Credit Union Bailout Needed – NCUA Insurance Fund Insolvent

Corporate Credit Unions Fail

The National Credit Union Administration (NCUA) announced today that two major corporate credit unions have been put into conservatorship as the true size of their losses became apparent.

March 20, 2009, Alexandria, Va. –The National Credit Union Administration Board today placed U.S. Central Federal Credit Union, Lenexa, Kansas, and Western Corporate (WesCorp) Federal Credit Union, San Dimas, California, into conservatorship to stabilize the corporate credit union system and resolve balance sheet issues. These actions are the latest NCUA efforts to assist the corporate credit union network under the Corporate Stabilization Plan.

The two corporate credit unions were placed into conservatorship to protect retail credit union deposits and the interest of the National Credit Union Share Insurance Fund (NCUSIF), as well as to remove any impediments to the Agency’s ability to take appropriate mitigating actions that may be necessary.

The Federal Credit Union Act authorizes the NCUA Board to appoint itself conservator when necessary to conserve the assets of a federally insured credit union, preserve member assets and protect the NCUSIF.

Corporate credit unions do not serve consumers. They are chartered to provide products and services to the credit union system.

U.S. Central has approximately $34 billion in assets and 26 retail corporate credit union members. WesCorp has $23 billion in assets and approximately 1,100 retail credit union members. The member accounts of both credit unions are guaranteed under provisions of the previously announced NCUA Share Guarantee Program, through December 31, 2010.

Following initial actions taken by the NCUA Board January 28, 2009 (see NCUA Letter to Credit Union No. 09-CU-02 http://www.ncua.gov/letters/letters.html), NCUA staff completed a detailed analysis and stress test of the mortgage and asset backed securities held by all corporate credit unions, including US Central and WesCorp. Specifically, this review determined that an unacceptably high concentration of risk resided only in the two conserved corporate credit unions. Securities held by US Central and WesCorp deteriorated further since late January 2009, contributing to diminished liquidity and payment system capacities, as well as further loss of confidence by member credit unions and other stakeholders.

The findings indicated an overall estimated reserve level, previously announced by NCUA, had increased from $4.7 to $5.9 billion. The specific computation and the impact of the refined reserve level are addressed in NCUA Letter No: 09-CU-06, which NCUA issued and posted online today at http://www.ncua.gov/letters/letters.html.

The National Credit Union Administration is the independent federal agency that regulates, charters and supervises federal credit unions. NCUA, backed by the full faith and credit of the U.S. government, also operates and manages the National Credit Union Share Insurance Fund (NCUSIF), insuring the deposits of over 89million account holders in all federal credit unions and the majority of state-chartered credit unions.

Concern has been growing over the past year about the financial health of the corporate credit unions.  In November 2008, Price Waterhouse was asked to review NCUA recommendations for the realignment of the corporate credit unions.  The Price Waterhouse report was released January 16, 2009 and noted the following issues with the corporate credit unions.

Liquidity, Capital, Structure and Risk Management Issues

1. The primary purpose of corporates to provide short-term liquidity to (retail) natural person credit unions (NPCUs) has been constrained by the decline in market value of securities.

2. Corporates have significant unrealized losses that may become realized other than temporary impairments.

3. Corporates have significant unrealized losses that may become realized other than temporary impairments

4. Corporates have borrowed from external sources that should not serve as a sustained daily source of liquidity.

5. Low Tier 1 capital levels and capacity of regulatory capital to absorb risk are a concern for external lenders.

6. Risks from non-core activities jeopardize core, systemic clearing, settlement, and liquidity functions.

Recognition of major weaknesses with the corporate credit unions came too late to prevent their collapse.  Huge losses on mortgage related assets were mounting rapidly.  In late January 2009 the NCUSIF provided a $1.0 billion recapitalization loan to US Central Credit Union after US Central booked losses of $1.2 billion in December 2008.  After the NCUSIF capital infusion, US Central was technically in compliance with its required regulatory capital ratio.  Barely two months later, it became apparent that US Central’s losses were much larger than what they had initially indicated.

In conjunction with the capital infusion to US Central the NCUSIF also booked a $3.7 billion “Insurance Loss Expense” to cover their guarantee of all corporate credit union share deposits.  There are a total of 28 corporate credit unions, of which US Central and Western Corporate are the largest.

As admitted by the NCUA in their announcement of the takeover of US Central and Western Corporate, the estimated reserve required for losses at the corporates has ballooned to $5.9 billion (from $4.7 billion), within the past two months.

Who Pays For Credit Union Losses?

The NCUA is the administrator of the credit union insurance fund, known as the National Credit Union Share Insurance Fund (NCUSIF).  Since the credit unions are a cooperative mutual industry, all losses in the credit union system become the responsibility of all federally insured credit unions.  If the entire $4.7 billion had been recognized as an insurance loss, this would have wiped out 58% of the NCUA’s equity and required a massive increase in the insurance premiums for every federally insured retail credit union.  Congress requires that premiums on credit unions be increased if the NCUA insurance fund equity ratio drops to 1.2% or if the insurance fund drops below 1% of all insured deposits.

Total credit union deposits according to the NCUA exceed $600 billion.  Had the $4.7 billion losses been properly recognized, the NCUA’s equity would have dropped to only $3.3 billion from $8 billion, requiring  a $2.7  billion premium increase for the retail credit unions.  The retail credit unions, already struggling with high default rates, strenuously objected to the prospect of large premium increases to cover losses that they had nothing to with.   For example, the Congressional Federal Credit Union, in a letter to its members on February 12, 2009 noted its strong disapproval of the US Central bailout and the attempt to raise insurance premiums.

The National Credit Union Administration (NCUA), the federal regulator of credit unions and the administrator of the National Credit Union Share Insurance Fund (NCUSIF) announced in late January that it has used deposits in the NCUSIF to provide a $1.0 billion recapitalization loan to US Central Credit Union. As a cooperative mutual industry, any loss in the credit union system is theresponsibility of all federally insured credit unions. As I reported earlier this year, Congressional has no investment exposure to US Central Credit Union. The Board and management team decided fourteen years ago to avoid any uninsured deposits in the
corporate credit union system. Nevertheless, as a result of the NCUA’s decision to recapitalize the debt of US Central through the CU insurance system and as a participant in the co-operative credit union movement, Congressional FCU will be recognizing approximately $3.3 million extraordinary expense during 2009 for the recapitalization of US Central Credit Union.

It is significant for Congressional FCU members to be aware that the Congressional FCU Board and management have vigorously opposed the decision by the NCUA to “bailout” US Central through the use of our deposit in the NCUSIF. As indicated, the impact of this inequitable NCUA decision is that credit unions, like Congressional FCU, who had long ago made a sound business decision not to participate in US Central Credit Union, are being required to pay an insurance premium to recapitalize US Central Credit Union. Members should also recognize that similar actions by the NCUA would result in further undue burden being
placed on Congressional FCU.

NCUSIF is the insurance that protects credit union member deposits up to $250,000. The insurance fund is 100% funded by credit unions and provides coverage for member deposits in more than 8,000 credit unions. The Federal Credit Union Act, federal legislation for credit unions, mandates that the NCUA maintain the insurance fund at a minimum level of 1% of total insured deposits in the credit union system. Each credit union maintains an account with the NCUSIF in an amount equal to 1% of the insured shares. As the funds for the loan to US Central are withdrawn from the NCUSIF, Congressional FCU will be required to expense our portion and then re-fund our NCUSIF account back to 1%.

How A $4.7 Billion Loss Is Not A Loss

In order to avoid the imposition of large insurance premium increases on the retail credit unions, the NCUA offset the $4.7 billion insurance loss with a $4.7 billion accounting entry called “accrued recapitalization and premium income”, which represents the premium income due from the credit unions to fund the insurance losses. This offsetting accounting entry by the NCUA eliminated the $4.7 billion loss and allowed them to remain technically solvent with an unchanged equity level.

This offsetting entry to the $4.7 billion reserve was made despite the fact that the NCUA has not assessed or collected any of the additional booked insurance premium from the credit unions.   Judging by the outraged response of the Congressional Federal Credit Union cited above, it is unlikely that the NCUA can impose or collect the huge insurance fee increases necessary to replenish the insurance fund of the NCUSIF.  Keep in mind also, that this original $4.7 billion reserve to cover corporate credit union losses is now inadequate as admitted by the NCUA which increased its estimated losses at the corporates to $5.9 billion in its March 20 announcement.

The NCUA’s “creative” non GAAP (generally accepted accounting principles) accounting was explained in a Credit Union National Association (CUNA) letter in early March 2009.

CUNA Explains NCUSIF Accounting

ALEXANDRIA, Va. (3/2/09)—The most recent monthly National Credit Union Share Insurance Fund (NCUSIF) report showed the fund booked both the expenses and the income associated with the corporate credit union stabilization plan in January.

The National Credit Union Administration’s (NCUA) NCUSIF booked, for accounting purposes, a $1 billion expense for “Loss on Investment – Corporate” that is related to its capital infusion into U.S. Central FCU.

It also booked a $3.7 billion “Insurance Loss Expense” to control for the risk associated with NCUA’s guarantee of “excess” corporate credit union share deposits. The information was revealed last week at the NCUA’s open board meeting.

However, the NCUA also booked the NCUSIF’s $4.84 billion in “accrued recapitalization and premium income” in January, again for accounting purposes, despite the fact that NCUA has not yet collected the premium from credit unions.

Unless the NCUA adopts an alternative approach to how the costs of the corporate stabilization program will be paid or changes course on its accounting decision, its action could force credit unions to have to reflect all of their insurance costs for the corporate assistance, the replenishment of the 1% deposit and the premium, on their March call reports.

The NCUA, as a government agency, has flexibility to deviate from Generally Accepted Accounting Principles (GAAP) in its financial reporting if the Office of Management and Budget (OMB) and the Comptroller General agree to such a deviation.

Losses Expanding Geometrically

After taking a $4.7 billion charge to reflect losses by the corporate credit unions, the NCUA’s accounting method resulted in a zero reduction of their total equity.  This almost makes AIG accounting look sound.   In the real world the NCUA insurance fund is totally inadequate to cover the mounting losses in the credit union industry and its reserves are below those required by Congress.  The ability to deviate from GAAP, as noted above, allows the NCUA to maintain a facade of solvency.

Making matters even worse, Michael Fryzel, chairman of the NCUA now states that the 28 corporate credit unions have estimated unrealized losses of $18 billion at the end of last year.   To replenish the NCUA insurance fund, premiums on the retail credit unions would have to be raised dramatically or the taxpayer has to fund another bailout.  Mr Fryzel quickly made it clear what his choice would be.

Wall Street Journal

WSJ – Michael E. Fryzel, chairman of the National Credit Union Administration, the industry’s federal regulator, said the seizure was necessary to maintain the integrity of the credit-union system and protect the insurance fund that backs up deposits in thousands of retail credit unions.

In total, the 28 wholesale (corporate) credit unions in the U.S. were showing paper losses of about $18 billion as of Dec. 31. Mr. Fryzel said regulators aren’t concerned about the health of any other wholesale credit union besides the two brought into conservatorship.

NCUA had said it would make up the expected losses in the insurance fund by dunning the nation’s thousands of retail credit unions. But after an outcry from the industry, Mr. Fryzel said the agency’s board now plans to ask Congress in the coming week for authority to borrow money from the Treasury. He said the industry isn’t looking for a bailout, and would repay all such borrowings.

Conclusion – NCUA Bailout To Cost At Least $15 Billion

The NCUA’s insurance fund is insolvent.  With total estimated losses at the corporates of $18 billion, the NCUSIF has equity of only $3.3 billion (after taking write-offs of $4.7 billion), leaving a black hole of at least $10 billion.  In addition, to maintain a statutory capital ratio of 1.2%, another $5 billion is necessary since the NCUA’s equity base has been depleted.

The losses of the corporate credit unions is estimated at $18 billion by the NCUA.   How can Michael Fryzel say that regulators aren’t concerned about the other 26 corporate credit unions after stating that their losses are at least $18 billion, and the loss estimates have been increasing dramatically month after month?

In addition, the NCUSIF has already paid out $1 million in claims on two failed retail credit unions in just the last month.  There are 8,000 retail federal credit unions insured by the NCUA fund that have an insured asset base of $611 billion and almost $400 billion of loans outstanding.  Credit unions make mortgage, credit card, car and personal loans to their members.  Delinquencies on similar loans at other lending institutions are running at upwards of 10%.  How many more retail credit unions will fail and what will the losses amount to?

The credit unions will be another large hole in the taxpayers’ wallet.  A best case scenario leaves the NCUA short by $15 billion.  Based on previous loss estimates that have spiraled upwards, the final total will probably be much larger.

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