How a tiny federal agency cheated 100 million US credit union members out of $3.1 billion while Congress looked the other way!

via creditunions:

The regulator kept the corporate crisis bailout money for itself, further undermining the pillars of the cooperative system. Does anybody care?

The NCUA’s retention of the initial $3.1 billion surplus from the closing of the Temporary Corporate Credit Union Corporate Stability Fund (TCCUSF) isn’t just about the money.

If you want to know where you’re going, you have to know where you’ve been. Evaluating this latest regulatory action in the 10 years of NCUA decisions since the Great Recession, there’s a growing disdain for member rights and property and a significant weakening of the pillars of the cooperative model.

Unlike privately held financial firms, coops are member-user owned where the capital created becomes common wealth. The regulatory structure is built upon similar, collectively founded common institutions, especially the Central Liquidity Fund and the National Credit Union Share Insurance Fund.

The NCUSIF and CLF are unique reflections of cooperatives’ collective strength, an advantage every individual institution can benefit from. However, should credit union leaders act as if their individual firm’s well being is not connected to the NCUA’s oversight of these cooperative pillars, then the whole system is at risk.

Sadly, credit unions’ collective shrug of the shoulders at the NCUA’s holdback of billions of members’ funds from the TCCUSF surplus continues a decade of supine genuflection in the face of their regulator’s self-serving feeding at the trough filled by members’ funds.

If credit union leaders do not speak out for responsive cooperative leadership by regulators, who is going to speak up for credit unions when their institutions are seen as no longer unique?

The NCUA’s Failure To Follow The Law

Congress in passing the TCCUSF in 2009 explicitly stated: “These provisions are intended to ensure that the activities of the Fund are restricted to resolving problems in the corporate credit union system, and not used for other purposes, such as for dealing with natural person credit union problems.”

But the whole justification last year for keeping the TCCUSF surplus, instead of returning it to credit unions, was to cover potential natural person credit union problems.

That action was after the NCUA’s seven years of oversight updates that explicitly projected that credit unions would receive a rebate of their $5.0 billion in TCCUSF premiums. In the semi-annual Resolution Costs Detail report posted on the NCUA’s website, one column is headed Projected Rebate on Assessments Paid to Date. The last entry for Q4 2016 shows an estimated rebate of $2.6 billion to $3.1 billion.

In addition, by retaining the TCCISF surplus versus returning members’ funds, the NCUA circumvented the explicit statutory requirement that the NCUSIF’s normal operating level (NOL) cannot be raised above 1.3% via a premium but only by retained earnings. TCCUSF surpluses are simply not NCUSIF retained earnings.

The NCUA Is Untethered To Facts: A $22 Billion Error

The NCUSIF’s financial statements, projections, and assumptions have been untethered to actual facts since the 2008 financial crisis.

Its first Resolution Cost Report on the status of the TCCUSF as of July 2010 projected a total loss of as much as $16.9 billion including the write off $5.6 billion in “depleted corporate capital.” This same report estimated that as much as $9.2 billion more in “projected remaining assessments” by credit unions could be needed. That’s on top of premiums already paid.

Today the minimum surplus from the corporate resolutions is $5.2 billion. This includes the $3.1 billion already taken by the NCUSIF and a minimum of $2.1 billion to be distributed to the shareholders in the liquidated corporates based on their September 2017 five Asset Managed Estate (AME) statements.

To date, the NCUA’s projected loss estimates used to justify the five corporate liquidations is incorrect by more than $22 billion.

To date, the NCUA’s initial projected loss estimates used to justify the five corporate liquidations is incorrect by more than $22 billion.

In the final call reports of August 2010 before the five corporates were seized, WesCorp reported the largest negative regulatory capital of $4.9 billion. Three of the corporates were solvent and held more than $430 million in capital, while Constitution reported a potential $23.5 million deficit.

However, all five had already recorded total OTTI expense write-offs of $11.6 billion that had been taken out of these regulatory capital numbers. As of the most recent legacy asset updates, there is still more than $3.1 billion in unused OTTI reserves, with four of the five corporates showing unused amounts of 35% to 49% of the total loss estimates. These losses, taken out of capital, have yet to occur.

Click here to see spreadsheets that lay out the actual performance of each corporate.

The corporates were highly over-reserved for potential credit impairments on the legacy assets. These loss shortfalls are not simply recoveries. Rather, the continued principal performance of these securities has created additional flows of interest income that NCUA estimates will exceed $1 billion.

To paraphrase the words of former Secretary of State Rex Tillerson, if we as credit union leaders become accepting of alternative realities that are no longer grounded in facts, then we as member-owners are on a pathway to losing our cooperative institutions.

Continued Untethering

The NCUA’s refusal to use actual numbers and instead project unverifiable future losses was most recently demonstrated when it raised the NCUSIF’s normal operating level (NOL) from 1.3% to 1.39% of insured shares. In projecting future losses to justify the new, higher NOL, the NCUA used the following economic assumptions for 2018-2019:

Higher and steadily rising unemployment to 7%
Short-term interest rates near zero
Long-term rates rise slowly, but always stay below 3%
Sustained decline in housing pricings will result in a 17% decline below the base year

Just like the earlier corporate projections, these assumptions are completely unhinged from any actual numbers or plausible future events.

Compounding this dystopian, imaginary future, the agency then stated it needed to keep another $400 million (4 basis points) due to a possible contingent liability incurred from the remaining NCUA Guaranteed Notes (NGN). The NCUA’s own auditor, KPMG, had opined for six consecutive TCCUSF audits, and in the year-end December NCUSIF audit, that no such contingency exists. The NCUA ignored this long-term audited fact.

Destroying The Liquidity Pillar

The extreme misjudgment of the actual risks in the corporate system resulted in the closure of four of the five largest corporates then in operation. By liquidating US Central, the agency also destroyed the innovative and unique liquidity safety net created by credit unions with the CLF.

This CLF-Corporate partnership gave access to more than $44 billion of guaranteed liquidity from the U.S. Treasury for any credit union to draw upon in the event of a liquidity crisis. That system-wide, internally mobilized government backup line is now gone. Every credit union must now negotiate its own backup liquidity with the FHLB, the Federal Reserve, the CLF, or other lenders.

Instead of mobilizing all the system’s surplus, the CLF’s unique cooperative safety and soundness solution has been trivialized. Virtually every study of financial crisis, including the recent Great Recession, demonstrates that liquidity shortfalls are the lynchpin for the crisis. As markets implode, capital losses ensue because liquidity dries up normal market pricing and transactions can no longer take place without unanticipated losses caused by “market dislocations.”

This 30-year liquidity pillar had provided the highest possible confidence (a “lender of unfailing reliability”) to credit unions during the deregulation restructuring crises of the 1980s (including the closure of Penn Square Bank), the periodic market scares in 1987 and 1997, the uncertainty around Y2K liquidity, the market uncertainty after 9/11, and the inevitable cycles of economic recession or downturn.

By terminating this vital public-private partnership, the NCUA has undermined the system’s collective safety and soundness.

By terminating this vital public-private partnership, the NCUA has undermined the system’s collective safety and soundness.

A State Of Perpetual Crisis

The NCUA learned during the 2008-2009 corporate credit union “crisis” that it could act unchallenged by credit unions or any other authority, unhindered by traditional process and accounting rules, and project unverifiable future losses which imposed enormous and immediate premium expense consequences for the industry.

Wildly inaccurate forecasts gave the agency carte blanche to raise its budget. In hiring outside “experts” to validate their various projects the agency turned its back on the traditional solutions of working with credit unions to resolve problems.

This pattern of predicting an extraordinary crisis was shown once again in February 2018 in releasing the year-end financial statements for the NCUSIF. For the first time ever, and during the longest period of economic growth in the nation’s economy, the share fund reported its first ever loss, $229 million.

To reach this unprecedented result the agency in the month of December expensed the single largest provision expense ever of $657.8 million. This resulted in an “allowance account” at year end of $925 million or 49 times the actual net cash losses in the year.

The results suggest one of two causes. One, the NCUA is facing the worst natural person loss in the history of the fund. If that’s the case, what does this say about the agency’s supervision oversight in an era of the longest uninterrupted economic expansion in U.S. history?

Or, once again NCUA is exaggerating actual problems to be able to retain funds that should have gone back to members. This second explanation seems the most plausible. The NCUSIF received more than $500 million in additional TCCUSF surplus after the initial Oct. 1 merger. If this additional surplus had not been expensed via this extraordinary reserving, more than $500 million in this “new” TCCUSF-related revenue would have added to the dividend for members. It would have increased further the excess reserves beyond the NCUA’s new NOL cap of 1.39%.

Accountability Gap Endangers The Cooperative System

When an agency routinely ignores the law and creates hypothetical facts to justify actions, the institution is bereft of professional leadership, accountability, and oversight. The danger is much worse than inefficiency. For the behavior portrays an agency unable to perform its core mission to sustain the credit union system.

There were 13,000 federally chartered credit unions when the three-person, independent NCUA board was created in 1977. At year-end 2017, there were approximately 3,300.

While consolidation is a trend in all financial firms, the difference before 1977 and now, is that under the NCUA new FCU charters have become increasingly harder to obtain. In the 43 years of federal chartering prior to 1977, the number of active charters increased in all but eight years, and three of those were during World War II.

In the NCUA’s four decades, there has not been a single year in which the number of FCU charters has increased. No more seed corn is being planted by future cooperative entrepreneurs.

In the NCUA’s mismanagement of the CLF and NCUSIF institutional pillars, the distinctive cooperative model is in danger of extinction. By both deed and example, the agency’s supervisory record is one of the inexorable demise of the credit union chartering system.

In the NCUA’s mismanagement of the CLF and NCUSIF institutional pillars, the distinctive cooperative model is in danger of extinction. By both deed and example, the agency’s supervisory record is one of the inexorable demise of the credit union chartering system.

Should Anybody Care?

The cooperative model’s design depends on the norms and values of collaboration, connection, community and self-reliance. These organizational requirements rely on democratic commitment to give direction and oversight to the collected resources. Democratic integrity relies on individual character.

To initially succeed, interdependence was essential for every credit union. Sponsoring groups, vendor subsidies, movement support, and regulatory encouragement all assisted the sweat equity of founding members.

Today this legacy of interdependence is not central for the financial success of most credit unions. Each credit union can sustain itself from its own inherited or created resources.

However, reputation risk affects everyone: those directly involved and onlookers just trying to mind their own business well. Credit unions still share a common destiny heavily influenced by NCUA actions, not just rule and regulation.

The above history portrays an agency that has lost its core purpose and any sense of answerability. These actions put the entire system at risk. The risk is unlikely to be as dramatic as total financial collapse. More likely it will be a subtle, step-by-step erosion in the public’s confidence in and need for tax-exempt firms that more and more seem like every other financial option.