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NCUA Fields Questions on US Central/WesCorp

By Ron Jooss

The National Credit Union Administration was hit with 500 questions from concerned credit union leaders during yesterday's Webcast explaining its decision to put US Central Credit Union and Western Corporate Credit Union into conservatorship last Friday. About all it could offer in return was more bad news.

NCUA Executive Director David Marquis said US Central and WesCorp were placed into conservatorship to reduce the credit union system's exposure in the face of estimated loss projections, to maintain greater control over the corporates and improve the transparency of financial information provided from the two institutions.

"It's very vital that we maintain confidence of member CUs and especially the payment system," Marquis said.

The CEOs, boards and some senior executives of the corporate credit unions have been removed, with NCUA-appointed officers assigned in their place.

In what he said was "a hurtful point," Marquis said projected credit losses have entirely wiped out paid in capital and member capital share accounts at WesCorp under the NCUA's base, pessimistic and optimistic test case scenarios."

At US Central the best case scenario reveals that 77 percent of paid in capital and membership share accounts have been impaired. In addition, all of the NCUA's $1 billion emergency infusion is gone.

Marquis said natural person credit union shares—but not capital—are insured up to $250,000, with any additional amount guaranteed under NCUA's Voluntary Temporary Corporate Credit Union Share Program and backed "by the full faith of the U.S. Government."

Marquis said the NCUA is holding a closed board meeting on Thursday, March 26, in an effort to hammer out a way for credit unions to spread the cost of the impairment. But any fix will take legislative approval.    

When asked why the corporate credit unions weren't allowed to fail Examination and Insurance Director Melinda Love said, "One of the reasons we took the conservatorship action was to ensure that the payment system and settlement processes continued uninterrupted. Had we gone ahead and just let the two corporates fail, that would have created an interruption in the payments system that would have come back and been felt by all of the members of all your natural person credit unions."

Marquis added that allowing the institutions to fail would also have meant putting their distressed securities on the market, rather than letting them continue paying down over time.

"We can't emphasize enough that it's vital to maintain liquidity in the system," he continued. "Since Jan. 28 credit unions have done a very good job in helping in that arena as they've taken a great deal of external borrowings off the table."

Yesterday, the NCUA released a statement that due to the success of the three Credit Union System Investment Program offerings there will not be an April CU SIP offering. Over $8.2 billion was issued in the first three subscriptions. Corporate credit unions used the funds to pay down external borrowings, freeing collateral for future contingency liquidity needs. 

Although the NCUA has said its examiners will be flexible with credit unions that approach Prompt Corrective Action status because of the expected reductions in return on assets and net worth, Marquis did not provide details. (See "Corporate Stabilization: The Longer View" for a previous NCUA explanation of PCA implications.)

"Our examiners have been told and we've worked with them more than once on taking these items into consideration," Marquis said. "That doesn't mean it's a complete free pass. We do have to look at the safety and soundness of the institution as it runs its own business and how its business model is working in this environment." (See also NCUA's Supervisory Letter No. 09-01.)

More bad news on the corporate credit union front is still to come. Marquis said US Central's absorption of paid in capital and membership capital shares will roll down to other corporate credit unions with capital investments in US Central and, depending on how hard this hits their balance sheets, will affect natural-person credit unions that invest in those corporates. Members of WesCorp will lose all their PIC and MCS.

Ron Jooss is a CUES editor.

After this Webcast, CUES held a teleconference on communicating industry issues like this with your staff and the media.

 

At the Edge of Chaos: An Industry in Transformation

By Kevin Foster-Keddie

The crisis in the financial services industry will re-shape the competitive landscape for decades to come. What can past financial crises teach us? How can credit unions survive this transition period? What will the new environment look like?

The world is experiencing the first global financial crisis in modern history. While there are no roadmaps to guide us, historical records can provide some perspective and even a range of scenarios with which to plan. In the broadest terms, financial crises have one element in common: speculation. This propensity of human beings to be overly optimistic about future plans has resulted in widespread speculation in the past and has led to the crisis we face today.

In what is sure to become a classic of modern economic analysis, the University of Maryland's Carmen Reinhart and Harvard University's Kenneth Rogoff completed a study of past financial crises that is startling in its simplicity and sobering in its conclusions. While Reinhart and Rogoff do not predict the ultimate outcome of the current crisis, even a casual reader can draw their own conclusions.

Unemployment will surpass 11 percent and last close to five years (or longer), equities prices will drop at least 55 percent and begin recovery only after three years (or more), and housing pricing will not recover for at least 6 years with an average drop in value of 35 percent (or more). The worst-case scenarios (Download Table) are based on historical record. Because the current event is worldwide in scope, a more severe scenario than average is a distinct possibility–-even a probability.

Chaos and Survival: the Transition Period. In the scientific world, the term "edge chaos" is sometimes used to describe an environment that exists between randomness–-chaos–-and a stable equilibrium. As a metaphor for the current state of the financial services environment, it helps to illustrate our current rapid pace of evolution–-and the uncertainty in the ability to predict the future equilibrium.

During this transition, credit unions can expect conditions that will create real threats to the survival of our institutions. While there are also great opportunities in a marketplace so unstable, most credit unions will seek survival over growth.

Balance sheet management is the primary objective of most financial institutions–-indeed most companies–-today. For CUs, capital preservation is the dominant concern. Many institutions should, or already have, implemented strategies to shrink the size of their institutions and increase margins as much as possible.

For credit unions whose past strategy has been price or technology leadership, such an adjustment may be difficult. Pricing to improve margins is very different from pricing that seeks increased market share and stimulates growth. Likewise, maintaining technological leadership during a severe contraction is difficult to justify.

Perhaps the biggest challenge for growth-oriented credit unions is accepting the idea that the transformation of financial services includes a contraction in the size of the entire industry. Growth for most individual financial institutions will only occur after the industry as a whole is "right-sized" to the needs of the marketplace. Those marketplace needs will be much smaller than they are now.

The hard wisdom of past industry transformations is that a survival rate of 60 percent is a good outcome. Perhaps credit unions will fare better than other financial institutions during this transition period. Perhaps not.

What will be the criteria for determining survival? Many factors will play a part, but it is a credit union's capital that will be most important. Does your credit union have sufficient capital to withstand its losses and to replenish the insurance fund for the losses of other credit unions as they fail?

The Aftermath: What will the New World Look Like? While it is impossible to predict how and when all the moving pieces will settle in the drama enveloping the financial services world, some broad elements can be identified as the chaos begins to subside.

First, there will be far more government involvement in financial services. During the transition, certainly, a pattern of government actions–-for example the introduction of "Making Home Affordable"-–will require immediate action by individual credit unions. Responding to this stream of new requirements will restrict credit unions' ability to move forward on internally generated priorities. And, after the transition, additional resources will be needed on a permanent basis to comply with the new regulations.

While increased government involvement in financial services will be a challenge, expect fewer players, less competition and higher margins. The number of financial institutions will fall. The ways in which these competitors will compete will be different. For example, Washington Mutual is gone. WAMU was a tough competitor in Washington State because it emphasized service. JP Morgan Chase is not as service oriented as WAMU. Margins will be higher because federal policy makers will need to create an operating environment to repair bank balance sheets. Also expect less innovation in financial institutions: The government will be risk-averse and seek to control and restrict risk-taking activities to a great degree.

Kevin Foster-Keddie is president/CEO of $1.3 billion WSECU, Olympia, Wash.

Considering a variety of scenarios for the future can help you succeed even in chaos. See what you think of the four scenarios outlined in the just-released 2015 Scenarios for Credit Unions in North America.

NCUA: Tell Us Where You Stand

By Ron Jooss

 

Credit unions should let the NCUA and their trade associations know if they are in favor of their industry accessing TARP funds to stabilize the corporate credit union system or rely on internal funding to ease the burden, NCUA Executive Director Dave Marquis said during a Webcast hosted by the regulator yesterday.

 

When one participant suggested that credit unions stand together and absorb the loss to distinguish themselves within the financial industry during a turbulent time, Marquis responded:

 

“We need to understand, and the trades need to understand, what the divide is on, because we don’t fully understand that. To the extent that you can send in your pros and cons on if we want the taxpayers to pay for it over time or do we want the credit unions to step up and take the hit to show we are a different type entity than the rest of financial institutions. We don’t know how that divides in the credit union community and that’s probably something we need to get a better handle on. Send in your e-mails to us or send them in to your trade association so we can get a better feel for what the community has a preference for out there.”

 

NCUA Insurance Director John Kutchey said the NCUA does not favor one solution over the other. “Where the industry wants to go, as the regulator, we’re behind it. But you as an industry, you’ve got two ways of solving this. If you solve it internally, the con of that is the charge-up funds that you've got to deal with, and there’s going to be a hit to your bottom line and there’s going to be a hit to your net worth.

 

"The pros of that is the political capital that the industry could gain in relation to future taxation, in relation to maintaining an independent regulatory and insurance structure and having the influence over that system in future legislation as it relates to your institution. The flip-side of that is TARP funds or Treasury injection. The pro of that is being able to spread the cost over time or forgoing the cost altogether. The negative of it is credit unions become, as I understand it, much more susceptible to taxation.”

 

Another issue under consideration is if the system should take a one-time hit or spread the charges over four to five years years. Pursuing the latter option would require legislative and Treasury approval.

 

“There has not been a consensus on how to approach some of these things but one of the core questions that comes up is if the industry wants to take this loss in one year or do you want to stretch it over several years so that you’ll be taking a 12 to 15 point hit over four to five years to pay for this or would you rather deal with a 60 basis point approach in year one,” explained Kutchey.

 

He likened the first strategy to removing a Band-Aid gradually, and the second approach to ripping it off quickly.

 

“That’s something you’re going to decide as an industry and you’re going to need to work through the legislative process to decide what the majority of the industry wants,” Kutchey said. “I encourage you to talk to your trades and your organizations so your voice is heard about whatever direction you want to go.”

 

What is the likelihood that more capital will be required from natural-person credit unions?

 

The short answer is that the NCUA doesn’t now, but “the market is not in our favor right now,” said NCUA Loss/Risk Analysis Officer Steve Farrar.

 

NCUA representatives said the regulator considered alternatives such as liquidating or purchasing the undervalued corporate credit union investments.

 

In regard to purchasing the undervalued assets, WHO? said, “The share insurance fund has “$7.5 billion in assets to draw from and the total investment portfolio of the corporate system is $80 billion, so there’s no way the insurance fund could fund a purchase of those investments. Secondly, the purchase of those assets does nothing to reduce the liability and exposure to natural-person credit unions because if the NCUSIF actually took those in they would have to bring them in at market value, so that market value basically becomes a realized loss and that downstream effect would be higher than the uninsured share guarantee and capital notes that we already used.”

 

The undervalued portfolios also created a problem for liquidating the problem institutions. Marquis said even if the undervalued assets were sold at 50 cents on the dollar, the NCUSIF would take a $30 million to $35 million dollar hit, which would downstream to natural-person credit unions.

 

"Think in terms of what does that does to you in terms of retraction to your lending ability,” Marquis said. “We don't want to economically create the effect of not making any loans in the community right now. If that retraction took place it really does some serious damage to your ability to make loans in the years to come.”

 

Kutchey added: “The approach we took we feel very strongly that it is the least-cost alternative to the credit union system. It was not an easy decision to make. This alternative gave us two things: the least cost to credit unions and the most flexibility for resolving this on a go-forward basis."

 

Ron Jooss is a CUES editor. 

Corporate Stabilization: The Longer View

By Mary Arnold

Yesterday Ron Jooss and I reported on the CUNA audioconference and the NAFCU Webcast held concurrently on Feb. 4. Now, highlights from yesterday's CUES Webinar, "NCUA's Corporate Stabilization Program: What Will it Mean to Your CU?" featuring Callahans' Chip Filson and Jay Johnson and John Kutchey, acting director of NCUA's Office of Examination & Insurance:

While all three programs have featured extensive Q&A between participants and NCUA representatives, the CUES Webinar also sought to put the situation into a going-forward context. According to Filson, this time of corporate stabilization is actually the first steps of establishing what credit unions will be like in the 21st century. He suggested looking at how the CU system can benefit from the issues that are coming to light and avoid "letting the problem claim us."

For example, the Central Liquidity Facility doesn't currently have authority to lend directly to corporates, hence the need for the System Investment Program, or SIP, which lends money to natural-person CUs so they can loan it to the corporates. Now is the time to get authority to use the fund to meet existing needs, Filson suggested.

Additionally, NCUA has said it is instructing examiners to look at CU financial results net of the insurance assessments necessary for corporate stabilization. Kutchey confirmed this in the Webinar, saying, "We would discount these actions in their CAMEL rating. I want to make this crystal clear to the universe."

However, if a CU fell below minimum reserve requirements, it would still need to file a capital restoration plan. Kutchey explained during the CUES Webinar that this is a statutory requirement under Prompt Corrective Action. NCUA must have the plan. But, he added, the agency has the discretion to evaluate it in light of the assessment.

Filson saw this as an opportunity to ask Congress to modify PCA.

Sharing a range of comments posted on the CUES Net listserve since NCUA first announced its corporate stabilization plan on Jan. 28, Filson illustrated how executives' responses quickly moved from shock and outrage, to denial and finger pointing, to a "how-can-we-work-together-to-survive-this-challenge" stance. It's the same repsonse you typically see as humans deal with any great change, including the death of a loved one.

"The challenge now," Filson continued, "is to convert this energy into positive opportunity. Credit union leaders across the board are eager to do more."

Kutchey opened his portion of the program by saying, "I know the impact on each credit union is substantial and significant. The industry is going to get a chance to not just tell its story as it has in the past, but to live a story." He said CUs' ability to right their own system would provide immeasurable "clout on Capital Hill."

He came back to this point later in the Webinar, as he addressed a participant question on whether CU members are being "double-whacked" by first paying for TARP through their tax dollars and then paying to stabilize corporates via their own CU's financial results.

Kutchey paused, then answered that "yes," he believed they are. "But you have to decide how you want to invest your political capital," he said, whether it should go into CU earnings and ROA or fixing this problem. "If we fix it ourselves, we gain political capital going forward--to articulate the strongest possible argument against taxation" and against having CUs fall under a single regulator.

Regarding the temporary guarantee on all corporate deposits, Kutchey confirmed that it would end on Feb. 29 for any corporates not signing a supervisory agreement with NCUA. "We are actively working with every corporate," he said. "The largest corporates that hold the bulk of the troubled securities are the priority, the corporates that are under the most stress.

"I couldn't imagine a corporate not participating," he said, suggesting that corporates' member CUs would urge them to do so to maintain the guarantee. Kutchey added that the $3.7 billion NCUA is reserving is based on all corporates participating.

Responding to another participant question, he noted that "as early as 2007, NCUA has had some supervisory agreements in place" concerning how certain corporates could invest their funds.

Kutchey also addressed a number of questions regarding the insurance fund assessments:

• By statute, the assessments will be based on $100,000 of member deposit insurance, not the temporary $250,000 level. It will be based on insured shares as of June 30, 2009. (To figure out how much your credit union would owe, go here.)

• He confirmed that the $1 billion capital infusion to U.S. Central will come back to the fund if it is not needed, explaining that the arrangement had been "structured with incentives" for U.S. Central to pay it back. Any dividends the $1 billion earns will also be returned to the fund. If the share insurance fund becomes over-capitalized, CUs will receive a dividend.

• Kutchey clarified that the $1 billion infusion will result in an immediate expense for credit unions, but that the premium assessment expected to be billed in September would be considered an asset. Read more on this in Accounting Bulletin 09-01. He added that national CU accounting practitioners are meeting this week with the American Institute of Certified Public Accountants about when the expense needs to be booked.

Regarding the $3.7 billion, Kutchey emphasized that it is "not an estimate of losses on U.S. Central's portfolio; that's just one factor. It's our best estimate of what we'd need if we had to perform on the (temporary) guarantee (on deposits)." He added that keeping liquidity in the corporates gives them "not only the intent but the ability of hold those (troubled) securities. Liquidity reduces the risk exponentially"--and thus reduces the risk of needing the guarantee.

To help NCUA get a better handle on potential real losses in U.S. Central's portfolio, the agency has engaged PIMCO to study each investment and its underlying mortgages and analyze the market for the investments. Results of the first, baseline, study are due in two to five weeks, Kutchey said.

What should credit unions do in the meantime? Filson suggested they should look for ways to improve their business, with helping homeowners at the top of the list. If you need help funding that, consider asking NCUA about the possibility of offering a second round of CU HARP (Credit Union Homeowners Affordability Relief Program), he said.

If your balance sheet will be severely hurt by the insurance assessment, be proactive about alerting NCUA.

Above all, "start thinking about the redesign of the corporate system (direct your comments to NCUA here.) Get involved in setting the legislative agenda ASAP."

And, finally, Filson said, "It's time to re-engage the corporates themselves in these conversations."

 

Thousands Dial in to Discuss Stabilization Plan

By Ron Jooss

3,000 people called in for CUNA's audio conference yesterday on NCUA's corporate stabilization plans. Here are some highlights:

CUNA President/CEO Dan Mica said CUNA's official position on the NCUA recent action was mixed. While the association agreed the regulator had to take action, CUNA is not convinced the proper mechanism has been prescribed.

"There are two parts with regard to our feelings about what's happened at NCUA. One, we have reviewed the information as to what NCUA has done and we feel they had no other course of action but to act. They had to do something, whether it was an injection of cash, whether it be conservatorship, they had to do something. Second, we do disagree at this point with the approach that they've taken and we are working as hard we can to find alternatives that are workable. NCUA has indicated to us as recently as today .... that any alternatives ... that are realistic responsible, and legal they will consider."

Owen Cole, director of the Office of Capital Markets and Planning at NCUA, said the proposed remedy by the NCUA was actually the least costly way to stabilize the credit union system. "By stabilizing the situation, even if we end up having to absorb the full $4.7 billion dollars in losses, that is significantly lower than the cost every CU would have borne, including the CUs that did not participate in the corporate system, through a premium expense based on the losses we would have realized if we had to liquidate these assets and subsequent assets of natural person credit unions that would have failed as a result at these fire-sale prices in this dysfunctional market," Cole said.

Bill Hampel, SVP/research/chief economist at CUNA noted that given the economic times credit unions already faced an uphill battle achieving profitability in 2009. "This is not the only bad thing happening to credit union financial statements this year," Hampel said. "Other bad things are going to. There are going to other negative pressures on credit unions this year."

Hampel did not mince word on the effect the NCUA proposal would have for natural personal credit unions--some 60 percent would finish in the red. "There is no sugar coating this. This would be horrible. I've been in this business 30 years. Never in my experience have over 60 percent of credit unions lost money in a year which is what would happen if these charges went through as they are."

Mary Dunn, CUNA SVP/deputy general counsel, outlined alternatives to be considered by the NCUA:

• injection of capital from natural person CUs through member capital accounts, paid-in capital accounts, subordinated notes and term deposits;
• greater use of the Central Liquidity Fund;
• natural person credit unions could purchase corporate CU assets (a group of natural person credit unions has expressed interest in this idea, according to Dunn); 
• expanding the System Investment Program;
• corporates could deposit capital to defray the deposit guarantee;
• explore extent to which NCUA can defer from GAAP rules for funding the premium and
• explore the Temporary Asset Relief Program.

As for pursuing TARP funds, Dunn said, "Even the critics of going to TARP are diminishing, as the need for assistance increases. So we are exploring all options and all opportunities to working with NCUA, Treasury and Congress."

Dunn said CUNA reps, including herself and Hampel, will be meeting with Vice President Joe Biden's economist, chief economist Jared Bernstein, next week and access to TARP funds is "tops on our list."

Regarding TARP funds, Mica said: In my conversation with Chairman Fryzel, they are now pursing aggressively TARP funds as backup funds for NCUSIF. Fryzel is requesting a meeting with Secretary of Treasury Geithner to discuss that this next week.

When asked if credit unions would concede lobbying power in legislation battles with bankers if they accepted TARP funds, Mica said: "Absolutely, we would love to see an internal solution, but I want to be realistic. Looking at the size and scope of the problem, it would be irresponsible not to have a back-up. We hope we never use it.  We don't want to use it. But it's a little like not having insurance."

Dunn said under the alternatives under consideration, natural-person credit unions would fund the first $1 billion if there were losses in the corporates. The next $5 billion would be sought from TARP. "Even though we are seeking funds from TARP, if would be in a much defined and circumscribed way," Dunn said.

NCUA Deputy Executive Director Larry Fazio was asked why the NCUA requires the 1.3 percent balance in the share insurance fund and why it can't be reduced. "The statute requires us to charge a premium when the equity ratio falls below 1.2 percent. We cannot charge a premium to increase the fund above 1.3 percent. That's the framework in which we currently operate.

"The board decided as part of its January action to replenish the fund all the way up to the 1.3 percent because of the continuing uncertainty regarding the economy and other potential losses in the corporate system as well as challenges being faced by natural person credit unions and potential further pending losses and also with the hope to provide a cushion that we would only have to charge the premium once."

Fazio was also asked, if the market turns around would the funds be returned to credit unions? "How we structured both the capital note and the guarantee program—the capital note has a $1 billion reserve implication for the fund, and the guarantee has a $3.7 billion guarantee implication for the fund—to the extent that we are repaid on all or any part of the $1 billion capital note given to U.S. Central and to the extent that we don't have to exercise on the guarantee for the uninsured deposits, that money would flow back to the share insurance fund and be returned to the credit unions."

Mica asked Fazio if $15 billion were to flow into the corporates, in term deposits for example, if that would mitigate "a great deal" the current problem. Fazio responded, "Yes, sir, that's correct.

Ron Jooss is a CUES editor. 

NCUA’s Marquis on Corporate Stabilization

By Mary Arnold

Why now and what does it mean to natural-person credit unions were two of the audience questions addressed yesterday by David Marquis, executive director of NCUA, during a free National Association of Federal Credit Unions archived Webcast.

Let's start with "why now?" which topped the list for the 1,200 Webcast participants.

Marquis explained that while NCUA had been tracking corporate liquidity on a daily basis for some time and had placed some restrictions on their investment actions, it became necessary to take immediate action when it learned U.S. Central would report other-than-temporary impairments of $1.2 billion on its year-end financials, turning unrealized investment losses into realized expenses and severely threatening its capital position.

"The biggest issue was the leverage on the corporate balance sheets and what happens in the credit markets if credit on U.S. Central's books gets called or there is a run on deposits," Marquis said. NCUA feared trouble would spread to natural-person credit unions, leaving thousands of CUs with problems.

"We needed to stabilize liquidity first. Then let (U.S. Central's troubled) assets pay out over time," added John Kutchey, acting director of NCUA's Office of Examination & Insurance. "This was the best scenario, industry wide."

When will the insurance assessment come? "When the fund drops below 1.2 percent, we have to restore it," Marquis explained. "Not like in 10 seconds," but within the established billing cycle of March and September.

He said the current plan is to bill for the infusion in September when the amount needed will be clearer. "We hope to only have to bill one time," he added, alluding to the possibility that the $3.7 billion loss reserve currently being estimated could fall short. There is also possibility Congress will approve a five-year time frame for replacing National Credit Union Share Insurance Funds, providing a reprieve for CU financials.

To help NCUA get a better handle on potential real losses in U.S. Central's portfolio, the agency has engaged PIMCO to study each investment and its underlying mortgages. "The real credit loss could be just a fraction of the OTTI loss" that U.S. Central is facing—or it could be greater.

Asked why NCUA can't access TARP funds, Kutchey noted that if TARP were provided as a loan, it would help the liquidity situation, but not the capital side. "Be careful what you wish for," he added. If TARP funds were used to buy up troubled assets, "What price would the assets be sold at? It could cost more than the program on the table."

Besides the $1 billion of capital infused into U.S. Central from the NCUSIF, NCUA temporarily is guaranteeing all corporate deposits, even those over $250,000, to help keep credit union investments in the corporates. Marquis said previous attempts to speak directly with larger credit unions about maintaining their corporate deposits had had the opposite effect of money being pulled out.

Marquis also said that NCUA "can reduce the $3.7 billion in a shorter term if corporate balance sheet structures improve," and that increasing corporate liquidity is one way to do so. If credit unions end up over-paying to the insurance fund, Marquis said, "a dividend payout could potentially be in the future."

The System Investment Program funds credit unions are purchasing from the Central Liquidity Fund and, in turn, placing into corporates at a 25 basis point, fully guaranteed spread greatly improve corporate liquidity because it is new money flowing in, Marquis said. He noted that SIP funds "inflate credit union balance sheets as short-term borrowing transactions and added that NCUA is "providing direction to examiners to take this into account, so SIP credit unions won't be penalized."

Following up on this point, Marquis said this information would be in a supervisory letter to NCUA examiners that would also be shared with state examiners and made public to credit unions.

He also emphasized that examiners are being instructed to look at credit unions' financial results net of the impending insurance assessment. "Our examiners get it," he said. "We don't want credit unions to make critical mistakes (or take on undue risk) to manage this issue.

"Examiners should look at the credit union separately from this industry event; your business models should show that you are adjusting to your own situation and that your balance sheet can stand future interest rate increases."

Still, those CUs that fall under minimum reserve requirements will be required to file capital restoration plans, Marquis said.

$8 billion of SIP has been purchased in two rounds so far. When asked where the $8 billion has gone, Marquis replied that the majority went to U.S. Central, explaining that infusing the "top tier (of the CU system) feeds the rest of the system."

To continue the unlimited deposit guarantee after Feb. 28, 2009, corporates will need to enter into what Marquis called supervisory agreements with NCUA, similar to the "letters of understanding " troubled natural-person CUs are familiar with. "This process will start at the end of the week," he noted.

NCUA is also looking at different regulations for the corporates but, instead of drafting something for comment, Marquis explained that NCUA issued an Advance Notice of Proposed Rulemaking with 60 days for CUs to provide feedback on the role of corporate credit unions and whether to amend corporate regulations pertaining to capital; permissible investments; management of credit risk and liquidity; and corporate governance. Comment here.

According to Marquis, the NCUA Board is also willing to listen to alternative solutions for corporate stabilitization. "They are open to solutions that are legal and represent the industry," he said.

Mary Arnold is VP/publications for CUES.

CU Corporates: The Way Forward

By Henry Wirz

SAFE Credit Union faces a $7 million expense (maybe more) for the U.S. Central bailout. That expense will wipe out any net income for 2009 and most likely cause us to report a loss. SAFE has advocated restructuring the corporate system for a long time. We use Wescorp to invest most of our liquidity and we depend on WesCorp for share draft processing and as our banker's bank. We believe it is time to restructure the corporate system.

We believe any restructure of the credit union system should have the following elements:

• The corporate system is a three-tier system. Members deposit their money in a natural person credit union that invests some of those dollars in a corporate like WesCorp which in turn invests some of its dollars in U.S. Central. There are 28 corporate credit unions. Many of those corporate credit unionss pass through most of their assets to U.S. Central. Each level of the corporate system maintains capital and takes a cut of the spread on the assets they manage. In my opinion we have one too many levels and too much capital and too much overhead. We don't need three levels. Many of the corporate credit unions should be consolidated. It would create more efficiency and better returns to the natural person credit unions. Some of the corporate credit unions have fewer assets than the natural person credit unions! Ironically NCUA has been a key impediment to consolidation of the credit union system by rejecting mergers of corporate credit unions (Volunteer Corporate Credit Union and SunCorp Corporate Credit Union).

• U.S. Central's board of directors is not directly accountable to the rest of the credit union system. We need to change that. The members of the board are elected by corporate credit unions or by ACCUL. I feel that our bailout of U.S. Central should give natural person credit unions the right to elect the board of U.S. Central.

• I would favor a corporate system that mirrors the Federal Home Loan Bank System. The corporate system should be consolidated into five or six regional corporate credit unions that have the ability to raise funds thorough bonds that have the full faith and credit of the U.S. Government. The Federal Home Loan Bank System provides liquidity to support home ownership. We should create a Federal Consumer Loan Association that provides liquidity for consumers. Consumer spending represents 70 percent of GDP. What could be more important than supporting consumers?

• The problem in the credit union system is that there is no tangible ownership. We have to change that. We have to give members ownership interest in their credit union and we have to give credit unions tangible ownership interest in their corporate credit unions. Owners pay attention to financial results and hold management and boards accountable. We have little or no accountability for what corporate boards are doing. The reason for that is that we have no tangible ownership equity in our corporate credit unions. We need to change that. We should get a dividend for our ownership interest and we should have a direct vote for all board members. We should not see board members run unopposed. There should be dividends paid based on the net income of the corporate. That would create a laser-like focus on the quality of management.

• There must be consequences for poor performance. Who is accountable for $1 billion of losses at U.S. Central? Is this just business as usual? I suggest that when a baseball team loses more than they win, we get a new manager. I expect the same results in the credit union system.

Henry Wirz, a CUES member, is president/CEO of $1.3 billion SAFE Credit Union, North Highlands, Calif.

Read another post from Henry.

CUES members, tune in for a free Webinar, "NCUA's Corporate Stabilization Program: What Will it Mean to Your CU?" Feb. 5 at 1-2 p.m. Central.

Calm Leaders = Calm Waters

By Bill Vogeney

Writing is one of my favorite activities when I want to unwind. And I do need to unwind. Over the last four to six months, I've felt like a 7-year old with ADD instead of a 47-year-old credit union vice president of lending. The cause of this workplace ADD is the state of the economy and the financial markets. My "worry list" has changed about every 30 days, except that nothing is really falling off the list. The list just keeps getting bigger:

• rising delinquency;
• members who are making very bad, short-sighted decisions to walk away from their cars and homes even though they can make the payments, just because they're "upside down";
• $147 a barrel oil (well, one thing off my list, thank goodness);
• slowing consumer loan volume;
• ALM issues with a growing mortgage portfolio;
• the economic impact of trillions of dollars of wealth wiped out in the real estate and stock markets and
• an impending NCUA exam.

Recently, I added the concern over how we'll be able to handle mortgage volume that will make the refinance boom of 2003 look like a slow year. Not to mention how we'll re-invest the funds from the sale of sub 5 percent coupon loans, because there is no way we're holding them in the portfolio. We'll unload our interest rate risk, along with a lot of future earnings, if rates hold for any measureable length of time.

These are indeed some turbulent times—the most challenging economy this country has faced since the early 1980s. What credit unions need is calm leadership if we want calm waters. For example, one of my biggest complaints with the lending industry over the last 20 years is that credit standards have fluctuated like a boat in rough waters. When times are good, lenders chase all the business they can, and standards go overboard (I was going to say "out the window," but I want to avoid mixing metaphors). When times are tough, these same lenders tend to over-react and pull back on lending because they don't have a strong comfort level as to how their portfolios will perform.

I've always believed in being a steady Eddie kind of lender. I like making small and manageable adjustments to credit policy. I have the good fortune of working in Colorado, so we didn't have the 20-30 percent yearly price appreciation that California and Florida experienced. We've also avoided the 20-30 percent price declines. But I can tell you that 5-10 percent declines per year are still pretty painful to our members.

Because of our area, we're still making 90 percent loan-to-value home equity loans. However, I've heard many stories about banks and credit unions lending 70 percent LTV in economically troubled areas. It's the ultimate double whammy. Homes are worth 30 percent less, so you won't make as many equity loans. Then, you only wind up making a loan equal to 70 percent of the value. Institutions in these areas might as well close their lending area and fire the employees.

Still, if you're in this situation, and you're confident of your appraiser's ability to value the homes, you should be able to make 80 to 90 percent LTV loans without undue losses—if you find the right borrowers.

Without a fresh supply of good loans coming into your portfolio, dealing with the large number of problem loans will be even more difficult. Do yourself a favor and see if you can find your loan policies from five years ago. What was your maximum LTV? What kind of FICO distribution were you willing to accept? How much did you bend your policy since then? If you stayed stable, you should not have to make drastic changes to your policy now.

I will admit, for some of you, it may be hard to look your CEO and board chair in the eye and talk about the need to keep lending, to stay calm, and to not over-react to this buffet of bad news served up almost every day. But making good, new loans really is crucial to getting out of this mess we're in.

Bill Vogeney is SVP/chief lending officer for $2.5 billion Ent, Colorado Springs, Colo.

Read Vogeney on indirect lending and credit scores.

 

 

Economic Action Plan

By Dennis Gibson, CSE

As this is written on Jan. 1, 2009, many, many people are thankful that 2008 has been left behind. The numbers tell us that the final quarter of the year just completed was the worst for the nation's economy since 1931. There is widespread belief, however, that the quarter has taken us near the bottom for this round, and signs of the beginning of recovery will be seen as early as mid-year. This, of course, is merely conjecture, and remains to be seen.

The direction in which the economy spins will have a basis in the decisions made and enacted by the incoming administration and the, virtually, single-party control of Congress (I say "virtual" control, as the potential for Republicans to filibuster in the Senate remains a possibility). But how does all this affect Credit Union Land, and what actions are needed from each credit union's leadership?

The two functions each credit union must succeed in fulfilling are:

• serving the financial needs of its members and

• remaining financially solvent.

Most certainly, the country's economic recession is providing a number of stumbling blocks for credit union leadership as attempts are made to succeed in accomplishing these key tasks.

As in any viable business, managing a financial institution's revenue and expense, in order to provide for a positive bottom line and a stable (or even growing) capital ratio, is paramount. If any credit union does not have a plan/budget in place as of the first business day of the year, then, perhaps, new leadership should be considered. One cannot count on luck—particularly in such an economic turmoil.

The key to the plan's success is the timely and correct control of the asset/liability function, and the associated maintenance of proper pricing. In a business environment with financial issues and problems coming from, seemingly, endless directions and points of origin, where does one invest and receive a viable return on the investment? The traditional investment vehicle for credit unions has been consumer loans. However, consumers have slowed spending and the associated borrowing. In addition, many of those who have borrowed, or currently wish to borrow, are no longer in a position to assure repayment of the loan (particularly if loan policy has been adjusted to reduce the risk of loss).

The second traditional form of investment has been in the monetary marketplace (CDs, Treasuries, bonds and so forth), but the current return on insured investments (and uninsured investments are, quite likely, simply too much of a risk in the current economy) is very low. The rates, in fact, have hit record lows.

What is a credit union leader to do? Since there are, pretty much, only less-than-ideal places to invest, credit union leadership should price deposits as low as possible. This means as TRULY low as possible.

With Treasuries and fed funds at the .25 percent mark, how can shares be priced at upward of 1 percent, or even more; and how can money markets pay greater than the overpriced shares? Ultra-conservative pricing should be the mode, even if it results in a slowing of asset growth. The worst-case scenario results in some temporary asset shrinking, but a retention of a viable capital ratio.

Along with the lowering of liability pricing should come a maintaining of loan rates at mid-2008 levels, and a willingness to raise rates at any opportunity. While this may not sound like the "Credit Union Way," the recommendation isn't being made to increase spread and capture windfall profits (although maintaining a viable spread is necessary). It is being made due to the fact that once the current economic wounds have healed, inflation will be bombarding us like a barrage of cruise missiles. Leadership does not want to be two years into a large volume of five-, six-, and even seven-year consumer loans at a rock-bottom rate when this inflation comes thundering through. Does anyone remember the rates during the very early 1980s and the number of thrifts that failed as a result?

Is it a guess that inflation will hit, and hit hard? Not at all! The government is now printing money to provide for bailouts and stimuli to attack the current economic ills. Basic economics tells us that, no matter how wise or needed such action may, or may not, be in the near term, the result will be inflation once the economy begins to recover; and the amount of money being "created" assures tremendous inflationary pressures.

There is also the release of pent-up buying that occurs once consumer confidence (another measure that is at an all-time low) returns. After holding on to older vehicles and missing out on updated technology in consumer products, our general materialism will spur a recession-weary public to spend, spend, spend!

At the same time credit unions are keeping a close watch on interest rates, they must control operational costs. Consider whether all your organization's processes and procedures are up-to-date and efficient, and whether staff is performing up to the level called for by such demanding times. For example: How many credit unions would find that implementing Check 21-based clearings for deposits would quickly pay for itself, and soon begin to be an expense reduction? Many more than the number that have already initiated the process, that is for sure.

Another challenge is the loss of revenue due to fewer loans, more delinquencies and write-offs, and lower overall return on investments. While paying special attention to asset/liability issues should help to prevent such losses from being as bad as they could be, consider ways your lending policies could help to slow the growth of delinquencies, and review product pricing and sales penetration. You might be surprised at what you find! I entered a credit union that had an ancillary loan product line—credit life, disability, warranties, etc.—with sales penetration of around 20 percent. They were able to raise penetration to over 70 percent while lowering incentive costs.

There remain credit unions that do not charge late fees and/or still provide credit union paid life insurance on share accounts (and even on unpaid loan balances). Can the cost of these products continue to be borne by the organization in today's environment? There are many other potential product pricing issues within the industry, as well—any of which could be viable revenue sources. Tough decisions must be made with the benefit of the credit union as a whole outweighing the benefit to the individual member.

While there are a myriad of additional challenges and issues that should, and even must, be dealt with as a result of the economic times we are experiencing, I believe the three discussed here are key:

• a variable budget/plan under which asset/liability pricing is finitely managed;
• refinement in operational costs (process, procedure and staffing efficiencies) and
• improved sales penetrations and product offerings.

I believe, as well, that the recommended responses to each challenge have strong potential to help CU leaders fulfill their two key goals: serving members' financial needs while staying solvent.

Dennis Gibson, CSE, a former CUES member, is senior vice president of The Sequoyah Corp., Glen Mills, Pa., and Gladstone, Mo.

Read more about ALM strategies in our archive and in ALM Spelled Out—Second Edition.

 

CU HARP: Will it Play?

By Mary Arnold

Since I left this comment on Friday about the Member Mortgage Relief Initiative, which a group of credit unions proposed to NCUA, the agency looks like it is serious about backing it. In a press release yesterday, "NCUA unveiled a new initiative aimed at assisting credit union members who are experiencing mortgage-related financial difficulties to preserve their homeownership.

"The Credit Union Homeowners Affordability Relief Program (CU HARP) would enable NCUA, through the Central Liquidity Facility, to work with credit unions and their members in temporarily lowering monthly mortgage payments. The CLF would provide credit unions with funds borrowed from the Department of Treasury at lower rates than otherwise available through private sources. In turn credit unions would pass the entire rate reduction to struggling low- and moderate-income borrowers. The credit union, in exchange for the reduced likelihood of borrower default on the mortgage, would also match the rate break, doubling the benefit to struggling homeowners." 

“My principal reason for advancing CU HARP is simple: The consumer must not be left out of the broader government efforts to mitigate the housing and credit market dislocations,” stated Chairman Fryzel. “CU HARP is an effort to foster a solution whereby the NCUA and credit unions work together to assist distressed borrowers.  It represents what I believe to be an innovative and practical use of federal homeowner assistance that will also benefit credit unions and the market. At the same time, the standards and requirements for CU HARP participation will be stringent and will enable NCUA to be responsible stewards of any public funds used. CU HARP will be a ‘win-win’ for all involved.”

As part of that win-win, the plan involves no spending of taxpayer dollars, something CUs can continue to feel good about. "CLF loans are made to credit unions on a fully-secured basis, and all advances received by the CLF will be repaid to the Federal Financing Bank (an arm of Treasury) with interest," the release explains.

NCUA's announcement comes on the heels of last week's change to the bailout plan, which eliminated CUs' possible use of TARP funding. Though, theoretically, being eligible for TARP placed credit unions on "equal footing" with the rest of the financial industry, most credit unions are already on higher ground, thank you very much, and eager to help their members--not to obtain taxpayer assistance.

To go forward, CU HARP must be approved by the NCUA Board, as well as the Treasury Department and the Board of Governors of the Federal Reserve, according to NCUA's release.

Initial funding would be $2 billion. What do you think? Does this have legs?

Mary Arnold is VP/publications for CUES.