High Hurdles to Dump Legacy Assets
Federal accounting rules, deteriorating securities and an increasing corporate bailout price tag are hurdles the NCUA will have to overcome in its quest to rid corporates of toxic investments.
Banking regulators didn't face these challenges when they issued $1.8 billion in securities March 5, and according to those familiar with both Wall Street and credit unions, they are preventing the NCUA from simply adopting the same structure as the FDIC.
The FDIC's revenue-generating bonds are backed by mortgage-backed securities it inherited from seven failed banks. The proceeds will be used to pay creditors, including the FDIC's share insurance fund.
"There must be different accounting requirements for the NCUA, or else they would have just followed the FDIC model and been done with it," said Scott Waite, Patelco Credit Union's chief financial officer, who serves on a FASB Advisory Board and provides GAAP accounting advice to CUNA and other industry organizations.
Waite said the NCUA has not asked his opinion on how the plan meets GAAP accounting rules, but said he's confident the agency has the right people involved and is as anxious as anyone else to see the structure.
He said he has heard the NCUA is subject to federal accounting rules in addition to GAAP accounting requirements.
"It might be rooted in the difference between for-profit and nonprofit balance sheets," Waite said. He explained that credit unions investments are generally excess deposits-funds they are unable to lend to members-so they invest them to draw a return.
"The thinking is that these investments are an extension of members' money or public funds, and therefore subject to a different fiduciary responsibility," he said.
First Empire Securities' Charlie Felker, a former NCUA investment officer, said he thinks the NCUA's legacy assets plan will be similar in structure to the FDIC's issuance but cautioned that will likely mean an increase in the total cost of the corporate bailout.
"In order to attract investors, NCUA will either have to provide a guarantee to make up the difference for underperforming assets or sell them at a deep discount or a combination of the two," Felker said.
Neither the NCUA nor trade organizations want to accept federal bailout funds, he said, so the full cost of the corporate restoration plan will be paid by the industry.
"Anyway you cut it, credit unions should understand they will be picking up the tab. This isn't a way out," he said. "Yes, it's a way to get the junk out of the corporates' trunks, but credit unions will still pony up ultimately."
D. Henry Blevins, managing director at Little Rock, Ark.-based investment bank Crews & Associates, said the deteriorating values of corporate assets suggest the legacy assets plan will cost more than the $9.5 billion credit unions are already paying for through assessments.
"Things are going from bad to worse," he said. "I have never seen a mixed up hybrid of unlike securities pooled together and sold. Who would buy it? The discount would have to be huge to attract a bid."
The FDIC notes were issued in two series. Tranche 1A totaled $1.33 billion, overcollateralized by 56.51%. Tranche 2A was an issuance of $480 million that was 11.97% overcollateralized. Both series were guaranteed by the U.S. government, the first time in the FDIC's history, according to the agency.
NCUA Chairman Debbie Matz has said corporate legacy assets are valued at approximately $50 billion, much larger than the FDIC's offering or the $1.5 billion in notes WesCorp issued last October.
Felker said the NCUA may package securities that are paying as promised along with the nonperforming ones, which would attract buyers and completely remove or substantially reduce undesired asset groups from corporate balance sheets in anticipation of new corporate regulations.
Blevins said he thinks NCUA will not package legacy assets into a single sale. Rather, various bidders will purchase individual CDOs in an event of default sale, which he said happens weekly in today's market.
"What is important to understand during these EOD sales is that the buyer must pay a low enough price to offset the risk he is taking on," he said.
The FDIC retains an equity interest in its notes, and the proceeds will eventually be used to pay the failed banks' creditors, including the banking regulator's deposit insurance fund.
If the NCUA follows a similar structure, gains above estimated losses would flow back to the NCUSIF but not back to credit unions. The NCUA has said it is attempting to craft a plan that would allow credit unions to benefit from unforeseen gains.
However, Blevins called that a moot point.
"Let's be perfectly clear. We are talking about toxic waste. It's only value is for a toxic waste hauler," he said.
CEOs who suggest there will be gains from bad corporate investments are "experiencing corporate Kool-Aid withdrawal," he said.
Blevins said his 50-plus credit union clients are asking how much more they will be asked to pay to ensure the financial stability of corporate assets. He said he's heard credit union boards and executives worry aloud that rising costs of corporate stabilization will prompt "the end of the current credit union era as we know it."
As of Dec. 31, U.S. Central FCU's securities portfolio was worth nearly $20 billion; Western Corporate FCU's securities were worth $11 billion; Members United Corporate FCU's securities were worth $3.6 billion, and Southwest Corporate FCU's securities had a value of $2.6 billion. Losses due to regulator action against monoline insurer Ambac have not yet been recorded by all corporates and are not included in those values. Additionally, Members United has not yet reported fourth-quarter 2009 investment losses.
The NCUA has stated it is trying to devise a plan that would avoid accounting entries that could increase costs to credit unions, attempting to effectively separate assets from corporates without recording an official liquidation or sale. Waite said it would take "a magical solution" to accomplish that task.
Felker speculated one possible approach would be instead of acquiring the assets, the NCUA would securitize and pass them directly from corporates to an investment bank, where they would be sold at a discount or with an NCUA guarantee.
"That way, NCUA is only on the hook for the discount and guarantee, not the entire amount," Felker said.
A $50 billion liability entry on NCUSIF books would result in insolvency, he said.
"They have to find some way to treat this as a true sale yet not have a liability end up on books of the insurance fund," he said. "It's conjecture on my part, but that would seem to be the goal."