ALEXANDRIA, Va.-It's been four years since the most cataclysmic and costly series of events in the history of U.S. credit unions: the conservatorship by NCUA of five failed corporates.
Those institutions-U.S. Central, WesCorp, Southwest Corporate, Members United and Constitution Corporate-are gone now. But they have left behind the so-called "legacy assets," with the biggest legacy being the question, "What will be the final cost of those failures to natural-person credit unions?"
It's a question Credit Union Journal has worked for many months to, if not answer, at least narrow down the forecasted range on the ultimate cost. There remains a divide in opinions, with some saying the projections being made by NCUA are in line with their own, and other analysts saying the costs are going to be higher than what NCUA is forecasting.
Another legacy has been a belief by some that NCUA has not been sufficiently transparent regarding the performance and ultimate costs related to the five corporates' investment portfolios. But NCUA has countered it has been robustly transparent, noting it has hosted town halls, and has more than 15 pages of related information available online.
As noted in the initial installment in this report in the May 6 Credit Union Journal report, in an effort to answer that question the Journal has spoken with analysts, economists, credit union CEOs and obtained information and data as the result of a Freedom of Information Act requests filed with NCUA.
Since that May 6 story, NCUA has released additional data to Credit Union Journal related to the "assets" that are the remaining legacy of those corporates, that is, the investment portfolios.
The Current Forecast
From the failure of five corporates, NCUA is now projecting that natural-person CUs are on the hook for a remaining $1.6 billion to $3.9 billion. Adding that amount to the $4.1 billion in assessments already paid and more than $5 billion in membership capital lost, the final tab, according to NCUA's projections, indicates it will fall in the range of $11.3 billion to $13.6 billion.
At this point in time, however, it's difficult to say whose estimate is closest to what the final cost will be. Everyone involved, from NCUA to the firms it has retained to outside parties, is using different models to make their best guess at how the economy and housing will perform. As housing has made all too clear in the past, that can prove to be a difficult bet.
A number of CEOs who spoke with Credit Union Journal, several requesting anonymity as the only way they would offer an opinion on the costs related to the failed corporates, said their hope is that there is now light at the end of the assessment tunnel. By NCUA's estimates, the costs related to the failed corporates could come off the books sometime in the next seven to eight years, possibly sooner. NCUA has also proposed an escalated repayment schedule to save credit unions money and shorten repayment time.
Many credit union executives are optimistic that NCUA's latest loss estimates are accurate. "I believe what NCUA is saying to be true," said Jim Blaine, CEO of State Employees' CU in Raleigh, N.C. "I have no reason to doubt NCUA is trying to provide a best estimate of the range of losses. I back them 100%."
"Get this-Jim Blaine endorses NCUA. People will read that," said Blaine with tongue in cheek.
Blaine, who has sparred with NCUA in recent years, acknowledged it is difficult for anyone to predict how the economy and residential mortgage-backed securities (RMBS) will perform and that NCUA's job is not simple in this case. The agency is using several investment advisors, including BlackRock, to create valuation models for the legacy assets it is managing.
Problem Could Be 'Bigger'
But along with that hope is concern among some analysts that the price tag for natural-person CUs to cover the losses suffered by the failed corporates is going to be higher than what NCUA has indicated. When the corporate assessments were first announced, NCUA was low-key about the eventual price tag, but projected that it would fall below $10 billion. Since those initial forecasts, however, the loss projections made by NCUA have steadily risen. The same holds true from forecasts from some outside analysts who have not been as optimistic and have suggested that figure could be as high as $25-$30 billion.
"The problem could well be much bigger than what NCUA is projecting," said Michael Moebs, who in 2010, at a time when discussions of the corporate losses suggested total losses well below $10 billion, estimated losses at $17 billion or higher (Credit Union Journal, July 19, 2010). "Now, with the performance we have seen of residential mortgage-backed securities, I fear the losses could be greater, much more than what NCUA is telling us," added the economist and CEO of Moebs $ervices in Lake Bluff, Ill. "These assets per the PIMCO report five years ago were not worth more than 50 cents on the dollar. Much of the securities remaining in the legacy assets are non-earning, or what the Street calls 'zombie securities.'"
One securities expert with close ties to the credit union system believes "there is going to be a big day of reckoning after it's been made known by NCUA that the assessments that have been paid fall well short of the cost to cover the losses of the legacy assets. There will be a big price tag to pay."
Some feel that day may arrive in the next five to 10 years, at a point when the Treasury has to step in to guarantee the NCUA-Guaranteed notes (NGN) when losses on the legacy assets become too great.
NCUA's Director of Examination and Insurance, Larry Fazio, stands by the forecasts the agency has released (see related story).
The Issue of Transparency
The divided forecasts and the uncertainly primarily stem from what many people described to Credit Union Journal as what they see as a lack of transparency by NCUA when it comes to its oversight of the corporate credit unions' operations, especially those legacy assets. But Fazio disagrees with that assertion, too, stating that NCUA has been releasing audits and making information available on its website ever since the conservatorships took place.
One factor driving some distrust around NCUA has to do with a misconception that the agency knew very little of the impending catastrophes at U.S. Central and WesCorp until only months before the agency conserved the former corporate giants in 2009.
NCUA board minutes released to Credit Union Journal through a Freedom of Information Act request revealed that discussion of troubles at WesCorp and U.S. Central did not begin at the level of an NCUA board meeting until the Feb. 26, 2009 meeting (Credit Union Journal, July 23, 2012). At that time, Owen Cole, then-head of NCUA's Central Liquidity Facility, said a PIMCO analysis had revealed that expected losses at both organizations were in excess of the corporates' total capital positions.
Up until that point, even with resident examiners at U.S. Central in Kansas and WesCorp in California, there had been only moderate concern expressed by NCUA and its three-member board over the health of the corporates' portfolios. All that changed just a little more than a month after Cole's disclosures, when NCUA stunned the credit union community by moving quickly and taking over WesCorp and U.S. Central on March 20, 2009.
A 'Ridiculous' Assertion
But Fazio stressed to Credit Union Journal that the agency knew of the former corporate giants' problems long before discussions of trouble at WesCorp and U.S. Central surfaced in the NCUA board room. "For people to suggest that we did not know what was going on at WesCorp and U.S. Central until early in 2009 is ridiculous. We talked about those matters in private, closed-door meetings, not in an open-board meeting where minutes are taken."
Four years after the conservatorships that shocked many people, what remains troubling, sources indicated, is that perception that NCUA is not sharing much detail on the legacy assets. Several investment experts who spoke with Credit Union Journal indicated that the information NCUA has shared on its website does little to allow for true long-term loss projections from the five failed corporates' investments. What is needed, they say, is detailed information on the legacy assets: the CUSIP (Committee on Uniform Securities Identification Procedures-the 9-character alphanumeric code which identifies a North American financial security), the original face, the label, and the original price paid.
That information has since been released to Credit Union Journal.
"We need to see what is behind these securities to get a true understanding of the potential losses," said Moebs. "Knowing the breadth and depth of a problem makes it easier to solve."
CUNA, NCUA Analyses Align
CUNA Chief Economist Bill Hampel explained that the trade association's legacy asset loss estimates closely align with NCUA's, as they have in the past. But he believes releasing the CUSIP-level data on the legacy assets is needed. CUNA, as a member of both U.S. Central and WesCorp, had the right to review the CUSIP-level information on the securities owned by the two failed corporates. Hampel reminded that in 2010-2011 the trade association ran an analysis and came up with values that were similar to NCUA's.
"We have asked NCUA to give us that information again, for the entire remaining legacy assets, and they have not," Hampel recently told Credit Union Journal. "That level of transparency would be useful. NCUA says it's too complicated and if they gave it to us they'd have to give it to everyone else. But I absolutely see no harm in them releasing that information."
Via a Freedom of Information Act request, CU Journal asked NCUA for those details on the investments currently held by the agency for the five failed corporates. Initially, NCUA provided all but the original price paid, citing FOIA exemption 5 U.S.C. § 552(b)(4), stating in a letter the exemption "protects from disclosure trade secrets and commercial or financial information obtained from a person, which is considered privileged or confidential."
However, that data was eventually provided after follow-up requests by the Journal.
Insights From Released Data
While NCUA for years has not shared CUSIP-level details on the legacy assets that investment experts say would allow them to more accurately project the future losses, information the agency has released on its website and through its lawsuits against 10 Wall Street Investment firms provides insights and possible reasons why some believe the losses may be greater than what NCUA's models project.
On the agency's website it lists "Performance Metrics" on the legacy assets and NGNs (http://www.ncua.gov/Resources/Corps/NGN/Pages/Metrics.aspx). The data on the page indicates the value of the legacy assets to have consistently been 55 to 60 cents on the dollar from Q4 2010 through Q2 2012. Analysts have not only questioned that valuation-some pegging the value at 20 to 30 cents on the dollar-but also have wondered why NCUA's market value on the assets has not changed much through this period when the value of RMBS securities have widely fluctuated.
NCUA's Fazio said it's important that those reviewing the numbers around the complex securities make "apples to apples" comparisons (see related story).
Analysts On Guard
But what really has a number of analysts on guard is the difference between the ending legacy asset market value ($19.064 billion) and the ending legacy asset balance ($28.201 billion) as of Q4 2012. That $9.1-billion gap has to be made up via improved legacy asset performance-much better than the securities' track record since 2010-or at some point down the road will need to be made up by credit unions. Experts question if that can happen due to the very "toxic" nature of the securities that remain. According to NCUA's website (http://www.ncua.gov/Resources/Corps/NGN/Pages/AssetOverview.aspx), 74.70% of the portfolio is below investment grade.
Language in the agency's lawsuits against the Wall Street investment firms, filed from 2011 through 2013, states that about 45% of securities invested by corporate credit unions through these firms are not performing. The suits say this portion of the mortgage collateral was in delinquency, bankruptcy, foreclosure, or was real estate owned.
NCUA spokesperson John Fairbanks, in a statement to Credit Union Journal, said "a vast majority" of the legacy assets were invested through the 10 Wall Street firms NCUA is suing. The agency's
The Toxic Securities
Another reason experts question NCUA's loss estimates is the overall poor performance of what are now described as toxic RMBS securities that sent the investment markets crashing in 2008-2009. NCUA recently updated its legacy assets metrics to include asset performance through Q4 2012, showing the performance of the legacy assets to have improved and their value increased, placing their value at 67 cents on the dollar, which is again higher than some analysts' forecasts.
Analysts have observed that on about $40 billion in legacy assets that NCUA took control of (after selling off $10 billion of the best-performing assets), placing a value of 20 to 30 cents on the holdings puts future losses closer to $25 to $30 billion. They noted that more than $5 billion has already been lost in membership capital from all the corporates, plus $4.1 billion in assessments paid. In addition, there is the matter of repaying $5.1 billion in Treasury borrowing to support the stabilization fund, which some say is really more of a liquidity issue.
The Fed, too, has weighed in on the matter. According to a 2012 Federal Reserve study, "From Wall Street to Main Street: The Impact of the Financial Crisis on Consumer Credit Supply," as the asset-backed securities (ABS) market became illiquid, corporate CUs faced about $30 billion in projected losses in that market.
After recently lowering estimates on projected losses, the NCUA is still holding to its 2013 corporate assessment estimate of 8 and 11 basis points. The lower loss estimate, the agency has stated, is due to the performance of the legacy assets and projected future performance of the NCUA Guaranteed Notes.
The Cash Flow Scenarios
Some have argued that the portion of the legacy assets that are not performing will eventually return some cash flow. Yet investment firms noted that a great deal of what U.S. Central, and particularly WesCorp, invested in were subordinate tranches of Alt-A securities, the first in line to take the losses. In May 2009, then NCUA Board Chairman Michael Fryzel testified on the state of the corporate CU system in front of the House Subcommittee on Financial Institutions and Consumer Credit. Offering a view of what NCUA believed was ahead, Fryzel said, "...the riskiest security tranches are those that protect more senior securities (i.e., they are subordinate) and/or have longer average lives. The unfortunate reality is that even for the lower end of the range, there are relatively large projected credit losses within the corporate system.
"The largest concentrations of projected losses are in the subordinated securities backed by Alt-A and Option ARM collateral that protect more senior securities, with the second-largest source of projected losses from securities backed by sub-prime mortgages. Alt-A and Option ARM loans have performed, and are expected to continue to perform, exponentially worse than expectations forecast at origination. Improvements in collateral performance for these types of securities can still have a marginal effect on losses, but NCUA is highly confident that significant losses will result under any reasonable scenario."
"Can some of the legacy assets come back? It's possible," said Moebs. "But it would take a lot of time, maybe 20 years, with all the bad underwriting behind these securities."
Not surprisingly, and consistent with the range of forecasts, not everyone agrees. "I believe that the 67 cents net worth is reasonable," one analyst told Credit Union Journal. "The price should have increased for two reasons: Most of the senior mezzanine and senior support structures of 2006 and 2007 vintages of the RMBS should be gone by now-100% losses-and market prices in non-conforming securities have increased during the last year.
Still Some Economic Value
"I continue to see economic value in retaining non-conforming securities, for market-value losses continue to be greater than the cost of selling versus retaining the securities. Remember, too, that RMBS-unlike ABS structures-do cash flow with coupon payments on the remaining principal even as they are defaulting. So the NCUA should be realizing some positive income with the coupons of the structures versus the NGN payments. If the market values are correct, chances are high there will not be a $9-billion gap. Actually, the way I see this, the NGN balance is only $2.1 billion higher than the current legacy assets' ending market value, which seems manageable."
KPMG has been the firm used to conduct the financial statement audit for both the stabilization fund and the share insurance fund. The stabilization fund has received clean audits every year, although 2010's results were delivered one year late. PIMCO, Barclay's and then BlackRock, respectively, have been used to value the legacy assets.
A Boost From Improving Market
CUNA's Hampel said the estimated losses on the legacy assets are falling because the underlying market-securities, housing and overall economy-is improving.
"The valuation is rising because all of the market is improving and more time has passed since the beginning of the economic crisis, so investors are less nervous. Yes, you can make estimates, but the important thing to remember is that no one knows what the final cost will be because they won't play out for next seven to eight years due to the long-term mortgages underlying the legacy assets."
Hampel projects remaining assessments to be in the lower to middle range of NCUA's current estimates ($1.6 billion to $3.9 billion). He also projects that NCUA may only need to collect little more than three years' assessments at last year's rate (9.5 BPs of insured shares). The chief economist, however, is not in favor of CUs overpaying and then taking a rebate, as that would impact balance sheets and understate credit union performance during years in which they overpay.
But Henry Wirz, CEO at the $1.9-billion SAFE CU, North Highlands, Calif., who has closely followed the plight of the corporates and the performance of the legacy assets, says there is disconnect between some information on the agency's website, and especially information shared in NCUA's lawsuits against the 10 Wall Street firms, with what NCUA is saying today.
"There is a lot of optimism today from NCUA and others," said Wirz. "The latest news is that we will experience lower losses than what had been projected as recently as a year or two ago. That is very difficult to reconcile with the information NCUA submitted in the lawsuits, where they are showing significant impairment with the legacy assets. Look at the suits. They show huge unrealized and realized losses in these securities and it is hard to see that same level of impairment in how the agency is projecting future losses to the remaining legacy assets."
Low Levels of Awareness
In March of 2013, Credit Union Journal reached out to 18 credit union CEOs asking them if they were aware of the legacy assets metrics page on NCUA's website, and to ask their opinions on the data. Only three were aware of the page on NCUA's website (http://www.ncua.gov/Resources/Corps/NGN/Pages/Metrics.aspx). The others were left wondering why the agency did not make it more apparent the information was there. Many commented that nothing can be determined unless CUSIP-level detail is released, questioning why that has not been done.
The agency, however, said it has published regular updates during the year, with the last two coming March 27 and 28. The March 27 release addressed the stabilization fund's clean audit, and then the following day updated corporate system resolution costs.
"NCUA has not adjusted the mark-to-market, even though Wall Street has," shared one CEO. "It's like NCUA is frozen in a point in time, living in a static world, not adjusting values for market changes-and gains. Who knows which is correct? This is where those CUSIPs would come in real handy. For the most part, we're dependent on NCUA and their consultants for evaluation of the assets and future losses."
It makes the industry wonder how much natural-person CUs will remain on the hook for, said another CU exec. "It looks like it might not all end until after 2020, with a nasty $2 billion in losses after that date. The anticipated losses are not in line with what we've been told-I thought they talked about $7 billion more and the chart on their site shows maybe another $10 billion in losses coming. Some of their charts show 2020 as an end-date and another chart shows an undetermined end date after 2020 with a $2-billion at-loss risk."
Criticism From The GAO
In January 2012, a Government Accountability Office study stated that NCUA's loss projections from the failure of the five corporates were unreliable and therefore it was not possible to estimate the ultimate losses from the corporate collapse (Credit Union Journal, Jan. 4, 2012). The study said NCUA was unable to provide the office with the requested documentation to support corporate loss estimates, which are being paid by the credit union system.
"Absent this documentation, it is not possible to determine the full extent of losses resulting from corporate credit union failures," said the GAO. "Moreover, without well-documented cost information, NCUA faces questions about its ability to effectively estimate the total costs of the failures and determine whether the credit unions will be able to pay for these losses."
However, in May 2012, the GAO verified NCUA’s estimates of projected losses for the legacy assets. NCUA reported that when the GAO completed its review, NCUA was in the last stage of finalizing the 2010 Financial Statement Audit for the Temporary Corporate Credit Union Stabilization Fund with accounting firm KPMG. NCUA stated that after the GAO reviewed the audit, the GAO verified NCUA’s estimates (
Some have suggested NCUA is doing little to encourage credit unions to understand the details of possible future loss scenarios, and may even be discouraging them from gaining an understanding with its website's "confusing data."
'No One Has Done What We've Done'
SAFE's Wirz, for instance, believes that the NCUA website data is hard to decipher and may even lead to misinterpretation of just how severe the losses may ultimately be. "NCUA needs to do a much better job of keeping us all informed on the valuation and pay-downs of the legacy assets. I think most people are not being given the kind of easy assimilated information that would allow us to keep track of what is unfolding."
But NCUA believes those statements are off-base. NCUA's Fazio told Credit Union Journal that the agency has shared an "unprecedented" level of transparency with the agency's website postings, regular updates, and letters to credit unions on the entire corporate resolution.
"You find me another government agency that has put out this same level of information. No one has done what we have done," said Fazio.
In addition to NCUA's updates and town halls, the agency has more than 15 pages of information on the legacy assets, NGN, and corporate resolution program, including an NGN timeline, legacy asset RMBS delinquency details and risk concentration, performance metrics, projected legacy asset losses, FAQs, background, and more (http://www.ncua.gov/Resources/Corps/NGN/Pages/default.aspx).
"We put out DVDs, held webinars . . . and there is a boatload of information on our website we continue to update," added Fazio. "It's a staggering amount of information we have put out and for people to say we have not been transparent is just ridiculous."
Fazio, too, believes that the data is understandable to those in the CU community with investment knowledge.
Yet Wirz, and several other credit union CEOs, reiterated what they say are problems they have had unraveling what the data on NCUA's website really says about future losses. "It's confusing, from the reconciliation of what was originally taken out of the corporates to where we stand today in terms of the legacy assets, to the amount the securities have recovered, the amount written off, it's very difficult to tease that out of NCUA's website," concluded Wirz, who noted that he also spoke with someone skilled in forensic accounting who has struggled to understand the NCUA data.
NCUA has provided to Credit Union Journal a detailed response to its handling of the legacy assets and corporate resolution. That interview appears separately.
"I believe that our regulators have sold our system a bill of goods with little to show for what we have bought," shared another CEO. "The indication to me is that losses will be extremely high at some point in the future. Natural-person credit unions will be forced to take the hit--again."
Part of the problem for credit unions may be self-inflicted, with several people suggesting CU leaders do not want to know if the losses will be greater than NCUA is stating are instead simply hoping for the best. As one CEO stated, "I admit this whole situation made me so upset that I simply had to let it go. I can't do a thing about it. The more I understood, the worse I felt."
Micromanaging The Message?
But Randy Karnes, CEO of CU*Answers, Grand Rapids, Mich., suggests the more CUs know about the legacy assets the better they'll feel. "NCUA is orchestrating this situation so they come out looking like heroes. This has been a crisis optimized for NCUA's advantage. They are managing the message to manage the industry's evaluation of their work.
"We never know (all the answers) because the industry owners did not to get to solve the problem," continued Karnes. "NCUA took the assets away and sold them guaranteeing an outcome and now they want to spin the outcome to the agency's benefit. Their transparency is poor, and is it poor because they are manipulating the message, or poor because they simply have disregard for what they have to live through versus what they tell credit unions to live through. They tell credit unions that if they don't get CPA and consultant opinions and don't share those opinions with a board of owners and NCUA, that they are suspect from day one. Now it's OK for NCUA to have late opinions and not use a broad base of experts. It's OK for them not to vet their solutions with ownership of industry."
But another analyst with industry ties to believes NCUA has been calling the corporate crisis exactly as it as it sees it all along.
"Their (legacy asset) numbers have consistently been quite solid along the way," the analyst told Credit Union Journal. "Yes, they have been adjusted upward some because they were merely projections earlier and subsequent actual performance in the pools over the past three years have now solidified some of those projections. But their audits, both CPA and GAO, have basically validated them all along. This program, barring a major Greece-type economic debacle, will pay off two or three years early. Assessments will stay in the single-digit range, whether there is a voluntary advance payment option provided."
Still, one economist observed that what NCUA is projecting for the future performance of the legacy assets is based on its own interpretation for the future of the economy and the housing market in particular. "You are forecasting performance of individual investments, how the markets will do etc. That gets into modeling, which requires a lot of assumptions-whether or not the housing market is picking up or a person will default or not. The devil is in the details, and it would be important to know what the agency's future expectations are."
Future expectations played a large role in optimistic views WesCorp leaders held for its portfolio, despite markets collapsing around them. NCUA board minutes revealed a great disparity between WesCorp's own analysis of its portfolio with those performed by PIMCO and RiskSpan. The PIMCO analysis triggered NCUA's conservatorship of WesCorp. During a March 16, 2009 board meeting, Scott Hunt, then acting director of the Office of Corporate CUs, and Rick Mayfield, Hunt's staff member, suggested a big reason for the disparity was that WesCorp assumed a dramatic turnaround in the real estate market that Mayfield called "unrealistically optimistic."
Yet Another Theory
There is another theory argued by some that NCUA is simply kicking the can down the road so as not incur another huge blow to the system so soon after the corporate failures. But if NCUA was hoping to eventually limit some losses through recoveries from suits against the Wall Street Investment firms, that strategy may have been checked when several federal courts recently ruled to tentatively dismiss some of NCUA's claims or delay proceedings on the grounds NCUA has filed the civil claims too late to satisfy the statute of limitations.
Gregg Stockdale, CEO of 1st Valley CU in San Bernardino, Calif., is concerned what could happen to the CU system if it becomes clear that significant losses above $16 billion are comings. "The horse has left the barn and there isn't anything we can do to fix it at this time. We just get to pay and pay and pay. Watch when a few of the larger credit unions decide it's cheaper to be a bank than pay the open-ended check to NCUA every year. Once one or two leave it may be a stampede, because of the multiplier effect of the increase in premium we all carry. This bubble is just waiting to burst and destroy the CU industry."
On the other hand, Brad McClain, EVP and CFO at the $1.7-billion UW CU in Madison, Wis., said, "My gut feeling is the final ticket will be less than what has been stated by NCUA. With each update the range of losses gets narrower. Plus I don't think NCUA wants to run this assessment period out until 2021. I think they will keep a consistent assessment as long as the credit union system remains healthy, but will try to accelerate payments. And as the range of losses continues to decline NCUA will build enough reserves cover any future losses."
Back To That Core Issue
Sources agree that all the debate, and the differing opinions would likely not be present today were there not perceptions that NCUA could have been more forthcoming regarding the problems within the five failed corporates and those legacy assets.
"It comes down to NCUA not being fully transparent," said Moebs, who also finds it interesting why the House and Senate, the Treasury, and most notably, the banking lobby, have not weighed in on the corporate losses. "I am not sure what that tells us. But one thing I do know is we are all flying blind now without instruments. This is like trying to land a plane in the dark of night in bad weather on an aircraft carrier in the middle of the ocean. That is about impossible to do-I know, I have done it and almost killed myself. That is where we are with these legacy assets now."
