NCUA’s Voluntary Prepayment

The new request presents an opportunity for a vote of confidence on NCUA’s management of the corporate stabilization process.

 
 

NCUA’s proposal asking credit unions to prepay assessments to cover cash shortfalls in its management of the legacy assets taken from corporates represents a unique opportunity for credit unions. By supporting the request and forwarding up to $3 billion, or 38 basis points of future premiums, credit unions can show their confidence in the Agency’s management of the corporate situation. If the minimum amount of $300 million is not raised, the result would indicate the opposite in NCUA’s handling of the corporate stabilization.

Why is there a cash shortfall?
In both written and public explanations, NCUA spokespersons say the need for cash is not because any loss estimates have changed. The loss estimate in the audited statement published in July 2010 for the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) was $6.4 billion.  

The cash shortfall has occurred because NCUA has been unable to manage the most basic of ALM tasks, which is matching assets with liabilities. In September, NCUA nationalized three additional corporates and then stripped the five corporates under their control of $50-$60 billion of their highest yielding investments, the so-called legacy assets. Some $10 billion of these assets were sold outright, even though that sale locked in losses that should have been recovered over the economic lives of these securities. 

The additional assets taken were to be funded by NCUA’s guaranteed note program. The problem is that assets taken and funding provided do not match. Wall Street requires over-collateralization so that each dollar of funding requires $1.10 to $1.30 of assets at book value. Having sold or already pledged all of the assets, NCUA has no more earning assets to borrow against, so it must ask credit unions to help out by covering its cash shortfall as its funding liabilities come due.

Corporates Managed the Funding Match
As long as these assets were managed by individual corporates, the problem did not exist. Each corporate managed its own ALM matching. Additionally, the spread between the cost of funds and investment yields helped the corporate system record the most successful year ever in 2010 — until NCUA’s September takeover. 

The corporates did not have to over-collateralize their investments. Rather, corporates had set up loss reserves, called OTTI, to fund any projected investment defaults. This total of $12 billion in OTTI estimates appears to have overestimated future losses as securities had steadily recovered from their valuation low points. Moreover, realized cash defaults were a fraction of these total reserves. That is, the investments were still paying as required even though projected loss estimates had already been expensed.

Both the potential losses and the dollar-for-dollar funding for the investments had been provided by each corporate. The situation was not only under control, but corporates also reported monthly on their earnings, cash flow, and the value of the securities they held. The process was transparent; open and net income, even in the most severe cases such as WesCorp, was positive. The entire network had started to rebuild its retained earnings base.  

When NCUA seized the highest yielding assets from the corporates, it also had the funding responsibility but no balance sheet to use. NCUA spent $33 million on Wall Street advisors to implement the NGN funding, pool by pool. The program, which is barely six months old, now comes up cash short. By comparison, the corporate funding was in place, producing net income and providing full coverage for estimated losses.

In addition NCUA is reportedly charging 30 basis points to manage the liquidation estates set up for the NGN funding. This expense, paid from credit union pockets, in effect duplicates the corporate system and adds an additional expense tier.

NCUA’s Liquidity Options
The NCUA is not the FDIC. The FDIC assessed three years of prepaid premiums in the fall of 2009 because it was running out of cash. This precedent was referred to in NCUA’s description of its proposed program.  FDIC is strictly an insurance resolution fund with a financial structure financed only by premiums. There is no 1% deposit as in the NCUSIF. The FDIC’s balance sheet was increasingly filled with illiquid assets acquired from failed institutions and it was reporting a negative net worth of more than $21 billion.

NCUA has multiple sources of liquidity because credit unions created a unitary regulatory structure under the NCUA board (chartering, liquidity, and insurance), not a stand-alone insurance solution. The liquidity sources available today include:

  1. The TCCUSF, with borrowing authority of up to $30 billion. (S 896)
  2. The CLF, with no outstanding loans and borrowing authority of up to $41 billion.
  3. The NCUSIF, which has more than $10 billion invested in cash at the U.S. Treasury.

All of these funding sources would be at the lowest rate available in any market, which is the U.S. Treasury’s rate. These institutions were established just for this purpose. In the “old” corporate system, managing system liquidity needs was the role of U.S. Central with the corporates.  But that structure has been dismantled.  By appealing directly for credit union funding support, NCUA is in effect creating a shadow U.S. Central function.

The Need for Transparency and Disclosure
NCUA has proposed borrowing from credit unions through “voluntary” prepayments. However, there has been no financial information presented that would allow credit unions to understand or to evaluate the request.

There have been no financial statements that show the status or the cash flows from the NGN programs. There have been no disclosures of any of the costs or losses, or how the estates have been managed.

Between $50-60 billion in total assets were stripped from the corporate system. Some were sold outright. The assets now in liquidation estates, funded by NGNs, would have a current book value of at least $30 billion. This amount exceeds the combined balance sheets of all of NCUA’s other funds. But no numbers were presented, there were no discussions of costs or revenue, and most importantly, no cash flow projections from the investments have been shown.  

A  Tenfold Funding Range?
If a borrower makes a request with a tenfold range from the minimum to the maximum amount needed ($300 million to $3 billion are NCUA’s program parameters), one has to question the underlying financial projections being used. If $300 million is all that is raised, where does the $2.7 billion come from?  Why not get the $300 million there? 

When these assets were part of the corporate network, full financial disclosures and projections were reported monthly. Credit unions had completely funded corporate investments. Now there is nothing to monitor except NCUA requests for more cash. 

Credit unions have already supported funding of the corporate network on at least five different occasions. The first was their support for the increase in the CLF borrowing authority to $41.5 billion in September 2008. The most recent was the continuing commitment of total direct funding with share deposits of $94 billion, an amount equal to all corporate investments in the fall of 2010. 

The Confidence Opportunity
NCUA has warned that if credit unions don’t agree to the voluntary prepayment, then NCUA will be forced to assess higher premiums. Even though the cash outlay would be similar, credit unions would be forced to “expense” such a premium now but apparently not if a voluntary prepayment of the same dollars were sent. It should be noted that the GAAP accounting for voluntary prepayments is not clear.

A large upfront expense was exactly the situation that the May 2008 TCCUSF legislation was passed to avoid. Specifically, S 896 provided funding so that credit unions could spread the costs out over seven years. Now, NCUA is using the threat of a large expense to make up for its liquidity, not loss, shortfalls.

It is critical to distinguish cash flow requirements from losses. Premium assessments were designed to cover losses, which is the role of insurance. The role of insurance is not to fund liquidity requirements.   Liquidity needs were to be met from other resources authorized in the CLF and the TCCUSF.

Credit unions may choose to support the voluntary prepayment of assessments, but it should be clear that this has nothing to do with the corporate losses. NCUA said repeatedly those estimates have not changed.

NCUA’s September 2010 nationalization of the corporate system was characterized in the press as a government “bailout.” The credit union system objected to this term because no government funds were involved.  Ironically, this proposal is a bailout –but by credit unions of their regulator!

Instead of settling any uncertainty that may have existed in the corporates, NCUA has just created a whole new set of financial and funding issues  without any disclosures for support.  How many more financial surprises will follow this one?

 

 

 

 

June 6, 2011


Comments

 
 
 
  • While I am no fan of the NCUA's recent actions, I respectfully disagree with the assertions in the article. Firstly, by participating in the prefunding I do not think our credit union is showing confidence in the NCUA's handling of the corporate situation, but rather taking a step back to evaluate a proposal that may be beneficial to our industry at this point in time. Secondly, while the NCUA's handling of the corporate crisis is debatable, surely the demise of the corporates was not entirely the fault of the regulator. Nice read but more interested in positive approaches to new challenges.
    nm
     
     
     
  • I'm not advocating participation but thank you 'nm' for stepping up and saying something contrary to the nearly 2 dozen other commenters. While the NCUA has not done the industry justice of late, participation in the voluntary prepayments should be a business decision and not an emotional--dare I say kneejerk?--one. The agency should have come up with a prepayment program 2 years ago for starters. But I've spoken with several CEOs who've said their modeling shows the savings better than the lost opportunity. Additionally, the NCUA has said it needs 25 bp; the prepayment participation, now up to $500M, will save all credit unions 6.4bp this year in stabilization assessments. My understnading is the NCUA is still taking 25 bp if they don't reach the $500M.
    Sarah Snell Cooke
     
     
     
  • Chip,

    You always hit the nail on the head. NCUA creates more problems than they solve with poorly thought out knee-jerk reactions.
    CS
     
     
     
  • And people wonder why the "Tea Party" movement is growing... It is because proposals like this coming from our Government/NCUA!
    mad
     
     
     
  • NCUA did the same thing with the demise of Capital Corporate years ago. You would think they could learn from their own history. They have a Chicken Little attitude and we all would be a lot better off if they would not be so quick on the draw.
    TNT
     
     
     
  • NCUA cannot be ompared with the President and his sidekicks. The president inherited

    this financial situation.

    Funny, before his election,was there concern pertaining to the economy?
    Anonymous
     
     
     
  • Thanks for the additional insight into the prepayment option. The additional overhead to manage this program has not been made clear. It just seems like a big shell game with all the various funds. You are correct, the transparency is lacking in every way! I will not support this option.
    Russ
     
     
     
  • Chip ... keep up the good work. The management in NCUA appears to fit very well with the President and his sidekicks. Neither know what they are doing. Turn up the heat.
    Jim Williams
     
     
     
  • We should start using the term "gov-amony" because its startinig to feel a lot like alimony. You get nothing for the privelege of paying, again and again, and you don't even get to know what you are paying for.
    Gerald
     
     
     
  • Chip-Thanks for an informative piece - as mentioned a real "eye opener". I have run numerous scenarios to model opportunity costs lost, future assessment probabilities and corresponding net income impact. Of course, I'm assuming a raising rate environment (IRR must be addressed) and modeling deposit growth. The result is that we pay less now to pay more later - I don't trust them.
    CJA
     
     
     
  • Thank you for the excellent article, I was actually thinking about funding the pre-payment. Thanks again for opening my eyes!
    Anonymous
     
     
     
  • Thanks Chip for pulling the curtain back to reveal NCUA's bumbling shenanigans. NCUA's actions do fit in well with the current President's much touted regime of "tranparency". It is sad to see George Orwell prescient's descriptions of our own government and regulator.
    Tom
     
     
     
  • Great article. Through 2013, the NCUA has a cashflow problem due to poor ALM planning as you described and so they are asking CUs to take money out of the CU sytem that is earning 3.25% at the margin and send it to NCUA to temporarily invest in treasuries at 20bps! They just can't seem to make decisions that are in the best interest of the CU industry.
    BB
     
     
     
  • I truly wish "everyone" in our industry would read and become aware of these facts...especially everyone at NCUA.

    I hope you consider placing this on CU Times.
    Anonymous
     
     
     
  • Thanks, Chip - an excellent, well researched, and informative article. I've lost all confidence in NCUA management's ability to achieve the Agency's stated mission to "serve and maintaine a safe, secure credit union community." We need a champion now more than ever. Unfortunately, both CUNA and NAFCU seem to be unable to step into that role. It's good to know you're out there.

    Ben Mauldin
     
     
     
  • It is obvious that our regulator is broken, yet we are seemilgy powerless to find solutions because the NCUA Board is either ignoring or incapable of performing their ownership or leadership roles.

    Regardless, the lack of transparency, boardering on criminal negligence, is destroying the long-term viability of the entire system and we should not be bullied into enabling this death spiral.

    The entire credit union system should say no to this current attempt at extortion and demand accountabilty for the system that our members own, not that the regulator thinks they own.
    Anonymous
     
     
     
  • In their dog and pony show explaining the prepayment program, didn't NCUA say they were just responding to the requests of numerous Credit Unions (and our trade associations)? I don't remember asking for this "solution" to our "problem."

    Thank you, Mr. Filson, for your knowledgable analysis of the situation.

    After being hammered by examiners for years for ALM deficiencies, it is interesting to see the proverbial shoe on the other foot!
    Jim
     
     
     
  • I wonder what NCUA would rate themselves on the "L" of their CAMEL ratio? Or, what my examiner would say if I had a liquidity shortfall of similar proportions?
    Nadine
     
     
     
  • Technical Knock Out. Your head is spinning after you get punched, your dazed,confused, disoriented, and need to sit it out. The official calls the fight. This article is a TKO for the agency. They need to regroup, put on their creative cap and get this right. Liquidity abounds, at credit unions and at Corporates, use the massive liquidity pool to solve the problem.
    TKO
     
     
     
  • Chip this is a well thought out analysis. It describes a seious failure, which if at the CU level would raise red flags with examiners.

    Also, I do not think the NCUA can be ompared with the President and his "sidekicks". The president inherited the financial situation, which until his election no one cared about. It appears the NCUA caused their cash flow shortfall by not understanding ALM.

    Stu
    Stu
     
     
     
  • This sounds like GM's CEO Akerson pushing for a gas tax because GM can't provide a product people want to purchase; so they charge a "gas" premium to force Americans

    to purchase something they'd never purchase voluntarily. NCUA pushes a 30BP

    "management" premium on credit unions for "managing" a solution the credit unions never wanted. The result is an "invisible solution" we can't evaluate, nor would we endorse voluntarily. Like most government entities - the NCUA is self-serving and grossly incompetent.

    KG
     
     
     
  • As usual, the NCUA is out of touch just like the Obama administration.
    WVF
     
     
     
  • Chip, It is really amazing that there seems to be no accountability from NCUA and their massive bumbling decisions. They continually have used this philosophy of selling investments at their lowest prices and making all other pay the price for that decision. Will they ever get it together?
    Stephen Gessel
     
     
     
  • great article, frustrating to watch the NCUA in action these past few years.

    And, the Prez and his circle ought to step up and lead, instead of blaming the ones who came before - leadership 101.
    sd
     
     
     
  • Chip,

    You are right on the money with your commentary. The NCUA is in essence asking for a 0% interest loan because they messed up the sources of funds to pay for the so called 'toxic' legacy assets. The nationalized corporates kept the deposits funding those assets.

    I want to see a cash flow statement from the NCUA showing actual losses on the legacy bonds to date as well as the IPO expenses to place those bonds in to the trust fund and bring them to market. How much revenue was made by the sale of those bonds via the NGN notes and how much will the guarantee cost? What assumptions are going into the estimated losses of the bonds going forward? Why are they not tapping into the TCCUSF and the CLF as a funding source for the nationalized legacy assets?

    The bottom line is who is regulating the regulator? We would get hammered by our examiners if we made a $1mm 0% interest loan to any entity based on the scanty amount of information we are getting from the NCUA. Our credit union did not request a prepayment (i.e. loan) to the Stabilization fund. We will not support this request until their is much more financial transparency of the stabilization fund from the NCUA.

    Great article. Continue to shed the light on the truth of what is really going on at the NCUA regarding this topic.
    Bill