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• 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

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

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

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)

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

Secondary Mortgage Market

• FNMA – FHLMC

• Countrywide – GMAC

• 2004-2007: Perfect Storm• Low mortgage rates• Poor underwriting• Home prices rising

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

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

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

Capital Distribution

Retained Earnings CU Contributions• NPCUs: 11% n/a• Corporates: 2-3% +$3.5 billion• US Central: 1-2% +$2.0 billion

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

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)

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

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

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

Corporate System -- 201216 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

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

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

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

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?

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

Questions