In 1997, the Treasury Department performed a study aimed atimproving credit unions. Many things have changed since the time ofthat report. For example, credit unions were required by law atTreasury's recommendation to adopt a formal system of promptcorrective action, even though an informal policy similar to PCAwas in place. I recall Dennis Dollar, who was then serving on theNCUA Board, justifying the change as something thrust upon the NCUAto 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% offederally insured credit unions qualify as well-capitalized. As ofSept. 30, 2008, 12 credit unions had less than 2% capital and thatclimbed to 21 as of June 30, 2009. Credit unions with capitallevels between 2% and 4% grew from 15 to 20, while credit unionswith 4% to 6% (undercapitalized) nearly doubled from 46 to 81 inthat time frame.

According to the Treasury in 1997, PCA should minimize “and, ifpossible, avoid” losses incurred by the NCUSIF. Obviously, the fundhas limited resources but to act in such a way never to have a lossis clearly not possible in the financial services industry,especially now when there are fewer and fewer credit unions willingor able to take on problem institutions.

Treasury also identified conflicts in mission for the NCUA asregulator and insurer. First, regulators tend to identify with theinstitutions they regulate, which might cause the agency tooverlook certain problems or at least not take immediate action.Second, short-term gains may exist for regulatory forbearance, suchas staving off criticism and blame. “Forbearance, on the otherhand, is inconspicuous and defers unpleasant consequences and istherefore less likely to draw criticism. Thus forbearance, althoughagainst the interests of the deposit insurance fund, may well servethe supervisor's self-interest.” Treasury said PCA would helpalleviate interference between a regulator supporting the industryand its responsibilities to the insurance fund.

Forbearance almost always is more expensive to the fund thandealing with the situation immediately, according to Treasury. Atthe last NCUA Board meeting in April, the agency extended itswaiver on corporate capital so they can continue using the Nov. 30,2008 capital levels and delegates authority to the corporate creditunion office director to modify or restrict the waiver. This waiverwas granted to ensure continued service to credit unions by thecorporates.

Additionally, the NCUA Chief Financial Officer Mary Ann Woodsonpresented on the state of the insurance fund. The fund's reservebalance was $726.7 million as of March 31. The equity ratio was1.26%. Eight federally insured credit unions have failed this yearat 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 2credit unions and 13.16% were in CAMEL 3s. The agency also added $1billion to the corporate stabilization fund based on increasingestimated corporate losses.

The Treasury report foresaw the possibility of the situationcredit unions find themselves in today. It stated, “Experienceindicates some correlation between federally insured depositoryinstitutions rapidly expanding their asset size and productofferings, and subsequent problems. Some institutions grew toorapidly to understand or properly manage the risks they wereundertaking. Such problems played a significant role in the thriftdebacle. The NCUA should be mindful of how to limit any increasedrisk to the share insurance fund posed by rapid growth in creditunions' asset size or product offerings.”

The report also devoted an entire chapter to the corporatecredit unions, in which it said, Cap Corp's failure resulted from“inadequate board oversight of an inappropriate investmentstrategy.” The report stated that the NCUA's examination andsupervision were inadequate; call report data were too limited andinaccurate; and capital standards were not appropriate for therisk. The report implied that corporates merely reviewed investmentratings given by the rating agencies and corporate management didnot understand the investments in their portfolios.

Treasury also said that if U.S. Central were to fail, membercorporates would face losses, and if the corporates faced losses,so would the natural person credit unions. The interdependenceraised questions about sufficient net worth and limited ability toprovide liquidity. It also notes that “viable market alternativesexist” though smaller credit unions have fewer options. Largecredit unions make the corporates economical, the report noted, butthey also have many other options to choose from. These optionsallowed larger credit unions to push the corporates for greaterreturns or risk losing their deposits.

The NCUA issued updated corporate credit union regs in 1997 thatset concentration limits on a corporate's investments in an issuer,but the rule did not limit concentration by asset class. Asubsequent rewrite in the early 2000s overlooked the concentrationrisk issue as well, a contributor to the failures of U.S. Centraland WesCorp. However, just because something is not forbidden doesnot make it a good idea. And, just because something isn't writtenin stone (regulation) doesn't mean it should be ignored inexams.

Much of the corporate chapter of the report could have beenwritten in the last couple of years rather than in 1997.

It's also notable that in 1997, only 15 of the 41 corporates hadfederal charters. But, as the regulations were eased over time,nearly all the corporates moved to the federal charter. It wouldtake a lot of incentive to produce such a swing.

As credit unions have painfully experienced, corporate capitalis their capital. Next in line is the NCUSIF, which also is creditunions' capital. The structure of the NCUSIF “in effect, gives theshare insurance fund a claim on the entire net worth of all insuredcredit unions,” Treasury pointed out. The NCUA was even forced lastyear to pull the CLF money from U.S. Central due to accountingissues. Treasury noted this interconnectedness and said that itprovides incentive for credit unions to keep an eye out for eachother.

The NCUA has fixed many of the concerns listed in the Treasury'sreport, including maintaining a 1% available assets ratio and usingthe latest call report information in calculating reserves. One ofthe key recommendations was to create more opportunity for publiccomment via rulemaking rather than a more informal approach. Theagency has moved in this direction but over the last few years, itsenforcement has been less public. However, I expect publicenforcement actions to pick up, not only because more will beneeded but also the agency will be less willing to keep some out ofthe public eye. The NCUA cannot afford to be perceived as not doingenough to help carry the credit union industry through the currenteconomic crisis.

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