WASHINGTON – The Government Accounting Office's report on corporates credit unions was generally positive, but it did question the capital make-up of corporate credit unions and some of NCUA's examination procedures, or lack therof, were criticized. While the report was just-released at press time, a few corporate CU leaders Credit Union Times spoke with said the report shows that the GAO doesn't understand the difference between the nonprofit CU industry – and corporates' role in it – and the for-profit banking industry. For example, the GAO considers Paid-in-Capital (PIC) and Membership Capital Shares (MCS) as "weaker forms" of credit union capital. In their eyes, Reserves and Undivided Earnings (RUDE) is the only solid corporate CU capital that should be counted. In its comment letter to the GAO, NCUA strongly disagreed with the GAO dismissing PIC and MCS. Corporate One FCU President/CEO Lee Butke, who will be representing the Association of Corporate CUs at NCUA's upcoming capital summit, also said the GAO is off base by not taking PIC and MCS into account when assessing capital. "They are an important part of capital. It's capital that's been formally upstreamed from credit unions to corporate credit unions and done so in a way that's structurally similar in the financial marketplace," said Butke. Butke said what this and other reports usually miss is how corporates are just one spoke in the credit union wheel. "The point that continues to get missed is we're part of a credit union system. When we talk about our tight margins and being competitive, we're talking about value we've returned returned to our credit unions. That's capital that has been retuned to them in competitive interest rates. That's money on their balance sheet, it isn't capital that has been lost," said Butke. "Corporates continue to be looked at in the singular, instead of as part of the system." He said if you take credit unions' 10.7% net worth, corporates' approximate 3% net worth, and U.S.Central's approximate 2% net worth and add it up, "there is a tremendous amount of capital in the system." On the capital issue, SunCorp Corporate President/CEO Eric Kenealy said the GAO was likely just going by generally accepted accounting principles, and said maybe it is time corporates look at how they handle capital. Along the lines of earnings, the report pointed out something that is very obvious to those in the industry – as nonprofits owned by their members, corporates have limited ability to "generate profits." ACCU Executive Director Mike Canning said this is where the GAO has to understand the difference between corporates and other financial institutions. "We don't want to be too profitable. That's our difference," he said. The GAO emphasized that corporates face an increasingly competitive environment that could "stress their overall financial condition." It cited competition with the Federal Reserve System and Federal Home Loan Banks. It also noted that 87% of corporates said they face competition from other corporates, which has been well-documented in this publication over the years. The GAO said corporates are moving to riskier investments to make up for slow growth in retained earnings. While it credited corporates for managing this increased risk by shifting to more variable-rate and shorter-term investments, it says this makes NCUA's role even more important and the agency may not be doing enough in some areas. The GAO said NCUA has not tracked or "systematically evaluated" examination trends to help its examiners anticipate emerging issues. The NCUA acknowledged this and said it will have a more aggregate tracking system, known as a Global Tracking System, in place by the end of the year. It also noted that NCUA also has not "considered certain operational risks, such as weak information system controls, when assigning specialists to examinations. This may have led to NCUA overlooking certain problems or not ensuring that problems were corrected in a timely manner," the GAO wrote. The GAO is also asking NCUA to consider having more specialists examining corporates. NCUA agreed that it needs a more formalized process to involve specialists in involving problem areas. The GAO criticized NCUA's handling of corporate mergers, which have flourished in recent years. "During our review of five recent mergers, we found that NCUA did not conduct their reviews in a consistent manner; additionally, we could not always determine why NCUA reached certain decisions concerning these mergers," it stated. NCUA did not agree with this point, saying it reviews each merger to ensure it will not affect the safety and soundness of the institutions involved. NCUA did concede though that it needs more corporate specific merger guidance and plans to release new guidance in the form of a revision to the Credit Union Merger Procedures and Merger Forms Manual. The GAO also questioned whether NCUA has enough information to assess corporates' internal controls given that corporates are not subject to internal control reporting requirements that similar sized institutions abide by under the Federal Deposit Insurance Corporation Improvement Act of 1991. The GAO recommended that corporates with more than $500 million in assets should provide an annual management report assessing their internal control structure. NCUA concurred with that recommendation. The report did put into perspective how the corporate network has changed, going from 44 corporates in in 1992 to 30 as of year-end 2003. And today the three largest corporates account for approximately half of corporates' total assets. It noted that the three largest corporates have tried to increase earnings by moving more of their investments out of U.S. Central and investing them in higher-yielding instruments. -

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