Corporate Comment Letters Debate Who Is to Blame and Who Will Survive
NCUA officials have repeatedly said they want credit unions to determine the future structure of the corporate system. And while Part 704 comment letters posted on the regulator's Web site consistently disapprove of several provisions, they show little consensus among corporates regarding the cause of the corporate crisis and which of them will survive.
The division is a matter of perspective.
In one camp, large corporates that have suffered substantial capital losses and national organizations like CUNA say the corporate business model is broken, and the system requires massive consolidation.
CUNA's comment letter, submitted on March 9, states that some corporates do not need to change their business models. However, President/CEO Dan Mica wrote that many corporates subsidized their pricing structures with earnings from investments and rely upon investments to provide value to members.
"To achieve sufficient investment yields to subsidize the other services, corporates had to take on excessive amounts of cash-flow mismatching and credit risk," Mica wrote.
Under proposed rules, which limit investments, CUNA's said that corporates will have to introduce efficiencies, which will force consolidation and likely raise the costs. "The apparent low cost of services in the past is now called into question by the over $9 billion credit unions are paying for the shortcomings of the old model," he said.
Members United Corporate Federal Credit Union agreed with Mica, acknowledging proposed regulations will force corporates to improve efficiencies and inevitably consolidate and went as far as proposing just one corporate with field offices. President/CEO Joseph Herbst called the problem "overcapacity."
Corporate system operating expenses run around $400 million per year, Herbst wrote. Reducing redundancies could shave at least 20% from operating expenses, worth $80 million.
Herbst broke corporates into three groups: large corporates that provide a full menu of proprietary products and services, smaller corporates that offer U.S. Central Federal Credit Union products to members and U.S. Central itself. Large corporates and U.S. Central face a long road of recapitalization ahead, and in addition, won't be able to continue with business as usual under new rules, he said. Smaller corporates have not suffered as many losses and are in a better capital position. But, without the support of U.S. Central, the so-called pass-through corporates "lack the infrastructure to be able to offer the requisite price performance or product breadth." As such, the corporate business model in most forms is no longer viable, Herbst concluded.
Brad Miller, who took over as Southeast Corporate Federal Credit Union's president/CEO in February, took a softer position on consolidation. Miller had a bird's eye view of the system during the crisis, serving as executive director of the Association of Corporate Credit Union before joining Southeast Corporate.
"By reflecting back on the history of the corporate system and applying lessons learned to the future, cooperation and collaboration were at the core of what we did well, and these basics can once again power us forward in adapting to a new business model in serving credit unions," Miller told Credit Union Times.
Not so fast, counter small corporates.
Melissa Ashley, chief financial officer at Corporate One Federal Credit Union, said credit unions face revenue challenges every day, like attacks on natural person credit union interchange income and courtesy pay.
"The world evolves and you have to adapt," she told Credit Union Times. "Corporates are not exempt from this concept and must act accordingly."
However, she also said Corporate One has a "strong business model" that will "continue to provide value to credit unions." The $3.3 billion institution has the expertise to effectively manage liquidity and investments to create valuable products for members and also maintains a "best-in-class brokerage operation."
Ashley said the NCUA should focus on improving regulatory provisions that have been criticized in comment letters. Specifically, she suggested the NCUA consider differentiating between asset types in proposed risk-modeling requirements, placing a higher percentage of weight on riskier assets and recognizing the importance of diversification.
Asset diversity allowed Corporate One to maintain liquidity by pledging available asset classes as collateral when others were out of favor, she said. The NCUA's proposed shock testing treats all assets the same when in fact, various asset classes react quite differently to market conditions.
Like many corporates, Corporate One's comment letter calls out the NCUA for mistakes in its modeling, like an underestimation of the risks of private student loans. However, Ashley also applauded the effort, saying the NCUA "opened the door for excellent dialogue" when it included a sample portfolio in proposed regulation and has received sound feedback as a result.
"We believe that with a few adjustments to the modeling requirements, a sufficient net interest margin can be achieved," she said. Further qualifying her position, Ashley added that a corporate must already be efficient enough to cover the majority of its expenses with fee income.
The $845 million Eastern Corporate Federal Credit Union acknowledged that its relationship with U.S. Central is an "Achilles heel." However, President/CEO Jane Melchionda wrote in her comment letter that she questioned U.S. Central's growth and investment strategies on numerous occasions and later learned the top tier corporate was granted several regulatory waivers by the NCUA to "operate without the customary level of oversight."
When EasCorp learned of the waivers, it began to withdraw its capital but was prevented from doing so as alleged in Corporate Central Federal Credit Union's lawsuit against the Kansas City corporate.
"We are mindful of management's responsibilities for establishing prudent policies and practices," Melchionda wrote. "However, we also believe that supervision is a critical 'third leg of the stool,' and we respectfully ask NCUA to consider how its supervisory controls may be improved."
First Empire Securities' Charlie Felker also criticized the NCUA's hand in the corporate mess. Felker said he hosted approximately 300 credit union executives in a Webinar a few days before the NCUA's March 9 comment deadline, and participants expressed doubts the NCUA could effectively prevent corporate losses in the future.
"NCUA's perception as a regulator has suffered," Felker said. "There's a feeling among credit unions that they didn't get the job done." He added that the NCUA's refusal to conduct an investigation into regulatory failures at U.S. Central, WesCorp and other corporates is fueling the fire.
"Credit unions are writing off capital, paying large assessments, and they deserve an answer," he continued. "There's a growing mood that NCUA's inspector general should be looking into this. It's not going away; credit unions are still asking that question."
Iowa Corporate Federal Credit Union President/CEO Sara Flynn also questioned whether corporate problems were a matter of business model or strategy, writing in her comment letter, "As a conservatively run corporate credit union, our members have no incurred losses related to the recent financial crisis. This is a result of our business decisions and not the permissible activities under current regulation." Excessive regulation as proposed is not the answer, she said.
Regardless of business model or capital position, all corporates are singing off the same song sheet when it comes to the need to relax proposed regulations. It was the one message corporates spoke in unison: without modifications to proposed rules, corporates won't earn enough revenue to provide value to members.
"Credit risk is not something we are interested in pursuing," wrote First Carolina Corporate Credit Union President/CEO David Brehmer. "That leaves the need for some flexibility in managing liquidity risks to provide a corporate with the ability to buy floating-rate investments to generate necessary earnings."
Specifically, the $1.7 billion corporate disagreed with a proposed two-year weighted average life limit on investments.
"A corporate's cash balances are extremely cyclical and can fluctuate significantly to stay within the two-year target given the other restrictions within the proposed regulation," Brehmer wrote. Requiring the sale of assets to keep WAL below two-years during seasonal periods of low deposits could affect a corporate's earning capacity, he explained.
Instead, he suggested the NCUA base WAL portfolio limits on 12-month average assets, which would take into account seasonal inflows and outflows.
The need for a plan for isolating toxic assets from corporates in need of recapitalization was another common request in Part 704 comment letters.
NAFCU President/CEO Fred Becker said he thinks the NCUA is "trying something similar" to the FDIC as it attempts to deal with the legacy asset issue. On March 5, the FDIC sold $1.8 billion worth of corporate debt backed by mortgage-backed securities previously owned by failed banks. While the sale doesn't absolve FDIC's responsibility for future losses, it does put the regulator in a better cash position and separates the assets from individual institution balance sheets.
Becker said his main concern over a similar plan for credit unions would be the cost of offering toxic securities at a mark-to-market price and how that might increase the size of future corporate assessments.
"That is the real concern for the industry," Becker said. "Credit unions are already paying 25 to 40 basis points. How much more, if any, will they have to pay?"
The trade association leader said he wasn't concerned about the FDIC's private issuance of the notes, which conceals who bought the debt, saying the FDIC chose private issuance to reduce the costs.