Corporate System Recommendations, Town Halls and New Rules: What is at stake?

The CUNA-NAFCU task force is just the first of several industry efforts to define (divine might be a better term) the future of the corporate network.

Most of these efforts are driven by one thought—how do credit unions prevent any corporate losses in the future. In setting this goal, proposals that might achieve it could result in the corporate network having a very limited role in credit union’s future. That would be a tragedy—for the corporate network has been an integral part of the success of the credit union system.

For if regulations as proposed in the Corporate Task Force report are focused on the solvency of individual institutions, not the stability of the system, then ultimately the whole system is at risk.

Some Recent Trends

Credit union’s interdependence on the corporate network and its subsequent risks, have at the same time lessened credit union dependence on external competitors for many correspondent services. Now that trend is being reversed.

Over the 12 months ending June 30 2009, total credit union investments increased by over $40 billion. However only $4.2 billion of this increase went into corporate credit unions. Over $13.3 billion was deposited in banks and S&L’s. This was a 40% increase in these institutions bringing the total investments to $46.8 billion.

In other words, credit unions are diversifying away from corporates. They are funding their banking competitors or going to the market directly.

This trend is a fact. If the revised rules do not permit corporates to regain their competitive position, then the rules will merely oversee the inevitable demise of the network.

What caused the corporate’s problem?

One way to summarize the corporate problem would be the following:

1. The assumptions about the risk of AAA mortgage backed securities backed by real estate collateral was wrong;
2. Selected corporates leveraged this assumption using borrowings to provide a greater return;
3. Investment competition became more of a commodity business focusing primarily on price and therefore scale economics became a key success factor.

NCUA has provided two broad explanations for its regulatory actions. In January and indeed in multiple speeches before, the Agency said the problem was market dislocations affecting all financial institutions. This was an external event imposed on the credit union system, i.e. systemic risk. We must all come together to work through this.

The second version of events began in March with the conservatorships when NCUA pointed the finger at the leadership in the corporates for not providing “honest” numbers.

But is it possible that these are only proximate events and that major causes of the loss are still unaddressed? If this is the case, then remedies addressing the investments and capital issues, may not only miss the mark, but also overlook opportunities to renovate the system in everyone’s interest.

A Longer View of Events

In 1984 US Central was the dominant player in the network, establishing system standards and guidelines. If a corporate wanted to use US Central and its services, it must agree to follow these practices.

Over time the network transitioned from a business with one’s peers in a network to individual corporates moving to a stand-alone model. This was permitted under NCUA’s granting of different levels of investment authority that encouraged credit unions to “qualify” for broader investment options. Corporates became more independent, competition increased, and US Central managed a smaller percentage of investments.

In essence the interests of the whole system became subordinate to the strategies of each corporate, a tendency that benefited larger credit unions able to operate independently of US Central.

The Current Situation

Now as each corporate faces its own capital adequacy issues and US Central’s future role uncertain, the network is more tattered than ever. There is no hub, no way to rally a network solution. Each corporate realizes that it will be difficult to expand opportunity alone. But there is no network to go back to.

Yet might a more interdependent corporate network model be the very design that can meet the multiple needs of credit unions, better manage risk and build system solutions for secondary market access?

So as the Town Hall meetings take place, other reports or recommendations issued, and a proposed rule laid out, a critical question will be whether the system’s future needs are being addressed? Or are these proposals just another way to bury the past?