.

To overlook the significant gains in the TCCUSF reported in 2011 creates a risk of “irrational pessimism.”  An unnecessary assessment imposes immediate costs that restrict incremental capital growth and can crush the spirit of credit union leaders adapting to new consumer needs. Furthermore, it creates a misimpression of the system’s progress resolving the corporate issue.

Here are just some of the positive results from the audit and NCUA’s recent website updates that demonstrate the opportunity to reassess tactics going forward.

A Minimum $3.2 Million Net Balance Forecast

There is now $8.8 billion more in interest paying, performing assets collateralizing the NGN trusts than the total liabilities of $24.7 billion. In addition, NCUA has collected total premiums of another $3.3 billion from credit unions not included in the above that provides total resources of $12.1 billion in excess of all principal payments due to holders of the NGN notes.

Even subtracting the highest loss estimates on NCUA’s website of $9.3 billion, there is still more than $3 billion remaining. This total does not include the $286 million payment from the overfunding of the NCUSIF, nor the $385 million (page 26) in future guarantee payments to NCUA from the NGN program.

The TCCUSF in 2011 recorded a net income of $1.9 billion. Moreover footnote eight shows that the loss reserve established for the NGN notes of $648 million in 2010 is now zero. Footnote 13 shows that the value of the legacy assets securing the NGN notes is $383 million more than the outstanding notes. Together these two numbers show a total gain of more than $1.03 billion in legacy asset valuation in just one year.

Even more importantly, the principal repayments on the legacy assets in 2011 exceeded the payments due on the notes by $465 million. This positive flow can be used for future note payments.

Revenue and interest expense related to the legacy assets were also positive. Total interest income from the legacy assets was $528 million. The total interest expense for the NGN’s and all other borrowings by the AME’s was only $406.6 million. This results in a positive interest “spread” of $121.4 million. Even after paying the NCUA’s guarantee fee of $82 million, the net interest income on thelegacy assets was $39 million.

Cash on hand and from the Treasury line is also plentiful. The AMEs have $709 million cash on hand, an amount that does not include the $349 million excess cash in the NGN trusts. There is more than $3 billion in the unobligated balance of the TCCUSF treasury line, which is costing only 0.165% for a one-year term. These two sources more than cover the repayments of the medium term notes ($3.5 billion) inherited from WesCorp and US Central due later this year. These payments are not losses but represent the funding mismatch between these short-term borrowings and the cash flow pay downs from the longer term legacy assets.

In sum, the cash flows and income streams are all positive. There are more than enough resources to cover loan repayments and current commitments for the NGNs. Perhaps the most important fact showing the state of the resolution program is that actual legacy investment losses total only $3.6 billion, which is still $2 billion less than the total capital in the conserved corporates.

A Crisis Manager Mindset Or A Cooperative Participant?

The KPMG audit report shows the over-collaterization of legacy assets to NGN note balances exceeds 140%, the ratio at the time the program was first established. However, credit unions have added another $3.3 billion in new funds on top of this ratio, providing a cushion that now exceeds 155%.   

Will the NCUA continue to act with the mindset of a crisis manager continuing to stockpile funds? Or will the board recognize the new opportunity of the pro-credit union sentiment and become part of the leadership on behalf of consumers?

This change is especially critical in light of what happened with the reserving activity over the past several years in the NCUSIF.

At the August 2011 NCUA open board meeting, one member asked if the NCUSIF reserve for losses was too high. The 2011 year-end audit by KPMG of the NCUSIF provided a final answer that showed the allowance account was overfunded by more than $600 million. The provision expense reversal resulted in the NCUSIF earnings exceeding the maximum equity  cap of 1.3% of insured shares by $286 million.

This excess of $286 million was transferred to the TCCUSF. This still left more than $500 million in the NCUSIF allowance account compared with actual losses of only $55 million in 2010, a ratio of almost 10 times  actual losses.

Fortunately, the NCUSIF has a combination of annual processes that include an audit, a total ratio cap, and a dividend option to return excess NCUSIF earnings to the member-owners of the fund. This is how cooperative ownership works.

Unfortunately, there is no annual truing up for the TCCSF. Excess funds remain unused until the final NGN notes are paid.  All of the NGNs have final maturities of 2020 or later. A misjudgment and overcollection today keeps credit union funds from members for the next nine years.

A Fresh Start For The Cooperative System

The TCCUSF assessment decision for the Board this week is simple. Does it continue to collect funds that are an immediate expense for credit unions for losses far in the future and that may never occur?

The fund’s audit shows the operating results and resources on hand are more than self-sufficient, not just for this year (now seven months over) but possibly for years to come. That is how the TCCUSF was designed — to operate at an accounting deficit (“the financial condition of the Fund may reflect a deficit” 12USC 1799e) while the value of longer term assets was fully realized.

The current accounting deficit results from loss estimates  going far past 2021 and recorded now even though these assets continue to perform, providing both principal and interest payments. The audit report refers repeatedly to the fact that these loss estimates are a subjective process:

“The development of assumptions for key input variables of the models and external valuations is a highly subjective process that involves significant judgment ... Future values are difficult to estimate, especially over longer time frames.”  (Page 27)

The NCUA Board now has the opportunity to align additional TCCUSF assessments with actual costs as incurred, not impose immediate expense burdens for losses that are “highly subjective … and difficult to estimate especially over longer time frames.”

Such a decision would show NCUA recognizes the cooperative structure and values that undergirds all of the Agency’s functions. The NCUA as a regulator is not a cooperative, but its goals are best served when aligned with credit union efforts to bring solutions based on cooperative ethics and priorities to the marketplace.

To impose a $1 billion expense on credit unions in the few remaining months of 2012 means that money cannot be used for working with members on loan modifications, lower cost refinancings, or new programs.  It reduces credit unions’ ability to build net worth when consumers as well as current member-owners are looking for places to move their funds.

To defer this decision would be a positive boost for credit union morale and underscore the real difference between cooperatives and other financial charters.

The past four years shows that credit unions can be counted on to do the right thing for their members and their cooperative system obligations even in the face of the worst financial crisis since the Great Depression. Credit unions will do the same in the future because that is at the core of what it means to be a cooperative — a business model for the people’s best interest.

The question now is will the NCUA board do the right thing for credit unions? Can NCUA evolve with changing priorities and contribute to the momentum for credit unions to be a growing, positive force in their communities and the national economy?

 
 

July 23, 2012


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