Beginning the Third Act of the Corporate Tragedy: Active Inertia

As NCUA’s oversight of the corporate network continues from the January 28, 2009 original pronouncement of a systemic problem, the unfolding events are similar to a tragedy entering its third act.

Act 1: The Agency commits. NCUA made a dramatic announcement of the systemic risk in the corporate system and projected NCUSIF losses of $4.7 billion. There were public declarations, signed LUA’s, a specific process to develop a collaborative solution and investment in additional resources (PIMCO). The plan appeared to be in place, relevant and proceeding to turn the situation around. The key goal was “stabilization.” A resolution process seemed to be underway.

Act II: Commitments harden. The first steps were not enough. WesCorp and US Central are conserved, NCUA puts their own examiners in charge as the Agents of the conservator, outside managers are brought in, and public statements of the potential impending insolvency of the entire network are made. The original assessments are updated and additional evidence is sought to document the follow-on actions.

Act III: Active Inertia. As commitments harden including Congressional legislation to spread the estimated cost burden, the environment changes. Despite initial statements, US Central is now deemed solvent and as a result all other corporates appear to have positive capital positions. Credit union liquidity in the first quarter rises to over $265 billion, the highest ever. Deposits in corporates are used to pay down external borrowings. Estimates continue about the problem, some positive, some negative.

But the regulatory involvement intensifies. Rather than progress toward resolution however, the conflicting roles of NCUA become more apparent. The Agency is simultaneously the regulator, conservator, manager of the two largest corporates, and board of oversight attempting to gain the confidence of members who wonder where the Agency was all along.

The corporate network, but especially the two largest institutions are in a state of active inertia, where they cannot move forward or backwards. They are like a car spinning its wheels while trapped in a rut.

Creating a Rut

The SIP loan program with its 25 basis point return to the lending credit union and 75 basis point guarantee expense are much more costly than direct CLF loans. This and the constraints on the investments and business activities of both WesCorp and US Central make it difficult to manage their portfolios to earn a positive spread. WesCorp’s first quarter results are an operating loss even though the marginal cost of funds has dropped to 25 basis points or less.

WesCorp is projecting a net interest margin of only $62 million in ‘09 versus $111 for ‘08 on essentially the same investment portfolio. Budgeted net income is forecast at $ 17 million versus $58 million in ‘08. All numbers do not include in investment gains or losses.

US Central members meanwhile are receiving contradictory signals from examiners and US Central. Examiners are telling individual corporates to diversify exposure from US Central, but not affect its liquidity. They ask them to develop other borrowing options, but in order to do that, the corporates would have to take deposits at US Central and buy securities to pledge to be able to use external lines of credit. Then examiners asked that they not do that. Corporates want to issue term certificates to their members, but US Central is limited about how far it can invest and by its strict matching requirements.

Requests to change these restrictions, for example to offer participation loans, are taking weeks, sometimes months, to decide.

The two conserved corporates are pledging to hold onto their securities but members want to know, what is the longer term strategy? This is especially important for those corporates that do the bulk of their investing and borrowing with US Central.

The Paradox of Conservatorship

NCUA is caught in a paradox of its own making. It is now 100% in charge; even the two new CEO’s are dependent on the Agency to make changes. There is no plan for the future, but a vague process of unknown length. Information is still highly selective and members are unable to get answers not just about the past, but also the future.

Trying to play it safe, the two corporates are gradually falling further and further away from the creative, market oriented actions that any sustainable business needs to practice. The irony is that trying to make the corporate system “safe and sound,” NCUA is making it more difficult for corporates to respond to the credit unions, which is vital if they are to be successful.

Credit unions are now finding it necessary to evaluate options should the corporates not meet their needs. They are approaching banks, setting up new lines and exploring different settlement relationships. As these efforts proceed, the events becoming a “self fulfilling prophecy” in which credit unions, to protect their own futures, reduce support for the corporates when they most need all the help the system can provide. This uncertain future is creating changes that will limit future corporate opportunities.

The sooner NCUA establishes a more open, collaborative set of practices with members and the industry, the more quickly the corporates might escape the rut.