There are invariably upsets during the NCAA Basketball Tournament and this year is no exception. On Friday, as an example, Dayton (#11) beat West Virginia (#6), Arizona (#12) thumped Utah (#5), USC (#10) thrashed Boston College (#7) and Cleveland State (#13) shocked Wake Forest (#4), among others. In the financial industry, there were 3 bank failures and two major "upsets" that will be felt for many years to come.
The "upsets" were the unexpected seizures of two significant corporate credit unions ("CCU") by the NCUA (in an effort to "stabilize the corporate credit union system" and "resolve balance sheet issues"). The entities seized were US Central Federal Credit Union ("USCCU," $34B, KS) and Western Corporate Federal Credit Union ("WesCorp," $23B, CA). USCCU had 26 CCU members (WesCorp among them) and WesCorp had 1,100 retail credit unions as customers. As with the FDIC when banks are taken over, the NCUA guaranteed all funds held by the CCUs under regular insurance. In addition, the NCUA guaranteed all other investments in the CCUs under the previously announced Share Guarantee Program (similar to TLGP, but broader).
Just what is a CCU and why should a community banker care? CCUs are the lynchpin of the entire credit union system. They carry specific charters that allow them to provide products and services to retail credit unions. Literally thousands and thousands of credit unions in local communities across the country feed into the CCUs, who in turn feed into USCCU.
What really happened here remains somewhat murky, but it appears to have been a liquidity event that was driven by the result of a detailed analysis and stress test of mortgage and asset-backed securities held by all corporate credit unions. These two CCUs reportedly held an unacceptable "concentrated risk," which was continuing to deteriorate (indicated these two would need to increase their reserve level from $4.7B to $5.9B). That, in turn resulted in reduced liquidity and payment system capacities. The NCUA said the remaining 26 CCUs have portfolio risk considered "manageable," so no further action will be taken.
What is the impact to the credit union industry? First, the NCUA said it will continue to provide full guarantees for both institutions through 12/31/10, so no investors will have a loss. Next, the NCUA has taken full control of both entities. Third, there will be an additional charge per credit union of 10bp of earnings and 9bp of net worth to cover the loss. Fourth, NCUA urged credit unions to continue to place excess liquidity into CCUs.
A quick analysis of the mortgage ("MBS") and asset-backed ("ABS") securities holdings of USCCU and Wescorp finds they held a whopping $41B of these types of investments. Of that, 5% were in government agencies, while 47% were private label MBS and 48% were ABS. Since we doubt the agency MBS caused any problems, we focus on the private securities. About 90% of private MBS were floating rate CMOs. These are some of the most complex securities to value and are usually backed by fixed rate loans. Meanwhile, the ABS portfolio held credit cards (29%), autos (11%), home equity (43%) and other (17%). Given the stress on consumers right now, it is no surprise that losses have hit credit unions on such holdings.
But, what is the impact on community banks? While it is still early, we would venture to say that as the press begins reporting on this massive issue this week, deposits will flow into the safety of community banks and away from credit unions. Before any bankers get too happy, however, we would also expect fear of all financial institutions to increase, so be prepared for more customer conversations and more volatility. In addition, given the heightened risk of the securities holdings identified by the NCUA, banks (that hold similar private-label securities) can expect their own regulators to get on board as well (so expect heightened regulatory scrutiny). Stock markets may gyrate as risk premiums rise, financial stocks could be strained (as investor fears increase), Treasury yields may fall (as investors move to safety) and banks should be prepared for the press to shift back to a negative tone (as they talk about how the financial contagion is spreading to other areas of the economy).
We'll be back with further analysis on this as things work through the system more, but the impact of these "upsets" will be significant. In short, banks should prepare staff to calm customer fears and increase education to help get through this latest piece of the financial crisis.