Corporate Credit Unions: Competitive Environment May Stress	 
Financial Condition, Posing Challenges for NCUA Oversight	 
(10-SEP-04, GAO-04-977).					 
                                                                 
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.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-977 					        
    ACCNO:   A12414						        
  TITLE:     Corporate Credit Unions: Competitive Environment May     
Stress Financial Condition, Posing Challenges for NCUA Oversight 
     DATE:   09/10/2004 
  SUBJECT:   Credit unions					 
	     Financial institutions				 
	     Financial management				 
	     Internal controls					 
	     Investments					 
	     Regulatory agencies				 
	     Risk management					 

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GAO-04-977

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

Contents

Tables

Figures

Abbreviations

September 10, 2004Letter

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.1

We last conducted a comprehensive review of corporates and their oversight
by NCUA in 1991.2 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.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.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.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.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.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.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

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

aIncludes cash management products and services, risk management,
settlement, and funds transfer.

bTwenty-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.

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

o investment services;

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

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

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

o credit card settlement; and

o 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.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 1968.10 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).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.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.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.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.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.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.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.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.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.  20

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

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.

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.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.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

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.

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.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.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)

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.

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.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

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

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

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.

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).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

Investments                                                                
relative to total     1997    1998    1999    2000    2001    2002    2003
investments                                                        
(percent)                                                          
U.S. Central                                                               
obligations held       53%     56%     57%     53%     45%     42%     45%
by corporates                                                      
Asset-backed            19      18      24      23      23      23      25 
securities                                                         
Privately issued                                                           
mortgage-related         1       2       3       4       6       9      14
securities                                                         
Government and                                                             
agency                  13       9       9       8       8       7       6
mortgage-related                                                   
securities                                                         
Other                   14      14       7      11      18      18      11 
Total investments  $29,727 $41,645 $35,642 $35,553 $55,449 $63,859 $65,280 
(in millions)                                                      

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.

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.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.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.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.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.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.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.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.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.35 The 1998 revisions required corporates to measure and report
on the impact of interest-rate and liquidity changes on their net economic
value.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.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.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:

o 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.

o 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.

o 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.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.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.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.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.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.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.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:

o 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

o 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.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 2002.47
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.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

o 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;

o 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;

o Pay increased attention to oversight of corporates' risk management
functions to ensure corporates have sufficient capacity and skills to
monitor and manage their risks;

o 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

o 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 http://www.gao.gov.

contact me at (202) 512-8678 or [email protected] or Debra R. Johnson at
(202) 512-9603 or [email protected]. Key contributors are acknowledged in
appendix IX.

Sincerely yours,

Richard J. Hillman Director, Financial Markets and Community Investment

Objectives, Scope, and MethodologyAppendix I

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.1 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
2001-2003.2 We conducted interviews with OCCU management and with OCCU
examiners-in-charge for 10 corporates.3 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.4

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:

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

o Credit Union Service Organizations (CUSO),

o competition,

o investment authorities,

o corporate investments with U.S. Central,

o regulatory changes and impacts on corporates' operations,

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

o corporates' fields of membership,

o challenges corporates face and their responses to these challenges, and

o 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.

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

Source: NCUA.

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

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.

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

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.

Financial Condition of Corporates, 1992-2003Appendix V

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

                     Total assets of   Total shares                           
           Number of     corporates, of corporates, Number of Total assets of 
         corporates,       excluding      excluding   natural  natural person 
Year    excluding                                   person   credit unions 
                        U.S. Central   U.S. Central    credit (in millions of 
        U.S. Central (in millions of   (in millions    unions        dollars)
                            dollars)    of dollars)           
1992           44         $43,447        $37,186    12,595        $258,365 
1993           44          40,982         33,922    12,317         277,130 
1994           44          35,993         29,217    11,991         289,453 
1995           41          33,807         29,199    11,687         306,642 
1996           40          30,154         24,196    11,392         326,887 
1997           38          33,097         27,222    11,238         351,165 
1998           37          43,555         38,743    10,995         388,700 
1999           36          39,206         32,768    10,630         411,418 
2000           35          39,627         32,248    10,316         438,219 
2001           34          59,154         51,997     9,984         501,540 
2002           32          68,968         60,421     9,688         557,075 
2003           30          73,835         58,808     9,369         610,156 

Source: NCUA call reports.

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

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

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

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

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.

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.1 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      
U.S. Central                                                               
obligations           1997    1998    1999    2000    2001    2002    2003
relative to total                                                  
investments                                                        
Daily shares        20.16%  24.17%  25.44%  21.03%  13.77%   9.37%   8.68% 
Time certificates    18.38   20.11   18.53   17.41   15.44   18.08   17.42 
Investments                                                                
resulting from        0.00    0.00    0.14    0.15    0.19    0.20    0.11
repurchase                                                         
transactions                                                       
Amortizing            1.42    0.40    0.18    0.30    0.11    0.52    0.88 
certificates                                                       
Smart floaters        0.00    0.00    0.12    0.00    0.00    0.00    0.00 
Step up               1.57    0.86    1.88    2.14    1.23    1.64    2.36 
certificates                                                       
FRAPs                 5.43    6.84    4.45    6.58   10.64    8.68    9.21 
Membership capital    2.25    1.93    2.61    2.10    1.47    1.58    1.74 
shares                                                             
Central Liquidity                                                          
Facility share        2.29    1.59    2.32    2.37    1.63    1.57    1.77
deposit                                                            
Paid-in capital       0.00    0.00    0.00    0.00    0.00    0.00    0.46 
U.S. Central                                                               
obligations           1997    1998    1999    2000    2001    2002    2003
relative to total                                                  
investments                                                        
Other                1.09a    0.48    0.87    1.04    0.54    0.70    2.12 
Total U.S. Central                                                         
obligations         52.59%  56.38%  56.56%  53.12%  45.03%  42.35%  44.76%
relative to total                                                  
investments                                                        
Total U.S. Central                                                         
obligations (in    $15,634 $23,480 $20,159 $18,887 $24,966 $27,041 $29,220
millions)                                                          
Privately Issued   
Mortgage-Related   
Issues, 1997-2003  
Privately issued                                           
mortgage-related                                           
issues relative to                                         
total investments                                          
Fixed-rate           0.33%   1.68%   2.17%   3.04%   2.13%   2.44%   3.11% 
CMOs/REMICs                                                        
Variable-rate         0.32    0.54    0.83    1.20    1.08    3.19    5.69 
CMOs/REMICs                                                        
Mortgage-backed       0.25    0.09    0.08    0.09    0.10    0.22    0.21 
pass-throughs                                                      
Other                 0.00    0.00    0.00    0.00    2.69    3.00    5.08 
Total privately                                                            
issued                                                             
mortgage-related     0.90%   2.31%   3.08%   4.33%   6.01%   8.85%  14.09%
issues relative to                                                 
total investments                                                  
Total privately                                                            
issued                                                             
mortgage-related      $267    $961  $1,098  $1,540  $3,333  $5,652  $9,199
issues                                                             
                                                                      
(in millions)                                                      
Asset-backed       
securities,        
1997-2003          
Asset-backed                                                       
securities                                                         
relative to total                                                  
investments                                                        
CUGRs               0.00%a   0.47%   0.64%   0.00%   0.00%   0.00%   0.00% 
Fixed-rate credit     2.44    1.24    1.58    1.75    1.96    1.42    0.68 
cards                                                              
Variable-rate         4.37    4.67    5.77    5.95    5.46    4.38    4.16 
credit cards                                                       
Fixed-rate autos      4.14    2.94    4.08    3.48    3.47    3.30    2.23 
Variable-rate         1.67    1.12    0.99    1.06    2.29    2.34    2.03 
autos                                                              
Fixed-rate home       1.35    1.91    1.87    1.53    1.39    1.73    1.33 
equity                                                             
Variable-rate home    3.89    4.18    5.64    5.86    5.80    8.20   12.09 
equity                                                             
Fixed-rate other      0.21    0.31    0.67    0.67    0.33    0.33    0.20 
Variable-rate         1.43    1.38    2.80    3.07    1.92    1.54    1.94 
other                                                              
Total asset-backed                                                         
securities          19.48%  18.23%  24.03%  23.37%  22.62%  23.24%  24.66%
relative to total                                                  
investments                                                        
Total asset-backed                                                         
securities (in      $5,792  $7,590  $8,563  $8,309 $12,541 $14,841 $16,100
millions)                                                          

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.

aIn 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.

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

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.

Net interest income as a percentage of average assets is often referred to
as net interest margin.2 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

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.

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.

Financial Condition of U.S. Central Generally Mirrors Other
CorporatesAppendix VI

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

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

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

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                                                   
Investments relative     1997    1998    1999    2000    2001    2002    2003 
to total investments                                                  
U.S. government and                                                           
government-guaranteed   5.17%   2.34%   1.23%   0.41%   0.55%   1.36%   1.35%
obligations                                                           
Obligations of U.S.                                                           
government-sponsored     0.10    1.19    0.43    0.30    0.10    0.50    0.00
enterprises                                                           
Central Liquidity                                                             
Facility stock           4.06    2.96    3.39    4.16    2.96    3.36    3.58
(direct)                                                              
U.S. banks              12.27   23.34   26.77   10.50    4.27    2.40    6.34 
Foreign banks            0.00    2.02    0.00   15.41    6.80    0.83    1.84 
Repurchase activity     14.73    9.89   17.65    4.51   10.41    5.38    0.94 
Government and agency                                                         
mortgage-related         7.10    3.80    2.61    3.01    2.74    4.55    8.05
issues                                                                
Privately issued                                                              
mortgage-related         3.35    0.69    1.04    2.94   13.17   19.24   24.66
issues                                                                
Asset-backed            52.12   50.23   44.20   52.68   44.10   49.00   48.24 
securities                                                            
Mutual funds             0.00    0.00    0.00    0.00    7.12    1.49    0.00 
Commercial debt          1.10    3.55    2.68    6.09    7.77   11.90    4.99 
obligations                                                           
Other                    0.00    0.00    0.00    0.00    0.24    0.34    0.18 
Total investments     $17,364 $24,773 $24,668 $20,444 $30,952 $30,342 $32,656 

Source: NCUA call reports.

Note: Totals may not add due to rounding.

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   
Privately issued                                                           
mortgage-related      1997    1998    1999    2000    2001    2002    2003
issues relative to                                                 
total investments                                                  
Fixed-rate           1.15%   0.00%   0.00%   0.00%   0.00%   0.00%   0.00% 
CMOs/REMICs                                                        
Variable-rate         2.20    0.00    0.07    1.13   12.57   18.76   23.70 
CMOs/REMICs                                                        
Mortgage-backed       0.00    0.69    0.97    1.81    0.60    0.48    0.97 
pass throughs                                                      
Other                 0.00    0.00    0.00    0.00    0.00    0.00    0.00 
Total privately                                                            
issued                                                             
mortgage-related     3.35%   0.69%   1.04%   2.94%  13.17%  19.24%  24.66%
issues relative to                                                 
total investments                                                  
Total privately                                                            
issued                                                             
mortgage-related      $582    $170    $256    $600  $4,066  $5,817  $8,040
issues                                                             
                                                                      
(in millions)                                                      
Asset-backed        
securities,         
1997-2003           
Asset-backed                                                               
securities relative   1997    1998    1999    2000    2001    2002    2003
to total                                                           
investments                                                        
Fixed-rate credit    0.60%   1.07%   1.02%   0.98%   1.53%   1.69%   2.67% 
cards                                                              
Variable-rate        20.57   17.45   22.12   18.84   17.14   20.76   20.87 
credit cards                                                       
Fixed-rate autos      0.14    0.61    1.40    1.59    1.12    0.80    0.59 
Variable-rate autos   0.34    2.82    6.24    5.21    7.85    4.76    5.17 
Fixed-rate home       0.00    0.08    0.31    0.13    0.33    0.78    1.28 
equity                                                             
Variable-rate home    6.08    5.38    6.50   19.10   12.90   16.26   16.05 
equity                                                             
Fixed-rate other      0.27    1.40    0.09    0.04    0.06    0.06    0.35 
Variable-rate other  24.13   21.41    6.52    6.78    3.16    3.89    1.26 
Total asset-backed                                                         
securities relative 52.12%  50.23%  44.20%  52.68%  44.10%  49.00%  48.24%
to total                                                           
investments                                                        
Total asset-backed                                                         
securities (in      $9,051 $12,442 $10,904 $10,770 $13,617 $14,818 $15,727
millions)                                                          

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.

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

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

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.

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

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.

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.

Expanded Authorities Available to CorporatesAppendix VII

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.1 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.2 For example, qualified corporates were allowed to invest in
BBB rated securities, subject to NCUA approval.3 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 Number of corporates Investments allowed under expanded 
level                                   authorities                        
                                           o Purchase investments with        
                                           long-term ratings no lower than A- 
                                           (or equivalent)                    
                                                                              
                                           o 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   
Part Ia            2                    security                           
                                                                              
                                           o Engage in short sales of         
                                           permissible investments to reduce  
                                           interest-rate risk                 
                                                                              
                                           o Purchase principal-only stripped 
                                           mortgage-backed securities to      
                                           reduce interest rate risk          
                                                                              
                                           o Enter into a "dollar roll"       
                                           transaction                        
                                           o 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       
                                                                              
                                           o 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       
Part IIb           3                    equivalent) or the investment is a 
                                           domestically issued asset-backed   
                                           security                           
                                                                              
                                           o Engage in short sales of         
                                           permissible investments to reduce  
                                           interest-rate risk                 
                                                                              
                                           o Purchase principal-only stripped 
                                           mortgage-backed securities to      
                                           reduce interest-rate risk          
                                                                              
                                           o Enter into a "dollar roll"       
                                           transaction                        
                                           o Invest in debt obligations of a  
                                           foreign country                    
                                                                              
                                           o Invest in deposits and debt      
                                           obligations of foreign banks or    
                                           obligations guaranteed by these    
                                           banks                              
                                                                              
Part IIIc          3                    o Invest in marketable debt        
                                           obligations of foreign             
                                           corporations; this authority does  
                                           not apply to debt obligations that 
                                           are convertible into stock of the  
                                           corporation                        
                                                                              
                                           o Invest in foreign-issued,        
                                           asset-backed securities            
                                           o Enter into derivative            
                                           transactions specifically approved 
Part IVd           3                    by NCUA to create structured       
                                           products, manage its own balance   
                                           sheet, and hedge the balance       
                                           sheets of its members              
                                           o Participate in loans with member 
Part Ve            1                    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.

aThe 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.

bThe 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.

cTo 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.

dThe 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.

eThe 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.

Comments from the National Credit Union AdministrationAppendix VIII

GAO Contacts and Staff AcknowledgmentsAppendix IX

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, Jose R. Pena, Julie
Phillips, Mitch Rachlis, Barbara Roesmann, Paul Thompson, and Richard
Vagnoni.

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