FROM THE OFFICE OF PUBLIC AFFAIRS

I. Introduction

I very much appreciate the opportunity to join you here, and I’d like to thank Kathy Garner for inviting me.

We at the Treasury have been working on our study of credit unions for over a year now. Today I’d like to share with you some of our thinking about corporate credit unions.

Last fall, Congress directed the Treasury to conduct a study of credit unions -- specifically, a study of issues involving corporate credit unions, the Share Insurance Fund, and the NCUA’s regulations. We’re working to complete our report now, and we expect to release it next month. Because the report is still in process, I’ll limit my comments today to issues involving corporate credit unions.

My comments will fall into five parts. First, I’ll describe how we went about our study of corporate credit unions (or "corporates"). Second, I’ll make some general observations about corporate credit unions’ health and prospects. Third, I’ll offer some thoughts based on our review of the 10 largest corporates. Fourth, I’ll make some comments about the NCUA’s supervision of corporate credit unions. And then I’ll offer some concluding observations.

II. The Treasury’s Approach to Evaluating Corporate Credit Unions

Congress directed us to evaluate the 10 largest corporate credit unions, including their "investment practices" and their "financial stability, financial operations, and financial controls."

RR-2063

It told us that, in evaluating the 10 largest corporate credit unions, we should work cooperatively with "appropriate employees of other Federal agencies with expertise in the examination of federally insured financial institutions." And it also directed us to evaluate the NCUA’s supervision of corporate credit unions.

The Association of Corporate Credit Unions helped all of us working on the study get off to a good start. You gave us a half-day presentation at the Treasury on corporate credit unions’ activities and operations.

In keeping with the Congressional mandate, we assembled an interagency team of six bank and thrift examiners to help us evaluate the 10 largest corporate credit unions. This team consisted of three examiners from the Office of the Comptroller of the Currency, and one each from the Office of Thrift Supervision, the FDIC, and the Federal Reserve System.

The team worked on this project nearly full-time for three months, in close coordination with my staff. The team reviewed the NCUA’s examination reports on corporate credit unions, together with examiner work papers, correspondence, and other documentation. The team also discussed with the appropriate NCUA officials the conclusions drawn in those examinations as well as the NCUA’s general approach to examining corporate credit unions.

The team also spent about two weeks on-site at U.S. Central and another two weeks on-site at WesCorp. During each of these visits, the team met with senior management, reviewed documents, and observed operations and risk assessment activities -- so that it could better gauge management performance and overall operations.

III. General Observations

With that as background, I’d like to offer a few general observations.

Corporate credit unions give small natural-person credit unions a safe place to invest their unloaned deposits. Small credit unions often don’t have the size or expertise necessary to invest efficiently on their own. So they turn to their corporate credit union. This is a real strength of the credit union system, but the safety of those funds must be paramount in running a corporate credit union.

Corporate credit unions generally appear to be in good health. And we heard from many credit unions that they are pleased with their corporate credit union and highly value their relationship with it.

Corporate credit unions invest in relatively high-quality assets, which minimizes their exposure to credit risk. And by keeping most of their investments short-term, corporates also limit their exposure to interest-rate risk. But interest-rate risk has been a problem in the past, as we all know, and it remains a concern at a few institutions.

Corporate credit unions also tend to be thinly capitalized and to operate with very narrow margins. These narrow margins mean that corporate credit unions would have difficulty increasing their capital quickly through retained earnings.

This combination of thin capitalization and narrow margins doesn’t leave a lot of room for error. It reinforces the need for adequate capital, strong management, and proper internal controls.

In recent years corporate credit unions have significantly increased their capital. We believe that this trend is critically important, and we see the NCUA’s new corporate credit union regulation as providing reasonable guidance in this area.

In addition to the challenge of boosting capital, corporate credit unions face increasing competitive pressure from each other and from other market participants. This competitive environment poses important safety and soundness concerns for both the near-term and the long-term. Some consolidation among corporate credit unions has begun and we anticipate more in the future. I don’t know what the corporate system will look like in 5 to 10 years, but I suspect it will look quite different than it does today -- and present a different set of safety and soundness challenges.

IV. The Ten Largest Corporate Credit Unions

Let me turn now to our review of the 10 largest corporate credit unions. We actually reviewed 11 -- the 10 largest corporates as of mid-1996 plus U.S. Central.

These 11 corporate credit unions generally have high credit quality investments. We also noted positive trends in their financial strength. We did, however, observe a concentration of corporate credit union assets in particular classes of asset-backed securities.

We have a couple of concerns about this concentration. First, corporate credit unions’ relatively thin capital ratios leave little room for error. And second, corporate credit unions’ balance sheets tend to resemble one another. Thus the risks of concentrating investments in a single asset class increase when the same concentration is repeated across many corporate credit unions.

The NCUA’s rules limit the amount that a corporate credit union can invest in obligations of a single issuer. But the NCUA does not limit the amount that a corporate credit union can invest in a single class of assets. There may be merit in considering the risks posed by similar balance sheet risk exposures, particularly in view of the interdependence within the corporate credit union system. For example, although an examiner may conclude that any one corporate credit union’s concentration in a particular asset class is within some acceptable level of tolerance, the NCUA might also consider the corporate system’s overall exposure to that particular asset class. This may also be an issue that your association may wish to give some thought to.

Our financial markets, and the instruments bought and sold in those markets, become more complex with each passing year. All financial institutions -- including corporate credit unions -- need to be sure that their management is sufficiently strong, deep, and knowledgeable to handle the risks they face.

Now let me turn to the NCUA’s supervision of corporate credit unions.

We reviewed the Office of Corporate Credit Union’s approach to supervising corporate credit unions, including its staffing, its policies and procedures, its examiner guidance, and its safety and soundness standards. The Office is still relatively new, yet it represents a significant improvement over the NCUA’s previous, less rigorous approach to supervising corporate credit unions.

It seems to us that the resources currently devoted to supervising corporate credit unions may fall short of reflecting the relative importance of corporates within the overall credit union system. And it’s worth considering whether the NCUA currently has the sort of capacity it should have to review industry trends, size up potential systemic risks, and assess corporate credit unions as a group.

The NCUA’s regulatory practices for corporate credit unions diverge, in some ways, from the best-practice approaches developed cooperatively by other federal regulatory agencies. In particular, the bank and thrift regulators have been developing risk assessment techniques that focus examiners’ attention on high risk areas and overall portfolio risk. Our review of NCUA corporate examination reports found a more audit-oriented focus, rather than a focus keyed to the critical risk areas in the particular credit union. We also found that examination reports contained excessive detail about small deficiencies, which detracted from the major findings and prescriptions for corrective action.

We did not find much in the way of detailed written guidance for corporate credit unions or their examiners. Of course, this surely reflects, to some degree, the newness of the Office of Corporate Credit Unions and the pressing issues that office has been facing.

Finally, we observed that the NCUA’s rating system for corporate credit unions does not include a specific component assessing an institution’s sensitivity to market risk -- a component that the federal bank regulatory agencies recently added to their own rating system. Given the nature of corporate credit union’s primary business, there may be merit in highlighting it in the examination process.

And now for a few concluding observations.

As corporate credit union managers, you can take pride in the many improvements you’ve made in recent years. But the job is never done. Our financial system grows ever more complex, posing challenges for all financial professionals.

One year ago, almost to the day, I addressed the California Credit Union League at its conference in Anaheim. While I was there, I had a chance to meet and talk with quite a few members of credit unions, large and small. And I was struck by the reliance that natural person credit unions have on their corporate credit unions. But that reliance -- that relationship -- implies an important responsibility on the part of corporate credit unions. Your safety and soundness is of paramount concern to the hundreds and thousands of credit unions that depend on you every day for a broad range of products and services.

I’d like to point to two advantages you have that I hope you consider as you face this challenge of meeting the needs of your members.

First, your members are in strong financial condition. Credit unions have high net worth and strong loan demand.

Second, credit unions, including corporate credit unions, have as part of their history -- and indeed, as part of their very operating philosophy -- a goal of constant self-improvement.

Next month, we’ll release our report. It is my hope that you’ll find its analysis and conclusions helpful in meeting your goal of self-improvement. I hope that you’ll look at the study as an opportunity for having a dialogue with the Treasury during the months ahead on issues of importance to credit unions.

And I wish you well in continuing to work together -- with your members and with the NCUA -- to build an even stronger credit union system.