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 -- 2012

16 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