Managing the Legacy (Not Just the Present) at NCUA

Leaders of all the organizations within the credit union system are stewards of a mutually endowed legacy.   That legacy includes financial and physical resources, but it also includes the values and promises to each other that were the basis for accumulating the resources in the first place.

Cooperatives depend on this ability to work together for common interest.   If one participant in the system becomes ineffective or dysfunctional then all of the other participants will suffer as well.  This interdependence is at the heart of the cooperative success.

The ultimate challenge is whether leaders will pass to their successors an enhanced legacy or, in the worse case, no legacy at all.   Ms. Matz has inherited a very difficult set of circumstances – aspects of which resemble a train wreck.  Moreover, the first months of her tenure have been filled with predictions that things will only get worse.

Questions for the Agency Leadership

However, a critical question is whether circumstances are causing these outcomes or whether it is the “mindset” that exists at the Agency.   Are the Agency’s legacy resources, and the promises made in accumulating them, being used in the best interests of the credit union system? Or are other motivations at work?

A case in point:  the Federal Credit Union Act requires that, “Not later than April 1 of each calendar year, and at such other times as the Congress shall determine, the Board shall make a report to the President and Congress.  Such a report shall summarize the operations of the Administration and set forth such information as is necessary for the Congress to review the financial program approved by the Board.”

No one, to my knowledge, has seen this report (traditionally called the Agency’s Annual Report) for 2008.  This is not just a bureaucratic delay, for this report contains the external audit of the three funds provided solely by credit unions and managed by the Agency: the NCUSIF, the CLF, and the operating fund.

This audit is not a casual commitment.  When the 1% funding proposal was presented to credit unions to seek their support, the most common question was, “How do we know our [credit union] funds will be well managed?  How do I know that government won’t just spend my members’ money?  Isn’t that what governments do?”

One of the responses was the assurance of external oversight through a timely, annual external private audit of the Agency’s funds done in accordance with GAAP.  Prior to this, NCUA’s only external audits were by the GAO – once every two years, often produced very late, and not presented in accordance with GAAP.  It took three years for the NCUSIF to establish the accounting processes and procedures to achieve a clean audit opinion.  It was the first government managed fund to do so.

Today, the 2008 audits have not been made available.  One can only speculate about the hold up.   Yet in August, the Board assessed credit unions $2.0 billion to add to the NCUSIF.  How could the NCUA Board require credit unions to forward a premium in the absence of an audit that would certify, among other numbers, the Agency’s loss reserve calculations? Do current actions fulfill the promises that were made when the 1% funding was proposed as “A Better Way” a generation ago?  These commitments were in the Agency’s Annual Reports, repeated at multiple meetings, and included in the Board’s own discussions approving the legislation and implementation.

Audits not only provide transparency, but they can also facilitate better decisions.   The Board’s August action in taking $ 1 billion from credit union’s collective capital as a premium expense, not only reduces the system’s ability to lend by as much as $14 billion; the action was also contrary to administration policy to assure a continuing flow of credit to consumers as well as the counter-cyclical role Congress mandated for credit unions.

A Recent Event: the U.S. Central $4.0 Billion Note Issue

Last week, U.S. Central issued $4.0 billion in three separate notes – one being a tranche for $2.0 billion extending out for three years.   This action by the NCUA raises significant legal, financial and policy questions.  But it also raises the issue of what kind of cooperative legacy NCUA is creating for future generations.

1. U.S. Central and NCUA are under common control and management.  Footnote 1 in the U.S. Central Deloitte 2008 audit states clearly the total control that NCUA has over every aspect of the corporate’s operations.  This raises a crucial legal question about the basis for NCUA to issue these notes.
   
   We already know that the Agency auditor would have forced the reclassification of U.S. Central’s CLF funding as a contra-equity account under the conservatorship.  The two entities are the same, so it could no longer be viewed as an arm’s length transaction, after 25 years of this presentation.  So how can NCUA obligate the U.S. government for $4.0 billion?  Where is the authorization and appropriation for this amount?  Where is the approval from Treasury?
   
2. On page 7 of the offering circular, NCUA states that the guarantee is a general obligation of the NCUA and will be paid to the extent necessary from the following sources:
   a.      From corporate credit unions participating in the TCCULG program
   b.      From the Temporary Corporate  Stabilization Fund
   c.      From the NCUSIF
   
   NCUA has no source of funds except credit unions who are being obligated to pay back all of these borrowings.  Yet the system had no say in this encumbrance:  it was not approved by the members of U.S. Central, and there was no public presentation of the rationale of why this was even necessary.   It is not merely the credit standing of the U.S. government that NCUA is using, but also that of the collective resources of entire credit union system.  Is this unilateral action the way a cooperative system should function?
   
3. Why did NCUA go to the private markets, pay a premium, and incur significant costs when the funds are already at hand?   The CLF has a $41 billion borrowing authority, the corporate stabilization program has an initial $6 billion (and up to $30 billion in total draws), all of which is sourced directly from the U.S. Treasury.  The immediate cost of the issue is $11 million (net proceeds are less than the $4.0 billion) plus all other accounting and legal expenses recorded elsewhere.  The rate set on the fixed rate senior notes, is approximately 25-30 basis points above Treasury debt for the same maturity.  And on top of this, U.S. Central is paying a 10 or 15 basis points guarantee fee to the NCUA!  This does not appear to be very smart funding strategy for an institution which has net income of only 15-25 basis points in total even in good times!
   
4. Why weren’t these funds borrowed from the credit union system which has over $260 billion in investments?   Why did NCUA-U.S. Central not raise the funds from their own members?  The use of the proceeds is to repay other short term loans, advances, and borrowings and to invest the funds in the meantime.  In all the analysis of corporate investment problems, the difficulties caused by the leveraging of the balance sheet and creating dependence on external borrowings were common themes.
   
   Why is U.S. Central turning its back on its own membership? Why is NCUA-U.S. Central using banks J.P. Morgan and Bank of America/Merrill Lynch and paying their fees to pay off credit union funding?  Is it because it has lost their confidence?  Cannot compete for their funds?  Or is it contemplating becoming a retail corporate and wanting to compete with its own members by setting up funding sources for itself, not for its members?
   
5. Why are there no financial statements for any of the borrowing and guarantee entities in the circular?   How can any investor evaluate the appropriateness of the risk and rate without knowing the size and net worth of the borrowers and obligors?  Or are the financial circumstances so suspect that all NCUA can do is assert that it has the credit standing of the U.S.  Government, and then pay a premium rate after doing so?

Where is all of this heading?

The financial strength of the credit union system is not measured by its ability to borrow in private markets.  Rather its strength and difference is self-reliance, the ability to assemble resources and use them mutually.  This is the primary reason why credit unions and their members have been spared the worst impact of the current financial collapse.  When markets shut off lenders, credit unions still could rely on member funding.

The cooperative system rests on mutual trust, respect, and transparency.   This trust is especially critical in the financial industry, where asset size often becomes synonymous with power in all its dimensions.  Witness the current debate about banker bonuses.  Without trust, the components of the system will fall back on the traditional marketplace, Darwinian response of “going it alone” – each institution trying to create its own advantage.  This is what happened to the mutual thrift industry.

Leaders throughout the system must hold each other accountable for how the legacy each inherits is being managed.  NCUA has a critical role in this process of ensuring there is mutual accountability. But it must apply the same standards to its own actions.

If a credit union failed to produce an annual audit which is required by law, then used the credit standing of its sponsor to raise external funds, and then paid off its members’ shares with those funds to convert to a different kind of financial institution, there would be hell to pay from the rest of the credit union system.  But isn’t that what has just happened with NCUA-U.S. Central?

This article is also featured on Creditunions.com.