Corporate Network Faces an Increasingly Challenging Business Environment, Creating Potential Stress on Its Financial Condition

Like other financial institutions, corporates face a challenging business  environment that affects their financial condition and is characterized by  increasing competition, changing product and service offerings, and rapid  technological advances. Corporates appear to be  managing risk by shifting toward more variable-rate and shorter-term  securities, providing a potentially better match for the relatively short-term  nature of their members’ deposits. The Challenging Business Environment in Which Corporates Operate May Impact Their Financial Condition

Corporate credit unions are operating in a challenging business  environment characterized by increased competition, pressure to increase  returns on their investments in a low-interest-rate environment, and the  need to invest in technology and personnel to meet the demands of their  credit union members for new and more sophisticated products and  services. However, since 2000 capital ratios have declined  as growth in assets outpaced growth in capital. However, a regulatory change effective in 2003 allowed certain corporates  to purchase securities with lower credit quality, but few have used this  investment authority. This shift highlights the importance of risk  monitoring and management by the corporates and NCUA. NCUA Strengthened Its Oversight of Corporates, but Could Do More to Anticipate and Address Emerging Network Issues

NCUA has made numerous changes over the last several years to  strengthen its oversight of corporates but faces challenges in such areas as  networkwide assessments, obtaining and utilizing technical staff resources,  developing merger guidance for corporates, and assuring the quality of  corporates’ internal control structures. NCUA established the Office of Corporate Credit Unions  (OCCU) in 1994, partly in response to problems with selected investments  at U.S. Central. NCUA Identified Deficiencies but Did Not Systematically Track Their Resolution or Evaluate Trends in Examination Data

NCUA’s risk-focused approach has helped it identify weaknesses in  corporates’ operations and require corrective actions at corporates;  however, we found that NCUA did not methodically aggregate and track  the resolution of deficiencies or systematically conduct trend analyses to  identify recurrent or networkwide issues. According to NCUA, information  systems specialists had reviewed the system’s performance in prior  examinations. Recommendations for Executive Action

To promote a more systematic and consistent approach in NCUA’s  oversight of corporates to ensure they are safely providing financial  services to natural person credit unions, we recommend that the Chairman  of the National Credit Union Administration take the following five actions:  Establish a process and structure to ensure more systematic  involvement of specialists in identifying and addressing problems and  developing and consistently applying policies, and reassess whether  there are sufficient specialists to oversee corporates;  Track and analyze examination deficiencies on a networkwide basis to  identify and track recurring and pervasive issues throughout the  network and to ensure that corporates take required corrective actions;  Pay increased attention to oversight of corporates’ risk management  functions to ensure corporates have sufficient capacity and skills to  monitor and manage their risks;  Provide specific guidance to corporates for merger proposal packages  to ensure they are providing sufficient and relevant information, and  improve guidance to examiners to ensure that merger proposals are  reviewed consistently and meet the goals of serving members while not  placing NCUSIF at undue risk; and   Require corporates with assets of $500 million or more to be subject to  the internal control reporting requirements of the Federal Deposit  Insurance Corporate Improvement Act of 1991 to ensure that corporates  are held to the same standards as other financial institutions that face  similar risks. 2. 1.
Why GAO Did This Study

Thousands of credit unions have placed about $55 billion of their excess funds in corporate credit unions (corporates). In a three-tiered system, corporates provide lending, investment, and processing services for their member credit unions. Problems with investments in the past prompted regulatory changes that required higher capitalization and stricter risk management, but allowed for expanded investment authorities. GAO assessed (1) the changes in financial condition of the corporate network and (2) the oversight of corporates by the National Credit Union Administration (NCUA), the federal regulator of credit unions.

What GAO Found

Corporates face an increasingly challenging business environment that potentially could stress their overall financial condition. In response to the competitive environment, corporates are offering new and more sophisticated products and services, expanding their use of technology, and seeking opportunities to merge or collaborate with other corporates. The corporates' financial condition as measured by profitability and capital ratios remained close to a range that has prevailed since the mid-1990s. However, since 2000, a large influx of deposits, coupled with low returns on traditional corporate investments, has constrained earnings and caused a downward trend in corporates' overall profitability. To generate earnings, corporates increasingly have targeted more sophisticated and potentially riskier investments, but appear to be managing risk by shifting toward more variable-rate and shorter-term investments, providing a potentially better match for the relatively short-term nature of their members' deposits. However, the corporates' changing business environment and utilization of more sophisticated and riskier investments increases the importance of NCUA regularly assessing its oversight processes to ensure that corporates are properly managing these risks. NCUA has strengthened its oversight of corporates by creating a centralized office for oversight, revising regulations, implementing risk-focused supervision, and hiring specialists. However, NCUA faces challenges in identifying networkwide problems on a consistent basis, using specialists effectively, providing relevant guidance on mergers, and assuring the quality of corporates' internal controls. Although NCUA identified deficiencies during its examinations, it has not systematically tracked their resolution or evaluated trends in examination data, which could help anticipate emerging issues facing corporates. NCUA also did not fully consider all risks when allocating resources or assigning specialists to examinations, leading to NCUA overlooking some information system deficiencies. Although corporates continue to consider mergers to remain competitive, NCUA had not developed adequate guidance for submitting and reviewing merger proposals. Finally, NCUA has not ensured that corporates' internal controls have remained consistent with those of similarly sized financial institutions