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A Couple of Questions to Consider Concerning Implementation of the Corporate Stabilization Fund…

How will you factor in the potential assessments, if at all, when evaluating long-term financial performance given that the dates and sums of the assessments will be unknown until 90 days before they are due?

Will you factor in the potential assessments when evaluating financial performance and making business decisions or will you view the assessments as extraordinary and separate them from your financial performance evaluation and decision-making process?  If you choose the latter, are you willing to do this, potentially, for the next seven years?

If you have limits on risks to earnings and net worth in your A/LM policy, will you factor in the cost of the assessment when comparing your risk to your A/LM policy?

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Response to the ANPR for Part 704

Below is an excerpt from our response to the ANPR for Part 704.  We encourage you to read the full nine-page version, which can be downloaded here.  Your thoughts and comments are appreciated.

Overview

It is apparent that the corporates with expanded investment authority are experiencing greater risk.  However, the range of risk varies in those with similar expanded authority levels as does the extent of the burden they are placing on the industry.  Such variance points to decision making with respect to risk management, each corporate’s appetite for risk and timely action of risk mitigation—a point we explore more in-depth later.   Unfortunately, healthy corporates with more conservative risk management strategies and processes may, in the end, cease to exist because of the actions, or lack thereof, taken by others.

If there continues to be a corporate structure, we recommend that the following decision drivers be used in determining how the system should be restructured.  Corporates should be:

  • Focused on providing support services only when viable alternatives are not available in the broader market for the masses of NPCUs
  • Made to pose as little systemic risk to the industry as possible
  • Designed to be not-for-profit

With these decision drivers in mind, we have formulated our recommendation for the restructuring of the corporate system.  Our recommendation is to separate Payment Systems/Operational Support Services and Liquidity/Investment Services into two businesses.  We believe institutional firewalls will not be adequate in an effort to limit systemic risks.

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Conservatorship of U.S. Central and WesCorp

Reading NCUA Letter 09-CU-06 was difficult.  However, since our founding in 1991, we have encouraged our clients to always consider Event Risk Conditions.  Most would agree that we are in such conditions!  Since the publication of NCUA Letter 09-CU-02 in January, we have encouraged our clients to consider the likelihood of additional assessments.  Following 09-CU-06, we continue that encouragement.

In light of 09-CU-06, here are some questions NPCUs should consider asking about Corporate Stabilization:

  • What would the cost to NPCUs be if additional corporates are put into conservatorship?
  • What would be the cost if a greater number of NPCUs fail over the next couple of years?
  • What would be the cost of recapitalizing the corporate system?

We hope a couple of these questions can be answered during NCUA’s Webcast Monday, March 23.  While these are ominous questions, facing them head-on will help NPCUs to be much better prepared.

The following are questions we feel NPCUs should be asking related to their long-term strategic and financial objectives:

  • What are our longer-term liquidity options should existing options become limited? (Note: the FHLBs are experiencing financial difficulties)
  • Are our strategic initiatives still applicable, or do they need to be altered or postponed given the most recent assessment?  …If member capital needs to be written off?  …If there are additional assessments in 2009/2010?
  • Would we be willing to contribute financially to a corporate recapitalization effort? If so, how much?
  • How much additional member deposit growth could we absorb while continuing to maintain sufficient net worth?
  • What if we have unexpected losses from our own business model?  How would we react?

A few words of caution.  It is understandable to want to find ways to improve upon a dismal earnings forecast for 2009.  However, while understandable, it may add unacceptable risks to your financial structure.  We strongly urge all NPCUs not to make decisions based on only the short term.  For example, the 10-year Treasury Bill and 30-year mortgages are now at, or near, record lows; increasing yield with longer-term investments or by making more mortgage loans and holding them in portfolio can add interest rate risk.

We encourage NPCUs to test the financial consequences, in advance, of all proposed changes to their financial structure, especially increases in long-term fixed assets.  Additionally, reducing operating expenses judiciously is one thing, but slashing them outright can threaten core drivers of profitability once markets stabilize.  A core purpose of net worth, after all, is to sustain a credit union through Event Risk Conditions and other rough times.

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Recapitalizing the Corporates

We have been asking numerous credit unions the following:

Assume corporates are stabilized but need to be completely recapitalized.  If the system were restructured and you felt it safe, how much would you be willing to spend as a percent of assets to recapitalize?  The most common answers are ” zero” and “we have not considered it.”

If this is the sentiment of the majority then it would greatly restrict the options for restructuring.