Learning from the Past

History is vital to interpreting human experience and meaning.   Understanding  where we have been helps us appreciate the present  and what the future may hold.

Our perspective of the past can change as events unfold.   What may have seemed wise or foolish at the time can now be viewed with greater clarity.  This capacity for self-reflection is critical when making decisions today.  It is called wisdom.

Calling for Wisdom by a Board Member

At the March NCUA Board meeting during the staff’s update on the Corporate Resolution Plan,  Rodney Hood observed:

But with any significant challenge, there are opportunities to learn lessons.  One lesson I would take away from the failed corporates is patience in the resolution process.  So I am glad that we are going to look back at the failed corporates, not to second guess or question decisions, but to learn from this experience as history can repeat itself. 

The Largest Loss Ever for Credit Unions

The liquidation en masse of five corporates was the largest projected loss ever.  NCUA said it would cost credit unions between $13.5-$16.0 billion.  The latest corporate AME numbers estimates the actual loss to the NCUSIF will be just over $2.0 billion and that is from just one corporate, WesCorp.

Absent an effort to understand how these projections were made, everyone will offer stories and interpretations that may be totally at odds with the facts as they unfolded.  In the desire to portray the resolution as a success, the most important lessons may be lost.   The seeds for future mistakes, remain unrecognized.

One example where the learning might begin is the liquidation of Southwest Corporate FCU.

Modeling for Failure

Unlike US Central and WesCorp, Southwest was not in conservatorship when seized.  It was being managed by its board and senior managers who made extensive monthly disclosures about the status of their credit union and every aspect of its investments.  The last report they issued was for July 2010 and was 21 pages of detailed information.

On September 24, 2010 NCUA issued an Order of Conservatorship on Southwest.  It was exercised “without notice” and warned that “Any business following service of this Order may subject members of the Board of Directors and management to civil or criminal liability.”  An explicit threat not to contest the Order.

A second document Grounds for Conservatorship included the following facts:

The credit union was solvent with “$88.6 million or 1.06% of  Southwest’s daily 12 month average net assets.”

The $88.6 million in remaining capital was after having “recorded OTTI charges totaling $496,258.357.” The Grounds document did not point out, as did the corporate in is July 2010 update, that only $49.7 million of actual losses (10%)  had been incurred. These investment write downs were based on modeling of  projected cash flows years, even decades,  into the future.

OTTI is not an allowance account.  It is a reduction in the value of an asset.  Under the accounting treatment at the time, improving loss projections based on the same modeling may not be recognized or netted with increasing loss projections.

In addition to its low solvency ratio NCUA declared it “marked to market” the investment portfolio resulting in a Net Economic Value (NEV) shortfall of ($718 million). This determination was accompanied by the statement that there was “with minimal opportunity for material improvement.”

Yet in the six-month period ending June 30, 2010 the negative NEV had improved by $382 million (35%).  The recovery had been underway since September 2009 and the market dislocations affecting the values of securities had begun to normalize.

But NCUA rejected these recent improvements asserting ‘future OTTI losses will continue to deplete its capital, negatively affect NEV, negatively affect its overall risk profile and decrease member confidence.  Even if NEV continued its recent slight improvement, the losses are more than Southwest’s balance sheet can absorb.” 

It further claimed: “Though a slight improvement in the increase in the fair value of the investment portfolio, the NEV increase is overwhelmed by the enormity of losses and the potential for additional OTTI charges from high risk investments.  The prospect of significant and sustained NEV improvement remains bleak.”  

A $1.5 Billion Modeling and Forecasting Error

 

Instead of a $718 million negative  NEV outcome and dire predictions of greater losses, the December 2021  projection is that SW Corp shareholders will receive $736 million in returned capital and liquidating dividends.  This is a $1.454 billion change in the actual economic value of the credit union.

The projected $736 million now being returned to shareholders equals 8.8% of the assets at the time of the seizure, or more than eight times the 1% solvency asserted by NCUA when placing the corporate in liquidation.

The projections and modeling were wrong.  The credit union had expensed hundreds of millions in  unrealized  OTTI losses that never took place, but were based on faulty assumptions.

Three of the other corporates had similar circumstances  Even in WesCorp’s situation, in which there will be no payment to shareholders, the estimated loss to the NCUSIF has gone from $6.2 million to just over $2.0 billion.

Next Steps in Understanding

 

A first review effort would be to update the projected versus actual loss experience on Southwest’s legacy assets.  The complete spreadsheet of legacy assets updated through September 2017 (when the TCCUSF was merged with the NCUSIF) is here.

How accurate were the OTTI write downs? What percentage of the $736 million payouts are from recoveries in the value of  “legacy assets”?

What can we learn further from the corporate resolution plan?   Especially in today’s economic circumstances?

Certainly the value of patience, in that there is a cycle of value with almost all assets in a dynamic economy.   This perspective could be especially important in this time of rapidly rising interest rates.  These increases  will temporarily depress the market value of many loan and investments assets on the books prior to Fed’s change in monetary policy.

The lessons should be more profound than relearning about fluctuations in economic value.  These might include the shortcomings of relying on “experts” like Black Rock and PIMCO for understanding what management options might be; or hiring Wall Street to design cooperative solutions; or even the native intelligence and insights of some of the corporate leaders who were summarily dismissed.

“No reasonable alternatives to conservatorship are evident.”

This assertion about the future of Soutwest in NCUA’s Order is perhaps the most important factor to assess.   What alternatives were evaluated?   By whom?  When?

One of the significant advantages of cooperative design versus private organizations is their dependence on member support and trust.   This factor is embodied in their democratic governance structure.

However, if those who lead an organization directly or through regulation do not honor this capability, then the advantage is loss.   The temptation to ignore, overrule or act based on solely on position and authority will sacrifice the long-term viability of an institution or even a system.

If NCUA demonstrates the ability to reflect on its own actions, transparently and in common cause with the industry, it could result in a leadership action that could resonate throughout the cooperative system—and perhaps beyond.

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