Corporate Credit Union Dilemma

A corporate credit union, also known as a wholesale credit union, provides services to natural person (consumer) credit unions. In the credit union industry, they are sometimes referred to as “the credit union’s credit union”. In the United States, corporate credit unions may either be chartered by the National Credit Union Administration (NCUA), or under state authority if permitted under that state’s financial services laws. There are approximately 26 corporate credit unions in the United States. Corporate credit unions provide the following three services to their clients:

  • Investments – Investments have ranged from overnight to term. Credit unions have for the last several years held about 60% of their cash and equivalents in corporate credit unions. Although the vast bulk of credit union deposits in corporate credit unions have been very short-term, they have often been invested by corporate credit unions in longer maturity assets. Historically, corporate credit unions engaged in maturity mismatching and concentrated in private label mortgage-backed and other asset backed securities that resulted in high dividend rates paid by them.
  • Credit Services – Credit services include both liquidity services (lines of credit and short term loans) and term credit services (long term lending). Credit services include both actual loans from corporate credit unions to credit unions and also lines of credit for potential credit union borrowing needs. Perhaps the most valued of the liquidity services provided by corporate credit unions is the form of lines of credit to cover short-term needs. According to the Credit Union National Association, a trade association, the aggregate amount of lines of credit from corporate credit unions is substantial, approximately $30 billion.
  • Settlement, Payment, and other Correspondent Services – Corporate credit unions offer a variety of services related to payments. Chief among these is the maintenance of a credit union’s core settlement account, and the provision of settlement to that account of all in-coming and out-going transactions caused by the member.

Bad bets on mortgage-backed securities have caused the NCUA to seize five of the 26 corporate credit unions since March 2009.  These five credit unions had approximately $76 billion in assets.

In late 2010, the federal government swooped in to stabilize a crucial part of the credit union sector battered by losses on subprime mortgages, two years after the peak of the financial crises.  In September 2010, the NCUA announced a rescue and revamping plan of the nation’s corporate credit union system, underpinned by a federal guarantee valued at $30 billion or more.  The NCUA also announced a plan to manage $50 billion of troubled assets inherited from failed institutions.  To help fund the plan, the NCUA announced plans to issue approximately $35 billion in government guaranteed bonds, backed by the seized mortgage related assets.  According to the chairman of the NCUA, the new regulations will make oversight of corporate credit unions much tougher.

To address the impaired assets and resolve the troubled intuitions involves several steps:

  • Isolating the impaired securities (legacy assets) held by these five corporate credit unions;
  • Repackaging the legacy assets into new securities with an NCUA guarantee backed by the U.S. government;
  • Issuing the new securities to investors on the open market;
  • Transferring the corporates’ still-valuable assets to newly created “bridge banks” that will allow for continued operations; and
  • Transitioning operations now under NCUA conservatorship over a target of 24 months to other service providers.

Since October 2010, the NCUA completed three offerings and raised proceeds totaling $17.7 billion.

NCUA adopted a new set of regulatory reforms aimed at strengthening the corporate credit union system. The new corporate regulation:

  • Implements stronger capital requirements and establishes prompt corrective action measures for corporate credit unions;
  • Establishes clear concentration limits on investments that will require corporate credit unions to better diversify their portfolios;
  • Improves asset/liability management requirements to avoid liquidity and interest-rate risks; and
  • Raises governance standards to improve levels of experience and expertise on corporate boards.

Due to the reform a lending dilemma was created:

  • CUSO (Credit Union Service Organization)—these are organizations formed by a number of credit unions to offer products and services typically outside of the not-for-profit structure of a credit union or it is a way for a group of credit unions to collaborate together to create scale or to share in operating cost. In this area a number of CUSOs were/are formed to provide lending alternatives to consumers/members and businesses, typically in the area or mortgages and business lending. Corporate Credit Unions have historically provided; warehouse lines and both short and long tem lending. Due to the reform they will no longer be able to provide this funding at levels sought after in the past
  • Credit Union—in the past Corporate Credit Unions have provided lines-of-credit (LOCs) to their member credit unions that have allowed credit unions to meet the required liquidity requirements of their regulation. Due to the changes in the regulation governing Corporate Credit Unions many of these lines will be offered at a reduced amount compared to the past.

These reforms will impact corporate credit unions ability to provide sources of liquidity and financing to credit unions and CUSOs.  Who will fill this void, commercial banks, investment banks, private equity firms, and other credit unions?  How much will costs of financing increase?  Time will tell. Though the economy has gotten better, we are still in challenging times.

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