Blindsided by US Central and the NCUA

This entry is a foundational explanation as to what’s going on in credit union-land for those who are shocked (as I was) to the NCUA’s Corporate Stabilization Program announcement two weeks ago. If you are a veteran of the credit union (CU) movement, please ignore this basic information. (Disclaimer: I am sooooo not an accountant or economist, just a geek/nerd paying attention to the credit union movement.)

Most of us understand that credit unions accept deposits from their members, pool the money together, and then lend those funds to members. All credit unions in the U.S. were founded by their first members making initial deposits. When a credit union needs to expand their operations, such as building a branch, they seek to borrow the money to do so, rather than paying it out of the current operating budget. If a credit union can make more prudent loans than they have cash on hand for, they can also seek to borrow the funds to do so. If a CU has extra funds on hand, they can invest it to increase their return.

When a credit union borrows money, rather than be at the mercy of banks, which may or may not want to lend money to a credit union, credit unions themselves banded together, pooled their extra deposits together, to create a credit unions’ credit union, otherwise known as a Corporate credit union. In the old days, a Corporate CU served a single state. Well, at another point, the 50 or so Corporate credit unions thought to themselves, “gee, we could get an even better rate on our funds if we all pooled them together.” and thus was born U.S. Central FCU in Lenexa, Kansas. US Central is the Corporate Credit Unions’ corporate credit union, or in other words, a “wholesale” corporate credit union. US Central takes funds in from, and loans them out to, “retail” corporate credit unions.

At a later point in time, someone got the bright idea that with modern technology, we could deregulate corporate CUs; let them merge with each other and serve many states at once, thus cutting costs, gaining economies of scale, and gaining a few more basis points of ROI. After all, we can now move and transfer funds anywhere in the world with just a few clicks of a mouse, right? Better competition equals better return on investment, n’est pas?

Well, unfortunately, no one saw the other consequence of that competition; the downside to opening up all corporate credit unions to compete for deposits from all 8,000 credit unions in the United States. And that downside is the increased pressure to increase ROI, which led to riskier investments.

Ooops!

There’s no use in crying over spilt milk now, except to motivate us to figure out how this went so wrong, and to fix the corporate CU system. This system, that credit unions themselves created to help each other out, needs to go back to its original purpose, which is to be a help to regular credit unions, not to nearly drown us out of existence by making horrible investment mistakes (who wouldda thunk?). One person at US Central has already lost his job (The Asset/Liability Management executive), and I’m guessing more will follow. Some sort of change and overhaul is needed in the way this thing is working. And it’s the NCUA’s (National Credit Union Administration) job to oversee and regulate the credit union system.

We can emerge from this crisis stronger, and re-dedicated to our members, with even more safeguards on our corporate CU system. It is a fine day (even if difficult) for credit unions if we can take care of our own problem ourselves, and step OUT of line for TARP/taxpayer dollars. But we must overhaul our corporate system; otherwise we may find ourselves going down this awful path again someday.

As a first step to fixing this, I’d suggest greater transparency, and making corporate CU investments visible to at least the ENTIRE CU community, if not to the entire public at large.

If I’ve made any errors in this simplified explanation, please let me know.

As a side note: Not everyone was blindsided by the announcement of the NCUA Corporate Stab Program. An anonymous writer, taking the pen name Will Magnus, has been blogging about this for more than a year at Unrealized Losses. His blog is being read by many in the industry, including Jim Blaine, the President/CEO of SECU (NC), the second largest CU in the nation with $16 billion in assets. By watching his corporate investments carefully, he saw the writing on the wall, and started pulling his CU’s invested money out of the corporate CU system in 2007. One of Blaine’s comments on that blog is here.

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10 Responses to “Blindsided by US Central and the NCUA”

  1. Paul Schwartz Says:

    Excellent summary Morriss. On your side note – another concern with CUs getting in line for TARP is that it makes them seem more like banks, and that gives banks more ammunition for removing the favorable tax status CUs currently have…

  2. Morriss Partee Says:

    @Paul Completely agree. I argue vociferously that accepting TARP spells the demise of the CU movement in this guest post on OpenSource CU, Let’s not snatch defeat from the jaws of victory.

  3. Christian Mullins Says:

    I’ve noticed that a lot of people tend to shy away from articles on this subject because accounting acronyms and other jargon tend to get in the way and otherwise slow down an explanation.

    This explains the situation clearly and concisely without needing an accounting degree. Thanks for the post.

  4. Jim Novo Says:

    Thanks for ‘splaining what was going on with this to us non-banker types!

  5. Ginny Brady Says:

    Morriss, a linchpin of the NCUA Corporate Stab Program is the PIMCO analysis of the toxic assets in the corporates. Everything I’m reading says that the US Treasury Dept. can’t figure out how to price the toxic assets in the banks. What makes us think that PIMCO can do it with any credibility? Why doesn’t the Treasury Dept. hire a company like PIMCO? I wish I had thought to ask this question during today’s Webinar. Maybe you or a reader of this blog can help me understand this?

  6. Morriss Partee Says:

    Good point Ginny, and I sure don’t have any answers as to the valuations. The problem with the ‘toxic’ assets is that they are complicated, designed to be hard to understand, and are new, and therefore not comparable to other assets that people are familiar with valuing. Much has been said about the CDOs in the banking and insurance system. But I have no idea what the investment portfolio of the corporates consist of. I’m not sure this is public information. (if not, that’s crazy, mutual funds are regulated and must divulge their investments, it would seem corporate CUs certainly ought to also.)

  7. Can someone please buy the NCUA a clue? « EverythingCU.com World 2.0 Adventure Says:

    […] EverythingCU.com World 2.0 Adventure Exploring new frontiers in the convergence of branding, marketing & technology « Blindsided by US Central and the NCUA […]

  8. Anonymous Says:

    Ginny & Morriss: the PIMCO analysis is likely to consist of analyzing each mortgage in each “tranche” of each bond. Each investment contains quite a bit of information about the location, type of loan, loan-to-value, credit score of the borrower, etc. etc.

    PIMCO will then use modeling (using the above mortgage parameters combined with expected future changes in the economy to project the total default rates of mortgages held in the bonds) to analyze the likely losses to the corporate system.

    Note that these projections are valid only IF liquidity is maintained in the corporates and IF there are no forced sales of these investments into the now dysfunctional credit market … and of course IF the PIMCO modeling of the depth of the recession is somewhat accurate.

    So it’s one part hard science and one part artistry.

    If you’d care to learn more about these investments, and hear the story of one hedge fund manager who made a killing by seeing the handwriting on the wall years ago, read the column below. Written by Jon Markman way back in November of 2007, the introductory section is spot-on in its expectation of the recession we currently find ourselves mired in.

    Sadly, the column clearly shows that a lot of “smart people in the room” should have known better.

    http://articles.moneycentral.msn.com/Investing/SuperModels/GettingRichOffTheSubprimeMess.aspx?page=all

  9. Anonymous Says:

    Ginny – I forgot to take a stab at your question about why the Treasury could not have someone do an external analysis of the likely losses throughout the financial system. My guess it would involve two factors:

    1. The overall size of the data set.

    and perhaps the more fundamental reason –

    2. That type of knowledge could actually make the problem WORSE by causing investors to dump their investments in firms that hold the most toxic portfolios.

    It’s a bit different in the CU instance because the NCUA plan can ONLY have an opportunity to work if NPCUs remain invested in the corporate system. A run on corporate deposits will force the sale of up to $64 billion in toxic assets – and guess who will be on the hook?

    In the for-profit banking system and free markets, capital preservation by investors is the logical choice in this environment, and carries no penalty. So that kind of information could actually be counterproductive – and the banks would probably fight Treasury tooth and nail against opening their books to that type of scrutiny.

  10. World 2.0 brings us to Pokagon « EverythingCU.com World 2.0 Adventure Says:

    […] the economy hit the skids recently, and our credit union clients were blind-sided, errrrrr assessed a heavy burden to their operating budgets in January, we decided to postpone our flagship event, the Triple-B, […]

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