NCUA is required to maintain  NCUSIF’s equity ratio at a percentage of no less than 1.2 percent and not  more than 1.5 percent of insured shares. Corporate and Credit Union Failures Were Largely the Result of Poor Investment Strategies and Weak Management

From January 1, 2008, to June 30, 2011, 5 corporates and 85 credit  unions failed. Specifically,  these five failed corporates accounted for 75 percent of all corporate  assets as of December 31, 2007 (see fig. Specifically, U.S. Central and the failed corporates  overconcentrated their investments in private-label, mortgage-backed  securities (MBS), investing substantially more in private-label MBS than  corporate credit unions that did not fail (see fig. Eventually, the deterioration of the  underlying credit quality of the private-label MBS led to the corporates’  insolvencies. Poor Management Was the Primary Reason That 85 Credit Unions Failed

According to our analysis of NCUA’s and its OIG’s data, the 85 credit  union failures were primarily the result of poor management.Management of failed credit unions exposed their institutions to increased  operational, credit, liquidity, and concentration risks, which it then failed to  properly monitor or mitigate. OIG Identified Weaknesses in NCUA’s Examination Processes for Corporates and Credit Unions

In addition to the management weaknesses in corporates and credit  unions, NCUA’s examination and enforcement processes did not result in  strong and timely actions to avert the failure of these institutions. NCUA Has Taken Various Actions to Stabilize and Reform the Corporate System

NCUA took actions to stabilize, resolve, and reform the corporate system  and to minimize the costs of its intervention. To resolve the failed corporates, NCUA placed five  corporates—U.S. NCUA used NCUSIF to provide liquidity to the corporate system. Second, NCUA ultimately placed the five failing corporates into  conservatorship. Third, NCUA established a securitization program to provide long-term  funding for the legacy assets formerly held in the securities portfolios of  certain corporate credit unions by issuing NCUA-guaranteed notes. Introduce new corporate governance requirements. Use of PCA and Other Enforcement Actions Highlight the Need to Address Deteriorating Credit Unions Earlier

The number of credit unions in PCA significantly increased as the  financial crisis unfolded (see fig. Prior to the  release of these statements, NCUA had estimated losses for the  Stabilization Fund, but NCUA did not provide adequate documentation to  allow us to verify the reasonableness and completeness of these  estimates. As previously reported, capital- based indicators have weaknesses, notably that they can lag behind  other indicators of financial distress. To improve the effectiveness of the PCA framework, we recommend  that the Chairman of NCUA consider additional triggers that would  require early and forceful regulatory actions, including the indicators  identified in this report. In considering these actions, the Chairman  should make recommendations to Congress on how to modify PCA  for credit unions, and if appropriate, for corporates. Although NCUA  has said that its analysis shows that the credit union system has the  capacity to pay for the loss estimates, we continue to believe that without  well-documented cost information, NCUA faces questions about its ability  to effectively estimate the total costs of the failures and determine  whether the credit unions will be able to pay for these losses. NCUA agreed with the recommendation to consider other  triggers for PCA but noted that some of the potential financial indicators  that we identified could have drawbacks. Appendix II: Objectives, Scope, and Methodology

Legislation enacted in January 2011 requires us to examine NCUA’s  supervision of the credit union system and the use of PCA. This report  examines (1) what is known about the causes of failures among  corporates and credit unions since 2008; (2) the steps that NCUA has  taken to resolve these failures and the extent to which its actions were  designed to protect taxpayers, avoid moral hazard, and minimize the cost  of corporate resolutions; and (3) NCUA’s use of PCA and other  enforcement actions. To determine loss data from the corporates’ and credit union  failures, we reviewed NCUA’s 2008, 2009, and 2010 annual reports;  MLRs; BAMs; and NCUA data on losses to National Credit Union Share  Insurance Fund (NCUSIF) and the Temporary Corporate Credit Union  Stabilization Fund (Stabilization Fund). In considering other indicators for detecting early  distress in credit unions, we reviewed data from regulatory filings from the  fourth quarter of 2005 through the first quarter of 2011 for three groups: (1)  the 85 credit unions that failed from January 2008 to June 2011; (2) a  group of 340 peer credit unions—the four closest credit unions in terms of  total assets within the state as each failed credit union; and (3) all credit  unions that reported their financial condition in a regulatory filing for each  quarter within the period.
Why GAO Did This Study

Corporate credit unions (corporates)financial institutions that provide liquidity and other services to the more than 7,400 federally insured credit unionsexperienced billions in financial losses since the financial crisis began in 2007, contributing to failures throughout the credit union system and losses to the National Credit Union Share Insurance Fund (NCUSIF). Since 1998, Congress has required the National Credit Union Administration (NCUA), the federal regulator of the credit union system, to take prompt corrective action (PCA) to identify and address the financial deterioration of federally insured natural person credit unions (credit unions) and minimize potential losses to the NCUSIF. Legislation enacted in 2011 requires GAO to examine NCUAs supervision of the credit union system and use of PCA. This report examines (1) the failures of corporate and credit unions since 2008, (2) NCUAs response to the failures, and (3) the effectiveness of NCUAs use of PCA. To do this work, GAO analyzed agency and industry financial data and material loss reviews, reviewed regulations, and interviewed agency officials and trade organizations.

What GAO Found

From January 1, 2008, through June 30, 2011, 5 corporates and 85 credit unions failed. As of January 1, 2008, the 5 failed corporates were some of the largestaccounting for 75 percent of all corporate assetsbut the 85 failed credit unions were relatively smallaccounting for less than 1 percent of total credit union assets. GAO found poor investment and business strategies contributed to the corporate failures. Specifically, the failed corporates over concentrated their investments in private-label, mortgage-backed securities (MBS) and invested substantially more in private-label MBS than corporates that did not fail. GAO also found that poor management was the primary reason the 85 credit unions failed. In addition, NCUAs Office of Inspector General has reported that NCUAs examination and enforcement processes did not result in strong and timely actions to avert the failure of these institutions NCUA took multiple actions to stabilize, resolve, and reform the corporate system. NCUA used existing funding sources, such as the NCUSIF, and new funding sources, including the Temporary Corporate Credit Union Stabilization Fund (Stabilization Fund), to stabilize and provide liquidity to the corporates. NCUA placed the failing corporates into conservatorship and liquidated certain poor performing assets. In order to decrease losses from the corporates failures, NCUA established a securitization program to provide long-term funding for assets formerly held in the portfolios of failed corporates by issuing NCUA guaranteed notes. To address weaknesses highlighted by the crisis, in 2010, NCUA issued regulations to prohibit investment in private-label MBS, established a PCA framework for corporates, and introduced new governance provisions. NCUA considered credit unions ability to repay borrowings from Treasury and included measures to reduce moral hazard, minimize the cost of resolving the corporates, and protect taxpayers. While NCUA has estimated the losses to the Stabilization Fund, it could not provide adequate documentation to allow NCUAs Office of Inspector General or GAO to verify their completeness and reasonableness. Without well-documented cost information, NCUA faces questions about its ability to effectively estimate the total costs of the failures and determine whether the credit unions will be able to pay for these losses. GAOs analysis of PCA and other NCUA enforcement actions highlights opportunities for improvement. For credit unions subject to PCA, GAO found those credit unions that did not fail were more likely subject to earlier PCA actionthat is, before their capital levels deteriorated to the significantly or critically undercapitalized levelsthan failed credit unions. GAO also found that for many of the failed credit unions, other enforcement actions were initiated either too late or not at all. GAO has previously noted that the effectiveness of PCA for banks is limited because of its reliance on capital, which can lag behind other indicators of financial health. GAO examined other potential financial indicators for credit unions, including measures of asset quality and liquidity, and found a number of indicators that could provide early warning of credit union distress. Incorporating such indicators into the PCA framework could improve its effectiveness.

What GAO Recommends

NCUA should (1) provide its Office Inspector General the necessary documentation to verify loss estimates and (2) consider additional triggers for PCA that would require early and forceful regulatory action and make recommendations to Congress on how to modify PCA, as appropriate. NCUA agreed with both recommendations.