Credit unions are tax-exempt, cooperative financial institutions run by member-elected, primarily volunteer boards. To build capital, credit unions do not issue stock; they are not-for-profit entities that build capital by retained earnings. Their tax-exempt status and cooperative, not-for- profit structure separate credit unions from other depository institutions. Like banks and thrifts, credit unions are either federally or state chartered. Prior to the financial crisis, the credit union system consisted of three tiers, as shown in figure 1. As of December 31, 2007, there were 8,101 credit unions, 27 corporate credit unions, and 1 wholesale corporate credit union—U.S. Central Federal Credit Union (U.S. Central). Credit unions are owned by individual members (natural persons) who make share deposits and are provided with products and services, such as lending, investments, and payment processing. Credit unions are subject to limits on their membership because members must have a “common bond”—for example, working for the same employer or living in the same community. Corporates are owned by and serve credit unions. Corporates provide payment processing services and loans for liquidity purposes and serve as repositories for credit unions’ excess liquidity, among other things. In particular, when loan demand is low or deposits are high, credit unions generally invest excess liquidity in corporates and then withdraw funds when loan demand is high or deposits are low. Corporates meet liquidity needs with member deposits and by borrowing from U.S. Central, capital markets, or the Federal Home Loan Banks.Corporates primarily owned by U.S. Central, which functioned as a corporate for the corporates, provide the same depository and other services that corporates provide to credit unions. U.S. Central was the agent group representative for the Central Liquidity Facility (CLF), which we discuss later in this section. U.S. Central also acted as an aggregator of corporate credit union funds, which allowed them better access to the markets at better rates. While the corporate system—including both U.S. Central and the corporates—was designed to meet the needs of credit unions, the corporates face competition from other corporates and financial institutions that can provide needed services. For instance, credit unions may also obtain loans and payment processing from Federal Reserve Banks. In addition, credit unions can obtain investment products and services from broker-dealers or investment firms rather than corporates. Credit union service organizations (CUSO) also compete with corporates and offer, among other things, investments and payment processing. As we reported in 2004, corporates seek to provide their members with higher returns on their deposits and lower costs on products and services than can be obtained individually elsewhere. Credit unions and corporates are insured by NCUSIF, which provides primary deposit insurance for 98 percent of the nation’s credit unions and corporates. NCUA administers NCUSIF, collects premiums from credit unions and corporates to fund NCUSIF, and ensures that all credit unions operate in a safe and sound manner. 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. In addition, NCUA provides oversight of the CLF, which lends to credit unions experiencing unusual loss of liquidity. Credit unions can borrow directly from the CLF or indirectly through a corporate, which acts as an agent for its members. U.S. Central was the primary agent for the CLF and was the depository for CLF funds until August 2009, when NCUA changed its investment strategy for the liquidity facility. NCUA supervises and issues regulations on operations and services for federally chartered credit unions and for both state- and federally chartered corporates. NCUA has supervisory and regulatory authority over both state- and federally chartered corporates because they provide services to federally insured credit unions. In addition, NCUA shares responsibility for overseeing state-chartered credit unions to help ensure they pose no risk to the insurance fund. NCUA categorizes corporate supervision into three categories (Types I, II, and III) based on asset size, investment authorities, complexity of operations, and influence on the market or credit union system. For example, a corporate with Type III supervision generally has billions of dollars in assets, exercises expanded investment authorities, maintains complex and innovative operations, and has a significant impact in the marketplace and on the credit union system. NCUA assigns a full-time, on-site examiner to corporates with Type III supervision. agency examinations, performs off-site monitoring, and conducts joint examinations of credit unions with state supervisory agencies. As part of its on-site examinations, NCUA assesses a credit union’s exposure to risk and assigns risk-weighted ratings under the CAMEL rating system. The ratings reflect a credit union’s condition in five components: capital adequacy, asset quality, management, earnings, and liquidity. Each component is rated on a scale of 1 to 5, with 1 being the best and 5 the worst. The five component ratings are then used to develop a single composite rating, also ranging from 1 to 5. Credit unions with composite ratings of 1 or 2 are considered to be in satisfactory condition, while credit unions with composite ratings of 3, 4, or 5 exhibit varying levels of safety and soundness problems. A similar rating system, known as the Corporate Risk Information System, is used to assess the corporates. NCUA has the authority to take an enforcement action against credit unions and corporates to correct deficiencies identified during an examination or as a result of off-site monitoring. NCUA can issue letters of understanding and agreement, which is an agreement between NCUA and the credit union or corporate on certain steps the credit union or corporate will take to correct deficiencies. They can also issue preliminary warning letters, which is an NCUA directive to a credit union or corporate to take certain actions to correct deficiencies. Further, NCUA can issue a cease- and-desist order, which requires a credit union or corporate to take action to correct deficiencies. Although not considered an enforcement action, NCUA examiners also can issue documents of resolution to record NCUA’s direction that a credit union or corporate take certain action to correct a deficiency or issue within a specified period. NCUA also has a number of options for dealing with a credit union or corporate that has severe deficiencies or is insolvent. It can place the institution into conservatorship—that is, NCUA takes over the credit union’s or corporates’ operations. After NCUA assumes control of the institution’s operations, it determines whether the credit union or corporate can continue operating as a viable entity. To resolve a credit union or corporate that is insolvent or no longer viable, NCUA may merge it with or without assistance, conduct a purchase and assumption, or liquidate its assets. In an assisted merger, a stronger credit union or corporate assumes all the assets and liabilities of the failed credit union or corporate with NCUA providing financial incentives or an asset guarantee. In a purchase and assumption, another credit union or corporate purchases specific assets and assumes specific liabilities of the failed corporate or credit union. In liquidation, NCUA sells the assets of a failed credit union or corporate. PCA is a comprehensive framework of mandatory and discretionary supervisory actions for credit unions. PCA is based on five categories and their associated net worth ratios—that is, capital as a percentage of assets (see table 1). If a credit union falls below well capitalized (7 percent net worth), the credit union is required to increase retained earnings. When NCUA determines the credit union is in the undercapitalized, significantly undercapitalized, or critically undercapitalized categories, NCUA is required to take additional mandatory supervisory actions. In addition to these mandatory supervisory actions, NCUA often enforces discretionary supervisory actions. Discretionary supervisory actions are applied to credit unions that fall into the undercapitalized category or below and include requiring NCUA approval for acquisitions or new lines of business, restricting dividends paid to members, and dismissing the credit union’s board members or senior management. Before 2010, U.S. Central and other corporate credit unions were not subject to PCA but were instead required to maintain total capital at a minimum of 4 percent of their moving daily average net assets. Total capital for U.S. Central and corporate credit unions was calculated using any combination of retained earnings, paid-in capital, or membership capital. If total capital fell below this level, NCUA required U.S. Central or the corporate to submit a capital restoration plan. If the capital restoration plan was inadequate or the corporate failed to complete the plan, NCUA could issue a capital directive. A capital directive orders the corporate to take a variety of actions including reducing dividends, ending or limiting lending of certain loan categories, ending or limiting the purchase of investments, and limiting operational expenses in order to achieve adequate capitalization within a specified time frame. From January 1, 2008, to June 30, 2011, 5 corporates and 85 credit unions failed. The five failed corporates—U.S. Central, Western Corporate (Wescorp), Members United, Southwest, and Constitution— were some of the largest institutions within the corporate system, although the credit unions that failed were relatively small. Specifically, these five failed corporates accounted for 75 percent of all corporate assets as of December 31, 2007 (see fig. 2). In contrast, the 85 credit unions that eventually failed represented around 1 percent of all credit unions and less than 1 percent of total credit union assets, as of December 31, 2007. NCUA’s OIG MLRs of the failed corporates and our analysis of historical financial data for the corporate system show that management of both U.S. Central and the failed corporate credit unions made poor investment decisions. 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. 3). At the end of 2007, the five failed corporates had invested 31 to 74 percent of their assets in private-label MBS. In particular, Wescorp and U.S. Central had invested 74 percent and 49 percent, respectively, of their portfolio in private-label MBS. In contrast, 10 of the 23 remaining corporates had also invested in private-label MBS but at lower levels—for example, from 1 to 19 percent. These high concentrations of private-label MBS exposed the failed corporates to the highs and lows of the real estate market, which experienced significant losses. Furthermore, corporates had significant deposits in U.S. Central, which led to indirect exposure to its high concentration of private-label MBS and losses when it failed. For example, in 2007, Members United had invested more than 40 percent of total assets in U.S. Central, and Southwest and Constitution had each invested approximately 30 percent of total assets, according to the MLRs. In addition to poor investment decisions, the business strategies U.S. Central and the other four failed corporates’ pursued contributed to their failure. Specifically, their management implemented business strategies to attract and retain credit union members by offering lower rates on services and higher returns on investments. According to the MLRs, U.S. Central shifted towards an aggressive growth strategy to maintain and increase its market share of corporates. This strategy led its management to increase its holdings of high-yielding investments, including private- label MBS. From 2006 to 2007, U.S. Central’s assets grew by 22 percent as members invested their liquid funds in return for competitive rates. The other failed corporates implemented similar business strategies. The financial crisis exposed the problems in the corporates’ investment and business strategies, leading to a severe liquidity crisis within the credit union system. Specifically, the downturn severely diminished the value and market for private-label MBS and depositors lost confidence in the corporate system because of the institutions’ substantial investment in these securities. The decline in value of these investments resulted in corporates borrowing significant amounts of short-term funds from outside of the credit union system to meet liquidity needs as credit unions reduced their deposits. However, these options became limited when credit rating agencies and lenders lost confidence in individual corporates and some lines of credit were suspended. For example, from 2007 to 2009, credit rating agencies downgraded U.S. Central’s long- and short- term credit ratings, and in 2009, the Federal Reserve Bank of Kansas City downgraded its borrowing ability. Eventually, the deterioration of the underlying credit quality of the private-label MBS led to the corporates’ insolvencies. 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. The following describes these risks and provides examples of how exposure to these risks led to the failure of a number of credit unions. Operational risk includes the risk of loss due to inadequate or failed internal controls, due diligence, and oversight. We found that management’s failure to control operational risk contributed to 76 of the 85 failures. For example, Norlarco Credit Union’s management had weak oversight policies and controls for an out of state construction lending program and failed to perform due diligence before entering into a relationship with a third party responsible for managing it. Norlarco’s management allowed the third party to have complete control in making and overseeing all of the credit union’s residential construction loans, leading to a decline in borrower credit quality and underreported delinquencies. Potential losses from its residential construction loan program led to Norlarco’s insolvency. Management’s failure to control operational risk can also create the potential for fraud. We analyzed NCUA’s and its OIG’s data and found that fraud or alleged fraud at credit unions contributed to 29 of 85 of credit union failures. According to NCUA, credit unions with inadequate internal controls are susceptible to fraud. In addition, NCUA’s internal assessments of fraud showed that their examiners often had cited inactive boards or Supervisory Committees, limited number of staff, and poor record keeping before the fraud was discovered at the failed credit unions. For example, the OIG reported that Certified Federal Credit Union’s internal controls were severely lacking, enabling the chief executive officer to report erroneous financial results to the credit union’s board and in quarterly call reports. According to the MLR, before the fraud was identified, the credit union’s board was weak and unresponsive to repeated reports of inaccurate accounting records and weak internal controls from NCUA examiners and external auditors. The credit union was involuntarily liquidated in 2010. NCUA OIG officials told us that some other indicators of potential fraud are high ratios of investments to assets and a low number of loan delinquencies. Credit risk is the possibility that a borrower will not repay a loan or will default. We found that management’s failure to control for credit risk contributed to 58 of the 85 credit union failures. For example, Clearstar Financial Credit Union management originated and funded a significant number of loans that were poorly underwritten—that is, they were made to borrowers with poor credit histories. Management then compounded these mistakes by extending delinquent loans and poor collection practices, contributing to the credit union’s eventual failure. Moreover, management at some failed credit unions did not consistently monitor the credit risk associated with member business loans (MBL). With some limitations, credit unions can lend to their members for business purposes. However, these loans can be risky for credit unions. For example, NCUA reported in recent congressional testimony that due to the lack of credit union expertise and challenging macroeconomic conditions, over half of the losses sustained by the NCUSIF were related to MBLs for a two year period in the late 1980s. Our analysis of NCUA’s and its OIG’s data indicated that MBLs contributed to 13 of the 85 credit union failures. According to our analysis of historical financial data, failed credit unions had more MBLs as a percentage of assets than peer credit unions that did not fail or the credit union industry (see fig. 4). In addition, more than 40 percent of failed credit unions participated in member business lending. Comparatively, NCUA had testified that only 30 percent of all credit unions participated in member business lending, as of March 31, 2011. Liquidity risk is the risk that the credit union may not be able to meet expenses or cover member withdrawals because of illiquid assets. We found that liquidity risk contributed to 31 of the 85 credit union failures. For example, the management of Ensign Federal Credit Union relied on a $12 million deposit to fund credit union operations. However, when the deposit was withdrawn in 2009, the credit union lacked other funding sources to meet normal member demands and operational expenses, contributing to the credit union’s failure. Concentration risk is excessive exposure to certain markets, industries, or groups. While some level of concentration may not be avoidable, it is the responsibility of management to put in place appropriate controls, policies, and systems to monitor the associated risks. We found that concentration risk contributed to 27 of the 85 credit union failures. For example, High Desert Federal Credit Union’s management began expanding its real estate construction lending in 2003, and by 2006, its loan portfolio had more than doubled from $73 million to $154 million. In 2006, construction lending accounted for more than 60 percent of the credit union’s loan portfolio. When the housing market collapsed, its concentration in the real estate construction loans led to its insolvency. 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. The OIG found that stronger and timelier action on the part of NCUA could have reduced losses from the failures from U.S. Central and the four other failed corporates. NCUA examiners had observed the substantial concentration of private-label MBS for U.S Central and three of the four other corporates that failed prior to 2008, but did not take timely action to address these concentrations. For example, NCUA examiners observed Wescorp’s growing concentration in private-label MBS beginning in 2003; but they did not limit or take action to address this issue until 2008. Similarly, the OIG’s material loss review of Southwest Corporate cites that NCUA’s March 2008 exam concluded, “current and allowable MBS exposures are significant given the unprecedented market dislocation… Southwest’s exposure is clearly excessive.” However, the MLR did not indicate that NCUA issued a document of resolution or enforcement action to address Southwest’s high concentration. In the case of Constitution Corporate, the MLR noted that NCUA took enforcement action to address concentration limits prior to failure. Similar to its findings for corporate failures, the OIG found weaknesses in NCUA’s examination and enforcement processes for 10 of the 11 failed credit unions for which it conducted MLRs. In particular, the OIG stated that “if examiners acted more aggressively in their supervision actions, the looming safety and soundness concerns that were present early-on in nearly every failed institution, could have been identified sooner and the eventual losses to the NCUSIF could have been stopped or mitigated.” The OIG made a number of recommendations to address the problems that the financial crisis exposed. For example, to better ensure that corporate credit unions set prudent concentration limits, the OIG recommended that NCUA provide corporate credit unions with more definitive guidance on limiting investment portfolio concentrations. Based on the credit union failures, the OIG recommended that NCUA take steps to strengthen their examinations process by, among other things, improving the review of call reports and third-party relationships, as well as following up credit union actions in response to documents of resolution and the quality control review process for examinations. Appendix I contains more information on the status of NCUA’s implementation of OIG’s recommendations. NCUA took actions to stabilize, resolve, and reform the corporate system and to minimize the costs of its intervention. NCUA based these actions on four guiding principles: to avoid any interruption of services provided by corporate credit unions to credit unions; to prevent a run on corporate shares by maintaining confidence in the overall credit union system; to facilitate a corporate resolution process in line with sound public policy that is at the least possible cost to the credit unions over the long term, while avoiding moral hazard; and to reform the credit union system through new corporate rules with a revised corporate and regulatory structure. NCUA established a number of measures to ensure that corporates had access to liquidity. To resolve the failed corporates, NCUA placed five corporates—U.S. Central, Wescorp, Members United, Southwest, and Constitution—into conservatorship and isolated their nonperforming assets. To reform the system, NCUA enacted new rules to address the causes of the failures, assessed credit unions for corporate losses, forecasted the impact of future assessments through scenario tests, and took measures to reduce moral hazard. Through these actions, NCUA attempted to resolve the corporates’ losses at the least possible cost. However, we could not verify all NCUA’s estimated losses of the corporates’ and credit union failures. To provide liquidity, NCUA used two existing funds—NCUSIF and CLF— and based on legislative changes, created a temporary fund—the Temporary Corporate Credit Union Stabilization Fund (Stabilization Fund). NCUA also created four new programs—the Credit Union System Investment Program (CU-SIP), the Credit Union Homeowners’ Affordability Relief Program (CU-HARP), the Temporary Corporate Credit Union Liquidity Guarantee Program (Liquidity Guarantee Program), and the Temporary Corporate Credit Union Share Guarantee Program (Share Guarantee Program). See appendix III for more information about these programs. NCUA used NCUSIF to provide liquidity to the corporate system. As stated earlier, U.S. Central had experienced substantial losses, impairing its ability to provide liquidity to the credit union system. In December 2008, NCUA provided for a NCUSIF loan to U.S. Central to cover an end- of-year liquidity shortfall. The loan was outstanding for 3 days and then fully repaid. In January 2009, NCUA placed a $1 billion capital note in U.S. Central. NCUSIF subsequently wrote off this note when it determined the credit losses on the private label MBS (held by U.S. Central) impaired the full value of the note. To avoid compromising its borrowing authority with Treasury, NCUA changed the CLF’s investment strategy in mid-2009. Specifically, before 2009, the CLF’s funds from subscribed capital stock and retained earnings placed in a deposit account with U.S. Central, the CLF agent. However, given U.S. Central’s insolvency, NCUA moved its funds out of U.S. Central and invested them with Treasury in 2009, to avoid an adverse accounting treatment for the fund—thereby reducing the fund’s member equity and ultimately limiting its borrowing authority with Treasury. restricted from lending directly to corporates, NCUA then used funds from NCUSIF to lend $5 billion to U.S. Central and $5 billion to Wescorp. By October 2010, U.S. Central and Wescorp had repaid their loans to NCUSIF using funds raised primarily from the sale of more than $10 billion in unencumbered marketable securities that sold near their par value in August and September 2010.$10 billion CLF loan with proceeds from asset sales. In addition, NCUA used a temporary fund created by Congress in 2009 to help increase liquidity in the system. In May 2009, Congress passed the Helping Families Save Their Homes Act, which, among other things, created a temporary fund to absorb losses from corporates. the act created the Stabilization Fund, which replaced NCUSIF as the primary source to absorb the corporates’ losses. The act also amended the Federal Credit Union Act to give NCUA the authority to levy assessments over the life of the Stabilization Fund to repay the corporates’ losses instead of repaying them in a lump sum. In addition, it increased NCUA’s borrowing authority with Treasury up to $6 billion through a revolving loan fund to be shared between the Stabilization Fund and NCUSIF. Amending the Federal Credit Union Act, 12 U.S.C. §§ 1751-1795k. funds to pay down their external debt, freeing up assets that had been posted as collateral against the debt. In exchange for participating in the programs, the corporates were required to pay CLF borrowing costs to credit unions and an additional fee to the credit unions as an incentive for them to participate in the programs. CLF lending to credit unions totaled approximately $8.2 billion under CU-SIP and about $164 million under CU-HARP. All borrowings for both programs were repaid in 2010. Liquidity Guarantee Program and Share Guarantee Program. NCUA created these two temporary guarantee programs in late 2008 and early 2009 to help stabilize confidence and dissuade withdrawals by credit unions, in an attempt to avoid a run on the corporates. These programs provided temporary guarantees on certain new unsecured debt obligations issued by eligible corporates and credit union shares held in corporates in excess of $250,000. Initially, NCUA provided the coverage to all the corporates for a limited time but later provided extensions to continue guaranteeing coverage to corporates that did not opt out of the program. Based on NCUA’s 2009 financial statements, no guarantee payments were required for either program. However, as of December 19, 2011, the audited financial statements for calendar year 2010 of the Stabilization Fund were not completed and available. NCUA took a variety of steps to resolve the failed corporates and maintain corporate payment processing services for credit unions. First, in April 2009, NCUA enacted a temporary waiver to allow corporates not meeting their minimum capital requirements to continue to provide services to credit unions. In particular, the waiver allowed corporates to use their capital levels of record on their November 2008 call reports in order to continue providing the necessary core operational services to credit unions. In addition, it granted the Office of Corporate Credit Unions discretionary authority to modify or restrict the use of this capital waiver for certain corporates based on safety and soundness considerations. Without the waiver, corporates that failed to meet the minimum capital requirements would have had to cease or significantly curtail operations, including payment system services and lending and borrowing activities. As a result, the credit union system would have faced substantial interruptions in its daily operations, potentially leading to a loss of confidence in other parts of the financial system. Second, NCUA ultimately placed the five failing corporates into conservatorship. According to NCUA, it placed the corporates into conservatorships to reduce systemic exposure, exert greater direct control, improve the transparency of financial information, minimize cost, maintain confidence, and continue payment system processing. When placing the five corporates into conservatorship, NCUA replaced the corporates’ existing boards, the chief executive officers, and in some cases, the management teams and took over operations to resolve the corporates in an orderly manner. As a part of the conservatorships, NCUA set up bridge institutions for the wholesale corporate—U.S. Central—and the three other corporates. Through these bridge institutions, NCUA managed the corporates’ illiquid assets and maintained payment services to the member credit unions. The member credit unions must provide sufficient capital to acquire the operations of these bridge institutions from NCUA. 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. NCUA’s analysis showed that MBS were trading at market prices considerably below the intrinsic value that would eventually be received by long-term investors. NCUA used a method similar to the “good bank-bad bank” model that the Federal Deposit Insurance Corporation has sometimes adopted with insolvent banks to remove illiquid or “bad” assets from the failed corporates. In particular, NCUA transferred the corporates’ assets into Asset Management Estates, also known as liquidation estates. Using these estates, NCUA held and isolated the corporates’ illiquid assets (i.e., MBS) from the bridge institutions and issued the NCUA-guaranteed notes. NCUA issued $28 billion (at the point of securitization) in these NCUA- guaranteed notes, while the face value of the original MBS assets was approximately $50 billion. notes so that its value would approximate the value of the principal and interest cash flows on the underlying legacy assets. NCUA officials said that by structuring the notes in this manner, NCUA minimized its exposure in the event that the underlying cash flow was less than the notes’ value. According to NCUA’s term sheet, cash flows from the underlying securities will be used to make principal and interest payments to holders of the notes, and NCUA guarantees timely payments. NCUA issued 13 separate notes, with the final sales occurring in June 2011 and maturing between 2017 and 2021. Any necessary guarantee payments are to be made from the Stabilization Fund, which also expires in 2021. NCUA structured each of the guaranteed Finally, as of November 2011, NCUA has initiated lawsuits against parties it believes are liable for the corporates’ MBS-related losses. These lawsuits allege violations of federal and state securities laws and misrepresentations in the sale of hundreds of securities, according to NCUA. NCUA relied on external consultants—in addition to its own analysis—to estimate its losses from the failed corporate credit unions. NCUA issued a new rule for corporates to address the key causes of the failures. Among other things, the rule (1) eliminates the definition and separate treatment of the wholesale corporate or third tier of the credit union system, (2) prohibits corporates from investing in certain securities and set sector concentration limits, (3) creates a new system of capital standards and PCA for corporates, and (4) introduces new corporate governance requirements. Some parts of the new rule addresses the recommendations of NCUA’s OIG. NCUA issued the rule on October 20, 2010, and it will be implemented over a number of years. For additional information on the rule, see appendix IV. Essentially eliminate the wholesale corporate or third tier of the credit union system. The new corporate rule that NCUA issued on October 20, 2010, eliminated both the definition of and the requirements applicable to a wholesale corporate or the third tier of the credit union system. NCUA essentially eliminated the wholesale corporate, in part, to mitigate inefficiency and systemic risk in the credit union system. The failure of U.S. Central, the credit union system’s only wholesale corporate, highlights some of the risks. Specifically, its failure contributed to the failure of three corporates, instability in the other corporates, and substantial losses to the Stabilization Fund. Prohibit corporates from certain investments and set sector concentration limits. NCUA amended the corporate rule to prohibit certain investments, such as private-label MBS, and set certain sector In addition to prohibiting private-label MBS, the concentration limits. rule prohibits corporate investments in collateralized-debt obligations, net interest-margin securities, and subordinated securities. Previously, corporates were allowed to set their own sector concentration limits, which enabled them to continually increase their limits or set excessive limits. The new rule sets maximum sector concentration limits for corporate investments and addresses OIG recommendations that NCUA provide corporates with more definitive guidance on limiting investment portfolio concentrations. Corporates are limited to investing less than 1,000 percent of capital or 50 percent of total assets in specific investments, including agency MBS, corporate debt obligations, municipal securities, and government-guaranteed student loan asset-backed securities. Furthermore, corporates are restricted from investing more than 500 percent of capital or 25 percent of total assets in other asset-backed security sectors, including auto loans and leases, private-label student loans, credit card loans, or any sector not explicitly noted in the rules. NCUA has taken additional steps to mitigate the associated risk by limiting the weighted-average life of the portfolio to approximately 2 years. NCUA also tightened the limits on securities purchased from a single obligor from 50 percent of capital to 25 percent. Create a new system of capital standards and PCA for corporates. NCUA’s new corporate rule also established a revised set of capital standards for corporates and PCA framework. The new capital standards replace the existing 4 percent mandatory minimum capital requirement with three minimum capital ratios, including two risk- The risk- based capital ratios and a leverage ratio (see table 2). based capital and interim leverage ratios became enforceable on October 20, 2011, and all corporates were required to meet these capital standards. Starting in October 2011, corporates are also subject to PCA if their capital falls below the adequately capitalized level for any of the three capital ratios. As discussed earlier, a corporate becomes subject to more severe supervisory actions and restrictions on its activities if its capital continues to fall. Introduce new corporate governance requirements. NCUA has instituted a new corporate governance rule. To ensure that corporate board members have adequate knowledge and experience to oversee sophisticated corporate investment and operation strategies, they must hold an executive management position, such as chief executive offer, chief financial officer, or chief operating officer of a credit union. Corporate board members are also prohibited from serving on more than one corporate credit union board. According to NCUA, this restriction will help ensure that board members’ loyalty is undivided and that they are not distracted by competing demands from another corporate. Effective October 21, 2013, the majority of a corporate’s board members must be representatives from member credit unions. The purpose of this rule is to limit another corporate from serving other corporates rather than serving their member credit unions. In addition, the governance rules require disclosure of executive compensation and prohibit “golden parachutes”—lucrative benefits given to executives who are departing their jobs. NCUA’s audited financial statements for NCUSIF reported an allowance for loss of $777.6 million at December 31, 2010. This allowance for loss represents the difference between funds expended to close failed retail credit unions and the amounts NCUA estimates it will recover from the disposition of the failed retail credit unions’ assets. Also, these financial statements reported additional estimated losses of about $1.23 billion as of December 31, 2010, associated with troubled credit unions considered likely to fail. With respect to the Stabilization Fund, the 2010 audited financial statements were not yet final, as of December 19, 2011. NCUA officials cited ongoing challenges in resolving and valuing failed corporate assets as contributing to the delays in finalizing the Stabilization Fund financial statements. We requested documentation adequate to support NCUA’s estimates of losses from corporate failures, but NCUA was not able to provide the documentation we required. The NCUA OIG was provided with the same information that we obtained and told us that they were unable to verify NCUA’s loss estimates. Absent this documentation, it is not possible to determine the full extent of losses resulting from corporate credit union failures. Moreover, 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. Credit unions are responsible for repaying NCUSIF and the Stabilization Fund, and NCUA has begun to assess credit unions for those losses. NCUA borrowed taxpayer funds from Treasury to fund NCUSIF and the Stabilization Fund to provide liquidity to the corporate system and it plans to repay the debt to Treasury with interest by 2021. Since 2009, NCUA has assessed credit unions a total of about $5 billion (about $1.7 billion for NCUSIF and $3.3 billion for the Stabilization Fund). NCUA officials told us that they had analyzed the credit unions’ ability to repay by determining the impact that varying assessment levels would have on the net worth ratios of both individual credit unions and the credit union system. NCUA considers factors such as the number of credit unions that would fall below 2 percent capital or be subject to PCA’s net worth restoration plan. In 2011, NCUA levied a $2 billion assessment for the Stabilization Fund. According to NCUA officials, NCUA determined that the credit union system had enough surplus capital to pay the assessment because of its strong return on assets of 0.86 percent for first three quarters of the year. NCUA determined that the assessment would result in around 811 credit unions having a negative return on assets. NCUA officials also noted that in a typical year about 10 to 20 percent of credit unions have had a negative return on assets. According to NCUA officials, the primary driver for the $2 billion Stabilization Fund assessment in 2011 was interest and principal on maturing medium-term notes that the corporates issued and that were to be repaid by the Stabilization Fund. NCUA officials told us that if they had found that the credit unions could not afford the Stabilization Fund assessment, they would have considered other options, such as issuing additional NCUA- guaranteed notes or unsecured debt. Although NCUA officials have stated that the credit union system will bear the ultimate costs of corporate and credit union failures, risks to the taxpayers remain. However, many of the reforms are ongoing and NCUA continues to resolve the failure of U.S. Central and Wescorp, as will be discussed. Moreover, the ultimate effectiveness of NCUA’s actions and associated costs remain unknown. As a result, whether the credit union system will be able to bear the full costs of the losses or how quickly NCUA will repay Treasury is unknown. Should the credit union system be unable to repay Treasury through NCUA assessments, taxpayers would have to absorb the losses. Moral hazard occurs when a party insulated from risk may behave differently than it would behave if it were fully exposed to the risk. In the context of NCUA’s actions to stabilize the credit union system, moral hazard occurs when market participants expect similar emergency actions in future crises, thereby weakening their incentives to manage risks properly. Furthermore, certain emergency assistance can also create the perception that some institutions are too big to fail. In general, mitigating moral hazard requires taking steps to ensure that any government assistance includes terms that make such assistance an undesirable last resort, except in the direst circumstances, and specifying when the government assistance will end. For example, we previously reported that during the 2007-2009 financial crisis, the federal government attached terms to the financial assistance it provided to financial institutions such as (1) limiting executive compensation, (2) requiring dividends be paid to providers of assistance, and (3) acquiring an ownership interest—all of which were designed to mitigate moral hazard to the extent possible. NCUA designed actions to mitigate moral hazard at various stages of its effort to resolve and reform the corporate credit union system, but the effectiveness of these actions remains to be seen. Examples of the actions designed to mitigate moral hazard include terminating the corporates’ management teams and eliminating their boards, issuing letters of understanding and agreement as a condition to entering the Share Guarantee Program, requiring a guarantee fee under the Liquidity Guarantee Program, requiring credit unions to repay the losses to NCUSIF and the Stabilization Fund, filing lawsuits against responsible parties, and requiring credit unions to disclose executive compensation. In addition, NCUA enhanced market discipline by requiring corporates to obtain capital from their member credit unions to remain in operation. That is, member credit unions decided whether to capitalize new corporates. As of October 30, 2011, the two of the four bridge corporates—Wescorp Bridge and U.S. Central Bridge—had either not succeeded in obtaining sufficient member capital (Wescorp) or had not attempted to do so because of a lack of anticipated demand (U.S. Central). They are both being wound down by NCUA. Credit unions that triggered PCA had mixed results. Our analysis of credit unions that underwent PCA indicates corrective measures that were triggered earlier were generally associated with more favorable outcomes. We observed successful outcomes associated with PCA, but also noted inconsistencies in the presence and timeliness of PCA and other enforcement actions. Furthermore, in most cases, other discretionary enforcement actions to address deteriorating conditions either were not taken or taken only in the final days prior to failure. Other financial indicators could serve to provide an early warning of deteriorating conditions at credit unions. The number of credit unions in PCA significantly increased as the financial crisis unfolded (see fig. 5).June 30, 2011, 560 credit unions triggered PCA. Specifically, of the 560 credit unions that entered PCA from January 1, 2006, through June 30, 2011, the vast majority (452) triggered PCA from January 2008 through June 2011. NCUA has taken steps to stabilize, resolve, and reform the corporate system. Many of the reforms are ongoing and NCUA continues to resolve the failures of U.S. Central and Wescorp. As a result, the ultimate effectiveness of NCUA’s actions and associated costs remain unknown. Moreover, while the 2010 financial statements for NCUSIF are final—and record a loss—the 2010 financial statements for the Stabilization Fund were only recently released at the end of December 2011. 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. 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. Before the recent financial crisis, PCA was largely untested because the financial condition of the credit unions had been generally strong since PCA was enacted. With the failure of the 85 credit unions, the PCA framework showed some weaknesses when addressing deteriorating credit unions. The main weakness of the PCA framework, as currently constructed in statute, stems primarily from tying mandatory corrective actions to only capital-based indicators. As previously reported, capital- based indicators have weaknesses, notably that they can lag behind other indicators of financial distress. Other alternative financial indicators exist or could be developed to help identify early warning signs of distress, which our analysis shows is a key to successful outcomes. Tying regulatory actions to additional financial indicators could mitigate these weaknesses and increase the consistency with which distressed credit unions would be treated. By considering which additional financial indicators would most reliably serve as an early warning sign of credit union distress—including any potential tradeoffs—and proposing the appropriate changes to Congress, NCUA could take the first steps in improving the effectiveness of PCA. Given that the 2010 financial statements for the Stabilization Fund were not available for our review and NCUA was unable to provide us adequate documentation for their estimates as well as the identified shortcomings of current PCA framework, we recommend that NCUA take the following two actions. 1. To better ensure that NCUA determines accurate losses incurred from January 1, 2008, to June 30, 2011, we recommend that the Chairman of NCUA provide its OIG the necessary supporting documentation to enable the OIG to verify the total losses incurred as soon as practicable. 2. 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. We provided a draft of this report to NCUA and its OIG for their review and comment. NCUA provided written comments that are reprinted in appendix V and technical comments that we have incorporated as appropriate. In its written comments, NCUA agreed with our two recommendations. Notably, NCUA stated that it had taken action to implement one of the recommendations by providing OIG with documentation of loss estimates for the Stabilization Fund as of December 31, 2010. It expects to provide additional documentation of loss estimates as of June 30, 2011, in January 2012. In its letter, NCUA also stated that the December 31, 2010, audited financial statements for the Stabilization Fund would be issued in the near future and described reasons for the delay in finalizing this audit. These reasons included the scope and magnitude of the corporate failures and the actions that NCUA had undertaken to resolve the corporate failures and strengthen its financial reporting systems. While NCUA acknowledged that some of the loss estimates were not finalized at the time of our audit, including the 2010 financial statements, it noted that the results from the valuation experts were complete and available. Our report recognizes the challenges that NCUA has faced in finalizing its financial statements and describes the actions that it has taken to stabilize, resolve, and reform the credit union system. However, as we reported, NCUA was unable to provide us with the documentation that we required to verify the reasonableness and completeness of the loss estimates for the Stabilization Fund. Subsequently, the NCUA 2010 Financial Statement Audit for Temporary Corporate Credit Union Stabilization Fund was released on December 27, 2011. 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. Taking the steps to address our recommendation will help NCUA address these questions. In its written comments, NCUA also described its commitment to continued research and analysis to improve the effectiveness of PCA. In particular, NCUA cited its membership on the Federal Financial Institutions Examination Council and the Financial Stability Oversight Council. NCUA also noted that it was following developments related to the federal banking agencies’ consideration of enhancements to PCA triggers, a step that we recommended in our report Banking Regulation: Modified Prompt Corrective Action Framework Would Improve Effectiveness. 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. We also acknowledged in the report that multiple indicators of financial health could be used as early warning indicators and that the extent to which the financial indicators we identified could serve as strong early warning indicators might vary. Furthermore, using some of these indicators as early warning signs of distress could present different advantages and disadvantages—all of which would need to be considered. Nevertheless, we continue to believe that considering a range of potential indicators, including those identified in the report, is a necessary and important step in improving the effectiveness of PCA. NCUA’s letter also noted a potential “misconception” in the report and said that it recognized the need for timelier use of formal enforcement action, as evidenced in its response to OIG findings and recommendations. However, NCUA stated that nearly all failed credit unions received an enforceable regulatory action prior to failure, either through PCA or non-PCA authorities. In some cases, the failures occurred so abruptly that NCUA did not have a long lead time to take action. NCUA also stated that it had a strong record of employing PCA actions when credit unions tripped PCA triggers, as PCA actions are often more expedient forms of enforceable regulatory action. As discussed in the report, successful outcomes were associated with PCA in some cases. However, we also found inconsistencies in the presence and timeliness of PCA and other enforcement actions. Furthermore, we also found that other discretionary enforcement actions to address deteriorating conditions either were not taken or were taken only in the final days before the failure. Finally, the letter concluded that credit unions performed well during the recent financial crisis and that NCUA had successfully mitigated the failures that did occur. Our report describes the scope and magnitude of failures among corporates and credit unions and also notes that the 85 credit unions represented less than 1 percent of credit union assets as of 2008. Finally, we also described actions NCUA had taken to stabilize the credit union system, but we note that NCUA’s examination and enforcement processes did not result in strong and timely actions to avert the failure of these institutions. We are sending copies of this report to NCUA, the Treasury, and the Financial Stability Oversight Council, and other interested parties. The report is also available at no charge on the GAO website at http://www.gao.gov. If you or your staffs have any questions about this report, please contact A. Nicole Clowers at (202) 512-8678 or clowersa@gao.gov. Contact points for our Office of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff that made major contributions to this report are listed in appendix V. During the period of November 2008 to October 2011, the National Credit Union Administration’s (NCUA) Office of Inspector General (OIG) made 25 recommendations to NCUA to improve both corporate and credit union supervision, operations and financial reporting. Six of the 25 recommendations were for corporates and 19 were for credit unions. NCUA has fully implemented 6 of the 25 recommendations relating to improving the corporate structure, corporate governance, examination processes, and call report data, as well as providing guidance on concentration risk. In addition, they have partially implemented another 10 recommendations—2 of these relate to corporate risk management and corporate examiner training. The other 8 partially implemented recommendations are related to improving the credit union examination process and financial monitoring of credit unions on areas such as fast growing and new business programs, third-party relationships, concentration risk, and ensuring credit union’s take appropriate action to respond to documents of resolution (DOR). Finally, NCUA has not yet implemented another 9 recommendations—6 of these recommendations are related to improving examination processes for credit unions with more than $100 million in assets, internal controls and documenting call report analysis. The remaining 3 recommendations that were not implemented relate to improving follow-up procedures for DORs. Furthermore, OIG officials have told us that 13 of the 19 partially or not implemented recommendations will likely be fulfilled with the issuance of the revised National Supervision Policy Manual (NSPM) in 2012. OIG officials have reviewed the draft revised NSPM and determined that it addresses their recommendations. Table 3 provides a summary of these recommendations and their status based on our evaluation of the information that NCUA and its OIG provided. 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. In addition, we reviewed NCUA’s implementation of its OIG recommendations. (See app. I.) To identify the causes of failures among corporates and credit unions, we obtained and analyzed NCUA documents, including Material Loss Reviews (MLR), postmortem reports, Board Action Memorandums (BAM), and other relevant documents. To corroborate this information, we also assessed the asset size and investment concentrations for all failed and nonfailed corporates by conducting analyses of data from SNL Financial—a financial institution database—on corporates’ investment portfolios from January 2003 to September 2010. We obtained and analyzed NCUA data related to conservatorships and resolution actions taken from January 2008 to June 2011 to determine the number and causes of corporates’ and credit union failures. We further assessed credit union member business loan participation as a percentage of total loans for both failed and their peer credit unions that did not fail from December 2005 to January 2011. To identify credit union failures related to fraud, we reviewed data, analyzed reports and documents by NCUA and its OIG on each of the failed credit unions from January 2008 to June 2011. 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). We interviewed NCUA’s OIG, Office of Corporate Credit Unions, Office of Capital Markets, Chief Financial Officer, and Office of Examination and Insurance to obtain their perspectives on the causes of the corporates’ and credit union failures. We further met with credit union industry associations to obtain their views on NCUA’s efforts to reform the corporate credit union system. We assessed the reliability of the SNL and NCUA data used for this analysis and determined that these data were sufficiently reliable for our purposes. To assess the steps that NCUA has taken to stabilize, resolve, and reform the corporate and credit union system, we reviewed NCUA documents and data including BAMs; MLRs; NCUA annual reports from 2008, 2009, and 2010; audited financial statements; NCUA’s Corporate Stabilization and Resolution Plan; and NCUA-commissioned reports; in addition to testimonies at relevant congressional hearings and planning documents. To determine actions taken to reform the corporate system, we reviewed NCUA’s proposed and final rules and interviewed NCUA’s General Counsel to discuss the potential impact of these rules and their effective dates. To determine NCUA’s assessments for credit unions’ and their ability to repay, we reviewed BAMs, NCUA’s scenario analyses for its credit union assessments and loss estimates, and interviewed NCUA officials. We requested detailed information on NCUA’s loss estimates for NCUSIF and Stabilization Fund; NCUA provided some information but it was not sufficient for us to determine the reasonableness and completeness of these estimates. To determine the steps that NCUA took to reduce moral hazard, we compared the actions taken to stabilize, resolve and reform the credit union system to principles cited in our past work on providing federal financial assistance. To assess the outcomes of PCA, we reviewed the outcomes of credit unions as a whole that were subject to PCA from January 1, 2006, through June 30, 2011. Additionally, we tracked a group of credit unions that were subject to PCA from January 1, 2008, through June 30, 2009, during the 2007-2009 financial crisis to identify those credit unions that (1) failed, (2) survived and remained in PCA, and (3) survived and exited PCA. To determine the actions that NCUA took to address deteriorating credit unions, we reviewed regulatory information that included CAMEL ratings, enforcement action data, and PCA-related activities over a 2 year period prior to each credit union failure from January 1, 2008, through June 30, 2011. Specifically, we analyzed the instances and dates of CAMEL downgrades, enforcement actions taken, and PCA-related actions to determine whether and when actions were taken. To assess the utility of various financial indicators in detecting credit unions’ distress, we reviewed the OIG’s MLRs, NCUA’s postmortem studies, and our previous work on PCA. credit unions that did not fail to assess their performance on numerous financial indicators, such as return on assets, operating expenses and liquid assets as an early warning of financial distress. We also compared the failed credit unions and their peers to credit union industry averages across the same period. 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. To compare the performance of these three groups, we chose a range of indicators from the CAMEL rating that demonstrates asset quality (A), management (M), earnings (E), and liquidity (L). For assessing asset quality, we also looked at credit unions’ risk exposure and credit performance.data from SNL Financial. GAO-11-612. We assessed the reliability of the SNL Financial database and NCUA’s enforcement data used in our analyses, and found these data to be sufficiently reliable for our purposes. To determine the status of NCUA’s implementation of OIG recommendations, we reviewed the OIG’s corporate and credit union MLRs and their recommendation tracking documents and interviewed NCUA and NCUA’s OIG officials. We conducted this performance audit from May 2011 to December 2011 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. To help stabilize the credit union system, NCUA created four new programs to provide liquidity to corporates. NCUA initiated two of these new programs, the Credit Union System Investment Program (CU-SIP) and the Credit Union Homeowners’ Affordability Relief Program (CU- HARP) in early 2009. Due to the restriction preventing the Central Liquidity Facility (CLF) from lending directly to the corporate credit unions, NCUA designed both programs, CU-SIP and CU-HARP, so that the CLF would lend to the credit unions, which agreed that they in turn would invest in NCUA-guaranteed notes issued by corporates. Starting in January 2009, corporates were required to use the invested funds to pay down their external secured debt. Money from the corporates’ debt issuances were used to free up collateral and to pay back loans made by the credit unions. In exchange for participating in the programs, the corporates were required to pay CLF borrowing costs to credit unions and an additional fee to the credit unions as an incentive for them to participate in the programs. CLF lending to credit unions totaled approximately $8.2 billion under CU-SIP and about $164 million under CU-HARP. All borrowings for both programs were repaid in 2010. CU-SIP. Credit unions received a 25-basis-point spread over the cost of borrowing from the CLF for investing in 1-year CU-SIP note issued by participating corporate credit unions. Lending from the CLF for the CU-SIP started in January 2009 and ended in March 2009, totaling approximately $8.2 billion. All borrowings were repaid by the credit unions to the CLF by the respective months in 2010 (see fig. 12). CU-HARP. This 2-year program was designed to assist struggling homeowners by temporarily facilitating modifications to their monthly mortgage payments. Credit unions invested in CU-HARP Notes from participating corporates. These notes had 1-year maturities and the option to extend the date of maturity for an additional year. The extension of the program’s 1-year maturity depended on the credit union’s continued good standing and available CLF funding. The CLF lent approximately $164 million to credit unions under the CU-HARP. All remaining notes under the program matured in December 2010 and the credit unions repaid all borrowings. The corporates paid a bonus to the credit unions, which was tied to a 50 percent reduction relief in mortgage payments to homeowners. According to NCUA,CU- HARP was not very successful as the program’s design for credit unions to earn the bonus was complex and the time frame in which to apply was limited (see fig. 13). NCUA created two temporary guarantee programs in late 2008 and early 2009 called the Temporary Corporate Credit Union Liquidity Guarantee Program (Liquidity Guarantee Program) and Temporary Corporate Credit Union Share Guarantee Program (Share Guarantee Program) to help stabilize confidence and dissuade withdrawals by credit unions, in an attempt to avoid a run on the corporates by member credit unions. These programs provided temporary guarantees on unsecured offerings by corporates and shares of credit unions held by corporates in excess of $250,000. NCUA originally included all corporates under both guarantee programs for a limited time after signing a letter of understanding and agreement limiting activities and compensation. It later extended the programs to corporates chose not to opt out of the programs. Liquidity Guarantee Program. NCUA guaranteed the timely payment of The program’s principal and interest of all corporates’ unsecured debt. debt issuance deadline was September 2011, with debt maturing no later than June 2017. However, the program was later revised so that any unsecured debt issued after June 2010 would mature no later than September 2012. NCUA stated that this revision was necessary to focus on short-term liquidity needs and bring the program’s deadline in line with its other stabilization efforts (see fig. 14). Share Guarantee Program. This program largely mirrors the Liquidity Guarantee Program. That is, NCUA guaranteed credit union shares in excess of $250,000 through February 2009, with the option of continuing participation in the program through December 2010. NCUA revised the program in May 2009 to extend the program’s deadline to December 2012 and shortened the length of the program’s coverage to shares with maturities of 2 years or less (see fig. 15). In mid-2009, NCUA transferred obligations from both the Liquidity Guarantee and Share Guarantee programs to the Stabilization Fund to limit NCUSIF’s losses stemming from any future corporate losses. According to NCUA officials, NCUSIF was obligated to provide for any guarantee payments that might arise from either the Liquidity Guarantee Program or the Share Guarantee Program. Based on NCUA’s 2009 financial statements, no guarantee payments were required for either program; however, as of December 19, 2011, audited 2010 financial statements for the Stabilization Fund were not available. On September 24, 2010, the NCUA Board adopted comprehensive new rules to govern corporates. Following its initial publication the final rule, the corporate rules underwent several technical corrections and five additions to the corporate rule were published on April 29, 2011. The corporate rule affect several parts of title 12 of the Code of Federal Regulations but is codified primarily in 12 C.F.R. Part 704. This table provides an overview of the corporate rule as initially published in October 2010 and later amended in April 2011. It summarizes the major provisions at a general level and gives references to where more detailed explanations can be found in the preambles of the October 2010 and April 2011 final rulemakings. The preambles describe in considerable detail the rationales for the provisions, section-by-section analyses of each provision, what NCUA initially proposed, the comments it received and its response to them, and how the final provisions differ from those originally proposed. In addition to the contacts named above, Debra R. Johnson, Assistant Director; Emily R. Chalmers; Gary P. Chupka; Nima Patel Edwards; Debra Hoffman; Barry A. Kirby; Colleen A. Moffatt; Timothy C. Mooney; Robert A. Rieke; and Gregory J. Ziombra made significant contributions to this report. Other contributors included Pamela R. Davidson, Michael E. Hoffman, Grant M. Mallie, Jessica M. Sandler, and Henry Wray.

Summary: Corporate credit unions (corporates)financial institutions that provide liquidity and other services to the more than 7,400 federally insured credit unionsexperienced 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 NCUAs supervision of the credit union system and use of PCA. This report examines (1) the failures of corporate and credit unions since 2008, (2) NCUAs response to the failures, and (3) the effectiveness of NCUAs 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. 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 largestaccounting for 75 percent of all corporate assetsbut the 85 failed credit unions were relatively smallaccounting 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, NCUAs Office of Inspector General has reported that NCUAs 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 NCUAs 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. GAOs 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 actionthat is, before their capital levels deteriorated to the significantly or critically undercapitalized levelsthan 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. 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.