Looking at the Present With an Eye on the Past
In 1997, the Treasury Department performed a study aimed at improving credit unions. Many things have changed since the time of that report. For example, credit unions were required by law at Treasury's recommendation to adopt a formal system of prompt corrective action, even though an informal policy similar to PCA was in place. I recall Dennis Dollar, who was then serving on the NCUA Board, justifying the change as something thrust upon the NCUA to enforce.
Prior to the NCUA implementing PCA in 2001, credit unions' aggregate net worth ratio was already 11.43% (as of Dec. 31, 2000), and the average net worth ratio according to the letter was 13.9%. Over 97% of credit unions had assets in excess of 7%. Today, 96% of federally insured credit unions qualify as well-capitalized. As of Sept. 30, 2008, 12 credit unions had less than 2% capital and that climbed to 21 as of June 30, 2009. Credit unions with capital levels between 2% and 4% grew from 15 to 20, while credit unions with 4% to 6% (undercapitalized) nearly doubled from 46 to 81 in that time frame.
According to the Treasury in 1997, PCA should minimize "and, if possible, avoid" losses incurred by the NCUSIF. Obviously, the fund has limited resources but to act in such a way never to have a loss is clearly not possible in the financial services industry, especially now when there are fewer and fewer credit unions willing or able to take on problem institutions.
Treasury also identified conflicts in mission for the NCUA as regulator and insurer. First, regulators tend to identify with the institutions they regulate, which might cause the agency to overlook certain problems or at least not take immediate action. Second, short-term gains may exist for regulatory forbearance, such as staving off criticism and blame. "Forbearance, on the other hand, is inconspicuous and defers unpleasant consequences and is therefore less likely to draw criticism. Thus forbearance, although against the interests of the deposit insurance fund, may well serve the supervisor's self-interest." Treasury said PCA would help alleviate interference between a regulator supporting the industry and its responsibilities to the insurance fund.
Forbearance almost always is more expensive to the fund than dealing with the situation immediately, according to Treasury. At the last NCUA Board meeting in April, the agency extended its waiver on corporate capital so they can continue using the Nov. 30, 2008 capital levels and delegates authority to the corporate credit union office director to modify or restrict the waiver. This waiver was granted to ensure continued service to credit unions by the corporates.
Additionally, the NCUA Chief Financial Officer Mary Ann Woodson presented on the state of the insurance fund. The fund's reserve balance was $726.7 million as of March 31. The equity ratio was 1.26%. Eight federally insured credit unions have failed this year at a cost of $12 million. And there were 349 problem credit unions, up 12 from the previous month, which accounted for 5.35% of assets. The agency highlighted that 81.49% of assets were in CAMEL 1 and 2 credit unions and 13.16% were in CAMEL 3s. The agency also added $1 billion to the corporate stabilization fund based on increasing estimated corporate losses.
The Treasury report foresaw the possibility of the situation credit unions find themselves in today. It stated, "Experience indicates some correlation between federally insured depository institutions rapidly expanding their asset size and product offerings, and subsequent problems. Some institutions grew too rapidly to understand or properly manage the risks they were undertaking. Such problems played a significant role in the thrift debacle. The NCUA should be mindful of how to limit any increased risk to the share insurance fund posed by rapid growth in credit unions' asset size or product offerings."
The report also devoted an entire chapter to the corporate credit unions, in which it said, Cap Corp's failure resulted from "inadequate board oversight of an inappropriate investment strategy." The report stated that the NCUA's examination and supervision were inadequate; call report data were too limited and inaccurate; and capital standards were not appropriate for the risk. The report implied that corporates merely reviewed investment ratings given by the rating agencies and corporate management did not understand the investments in their portfolios.
Treasury also said that if U.S. Central were to fail, member corporates would face losses, and if the corporates faced losses, so would the natural person credit unions. The interdependence raised questions about sufficient net worth and limited ability to provide liquidity. It also notes that "viable market alternatives exist" though smaller credit unions have fewer options. Large credit unions make the corporates economical, the report noted, but they also have many other options to choose from. These options allowed larger credit unions to push the corporates for greater returns or risk losing their deposits.
The NCUA issued updated corporate credit union regs in 1997 that set concentration limits on a corporate's investments in an issuer, but the rule did not limit concentration by asset class. A subsequent rewrite in the early 2000s overlooked the concentration risk issue as well, a contributor to the failures of U.S. Central and WesCorp. However, just because something is not forbidden does not make it a good idea. And, just because something isn't written in stone (regulation) doesn't mean it should be ignored in exams.
Much of the corporate chapter of the report could have been written in the last couple of years rather than in 1997.
It's also notable that in 1997, only 15 of the 41 corporates had federal charters. But, as the regulations were eased over time, nearly all the corporates moved to the federal charter. It would take a lot of incentive to produce such a swing.
As credit unions have painfully experienced, corporate capital is their capital. Next in line is the NCUSIF, which also is credit unions' capital. The structure of the NCUSIF "in effect, gives the share insurance fund a claim on the entire net worth of all insured credit unions," Treasury pointed out. The NCUA was even forced last year to pull the CLF money from U.S. Central due to accounting issues. Treasury noted this interconnectedness and said that it provides incentive for credit unions to keep an eye out for each other.
The NCUA has fixed many of the concerns listed in the Treasury's report, including maintaining a 1% available assets ratio and using the latest call report information in calculating reserves. One of the key recommendations was to create more opportunity for public comment via rulemaking rather than a more informal approach. The agency has moved in this direction but over the last few years, its enforcement has been less public. However, I expect public enforcement actions to pick up, not only because more will be needed but also the agency will be less willing to keep some out of the public eye. The NCUA cannot afford to be perceived as not doing enough to help carry the credit union industry through the current economic crisis.
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