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The March 20 conservatorships of U.S. Central and WesCorp are causing some to question Part 704 rules that permit expanded investment authorities. The NCUA has said that credit losses on asset-backed securities, investments allowed after the rule change, resulted in the depletion of capital and regulatory action at the two institutions.Following the 1994 conservatorship of Capital Corporate Credit Union, the NCUA approved Rules and Regulations Part 704 in 1995, which allowed for four categories of expanded investment authorities, with Part IV having the broadest authority.Most corporates operate with Part I or II authorities, but both U.S. Central and WesCorp eventually applied and were approved for Part IV authorities. This allowed them to invest in vehicles like private-label, mortgage-backed securities, which were responsible for U.S. Central’s $1.2 billion other-than-temporary-impairments, announced in late January for 2008′s year-end posting.Why venture into riskier investment territory and expose capital? At the time, the capital debate resembled the chicken or the egg conundrum: more risk requires more capital, but corporates needed to tap a more robust revenue stream to build that capital, recalled former NCUA Chairman Dennis Dollar. Plus, corporates needed the expanded authorities to compete against entities like the Federal Home Loan Bank, he said.WesCorp members weren’t complaining about the newly approved expanded authorities back in 2000, when the San Dimas, Calif-based corporate offered a 7.17% four-day certificate deal that sold out in four hours, according to a Dec. 20, 2000 Credit Union Times article. The investment was possible because expanded authorities allowed WesCorp to leverage a long holiday in the European market.Access to riskier markets didn’t come without additional regulatory requirements and oversight. Comptroller General Charles Bowsher chastised the NCUA during 1995 testimony before the Senate Banking, Housing and Urban Affairs Committee on the CapCorp failure.“NCUA’s supervision of CapCorp was ineffective on several fronts. For four years, NCUA essentially tolerated weaknesses in CapCorp’s internal controls,” Bowsher said, blaming the failure on lax supervision as well as inadequate capital, insufficient board oversight, inadequate risk management and inappropriate investment strategy.When it approved Part 704, the NCUA also created the Office of Corporate Credit Unions to step up corporate oversight. The application process for expanded authorities required corporates to employ internal auditors, document the expertise of their investment staff and place more responsibility on corporate boards and supervisory committees. In the late 1990s, acknowledging systemic risk potential, the NCUA mandated large corporates maintain on-site agency examiners.Debate over corporate capital and risk has come and gone since Part 704 was originally approved, often prompted by market conditions. In October 2002, after years of debate, the NCUA revised Part 704, which included investments rated below BBB, but only to a maximum of 25% of capital. Board member Deborah Matz voted against the new rules, citing opposition to permitting investments in lower-grade securities.Each time corporate regulations were reviewed, risk-based capital was considered. In fact, in 1995 the then-General Accounting Office recommended developing and enforcing “capital standards that adequately account for all risks and that include a minimum leverage ratio.”“The corporate experts on staff at NCUA were reluctant to support a risk-weighted capital structure, citing such a system as unnecessarily complex and strongly emphasizing their belief that the current capital system of RUDE, PIC and MCS adequately protected corporate credit unions against the risk on their balance sheets,” Dollar recalled. Historical evidence supported that opinion until recently, he added.“I’ll be the first to admit that, even though it was not included in the original corporate rules established in 1995 that we inherited, we obviously made a mistake when we re-wrote the corporate rules in 2003 by not overriding the internal staff’s reluctance and adopting a Basel-type, risk-weighted capital system that correlated the weighting process into the expanded authority regimen for corporates,” he said.Dollar stressed that he’s not claiming risk-based capital would have prevented the conservatorships; however, he said “basing capital requirements on risk is pretty basic to effective regulation and supervision.”The implementation of risk-based capital is as tough an issue for corporates as it is for natural person credit unions. The unique structure of corporates as nonprofit, largely back-office support institutions makes it difficult to apply the same standards that are applied to retail institutions of the same asset classification.The ACCU had lobbied for a risk-based capital system until it made a surprise announcement in late 2006, saying it had decided to shelve the initiative. At the time, the ACCU told Credit Union Times that some corporates would have trouble meeting Basel’s leverage ratio “based on the way term paid-in capital and perpetual paid-in capital are counted.”That debate continues today.World Council of Credit Union vice president of association services Dave Grace will meet with Basel Committee Chairman Nout Wellink April 15 to discuss new standards that could potentially be required of U.S. credit unions, including risk-based capital (see article, page 6).–[email protected]

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