Recently a friend of mine gave me a wonderful explanation of a financial intermediary. Most of us could not afford the risk of lending someone the money to buy a car. If the person had problems paying us back we would find it difficult to absorb the loss. That's where a financial intermediary such as a bank or a credit union plays a valuable role in our economy. A credit union collects the deposits of its members and then prudently lends and invests those funds. If a loan goes bad, the credit union can typically absorb the loss through the earnings of operations. The role of corporate credit unions was that of financial intermediary for member credit unions. They were able to invest in ways that their member credit unions may not have had the ability or scale to invest. If the proposed corporate regulations go through in their current form, corporate credit unions will lose much of their ability to be financial intermediaries for natural person credit unions. It is questionable whether restrictions such as limiting the average lives of a corporate's investment portfolio to two years will allow the corporates to generate enough income to fund their operations never mind offer a competitive return on investments to member credit unions.
There are other parts of the proposed regulations that are problematic as well. For example, the over emphasis on net economic value. NEV is easily manipulated. If it is to be relied upon then there should be strict guidelines for monitoring the assumptions underneath the modeling. And I believe net interest income testing, a much better measure of interest rate risk in the balance sheet should play a more prominent role in the ALM testing. Only passing mention of NII is made in the proposed regs.
I also have issue with the fact that the aforementioned average life restriction does not differentiate between fixed-rate and variable-rate investments. In a rising rate environment. the average lives of mortgage-backed securities both fixed and variable will extend. And yet a variable-rate bond can be a very ALM friendly. One more question on the average life restriction. In a rising rate environment as the average lives of investments extend and the value declines will the corporates be forced to sell investments at the worst possible time in the market to comply with the new regs? Can you say Cap Corp?
And how about this? The average life restriction may limit a corporate's ability to invest in ALM friendly bonds even though in the expanded authorities section of the regs there are a list of foreign investments that would be permissible. Why would we want our corporates investing in foreign countries?
Finally, the regs put so much emphasis on NEV and average lives but I think they completely miss the true cause of the corporate mess: credit. The credit of the collateral underlying the investments bought by Wescorp and US Central was just plain bad. And the NCUA's solution? Rely on the rating agencies. If you rely on the rating agencies to evaluate the bonds, you're relying on the people who pay the rating agencies. Guess who that is? The underwriters of the investments. What should be required of corporate credit unions is a careful evaluation of the collateral underlying the bonds being considered for purchase and continued evaluation thereafter. If the corporates do not have the expertise on staff to evaluate the bonds, then a bond firm such as PIMCO, Clayton or Amherst should be hired to evaluate the bonds prior to purchase and on an ongoing basis. All mention of and reliance upon the rating agencies should be taken from the regs.
Have you taken the time to read the corporate regs? If you have, then none of the items I mentioned should surprise you. If not, I have another question, why? We're going to pay a lot for the corporate mess for a long time. Isn't it worth your time to help lay the foundation for a stronger corporate system and a stronger credit union movement going forward? Forget about recovery of OTTI losses. There's a reason they're other than temporary, they're gone forever and forever is a long, long time. Forget about how the legacy assets will be disposed of. If the OTTI losses have all been fairly stated then the legacy assets will eventually regain their remaining market value as the bond market's liquidity continues to improve and they can be sold with little if any market loss. And don't forget about your investment portfolio. Take some time to learn about a third of your balance sheet. Don't make the corporate system your default investment choice. We are at a watershed moment in the credit union movement's history. Now is the time to make sure we are not swept over the falls and out to sea again by the corporates or by our regulators.
Evan Clark
CEO
DOC FCU
Washington, D.C.
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