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Report to the Ranking Minority Member, Committee on Banking, Housing, 
and Urban Affairs, U.S. Senate:

September 2004:

CORPORATE CREDIT UNIONS:

Competitive Environment May Stress Financial Condition, Posing 
Challenges for NCUA Oversight:

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-977]

GAO Highlights:

Highlights of GAO-04-977, a report to the Ranking Minority Member, 
Committee on Banking, Housing, and Urban Affairs, U.S. Senate: 

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. 

Three-Tiered Credit Union System as of December 31, 2003: 

[See PDF for image]

[End of figure]

What GAO Recommends:

To improve oversight of corporates, GAO recommends that the Chairman 
of NCUA (1) establish a process and structure to systematically 
involve specialists in identifying and addressing problems, (2) track 
and analyze examination deficiencies to address complex and emerging 
issues, (3) pay increased attention to oversight of corporates’ risk 
management functions, (4) provide improved guidance to corporates and 
examiners for preparing and reviewing merger packages, and (5) require 
internal control reporting consistent with other financial 
institutions. NCUA agreed to implement all of these recommendations, 
except for providing improved guidance to examiners reviewing mergers.

www.gao.gov/cgi-bin/getrpt?GAO-04-977.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Richard J. Hillman at 
(202) 512-9073 or hilmanr@gao.gov.

[End of section]

Contents:

Letter:

Background:

Results in Brief:

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

NCUA Strengthened Its Oversight of Corporates, but Could Do More to 
Anticipate and Address Emerging Network Issues:

Conclusions:

Recommendations for Executive Action:

Agency Comments and Our Evaluation:

Appendixes:

Appendix I: Objectives, Scope, and Methodology:

Appendix II: Corporate Credit Unions Active as of December 31, 2003:

Appendix III: Structured Questionnaire to Corporate Credit Unions on 
Their Current Makeup and Challenges Facing the Network:

Appendix IV: Selected Responses to Structured Questionnaire Distributed 
to Corporate Credit Unions:

Appendix V: Financial Condition of Corporates, 1992-2003:

Appendix VI: Financial Condition of U.S. Central Generally Mirrors 
Other Corporates:

Appendix VII: Expanded Authorities Available to Corporates:

Appendix VIII: Comments from the National Credit Union Administration:

Appendix IX: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Staff Acknowledgments:

Tables:

Table 1: Corporates' Investments Shifted toward Potentially Higher 
Yielding and More Volatile Securities:

Table 2: Number of Institutions and Total Assets in the Corporate and 
Natural Person Credit Union Systems, 1992-2003:

Table 3: Composition of Selected Investments of Corporates, 1997-2003:

Table 4: Composition of Total Investments of U.S. Central, 1997-2003:

Table 5: Composition of Selected Investments of U.S. Central, 1997-
2003:

Table 6: Expanded Authorities and Number of Corporates Authorized to 
Engage in Investments under These Authorities, as of December 31, 2003:

Figures:

Figure 1: Location of Corporate Credit Unions, as of December 2003:

Figure 2: Services Provided to Natural Person Credit Unions by 
Corporate Credit Unions and U.S. Central Credit Union, as of December 
31, 2003:

Figure 3: Net Income Has Generally Risen, but Profitability Has 
Declined Recently:

Figure 4: Capital Levels Have Risen, but Corporates Have Increasingly 
Relied on Less Permanent Forms of Capital:

Figure 5: Capital Ratios Have Declined Recently (1998-2003):

Figure 6: Corporates' Investments Have Grown and Consistently Represent 
Most of Corporates' Assets:

Figure 7: Largest Corporates Have Invested Relatively Less in U.S. 
Central Obligations Than Smaller Corporates:

Figure 8: Size Distribution of Corporates, by Number, 1992-2003:

Figure 9: Asset Concentration Levels of Corporates, 1992-2003:

Figure 10: Income and Expense Ratios of Corporates, 1993-2003:

Figure 11: Interest Income and Expense Ratios, 1993-2003:

Figure 12: Balance Sheet of U.S. Central, 1992-2003:

Figure 13: U.S. Central's Investments Relative to Total Assets, 1992-
2003:

Figure 14: Total Capital of U.S. Central, 1998-2003:

Figure 15: Capital Ratios of U.S Central, 1998-2003:

Figure 16: Net Income and Profitability of U.S. Central, 1992-2003:

Abbreviations:

ACCU: Association of Corporate Credit Unions:

ACH: automated clearing house:

ALM: asset/liability management:

CLF: Central Liquidity Facility:

CMO: collaterized mortgage obligation:

corporates: corporate credit unions:

CRIS: Corporate Risk Information System:

CUGR: U.S. Central Grantor Trusts:

CUSO: Credit Union Service Organization:

DANA: daily average net assets:

DCI: data collection instrument:

FDIC: Federal Deposit Insurance Corporation:

FDICIA: Federal Deposit Insurance Corporation Improvement Act of 1991:

FFIEC: Federal Financial Institutions Examination Council:

FRAP: floating rate asset program:

NCUA: National Credit Union Administration:

NCUSIF: National Credit Union Share Insurance Fund:

NEV: net economic value:

OCC: Office of the Comptroller of the Currency:

OCCU: Office of Corporate Credit Unions:

OSPSP: Office of Strategic Program Support and Planning:

OTS: Office of Thrift Supervision:

REMIC: real estate mortgage investment conduit:

RUDE: reserves and undivided earnings:

U.S. Central: U.S. Central Credit Union:

Letter September 10, 2004:

The Honorable Paul S. Sarbanes: 
Ranking Minority Member: 
Committee on Banking, Housing, and Urban Affairs: 
United States Senate:

Dear Senator Sarbanes:

Thousands of credit unions have placed about $55 billion of their 
excess funds in corporate credit unions for investment purposes. Under 
a three-tiered system, corporate credit unions (corporates) are member-
owned financial cooperatives whose members are credit unions, not 
individuals. As the "credit union for credit unions," corporates 
provide deposit, liquidity, investment, and processing services for 
their members. In turn, the member credit unions have about 82 million 
members, to whom they provide deposit, loan, and some investment 
services. U.S. Central Credit Union (U.S. Central), a nonprofit 
cooperative, is owned by corporates (serves as the "corporate for the 
corporates") and it serves its members much like corporates serve their 
credit union members--which the federal regulator for credit unions, 
National Credit Union Administration (NCUA), and the corporate network 
refer to as natural person credit unions.[Footnote 1]

We last conducted a comprehensive review of corporates and their 
oversight by NCUA in 1991.[Footnote 2] In addition, we conducted more 
targeted reviews of corporates in 1994 and 1995 in response to the 
failure of a large corporate in the mid-1990s.[Footnote 3] Since that 
time, assets placed in corporates have grown, corporate credit union 
business strategies have changed, and NCUA has significantly changed 
its approach to oversight. In light of the evolution of corporate 
credit union operations and the change in NCUA's supervisory approach, 
and as part of our overall review of the credit union industry, you 
asked us to review a number of issues involving corporates and 
NCUA.[Footnote 4] Based on discussions with your staff, we assessed (1) 
the changes in financial condition of corporate credit unions since 
1992 and (2) NCUA's supervision and oversight of corporates, 
particularly with regard to how it identifies and addresses safety and 
soundness issues.

To assess the changes in the financial condition of corporates, we 
analyzed corporate credit union call report data from December 1992 to 
December 2003, and reviewed internal corporate credit union analyses 
and independent studies of the industry from rating agencies.[Footnote 
5] We also conducted a legislative and regulatory review to determine 
the key legislative and regulatory changes affecting corporates since 
1992. To depict the business environment that can affect the financial 
condition of corporates, we administered a questionnaire to all 31 
currently operating corporates, and interviewed NCUA and credit union 
trade organization officials. To assess how NCUA's supervision of 
corporates identified and addressed safety and soundness issues, we 
reviewed NCUA documentation on its risk-focused examination program and 
reviewed examinations and NCUA management reports for all corporates 
from 2001 through 2003. We also conducted a detailed review of NCUA 
workpapers for 10 corporates and interviewed the examiners who were 
responsible for supervising these corporates. In addition, we conducted 
site visits to seven corporates, selected based on their size, 
geographic location, and whether they were state or federally 
chartered, or were granted expanded investment authorities.[Footnote 6] 
Appendix I provides additional details on our scope and methodology. 
Appendix II provides a list of all 31 corporates that were active as of 
December 31, 2003, and appendix III contains a copy of the structured 
questionnaire. We conducted our work in Alexandria, Virginia, 
Washington, D.C., and other U.S. cities from December 2003 to September 
2004 in accordance with generally accepted government auditing 
standards.

Background:

Corporate credit unions occupy a unique niche among financial 
institutions.[Footnote 7] They are nonprofit financial cooperatives 
that are owned by natural person credit unions (that is, credit unions 
whose members are individuals), and provide lending, investment, and 
other financial services to these credit unions. For example, 
corporates offer loans to member credit unions, which in turn use these 
loans to meet the loan demands of their individual members. However, 
corporates are not the only financial institutions that provide 
products and services to credit unions. For example, some credit unions 
may also obtain loans from Federal Reserve Banks or Federal Home Loan 
Banks.[Footnote 8] Additionally, corporates offer credit unions 
investment products and investment advice, but credit unions can also 
obtain these services from broker-dealers or investment firms. Finally, 
corporates also offer automated settlement, securities safekeeping, 
data processing, accounting, and electronic payment services, which are 
similar to the correspondent services that large commercial banks have 
traditionally provided to smaller banks. With an emphasis on safety and 
liquidity, 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. However, corporates' limited ability 
to generate profits--as nonprofit institutions, owned and controlled by 
their primary customers--constrains their ability to build a financial 
cushion against adverse financial conditions or unexpected losses.

Since 2000, corporates have experienced deposit inflows from natural 
person credit unions that increased corporates' assets and shares. 
Corporates act as a "liquidity sponge" for the underlying natural 
person credit union system, and the cyclical rise and fall of 
corporates' assets and shares (deposits) are rooted in the deposit 
flows of the natural person credit unions. Thus, these inflows and 
outflows of deposits, which are beyond corporates' control, affect 
their measures of financial strength--such as profitability and capital 
ratios. As we discuss later in the report, this has exacerbated the 
stress on their financial condition.

Since 1992, the number of corporates in the corporate network has 
decreased, with assets more concentrated in larger institutions. (See 
fig. 1 for an illustration of the network's geographic distribution.) 
Mainly as a result of mergers, corporates have decreased in number from 
44, at the end of 1992, to 30 as of December 31, 2003, excluding U.S. 
Central. On average, corporates also have become larger, with the 
median asset size (excluding U.S. Central) increasing from $450.6 
million in 1992 to $1.2 billion at the end of 2003. However, the 
corporate network still encompasses small and large institutions, 
ranging in size from $7.3 million in assets to $25 billion, as of 
December 31, 2003. In addition, asset concentration in the network has 
become more pronounced since 1992. Excluding U.S. Central, at the end 
of 1992 the three largest corporates accounted for approximately 42 
percent of the corporates' total assets. By the end of 2003, these 
corporates accounted for roughly half of corporates' total assets and 
the largest corporate accounted for about one-third.

Figure 1: Location of Corporate Credit Unions, as of December 2003:

[See PDF for image] 

[End of figure] 

As shown in figure 2, the credit union industry is organized into three 
closely connected groupings. At the "top" or retail level, as of 
December 31, 2003, there were the 9,488 credit unions that served 
roughly 82 million individual customers. In the middle are the 30 
corporates, which serve credit unions by investing the cash they have 
not lent out and by providing loans and other financial services to the 
credit unions. Finally, on the "bottom" or wholesale level is U.S. 
Central, which provides corporates a range of products and services, 
similar to those that corporates provide to credit unions.

Figure 2: Services Provided to Natural Person Credit Unions by 
Corporate Credit Unions and U.S. Central Credit Union, as of December 
31, 2003:

[See PDF for image] 


[A] Includes cash management products and services, risk management, 
settlement, and funds transfer.

[B] Twenty-nine corporates are members of U.S. Central Credit Union. 
LICU Corporate Federal Credit Union is not a member of U.S. Central. 
LICU Corporate was originally established as a corporate credit union 
to facilitate payment and payroll processing for a league of IBM credit 
unions. While LICU Corporate and U.S. Central have discussed the 
possibility of LICU Corporate joining U.S. Central, LICU has not 
applied for membership.

[End of figure]

Since their inception, corporates' primary functions have been to 
accept deposits and make loans to their members. In addition, today, 
they also provide investments and other financial services to credit 
unions, and corporates over time have broadened the types of products 
and services they offer. Most corporates offer:

* investment services;

* electronic services, such as the Automated Clearing House (ACH) and 
wire transfers;

* correspondent services, such as settlements with the Federal Reserve 
and other financial institutions;

* check services, including collection and settlement of money orders 
and traveler's checks;

* credit card settlement; and:

* education and training.

However, corporates now offer or plan to introduce new products and 
services such as online training, electronic bill payment, Internet 
banking, asset/liability management (ALM), and brokerage 
services.[Footnote 9] For more detailed information on the products and 
services corporates offered or planned to offer, see appendix IV.

While the first credit union in the United States started in 1909, the 
first corporate did not start operations until 1968.[Footnote 10] Many 
corporates grew out of the various state credit union leagues and 
initially served only single states or regions. Over time, corporates 
were granted national fields of membership that allowed them to expand 
the number of credit unions they served. While corporate credit union 
membership can be national, corporates can have either a state or 
federal charter. As of December 31, 2003, 18 of the 31 corporates, 
including U.S. Central, were state-chartered. In terms of oversight, 
NCUA has authority for supervision and examination of federally 
chartered corporates. Under the dual-chartering system, the supervisory 
authorities for those states that have state-chartered corporates are 
primarily responsible for supervision of these institutions. However, 
since all corporates provide deposit, liquidity, and correspondent 
services to federally insured credit unions, NCUA also has regulatory 
authority over state-chartered corporates and assesses the risks 
federally insured, state-chartered corporates and noninsured, state-
chartered corporates present to the National Credit Union Share 
Insurance Fund (NCUSIF).[Footnote 11] This assessment, which is 
essentially an examination of the corporates' operations, is performed 
jointly with state supervisory authorities during their examinations of 
state-chartered corporates.

Part 704 of NCUA's regulations, together with the relevant provisions 
of the Federal Credit Union Act of 1934, constitutes the primary 
federal regulatory framework for both state-and federally chartered 
corporates.[Footnote 12] NCUA first issued Part 704 in 1982. Since our 
previous report on corporates in 1991, NCUA made significant revisions 
to Part 704 in 1998 and 2002 relating to risks, capital, investments, 
and other areas covered by this report.

Results in Brief:

Corporates face an increasingly challenging business environment that 
has created potential stresses on their financial condition. Like other 
financial institutions, corporates operate in an environment 
characterized by increasing competition, changing product and service 
offerings, and the continuous introduction of new technology--thus 
increasing the complexity of their operations, which in turn can impact 
their financial condition. The corporates' financial condition, as 
measured by profitability (the ratio of net income to average assets) 
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 caused a 
downward trend in corporates' overall profitability because deposits/
assets have grown more quickly than income. More recently, the 
relatively slower growth in retained earnings (a component of income) 
has also put pressure on capital ratios, which raises some concern 
since capital ratios are an important indicator of financial strength. 
To generate earnings, corporates increasingly have targeted more 
sophisticated and potentially riskier investments. However, corporates 
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 and managing 
its other risks. Further, NCUA recently permitted the three largest 
corporates to invest in lower-rated securities, potentially increasing 
their credit risk (that is, there is a higher risk of nonpayment on 
assets held by the corporate), but their use of this expanded authority 
has been negligible to date. The corporates' changing business 
environment and their use of more sophisticated and potentially 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, which has allowed it 
to better address safety and soundness issues; 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. Since 1991, 
NCUA has created an office dedicated to the oversight of corporates--
the Office of Corporate Credit Unions (OCCU)--significantly revised 
regulations specific to corporates, implemented risk-focused 
supervision and examinations, and hired specialists in areas such as 
capital markets and information systems. Based on our review of NCUA 
examinations for 2001 through 2003, NCUA examiners generally have 
identified safety and soundness issues and mandated corrective actions 
to address them. However, NCUA has not tracked or systematically 
evaluated trends in examination findings and their resolution to help 
its examiners anticipate emerging issues within the corporate network. 
Further, NCUA has not systematically 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. In addition, although it has responsibilities to approve 
proposed mergers, we found that NCUA had not developed specific 
guidance for corporates submitting merger proposals or ensured that the 
guidance examiners used to assess these proposals was comprehensive and 
clearly applicable to corporates. For example, NCUA has referred 
corporates to guidance issued for natural person credit unions that 
provides step-by-step instructions for completing the merger process, 
but the capital ratios were not relevant for evaluating corporates' 
proposals. 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. In an increasingly competitive environment in 
which corporates are considering mergers to remain competitive, 
nonspecific guidance and inconsistent reviews of merger proposals might 
lead to mergers that would not be in the best interest of members and 
would present undue risks to the network's safety and soundness. 
Finally, as corporates introduce new technologies and offer their 
members more sophisticated products and services, NCUA's oversight of 
corporates' internal controls has become more important. However, 
corporates are not subject to the internal control reporting 
requirements imposed on other financial institutions of similar size 
that help to ensure safety and soundness, as defined under the Federal 
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). This 
raises a question about whether NCUA has the necessary information to 
assess corporates' internal controls.

This report contains recommendations to NCUA that, if implemented, 
would provide a more systematic and consistent approach to NCUA's 
oversight of corporates to help achieve its goal of promoting a network 
of financially healthy, well-managed federally insured corporates.

We requested comments on a draft of this report from the Chairman of 
the National Credit Union Administration. We received written comments 
from NCUA that are reprinted in appendix VIII. NCUA concurred with most 
of our assessments and conclusions and agreed to take action to 
implement all but part of one of our report's recommendations. NCUA's 
comments and our response are discussed at the end of this report.

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.[Footnote 13] Moreover, 
recent pressure from a low-interest-rate environment and rapid growth 
in assets has put additional stress on the corporate network's 
profitability and capital ratios.[Footnote 14] While net income levels 
have grown since 2000, corporates' profitability was lower in 2003 than 
in 1993. As rapid asset growth negatively impacts profitability, it 
affects corporates' ability to generate sufficient retained:

earnings--the primary component of their capital.[Footnote 15] As 
overall capital levels have been rising, corporates have been relying 
more on less permanent (relatively weaker) forms of capital. 
Additionally, rapid asset growth and the relatively slower growth in 
retained earnings has put pressure on corporates' capital ratios, which 
could be a cause for concern since capital ratios are an important 
indicator of financial strength. Growth and changes in corporate 
investments, such as recent shifts of more of the corporates' 
investment portfolios into potentially higher yielding and more 
volatile securities, may increase interest-rate risk if the investments 
are not managed properly. In particular, the percentage of corporate 
investments in obligations of U.S. Central has declined while the 
percentages of corporates' investments in privately issued mortgage-
related and asset-backed securities have increased.[Footnote 16] 
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. 
However, a regulatory change effective in 2003 allowed certain 
corporates to purchase securities with lower credit quality (more 
credit risk), raising implications for NCUA oversight since this 
activity may lead to increased risk if it is not managed properly.

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. To obtain the corporates' views on 
their business environment, we distributed a questionnaire to the 
entire network and achieved a 100 percent response rate. The corporates 
reported that they faced competition from outside the corporate network 
from entities such as banks, broker-dealers, the Federal Reserve 
System, and Federal Home Loan Banks. About 87 percent of the corporates 
reported that they also faced competition from other corporates despite 
the cooperative nature of the network. In addition, in recent years 
(since 2000), corporates have received a large inflow of deposits from 
their natural person credit union members, which had increasing amounts 
of unloaned funds because of the "flight to safety" that occurred in 
the wake of the stock market downturn.[Footnote 17] These inflows 
increased corporates' assets, pressuring them to ensure that they 
received sufficient returns when investing these funds to maintain 
adequate capital levels and fund operations. However, over the last 
several years, low interest rates have reduced the returns that 
corporates could obtain on their investments, which has put stress on 
their overall profitability. Finally, the corporates stated that they 
faced a rapidly changing marketplace, particularly related to the 
increased demands from credit unions for more sophisticated products 
and services such as electronic banking.

The strategies corporates have employed to respond to their challenging 
business environment can have positive or negative impacts on their 
overall financial condition. For example, over time, corporates have 
increasingly invested in securities such as privately issued mortgage-
related and asset-backed securities and less so in obligations of 
U.S.Central, suggesting that they are seeking to enhance the yields on 
their investments. As corporates shift their investments into 
potentially higher-yielding securities, the network could face 
increased risks if individual corporates do not have adequate 
infrastructure in place to manage risks associated with their 
investments.[Footnote 18]

Increasing competitive pressures may have encouraged consolidation, 
through mergers within the network, as corporates sought to achieve 
economies of scale. Consolidation is likely to continue as 7 of the 30 
corporates responding to our questionnaire stated that they were likely 
or would consider merging in the next 2 years. Industry observers have 
noted that mergers are an effective strategy to attain economies of 
scale necessary to afford investments in technology and skilled 
personnel; however, if poorly implemented, mergers have the potential 
to impact operating performance. The recent and expected consolidation 
activities within the network could impact the financial condition of 
the acquiring corporate, as well as the corporate network.

Finally, based on the responses to our questionnaire, corporates 
reported that they have been forming strategic alliances with other 
corporates to provide member credit unions with sophisticated products 
and services such as online banking and business lending services. 
Industry observers have viewed these alliances as an effective approach 
to meet the demands of members while distributing the costs among 
several corporates. However, as corporates move into new areas to meet 
the demands of their members, corporates need to maintain sufficient 
retained earnings and capital levels.

Despite General Growth in Net Income, Corporate Profitability Has 
Trended Lower Recently:

Despite generally rising net income levels since 1995, the 
profitability of corporates has declined recently due to the low-
interest-rate environment and large inflows of deposits from natural 
person credit unions.[Footnote 19] More specifically, as shown in 
figure 3, while net income of corporates generally fluctuated since 
1992, it grew overall since 1995. While profitability generally 
remained within ranges prevalent in the industry since the mid-1990s, 
it was lower at the end of 2003 than at the end of 1993.[Footnote 20]

Figure 3: Net Income Has Generally Risen, but Profitability Has 
Declined Recently:

[See PDF for image] 

Note: In this figure, profitability in a given year is measured by the 
ratio of that year's net income to the average of that year's total 
assets and the prior year's total assets. This figure excludes data on 
U.S. Central.

[End of figure] 

Also, as shown in figure 3, profitability--the net income corporates 
realize on their assets--was relatively stable in the mid-1990s, but 
has been trending downward since 2001. Effectively, the recent lower-
interest-rate environment has narrowed the difference between what 
corporates were earning on their investments and what they were paying 
to their members. (Appendix V provides more details on corporates' 
income and operating expenses.) Profitability is an important indicator 
of financial condition, as it is a key determinant of the sufficiency 
of a corporate's retained earnings. Retained earnings are the primary 
component of a corporate's capital, representing that corporate's 
financial strength and its ability to withstand adverse financial 
events. The recent trend downward in corporates' profitability has 
slowed growth in their retained earnings and capital compared with 
their assets.

Despite Increases in Overall Capital Levels, Corporates' Capital Ratios 
Have Trended Lower Recently:

The overall level of capital at corporates has steadily increased since 
1998, in part due to regulatory changes that allowed corporates to use 
other, less permanent (or relatively weaker) forms of capital in 
addition to retained earnings.[Footnote 21] Corporates have been 
increasingly relying on these relatively weaker forms of capital. 
However, since 2000 capital ratios have declined as growth in assets 
outpaced growth in capital.[Footnote 22] The increasing reliance on 
less permanent forms of capital and corporates' generally constrained 
ability to build capital in periods of stress raises a potential 
concern about the financial strength of the corporate network.

Capital Levels Have Generally Risen, but Corporates Increasingly Have 
Relied on Less Permanent Forms of Capital:

As shown in figure 4, the overall level of capital at corporates has 
steadily increased since 1998. This is due in part to regulatory 
changes that allowed corporates to use other, less permanent (or 
relatively weaker) forms of capital in addition to retained earnings.

Figure 4: Capital Levels Have Risen, but Corporates Have Increasingly 
Relied on Less Permanent Forms of Capital:

[See PDF for image] 

Note: Retained earnings represent the most permanent form of capital, 
while membership capital represents the least permanent. This figure 
excludes data on U.S. Central.

[End of figure] 

Beginning in 1998, Part 704 of NCUA regulations expanded the definition 
of regulatory capital by defining capital as the sum of reserves and 
undivided earnings (that is, retained earnings) and permitted 
corporates to include two other, less permanent forms--paid-in capital 
and membership capital. More specifically, reserves and undivided 
earnings include all forms of retained earnings, including regular or 
statutory reserves and any other appropriations designated by 
management or regulatory authorities. NCUA currently defines "core 
capital" for corporates in Part 704 as retained earnings plus paid-in 
capital. Retained earnings, which are internally generated, are the 
most permanent form and the primary component of corporates' capital. 
Both paid-in capital and membership capital, which are from external 
sources, are less permanent forms of capital, suggesting they provide a 
relatively weaker cushion against adverse financial events. Prior to 
July 1, 2003, paid-in capital was defined as a member deposit account 
with an initial maturity of at least 20 years. However, NCUA now 
requires paid-in capital to be a more permanent form of capital (a 
perpetual dividend account), available to cover losses that exceed 
reserves and undivided earnings. NCUA had noted that, due to its high 
cost, paid-in capital would be used by corporates as a bridge during 
short periods of stress, such as rapid growth, and should not be used 
for long periods. While NCUA's redefinition of paid-in capital has 
increased the relative permanence of this form of capital, membership 
capital represents funds contributed by members that have either an 
adjustable balance with a required notice of withdrawal of at least 3 
years or are term certificates with a minimum term of 3 years.[Footnote 
23] As such, membership capital is probably best thought of as a form 
of subordinated debt, which can protect the insurance fund in the event 
of a corporate failure.

As shown in figure 4, corporate capital rose from $2.9 billion in 1998 
to $5 billion at the end of 2003. Retained earnings accounted for 41 
percent of total capital in 1998 but declined to around 36 percent of 
total capital at the end of 2003. Paid-in capital increased from around 
6 percent of total capital in 1998 to around 10 percent in 2003. 
Membership capital shares have consistently represented the largest 
percentage of capital, typically around 50 percent, and have been 
steadily accounting for a greater percentage of capital since 2000. 
Thus, while the capital of corporates continues to rise, corporates 
have increasingly relied on less permanent (that is, relatively weaker) 
forms of capital. While this is a method corporates can use to increase 
capital during periods of rapid growth in assets, it does lead to 
concerns about the ability of the network to withstand financial 
shocks, especially in light of the increasingly challenging business 
environment they face.

Capital Ratios Have Declined Recently but Remain above Current 
Regulatory Requirements:

While the total capital of corporates has steadily increased since the 
late-1990s, since 2000 capital ratios have declined as growth in assets 
outpaced growth in capital. NCUA currently specifies three capital 
ratios: the capital ratio, which includes all forms of capital relative 
to moving daily average net assets (DANA); the core capital ratio, 
which includes core capital (retained earnings plus paid-in capital) 
relative to moving DANA; and the retained earnings ratio, which 
includes reserves plus undivided:

earnings relative to moving DANA.[Footnote 24] As depicted in figure 5, 
these capital ratios were lower in 2003 than in 1998 despite generally 
rising capital levels.

Figure 5: Capital Ratios Have Declined Recently (1998-2003):

[See PDF for image] 

Note: In this figure, capital ratios are calculated by dividing capital 
by the moving daily average of net assets (DANA), which is a measure of 
average assets as set forth in Part 704 in 1998. This figure excludes 
data on U.S. Central.

[End of figure] 

As assets have increased, corporates have been unable to generate 
sufficient capital to maintain capital ratios. In particular, after 
peaking in 2000, capital ratios declined, as the corporates' asset 
base--which inversely affects the capital ratio--increased by over 80 
percent over the same period. Despite recent declines, at the end of 
2003 the capital and retained earnings ratios remained in excess of 
their current respective regulatory requirements of 4 percent and 2 
percent.[Footnote 25] Due to corporates' role in serving their members, 
their generally low earnings continue to present a challenge and a 
potential weakness--as corporates generally rely on building permanent 
capital from retained earnings--and could put a strain on the 
profitability of the corporate network in the future. As a result, 
corporates' capital ratios, although above current regulatory 
requirements for safety and soundness purposes, are vulnerable to 
erosion from factors such as rapid inflows of deposits that corporates 
may not be able to control.

Growth and Changes in Corporates' Investments May Increase Risks If Not 
Monitored or Managed Properly:

Although assets have grown through the recent influx of deposits, 
corporates have continued to allocate them almost exclusively to 
investments (rather than other assets that include cash, loans, or 
fixed assets). With this growth, the percentage of corporates' 
investments in obligations of U.S. Central has declined somewhat, 
particularly for the largest corporates. In response to the low-
interest-rate environment, corporates have moved relatively more of 
their investments into potentially higher yielding--and more volatile-
-securities. The largest corporates also appear to be managing 
interest-rate 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. However, a 
regulatory change effective in 2003 allowed certain corporates to 
purchase securities with lower credit quality, but few have used this 
investment authority. It is not clear, however, to what extent 
corporates might use this investment flexibility in the future, raising 
implications for NCUA oversight since this activity may lead to 
increased credit risk if it is not managed properly.

While Corporate Investment Portfolios Have Grown, Larger Corporates 
Invested Less in U.S. Central:

Corporates' investments have grown with the recent inflows of deposits 
from natural person credit unions. Investments, which include asset-
backed securities, commercial debt obligations, mortgage-related 
issues, and U.S. government obligations, represent the vast majority of 
corporates' assets--usually 90 percent or more (see fig. 6). At the end 
of 1992, total investments of corporates stood at $41.1 billion; at the 
end of 2003, they were reported at $65.3 billion. Since 2000, total 
investments of corporates have grown by 84 percent.

Figure 6: Corporates' Investments Have Grown and Consistently Represent 
Most of Corporates' Assets:

[See PDF for image] 

Note: Other assets include cash, loans, and fixed assets. This figure 
excludes data on U.S. Central.

[End of figure] 

Since 1992, corporates' investments in U.S. Central obligations have 
typically accounted for approximately one-half of their total 
investments, the largest single investment category. The generally high 
proportion of investments in U.S. Central obligations reflects the 
"pass-through" nature of many corporates. Historically, U.S. Central 
has functioned as a conduit between corporates and the capital markets. 
Despite growth in the overall amount of corporates' investments in U.S. 
Central obligations, they declined as a percentage of corporates' total 
investments from 1997 to 2003. For example, they went from $15.6 
billion (53 percent) at the end of 1997 to $29.2 billion (45 percent) 
at the end of 2003. This decline indicates that the largest corporates 
are investing their funds directly, rather than through U.S. Central. 
As shown in figure 7, in general, the largest corporates have held 
smaller percentages of their investments in U.S. Central obligations 
than smaller corporates.

Figure 7: Largest Corporates Have Invested Relatively Less in U.S. 
Central Obligations Than Smaller Corporates:

[See PDF for image] 

Notes: In this figure, which separates corporates into three categories 
according to their year-end assets, corporates' investments in U.S. 
Central obligations are shown relative to corporates' total 
investments. Prior to 1997, NCUA call reports did not disaggregate 
investments in U.S. Central obligations from investments in corporate 
credit unions, and thus a proxy measure--investments in corporates 
relative to corporates' total investments--is depicted for 1992-1996. 
To the extent that corporates invested in other corporates during 1992-
1996, the call report data reflect an upper bound on investments in 
U.S. Central obligations. This figure does not follow the same 
institutions each year; rather, it reflects the investments of those 
corporates in a given size category in a given year. This figure 
excludes data on U.S. Central.

[End of figure] 

As investment management has increased in complexity, smaller 
corporates may not have had the resources necessary to develop and 
maintain investment capabilities internally, and U.S. Central thus was 
able to provide smaller corporates with these services by leveraging 
the efficiencies gained through its economies of scale. Despite the 
recent decline in the percentage of corporates' investments in U.S. 
Central obligations, U.S. Central still provides substantial investment 
services--suggesting that the health of U.S. Central remains critically 
important for its members and their associated natural person credit 
unions.

Investments Have Shifted Toward Potentially Higher Yielding and More 
Volatile Securities, but Largest Corporates Appear to Be Managing 
Interest-Rate Risk:

In response to the low-interest-rate environment, corporates have moved 
relatively more of their investments into potentially higher yielding-
-and more volatile--securities. In particular, corporates have 
increased their relative holdings of privately issued mortgage-related 
and asset-backed securities, which may offer higher yields for 
corporates relative to other investments such as government-guaranteed 
obligations. As illustrated in table 1, the percentage of investments 
in privately issued mortgage-related securities increased from 0.9 
percent of total investments in 1997 to 14.1 percent in 2003. Asset-
backed securities also increased relative to total investments (from 
19.5 percent in 1997 to 24.7 percent in 2003).[Footnote 26] With the 
potentially higher yields, the corporates are also potentially 
increasing risk--notably interest-rate risk. This shift highlights the 
importance of risk monitoring and management by the corporates and 
NCUA.

Table 1: Corporates' Investments Shifted toward Potentially Higher 
Yielding and More Volatile Securities:

U.S. Central obligations held by corporates; 
1997: Investments relative to total investments (percent): 53%; 
1998: Investments relative to total investments (percent): 56%; 
1999: Investments relative to total investments (percent): 57%; 
2000: Investments relative to total investments (percent): 53%; 
2001: Investments relative to total investments (percent): 45%; 
2002: Investments relative to total investments (percent): 42%; 
2003: Investments relative to total investments (percent): 45%.

Asset-backed securities; 
1997: Investments relative to total investments (percent): 19%; 
1998: Investments relative to total investments (percent): 18%; 
1999: Investments relative to total investments (percent): 24%; 
2000: Investments relative to total investments (percent): 23%; 
2001: Investments relative to total investments (percent): 23%; 
2002: Investments relative to total investments (percent): 23%; 
2003: Investments relative to total investments (percent): 25%.

Privately issued mortgage-related securities; 
1997: Investments relative to total investments (percent): 1%; 
1998: Investments relative to total investments (percent): 2%; 
1999: Investments relative to total investments (percent): 3%; 
2000: Investments relative to total investments (percent): 4%; 
2001: Investments relative to total investments (percent): 6%; 
2002: Investments relative to total investments (percent): 9%; 
2003: Investments relative to total investments (percent): 14%.

Government and agency mortgage-related securities; 
1997: Investments relative to total investments (percent): 13%; 
1998: Investments relative to total investments (percent): 9%; 
1999: Investments relative to total investments (percent): 9%; 
2000: Investments relative to total investments (percent): 8%; 
2001: Investments relative to total investments (percent): 8%; 
2002: Investments relative to total investments (percent): 7%; 
2003: Investments relative to total investments (percent): 6%.

Other; 
1997: Investments relative to total investments (percent): 14%; 
1998: Investments relative to total investments (percent): 14%; 
1999: Investments relative to total investments (percent): 7%; 
2000: Investments relative to total investments (percent): 11%; 
2001: Investments relative to total investments (percent): 18%; 
2002: Investments relative to total investments (percent): 18%; 
2003: Investments relative to total investments (percent): 11%.

Total investments (in millions); 
1997: $29,727; 
1998: $41,645; 
1999: $35,642; 
2000: $35,553; 
2001: $55,449; 
2002: $63,859; 
2003: $65,280. 

Source: Call report data.

Notes: Totals may not add due to rounding. "Other" includes U.S. 
government obligations, U.S. government-guaranteed obligations, 
obligations of U.S. government-sponsored enterprises, and commercial 
debt obligations. This table excludes data on U.S. Central.

[End of table]

However, corporates also have shifted the composition of their 
investment portfolios toward more variable-rate and shorter-term 
securities, a strategy that tends to reduce adverse exposure to 
changing interest rates and thus reduces interest-rate risk. While 41.7 
percent of corporates' asset-backed securities were classified as 
fixed-rate at the end of 1997, 18 percent were so classified at the end 
of 2003. Since corporates' call reports do not include weighted-average 
life data--the expected time that the principal portion of a security 
will remain outstanding--we reviewed materials from the three largest 
corporate credit unions that showed these institutions tended to hold 
securities with relatively short weighted-average lives, with most 
being less than 3 years.[Footnote 27] As a result, while corporates 
have moved to securities that may entail additional investment risk, 
the largest corporates in the network appear to be managing interest-
rate 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.[Footnote 28]

Expanded Authority to Invest in BBB Rated Securities May Lead to 
Increased Credit Risk If Not Managed Properly:

Due to the revision of Part 704, some corporates have been allowed to 
invest in lower-rated securities (down to BBB rated), which might lead 
to increased credit risk if these investments were not managed 
properly.[Footnote 29] Investments with lower credit quality tend to 
provide higher yields but can also expose investors to the increased 
likelihood that promised cash flows will not be paid. While "moving 
down the credit curve" (that is, investing in lower credit quality 
securities) potentially exposes a corporate to increased credit risk, 
such a strategy might not increase the overall risk for a corporate 
making such investments provided the additional risk was managed 
appropriately. According to NCUA, this regulatory change gave 
corporates added flexibility with which to diversify their portfolios 
and reduce investment concentration.[Footnote 30] In particular, these 
securities could be used in an attempt to limit credit risk by lowering 
concentrations in certain industries or geographical areas and creating 
a more diversified portfolio. Also, lower-rated securities could be 
purchased because they carried a particularly attractive return for 
their credit rating or provided a good mix of credit risk and interest-
rate risk given the other holdings of a corporate.[Footnote 31] 
According to NCUA and corporate officials, the ability to hold such 
lower-rated securities in their portfolios (as opposed to having to 
sell a security immediately if it were downgraded) might provide these 
institutions more flexibility in disposing of an investment that 
suffered a rating downgrade. Corporates would be able to hold the 
investment in an effort to limit realized losses rather than being 
forced to promptly liquidate it. Based on our review of information 
provided by the three corporates that have the authority to invest in 
these securities, as well as discussions with their officials and risk 
management staff, corporates either have made few such investments or 
none. Further, officials at the three institutions indicated that they 
did not plan to use their authority to purchase BBB rated securities.

However, it is not clear to what extent corporates will take advantage 
of this investment flexibility in the future, which has implications 
for NCUA oversight that we discuss later in this report. If corporates 
were to hold or invest in BBB rated securities to a greater extent, 
these investments might create additional risks to the corporate 
network if not managed properly. In general, like other financial 
institutions, a corporate's vulnerability to risk depends on its 
overall portfolio and the amount of capital that is backing it. Some 
have suggested that corporates tend to be relatively thinly capitalized 
compared with other financial institutions, which may raise concerns 
over potential additional exposure to risk. For example, the Department 
of the Treasury has raised concerns that allowing corporates to invest 
in BBB rated securities could weaken the safety and soundness of the 
corporate network because the amount of capital held in the 
corporatesmight not be commensurate with the risks associated with 
these lower credit quality investments.[Footnote 32]

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. 
Specifically, NCUA established a separate office dedicated to the 
oversight of corporates, and revised its corporate regulation (Part 
704) to improve corporates' management of credit, interest-rate, and 
liquidity risks. NCUA also adopted a risk-focused supervision and 
examination approach, and trained or hired a limited number of 
specialists to help oversee increasingly complex operations at 
corporates. However, NCUA has not put in place a system to track the 
resolution of deficiencies or evaluate trends in examination data and 
therefore may not be able to anticipate emerging issues within the 
network. Further, NCUA has not systematically considered certain 
operational risks, such as weak information system controls, when 
assigning specialists to examinations, which may have led to NCUA 
overlooking certain problems or not ensuring that problems were 
corrected in a timely manner. While continued consolidation of the 
corporate network appears likely, NCUA has not developed merger 
guidance specific to corporates, and its examiner guidance has not 
ensured that merger proposals were assessed consistently. Thus, NCUA's 
inadequate guidance has increased the risk that resulting decisions may 
not be in the best interests of corporates or their members, or may 
negatively affect the safety and soundness of corporates. Also, as 
corporates have invested in more complex technologies and added more 
sophisticated products and services, the importance of NCUA's oversight 
of corporates' internal controls has increased. However, corporates are 
not subject to the internal control reporting requirements imposed on 
other financial institutions of similar size that help to ensure safety 
and soundness, as defined under the Federal Deposit Insurance 
Corporation Improvement Act of 1991 (FDICIA). This raises a question 
about whether NCUA has the necessary information to assess corporates' 
internal controls.

NCUA Made Several Major Improvements in Oversight Since 1991:

Since 1991, NCUA has strengthened its oversight of corporates by 
reorganizing staff, revising regulations, and changing examination and 
supervisory focus. NCUA established the Office of Corporate Credit 
Unions (OCCU) in 1994, partly in response to problems with selected 
investments at U.S. Central.[Footnote 33] Within this new office, NCUA 
centralized its supervision of corporates and increased the number of 
examiners dedicated to supervision and examination of corporates. 
According to NCUA officials, prior to this change, NCUA examiners 
lacked adequate training and expertise to examine activities undertaken 
by corporates, since they spent most of their time examining natural 
person credit unions, whose operations generally are less complex than 
those of corporates. Further, in 1992, NCUA had 12 examiners dedicated 
to the oversight of 44 corporates and U.S. Central. As of June 2004, 
NCUA had 22 examiners plus three information systems specialists and 
one payments system specialist hired to help oversee the 30 corporates 
and U.S. Central.

NCUA also revised its corporate regulation (Part 704) in 1998 to 
increase measurement and monitoring of interest-rate, liquidity, and 
credit risk within the corporate network.[Footnote 34] The revisions to 
Part 704 were in response to the failure of Capital Corporate Federal 
Credit Union in January 1995 and GAO and other recommendations for NCUA 
to improve its oversight of corporates.[Footnote 35] The 1998 revisions 
required corporates to measure and report on the impact of interest-
rate and liquidity changes on their net economic value.[Footnote 36] 
Corporates also were required to change the methods used to calculate 
their investment concentration limits--moving from a calculation that 
used an asset base to one that consisted of core capital (reserves and 
undivided earnings and paid-in-capital). Corporates could use this 
method to improve their management of credit risk by matching the risks 
associated with investment concentrations with capital, which protects 
corporates if investment risks lead to losses.

NCUA also implemented a risk-focused supervision and examination 
approach in 1999 to concentrate its resources on the high-risk areas 
within corporate operations. Similar to the examination approach taken 
by other financial institution regulators, the risk-focused approach is 
intended, in part, to better employ examiner resources and improve 
examination results by emphasizing the areas of greatest risk. Under 
this approach, examiners have greater discretion to identify areas that 
require their attention and allocate their time accordingly. Further, 
examiners can determine when and where to employ the assistance of 
specialists with skills tailored to the activities of the institution, 
as its operations become more complex. According to NCUA officials, 
OCCU also began to promote examiners who had experience in investments 
and asset/liability management to the position of capital market 
specialist. As of August 2004, OCCU had five capital market 
specialists. Additionally, NCUA's Office of Strategic Program Support 
and Planning (OSPSP) had three investment specialists with private-
sector financial market experience that could assist OCCU's capital 
markets specialists.[Footnote 37] For example, OSPSP investment 
specialists participate in selected examinations of corporates that 
have expanded investment authorities.

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. We have reported that 
sound risk-focused examination practices rely on the regulator's 
ability to maintain an awareness of industrywide risk.[Footnote 38] 
Other depository institution regulators, such as the Office of the 
Comptroller of the Currency, the Board of Governors of the Federal 
Reserve System, and the Office of Thrift Supervision reported that they 
have mechanisms in place to conduct some degree of industrywide 
assessments of their depository institutions. Further, the Federal 
Deposit Insurance Corporation (FDIC) tracks and analyzes trends in 
examination findings and their resolution in several ways. For example, 
after each examination, FDIC reviews, analyzes, and enters findings and 
their resolution into various databases. In addition, FDIC gathers 
information on its institutions' internal controls to report on local, 
regional, and national trends in bank performance and identify 
activities, products, and risks that affect banks and the banking 
industry.

Based on our review of about 100 risk-focused examinations for all 
corporates and U.S. Central from January 2001 through December 2003, 
NCUA examiners had identified deficiencies--most frequently in the 
areas of asset/liability management, investments, management, funds 
transfer, and information systems--but we could not always determine if 
corporates had resolved these deficiencies. NCUA also had established 
time frames for correcting deficiencies and procedures for corporates 
to take actions to address the deficiencies. According to NCUA, 
corporates must prepare plans that specify the action needed and 
identify the corporate official responsible for implementing the plan. 
Further, NCUA reported that examiners typically verify the resolution 
of deficiencies during an examination or on-site supervision, actions 
that examiners were expected to document in the examination workpapers. 
Examiners assigned to subsequent examinations also were to review the 
deficiencies from the last examination report to see what corrective 
action had been implemented. NCUA reported that based on the severity 
of the deficiency, as a matter of practice, resolutions might be noted 
in the examination report or in the workpapers.

However, after reviewing these examination reports and other NCUA 
oversight documents, we were unable to consistently determine whether 
the deficiencies NCUA had identified for individual corporates had been 
resolved. The executive summaries included in some examination reports 
noted that deficiencies from the previous year had been addressed, but 
this practice was not standard for all of the exam reports we reviewed. 
For example, 14 of 38 examination reports we reviewed had discussed the 
status of deficiencies and whether they were resolved. Moreover, the 
corporate examiners' guide did not stipulate that examiners should 
document the resolution of prior deficiencies when preparing the final 
examination report. NCUA officials told us that the examiner-in-charge 
tracked the status of deficiencies at individual institutions and 
reported this information in monthly examiner reports. While these 
reports documented the status of deficiencies, information on the 
status was not included or consolidated in monthly reports prepared for 
the OCCU Director or in quarterly reports to NCUA's Board. As a result, 
NCUA management may have been unaware of issues related to the 
resolution of examination deficiencies, as can be seen in the following 
examples:

* In the review of one corporate's examinations, we noted that its 
information system disaster recovery site did not meet NCUA 
requirements (for site location and a separate power system) for at 
least 3 years. The examination documentation we reviewed did not issue 
a deficiency finding detailing the weaknesses of the recovery site. 
After further review, we found that the disaster recovery site was 
located at the chief executive officer's home for at least 6 years 
before the examination report detailed the need to replace the disaster 
recovery site.

* At another corporate, NCUA acknowledged in the examination that the 
institution had not addressed information systems deficiencies related 
to information security for 3 years. However, in the prior year's 
examination, NCUA had no mention of recurring problems with information 
systems at this corporate.

* NCUA issued a deficiency finding in the area of accounting and 
financial reporting for a corporate after it had submitted 13 months of 
data inaccuracies in its 5310 call reports, exposing the corporate to 
financial and reputation risk.

NCUA management believed that its existing examination processes and 
available information (such as call reports, examiner reports on 
corporates, internal monthly management and quarterly reports, and 
staff's institutional knowledge) provided it with sufficient 
information to assess the adequacy and timeliness of corporates' 
corrective actions. For example, NCUA officials stated that OCCU 
management reviews all examination reports prior to issuance, including 
any noted deficiencies. In the regulator's view, this practice provides 
an additional layer of oversight and evaluation. Additionally, OCCU 
emphasized that its monthly management reports serve as a key 
supervision tool to assess issues, trends, and corrective action at 
individual corporates. Despite OCCU's practices for coordinating and 
overseeing individual examinations, these practices were informal (that 
is, we did not identify guidance or formal operating procedures) and 
appeared to operate independently of one another. Additionally, these 
processes and practices did not constitute a system that would 
aggregate the number and type of deficiencies occurring at all 
corporates.

According to NCUA officials, their current practices kept them abreast 
of potential overall issues affecting the network without the need for 
a separate system to catalogue the deficiencies. For example, OCCU has 
trained three corporate program specialists to support field examiners, 
who track issues and trends in their assigned corporates and meet 
periodically with OCCU management to discuss issues and trends across 
the corporate system. They also noted that the examination review 
process had identified a number of issues or trends such as the need to 
address Bank Secrecy Act-related issues. However, NCUA officials also 
said that at the request of their corporate program specialists, they 
were developing a database to track deficiencies identified in 
examinations to better track their resolution. They did not specify the 
planned completion date for this database.

NCUA's current system has relied on interaction between the different 
offices, examiners, and specialists involved in oversight of 
corporates. A tracking system may have helped NCUA to identify, 
anticipate, or otherwise address some of the information system 
weaknesses we noted above. More specifically, without such a system for 
tracking examination findings and their resolution, NCUA's ability to 
identify the extent and duration of a problem at an individual 
corporate is limited, which may prevent the timely resolution of 
deficiencies. Similarly, the lack of a tracking system that aggregates 
deficiencies diminishes NCUA's ability to identify networkwide problems 
readily, assist examiners-in-charge in developing examination plans, 
and devise strategies to address issues before they become a 
significant safety and soundness concern.

NCUA Did Not Systematically Consider Certain Risks When Allocating 
Resources or Scheduling Specialists for Examinations:

NCUA has not systematically considered corporates' risk management 
(both quality and capacity) when allocating resources and scheduling 
specialists for examinations.[Footnote 39] Federal depository 
institution regulators, under the auspices of the Federal Financial 
Institution Examination Council (FFIEC)--of which NCUA is a member--had 
issued guidance on how to systematically determine when to assign 
specialists to an examination.[Footnote 40] In addition, FDIC and 
Office of the Comptroller of the Currency (OCC) have issued specific 
guidance on the frequency with which specialty examinations should be 
conducted. For example, OCC's guidance requires that information 
systems examinations be consistently conducted at least every 12 to 18 
months for community banks with assets of less than $1 billion, with a 
minimum objective of assessing the quantity of transaction risk and the 
quality of risk management, including staff capacity and skills. By 
contrast, NCUA has not established a minimum level of involvement of 
specialists in examinations.

Since we noted that NCUA had identified a number of problems in 
information systems at the corporates and were concerned that they had 
relatively few specialists in this area, we reviewed FFIEC's 
Information Systems Examination Handbook, which also provides a process 
by which regulators can determine when and where to employ information 
systems specialists. We used this handbook to assess how NCUA deployed 
examiners, relative to best practices and guidance as exemplified in 
the handbook. According to this handbook, information systems examiners 
must judge risk posed by the quantity of transactions and quality of 
the institution's risk management.[Footnote 41] Assessing aggregate 
risk allows examiners to weigh the relative importance of both the 
quantity of transactions and the quality of risk management for a given 
institution and direct the activities and resources for the regulators' 
supervisory strategies. Under this approach, a smaller corporate with a 
low volume of transactions and weak risk management could pose a risk 
to the network equal to that of a large corporate with a high volume of 
transactions and a strong risk management program.

We reviewed examination-planning documents for all 31 corporates to 
determine how NCUA evaluated these risks when determining the frequency 
at which specialists would be assigned to examinations. We found that 
NCUA documented its assessment of operations risk in these planning 
documents, but did not explicitly discuss the quality of risk 
management for various functions and operations when determining if 
specialists should be assigned to examinations.[Footnote 42] For 
example, in some cases, we found that the examination-planning 
documents only provided a single line stating that an information 
systems specialist was not needed on the next examination and did not 
document the reason for this assessment. While the planning documents 
were not clear about NCUA's decision process for assigning specialists 
to examinations, it also was not clear to us whether NCUA routinely or 
consistently considered various operational weaknesses at these 
corporates when assigning specialists.

An external review of OCCU in 2002 concluded that NCUA's complement of 
two information systems specialists and one payment system specialist 
did not appear to be sufficient to adequately oversee the corporate 
network and that OCCU should consider hiring additional specialists in 
these areas. NCUA believes it has sufficient specialists to examine the 
31 corporates; however, it has made this determination without fully 
assessing the corporates' business environment and networkwide 
challenges. NCUA tended to assign specialists on the examinations of 
larger corporates or those implementing newer systems and less so on 
examinations of smaller corporates or examinations of established 
systems at large corporates. According to NCUA, specialists had limited 
or no involvement in examinations at the 12 smallest corporates (with 
assets of less than $1 billion) from 2001 to 2003. During the same 
period, specialists were annually involved in the examination of the 
eight corporates with assets above $2.6 billion. While this approach 
appears reasonable, the limited involvement of specialists under such 
circumstances may have contributed to important information system 
weaknesses at corporates that were either not identified by NCUA or not 
promptly corrected. For example, U.S. Central's automated clearing 
house (ACH) software had deficiencies that led to a system failure that 
delayed payments to customers of 2,200 natural person credit unions for 
nearly 2 days. According to NCUA, information systems specialists had 
reviewed the system's performance in prior examinations. However, 
because the Automated Clearing House (ACH) software was mature and U.S. 
Central staff was monitoring its performance, NCUA did not consider it 
a high-risk component of U.S. Central's operations and had not reviewed 
it recently. As a result, weaknesses in their backup procedures and 
routine maintenance, insufficient capacity (noted in prior examinations 
but not satisfactorily resolved), and other deficiencies that resulted 
in the outage were not corrected. NCUA has stated that it is reviewing 
its procedures to determine if such systems should receive a minimum 
level of review. NCUA has also acknowledged that the ACH delay resulted 
in financial loss and increased reputation risk to the corporate 
network.

NCUA also faces other obstacles to conducting more systematic 
evaluations of risk--both in assuring that corporates have the capacity 
for managing risks and ensuring that, as a regulator, it has the staff 
to assess the quality and operations in corporates' risk management 
functions. As noted previously, corporates have been operating in a 
challenging investment environment, with additional authorities to make 
lower-rated investments. Consequently, the quality of risk management 
at corporates has grown in importance. While the results of our review 
of the risk management function at the three largest corporates 
suggested that these corporates were taking appropriate steps to assess 
and mitigate their risks, these corporates had a relatively small 
number of staff in their risk management functions. More specifically, 
the largest corporates and U.S. Central were using sophisticated 
financial models to assess and manage interest-rate, credit, and 
liquidity risks.[Footnote 43] But a rating agency and external auditor 
have expressed concerns about small staff sizes and how they affect 
these corporates' continued ability to evaluate and manage risks and 
undertake succession planning should key staff leave. The loss of any 
such staff at a corporate could hamper its ability to undertake the 
sophisticated analyses needed to evaluate risks. The thinness of 
corporates' risk management staffs indicates that NCUA should routinely 
assess corporates' investment risk. However, as we noted earlier, NCUA 
also has a limited number of specialists to conduct comprehensive 
evaluations of risk management at corporates. Given that the risk-
focused approach allows judgment in assigning resources to areas of 
greatest concern, the thinness of corporates' risk management staff, 
in combination with the limited number of specialists at NCUA, suggests 
that continued attention to corporates' investment strategies may help 
to ensure that corporates are adequately undertaking their risk 
management functions. Therefore, this may require NCUA to reassess its 
staffing levels and consider the costs and benefits of adding 
additional examiners or specialists to adequately monitor and oversee 
the growing complexity of corporates' operations.

As Corporate Network Consolidates, Merger Approval Process Could Be 
Improved with Better Guidance:

As part of its regulatory authority to ensure the safety and soundness 
of corporates, NCUA reviews and approves corporate merger applications. 
Some corporates, NCUA, and trade-organization officials indicated that 
consolidation in the network--as a result of mergers--would likely 
continue over the next several years. However, with more mergers 
likely, NCUA has not developed specific guidance for corporates 
preparing merger proposal packages. In contrast, NCUA has issued 
guidance for natural person credit unions that provides step-by-step 
instructions for completing the merger process, and NCUA refers 
corporates to this guidance. However, NCUA has recognized that this 
guidance may be insufficient for corporates. In its guidance to 
examiners, who are responsible for evaluating merger proposal packages, 
NCUA has suggested that capital ratios unique to corporates, defined in 
Part 704 of NCUA's Rules and Regulations, were more appropriate than 
the probable asset share ratio applicable to natural person credit 
unions.[Footnote 44] However, in the guidance on mergers available to 
corporates on its Web site, NCUA has not indicated that corporates 
needed to include this information. In our review of five merger 
packages recently approved by NCUA, we found that three merger packages 
were initially submitted without the corporate capital ratios defined 
in Part 704. These merger packages required revision or additional 
analysis by the corporate and NCUA before the package could be 
approved, encumbering the approval process.

Other regulators such as OCC have provided detailed guidance to banks 
applying for mergers that listed specific data needed for evaluation 
and described the regulators' merger review process. OCC has stated 
that their approach is intended to avoid misunderstandings and 
unnecessary delays in the approval. NCUA officials told us they 
considered several factors when approving corporate mergers such as 
consolidated budgets and conversion and consolidation plans for 
information systems that it has not discussed in the natural person 
credit union guidance. However, only one of the five merger proposals 
we analyzed was submitted with this additional information. Other 
corporate's proposals required revisions or were approved without 
additional information being provided. One corporate stated they 
believed the merger process could be improved and made less cumbersome 
if NCUA provided clearer or more specific guidance for corporates. 
Finally, NCUA's guidance did not explicitly discuss how the effects of 
competition should be considered when approving corporate mergers, 
which may become more of an issue as the network continues to 
consolidate and corporates increasingly compete with each other or with 
other financial institutions.

Corporates Not Subject to Internal Control Reporting Requirements of 
FDICIA:

As corporates react to a competitive environment by investing in 
technology and offering more products and services, NCUA's oversight of 
internal controls at corporates becomes even more critical. However, 
corporates with assets over $500 million were not required to report on 
the effectiveness of their internal controls for financial 
reporting.[Footnote 45] Under the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (FDICIA) and its implementing regulations, 
banks and thrifts with assets over $500 million are required to prepare 
an annual management report that contains:

* a statement of management's responsibility for preparing the 
institution's annual financial statements, for establishing and 
maintaining an adequate internal control structure and procedures for 
financial reporting, and for complying with designated laws and 
regulations relating to safety and soundness; and:

* management's assessment of the effectiveness of the institution's 
internal control structure and procedures for financial reporting as of 
the end of the fiscal year and the institution's compliance with the 
designated safety and soundness laws and regulations during the fiscal 
year.[Footnote 46]

Additionally, the institution's independent accountants are required to 
attest to management's assertions concerning the effectiveness of the 
institution's internal control structure and procedures for financial 
reporting. The institution's management report and the accountant's 
attestation report must be filed with the institution's primary federal 
regulator and any appropriate state depository institution supervisor, 
and must be available for public inspection. These reports allow 
depository institution regulators to gain increased assurance about the 
reliability of financial reporting.

The reporting requirement for banks and thrifts under FDICIA is similar 
to the reporting requirement included in the Sarbanes-Oxley Act of 
2002.[Footnote 47] Under Sarbanes-Oxley, public companies are required 
to establish and maintain adequate internal control structures and 
procedures for financial reporting. In addition, a company's auditor is 
required to attest to, and report on, the assessment made by company 
management on the effectiveness of internal controls. As a result of 
FDICIA and Sarbanes-Oxley, reports on management's assessment of the 
effectiveness of internal controls over financial reporting and the 
independent auditor's attestation on management's assessment have 
become a normal business practice for financial institutions and many 
companies.

While NCUA has issued a letter to corporates indicating that selected 
provisions of the Sarbanes-Oxley Act of 2002, including the provision 
on internal control reporting standards, may be appropriate to 
consider, NCUA has not mandated that corporates adopt this 
standard.[Footnote 48] Given that other depository institutions of 
similar size are required by FDICIA to adhere to the internal control 
reporting requirements to ensure safety and soundness, NCUA's lack of 
such a requirement for corporates raises the question of whether NCUA 
has the necessary information to adequately assess corporates' internal 
controls. This assessment has become more important as corporates' 
operations have grown in complexity due to their changing investment 
strategies, investments in technology, and introduction of new products 
and services.

Conclusions:

Increased competition both inside and outside of the credit union 
system has challenged corporates to explore new technologies and 
introduce more products and services to retain their members. Increased 
competition, large fluctuations in inflows and outflows of deposits, in 
combination with low interest rates, have created potential stress on 
the financial condition of corporates and U.S. Central. While 
corporates' assets have increased rapidly, their ability to increase 
earnings remained constrained. As a result, corporates have increased 
their investments in privately issued, mortgage-related and asset-
backed securities, which can increase returns but require more 
sophisticated analysis and monitoring. The change in corporates' 
investment profile is another indication of the growing complexity in 
their operations. Since some corporates have been allowed to invest in 
lower-rated securities (although few have), this could introduce 
increased risks in the system if not managed properly. With the 
changing operating and investment environments, this increases 
corporates' potential vulnerability to different financial stresses--
and requires that corporates and their regulator, NCUA, place continued 
attention on their risk-assessment and monitoring strategies.

NCUA has made strides in strengthening its oversight of corporates, 
particularly with the adoption of a risk-focused approach, certain 
regulatory changes, and the hiring or training of specialists in 
information and payment systems and capital markets. We believe these 
actions have helped NCUA to more effectively oversee corporates. 
However, based on issues we identified, we believe NCUA should do more 
to anticipate and address emerging network issues. In particular, a 
tracking system used in conjunction with other measures, such as 
information from its management and call reports, could provide timely 
and significant information to NCUA that would help ensure that its 
risk-focused approach addressed individual as well as networkwide 
risks. The relatively small number of specialists during a time of 
increased competition and growing complexity in corporate operations 
raises additional concerns since NCUA had not systematically 
incorporated specialists in planning risk-focused examinations, or 
tracked recurring or pervasive issues throughout the network. We 
believe this makes it difficult for NCUA to determine the number and 
type of specialists that are needed or to anticipate problems to 
adequately monitor or oversee the corporate network. Further, with the 
continued consolidation in the network, NCUA's guidance was inadequate 
to ensure that examiners consistently evaluate proposed corporate 
mergers. Without sufficient guidance for corporates and examiners, NCUA 
lacks assurances that decisions on corporate mergers are consistently 
being made using appropriate criteria and information or that these 
decisions are consistently being made in the best interests of their 
members and NCUSIF. We believe that corporates and NCUA examiners would 
benefit from better guidance since consolidation, through mergers, is 
likely to continue. The growing complexity in operations and the 
products that corporates have introduced also raise important concerns 
about whether NCUA can ensure that corporates' internal controls, which 
are central to monitoring operations and risk management, are properly 
assessed and monitored. However, NCUA has not required corporates to 
follow the same internal control reporting requirements (defined under 
FDICIA) as other financial institutions that face similar risks. 
Finally, the changing profile of the industry introduces both greater 
opportunities and greater challenges for NCUA, as the regulator of 
these institutions, to achieve a balance that ensures the network's 
ability to introduce beneficial changes and properly manage its risks.

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.

Agency Comments and Our Evaluation:

We requested comments on a draft of this report from the Chairman of 
the National Credit Union Administration. We received written comments 
from NCUA that are summarized below and reprinted in appendix VIII. In 
addition, we received technical comments from NCUA that we incorporated 
into the report, as appropriate.

NCUA stated that it concurred with most of our assessments and 
conclusions contained in the report and plans to take actions to 
implement all but part of one of our recommendations.

Specifically, NCUA concurred with the report's assessment that 
corporates are operating in an increasingly challenging and competitive 
environment. In its comments on a draft of this report, NCUA stated 
that its changes to the corporate rule, made in response to the dynamic 
financial marketplace, functioned as intended, thus permitting the 
corporates' balance sheets to expand and contract, sometimes rapidly, 
depending on liquidity levels in credit unions, while not compromising 
safety and soundness. NCUA agreed that the influx of deposits, combined 
with decreasing interest rates had strained profitability and resulted 
in lower capital ratios. However, NCUA did not agree with the report's 
assessment that paid-in capital and membership capital are "weaker 
forms of capital." NCUA restated its requirements for these two forms 
of capital and, as stated in the report, believed that both paid-in 
capital and membership shares are available to cover losses that exceed 
retained earnings, and are not insured by either NCUSIF and cannot be 
pledged against borrowings. While we agree with NCUA's statements, as 
further discussed in the report, we remain concerned that both forms of 
capital are from external sources and are less permanent than retained 
earnings, therefore, providing a relatively weaker cushion against 
adverse financial events.

In commenting on corporates' investments, NCUA believed that the slight 
potential increase in credit risk exposure due to the 2002 rule change 
permitting corporates to purchase securities with lower credit quality 
is more than offset by the rule's decrease in exposure to credit 
concentration risk. Additionally, NCUA is of the opinion that the 
rule's "modest expansion" of permissible investment graded securities, 
combined with its reduction in credit concentration limits, results in 
a stronger corporate network--that corporate management is better 
positioned to compete, within prudent safety and soundness thresholds, 
than under the previous rule. NCUA also pointed out in its comments 
that as of June 30, 2004, 97 percent of the network's rated long-term 
securities are rated AAA. Based on the high quality and diversification 
of the network's investments, NCUA believes credit risk is minimal. 
NCUA stated that it has addressed controlling interest-rate risk in the 
corporate rule and its assessment of the network's investment portfolio 
interest-rate risk is minimal. We acknowledged in our report that 
corporates either have made few or no investments in BBB rated 
securities, and they indicated that they did not plan to use their 
authority to purchase such investments. However, it is not clear to 
what extent corporates will take advantage of this investment 
flexibility in the future, which has implications for NCUA's oversight, 
especially given the thinness of risk-management staff at corporates. 
Further, we share Treasury's concerns that allowing corporates to 
invest in BBB rated securities could weaken the safety and soundness of 
the corporate network because the amount of capital held in the 
corporates might not be commensurate with the risks associated with 
these lower credit quality investments.

While NCUA concurred with the report's recommendation for the need to 
provide corporates with specific merger guidance to facilitate the 
regulatory review process, NCUA did not concur with the report's 
conclusion that improved guidance to examiners is needed to ensure 
mergers meet the goals of serving members while not placing NCUSIF at 
undue risk. NCUA stated in its comments that it has adequate procedures 
in place, and that every corporate merger package prepared by OCCU is 
reviewed by NCUA's Office of General Counsel prior to being presented 
to the NCUA Board for action. As stated in the report, NCUA officials 
told us that they considered several factors when approving corporate 
mergers such as consolidated budgets and conversion plans for 
information systems that NCUA has not discussed in the natural person 
credit union guidance. However, we found that only one of the five 
merger proposals we analyzed was submitted with this additional 
information and, therefore, we do not believe that NCUA's guidance to 
examiners was sufficient to ensure that examiners consistently evaluate 
corporate mergers. As stated in the report's conclusions, without 
sufficient guidance, NCUA lacks assurances that decisions on corporate 
mergers are consistently made using appropriate criteria and 
information or that these decisions are made in the best interests of 
their members and NCUSIF. While clear criteria and consistency in 
review are important, improving examiner guidance for mergers is also 
necessary to help protect against forbearance on the part of NCUA.

As agreed with your office, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from its issuance. At that time, we will send copies of the report to 
the Chairman of the Senate Committee on Banking, Housing, and Urban 
Affairs; the Chairman and Ranking Minority Member of the House 
Committee on Financial Services; and interested congressional 
committees. We also will send copies to the National Credit Union 
Administration and make copies available to others upon request. In 
addition, this report will be available at no charge on the GAO Web 
site at [Hyperlink, http://www.gao.gov].

If you or your staff have any questions regarding this report, please 
contact me at (202) 512-8678 or [Hyperlink, hillmanr@gao.gov]  or Debra 
R. Johnson at (202) 512-9603 or [Hyperlink, johnsond@gao.gov]. Key 
contributors are acknowledged in appendix IX.

Sincerely yours,

Signed by: 

Richard J. Hillman: 
Director, Financial Markets and Community Investment:

[End of section]

Appendixes:

Appendix I: Objectives, Scope, and Methodology:

Our report objectives were to (1) assess the changes in financial 
condition of corporate credit unions (corporates) since 1992 and (2) 
assess the National Credit Union Administration's (NCUA) supervision 
and oversight of corporates, particularly with regard to how it 
identifies and addresses safety and soundness issues in the industry.

Financial Condition of Corporate Credit Unions Since 1992:

To assess the changes in the financial condition of corporates since 
1992, we analyzed corporate credit union call report data, which 
include balance sheet and income statement data for corporates. Our 
analysis, based on Forms 5300 and 5310 data supplied by NCUA, included 
calculating descriptive statistics and key financial ratios and 
describing trends in financial performance and the structure of the 
industry.[Footnote 49] The information included Form 5300 data from the 
end of 1992 through the end of 1996 and monthly Form 5310 data from 
January 1997 through December 2003. Our analysis relied upon selected 
balance sheet and income statement data such as assets, shares, 
investments, capital, net economic value (NEV), and various income 
measures and ratios that are commonly used to assess the financial 
condition of financial institutions. The transition in 1997 from Form 
5300 (still used by natural person credit unions) to Form 5310, which 
is specifically designed for corporates, entailed numerous changes in 
reporting. Furthermore, significant regulatory changes, effective in 
1998, also resulted in numerous changes to the information reported on 
Form 5310 for 1998. Overall, these changes resulted in the deletion of 
some items from the financial reports and the addition of others. 
Subsequently, in some cases the data were not comparable across time. 
For example, NEV, which is a measure of interest-rate risk, was added 
to Form 5310 in 1998; thus, we were only able to conduct analysis on 
this measure from 1998 to 2003. In our prior report on natural person 
credit unions, we reviewed NCUA's procedures for verifying the accuracy 
of the Form 5300 database and found that the data were verified on an 
annual basis, either during the corporate credit union's examination, 
or through off-site supervision. We determined that the data were 
sufficiently reliable for the purposes of this report. We also 
performed a data reliability assessment on data from January 1997 
through December 2003 for Form 5310, which involved electronic testing 
of the data and obtaining information from NCUA on its data 
verification procedures. We found that the data were verified for 
accuracy on a monthly basis and determined that the data were 
sufficiently reliable for the purposes of this report.

To augment our analysis and obtain a more comprehensive assessment of 
corporates' financial condition and risks, we reviewed internal 
corporate credit union financial analysis reports from selected 
corporates, independent evaluations of corporate risk controls and 
models, and external studies of the industry from major rating 
agencies, such as Fitch, Moody's, and Standard and Poor's. We also met 
with selected NCUA examiners and risk management staff at corporates to 
better assess how corporates were managing their risks. In addition, we 
reviewed internal documents and analyses dealing with risk monitoring 
and control from several corporates in order to assess how well these 
corporates could assess and manage risk.

NCUA's Supervision of Corporates:

To assess how NCUA's supervision of corporates identifies and addresses 
safety and soundness issues, we conducted a review of key legislative 
and regulatory changes affecting corporates since 1992. We reviewed 
NCUA documentation on its risk-focused program, including NCUA 
examination reports, their corresponding three-year plans, and the 
Office of Corporate Credit Union (OCCU) management reports for all 31 
corporates for 2001-2003.[Footnote 50] We conducted interviews with 
OCCU management and with OCCU examiners-in-charge for 10 
corporates.[Footnote 51] In addition, we visited seven corporates. We 
developed a structured questionnaire for all 31 corporates to solicit 
their views on what challenges individual institutions and the 
collective corporate network faced. We reviewed past GAO and U.S. 
Department of the Treasury reports on corporates and NCUA, internal 
reviews of OCCU, and an external review of OCCU performed by an outside 
auditing firm. We also contacted officials from the Federal Deposit 
Insurance Corporation (FDIC), the Office of Thrift Supervision (OTS), 
the Office of the Comptroller of Currency (OCC), and the Board of 
Governors of the Federal Reserve System. Lastly, we interviewed trade 
association officials.

As part of our legislative review, we reviewed the Federal Credit Union 
Act to determine the legislative authority for corporates and NCUA's 
Part 704, which is the primary regulation governing corporates. 
Specifically, we reviewed the Federal Register for all changes made to 
Part 704 since 1992 to understand the rationale behind these changes. 
We also obtained summaries from NCUA, which provided their rationale 
for the changes and brief descriptions of the changes to specific 
sections of Part 704.

To assess NCUA's documentation for its risk-focused program, we 
reviewed NCUA's Corporate Examiner's Guide, which describes the 
policies and procedures under which examiners are to implement the 
risk-focused program. The guide describes procedures for off-site 
monitoring, on-site examinations, information required in an 
examination report, and coordination with state supervisory authorities 
for corporates that have a state charter.

Also, as part of our assessment of NCUA's risk-focused examination 
program, we reviewed about 100 examinations for the 31 currently 
operating corporates, corresponding 3-year plans, and OCCU monthly 
management and quarterly reports for the period January 2001 through 
December 2003. For the review of examinations, we developed a data 
collection instrument (DCI) to collect 3 years' worth of information 
for each of the 31 corporates. The DCI enabled us to aggregate 
examination areas appearing in a large number of corporates over the 
time period reviewed that could be potential networkwide issues due to 
their prevalence or persistence. Examples of findings identified by 
NCUA in the various examination areas included errors or problems 
associated with 5310 reporting, accounting procedures, asset/liability 
management, Bank Secrecy Act compliance, contingency planning, 
corporate governance, credit analysis, funds transfer, information 
systems, interest-rate risk, investment, lending, and management.

The 3-year plans included information on the last examination and 
financial profiles--for example, daily average net assets (DANA), 
capital ratios, and net economic value (NEV). These plans also 
contained the supervision type of the corporate, supervision plans, 
Corporate Risk Information System (CRIS) ratings, and in some cases, 
requests for information system, payment system, or capital market 
specialists for the next examination or supervision contact.[Footnote 
52]

The OCCU monthly management reports covered areas such as OCCU's 
administration news, trends in corporates, significant problem case 
corporates, other significant program issues, miscellaneous corporate 
information, information on internal or external affairs, board action 
items, and the next month's calendar. The quarterly reports provided a 
brief update of events since the previous report, a summary of 
corporate network trends, the current status of e-commerce in 
corporates, specific discussions on 20 percent to 50 percent of 
individual corporates, and the future outlook for corporates and OCCU 
during the next quarter and beyond.

We met with OCCU management to follow up on questions generated from 
our review of the examinations, 3-year plans, and OCCU monthly 
management and quarterly reports. We also selected a judgmental sample 
of 10 corporates from which to gather additional information about NCUA 
oversight. These corporates were selected based on asset size, 
geographic location, charter type, level of expanded investment 
authority, and significant findings in the examinations. We obtained 
NCUA's most recent examiner workpapers for these 10 corporates to 
review how NCUA supported its findings. We also met with the examiner-
in-charge and, when possible, capital market specialists for the 10 
corporates to better comprehend their approach to examining the 
corporate credit union and to understand the support and rationale for 
some examination findings. In addition, we visited 7 of the 10 
corporates to observe and discuss their operations, risk management 
practices, and interactions with NCUA. We selected these 7 based on 
their asset size, geographic location, type of charter (state or 
federal), and whether they had expanded investment authorities. We 
interviewed senior management and some board and supervisory committee 
members. We asked structured questions of officials from various 
departments within the corporates. The departments included 
investments, risk management, accounting, internal audit, external 
audit, information systems, and product support. We obtained policies 
and procedures for various areas within the corporates, including 
investments, lending, and risk management. We also obtained 
documentation packages, which were submitted to the asset/liability 
committees of corporates for some of the institutions we visited, to 
review investments and their impact on the risk within the corporates. 
We also observed corporates' physical environment to determine the 
types of safeguards that were in place, particularly for information 
technology.

We developed a structured questionnaire to collect information from the 
corporate network that focused on their perspectives about various 
components of the industry. We pretested the questionnaire with one of 
the largest corporates and received numerous meaningful observations 
about our original version and made refinements. We administered the 
structured questionnaire to the entire population of active corporates 
(as of December 31, 2003) as shown in appendix II.

Appendix III includes a copy of our structured questionnaire, and 
appendix IV includes responses to the majority of questions in the 
questionnaire. The Association of Corporate Credit Unions (ACCU) 
oversaw the distribution of our structured questionnaire to its 30 
corporate members. We administered the questionnaire to the one non-
ACCU corporate member. The questionnaires were sent by e-mail at the 
end of March 2004. We received all responses to our questionnaire by 
mid-May 2004 and achieved a 100 percent response rate. We conducted 
follow-up telephone interviews with numerous corporates to obtain 
clarification on some of their responses. Our questionnaire covered the 
following areas:

* products and services that corporates offer to their natural person 
credit unions,

* Credit Union Service Organizations (CUSO),

* competition,

* investment authorities,

* corporate investments with U.S. Central,

* regulatory changes and impacts on corporates' operations,

* the effects of the risk-focused approach on corporates,

* corporates' fields of membership,

* challenges corporates face and their responses to these challenges, 
and:

* corporates' immediate and future merger plans.

We analyzed the results by summarizing responses or providing simple 
statistics (for example, range, median, and average) to most of the 
quantitative questions. Specifically, we conducted quantitative 
analysis on questions 1, 3, 4, 5, 7, 7a, 11, 12, 13, 14, 17, and 21. We 
performed content analysis on most of the responses to the qualitative 
questions. Specifically, we conducted content analysis on questions 8, 
9, 10, 16, 19, 20, 21a, and 22. The results of our analysis for most of 
the questions are presented in appendix IV.

To gain a better understanding on the challenges and problems NCUA has 
faced in overseeing corporates, we reviewed past GAO and U.S. 
Department of the Treasury reports on corporates and NCUA. These 
reports also provided recommendations for NCUA to improve its 
oversight. Additionally, we reviewed internal NCUA reviews on OCCU. 
These reviews are conducted about every 3 years by OCCU's Director and 
staff from outside OCCU, who review OCCU's operations and suggest 
improvements. Similarly, NCUA has contracted for an outside party to 
review OCCU's operations, and this party also has provided 
recommendations on improvements in OCCU management and oversight. 
OCCU's last external review was completed in 2002. We interviewed 
officials from the Department of the Treasury and academia who had 
studied corporates.

To obtain information on the experiences of other depository 
institution regulators with the risk-focused examination and 
supervision approach, we obtained written responses from officials at 
FDIC, OTS, OCC, and the Board of Governors of the Federal Reserve 
System.

Finally, to obtain perspectives on the business environment confronting 
the corporate network and their responses to a changing environment, we 
interviewed trade association officials from ACCU, the National 
Association of Federal Credit Unions, including its board of directors, 
and the National Association of State Credit Union Supervisors.

We conducted our work from December 2003 to September 2004 in 
Alexandria, Virginia, Washington, D.C., and other U.S. cities in 
accordance with generally accepted government auditing standards.

[End of section]

Appendix II: Corporate Credit Unions Active as of December 31, 2003:

Corporate credit union: Central Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Central Credit Union Fund; 
Federally or state- chartered: State.

Corporate credit union: Constitution State Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Corporate America Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Corporate Central Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Corporate One Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Eastern Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Empire Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: First Carolina Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: First Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Georgia Central Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Iowa League Corporate Central Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Kansas Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Kentucky Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: LICU Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Louisiana Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Mid-Atlantic Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Mid-States Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Midwest Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Missouri Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Northwest Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Southeast Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Southwest Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Sun Corporate Credit Union; 
Federally or state- chartered: State.

Corporate credit union: Treasure State Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Tricorp Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: U.S. Central Credit Union; 
Federally or state- chartered: State.

Corporate credit union: Virginia League Corporate Federal Credit Union; 
Federally or state-chartered: Federal.

Corporate credit union: Volunteer Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: West Virginia Corporate Credit Union; 
Federally or state-chartered: State.

Corporate credit union: Western Corporate Federal Credit Union; 
Federally or state-chartered: Federal. 

Source: NCUA.

[End of table]

[End of section]

Appendix III: Structured Questionnaire to Corporate Credit Unions on 
Their Current Makeup and Challenges Facing the Network:

We distributed the following questionnaire to the entire network of 
corporates in the United States, including both federally and state-
chartered institutions, and achieved a 100 percent response rate. 
(Appendix II lists the 31 corporates active as of December 31, 2003, 
and whether they are federally or state-chartered.) The questionnaire 
has three sections: products and services, regulatory changes, and 
challenges facing corporates. The first section addresses the types of 
products and services offered by corporates to their members, the 
issues they faced regarding competition, the type of investment 
authorities corporates had or sought, and the extent of their 
investments with U.S. Central Corporate Credit Union. The second 
section addresses various regulatory issues such as what regulatory 
changes affected their institution, a description of the corporate's 
field of membership (for example, whether they had a national field of 
membership), and their perception of NCUA's risk-focused supervisory 
approach. Finally, the questionnaire solicits the opinions of corporate 
managers on what future issues the corporate credit union industry 
faces. Appendix IV contains selected responses to the questionnaire.

[See PDF for image] 

[End of figure] 

[End of section]

Appendix IV: Selected Responses to Structured Questionnaire Distributed 
to Corporate Credit Unions:

As noted in appendix III, we distributed a questionnaire to the entire 
network of corporates. This appendix provides responses to the majority 
of questions posed in the questionnaire (see questions 1, 3-5, 7-14, 
16-17, and 19-22). This information was analyzed in the aggregate to 
prevent specific responses from being associated with an individual 
institution.

[See PDF for image] 

[End of figure] 

[End of section]

Appendix V: Financial Condition of Corporates, 1992-2003:

The corporate credit union network has consolidated since 1992, with 
asset concentration rising moderately. As corporates' investments have 
grown, their composition has changed, with relatively more emphasis on 
privately issued mortgage-related and asset-backed securities and a 
shift toward more variable-rate investments. Concurrent with net income 
ratios, interest-related income and expense ratios have declined 
recently. In recent years, natural person credit unions have invested 
less in corporates.

Corporate Credit Union Network Has Consolidated and Asset Concentration 
Has Risen Moderately:

Since 1992, the corporate system has consolidated, a change primarily 
driven by mergers. This consolidation trend has resulted in a moderate 
increase in asset concentration. For more detailed, year-by-year 
information, see the table and figures below.

Table 2: Number of Institutions and Total Assets in the Corporate and 
Natural Person Credit Union Systems, 1992-2003:

Year: 1992; 
Number of corporates, excluding U.S. Central: 44; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $43,447; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $37,186; 
Number of natural person credit unions: 12,595; 
Total assets of natural person credit unions 
(in millions of dollars): $258,365.

Year: 1993; 
Number of corporates, excluding U.S. Central: 44; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $40,982; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $33,922; 
Number of natural person credit unions: 12,317; 
Total assets of natural person credit unions 
(in millions of dollars): $277,130.

Year: 1994; 
Number of corporates, excluding U.S. Central: 44; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $35,993; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $29,217; 
Number of natural person credit unions: 11,991; 
Total assets of natural person credit unions 
(in millions of dollars): $289,453.

Year: 1995; 
Number of corporates, excluding U.S. Central: 41; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $33,807; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $29,199; 
Number of natural person credit unions: 11,687; 
Total assets of natural person credit unions 
(in millions of dollars): $306,642.

Year: 1996; 
Number of corporates, excluding U.S. Central: 40; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $30,154; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $24,196; 
Number of natural person credit unions: 11,392; 
Total assets of natural person credit unions 
(in millions of dollars): $326,887.

Year: 1997; 
Number of corporates, excluding U.S. Central: 38; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $33,097; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $27,222; 
Number of natural person credit unions: 11,238; 
Total assets of natural person credit unions 
(in millions of dollars): $351,165.

Year: 1998; 
Number of corporates, excluding U.S. Central: 37; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $43,555; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $38,743; 
Number of natural person credit unions: 10,995; 
Total assets of natural person credit unions 
(in millions of dollars): $388,700.

Year: 1999; 
Number of corporates, excluding U.S. Central: 36; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $39,206; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $32,768; 
Number of natural person credit unions: 10,630; 
Total assets of natural person credit unions 
(in millions of dollars): $411,418.

Year: 2000; 
Number of corporates, excluding U.S. Central: 35; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $39,627; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $32,248; 
Number of natural person credit unions: 10,316; 
Total assets of natural person credit unions 
(in millions of dollars): $438,219.

Year: 2001; 
Number of corporates, excluding U.S. Central: 34; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $59,154; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $51,997; 
Number of natural person credit unions: 9,984; 
Total assets of natural person credit unions 
(in millions of dollars): $501,540.

Year: 2002; 
Number of corporates, excluding U.S. Central: 32; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $68,968; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $60,421; 
Number of natural person credit unions: 9,688; 
Total assets of natural person credit unions 
(in millions of dollars): $557,075.

Year: 2003; 
Number of corporates, excluding U.S. Central: 30; 
Total assets of corporates, excluding U.S. Central 
(in millions of dollars): $73,835; 
Total shares of corporates, excluding U.S. Central 
(in millions of dollars): $58,808; 
Number of natural person credit unions: 9,369; 
Total assets of natural person credit unions 
(in millions of dollars): $610,156. 

Source: NCUA call reports.

Note: This table includes only federally insured natural person credit 
unions.

[End of table]

Figure 8: Size Distribution of Corporates, by Number, 1992-2003:

[See PDF for image] 

Note: This figure excludes data on U.S. Central.

[End of figure] 

Figure 9: Asset Concentration Levels of Corporates, 1992-2003:

[See PDF for image] 

Note: While one corporate was the largest in each year from 1992 
through 2003, this figure depicts the asset concentration in a given 
year for the largest corporates in that year, and the largest four 
corporates were not necessarily the same in all years. This figure 
excludes data on U.S. Central.

[End of figure] 

Investments of Corporates Have Grown since 1992, and Composition Has 
Changed:

As noted earlier, investments, which are the vast majority of 
corporates' assets, have grown since 1992, but recently the percentage 
of corporates' investments in U.S. Central has declined somewhat and 
corporates have moved relatively more of their investments into 
privately issued mortgage-related and asset-backed securities. We made 
this determination using call reports and other data (for more 
information on our methodology see app. I). Since there were 
significant changes to NCUA's call reports in 1997, in the transition 
from Form 5300 to Form 5310, some account codes were not available 
previously and thus could not be disaggregated.

In general, corporates' investments in mortgage-backed securities 
(including mortgage pass-throughs, collateralized mortgage 
obligations, and real estate mortgage investment conduits) as a 
percentage of total investments declined from the mid-1990s through 
1998 in the wake of the Cap Corp failure, which was largely driven by 
ineffective interest-rate risk management for collateralized mortgage 
obligations. However, since 1998, corporates steadily have been 
increasing their investments in mortgage-backed securities. In 
addition, corporates have been shifting more of their investments in 
mortgage-related and asset-backed securities to variable-rate 
securities, a move that tends to lessen interest-rate risk. In 
particular, while 41.7 percent of corporates' asset-backed securities 
were classified as fixed-rate at the end of 1997, by the end of 2003 
this proportion stood at 18.0 percent. The trend in collateralized 
mortgage obligations and real estate mortgage investment conduits 
(REMIC) has been similar, with a relatively greater proportion now 
classified as variable rate.[Footnote 53] Table 3 offers additional 
details of corporates' investments in U.S. Central, privately issued 
mortgage-related securities, and asset-backed securities, from 1997 
through 2003.

Table 3: Composition of Selected Investments of Corporates, 1997-2003:

U.S. Central obligations held by corporates: Daily shares; 
U.S. Central obligations relative to total investments: 1997: 20.16%; 
U.S. Central obligations relative to total investments: 1998: 24.17%; 
U.S. Central obligations relative to total investments: 1999: 25.44%; 
U.S. Central obligations relative to total investments: 2000: 21.03%; 
U.S. Central obligations relative to total investments: 2001: 13.77%; 
U.S. Central obligations relative to total investments: 2002: 9.37%; 
U.S. Central obligations relative to total investments: 2003: 8.68%. 

U.S. Central obligations held by corporates: Time certificates; 
U.S. Central obligations relative to total investments: 1997: 18.38%; 
U.S. Central obligations relative to total investments: 1998: 20.11%; 
U.S. Central obligations relative to total investments: 1999: 18.53%; 
U.S. Central obligations relative to total investments: 2000: 17.41%; 
U.S. Central obligations relative to total investments: 2001: 15.44%; 
U.S. Central obligations relative to total investments: 2002: 18.08%; 
U.S. Central obligations relative to total investments: 2003: 17.42%. 

U.S. Central obligations held by corporates: Investments resulting 
from repurchase transactions; 
U.S. Central obligations relative to total investments: 1997: 0.00%; 
U.S. Central obligations relative to total investments: 1998: 0.00%; 
U.S. Central obligations relative to total investments: 1999: 0.14%; 
U.S. Central obligations relative to total investments: 2000: 0.15%; 
U.S. Central obligations relative to total investments: 2001: 0.19%; 
U.S. Central obligations relative to total investments: 2002: 0.20%; 
U.S. Central obligations relative to total investments: 2003: 0.11%. 

U.S. Central obligations held by corporates: Amortizing certificates; 
U.S. Central obligations relative to total investments: 1997: 1.42%; 
U.S. Central obligations relative to total investments: 1998: 0.40%; 
U.S. Central obligations relative to total investments: 1999: 0.18%; 
U.S. Central obligations relative to total investments: 2000: 0.30%; 
U.S. Central obligations relative to total investments: 2001: 0.11%; 
U.S. Central obligations relative to total investments: 2002: 0.52%; 
U.S. Central obligations relative to total investments: 2003: 0.88%. 

U.S. Central obligations held by corporates: Smart floaters; 
U.S. Central obligations relative to total investments: 1997: 0.00%; 
U.S. Central obligations relative to total investments: 1998: 0.00%; 
U.S. Central obligations relative to total investments: 1999: 0.12%; 
U.S. Central obligations relative to total investments: 2000: 0.00%; 
U.S. Central obligations relative to total investments: 2001: 0.00%; 
U.S. Central obligations relative to total investments: 2002: 0.00%; 
U.S. Central obligations relative to total investments: 2003: 0.00%. 

U.S. Central obligations held by corporates: Step up certificates; 
U.S. Central obligations relative to total investments: 1997: 1.57%; 
U.S. Central obligations relative to total investments: 1998: 0.86%; 
U.S. Central obligations relative to total investments: 1999: 1.88%; 
U.S. Central obligations relative to total investments: 2000: 2.14%; 
U.S. Central obligations relative to total investments: 2001: 1.23%; 
U.S. Central obligations relative to total investments: 2002: 1.64%; 
U.S. Central obligations relative to total investments: 2003: 2.36%. 

U.S. Central obligations held by corporates: FRAPs; 
U.S. Central obligations relative to total investments: 1997: 5.43%; 
U.S. Central obligations relative to total investments: 1998: 6.84%; 
U.S. Central obligations relative to total investments: 1999: 4.45%; 
U.S. Central obligations relative to total investments: 2000: 6.58%; 
U.S. Central obligations relative to total investments: 2001: 10.64%; 
U.S. Central obligations relative to total investments: 2002: 8.68%; 
U.S. Central obligations relative to total investments: 2003: 9.21%. 

U.S. Central obligations held by corporates: Membership capital shares; 
U.S. Central obligations relative to total investments: 1997: 2.25%; 
U.S. Central obligations relative to total investments: 1998: 1.93%; 
U.S. Central obligations relative to total investments: 1999: 2.61%; 
U.S. Central obligations relative to total investments: 2000: 2.10%; 
U.S. Central obligations relative to total investments: 2001: 1.47%; 
U.S. Central obligations relative to total investments: 2002: 1.58%; 
U.S. Central obligations relative to total investments: 2003: 1.74%. 

U.S. Central obligations held by corporates: Central Liquidity Facility 
share deposit; 
U.S. Central obligations relative to total investments: 1997: 2.29%; 
U.S. Central obligations relative to total investments: 1998: 1.59%; 
U.S. Central obligations relative to total investments: 1999: 2.32%; 
U.S. Central obligations relative to total investments: 2000: 2.37%; 
U.S. Central obligations relative to total investments: 2001: 1.63%; 
U.S. Central obligations relative to total investments: 2002: 1.57%; 
U.S. Central obligations relative to total investments: 2003: 1.77%. 

U.S. Central obligations held by corporates: Paid-in capital; 
U.S. Central obligations relative to total investments: 1997: 0.00%; 
U.S. Central obligations relative to total investments: 1998: 0.00%; 
U.S. Central obligations relative to total investments: 1999: 0.00%; 
U.S. Central obligations relative to total investments: 2000: 0.00%; 
U.S. Central obligations relative to total investments: 2001: 0.00%; 
U.S. Central obligations relative to total investments: 2002: 0.00%; 
U.S. Central obligations relative to total investments: 2003: 0.46%. 

U.S. Central obligations held by corporates: Other; 
U.S. Central obligations relative to total investments: 1997: 1.09%[A]; 
U.S. Central obligations relative to total investments: 1998: 0.48%; 
U.S. Central obligations relative to total investments: 1999: 0.87%; 
U.S. Central obligations relative to total investments: 2000: 1.04%; 
U.S. Central obligations relative to total investments: 2001: 0.54%; 
U.S. Central obligations relative to total investments: 2002: 0.70%; 
U.S. Central obligations relative to total investments: 2003: 2.12%. 

U.S. Central obligations held by corporates: Total U.S. Central 
obligations relative to total investments; 
U.S. Central obligations relative to total investments: 1997: 52.59%; 
U.S. Central obligations relative to total investments: 1998: 56.38%; 
U.S. Central obligations relative to total investments: 1999: 56.56%; 
U.S. Central obligations relative to total investments: 2000: 53.12%; 
U.S. Central obligations relative to total investments: 2001: 45.03%; 
U.S. Central obligations relative to total investments: 2002: 42.35%; 
U.S. Central obligations relative to total investments: 2003: 44.76%. 

U.S. Central obligations held by corporates: Total U.S. Central 
obligations (in millions); 
U.S. Central obligations relative to total investments: 1997: $15,634; 
U.S. Central obligations relative to total investments: 1998: $23,480; 
U.S. Central obligations relative to total investments: 1999: $20,159; 
U.S. Central obligations relative to total investments: 2000: $18,887; 
U.S. Central obligations relative to total investments: 2001: $24,966; 
U.S. Central obligations relative to total investments: 2002: $27,041; 
U.S. Central obligations relative to total investments: 2003: $29,220.

Privately Issued Mortgage-Related Issues, 1997-2003: Fixed-rate CMOs/
REMICs; 
Total privately issued mortgage-related issues relative to total 
investments: 1997: 0.33%; 
Total privately issued mortgage-related issues relative to total 
investments: 1998: 1.68%; 
Total privately issued mortgage-related issues relative to total 
investments: 1999: 2.17%; 
Total privately issued mortgage-related issues relative to total 
investments: 2000: 3.04%; 
Total privately issued mortgage-related issues relative to total 
investments: 2001: 2.13%; 
Total privately issued mortgage-related issues relative to total 
investments: 2002: 2.44%; 
Total privately issued mortgage-related issues relative to total 
investments: 2003: 3.11%. 

Privately Issued Mortgage-Related Issues, 1997-2003: Variable-rate 
CMOs/REMICs; 
Total privately issued mortgage-related issues relative to total 
investments: 1997: 0.32%; 
Total privately issued mortgage-related issues relative to total 
investments: 1998: 0.54%; 
Total privately issued mortgage-related issues relative to total 
investments: 1999: 0.83%; 
Total privately issued mortgage-related issues relative to total 
investments: 2000: 1.20%; 
Total privately issued mortgage-related issues relative to total 
investments: 2001: 1.08%; 
Total privately issued mortgage-related issues relative to total 
investments: 2002: 3.19%; 
Total privately issued mortgage-related issues relative to total 
investments: 2003: 5.69%. 

Privately Issued Mortgage-Related Issues, 1997-2003: Mortgage-backed 
pass-throughs; 
Total privately issued mortgage-related issues relative to total 
investments: 1997: 0.25%; 
Total privately issued mortgage-related issues relative to total 
investments: 1998: 0.09%; 
Total privately issued mortgage-related issues relative to total 
investments: 1999: 0.08%; 
Total privately issued mortgage-related issues relative to total 
investments: 2000: 0.09%; 
Total privately issued mortgage-related issues relative to total 
investments: 2001: 0.10%; 
Total privately issued mortgage-related issues relative to total 
investments: 2002: 0.22%; 
Total privately issued mortgage-related issues relative to total 
investments: 2003: 0.21%. 

Privately Issued Mortgage-Related Issues, 1997-2003: Other; 
Total privately issued mortgage-related issues relative to total 
investments: 1997: 0.00%; 
Total privately issued mortgage-related issues relative to total 
investments: 1998: 0.00%; 
Total privately issued mortgage-related issues relative to total 
investments: 1999: 0.00%; 
Total privately issued mortgage-related issues relative to total 
investments: 2000: 0.00%; 
Total privately issued mortgage-related issues relative to total 
investments: 2001: 2.69%; 
Total privately issued mortgage-related issues relative to total 
investments: 2002: 3.00%; 
Total privately issued mortgage-related issues relative to total 
investments: 2003: 5.08%. 

Privately Issued Mortgage-Related Issues, 1997-2003: Total privately 
issued mortgage-related issues relative to total investments; 
Total privately issued mortgage-related issues relative to total 
investments: 1997: 0.90%; 
Total privately issued mortgage-related issues relative to total 
investments: 1998: 2.31%; 
Total privately issued mortgage-related issues relative to total 
investments: 1999: 3.08%; 
Total privately issued mortgage-related issues relative to total 
investments: 2000: 4.33%; 
Total privately issued mortgage-related issues relative to total 
investments: 2001: 6.01%; 
Total privately issued mortgage-related issues relative to total 
investments: 2002: 8.85%; 
Total privately issued mortgage-related issues relative to total 
investments: 2003: 14.09%. 

Privately Issued Mortgage-Related Issues, 1997-2003: Total privately 
issued mortgage-related issues (in millions)%; 
Total privately issued mortgage-related issues relative to total 
investments: 1997: $267; 
Total privately issued mortgage-related issues relative to total 
investments: 1998: $961; 
Total privately issued mortgage-related issues relative to total 
investments: 1999: $1,098; 
Total privately issued mortgage-related issues relative to total 
investments: 2000: $1,540; 
Total privately issued mortgage-related issues relative to total 
investments: 2001: $3,333; 
Total privately issued mortgage-related issues relative to total 
investments: 2002: $5,652; 
Total privately issued mortgage-related issues relative to total 
investments: 2003: $9,199. 

Asset-backed securities, 1997-2003: CUGRs; 
Asset-backed securities relative to total investments: 1997: 0.00%[A]; 
Asset-backed securities relative to total investments: 1998: 0.47%; 
Asset-backed securities relative to total investments: 1999: 0.64%; 
Asset-backed securities relative to total investments: 2000: 0.00%; 
Asset-backed securities relative to total investments: 2001: 0.00%; 
Asset-backed securities relative to total investments: 2002: 0.00%; 
Asset-backed securities relative to total investments: 2003: 0.00%. 

Asset-backed securities, 1997-2003: Fixed-rate credit cards; 
Asset-backed securities relative to total investments: 1997: 2.44%; 
Asset-backed securities relative to total investments: 1998: 1.24%; 
Asset-backed securities relative to total investments: 1999: 1.58%; 
Asset-backed securities relative to total investments: 2000: 1.75%; 
Asset-backed securities relative to total investments: 2001: 1.96%; 
Asset-backed securities relative to total investments: 2002: 1.42%; 
Asset-backed securities relative to total investments: 2003: 0.68%. 

Asset-backed securities, 1997-2003: Variable-rate credit cards%; 
Asset-backed securities relative to total investments: 1997: 4.37%; 
Asset-backed securities relative to total investments: 1998: 4.67%; 
Asset-backed securities relative to total investments: 1999: 5.77%; 
Asset-backed securities relative to total investments: 2000: 5.95%; 
Asset-backed securities relative to total investments: 2001: 5.46%; 
Asset-backed securities relative to total investments: 2002: 4.38%; 
Asset-backed securities relative to total investments: 2003: 4.16%. 

Asset-backed securities, 1997-2003: Fixed-rate autos; 
Asset-backed securities relative to total investments: 1997: 4.14%; 
Asset-backed securities relative to total investments: 1998: 2.94%; 
Asset-backed securities relative to total investments: 1999: 4.08%; 
Asset-backed securities relative to total investments: 2000: 3.48%; 
Asset-backed securities relative to total investments: 2001: 3.47%; 
Asset-backed securities relative to total investments: 2002: 3.30%; 
Asset-backed securities relative to total investments: 2003: 2.23%. 

Asset-backed securities, 1997-2003: Variable-rate autos; 
Asset-backed securities relative to total investments: 1997: 1.67%; 
Asset-backed securities relative to total investments: 1998: 1.12%; 
Asset-backed securities relative to total investments: 1999: 0.99%; 
Asset-backed securities relative to total investments: 2000: 1.06%; 
Asset-backed securities relative to total investments: 2001: 2.29%; 
Asset-backed securities relative to total investments: 2002: 2.34%; 
Asset-backed securities relative to total investments: 2003: 2.03%. 

Asset-backed securities, 1997-2003: Fixed-rate home equity; 
Asset-backed securities relative to total investments: 1997: 1.35%; 
Asset-backed securities relative to total investments: 1998: 1.91%; 
Asset-backed securities relative to total investments: 1999: 1.87%; 
Asset-backed securities relative to total investments: 2000: 1.53%; 
Asset-backed securities relative to total investments: 2001: 1.39%; 
Asset-backed securities relative to total investments: 2002: 1.73%; 
Asset-backed securities relative to total investments: 2003: 1.33%. 

Asset-backed securities, 1997-2003: Variable-rate home equity; 
Asset-backed securities relative to total investments: 1997: 3.89%; 
Asset-backed securities relative to total investments: 1998: 4.18%; 
Asset-backed securities relative to total investments: 1999: 5.64%; 
Asset-backed securities relative to total investments: 2000: 5.86%; 
Asset-backed securities relative to total investments: 2001: 5.80%; 
Asset-backed securities relative to total investments: 2002: 8.20%; 
Asset-backed securities relative to total investments: 2003: 12.09%. 

Asset-backed securities, 1997-2003: Fixed-rate other; 
Asset-backed securities relative to total investments: 1997: 0.21%; 
Asset-backed securities relative to total investments: 1998: 0.31%; 
Asset-backed securities relative to total investments: 1999: 0.67%; 
Asset-backed securities relative to total investments: 2000: 0.67%; 
Asset-backed securities relative to total investments: 2001: 0.33%; 
Asset-backed securities relative to total investments: 2002: 0.33%; 
Asset-backed securities relative to total investments: 2003: 0.20%. 

Asset-backed securities, 1997-2003: Variable-rate other; 
Asset-backed securities relative to total investments: 1997: 1.43%; 
Asset-backed securities relative to total investments: 1998: 1.38%; 
Asset-backed securities relative to total investments: 1999: 2.80%; 
Asset-backed securities relative to total investments: 2000: 3.07%; 
Asset-backed securities relative to total investments: 2001: 1.92%; 
Asset-backed securities relative to total investments: 2002: 1.54%; 
Asset-backed securities relative to total investments: 2003: 1.94%. 

Asset-backed securities, 1997-2003: Total asset-backed securities 
relative to total investments; 
Asset-backed securities relative to total investments: 1997: 19.48%; 
Asset-backed securities relative to total investments: 1998: 18.23%; 
Asset-backed securities relative to total investments: 1999: 24.03%; 
Asset-backed securities relative to total investments: 2000: 23.37%; 
Asset-backed securities relative to total investments: 2001: 22.62%; 
Asset-backed securities relative to total investments: 2002: 23.24%; 
Asset-backed securities relative to total investments: 2003: 24.66%. 

Asset-backed securities, 1997-2003: Total asset-backed securities (in 
millions); 
Asset-backed securities relative to total investments: 1997: $5,792; 
Asset-backed securities relative to total investments: 1998: $7,590; 
Asset-backed securities relative to total investments: 1999: $8,563; 
Asset-backed securities relative to total investments: 2000: $8,309; 
Asset-backed securities relative to total investments: 2001: $12,541; 
Asset-backed securities relative to total investments: 2002: $14,841; 
Asset-backed securities relative to total investments: 2003: $16,100. 

Source: NCUA call reports.

Notes: CUGR stands for U.S. Central Grantor Trusts, FRAP stands for 
Floating Rate Asset Program, CMO stands for collateralized mortgage 
obligation, and REMIC stands for real estate mortgage investment 
conduit. Totals may not add due to rounding. This table excludes data 
on U.S. Central.

[A] In the 1997 data in this table, the "Other" category of U.S Central 
obligations held by corporates includes CUGRs--which accounted for 0.81 
percent of total investments--as NCUA specified CUGRs with U.S. Central 
obligations in Form 5310. Beginning in 1998, CUGRs were specified with 
asset-backed securities in Form 5310.

[End of table]

Concurrent with Net Income Ratios, Interest-Related Income and Expense 
Ratios Have Declined Recently:

Concurrent with the recent low-interest rate environment, corporates' 
interest-related income and expenses, relative to average assets, have 
declined, as illustrated in figure 10. Net interest income, total 
noninterest income, and operating expense ratios cycled from 1993 
through 2003, generally expanding from 1995 through 2000 and then 
contracting through 2003. Recently, net interest income and operating 
expense ratios were lower and total noninterest income ratios were 
higher, suggesting that fee income has become more important for 
corporates.

Figure 10: Income and Expense Ratios of Corporates, 1993-2003:

[See PDF for image] 

Note: In this figure, net income components in a given year are 
measured relative to the average of that year's total assets and the 
prior year's total assets. The operating expense ratio is shown as a 
negative number for illustrative purposes. This figure excludes data on 
U.S. Central.

[End of figure] 

Net interest income as a percentage of average assets is often referred 
to as net interest margin.[Footnote 54] A corporate can maximize its 
net interest margin by effectively allocating resources among earning 
and nonearning assets, maintaining low levels of nonperforming assets, 
providing adequate funding through the lowest cost mix of funds, and 
maintaining a strong capital position. In a volatile interest-rate 
environment, large changes in a corporate's net interest margin are 
associated with high-interest-rate risk exposures and weak risk 
management.

Net interest income, which is interest income minus interest expense, 
is normally the primary source of income for a corporate and a key 
indicator of earnings performance and stability. Interest income 
consists of interest earned on loans and investments. The major 
contributor to interest income within a corporate is normally the 
investment portfolio. Interest expense consists of the corporate's cost 
of funding operations, or simply its "cost of funds." Interest expense 
in a corporate is realized through dividends on shares, share 
certificates, member capital accounts, and interest on borrowings (for 
example, loans and commercial paper). As illustrated in figure 11, 
interest income and expense have narrowed significantly since 2000.

Figure 11: Interest Income and Expense Ratios, 1993-2003:

[See PDF for image] 

Note: In this figure, interest income (yields on investments and loans) 
and expense (cost of funds) ratios in a given year are measured 
relative to the average of that year's total assets and the prior 
year's total assets. The cost of funds is shown as a negative number 
for illustrative purposes. This figure excludes U.S. Central.

[End of figure] 

In Recent Years, Natural Person Credit Unions Have Invested Less in 
Corporates:

Natural person credit unions' investments in corporates, which include 
membership capital, paid-in capital, and other investments, actually 
were lower at the end of 2003 than at the end of 1998--both in amount 
($37.8 billion versus $29.1 billion) and as a percentage of investments 
(30.4 percent versus 18.1 percent). The smallest natural person credit 
unions (those with assets of less than $100 million) consistently 
invested more in corporates, as a percentage of their total 
investments, from 1998 through 2003. It is important to note that this 
measure does not include cash on deposit in corporates, since these 
data were not disaggregated from deposits in other financial 
institutions in the Form 5310 report until 2003. At the end of 2003, 
natural person credit unions reported $26.2 billion in cash on deposit 
at corporates, which represented over three-quarters of natural person 
credit unions' total cash on deposit. Corporates held $55.3 billion, or 
26.9 percent, of the total amount of natural person credit unions' cash 
on hand, cash on deposit, and investments at the end of 2003, with the 
smallest natural person credit unions (those with assets of less than 
$100 million) holding around 34 percent and the largest (those with 
assets in excess of $1 billion) holding around 23 percent of their 
total in corporates. While it cannot be confirmed given the available 
data, the growth in natural person credit unions' loans, coupled with 
the possibility that natural person credit unions have become more 
willing to invest their funds directly rather than through corporates, 
may have resulted in relatively less funds flowing from natural person 
credit unions into corporates.

[End of section]

Appendix VI: Financial Condition of U.S. Central Generally Mirrors 
Other Corporates:

U.S. Central Credit Union (U.S. Central) is a nonprofit cooperative 
that is owned by corporates, and it serves these member-owners much 
like corporates serve their natural person credit union members. Trends 
in U.S. Central's balance sheet and income statement suggest that its 
financial condition has been similar to other corporates, with greater 
profitability and slightly higher capital ratios.

The balance sheet of U.S. Central grew overall from 1992 through 2003. 
However, as with the corporates, the dynamics of its asset and share 
growth have varied as the use of U.S. Central by its member-owners has 
varied. Investments, the vast majority of U.S. Central's assets, have 
mirrored the general growth pattern of its assets, declining through 
the early to mid-1990s and rising thereafter. Recently, U.S. Central 
has moved relatively more of its investments into privately issued 
mortgage-related securities.

Overall, total assets and shares of U.S. Central have grown since 1992; 
after generally declining in the early to mid-1990s, by the end of 2003 
they were reported at $35 billion and $30.7 billion, respectively (see 
fig. 12).

Figure 12: Balance Sheet of U.S. Central, 1992-2003:

[See PDF for image] 

[End of figure] 

U.S. Central's balance sheet is primarily influenced by the balance 
sheet dynamics of its underlying corporate member-owners, which have 
varied since 1992. As noted earlier, corporates saw their assets and 
shares decline in the early to mid-1990s but then rebound; corporates' 
assets and shares both grew by over 80 percent from 2000 through 2003. 
While displaying a similar cyclical trend from 1992 through 2003, U.S. 
Central did not experience the same degree of growth from 2000, as 
assets grew by around 54 percent and shares grew by around 57 percent. 
As with corporates, in general investments represent over 90 percent of 
U.S. Central's assets, as illustrated in figure 13.

Figure 13: U.S. Central's Investments Relative to Total Assets, 1992-
2003:

[See PDF for image] 

Note: Other assets include cash, loans, and fixed assets.

[End of figure] 

Investments in accounts at U.S. Central, including overnight accounts, 
term certificates, structured products, and membership shares, are 
important to many corporates, especially the smaller ones. As of the 
end of 2003, 17, or 57 percent of all corporates, had at least 70 
percent of their total investments in accounts at U.S. Central and 4 
had over 60 percent. With the recent investment environment 
characterized by historic low interest rates, U.S. Central's members 
may have increased their utilization of U.S. Central's economies of 
scale to help increase the spreads between the rates they offered their 
customers and the rates they earned on their investments. In general, 
it seems sensible for corporates--especially the smaller ones--to be 
able to rely on the services of U.S. Central given its economies of 
scale. This reliance, however, adds more weight to the need for U.S. 
Central to be a safe and sound investment.

As U.S. Central's total investments have grown, the composition of 
these investments has changed, particularly with increases in 
investments in mortgage-related securities since 1997 (see table 4). 
U.S. Central's investments in privately issued mortgage-related 
securities increased from 3.4 percent of its total investments in 1997 
to 24.7 percent of its total investments in 2003. Overall, U.S. 
Central's mortgage-related investments, including government and 
agency mortgage-related issues, rose from 10.5 percent of its total 
investments to 32.7 percent of its total investments over this period. 
As with corporates, asset-backed securities have consistently been an 
important investment type for U.S. Central.

Table 4: Composition of Total Investments of U.S. Central, 1997-2003:

Dollars in millions.

U.S. government and government-guaranteed obligations; 
Investments relative to total investments: 1997: 5.17%; 
Investments relative to total investments: 1998: 2.34%; 
Investments relative to total investments: 1999: 1.23%; 
Investments relative to total investments: 2000: 0.41%; 
Investments relative to total investments: 2001: 0.55%; 
Investments relative to total investments: 2002: 1.36%; 
Investments relative to total investments: 2003: 1.35%.

Obligations of U.S. government-sponsored enterprises; 
Investments relative to total investments: 1997: 0.10%; 
Investments relative to total investments: 1998: 1.19%; 
Investments relative to total investments: 1999: 0.43%; 
Investments relative to total investments: 2000: 0.30%; 
Investments relative to total investments: 2001: 0.10%; 
Investments relative to total investments: 2002: 0.50%; 
Investments relative to total investments: 2003: 0.00%.

Central Liquidity Facility stock (direct); 
Investments relative to total investments: 1997: 4.06%; 
Investments relative to total investments: 1998: 2.96%; 
Investments relative to total investments: 1999: 3.39%; 
Investments relative to total investments: 2000: 4.16%; 
Investments relative to total investments: 2001: 2.96%; 
Investments relative to total investments: 2002: 3.36; 
Investments relative to total investments: 2003: 3.58%.

U.S. banks; 
Investments relative to total investments: 1997: 12.27%; 
Investments relative to total investments: 1998: 23.34%; 
Investments relative to total investments: 1999: 26.77%; 
Investments relative to total investments: 2000: 10.50%; 
Investments relative to total investments: 2001: 4.27%; 
Investments relative to total investments: 2002: 2.40%; 
Investments relative to total investments: 2003: 6.34%.

Foreign banks; 
Investments relative to total investments: 1997: 0.00%; 
Investments relative to total investments: 1998: 2.02%; 
Investments relative to total investments: 1999: 0.00%; 
Investments relative to total investments: 2000: 15.41%; 
Investments relative to total investments: 2001: 6.80%; 
Investments relative to total investments: 2002: 0.83%; 
Investments relative to total investments: 2003: 1.84%.

Repurchase activity; 
Investments relative to total investments: 1997: 14.73%; 
Investments relative to total investments: 1998: 9.89%; 
Investments relative to total investments: 1999: 17.65%; 
Investments relative to total investments: 2000: 4.51%; 
Investments relative to total investments: 2001: 10.41%; 
Investments relative to total investments: 2002: 5.38%; 
Investments relative to total investments: 2003: 0.94%.

Government and agency mortgage-related issues; 
Investments relative to total investments: 1997: 7.10%; 
Investments relative to total investments: 1998: 3.80%; 
Investments relative to total investments: 1999: 2.61%; 
Investments relative to total investments: 2000: 3.01%; 
Investments relative to total investments: 2001: 2.74%; 
Investments relative to total investments: 2002: 4.55%; 
Investments relative to total investments: 2003: 8.05%.

Privately issued mortgage-related issues; 
Investments relative to total investments: 1997: 3.35%; 
Investments relative to total investments: 1998: 0.69%; 
Investments relative to total investments: 1999: 1.04%; 
Investments relative to total investments: 2000: 2.94%; 
Investments relative to total investments: 2001: 13.17%; 
Investments relative to total investments: 2002: 19.24%; 
Investments relative to total investments: 2003: 24.66%.

Asset-backed securities; 
Investments relative to total investments: 1997: 52.12%; 
Investments relative to total investments: 1998: 50.23%; 
Investments relative to total investments: 1999: 44.20%; 
Investments relative to total investments: 2000: 52.68%; 
Investments relative to total investments: 2001: 44.10%; 
Investments relative to total investments: 2002: 49.00%; 
Investments relative to total investments: 2003: 48.24%.

Mutual funds; 
Investments relative to total investments: 1997: 0.00%; 
Investments relative to total investments: 1998: 0.00%; 
Investments relative to total investments: 1999: 0.00%; 
Investments relative to total investments: 2000: 0.00%; 
Investments relative to total investments: 2001: 7.12%; 
Investments relative to total investments: 2002: 1.49%; 
Investments relative to total investments: 2003: 0.00%.

Commercial debt obligations; 
Investments relative to total investments: 1997: 1.10%; 
Investments relative to total investments: 1998: 3.55%; 
Investments relative to total investments: 1999: 2.68%; 
Investments relative to total investments: 2000: 6.09%; 
Investments relative to total investments: 2001: 7.77%; 
Investments relative to total investments: 2002: 11.90%; 
Investments relative to total investments: 2003: 4.99%.

Other; 
Investments relative to total investments: 1997: 0.00%; 
Investments relative to total investments: 1998: 0.00%; 
Investments relative to total investments: 1999: 0.00%; 
Investments relative to total investments: 2000: 0.00%; 
Investments relative to total investments: 2001: 0.24%; 
Investments relative to total investments: 2002: 0.34%; 
Investments relative to total investments: 2003: 0.18%.

Total investments; 
Investments relative to total investments: 1997: $17,364; 
Investments relative to total investments: 1998: $24,773; 
Investments relative to total investments: 1999: $24,668; 
Investments relative to total investments: 2000: $20,444; 
Investments relative to total investments: 2001: $30,952; 
Investments relative to total investments: 2002: $30,342; 
Investments relative to total investments: 2003: $32,656.

Source: NCUA call reports.

Note: Totals may not add due to rounding.

[End of table]

Holding variable-rate investments and securities with shorter weighted 
average lives tends to result in relatively lower interest-rate risk. 
U.S. Central, like the corporates, tends to have significant holdings 
of mortgage-related issues and asset-backed securities--80 percent of 
its portfolio was in such investments at the end of 2003--but holds 
most of these in the form of variable-rate and shorter weighted 
average life issues. Holdings of variable-rate asset-backed and 
privately issued mortgage-related securities accounted for 67 percent 
of all investments at the end of 2003. According to its 2003 annual 
report, at the end of the year, mortgage-related and asset-backed 
securities in U.S. Central's portfolio had weighted average lives of 
approximately 2.8 years and 3 years, respectively, and approximately 
83 percent of interest-earning assets were set to reprice or mature 
within 1 year. Table 5 details selected investments of U.S. Central 
from 1997 through 2003.

Table 5: Composition of Selected Investments of U.S. Central, 1997-
2003:

Privately issued mortgage-related issues, 1997-2003: Fixed-rate CMOs/
REMICs; 
Privately issued mortgage-related issues relative to total 
investments: 1997: 1.15%; 
Privately issued mortgage-related issues relative to total 
investments: 1998: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 1999: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 2000: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 2001: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 2002: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 2003: 0.00%.

Privately issued mortgage-related issues, 1997-2003: Variable-rate 
CMOs/REMICs; 
Privately issued mortgage-related issues relative to total 
investments: 1997: 2.20%; 
Privately issued mortgage-related issues relative to total 
investments: 1998: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 1999: 0.07%; 
Privately issued mortgage-related issues relative to total 
investments: 2000: 1.13%; 
Privately issued mortgage-related issues relative to total 
investments: 2001: 12.57%; 
Privately issued mortgage-related issues relative to total 
investments: 2002: 18.76%; 
Privately issued mortgage-related issues relative to total 
investments: 2003: 23.70%.

Privately issued mortgage-related issues, 1997-2003: Mortgage-backed 
pass throughs; 
Privately issued mortgage-related issues relative to total 
investments: 1997: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 1998: 0.69%; 
Privately issued mortgage-related issues relative to total 
investments: 1999: 0.97%; 
Privately issued mortgage-related issues relative to total 
investments: 2000: 1.81%; 
Privately issued mortgage-related issues relative to total 
investments: 2001: 0.60%; 
Privately issued mortgage-related issues relative to total 
investments: 2002: 0.48%; 
Privately issued mortgage-related issues relative to total 
investments: 2003: 0.97%.

Privately issued mortgage-related issues, 1997-2003: Other; 
Privately issued mortgage-related issues relative to total 
investments: 1997: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 1998: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 1999: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 2000: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 2001: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 2002: 0.00%; 
Privately issued mortgage-related issues relative to total 
investments: 2003: 0.00%.

Privately issued mortgage-related issues, 1997-2003: Total privately 
issued mortgage-related issues relative to total investments; 
Privately issued mortgage-related issues relative to total 
investments: 1997: 3.35%; 
Privately issued mortgage-related issues relative to total 
investments: 1998: 0.69%; 
Privately issued mortgage-related issues relative to total 
investments: 1999: 1.04%; 
Privately issued mortgage-related issues relative to total 
investments: 2000: 2.94%; 
Privately issued mortgage-related issues relative to total 
investments: 2001: 13.17%; 
Privately issued mortgage-related issues relative to total 
investments: 2002: 19.24%; 
Privately issued mortgage-related issues relative to total 
investments: 2003: 24.66%.

Privately issued mortgage-related issues, 1997-2003: Total privately 
issued mortgage-related issues (in millions); 
Privately issued mortgage-related issues relative to total 
investments: 1997: $582; 
Privately issued mortgage-related issues relative to total 
investments: 1998: $170; 
Privately issued mortgage-related issues relative to total 
investments: 1999: $256; 
Privately issued mortgage-related issues relative to total 
investments: 2000: $600; 
Privately issued mortgage-related issues relative to total 
investments: 2001: $4,066; 
Privately issued mortgage-related issues relative to total 
investments: 2002: $5,817; 
Privately issued mortgage-related issues relative to total 
investments: 2003: $8,040.

Asset-backed securities, 1997-2003: Fixed-rate credit cards; 
Asset-backed securities relative to total investments: 1997: 0.60%; 
Asset-backed securities relative to total investments: 1998: 1.07%; 
Asset-backed securities relative to total investments: 1999: 1.02%; 
Asset-backed securities relative to total investments: 2000: 0.98%; 
Asset-backed securities relative to total investments: 2001: 1.53%; 
Asset-backed securities relative to total investments: 2002: 1.69%; 
Asset-backed securities relative to total investments: 2003: 2.67%.

Asset-backed securities, 1997-2003: Variable-rate credit cards; 
Asset-backed securities relative to total investments: 1997: 20.57%; 
Asset-backed securities relative to total investments: 1998: 17.45%; 
Asset-backed securities relative to total investments: 1999: 22.12%; 
Asset-backed securities relative to total investments: 2000: 18.84%; 
Asset-backed securities relative to total investments: 2001: 17.14%; 
Asset-backed securities relative to total investments: 2002: 20.76%; 
Asset-backed securities relative to total investments: 2003: 20.87.

Asset-backed securities, 1997-2003: Fixed-rate autos; 
Asset-backed securities relative to total investments: 1997: 0.14%; 
Asset-backed securities relative to total investments: 1998: 0.61%; 
Asset-backed securities relative to total investments: 1999: 1.40%; 
Asset-backed securities relative to total investments: 2000: 1.59%; 
Asset-backed securities relative to total investments: 2001: 1.12%; 
Asset-backed securities relative to total investments: 2002: 0.80%; 
Asset-backed securities relative to total investments: 2003: 0.59.

Asset-backed securities, 1997-2003: Variable-rate autos; 
Asset-backed securities relative to total investments: 1997: 0.34%; 
Asset-backed securities relative to total investments: 1998: 2.82%; 
Asset-backed securities relative to total investments: 1999: 6.24%; 
Asset-backed securities relative to total investments: 2000: 5.21%; 
Asset-backed securities relative to total investments: 2001: 7.85%; 
Asset-backed securities relative to total investments: 2002: 4.76%; 
Asset-backed securities relative to total investments: 2003: 5.17.

Asset-backed securities, 1997-2003: Fixed-rate home equity; 
Asset-backed securities relative to total investments: 1997: 0.00%; 
Asset-backed securities relative to total investments: 1998: 0.08%; 
Asset-backed securities relative to total investments: 1999: 0.31%; 
Asset-backed securities relative to total investments: 2000: 0.13%; 
Asset-backed securities relative to total investments: 2001: 0.33%; 
Asset-backed securities relative to total investments: 2002: 0.78%; 
Asset-backed securities relative to total investments: 2003: 1.28.

Asset-backed securities, 1997-2003: Variable-rate home equity; 
Asset-backed securities relative to total investments: 1997: 6.08%; 
Asset-backed securities relative to total investments: 1998: 5.38%; 
Asset-backed securities relative to total investments: 1999: 6.50%; 
Asset-backed securities relative to total investments: 2000: 19.10%; 
Asset-backed securities relative to total investments: 2001: 12.90%; 
Asset-backed securities relative to total investments: 2002: 16.26%; 
Asset-backed securities relative to total investments: 2003: 16.05.

Asset-backed securities, 1997-2003: Fixed-rate other; 
Asset-backed securities relative to total investments: 1997: 0.27%; 
Asset-backed securities relative to total investments: 1998: 1.40%; 
Asset-backed securities relative to total investments: 1999: 0.09%; 
Asset-backed securities relative to total investments: 2000: 0.04%; 
Asset-backed securities relative to total investments: 2001: 0.06%; 
Asset-backed securities relative to total investments: 2002: 0.06%; 
Asset-backed securities relative to total investments: 2003: 0.35.

Asset-backed securities, 1997-2003: Variable-rate other; 
Asset-backed securities relative to total investments: 1997: 24.13%; 
Asset-backed securities relative to total investments: 1998: 21.41%; 
Asset-backed securities relative to total investments: 1999: 6.52%; 
Asset-backed securities relative to total investments: 2000: 6.78%; 
Asset-backed securities relative to total investments: 2001: 3.16%; 
Asset-backed securities relative to total investments: 2002: 3.89%; 
Asset-backed securities relative to total investments: 2003: 1.26.

Asset-backed securities, 1997-2003: Total asset-backed securities 
relative to total investments; 
Asset-backed securities relative to total investments: 1997: 52.12%; 
Asset-backed securities relative to total investments: 1998: 50.23%; 
Asset-backed securities relative to total investments: 1999: 44.20%; 
Asset-backed securities relative to total investments: 2000: 52.68%; 
Asset-backed securities relative to total investments: 2001: 44.10%; 
Asset-backed securities relative to total investments: 2002: 49.00%; 
Asset-backed securities relative to total investments: 2003: 48.24%.

Asset-backed securities, 1997-2003: Total asset-backed securities (in 
millions); 
Asset-backed securities relative to total investments: 1997: $9,051; 
Asset-backed securities relative to total investments: 1998: $12,442; 
Asset-backed securities relative to total investments: 1999: $10,904; 
Asset-backed securities relative to total investments: 2000: $10,770; 
Asset-backed securities relative to total investments: 2001: $13,617; 
Asset-backed securities relative to total investments: 2002: $14,818; 
Asset-backed securities relative to total investments: 2003: $15,727. 

Source: NCUA call reports.

Note: CMO stands for collateralized mortgage obligation, and REMIC 
stands for real estate mortgage investment conduit. Totals may not add 
due to rounding.

[End of table]

U.S. Central's Capital Levels Generally Increased Since 1998 and, 
Despite Recent Asset Growth, Capital Ratios Were Higher in 2003 Than in 
1998:

Since 1998, U.S. Central's capital has generally been rising. Total 
capital, as defined in Part 704, rose from $1.2 billion in 1998 to $2 
billion at the end of 2003. Figure 14 illustrates the growth in U.S. 
Central's total capital. Retained earnings and membership capital have 
grown overall, but paid-in capital has remained constant since 1999.

Figure 14: Total Capital of U.S. Central, 1998-2003:

[See PDF for image] 

[End of figure] 

Since 1998, undivided earnings (a component of retained earnings) have 
provided the fastest growth, increasing 61 percent, while membership 
capital, the largest component, has grown 37 percent. At the end of 
2003, membership capital accounted for 58 percent, or $1.1 billion, of 
U.S. Central's total capital.

Despite recent asset growth, U.S. Central's capital ratios have 
remained relatively stable, as shown in figure 15. After peaking in 
2000, capital ratios declined in 2001 but have since leveled off. They 
remain above the current regulatory requirements.

Figure 15: Capital Ratios of U.S Central, 1998-2003:

[See PDF for image] 

Note: In this figure, capital ratios are calculated by dividing capital 
by the moving daily average of net assets (DANA), which is a measure of 
average assets as set forth in Part 704 in 1998. NCUA currently 
specifies three capital ratios: the capital ratio, which includes all 
forms of capital relative to moving DANA; the core capital ratio, which 
includes core capital (that is, retained earnings plus paid-in capital) 
relative to moving DANA; and the retained earnings ratio, which 
includes reserves plus undivided earnings relative to moving DANA.

[End of figure] 

U.S. Central's Net Income and Profitability Have Grown Since 1992:

U.S. Central's net income has grown since 1992 and was at its highest 
level at the end of 2003. As depicted in figure 16, after declining to 
$10.7 million at the end of 1994, U.S. Central's net income rebounded, 
generally rising through 1998. After peaking in 1998 at $38.4 million, 
net income declined to $22.8 million at the end of 2000. However, by 
the end of 2003, net income had tripled to $67.9 million. U.S. 
Central's profitability--that is, net income divided by average assets-
-followed the general pattern exhibited by net income since 1992, and 
it was at its highest at the end of 2003.

Figure 16: Net Income and Profitability of U.S. Central, 1992-2003:

[See PDF for image] 

Note: In this figure, profitability in a given year is measured by the 
ratio of that year's net income to the average of that year's total 
assets and the prior year's total assets.

[End of figure] 

As with the corporates, U.S. Central witnessed a narrowing of its 
yields on investments recently. However, while profitability suffered 
at the corporates since 2001, U.S. Central managed to increase its 
profitability, in part through increased noninterest income.

[End of section]

Appendix VII: Expanded Authorities Available to Corporates:

In 1998 NCUA revised Part 704. Among other things, the new regulations 
provided qualified corporates with expanded authorities that allowed 
corporates having a strong financial position, management, and 
infrastructure to exercise greater flexibility in managing their risks 
subject to NCUA approval.[Footnote 55] For example, corporates with 
certain levels of expanded authorities were allowed to invest in 
foreign securities or A-rated securities, compared with the higher-
rated AAA securities in which other corporates were allowed to invest. 
In 2002, NCUA again revised Part 704 to allow for further flexibilities 
in expanded investment authorities.[Footnote 56] For example, qualified 
corporates were allowed to invest in BBB rated securities, subject to 
NCUA approval.[Footnote 57] Table 6 provides more detail on the types 
of investments allowed under the various levels of expanded 
authorities, and the number of corporates that currently have these 
authorities.

Table 6: Expanded Authorities and Number of Corporates Authorized to 
Engage in Investments under These Authorities, as of December 31, 2003:

Expanded authority level: Part I[A]; 
Number of corporates: 2; 
Investments allowed under expanded authorities: 
* Purchase investments with long-term ratings no lower than A-(or 
equivalent); 
* Purchase investments with short-term ratings no lower than A-2 (or 
equivalent), provided that the issuer has a long-term rating no lower 
than A-(or equivalent) or the investment is a domestically issued 
asset-backed security; 
* Engage in short sales of permissible investments to reduce interest-
rate risk; 
* Purchase principal-only stripped mortgage-backed securities to 
reduce interest rate risk; 
* Enter into a "dollar roll" transaction.

Expanded authority level: Part II[B]; 
Number of corporates: 3; 
Investments allowed under expanded authorities: 
* Purchase investments with long-term ratings no lower than BBB (flat) 
(or equivalent); the aggregate of all investments rated BBB+ (or 
equivalent) or lower in any single obligor is not to exceed 25 percent 
of capital; 
* Purchase investments with short-term ratings no lower than A-2 (or 
equivalent), provided that the issuer has a long-term rating no lower 
that BBB (flat) (or equivalent) or the investment is a domestically 
issued asset-backed security; 
* Engage in short sales of permissible investments to reduce interest-
rate risk; 
* Purchase principal-only stripped mortgage-backed securities to reduce 
interest-rate risk; 
* Enter into a "dollar roll" transaction.

Expanded authority level: Part III[C]; 
Number of corporates: 3; 
Investments allowed under expanded authorities: 
* Invest in debt obligations of a foreign country; 
* Invest in deposits and debt obligations of foreign banks or 
obligations guaranteed by these banks; 
* Invest in marketable debt obligations of foreign corporations; this 
authority does not apply to debt obligations that are convertible into 
stock of the corporation; 
* Invest in foreign-issued, asset-backed securities.

Expanded authority level: Part IV[D]; 
Number of corporates: 3; 
Investments allowed under expanded authorities: 
* Enter into derivative transactions specifically approved by NCUA to 
create structured products, manage its own balance sheet, and hedge 
the balance sheets of its members.

Expanded authority level: Part V[E]; 
Number of corporates: 1; 
Investments allowed under expanded authorities: 
* Participate in loans with member natural person credit unions as 
approved by the Office of Corporate Credit Union Director. 

Source: Part 704 of NCUA Rules and Regulations.

Notes: Corporates can be granted more than one expanded authority 
level.

[A] The investments under Part I authority are subject to certain 
conditions, including the requirement that aggregated investments in 
repurchase and securities lending agreements with any one counterparty 
are limited to 300 percent of capital.

[B] The investments under Part II authority are subject to certain 
conditions, including the requirement that aggregated investments in 
repurchase and securities lending agreements with any one counterparty 
are limited to 400 percent of capital.

[C] To engage in Part III expanded authorities, the corporate must have 
met the requirements of Part I or Part II, and additional requirements 
for Part III. Foreign investments are subject to the following 
requirements: The investments must be rated no lower than the minimum 
permissible domestic rating under the corporate's Part I or Part II 
authority. The sovereign issuer, or the country in which an obligor is 
organized, must have a long-term foreign currency (nonlocal currency) 
debt rating no lower than AA-(or equivalent). For each approved foreign 
bank line, the corporate credit union must identify the specific 
banking centers and branches to which it will lend funds. Obligations 
of any single foreign obligor may not exceed 50 percent of capital. 
Finally, obligations in any single foreign country may not exceed 250 
percent of capital.

[D] The derivative transactions under Part IV are subject to the 
following requirements: If the counterparty is domestic, the 
counterparty rating must be no lower than the minimum permissible 
rating for comparable term permissible investments. If the counterparty 
is foreign, the corporate must have Part III expanded authority and the 
counterparty rating must be no lower than the minimum permissible 
rating for a comparable term investment under Part III authority.

[E] The ability to engage in Part V authorities is subject to the 
maximum aggregate amount of participation loans with any one member 
credit union, which must not exceed 25 percent of capital. In addition, 
the maximum aggregate amount of participation loans with all member 
credit unions must be determined on a case-by-case basis by the Office 
of Corporate Credit Union Director.

[End of table]

[End of section]

Appendix VIII: Comments from the National Credit Union Administration:

National Credit Union Administration:
Office of the Chairman:

September 8, 2004:

Richard J. Hillman, Director:
Financial Markets and Community Investment: 
United States General Accounting Office: 
Washington, D.C.

Re: Draft GAO Report 04-977:

Dear Mr. Hillman:

Thank you for the opportunity to review and comment on GAO's draft 
report entitled Corporate Credit Unions Competitive Environment May 
Stress Financial Condition, Posing Challenges for NCUA Oversight 
(Report). On behalf of the National Credit Union Administration (NCUA), 
I would like to express our appreciation for the professionalism 
exhibited by your staff and the thoroughness of their review, our 
gratitude for the dialogue between NCUA and GAO throughout your study, 
and our concurrence with most of your assessments and conclusions 
contained in the Report. The comments below respond specifically to 
your report's conclusions and recommendations.

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

NCUA concurs with the Report's assessment that corporate credit unions 
are operating in an increasingly challenging and competitive business 
environment. Recognizing the dynamic financial marketplace in which 
corporate credit unions operate and the need for NCUA's corporate rule 
to be current, NCUA, as noted in the Report, revised its corporate rule 
twice in recent years, once in 1998 and again in 2002. The important 
and timely revisions to the corporate rule considered the unique nature 
and mission of corporate credit unions, improved their ability to 
provide competitive products and services, and strengthened the 
financial soundness of the corporate system. The corporate rule has 
functioned as intended, permitting corporate balance sheets to expand 
and contract, sometimes rapidly, depending on liquidity levels in 
natural person credit unions, while not compromising safety and 
soundness.

The Report correctly notes that since 2000 a significant inflow of 
share deposits, coupled with recent historic low interest rates, have 
put pressure on corporate earnings and capital ratios. Despite 
increases in overall capital levels, profitability, as well as capital 
ratios (retained earnings, core, and capital), has declined since 
December 2000. Notwithstanding these recent stresses, the corporate 
system has performed remarkably well since 2000 as evidenced by the 33 
percent increase in retained earnings. This level of earnings retention 
was accomplished by corporate management prudently controlling credit, 
interest-rate, and liquidity risks while, at the same time, expanding 
the menu of products and services being made available to their member 
credit unions.

To illustrate the rapid influx of corporate share deposits, network 
assets increased by $42 billion, or 79 percent, during the 5 month 
period ending March 2001. Assets continued to increase, reaching a 
record aggregate level of $126 billion at the end of May 2003, before 
subsequently subsiding to $109 billion as of December 2003. This rapid 
expansion of the network's assets (October 2000 to December 2003) 
occurred at the same time the Fed Fund Effective Rate declined from 
6.51 percent to 1.00 percent. Due to the high credit quality and short 
duration of the network's investment portfolio, corporate earnings did 
not increase proportionately to asset growth. This influx of deposits 
combined with decreasing interest rates did strain profitability and 
resulted in lower capital ratios. However, because the corporate 
network and the corporate rule performed as intended, corporate credit 
unions were capable of absorbing the credit union industry's excess 
liquidity while not compromising safety and soundness.

The Report further explains that despite declining capital ratios since 
2000, overall levels of capital have increased since 1998. The Report 
indicates, however, there is an increasing reliance on weaker, less 
permanent, forms of capital suggesting that these capital instruments 
provide a weaker cushion against adverse financial trends. NCUA does 
not concur with the assessment that either paid-in capital or 
membership capital are "weaker forms" of capital. [NOTE 1] Both capital 
instruments are available to cover losses that exceed retained 
earnings, are not insured by either the National Credit Union Share 
Insurance Fund (NCUSIF) or any other deposit insurer, and cannot be 
pledged against borrowings. With the 2002 corporate rule change, paid-
in capital issued must be perpetual maturity, non-cumulative dividend 
accounts. Prior to the 2002 rule change, paid-in capital required an 
initial 20 year minimum maturity. When a paid-in capital instrument 
issued prior to the rule change has a remaining maturity of 5 years, 
the amount of the instrument that may be considered as paid-in capital 
is reduced by a constant monthly amortization which ensures the 
recognition of paid-in capital is fully amortized when the instrument 
has a remaining maturity of 3 years. Membership capital requires a 
minimum withdrawal notice of 3 years. When a membership capital account 
has been placed on notice or has a remaining maturity of less than 3 
years, the amount that can be considered membership capital is reduced 
by a constant monthly amortization that ensures membership capital is 
fully amortized one year before the date of maturity or one year before 
the end of the notice period. The full balance of both paid-in capital 
and membership capital being amortized, not just the remaining non-
amortized portion, are available to absorb losses in excess of retained 
earnings. Neither paid-in nor membership capital accounts are 
releasable due to a merger, charter conversion, or liquidation of a 
member credit union.

The Report confirms that despite the rapid expansion in corporate 
balance sheets since 2000, the rule's minimum 4 percent capital 
requirement was exceeded by all corporates. This was achieved as a 
result of the flexibility incorporated in the rule which allows 
corporates to adjust their membership capital accounts in relation to 
either their member credit unions' assets or other measure. The rule 
functioned as intended, recognizing that if corporate credit unions are 
to fulfill their mission, they must have the ability to either expand 
or contract their deposit base depending on the liquidity level of 
their member credit unions.

Importantly, corporates continue to improve. For the period ending July 
2004, the network's capital ratios (retained earnings, core, and 
capital) have increased for each of the last six months. The retained 
earnings, core, and capital ratios are 2.31 percent, 3.09 percent, and 
6.75 percent, respectively.

The Report observes that the percentage of corporates' investments in 
U.S. Central obligations has declined, particularly for the largest 
corporates, as a result of corporates shifting some of their 
investments into potentially higher yielding, more volatile securities 
such as privately issued mortgage-related and asset-backed securities. 
The Report further states the 2002 rule change, permitting corporates 
to purchase securities with lower credit quality, may lead to increased 
credit risk if not properly managed. NCUA believes the slight potential 
increase in credit risk exposure is more than offset by the rule's 
decrease in exposure to credit concentration risk. Additionally, NCUA 
is of the opinion the rule's modest expansion of permissible investment 
graded securities, combined with its reduction in credit concentration 
limits, results in a stronger corporate network. Corporate management 
is better positioned to compete, within prudent safety and soundness 
thresholds, than under the previous rule.

The 2002 rule change permits corporates to purchase lower credit 
quality securities, but only marginally. As the Report notes, all 
corporate investments are required to be of investment grade. Base and 
Base Plus corporates (26 of 31 corporates) are only permitted to 
purchase short-term securities having a minimum short-term credit 
rating of A-1 and long-term securities having a minimum long-term 
credit rating AA-. The rule did not change the short-term credit 
rating, but lowered the long-term credit rating from AA to AA-. 
Corporates approved for Part I expanded authorities (2 of 31 
corporates) are permitted to purchase short-term securities having a 
minimum short-term credit rating of A-2, provided that the issuer has a 
long-term rating no lower than A-, and long-term securities having a 
minimum long-term credit rating of A-. The rule change lowered the 
short-term credit rating from A-1 to A-2 and the long-term credit 
rating from AA-to A-. Finally, corporates approved for Part II expanded 
authorities (3 of 31 corporates) are permitted to purchase short-term 
securities having a minimum short-term credit rating of A-2, provided 
that the issuer has a long-term rating no lower than BBB, and long-term 
securities having a minimum long-term credit rating no lower than BBB. 
The rule change lowered the short-term credit rating from A-1 to A-2 
and the long-term credit rating from A-to BBB.

Credit risk is also controlled by a single obligor concentration limit. 
With investments rated higher than BBB+, the aggregate investment in a 
single obligor is 50 percent of capital or $5 million, whichever is 
greater. However, for investments rated BBB or BBB+, the aggregate 
investment in a single obligor is restricted to 25 percent of capital.

As of June 30, 2004, 97 percent of the network's rated long-term 
securities (excludes government and agency securities) are rated AAA, 
or equivalent, by at least one nationally recognized statistical rating 
organization. Only 0.2 percent of the network's rated long-term 
securities are rated BBB+ or lower. Credit risk is well diversified 
over a reasonable universe of counterparties (360 issuers). The largest 
single obligor concentration is Fannie Mae at 8.9 percent. Based on the 
high quality and diversification of the network's investments, NCUA 
believes credit risk is minimal.

Recognizing there is a potential for increased credit risk based on 
investments granted above the Base Plus level, NCUA requires corporates 
applying for greater expanded authorities to have an appropriate 
infrastructure in place (systems, people, and processes) and to submit 
to a rigorous review process prior to approval being granted. NCUA has 
developed the Guidelines for Submission of Requests for Expanded 
Authority to assist interested corporates in preparing and applying for 
expanded authorities. In addition, NCUA's capital markets specialists 
provide monthly supervision to the 5 corporates granted expanded 
authorities above Base Plus. On-site monthly supervision is provided to 
the 3 corporates granted Part II expanded authorities. Investments of 
either Base or Base Plus corporates receive monthly monitoring by 
corporate examiners.

Your analysis correctly asserts that with potentially higher yields 
from privately issued mortgage-related and asset-backed securities, as 
opposed to government-guaranteed obligations, corporates may 
potentially be increasing interest-rate risk. You note, however, the 3 
largest corporates you reviewed are managing interest-rate 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 Report concludes the investment 
portfolios of these 3 corporates have relatively short weighted-average 
lives, most being less than 3 years.

NCUA has addressed controlling interest-rate risk in the corporate 
rule. The rule establishes a minimum net economic value (NEV) ratio of 
2 percent and limits risk exposures to levels that do not result in a 
decline in NEV of more than 15 percent in an instantaneous, permanent, 
and parallel shock in the yield curve of plus and minus 100, 200, and 
300 basis points. As of June 30, 2004, the network's NEV ratio is 7.04 
percent and NEV volatility is (8.07) percent in a +300 basis point 
shock scenario. Seventy-six percent of the network's marketable 
securities are variable rate. The majority of these variable rate 
securities, 86 percent, reset to the one-month U.S. Libor rate and 
another 8 percent reset to the three-month U.S. Libor rate. The 
network's estimated dollar weighted-average life and dollar weighted-
average life to call are 4.5 and 3.4 years, respectively. NCUA's 
assessment of the network's investment portfolio is interest-rate risk 
is minimal.

NCUA Strengthened Its Oversight of Corporates, but Could Do More to 
Anticipate and Address Emerging Network Issues:

The Report comments on several major improvements in NCUA's oversight 
of corporates, the most notable being the creation of a separate office 
within NCUA charged with examining and supervising corporates, revising 
the corporate rule to address corporates' management of credit, 
interest-rate, and liquidity risks, implementing risk-focused 
supervision and examinations, and hiring specialists in the areas of 
capital markets, information systems, and payment systems. 
Additionally, it is important to note that NCUA is committed to 
providing effective oversight of the corporate system as demonstrated 
by the above improvements. On-going agency efforts include periodic 
independent Office of Corporate Credit Unions (OCCU) reviews that 
evaluate OCCU's structure and operations, assess corporate examination 
policies and practices, and oversee the completion and review of OCCU 
internal and external audits and reviews. Annually, OCCU performs a 
self-assessment review that results in recommendations to structure, 
staffing, education, and specialty needs (contractors and tools) to 
ensure NCUA is positioned to properly assess risks in the rapidly 
changing corporate environment.

Trackinq Problem Resolution:

Your review of examination reports found examiners had identified 
deficiencies and had established time frames for correcting 
deficiencies, however, in some cases, you were unable to locate 
documentation to support problem resolution. You cite that only 9 of 38 
examination reports reviewed addressed resolution of the prior 
examination's deficiencies in the current examination report's 
Executive Summary. Examiners document prior examination's unresolved 
deficiencies in the Executive Summary, Document of Resolution, and/or 
Examiner's Findings section(s) of the current examination report 
depending on the issue's materiality and severity. All prior 
examination report deficiencies, either corrected or not, are addressed 
in the current examination's work papers, specifically in the Corporate 
Examiner's Memorandum.

NCUA concurs with your recommendation that implementing an aggregate 
tracking system will enhance our ability to identify and monitor 
resolution of deficiencies and to evaluate trends in examination data 
on a system-wide basis. OCCU is developing a Global Tracking System 
(GTS) to track resolution of problems areas, monitor examination 
trends, identify emerging examination issues, and assist in ensuring 
consistency in its supervision approach. The GTS prototype is presently 
being tested. GTS will be fully functional and implemented by December 
31, 2004.

Systematic Procedures for Allocating Resources:

The Report suggests NCUA systematically consider corporates' risk 
management (quality and capacity) when allocating resources and 
scheduling specialists for examinations. Since the inception of 
specialist positions in 1998, OCCU has prioritized assigning 
specialists to examinations based on potential risk exposures 
identified by corporate examiners and specialists. As noted in the 
Report, NCUA documented its assessment of operations risk in its 
planning documents, but did not always explicitly discuss the quality 
of risk management when determining if specialists should be assigned 
to examinations. Whether or not specialists participate on an 
examination, operation reviews are conducted and detailed 
questionnaires and examination procedures are completed by examiner 
staff for each specialist's discipline area. However, NCUA agrees that 
a more formalized process and structure to ensure a more systematic 
involvement of specialists in identifying and addressing problems as 
well as developing and applying policies consistently will improve 
oversight effectiveness. OCCU will implement such a formalized process 
and structure by December 31, 2004.

Assessing Risk Management Functions:

NCUA agrees with the assessment that there is a need for strong risk 
management practices at corporates to properly manage and mitigate 
credit, interest-rate, and liquidity risks. One of the challenges you 
suggest NCUA faces is OCCU's ability to assess the quality and 
operations in corporates' risk management functions based on its 
present staffing level. Annually, OCCU reassesses its staffing 
requirements to evaluate not only the number of staff needed, but also 
the type of specialists needed to ensure it has the ability to 
adequately monitor the increasing complexity of corporates' operations. 
As a result of OCCU's recent staffing assessments, NCUA has increased 
the number of information systems specialist and payment systems 
specialist positions by 2 and 1, respectively. NCUA agrees with the 
report's recommendation to reassess OCCU's staffing of examiners and 
specialists to ensure OCCU has the resources to adequately monitor 
corporates' operations.

Merger Guidance:

NCUA concurs with the Report's recommendation for the need to provide 
corporates with specific merger guidance to facilitate the regulatory 
review process. Accordingly, major revisions to the Credit Union Merger 
Procedures and Merger Forms Manual are currently in process. Rather 
than developing a separate merger manual for corporates, which would be 
largely redundant, revisions to the existing manual will include 
guidance specific to corporates.

However, NCUA does not concur with the Report's conclusion that 
improved guidance to examiners is needed to ensure mergers meet the 
goals of serving members while not placing the NCUSIF at undue risk. 
These procedures are already in place. OCCU has issued internal 
instructions providing specific guidance to examiners on assessing 
merger proposals and preparing merger packages for further agency 
review. Every corporate merger package prepared by OCCU is reviewed by 
NCUA's Office of General Counsel prior to being presented to the NCUA 
Board for action. Each merger package documents whether or not the 
merger is in the members' best interest, both of the merging and 
continuing corporates. Additionally, the merger is reviewed to 
determine if it will adversely impact the continuing corporate, thereby 
potentially presenting undue risk to the NCUSIF.

Internal Control Reporting:

NCUA concurs with the Report's recommendation that corporates with 
assets greater than $500 million should provide an annual management 
report assessing the effectiveness of their internal control structure, 
and the independent auditor's attestation to management's assertions. 
This is consistent with expectations and best practices already 
established for banks and thrifts under the Federal Deposit Insurance 
Corporation Improvement Act of 1991 and for public companies under the 
Sarbanes-Oxley Act of 2002. NCUA agrees this reporting will further 
assist its ability to assess corporates' internal controls. NCUA will 
pursue a Part 704 rule change to require this reporting.

Thank you for the opportunity to comment on the draft report. If you 
have any questions or need further information, please feel free to 
contact NCUA Executive Director J. Leonard Skiles at (703) 518-6321.

Sincerely,

Signed by: 

JoAnn Johnson: 
Chairman:

NOTES: 

[1] Capital Corporate Federal Credit Union failed in 1995. The 
corporate's losses exceeded their retained earnings. Capital 
Corporate's membership capital accounts absorbed all losses in excess 
of their retained earnings. The NCUSIF incurred no losses as a result 
of this corporate's failure.

[End of section]

Appendix IX: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Richard J. Hillman, (202) 512-8678 Debra R. Johnson, (202) 512-9603:

Staff Acknowledgments:

In addition to those named in the body of this report, the following 
individuals made key contributions: William Chatlos, May Lee, John 
Lord, Alexandra Martin-Arseneau, Kimberley Mcgatlin, José R. Peña, 
Julie Phillips, Mitch Rachlis, Barbara Roesmann, Paul Thompson, and 
Richard Vagnoni.

(250165):

FOOTNOTES

[1] NCUA's authority over corporate credit unions exists in NCUA's 
general regulatory powers under section 120(a) of the Federal Credit 
Union Act. See 12 U.S.C. § 1766(a) (2000); see also, 12 C.F.R. § 704.1 
(2004).

[2] GAO, Credit Unions: Reforms for Ensuring Future Soundness, GAO/GGD-
91-85 (Washington, D.C.: July 10, 1991). 

[3] See GAO, Corporate Credit Unions: Conditions, Issues, and Concerns, 
GAO/T-GGD-95-15 (Washington, D.C.: Oct. 6, 1994). In addition, see 
Credit Unions: The Failure of Capital Corporate Federal Credit Union, 
GAO/T-GGD-95-107 (Washington, D.C.: Feb. 28, 1995) and Credit Unions: 
Proposed Reforms for Corporate Credit Union Regulation, GAO/T-GGD-95-
115 (Washington, D.C.: Mar. 8, 1995). These testimonies described the 
reasons for the failure and provided recommendations to Congress and 
NCUA to improve the safety and soundness of corporates. 

[4] See GAO, Credit Unions: Financial Condition Has Improved, but 
Opportunities Exist to Enhance Oversight and Share Insurance 
Management, GAO-04-91 (Washington, D.C.: Oct. 27, 2003).

[5] A call report is a periodic (for example, monthly or quarterly) 
statement detailing income and certain financial condition information, 
which is filed by an institution with its regulator. Corporate credit 
unions currently file the Form 5310 monthly with NCUA. See appendix I 
for more information.

[6] As part of NCUA's revision of Part 704 of its rules and 
regulations, corporate credit unions that meet applicable requirements 
of this rule and fulfill additional management and infrastructure 
requirements are allowed to invest in a broader array of products, such 
as lower-rated investments and certain foreign investments, and engage 
in derivative transactions. See 12 C.F.R. Part 704, App. B (2004); see 
also, 67 Fed. Reg. 65640, 65658 (Oct. 25, 2002).

[7] In this report, we refer to the retail corporate credit unions as 
"corporates," emphasizing the distinction between these institutions 
and U.S. Central, which is a wholesale corporate credit union. We refer 
to corporates and U.S. Central as the "corporate network." 

[8] In addition, the Central Liquidity Facility (CLF) is a source of 
funds for credit unions. Congress created CLF, which is managed by 
NCUA, in 1978 to improve the financial stability of credit unions by 
serving as a lender to credit unions experiencing unusual or unexpected 
shortfalls in funds. Most credit unions join CLF through their 
corporate, which acts as an agent for its members.

[9] Asset/liability management is the process of evaluating interest-
rate and liquidity risk and making decisions about the mix of assets 
and liabilities to hold, which enable a credit union to remain 
financially viable as economic conditions change. Interest-rate risk is 
the potential for lower earnings and capital resulting from interest-
rate changes. Liquidity risk is the risk that a sudden withdrawal of 
deposits by natural person credit unions will force the corporate to 
sell assets quickly to cover the withdrawals.

[10] U.S. Central started operations in 1974.

[11] NCUSIF provides primary deposit insurance up to $100,000 per 
member per qualifying account. In the case of corporates, the members 
are natural person credit unions. Since the insurance coverage is very 
small compared with the deposits natural person credit unions have in 
corporates, most of these deposits are not federally insured. One 
state-chartered corporate does not have insurance coverage by NCUSIF. 
NCUA administers NCUSIF, which is funded by credit unions that deposit 
1 percent of their insured shares into NCUSIF.

[12] 12 C.F.R. Part 704 (2004). 

[13] We assessed the financial condition of the corporate network by 
the overall profitability, capital ratios, and assets of the corporates 
and U.S. Central. Assets include cash, investments, and loans, among 
other things. Profitability is the ratio of net income to average 
assets. Capital, which represents the long-term funding of a financial 
institution, enables a corporate to continue to fund operations, 
generate earnings, and grow, and it also provides a cushion to absorb 
unexpected losses. A capital ratio is the ratio of capital to average 
assets, which takes into account the size of an institution.

[14] Our quantitative analysis is based on publicly available balance 
sheet and income statement information from call reports and annual 
reports, unless otherwise noted. We generally separated U.S. Central 
from the corporates to control for the interrelationship that exists 
between the corporates and U.S. Central, in which a substantial portion 
of corporates' assets is held by U.S. Central and contributes to its 
capital. U.S. Central's overall financial holdings and investments tend 
to parallel those made by other large corporates. For more information 
on the financial condition of U.S. Central, see appendix VI.

[15] A corporate's retained earnings are the key component of its 
capital, as they represent the corporate's net income not distributed 
to members and, as they are generated internally, are the most 
permanent form of capital.

[16] These include investments usually secured by mortgages, automobile 
loans, or credit cards.

[17] As investors sought high-quality (that is, safe) investments due 
to weak performance by the stock and other investment markets in the 
early 2000s, credit unions experienced significant growth in member 
share deposits. See GAO, Credit Unions: Available Information Indicated 
No Compelling Need for Secondary Capital, GAO-04-849 (Washington, D.C.: 
Aug. 6, 2004).

[18] Risks include interest-rate, liquidity, and credit risks. Credit 
risk is the risk that the promised cash flows due from an investment 
will not be fully paid, exposing investors to potential decreases in 
its capital. 

[19] Profitability in a given year is measured by the ratio of that 
year's net income to the average of that year's total assets and the 
prior year's total assets. We used this measure of average assets to 
create consistency in 1993-2003 data.

[20] U.S. Central did not experience the same rapid increase in its 
assets and, thus, has not suffered recent declines in its 
profitability. In fact, U.S. Central's profitability has generally been 
increasing. See appendix VI for more information.

[21] Because changes in the regulatory definition of capital preclude 
meaningful comparisons between the pre-and post-1998 periods, we 
focused our discussion on 1998-2003.

[22] In general, an institution's capital ratio reflects the extent to 
which it has a cushion against losses--the higher the ratio, the more 
severe an adverse financial shock it can endure. The relative cushion 
offered by a particular type of capital also depends on the relative 
permanence of the capital. To calculate the capital ratio, we divided 
capital by the moving daily average of net assets (DANA), which is the 
average of a corporate's daily average net assets for the month being 
measured and the previous 11 months. Effective 1998, Part 704 
prescribed moving DANA as the denominator for capital ratios.

[23] Neither paid-in nor membership capital is insured by NCUSIF or 
other share or deposit insurers and cannot be pledged against 
borrowings.

[24] Prior to 2003, NCUA defined the ratio of retained earnings and 
paid-in capital to moving DANA as the reserve ratio, and it defined the 
ratio of retained earnings to moving DANA as the reserves and undivided 
earnings, or RUDE, ratio.

[25] The regulatory requirements (Part 704) for capital and retained 
earnings ratios represent the basic level of capital regulation for 
credit unions. In general, regulatory capital requirements for 
corporates can vary, depending on such factors as corporate type (that 
is, retail or wholesale), the corporate's eligibility for expanded 
investment authorities, and limits on monthly changes in risk.

[26] Asset-backed securities include securities backed by fixed-and 
variable-rate credit card, auto, and home equity loans.

[27] We chose the largest corporates because they had been granted the 
broadest investment authorities.

[28] Because members' deposits tend to be short-term in nature, a 
corporate's asset mix tends to be short-term, too. In general, 
corporates need to maintain a high level of liquidity given their role 
as a liquidity provider to credit unions.

[29] Investment ratings are a measure of credit risk, ranging from AAA 
to D (a total of 10 ratings). Investment grade (that is, highest 
quality to medium grade) investments carry the top four ratings--AAA, 
AA, A, or BBB. A BBB rated investment is considered to be of medium 
investment grade.

[30] The 1998 revisions to Part 704 also allowed corporates, with prior 
NCUA approval, to seek expanded investment authorities and greater 
flexibility to manage their risks and earnings. For example, under this 
additional authority, a corporate that fulfilled additional capital, 
management, infrastructure, and asset and liability requirements, and 
received NCUA's written approval, was allowed greater flexibility in 
managing its net economic value, given more relaxed concentration 
limits on investments, and given the ability to invest in lower-rated 
securities. NCUA subsequently revised Part 704 in 2002 and allowed 
corporates with certain types of expanded authorities to invest in BBB 
rated securities. Prior to the 2002 revisions, some corporates had been 
allowed to invest in securities rated as low as A-.

[31] Interactions among the risks to which a corporate is exposed, such 
as interest-rate and credit risk, can be complex and need to be 
considered in the context of the institution's overall portfolio of 
assets and liabilities. The addition of a particular investment to a 
corporate's investment portfolio can impact risks in differing ways, 
potentially increasing some risks while lessening others.

[32] Department of the Treasury comment letter concerning NCUA's 
proposed rule on corporate credit unions, amending Part 704, dated 
October 15, 2002. Treasury has not modified its position since then.

[33] In mid-1993, U.S. Central made a series of investments in Banco 
Español de Credito (Banesto). On December 28, 1993, the Spanish Central 
Bank took over Banesto because of problems in its commercial loan 
portfolio, which placed some of U.S. Central's remaining investments in 
potential jeopardy (at that time $255 million). Although U.S. Central 
did not incur any loss as a result of the Banesto investment, NCUA and 
Congress raised questions about these investments.

[34] 62 Fed. Reg. 12929 (Mar. 19, 1997, effective Jan. 1, 1998).

[35] See GAO/T-GGD-95-107 (Feb. 28, 1995) and GAO/T-GGD-95-115 (Mar. 8, 
1995). These two testimonies provided recommendations for NCUA to 
improve oversight of corporate credit unions in the wake of the failure 
of Capital Corporate Federal Credit Union. See NCUA-commissioned study 
by Harold Black, Albert DePrince, William Ford, James Kudlinski, and 
Robert Schweitzer, Corporate Credit Union Network Investments: Risks 
and Risk Management (Alexandria, Virginia, 1994).

[36] Net economic value is defined as the fair or economic value of 
assets minus the fair value of liabilities. Specifically, corporates 
must limit their risk exposure to levels that did not result in a 
decline in the net economic value of more than 18 percent. 

[37] OSPSP develops agency policies and procedures related to credit 
union investments and asset/liability management, and the office 
assists examiners in evaluating investment issues in credit unions.

[38] GAO, Risk-Focused Bank Examinations: Regulators of Large Banking 
Organizations Face Challenges, GAO/GGD-00-48 (Washington, D.C.: Jan. 
24, 2000). 

[39] Risk management includes the identification of risk to recognize 
and understand existing risks or risks that may arise from new business 
initiatives. It also includes the accurate and timely measurement of 
risks, policies, and procedures to control risk, and monitoring of risk 
to ensure timely review of risk positions of the institution. The staff 
responsible for risk management should be independent from the 
institutions risk-taking activities and the board of directors should 
be informed of the institution's risk management program. Capable 
management and appropriate staffing are critical to effective risk 
management.

[40] NCUA is a member of FFIEC, which is an interagency body empowered 
to prescribe uniform principles, standards, and report forms for the 
federal examination of financial institutions, and make recommendations 
to promote uniformity in the supervision of financial institutions. 
Other members include the Board of Governors of the Federal Reserve 
System, FDIC, OCC, and the Office of Thrift Supervision. 

[41] We focused on FFIEC guidance that was in place until March 2003, 
which covered the major portion of the exam periods we reviewed. FFIEC 
has updated this guidance in the form of various information technology 
examination handbooks that address various aspects of financial 
institutions' computerized operations. The updated guidance also 
suggests that information technology examinations should focus on 
institutions' management of technology.

[42] Operations risk is the risk that existing technology or support 
systems may malfunction or break down. For example, breakdowns in the 
information systems could limit the ability of a corporate to process 
payments and transfers or it could lead to mistakes in the estimation 
of risk, and thereby let the corporate undertake unwarranted risks and 
sustain potential losses. 

[43] We focused on the largest corporates and U.S. Central, since we 
judged them to have the most significant potential exposure to risk. We 
reviewed internal and corporate examiner documents, and independent 
third-party reviews, and discussed risk management with corporate 
officials and examiners. As a result, we have some confidence that the 
corporates appropriately staffed risk management functions and 
regularly evaluated and updated risk management models and the economic 
assumptions underlying them. Our analysis also was consistent with 
findings of a rating agency and independent analyses of larger 
corporates.

[44] NCUA's Credit Union Merger Manual requires natural person credit 
unions to compute a "probable asset share" ratio for both the merging 
and continuing credit unions. The probable asset share ratio is 
computed by dividing the net value of a natural person credit union's 
assets by its total shares and reflects the relative worth of each 
dollar invested in shares.

[45] See GAO-04-91.

[46] See 12 U.S.C. § 1831m; 12 C.F.R. Part 363 (2003).

[47] See e.g., 15 U.S.C. §§ 7241, 7262.

[48] In October 2003, NCUA issued a Letter to Federal Credit Unions, 
03-FCU-07, that discusses guidance on selected provisions of the 
Sarbanes-Oxley Act of 2002 for federally chartered credit unions, 
including federally chartered corporates. NCUA encouraged all 
corporates, regardless of their charter type to review this letter.

[49] NCUA provided most of the information in electronic form. 
Additional data were obtained from the regulator's Web site--
www.ncua.gov. 

[50] Appendix II lists the 31 active corporates, including U.S. 
Central, as of December 31, 2003.

[51] Consistent with our policy on auditing financial institutions, we 
did not identify the locations of these 10 corporates, with the 
exception of U.S. Central (because of its unique role), because it 
would identify the operations of ongoing institutions. 

[52] The supervision type is a code assigned to a corporate to 
determine the specific targeted examination and supervision program 
applied to the institution. It is not a rigid function of asset size, 
expanded authority level, or rating from an examination. Rather, it 
represents a combination of factors that may include these elements in 
addition to perceived risk levels, quality of changes in management, 
and financial condition.

[53] A REMIC is a mortgage securities vehicle authorized by the Tax 
Reform Act of 1986 that holds commercial and residential mortgages in 
trust, and issues securities representing an undivided interest in the 
mortgage.

[54] NCUA defines net interest margin in terms of moving DANA. As 
moving DANA was not calculated prior to 1998, we used the average of 
assets measured at year-end for the two most recent years in order to 
create consistency for 1998-2003.

[55] See 62 Fed. Reg. 12929, 12937 (Mar. 19, 1997).

[56] See 67 Fed. Reg. 65640 (Oct. 25, 2002).

[57] 12 C.F.R. Part 704, App. B (2004); see 67 Fed, Reg. 65649-50.

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