ALEXANDRIA, Va.-The credit union community has expressed both support and concern for NCUA's handling of the legacy assets from the five failed corporate credit unions. To get the agency's perspective, Credit Union Journal spoke with NCUA Director of Examination and Insurance Larry Fazio, who shared NCUA's view on its management of those five failed corporates' investments and the conservatorships.
CUJ: When will the Temporary Corporate CU Stabilization Fund expire, by 2021 as NCUA originally stated, or sooner?
Fazio: It is impossible to predict when it will end. There are a lot of variables. One is ongoing performance of the underlying legacy assets and how that relates to the obligations we owe the NGN investors. There are some other residual assets in the Asset Management Estates we are still in the process of monetizing. However, most of that is done. The other variable is the pace at which the NCUA board makes assessments. But one thing I will say with certainty is that (the stabilization fund) will be done by 2021.
CUJ: Which firms have been used to audit the legacy assets?
Fazio: I want to make a distinction between conducting the underlying valuation of the assets versus the audit function. In terms of valuation, the first was PIMCO. In 2010 we started working with Barclays as part of the NGN process and overall corporate resolution. We used their analytics capability to value the bonds in that period. We engaged BlackRock by the end of 2010 and they have since been doing the valuation of the underlying legacy assets and helped with some of the analytics. The audit firm we have primarily used to conduct the financial statement audit for both the stabilization fund and the share insurance fund is KPMG.
CUJ: Many believe the current market value (67 cents on the dollar) NCUA has set for the remaining legacy assets is high, as they believe the remaining legacy assets are the poorest performing.
Fazio: Actually, the situation is reversed from what you stated. The really toxic stuff has defaulted already. Typically the worst stuff defaults quicker. Therefore, as time passes, you would expect to see better performance-what's left is what is still performing. My worry is that some in the CU community do not understand this.
CUJ: Another concern several CEOs raised is that the market value NCUA has placed on the legacy assets has not fluctuated much since 2010 through much of 2011, while they say the market values of RMBS traded during that period varied a great deal. Why did NCUA hold to a fairly consistent value, about 55 to 60 cents on the dollar from 2010 through most of 2011?
Fazio: I am not sure exactly what RMBS statistics your sources have been looking at-is it GSE paper, private label MBS? You have to compare apples to apples in terms of the structure of the securities. That said, NCUA is not setting the market value; BlackRock is not setting that number. The market is setting that number.
CUJ: Looking at the NCUA's lawsuits against 10 Wall Street firms, they show about 45% not performing-stating the securities are either in delinquency, bankruptcy, foreclosure, or real estate owned. Will any of this come back?
Fazio: We did not sue on all the bonds. We picked a subset of the bonds that we sued on, the worst of them for which we knew we really had a good case. Some of the assets securitized into the NGNs are actually performing very well. The CMBS (commercial mortgage-backed securities) securities are actually above par.
CUJ: There is a $9.1-billion gap between the ending legacy asset balance as of Q4 2012, and the ending market value of these securities. How can that be made up?
Fazio: The unpaid principal balance of the legacy assets as of Q4 2012 is $28.2 billion. The value assigned by the market to the legacy assets as of Q4 2012 is $19.1 billion. Hence the $9.1 billion difference you refer to. While we don't project collecting all of the remaining unpaid principal balance ($28.2 billion) on the legacy assets-there are still bonds that will default-our estimates of the net realizable value on the legacy assets exceeds the current market value by several billion dollars.
We owe the NGN investors $21.2 billion as of Q4 2012. The cash flows on the legacy assets (principal and interest) service the NGN note payments (principal and interest), backed up by an NCUA guarantee. So provided the cash flows on the legacy assets exceed what is owed to the NGN investors (netted out all in), there won't be any additional "losses" not already accounted for, and this is all already factored into the projected remaining assessments. Hypothetically, if we had to sell the legacy assets today we'd get $19.1 billion. But we don't have to sell today-that is the value of our strategy (of holding onto the legacy assets). We recoup a higher value, not even counting the potential for additional recoveries related to ongoing litigation.
CUJ: Securities analysts and economists told CU Journal 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 housing market. A lot is based on the assumptions within the predictive modeling. Can you tell us what is behind those assumptions, perhaps the agency's prediction on how quickly the housing market will recover?
Fazio: When you model, especially any amortizing security and ones tied to mortgages, you are really trying to understand the repayment behavior of the consumers behind those underlying mortgages. Every residential mortgage can prepay for free. There is also extension risk. Current interest rates affect how people hold onto mortgages or pay them off, as well as their ability to refinance. For example, when rates go down, people tend to prepay faster. If the person is underwater on their mortgage and if housing prices have dropped, they can't refi or do a short sale. So when you foreclose you get less recovery.
If housing prices go up, all that starts to change. Now banks can foreclose and get more money out of the sale, the borrower can do better on a short sale . . . So the biggest driver in terms of assumptions are home price appreciation, unemployment to a certain extent, and the foreclosure process itself. Mortgage modifications are a piece of this as well.
CUJ: Can we dig a little deeper into what are some of the actual assumptions?
Fazio: BlackRock does most of the modeling and they have expert economists tracking the economy, foreclosures, etc. Ultimately it feeds into a somewhat of a proprietary mix, a recipe if you will, for how they come up with these assumptions. It would be challenging to publish that as we would be giving away for free this proprietary mix BlackRock has.
CUJ: WesCorp relied on its own modeling that, in turn, relied, as experts have weighed in-including the NCUA's Office of Inspector General and the NCUA board-on overly optimistic forecasts.
Fazio: The difference between NCUA and WesCorp is that we are not using our own assumptions. We hired BlackRock, one of the top (analysis) firms in the world. They have no incentive to make things look good or bad. In fact, their incentive is to make their modeling as accurate as possible because their company's integrity is on the line.
CUJ: The biggest issue that bubbled to the surface from Credit Union Journal's conversations with CU CEOs is that they don't think NCUA has been fully transparent in handling, first, the corporate crisis, and then the legacy assets. For example, several CEOs asked why NCUA boardroom discussions of problems at WesCorp or U.S. Central did not begin until February 2009, one month before they were conserved.
Fazio: First, it is very easy to Monday morning quarterback. Second, 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. We knew the corporates were having liquidity pressures. We knew their investment portfolios were highly challenged. You could see it in their call reports. We tried to figure out the most orderly way to take action and worked on that throughout 2008. We don't broadcast these kinds of matters in advance, because we can't. They are inherently supervisory.
CUJ: The Journal spoke with 18 credit union CEOs and only three were aware of NCUA's legacy assets performance metrics page on your website, a key page in understanding the performance of the securities. Many have said NCUA has not been fully transparent in its handling of the legacy assets. Do you think this lack of awareness among CEOs of the information you are putting out supports that assertion-with many wondering why the agency did not make it more apparent the information was there?
Fazio: It really bugs me that people who have not taken the time to see and read what we have put out on our website to complain we have not been transparent. We have exhibited an unprecedented level of transparency. You find me another government agency that has put out the same level of information we have on the corporate resolution process and legacy assets. We put out DVDs, held webinars and town hall meetings, and there is a boatload of information on our website we continue to update. It's a staggering amount of information we have put out and for people to say we have not been transparent is just ridiculous.
CUJ: A number of CEOs say that the website information only confuses them and is difficult to understand. Shouldn't the agency be addressing this matter?
Fazio: That is a fair question. But there are three types of groups in our audience, and it is challenging to serve all three. One group really understands finance, bonds and economics, and they want all this nitty-gritty information so they can recalculate all the numbers. On the other side of the scale, unfortunately, you have CEOs who don't understand investments or finance. So for them to grasp some of the complicated concepts . . . to a certain extent we are presenting calculus and trigonometry and they are still in the arithmetic and algebra mode. And then you have those in the middle. But we are not shooting for the lowest common denominator in terms of a baseline understanding, and if people don't have some base of knowledge that helps them understand this information, I can't fix that.
CUJ: You recently put out a Q&A on the legacy assets that was included with a press release updating legacy asset performance. It seemed to address many questions that CEOs had been asking; why wait until the first quarter of this year to put that information out?
Fazio: We have had a couple standing Q&As on the website. We put this latest one out because we did recognize people were not necessarily seeing all the different places on our website where we provided legacy asset details. Plus, we wanted to give people a document they could print and hand out.
CUJ: It took NCUA until late in 2011 to produce its 2010 audited financial statement for the Temporary Corporate Credit Union Stabilization Fund. Why so long, and were auditors changed in that process?
Fazio: In 2010 KPMG was the new firm coming in and I do not recall the firm going out. There are a few reasons why that audit took longer than we would have liked. As we rolled over year-end 2010 we were halfway through the NGN process, so we have all five corporates in conservatorship. Only half of the legacy assets had been securitized, and we were rolling into 2011. It was a complicated period with some big numbers and simply a lot to deal with as were going through that audit. That's why it took longer-for the audit firm to get comfortable with exactly where the numbers were etc. Ultimately we did and we got clean opinion, and then again in in 2011 and 2012. Plus, the audits on the stabilization fund proceeded much more quickly in the last two year, mainly because the audit process became more refined and there were many fewer variables to account for.
