o Legacy assets will be pooled and place into a trust for securitization. The investments will be structured to match estimated incoming cash flow from legacy assets.
o Credit unions will be permitted to purchase the securities. This will not present a systemic risk to the industry, nor a credit risk for investing credit unions.
o Corporates that own legacy assets but were not seized by NCUA will be expected to remove them from their balance sheets, but can hold them to maturity if they successfully prove that this is the least costly resolution for members.
o U.S. Treasury approved an extension through 2021 for the corporate stabilization fund and repayment. However, assessments are expected to rise in 2011 and 2012 before falling for the remaining nine years.
After months of speculation, the NCUA revealed on Sept. 24 a "good bank, bad bank" plan to deal with corporate legacy assets. In short, the NCUA will pool distressed investments from five seized corporate credit unions and issue securities against the collateral.
The "good banks" are the bridge chartered corporates, which now hold nonlegacy assets.
These bridge corporates will be active for two years while members decide whether they want to buy them back from the NCUA and recapitalize them or not. The "bad banks" are the old, inactive corporate charters where the legacy assets reside.
Inactive bad bank corporate charters and the legacy assets attached to them will be placed into a trust and transferred to NCUA's Asset Management and Assistance Center in Austin, Texas for management. The trust structure should allow the NCUA to securitize the bonds without having to realize part or all of so-called unrealized losses, which would result in an immediate and severe write-down of legacy assets.
The trust structure will also provide greater transparency, said NCUA Deputy Executive Director Larry Fazio.
"It will be on autopilot, out of our hands," he said.
Because the bonds will be offered to all eligible investors, prospectus documents and other disclosures will be available in the public domain and will reveal facts on all underlying collateral, including current performance.
Credit unions that wish to compare the performance of legacy assets to actual losses charged to credit unions through assessments will be able to track it, he added.
The $50 billion price tag represents unpaid principal and interest outstanding on the investments, rather than original purchase price or current market value, Fazio said.
The NCUA has estimated that credit losses on the underlying bonds will range from $14 billion to $16 billion, and will serve as the investments' "overcollateralization." The net difference between $50 billion in outstanding principal and estimated credit losses will determine the market value of the reissued bonds, approximately $35 billion.
According to Fazio, the securities will be guaranteed by the NCUA, and the investments will be carefully structured so that incoming cash flow will service outgoing payments to investors. Approximately 70% of the securities will have floating rates tied to Libor, which matches terms on the underlying securities owned by credit unions, guaranteeing an orderly cash flow. The remaining 30% will have fixed rates.
"We're not expecting to ever have to make a guarantee payment," he said. The NCUA consulted with the Federal Reserve Bank, U.S. Treasury and bonds experts to estimate future performance, and Fazio said the agency is very confident in its figures. However, should the bonds perform worse than estimated, credit unions would have to fund the shortfall to fund investment payments.
On the flip side, should the bonds perform better than estimated, any windfalls would be transferred to the NCUSIF to ease corporate stabilization assessments, rather than go to new investors.
"We continue to own the upside and downside," he said.
Members of seized corporates will be issued claims against future gains, and can potentially recover lost capital. However, gains must first repay senior positions, Fazio said, which includes the share insurance fund and assessments charged to federally insured credit unions so far and in the future. Fazio said it would be unlikely that the claims would ever result in recoveries, but the legal framework is there nonetheless.
Credit unions will be allowed to purchase the securitized legacy assets. The investments will be made available to "eligible investors," Fazio said, which includes "just about anybody."
The NCUA will neither encourage nor discourage credit unions from buying the bonds. Credit unions won't create any systemic risk investing in the bonds, although it does create an unusual hedge situation in which credit unions both draw revenue from legacy assets while paying for losses through assessments.
Because the bonds are guaranteed, there won't be any credit risk for investing credit unions. However, Fazio said credit unions who purchase the investments would need to manage potential interest rate and liquidity risk.
The instruments will have an average weighted life of four to five years, and all will have "hard finals" of 10 years or less.
U.S. Central FCU's brokerage CUSO, CU Investment Solutions Inc., has been selected to provide access to the bond auctions for interested credit unions and to answer questions about the investments.
"We wanted to make sure credit unions weren't crowded out, so we made these arrangements to make sure that's not the case," Fazio said.
Corporates that own legacy assets but weren't seized by NCUA, which include the $3 billion Southeast Corporate FCU, the $2.5 billion Systems United Corporate FCU, the $3.2 billion Corporate One FCU and others, were not included in the legacy assets plan.
Toxic assets from the five seized corporates address more than 90% of all legacy assets, and 98% of losses to the industry, Fazio said.
Even under very pessimistic scenarios, corporates with legacy assets left untouched by the NCUA aren't expected to experience additional losses that would deplete member contributed capital.
"They should be able to weather the storm and raise more capital," Fazio said. "They should be fine."
Brad Miller, President/CEO of Southeast Corporate, praised the NCUA for the decision. He said the regulator's labeling of his Tallahassee, Fla.-based institution as "viable" is encouraging, and allows the corporate to move forward with plans for a new business model that will continue to provide value to members.
Generally, the NCUA wants corporates to sell legacy assets as soon as possible to come into compliance with the corporate rule, Fazio said. However, if a corporate decides an alternative approach to selling the legacy assets is sound and supportable, the corporate may submit a draft investment action plan to NCUA for its approval.
For example, the NCUA will consider an action plan that includes retention of legacy assets while they amortize, provided the corporate can document that the expected future credit losses are significantly less than the losses the corporate would take if the investments were sold at current market prices.
Depending on the circumstances, an NCUA-approved action plan might permit the corporate to operate temporarily outside the rules. In addition, the NCUA might grant corporates a waiver of time to build the retained earnings required by this regulation, but only to the extent stipulated in the approved action plan.
Industry consultant Marvin Umholtz, who had been critical of the NCUA's delay in releasing the legacy assets plan, called the resolution "prudent and responsible."
"They have bent over backwards to share their rationale," he said.
He praised the regulator for tapping the U.S. Treasury, Federal Reserve, other financial institution regulators and bond specialists for advice and assistance in formulating the resolution, saying to have done it alone would have been foolhardy.
"It is vitally important to the resolution plan's success that the Treasury walk arm-in-arm with the NCUA board," he said.
Umholtz said he submitted a question during the NCUA's virtual town hall that was not answered regarding the Treasury's influence on NCUA board policy decisions and staff implementation of the resolution plan moving forward.
"I believe that an honest answer would be that Treasury is right there in the NCUA board's face-but until [NCUA Chairman Debbie] Matz owns up to it, we can only guess," he said.
"A number of my non-credit union Washington beltway sources are already speculating about the NCUSIF and TCCUSF being taken over by the FDIC to manage at the insistence of Treasury. The 112th Congress could be the beginning of that process," he added.
Treasury Secretary Timothy Geithner was involved in the resolution, specifically approving an extension of the Temporary Corporate Credit Union Stabilization Fund to June 30, 2021, which provides the NCUA board flexibility in mitigating the impact of the annual assessments. The option to extend the fund repayment to 2021 was written into the original framework.
Spreading out the repayment period further allows NCUA to synchronize assessments with actual losses, Fazio said. So far, NCUA has assessed $1.3 billion in corporate assessments, and actual losses to date total $1.1 billion. NCUA does not want to publish a schedule of assessments for credit unions, he said, because they would be obligated to write them off immediately to satisfy GAAP accounting.
However, NCUA will have to deal with some cash management issues in the short run. Because previously issued corporate debt from WesCorp and U.S. Central comes due in 2012, and actual losses on shorter terms and most problematic securities will peak over the next couple of years, assessments will rise in 2011 and 2012 before decreasing, Fazio said.
"Spreading out the costs until June 30, 2021 does provide the NCUA board with flexibility, but the notion that there is a decade of pain ahead is difficult to stomach," Umholtz said.
Umholtz also minced no words in response to the industry's disappointment in mainstream media coverage that referred to NCUA's resolution as a bailout.
"Without the extraordinary government intervention and stabilization funding, the industry would have experienced a disaster of huge proportions," he said. "The public perception that it is a bailout makes it one."