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The Corporate Credit Union Crisis and Aftermath:  Evolution of an Industry

The Corporate Credit Union Crisis and Aftermath:  Evolution of an Industry. September 27, 2012. Corporate System – The Beginning. Created in mid-late 1970s NPCUs did not have access to the Fed Most NPCUs 100+% loan/share ratios Original vision – mimic the 12 Fed districts

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The Corporate Credit Union Crisis and Aftermath:  Evolution of an Industry

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  1. The Corporate Credit Union Crisis and Aftermath: Evolution of an Industry September 27, 2012

  2. Corporate System – The Beginning • Created in mid-late 1970s • NPCUs did not have access to the Fed • Most NPCUs 100+% loan/share ratios • Original vision – mimic the 12 Fed districts • Leagues led movement to create system • Ended up with 41 corporates (2 in Mass)+ USC -official network tied to State Leagues • US Central created in 1975 • Spun-off from central credit unions • CUNA controlled US Central • Majority of corporates shared management with leagues

  3. Corporate System – The Beginning • Primary purpose – provide cash flow assistance • Reliable Liquidity Provider • Developed correspondent & payments services • Balance sheet growth mid-late 1980s with fall of S&Ls • Developed investment expertise • Corporates growth reflected their memberships • All had set FOMs – no overlaps • Some cases had to be a League member to join • Varying memberships resulted in very different sized corporates – assets and subsequently infrastructures • Wescorp (California + Nevada) • South Dakota Corporate • Some corporates experienced financial troubles

  4. Corporate System – the 1990s • Standards & Guidelines (ALM) • Banesto • CapCorp failure (CMOs) • Liquidity problem / Member capital lost ($60m) • Regulation 704 • Separation of league/corporate management • NCUA witch hunt • Merger activity starts • NCUA wants consolidation • Opens up all FOMs - nationwide • Paid-in Capital introduced (PIC) • MCS – notice goes from 1 to 3 years

  5. 2000s - the beginning of the end • Competition begins to trump cooperation • Corporate system – dysfunctional • Competition creates rate inflation • Corporates create own investment rate curve above agency yields • Asset growth greatly exceeds retained earnings accumulation capabilities • Growth fueled by above market rates • Additional risks taken to provide more competitive yields • Capital imbalance masked by member capital • Concentrations in private issue mortgage-backed securities by largest corporates • Arbitrage transactions • Sandlot (USC)

  6. Background – Corporate Investments • By regulation – highly rated securities • Majority AAA-rated when purchased • Securities can be readily sold for liquidity • Expanded powers needed for additional credit/NEV risk • 5 Levels of expanded authorities • Credit (2)/Foreign/Derivatives/Loan Participation

  7. Secondary Mortgage Market • FNMA – FHLMC • Countrywide – GMAC • 2004-2007: Perfect Storm • Low mortgage rates • Poor underwriting • Home prices rising

  8. Secondary Mortgage Market • Market conditions steady decline since mid 2007 – starting with sub-prime • Problems moved into all mortgage markets –prime & non-prime • Market values of private issue mortgage securities in free fall making them completely illiquid • Monoline insurers masked deeper underwriting problems – start to fail

  9. Secondary Mortgage Market • Rating agencies underestimated potential losses on AAA-rated mortgage securities • Did not factor in severe drop in RE values • US Central FCU & several other large corporates overly concentrated in non-agency mortgage securities (up to 50% of portfolio) • NCUA examiners on-site full-time at each of the conserved corporates

  10. Corporate Holdings – March 2009 • Corporate Investment Holdings • $64 billion in mortgage securities • $41 billion in non-agency mortgages • $22 billion outside US Central • $18 billion in unrealized losses • First Carolina • $98 million in non-agencies (0.24%) • $48 million in unrealized losses

  11. Capital Distribution Retained EarningsCU Contributions • NPCUs: 11% n/a • Corporates: 2-3% +$3.5 billion • US Central: 1-2% +$2.0 billion

  12. NCUA Actions • SIP/HARP Liquidity Programs (4Q-2008) • Capital infusion in USC $1 billion (Jan 2009) • Guarantee of US Central Deposits (excluding capital) • Voluntary guarantee for corporate CUs • PIMCO review- 100% of private mortgages in corporate system • Expectation of further large write-downs • Seeking comments to re-write Corporate Regulations - due April 6th (ANPR) • March – Wescorp & US Central conserved • Constitution, Southwest, & Members United followed

  13. New Regulation 704 • Significant reduction in allowable managed on-balance sheet risks • More focus on liquidity function – much shorter portfolio WAL (2 year limit for weighted average life of portfolio) • Eliminates most leveraging capacity • Reduces credit concentrations limits (Sector & Issuer) • Non-agency mortgage securities prohibited • No more wholesale corporate • Higher capital requirements for Tier 1 or Core Capital • Retained earnings + Perpetual Contributed Capital (PCC)

  14. Corporate System -- 2011 • Total of 25 retail corporates + 1 wholesale corporate (US Central) when financial crisis hit • 5 corporates conserved • Troubled MBS assets @ NCUA’s asset liquidation unit • Constitution corporate liquidated into Members United Corporate • 4 Bridge Corporates formed with 2-year charters: • US Central Bridge • Western Bridge (Wescorp) • Southwest Bridge • Members United Bridge

  15. Corporate System -- 2011 • Western (Wescorp) Bridge failed its recapitalization effort to become United Resources Corporate • NCUA will maintain until a smooth transition can be made so current members do not have interrupted service • NCUA trying to sell off Wescorp operation/members to another corporate • Current Bridge Charter good through September 2012

  16. Corporate System -- 2011 • Southwest Bridge merged into Georgia Corporate although headquarters to remain in Dallas, TX • Successfully recapitalized* and is now operating as Catalyst Corporate CU • Members United Bridge successfully recapitalized* • Now operating as Alloya Corporate *both did have to modify recapitalization plans to lower capital expectations

  17. Corporate System -- 2012 16 corporates (in 2009 > 25+1) • 5 mergers (VA, WVA, GA, SE, MT)/3 liquidations (IA, Midwest, Constitution)/1 P&A (Wescorp) • Less First Corp: P & A (by Catalyst) • Less Cencorp: merging with Alloya • Less Louisiana: merging with Corp America (called off 9/17) • 4 others at risk due to weak earnings • US Central to be closed by end of October 2012 • NCUA LUA/Share Guarantee will expire as of December 31, 2012

  18. Corporate System -- 2012 • When NCUA liquidates US Central the end of October -- 6000+ NPCUs lose access to the Central Liquidity Facility (CLF) • CLF lending capacity drops from $46B to $2.1B • (only 96 direct members) • Balance sheet and earnings constraints impact corporates ongoing ability to be a CLF Agent • Will continue to serve correspondent role to CLF

  19. Corporates -- Future Outlook • Corporates capitalized to varying degrees: • Some will focus just on settlement balances & payments • Some will be able to provide variety of on-balance sheet deposit products • Ability to provide liquidity & LOCs will also vary corporate to corporate depending on how well capitalized they are for the membership they serve • Term deposits will primarily be handled off-balance sheet (>1 year) • Fed EBA program has become critical for managing balances & capital levels • Some corporates more dependent than others

  20. Corporates -- Future Outlook • Value of corporates can vary quite a bit under new environment. Size may no longer dictate competitiveness of product offerings – capitalization to membership very important to long term stability. • Retained earnings requirements • Must be able to earn enough spread to build retained earnings • NCUA has set retained earnings thresholds for 3 years, 6 years, & 10 years • Narrow NEV tightrope – particularly with limited capital • Potential for additional consolidation as corporates operate within the new corporate and regulatory framework

  21. Corporates -- Future Outlook • Sole purpose of corporate system – add value to NPCUs • Innovate & aggregate/cooperatively owned and controlled • Essentially high participation CUSOs • Corporate system has changed but still maintains considerable value in skill levels & ability to adopt and change • Will credit unions participate?

  22. First Carolina Corporate • $2B in assets • Lost $98.5 million in capital at USC/100% of RUDE • Members lost PIC & 20% of MCSD • Transparent & Open throughout crisis • 90% recapitalization rate -- $68m/ 5.57% capital ratio • Liquidity resource still important to members so additional levels of new member capital needed • $1.5 B in assets • Settlement services: <1 year short term deposits • Low cost correspondent services • ALM & Investment advisory & sales • Financial Education

  23. Questions

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