o Legacy assets will be pooled and place into a trust forsecuritization. The investments will be structured to matchestimated 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 creditrisk for investing credit unions.

o Corporates that own legacy assets but were not seized by NCUAwill be expected to remove them from their balance sheets, but canhold them to maturity if they successfully prove that this is theleast costly resolution for members.

o U.S. Treasury approved an extension through 2021 for thecorporate stabilization fund and repayment. However, assessmentsare expected to rise in 2011 and 2012 before falling for theremaining nine years.

After months of speculation, the NCUA revealed on Sept. 24 a“good bank, bad bank” plan to deal with corporate legacy assets. Inshort, the NCUA will pool distressed investments from five seizedcorporate credit unions and issue securities against thecollateral.

The “good banks” are the bridge chartered corporates, which nowhold nonlegacy assets.

These bridge corporates will be active for two years whilemembers decide whether they want to buy them back from the NCUA andrecapitalize them or not. The “bad banks” are the old, inactivecorporate charters where the legacy assets reside.

Inactive bad bank corporate charters and the legacy assetsattached to them will be placed into a trust and transferred toNCUA's Asset Management and Assistance Center in Austin, Texas formanagement. The trust structure should allow the NCUA to securitizethe bonds without having to realize part or all of so-calledunrealized losses, which would result in an immediate and severewrite-down of legacy assets.

The trust structure will also provide greater transparency, saidNCUA 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 thepublic domain and will reveal facts on all underlying collateral,including current performance.

Credit unions that wish to compare the performance of legacyassets to actual losses charged to credit unions throughassessments will be able to track it, he added.

The $50 billion price tag represents unpaid principal andinterest outstanding on the investments, rather than originalpurchase price or current market value, Fazio said.

The NCUA has estimated that credit losses on the underlyingbonds will range from $14 billion to $16 billion, and will serve asthe investments' “overcollateralization.” The net differencebetween $50 billion in outstanding principal and estimated creditlosses will determine the market value of the reissued bonds,approximately $35 billion.

According to Fazio, the securities will be guaranteed by theNCUA, and the investments will be carefully structured so thatincoming cash flow will service outgoing payments to investors.Approximately 70% of the securities will have floating rates tiedto Libor, which matches terms on the underlying securities owned bycredit 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, andFazio said the agency is very confident in its figures. However,should the bonds perform worse than estimated, credit unions wouldhave to fund the shortfall to fund investment payments.

On the flip side, should the bonds perform better thanestimated, any windfalls would be transferred to the NCUSIF to easecorporate stabilization assessments, rather than go to newinvestors.

“We continue to own the upside and downside,” hesaid.

Members of seized corporates will be issued claims againstfuture gains, and can potentially recover lost capital. However,gains must first repay senior positions, Fazio said, which includesthe share insurance fund and assessments charged to federallyinsured credit unions so far and in the future. Fazio said it wouldbe unlikely that the claims would ever result in recoveries, butthe legal framework is there nonetheless.

Credit unions will be allowed to purchase the securitized legacyassets. The investments will be made available to “eligibleinvestors,” Fazio said, which includes “just about anybody.”

The NCUA will neither encourage nor discourage credit unionsfrom buying the bonds. Credit unions won't create any systemic riskinvesting in the bonds, although it does create an unusual hedgesituation in which credit unions both draw revenue from legacyassets while paying for losses through assessments.

Because the bonds are guaranteed, there won't be any credit riskfor investing credit unions. However, Fazio said credit unions whopurchase the investments would need to manage potential interestrate and liquidity risk.

The instruments will have an average weighted life of four tofive years, and all will have “hard finals” of 10 years orless.

U.S. Central FCU's brokerage CUSO, CU Investment Solutions Inc.,has been selected to provide access to the bond auctions forinterested credit unions and to answer questions about theinvestments.

“We wanted to make sure credit unions weren't crowded out, so wemade these arrangements to make sure that's not the case,” Faziosaid.

Corporates that own legacy assets but weren't seized by NCUA,which include the $3 billion Southeast Corporate FCU, the $2.5billion Systems United Corporate FCU, the $3.2 billion CorporateOne FCU and others, were not included in the legacy assetsplan.

Toxic assets from the five seized corporates address more than90% of all legacy assets, and 98% of losses to the industry, Faziosaid.

Even under very pessimistic scenarios, corporates with legacyassets left untouched by the NCUA aren't expected to experienceadditional losses that would deplete member contributedcapital.

“They should be able to weather the storm and raise morecapital,” Fazio said. “They should be fine.”

Brad Miller, President/CEO of Southeast Corporate, praised theNCUA for the decision. He said the regulator's labeling of hisTallahassee, Fla.-based institution as “viable” is encouraging, andallows the corporate to move forward with plans for a new businessmodel that will continue to provide value to members.

Generally, the NCUA wants corporates to sell legacy assets assoon as possible to come into compliance with the corporate rule,Fazio said. However, if a corporate decides an alternative approachto selling the legacy assets is sound and supportable, thecorporate may submit a draft investment action plan to NCUA for itsapproval.

For example, the NCUA will consider an action plan that includesretention of legacy assets while they amortize, provided thecorporate can document that the expected future credit losses aresignificantly less than the losses the corporate would take if theinvestments were sold at current market prices.

Depending on the circumstances, an NCUA-approved action planmight permit the corporate to operate temporarily outside therules. In addition, the NCUA might grant corporates a waiver oftime 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 theNCUA's delay in releasing the legacy assets plan, called theresolution “prudent and responsible.”

“They have bent over backwards to share their rationale,” hesaid.

He praised the regulator for tapping the U.S. Treasury, FederalReserve, other financial institution regulators and bondspecialists for advice and assistance in formulating theresolution, saying to have done it alone would have beenfoolhardy.

“It is vitally important to the resolution plan's success thatthe Treasury walk arm-in-arm with the NCUA board,” he said.

Umholtz said he submitted a question during the NCUA's virtualtown hall that was not answered regarding the Treasury's influenceon NCUA board policy decisions and staff implementation of theresolution plan moving forward.

“I believe that an honest answer would be that Treasury is rightthere 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 arealready speculating about the NCUSIF and TCCUSF being taken over bythe FDIC to manage at the insistence of Treasury. The 112thCongress could be the beginning of that process,” he added.

Treasury Secretary Timothy Geithner was involved in theresolution, specifically approving an extension of the TemporaryCorporate Credit Union Stabilization Fund to June 30, 2021, whichprovides the NCUA board flexibility in mitigating the impact of theannual assessments. The option to extend the fund repayment to 2021was written into the original framework.

Spreading out the repayment period further allows NCUA tosynchronize assessments with actual losses, Fazio said. So far,NCUA has assessed $1.3 billion in corporate assessments, and actuallosses to date total $1.1 billion. NCUA does not want to publish aschedule of assessments for credit unions, he said, because theywould be obligated to write them off immediately to satisfy GAAPaccounting.

However, NCUA will have to deal with some cash management issuesin the short run. Because previously issued corporate debt fromWesCorp and U.S. Central comes due in 2012, and actual losses onshorter terms and most problematic securities will peak over thenext couple of years, assessments will rise in 2011 and 2012 beforedecreasing, Fazio said.

“Spreading out the costs until June 30, 2021 does provide theNCUA board with flexibility, but the notion that there is a decadeof pain ahead is difficult to stomach,” Umholtz said.

Umholtz also minced no words in response to the industry'sdisappointment in mainstream media coverage that referred to NCUA'sresolution as a bailout.

“Without the extraordinary government intervention andstabilization funding, the industry would have experienced adisaster of huge proportions,” he said. “The public perception thatit is a bailout makes it one.”

–[email protected]