What A History Lesson In Corporates Means For Future
LAS VEGAS-What goes around, comes around, especially when it comes to corporate credit unions and crises.
But this most recent crash of many of the corporate CUs ultimately will have to break that cycle, according to one person, who has a long history working with credit unions through various meltdowns and problems.
In 1976 Mike Mercer was a graduate student at the University of Wisconsin when he took a part-time job with CUNA and began work on U.S. Central, which had been chartered two years earlier. It had emerged out of a debate within credit unions over how to create a central banking function that didn't require using a bank. Proposals ranged from one, national, central corporate, to an NCUA-backed plan that had one corporate for each of its six regions, to the plan that eventually won out, corporate CUs affiliated with nearly every state.
State-level corporates handled deposits, clearances and liquidity; U.S. Central's role was to focus on interactions with the money markets, primarily the investment banks. "U.S Central and the corporate CUs had clearly defined roles, and pretty clearly defined markets," said Mercer in remarks before the 1 Credit Union Conference co-sponsored by CUNA and WOCCU. "There was very little competition. It went that way until we had a spike in interest rates in the 1980s, and corporates found themselves invested long."
That was the first of three crises corporates have had to work through, noted Mercer, who was dispatched to Georgia to help turn that troubled corporate around at the time. "In those days we didn't close the corporate, we fixed it. Things went along that way, but we heavily dependent on voluntary, self-disciplined guidelines to manage risk."
That worked only until the end of the 1980s and early 1990s, when the savings & loan crisis struck. During that time Maryland-based Capital Corporate would fail, and several other major corporates came close to the same fate, recalled Mercer. "After that period, we learned from our mistakes-again-and we traded off standards and guidelines that were generally being ignored by that time for tighter federal regulations," he said. "The corporates got independence from their trade associations, and U.S. Central from CUNA. Open eligibility became popular, and that opened the door for problems that came to roost later on."
And competition "dramatically intensified." "By this time credit unions very liquid, so corporates got very involved in pumping money out of credit unions and into the money markets, and then into mortgage-backed securities," said Mercer. "And here we were again, as in the 1980s. Many corporates were seeking access to expanded investment authority. And all the while we were talking about all the fireproof and foolproof protections that were in place. Examiners were living in U.S. Central. And like everyone else in the money markets, we did not see the meltdown coming like it did, and corporate centrals were left holding what they thought were high-grade investment securities."
That leaves the question of "what does this all mean for the future," observed Mercer. "I think what you're hearing from NCUA is 'Enough,'" Mercer continued. "We can't tolerate another crisis to learn from. I think there's going to be a fair amount of over-reaction on the part of the agency. They are going to confine interest rate risk significantly in the new regulation, very little liquidity risk (the investment in cash flows), and they are going to be emphatic that leverage cannot exceed 25:1, or 4% of assets. So they are going to want real capital."
What's ahead, predicted Mercer, is a corporate with a highly-shrunk balance sheet built around crucial settlement balances. Nearly everything else will be off-balance-sheet, meaning it's going to be on the balance sheet of natural-person CUs. "So the risk is being transferred," noted Mercer. "I think that is going to impose a higher duty of care to understand how investments are being made. In the past you could have 100% of your investments in the corporates, and nary a word was spoken in the examination report. That's going to change."
Mercer expects corporates will continue to offer investment-related consulting, as they have strong skill sets in that area.