GGD-95-63 National Consumer Cooperative Bank: Oversight Adequate But Federal Loan Repayment Needs Monitoring

United States General Accounting Office

GAO

Report to Congressional Requesters

February 1995

NATIONAL CONSUMER

COOPERATIVE BANK

Oversight Adequate But

Federal Loan Repayment

Needs Monitoring

GAO/GGD-95-63

GAO

United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-258190

February 24, 1995

The Honorable Alfonse M. D’Amato

Chairman, Committee on Banking,

Housing, and Urban Affairs

United States Senate

The Honorable Marge Roukema

Chairwoman, Subcommittee on Financial

Institutions and Consumer Credit

Committee on Banking and Financial Services

House of Representatives

The past chairmen of your committee and subcommittee asked us to

determine if the National Consumer Cooperative Bank’s (

NCB)

safety and

soundness is effectively monitored by the present oversight arrangement.

Congress created

NCB in 1978 to provide financial and technical assistance

to cooperatives to increase their contribution to the nation’s economy. The

Farm Credit Administration (

FCA) examines this approximately

$536 million asset institution; however, Congress did not assign regulatory

or enforcement powers over

NCB to FCA or any federal financial regulator.

The U.S. Department of the Treasury holds approximately $183 million in

NCB debt that NCB must repay no later than October 31, 2020.

This report addresses the adequacy of federal oversight for monitoring

NCB’s safety and soundness and NCB’s obligation to repay the Treasury

debt. We are making recommendations to Congress to ensure better

monitoring of the government’s financial interest.

Results in Brief

Although NCB was chartered by Congress, it is a private, cooperatively

owned financial institution with limited ties to the government. Despite its

name,

NCB is not a true bank because it does not accept insured deposits.

While

NCB is examined by FCA, an independent federal agency that is

overseen by Congress, its primary discipline comes from private sector

lenders, from whom

NCB borrows most of its funds. The government does

not guarantee any obligations incurred by

NCB. In addition, it appears that

NCB’s creditors do not believe that the government would intervene if NCB

became financially stressed. In the absence of insured deposits or an

explicit or implicit federal guarantee, we do not see any need for

additional regulatory oversight because

NCB’s safety and soundness appear

In November 1984, the National Consumer Cooperative Bank adopted “National Cooperative Bank” as

a trade name, although its formal name has never been changed.

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to be effectively monitored by the existing combination of federal

examination and market discipline.

While

NCB is a private institution, as defined above, it does have a direct

financial link to the government—the part of its debt held by Treasury.

Should

NCB fail, the government’s direct exposure to loss as of December

31, 1993, was about $183 million in

NCB’s debt held by Treasury and any

interest owed on that debt.

NCB is required to pay interest semiannually.

The law requires

NCB to maintain a schedule to ensure repayment of the

principal amount of the debt no later than October 31, 2020.

NCB adopted a

plan in February 1993 to accumulate a portion of the funds needed to

repay the debt. During the course of our review,

NCB adopted a plan to

prepare for retiring the total principal amount no later than October 31,

2020.

Treasury is not required by law to approve or monitor

NCB’s repayment

plan. However, we believe it would be appropriate for the law to be

amended to require that Treasury approve

NCB’s repayment plan and,

through

FCA, monitor NCB’s performance against the plan. In our opinion,

Treasury’s involvement would help ensure that

NCB maintains the

repayment schedule, thus meeting the requirements of its debtor

relationship with Treasury and better protecting the taxpayers’ interest.

Background

NCB’s mission is to support eligible cooperatives with credit and technical

assistance and encourage broad-based ownership, control, and

participation in

NCB. In general, cooperatives eligible for NCB loans and

services are organizations operating on a cooperative, not-for-profit basis

to produce or furnish goods, services, or facilities primarily for the benefit

of their member-stockholders who are the ultimate consumers.

Under the 1978 National Consumer Cooperative Bank Act, NCB was

established as a mixed-ownership government corporation and

“instrumentality of the United States.”

NCB received initial federal funding

through Treasury purchases of shares of its class A stock. In 1981,

Congress converted

NCB from an instrumentality of the United States to a

federally chartered, private financial institution that is owned and

The National Consumer Cooperative Bank Act sets out additional criteria. For example, an eligible

cooperative must make membership available on a voluntary basis without discrimination. It must

restrict voting control to members on a one-person, one-vote basis. The act excludes certain

cooperatives, such as credit unions (although certain credit unions may receive technical assistance),

mutual savings banks, and mutual savings and loan institutions. Except under certain circumstances,

the act also excludes cooperatives eligible for credit from the Farm Credit System banks for

cooperatives, the Rural Electrification Administration, the Rural Telephone Bank, and others.

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controlled by its cooperative stockholders. The 1981 amendments to the

act provided that all Treasury-held stock be exchanged for

NCB class A

notes. The act prohibited Treasury from purchasing any class A stock

issued by

NCB after the exchange occurred on December 31, 1981. Treasury

now holds approximately $183 million in class A notes, which must be

repaid no later than October 31, 2020.

In addition to these public funds,

NCB raises funds from private lenders; its

major creditors are banks and insurance companies.

NCB uses these funds

and funds from other liabilities, combined with members’ equity (retained

earnings and members’ stock), to make loans and provide services to

eligible cooperatives. The act requires all borrowers to own not less than

1 percent of the face amount of their loans in class B stock when the loan

is made. It has been

NCB’s practice to guarantee that it will redeem the

borrowers’ stock at par value when the loan is repaid. It is through this

required stock purchase that borrowers become member-stockholders in

NCB.

NCB’s total common stock and retained earnings comprised its core

capital of 20 percent as of December 31, 1993.

The business activities of

NCB have diversified since its creation. Initially,

NCB served cooperatives in retail food, sporting goods and other industries,

and housing cooperatives. Today,

NCB serves community health centers,

health maintenance organizations, and employee stock ownership plans as

well as worker-owned cooperatives in manufacturing, retail, and service

industries. In addition,

NCB serves retailer-owned wholesale food and

hardware cooperatives.

NCB’s transactions range from making a simple

loan to a quilting cooperative in rural Alabama to securitizing assets

improve liquidity for cooperatives.

NCB is governed by a 15-member board of directors. Twelve members are

elected by the stockholders, who are borrowers or organizations

controlled by eligible borrowers. Three members are appointed by the

president of the United States, with the advice and consent of the U.S.

Senate. Of these three members, the act requires that small business

proprietors, eligible low-income borrowers, and the federal government be

A similar practice in the Farm Credit System led Congress, in 1987, to provide statutory protection for

such stock to existing stockholders and to expressly require that borrower stock issued in the future

be at risk. There is currently very little remaining protected stock in the Farm Credit System. We

recently issued two reports on the System and its regulator. See Farm Credit System: Farm Credit

Administration Effectively Addresses Identified Problems (GAO/GGD-94-14, Jan. 7, 1994) and Farm

Credit System: Repayment of Federal Assistance and Competitive Position (GAO/GGD-94-39, Mar. 10,

1994).

Securitizing assets is the process of bundling similar types of loans and creating a security, which is

sold in the securities markets.

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represented. The government position on the Board has been vacant since

1990.

The act, as amended in 1981, provides for the creation of a nonprofit

affiliate of

NCB that does not have capital stock. This affiliate, the NCB

Development Corporation, specializes in lending to low-income and newly

established cooperatives and also provides loans and technical support to

established cooperative enterprises. The Development Corporation’s

assets are not included on

NCB’s consolidated financial statements. As of

December 31, 1993, the Development Corporation’s fund balance was over

$56 million, which was derived from about $25 million in government

appropriations, $13 million from

NCB, and about $18 million in retained

earnings. Its nine-member board includes six

NCB directors who elect three

outside directors.

Since 1984,

NCB has acquired a federally insured savings bank and created

six subsidiaries to help serve its customers. The

NCB Savings Bank (NCBSB)

had approximately $76 million in assets at December 31, 1993.

NCBSB is

examined and regulated by the Office of Thrift Supervision (

OTS). Deposits

of up to $100,000 at the savings bank, like those of other thrift institutions,

are insured by the Savings Association Insurance Fund (

SAIF), which is

backed by the full faith and credit of the U.S. government. If

NCBSB were to

fail,

SAIF would be responsible for repaying insured depositors.

The subsidiaries perform services for cooperatives, such as investment

management. See appendix I for a list of

NCB subsidiaries and affiliates. As

shown in table 1, the consolidated assets of

NCB, its subsidiaries, and NCBSB

totaled approximately $536 million at December 31, 1993.

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Table 1: Selected Financial Data for

NCB, Its Subsidiaries, and NCBSB, as

of December 31, 1993

Category Amount

Assets

Cash and cash equivalents $31,300,314

Investment securities

Available-for-sale 26,406,171

Held-to-maturity 3,380,698

Loans and lease financing 417,438,593

Loans held for sale 40,274,829

Less: allowance for loan

and other assets

(12,309,359)

Excess servicing fees receivable

and other assets

29,275,730

Total assets $535,766,976

Liabilities and Members’ Equity Liabilities

Short-term borrowings $31,541,577

Long-term debt 130,354,889

Other borrowings 2,040,406

Patronage dividends payable in cash 3,147,860

Other liabilities 75,653,929

Subordinated class A notes 182,989,162

Total liabilities $425,727,823

Members’ Equity

Common stock $80,245,148

Retained earnings

Allocated 12,844,968

Unallocated 16,949,037

Total members’ equity (core

members’ equity

$110,039,153

Total liabilities and

members’ equity

$535,766,976

Source: NCB consolidated financial statement, 1993 annual report.

NCB acquired NCBSB to help fulfill its mission of providing credit to

cooperatives. According to

NCB’s application, its primary reasons for

acquiring

NCBSB were to have an institution that could solicit

nontransactional deposits from its cooperative members,

originate loans

to cooperative borrowers, and buy portions of

NCB loans using the

Nontransactional deposits involve limited banking activity, such as certificates of deposit, for a fixed

number of days or years. Such deposits are in contrast to a checking account where deposits and

withdrawals are made often.

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NCB-attracted deposits as the funding source. The act authorizes NCB to

accept certificates of deposit and pay interest on them; but

NCB officials

said that they could not attract large deposits (e.g., in amounts of $10,000

or more) without federal insurance.

In the past, we provided two legal opinions on

NCB matters at the request

of Congress. In a 1982 legal opinion, we determined that

NCB’s conflict of

interest policy met the statutory requirements and that a specific

cooperative was an eligible

NCB customer.

In 1986, we opined that NCB

was authorized to form subsidiaries and invest in affiliates.

We also issued

a report

on NCB soon after it was converted to a federally chartered,

private financial institution owned by its cooperative stockholders.

Objectives, Scope,

and Methodology

The primary objective of our review was to determine if the financial

safety and soundness of

NCB is effectively monitored by the present

oversight arrangement. In addition, we wanted to determine the extent of

any potential losses to the government if

NCB were to fail. Our work

focused on

NCB, including its relationship with NCBSB.

In the course of our work, we analyzed the National Consumer

Cooperative Bank Act to determine

NCB’s mission and operational

requirements and requirements related to its Treasury debt. We analyzed

the statutory provisions applicable to safety and soundness. We reviewed

FCA’s examination reports and related documents on NCB for 1990 through

1994 to determine the key safety and soundness and other issues

FCA

assessed. We also analyzed the deficiencies or problems examiners

identified. We reviewed

FCA, NCB, and other organizations’ relevant

documents to determine

NCB’s responses to FCA’s findings.

We compared the scope and results of

FCA’s examinations with issues that

we have found, in previous work, to be important to the safety and

soundness of financial institutions. In making this comparison, we looked

for any constraints

FCA examiners might have had in identifying or

addressing

NCB problems. We also asked FCA examination officials about

their experiences and opinions regarding any such constraints.

Letter of the Comptroller General, GAO, to the Chairman, Committee on Banking, Finance and Urban

Affairs, House of Representatives, December 16, 1982, (B-200951).

Letter of the Comptroller General, GAO, to the Chairman, Committee on Banking, Finance and Urban

Affairs, House of Representatives, October 10, 1986, (B-219801).

See The National Consumer Cooperative Bank: An Institution In Transition (GAO/RCED-84-75,

Dec. 15, 1983).

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We reviewed OTS examination reports and other documents on NCBSB, and

we also reviewed

OTS reports for 1990 through 1994 on NCB as the savings

bank’s holding company. We focused on any transactions between

NCBSB

and NCB, documented and analyzed any safety and soundness deficiencies

examiners identified, and traced both institutions’ responses and

OTS’ and

FCA’s follow-up.

To form our opinion on the adequacy of the government’s monitoring of

NCB’s safety and soundness, we compared the results of our analyses to the

safety and soundness provisions of the act,

FCA’s own standards, and the

characteristics of lax financial institution oversight that we had identified

in previous work. We modified these criteria to reflect the fact that

FCA

does not have regulatory or enforcement authority over NCB. We

considered whether

FCA called for NCB to address examiner-identified

deficiencies or problems documented in each examination report and

whether

FCA followed up until these issues were corrected. We met with

NCB, FCA, OTS, and Treasury officials to discuss our work and solicit their

opinions about the adequacy of federal oversight of

NCB.

To assess the discipline imposed by the private sector lenders, we

analyzed opinions of

NCB’s creditworthiness issued by credit rating firms

and the performance requirements imposed by

NCB’s major private

creditors. We compared our findings to the performance requirements of

selected federal regulators of financial institutions.

To identify the extent of the government’s exposure to financial loss, we

reviewed the Treasury-

NCB financing agreement, notes, and applicable law.

We compared

NCB’s credit ratings and the characteristics of its financial

relationship to the government with those of other business entities with

government ties.

We did our work between December 1993 and September 1994 at the

NCB

headquarters in Washington, D.C., and at the FCA headquarters in McLean,

VA. Our work was done in accordance with generally accepted

government auditing standards.

We obtained written comments on a draft of this report from

NCB, FCA, and

Treasury. We incorporated these comments in the text where appropriate

and summarized them on pages 24 and 25 of this report. In addition, the

full text of each entity’s comments and our responses are provided in

appendixes II through IV.

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NCB Has Few Ties to

the Government

One important reason that the government regulates financial institutions

is to help stabilize the nation’s financial system. A second and related

reason is to protect depositors whose accounts it insures and to protect

the government deposit insurance funds from large losses. Neither of

these reasons apply to

NCB because it is a comparatively small institution

that does not have insured deposits.

The government also regulates certain financial institutions, e.g., certain

government-sponsored enterprises (

GSE), when the market perceives that

the government stands behind their obligations. These

GSEs expose the

government to the potential for large losses.

Because GSEs have

congressional charters and strong financial ties to the government,

investors perceive that

GSE debt has an implicit government guarantee.

Although

NCB is a federally chartered, private institution that is

cooperatively owned by its stockholders, it has much weaker financial

links to the government. It appears

NCB’s creditors do not believe that the

government will intervene if the bank becomes financially stressed. Thus,

because

NCB is a small institution that does not accept insured deposits,

and the government’s potential loss due to

NCB’s outstanding debt to the

Treasury is limited to $183 million, the reasons why the government

regulates financial institutions do not apply to

NCB.

Congress chartered

NCB to help fulfill the financial and technical assistance

needs of a special segment of the economy—cooperatives. Congress found

a lack of access to adequate credit and a lack of technical assistance

hampered consumers’ and other self-help cooperatives’ formation and

growth. The reasons Congress established

NCB are similar to its reasons for

establishing

GSEs. Congress chartered GSEs to help fulfill the credit needs

of certain sectors of the economy, and their charters limit each

GSEs’

activities. For example, the Farm Credit System exists to facilitate the flow

of funds to the agricultural sector. Similarly,

NCB is limited to providing

credit to cooperatives.

NCBSB has deposits that are insured by SAIF. However, NCBSB is regulated by OTS, which has

comprehensive regulatory and enforcement powers.

The largest GSEs and the estimated assets they control in fiscal year 1995 are: the Federal National

Mortgage Association, $863 billion; the Federal Home Loan Mortgage Corporation, $617 billion; the

Federal Home Loan Bank System, $172 billion; the Farm Credit System, $60 billion; and the Student

Loan Marketing Association, $49 billion. NCB is not identified by the Office of Management and Budget

or by us as a GSE. See Budget Issues: Profiles of Government-Sponsored Enterprises

(GAO/AFMD-91-17, Feb. 1991). In addition, the Congressional Budget Office has cited NCB as an

example of Congress’ subsidizing an entity’s activities without giving it federal grants or the legal

characteristics of a GSE that would imply a federal guarantee of its debt securities. See An Analysis of

the Report of the Commission to Promote Investment in America’s Infrastructure, CBO,

February 1994.

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Other than its charter, NCB’s link to the government is financial. Congress

provided funds to establish

NCB, and it continues to support NCB by

allowing Treasury to hold its debt until 2020. When Congress privatized

NCB in 1981, it required that all outstanding Treasury stock in NCB be

converted to subordinated debt.

The act prohibited Treasury from buying

any

NCB stock in the future. Further, as we discuss later, Congress required

repayment of the debt by October 31, 2020. At the same time, the

government declared that it does not guarantee obligations incurred by

NCB.

Government-Held Debt

Enhances NCB’s Credit but

Government Exposure to

Loss Is Limited

NCB’s Treasury debt has a favorable interest rate for NCB and, because it is

subordinated debt, it enhances

NCB’s creditworthiness to private lenders.

However, the actual amount at risk and, therefore, the potential loss to the

government is limited to principal and accrued interest. Thus, the

government’s potential loss, as of December 31, 1993, would have been

limited to about $183 million in principal and any interest due. In contrast,

most

GSEs have access to federal funding at Treasury’s discretion, should it

ever be needed. Treasury’s funding authority varies for each

GSE, but totals

billions of dollars. For example, Treasury is authorized to purchase up to

$2.25 billion of the Federal National Mortgage Association’s obligations.

Until October 1, 1990,

NCB paid interest rates on its Treasury debt that

were below the interest rates paid on Treasury debt of comparable

maturities. The act, as amended in 1981, limited the interest

NCB paid on

the debt to 25 percent of

NCB’s gross revenues less necessary operating

expenses, including a provision for possible losses. The effective rates of

interest for 1988, 1989, and 1990 were 2, 2, and 3.5 percent, respectively.

According to

FCA, the subsidy due to the below market rates (assuming a

market rate of 8 percent) amounted to approximately $11 million in 1989

alone. We believe this comparison underestimates the actual subsidy

because

NCB would not have been able to borrow long-term funds at

Treasury rates.

The debt is represented by notes that are subordinated to any secured or unsecured notes and bonds

issued by NCB, but the notes have first preference over all classes of NCB stock.

It was not within the scope of our work to explore the accounting treatment of this subsidy by NCB

and Treasury.

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A 1989 amendment to the act provided for a change in the interest rates on

the notes.

After October 1, 1990, the interest paid was to be pegged to

outstanding Treasury debt of comparable maturities. This action raised the

1991, 1992, and 1993 effective interest rates to 7.1, 6, and 5.4 percent,

respectively. The future rates for four series of notes were to be set,

according to their respective maturities, to equal market rates for Treasury

obligations having the same maturities.

At December 31, 1993, those

rates ranged from 2.98 percent to 8.82 percent. These rates were better

than

NCB could have obtained in the private market so it still benefited

from the Treasury funds, although the subsidy had been reduced since

1990.

In addition to the favorable interest rate on this debt,

NCB’s

creditworthiness is enhanced by the nature of this subordinated debt.

Subordinated debt gives private creditors some assurance that, should the

institution fail, funds owed to them will be repaid before those of

subordinated debt holders. Thus, subordinated debt acts like equity from a

superior creditor’s perspective. The value of this debt to other creditors is

illustrated by the fact that agreements with these creditors generally

prohibit

NCB from prepaying the debt. This limitation preserves private

creditors’ place “in line” should the bank be liquidated. One

NCB official

explained that the prepayment prohibition was demanded by their lenders.

He said lenders did not want to extend credit without the additional

security provided by the prepayment prohibition.

Without Guarantee, Market

Provides Funds Under

Strict Covenants

In previous work on GSEs,

we noted that their close ties to the

government, and especially the markets’ perception of an implicit

government guarantee of their debt, encouraged

GSE risk-taking and

exposed the government to possible losses.

GSE debt totals hundreds of

billions of dollars and their operations are important to certain sectors,

The amendment also provided that NCB may, with Treasury’s approval and consistent with the other

provisions of the act, issue replacement notes. The full amount of the class A notes can still remain

outstanding until 2020. However, the final due date was advanced from December 31, 2020, to

October 31, 2020.

Per NCB’s agreement with Treasury, the total principal of the debt comprises four series of notes

whose interest rates are tied to the 91-day, 3-year, 5-year, and 10-year Treasury rates. As each note

comes due, NCB has the right to borrow again from Treasury, the maturing amount under the same

terms. NCB has stated it intends to avail itself of this right. For example, the 3-year Treasury note for

approximately $37 million, with an interest rate of 4.24 percent, matures on October 1, 1996. At that

time, NCB can borrow the principal amount again and Treasury is to issue a new 3-year note at the

prevailing rate of interest. Interest on all notes is payable semiannually.

See Government-Sponsored Enterprises: The Government’s Exposure to Risks (GAO/GGD-90-97,

Aug. 15, 1990) and Government-Sponsored Enterprises: A Framework for Limiting the Government’s

Exposure to Risks (GAO/GGD-91-90, May 22, 1991).

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such as housing and agriculture. Because of their size, their public policy

purposes, and the probability that the federal government would assist a

financially troubled enterprise, we recommended that the government

supervise

GSEs’ risk-taking activities. However, NCB is a comparatively

small institution, and the cooperative community is not entirely dependent

NCB for financing. Most importantly, it appears creditors do not believe

that the government would assist

NCB if it were financially stressed. The

creditors impose discipline on

NCB as a requirement of extending credit,

and

NCB appears to be responsive to this market discipline.

The 1981 amendments state that debt issued by

NCB is not guaranteed by

the government. In remarks concerning this amendment, one Member of

Congress said in regard to

NCB debt that

“. . . the bank’s obligations should be viewed in the market as are other issues of private

corporations. The U.S. Government is not to be responsible in any way for these

obligations. There is not even to be a moral obligation of the United States behind these

obligations.”

Credit-rating firms accept the government’s declaration that it is not liable

for

NCB debt. The three credit-rating firms that have given NCB’s short-term

senior debt an investment-grade rating assumed that the government

would not protect

NCB’s creditors if the bank failed. For example, Moody’s

Investors Service reported in October 1993 that “

NCB retains loose ties with

the U.S. Government, but it is unlikely that the Government would provide

support to the bank in a stress situation.”

NCB borrows funds from private lenders on the strength of its own credit

and is subject to the discipline imposed by the market through covenants

in agreements with its creditors.

NCB’s creditors impose restrictions that

are typical of those in private market financial transactions. For example,

NCB’s major creditors require that NCB

• maintain proper books and records that are available for creditors’

inspection;

• not transact business with affiliates except on an arms-length basis;

• remain primarily in its present line of business and not change its

operations significantly; and

• meet specific minimum standards for net worth, earnings, liquidity, and

debt ratio.

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Breaching any of these requirements would result in default and,

according to

NCB, probable liquidation of the institution. NCB’s creditors

also require periodic reports to enable them to monitor

NCB’s performance.

These include quarterly financial reports, reports of an annual

independent audit, detailed calculations showing compliance with various

financial requirements, reports on the loan portfolio, and reports on loan

losses and loan loss reserves.

These creditor requirements show that

NCB is subject to significant market

discipline similar to the discipline imposed by government regulators on

banks and

GSEs.

In the case of capital standards, NCB actually meets a

higher standard. For example, the regulatory standards for bank core and

total risk-based capital are 4 percent and 8 percent of assets, respectively.

NCB believes that it needs to hold much higher amounts of capital to obtain

funding in the private markets. As of December 31, 1993,

NCB held

20-percent core and 26-percent risk-based capital.

NCB’s Plan to Repay

Treasury Is Not

Subject to

Government Approval

The act contains two provisions relating to the repayment of NCB’s

Treasury debt. One section provides for repayment of the debt on the basis

of any annual sale of class B stock. However, the act does not specify that

NCB must sell class B stock. The other section requires that NCB maintain a

schedule to ensure repayment of the debt by October 31, 2020.

This

provision does not require that Treasury monitor the repayment plan.

FCA

encouraged NCB to adopt a long-term repayment plan. NCB adopted a

partial schedule or plan in February 1993 and a new plan in

November 1994.

Mechanism to Paydown

Debt Effectively

Eliminated

Section 104(c) of the act, added in the 1981 amendments, states that

beginning October 1, 1990,

NCB shall use the proceeds from the sale of

certain stock to borrowers (class B stock) to redeem an equal amount of

the Treasury-held notes (class A notes).

NCB applied such proceeds for

FCA imposes some similar requirements on the Farm Credit System, as does the Office of Federal

Housing Enterprise Oversight on the Federal Home Loan Mortgage Corporation and the Federal

National Mortgage Association, and the Federal Housing Finance Board on the Federal Home Loan

Banks. The failure of the regulated entities to meet regulatory requirements would not necessarily

result in liquidation.

In addition, section 211(c)(1) of the act provides that before NCB makes contributions to the

nonprofit NCB Development Corporation it “shall set aside amounts sufficient to satisfy its obligations

to the Secretary of the Treasury for payments of principal and interest on Class A notes and other

debt.” As we noted previously in this report, NCB has paid all interest when due. NCB also has made

payments on the notes required due to the sale of class B stock, as we discuss in this section.

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fiscal years 1991 and 1992 (approximately $1.4 million and $.3 million,

respectively). However, in March 1992,

NCB changed its policy on borrower

stock to effectively eliminate this mechanism for paydown of the debt.

In March 1992,

NCB announced it would no longer sell class B stock to

borrowers, but would facilitate the sale of stock among the borrowers

themselves. Borrowers are required to hold at least 1 percent of the

amount of their

NCB loans in class B stock.

However, the act does not

specify that

NCB must sell class B stock. Thus, although the act requires

NCB to use the proceeds from the sale of class B stock to redeem the

Treasury-held notes, under its current policy, there will no longer be stock

sales that generate such proceeds. If the policy should change so that

NCB

would again make payments on the principal of the debt, Treasury would

once again receive such payments.

In addition, before the March 1992 policy change,

NCB guaranteed that it

would redeem outstanding class B stock at par when a borrower repaid its

loan. Under the new policy,

NCB will honor outstanding commitments but

will not redeem this stock in the future.

NCB officials stated that the Board

changed the policy to enhance

NCB’s financial base. Over the long term,

NCB officials believed that with this enhancement they would have a larger

financial cushion (capital plus subordinated debt) than if

NCB repaid part

of the Treasury-held notes with proceeds from the sale of class B stock

and obligated itself to redeem that class B stock in the future. In short,

NCB

believes it is not prudent to repay the Treasury debt sooner than the

ultimate due date of October 31, 2020.

NCB Recently Adopted a

New Plan for Repaying the

Debt

Another section of the act (section 116(a)(3)(C)), also added in the 1981

amendments, states that “after December 31, 1990, the Bank shall maintain

a repayment schedule for class A notes which will assure full repayment of

all class A notes not later than December 31, 2020.”

There is an adequate amount of outstanding class B stock to allow potential borrowers to obtain the

required 1 percent and to allow growth in NCB lending because there is class B stock in excess of 1

percent of NCB’s total loan portfolio. As of December 31, 1993, outstanding class B stock totaled

$59.7 million. NCB’s loan portfolio totaled $457.7 million; borrowers needed to hold a total of only

$4.577 million in class B stock (1 percent of $457.7 million). Thus, some $55 million is available for sale

to borrowers. NCB customers have excess class B stock because NCB previously paid a portion of its

patronage dividends in class B stock. Between 1984 and 1990, NCB paid 20 percent of its patronage

dividends in cash and 80 percent (up to 10 percent of the customers’ loan amounts) in class B stock.

The balance was paid in class C stock.

In a 1989 amendment to the act, the final redemption date for all class A notes was changed to

October 31, 2020. (See P.L. 101-206, Sec. 2, 103 Stat. 1831 (1989)).

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NCB adopted a plan in February 1993 to accumulate a portion of the funds

needed to repay the debt. Because this plan provided for accumulating a

portion of the funds ultimately needed, rather than the total amount, we

refer to it as a “partial plan.” The partial plan established a sinking fund

and provided for

NCB to pay $1 million to the fund annually for 15 years.

The fund, plus its accrued income, was to be used with other funds to

retire the Treasury debt when due. The partial plan did not address how

the balance of the funds would be obtained.

The

NCB Board also directed management to develop a new plan for the

retirement of the total amount of the debt. In November 1994, the Board

approved a new plan for the ultimate repayment of the total principal

amount by October 31, 2020.

NCB’s new plan provides for the creation of a

class A Note Redemption Reserve Fund and the sale over the next 25 years

of preferred stock or subordinated debt.

NCB projects that the Reserve

Fund will accumulate $100 million by 2020 from

NCB contributions and an

assumed average yield of 6 percent. The

NCB plan notes that given the

subordinated status of the class A notes, the Reserve Fund will be subject

to claims of senior creditors. The plan stipulates that

NCB will obtain the

remaining funds needed to retire the class A notes through the sale of

preferred stock or subordinated debt.

NCB adopted a strategy for issuing

such stock or subordinated debt every 5 years beginning in 2000.

The subordinated debt is viewed as added equity by senior creditors and

thus affords

NCB creditors some protection should NCB become troubled.

NCB’s new repayment plan maintains this protection by noting that the

Reserve Fund will be subject to claims by senior creditors. Without the

subordinated debt or an amount of equity that creditors believe to be

adequate, the risks posed to creditors would be greater, and we believe

creditors might demand that

NCB meet even more stringent standards or

pay higher interest rates.

We met with Treasury’s Director of the Office of Cash and Debt

Management and other Treasury officials to get their views on

NCB’s

responsibilities regarding the $183 million in subordinated debt. The

officials reported that

NCB has made all interest payments as required, and

we verified this fact by reviewing Treasury’s records. In 1992 and 1993,

NCB

used the proceeds from the sale of class B stock in the preceding fiscal

years (a total of about $1.7 million) to redeem an equal amount of class A

notes as the law requires. Treasury officials were unaware of the 1992

NCB

policy change that will preclude similar redemptions in the future. The

officials said that they saw nothing in the act that requires

NCB to sell class

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B stock and that, therefore, they concluded NCB’s policy change is not

inconsistent with the act.

The Treasury officials told us they fully expect

NCB to repay all outstanding

debt by October 31, 2020, and believe it is

NCB’s responsibility to have a

plan to do so. They noted that the act says “the bank shall maintain a

repayment schedule” to ensure full repayment of the notes and thus, they

said, it is up to the bank to determine what that plan will be. Treasury

officials were not aware of

NCB’s partial repayment plan and had not

discussed with

NCB any additional plans for repaying the debt. The

Treasury officials told us that if

NCB were unable to repay the full principal

in 2020, as the law requires,

NCB ultimately would have to answer to

Congress. During the course of our review, Treasury officials contacted

NCB officials who told them of the sinking fund plan. After NCB adopted its

new repayment plan in November 1994,

NCB officials told us they provided

the plan to Treasury officials and discussed its implementation with them.

As of December 1994,

NCB was seeking its senior creditors’ approval of the

new plan.

The Treasury officials also told us they will continue to monitor receipt of

NCB’s payments of interest, monitor notes when due, and follow up as

needed. Treasury is, therefore, monitoring the current interest payments

on, and renewal of,

NCB’s class A notes. As with failure to repay principal,

NCB were not able to meet their obligations, Treasury officials believe,

based on their past experience, that

NCB ultimately would have to answer

to Congress. In commenting on our draft report, Treasury officials noted

that in instances when other borrowers did not make principal payments

at maturity, “Treasury notified these entities of their failure to pay and

required payment, including late fees.” Further, the Treasury officials

noted that they would consider whatever legal or other action they view as

appropriate in the event of an

NCB default.

In summary, the officials did not believe Treasury is obligated to ensure

that

NCB has and follows an acceptable plan to repay the debt. We agree

that Treasury is not so obligated under present law. We believe, however,

that prudent and responsible financial management on the part of the

government would call for Treasury, as

NCB’s government creditor, to

protect the public’s investment in

NCB by approving and monitoring NCB’s

plans to repay its debt. We believe this is more important now because

NCB’s policy change regarding selling class B stock means that one

mechanism for debt repayment has been effectively eliminated.

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We asked the Treasury officials if there were entities similar to NCB with

outstanding debts to Treasury and what the repayment requirements were.

The officials could not identify any similar entity with such debt. They did

tell us about two semipublic entities for which Treasury held notes.

However, in both cases a federal agency had cosigned the notes. It appears

to us, therefore, that

NCB and Treasury have a unique debtor-creditor

relationship.

FCA Advised NCB to

Adopt a New Plan for

Repaying the Treasury

Debt

FCA officials were aware of both NCB’s policy change regarding class B

stock and the creation of the sinking fund. They noted in the 1991

examination report, issued in 1992, that the new method of stock

exchange among borrowers would allow

NCB to preserve and strengthen

its financial cushion. The officials told us they had not considered the

effect of the policy change on the repayment of the Treasury debt, but on

the immediate safety and soundness of

NCB.

FCA did not directly address NCB’s repayment of the Treasury debt in the

1990 or 1991 examination reports. Examination officials told us that in

discussing

NCB’s long-range planning process with the Board, they noted

the need for

NCB to make plans regarding this debt. NCB included this

objective in its 1993 revised strategic plan and established a sinking fund

for repayment of the debt, which

FCA acknowledged in its 1992

examination report issued in early 1993.

FCA told us they again questioned

NCB officials about the plans for debt repayment during their 1993

examination completed in May 1994.

FCA notified NCB in the report of

examination that it should adopt a long-term plan to repay the Treasury

notes.

NCB responded that it was considering such a plan and would

provide

FCA a copy when it was adopted by the NCB Board.

We asked

FCA officials if they planned to approve or comment on NCB’s

proposed plan. The officials noted that

FCA had no authority to approve or

disapprove the plan. If

NCB adopts such a plan, FCA officials said they

would evaluate it during the next annual examination. We believe it would

be useful to Congress for

FCA to evaluate and report on NCB’s repayment

plans in the annual reports of examination. However, we do not believe it

would be appropriate for

FCA to be given authority to approve such a plan.

Such authority could be interpreted as a regulatory function and lead to

confusion about

FCA’s role as NCB’s examiner. In addition, as FCA

acknowledges, there may be a perceived conflict between FCA’s

examination function and its involvement in the design or approval of the

debt repayment plan. We believe that responsibility for approving and

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monitoring the implementation of any such plan should rest with Treasury,

NCB’s government creditor.

In a past study of government programs to assist troubled private firms

and municipalities, we developed guidelines for structuring and

administering such programs.

NCB is not a troubled institution, but like

some of the entities aided by assistance programs, it received a loan from

the government that must be repaid. Our guidelines proposed that

Congress create some mechanism to administer and oversee assistance

programs. A primary reason for oversight is to help ensure that the

government funds are repaid. In our past study, we recommended that an

administrator or board review, approve, and monitor the financial plans of

the assisted entity and report to Congress.

We see no reason why these

guidelines, with regard to repayment of government funds, should not be

applied to

NCB. While NCB is not a troubled institution, it seems appropriate

for the government to approve and monitor implementation of

NCB’s plan

to repay this long-term debt.

We believe that it would be prudent for Congress to require Treasury to

approve and monitor

NCB’s required plan for repaying its outstanding debt.

Congress required similar oversight arrangements in extending loans or

loan guarantees to the Consolidated Rail Corporation, the Chrysler

Corporation, Lockheed Aircraft Corporation, New York City, and the Farm

Credit System. We believe that the clear intent of the law is for

NCB to have

a plan that ensures full repayment. We also believe that such a plan, at a

minimum, should specify how

NCB would accumulate or obtain the total

amount of the funds due to Treasury in 2020. The law requires that after

December 31, 1990,

NCB maintain “a repayment schedule” to ensure full

repayment in 2020, but does not define this repayment schedule. In

November 1994,

NCB adopted a new plan. In commenting on our draft

report,

NCB officials said they were seeking the approval of their senior

creditors to implement the plan.

These senior creditors’ reviews raise the possibility of revisions to the new

plan. We understand

NCB’s need for the subordinated Treasury debt to

See Guidelines for Rescuing Large Failing Firms and Municipalities (GAO/GGD-84-34, Mar. 29, 1984).

We developed these guidelines from our own experiences and those of others involved in the

government programs to assist the Consolidated Rail Corporation, Lockheed Aircraft Corporation, the

Chrysler Corporation, and New York City.

The mechanism Congress established in 1987 to oversee assistance to the Farm Credit System

reflected our guidelines. The Farm Credit System Assistance Board approved plans of the assisted

Farm Credit Banks, monitored them closely, and reported to Congress. (See GAO/GGD-94-39, Mar. 10,

1994).

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borrow in the private markets, and we recognize that Congress intended to

support

NCB by allowing the Treasury debt to remain outstanding until

2020 (except for partial payments on the principal when class B stock is

sold). Nevertheless, we believe it is appropriate for Congress to give

Treasury a broader role in reviewing, approving, and monitoring

NCB’s

plans to repay the debt.

NCB took the initiative to submit its new repayment

plan to Treasury. In addition,

NCB officials said they had discussed with

Treasury officials the possibility of entering into an agreement relating to

the implementation of the plan if the plan is acceptable to Treasury.

To avoid duplication in reviewing

NCB’s financial records, we believe FCA

could review NCB’s performance against a Treasury-approved repayment

plan during its annual examination process.

FCA could report the results of

this review in its examination reports and provide copies to Treasury.

The act already provides for the government to have a representative on

the

NCB board, and Congress could link the selection of the representative

to the government’s need to ensure the

NCB debt is repaid. Of the

15-member

NCB board, 3 members are to be appointed by the president

with the advice and consent of the Senate. According to the act, one of

these three members is to be “selected from among the officers of the

agencies and departments of the United States. . . .” Congress could

require that this representative be from Treasury.

FCA Examinations

Focus on NCB Safety

and Soundness

FCA examines NCB annually and addresses issues that are important to

safety and soundness, such as capital adequacy, internal controls, and

standards of conduct.

The examiners evaluate NCB against requirements

in the act and

NCB policy and procedures. The act directs FCA to examine

NCB and forward the reports to Congress. It does not specify the frequency,

scope, or purpose of the examinations.

On the basis of our review of

FCA’s examinations of NCB, and other

documents that reflect its monitoring of

NCB operations, we believe FCA

applies the same standards of quality to its examination of NCB that it

applies to the Farm Credit System. In a recent study, we determined

FCA

was an effective regulator of the Farm Credit System.

FCA effectively

We identified capital, internal controls, external and internal audits, financial reporting, standards of

conduct, and lending and investing practices as key safety and soundness issues in previous work.

Deficiencies related to these issues have been associated with problem and failed financial

institutions.

(See GAO/GGD-94-14, Jan. 7, 1994).

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addressed the problems examiners identified at the System banks we

studied.

FCA customized its examinations and monitoring for each

individual institution within a framework of minimum standards.

FCA also

ensured quality and reliability in examinations through supervisory review,

quality standards, peer reviews, and other techniques.

FCA has conducted full examinations of NCB’s capital, asset quality, asset

and liability management, management, earnings, liquidity, and related

internal controls since 1990.

FCA assigns a CAMEL

rating to NCB to reflect

its overall condition and the nature of oversight needed.

FCA officials told

us that their examinations before 1990 were more limited in scope because

they focused on asset quality. However, the officials said

FCA has always

reviewed

NCB’s compliance with the act’s borrower eligibility

requirements.

We believe

FCA examiners have the combination of experience and

acquired expertise on

NCB lending to make them appropriate examiners for

NCB. FCA officials noted that NCB’s lending to cooperatives is similar to

lending activities of the Farm Credit System banks for cooperatives.

Because

FCA has retained a core group of examiners on the NCB

examination team for some 12 years, the FCA officials believed they had

developed the special expertise needed to examine a particularly unique

portion of

NCB’s loan portfolio—its cooperative housing loans. In

discussions with us,

NCB officials agreed that FCA had developed

appropriate expertise to examine the bank.

In addition to its annual, on-site examinations,

FCA reviews OTS

examinations of NCBSB and OTS’ reports on NCB as the thrift’s holding

company. Since 1992,

OTS and FCA have exchanged examination reports. In

1994,

OTS participated in FCA’s examination of NCB as part of its holding

company review. The

FCA officials told us that they are comfortable with

the ongoing arrangement with

OTS, and they believe it allows them to

adequately monitor the relationship of

NCB and NCBSB.

Since 1991,

FCA has reviewed NCB’s compliance with the statutory limit for

housing-related loans and the standard for loans to low-income

cooperatives, or those serving low-income persons.

FCA broadened its

examination scope in 1993 to review other statutory requirements related

NCB’s mission, such as the eligibility of its board members.

CAMEL is a rating system that assesses capital adequacy, asset quality, management, earnings, and

liquidity management. Regulators of all financial institutions assign CAMEL ratings on the basis of

their examinations.

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FCA Supports

Regulation of NCB

On two occasions since 1991, the FCA Board recommended to

congressional banking committee officials that

FCA or some other

regulator be given comprehensive regulatory authority over

NCB.

According to the Board, comprehensive authority would add the power to

promulgate regulations and take enforcement action to

FCA’s authority to

examine

NCB. The current FCA Board members told us that comprehensive

authority is needed to address any problems that might arise and, if

FCA is

to continue examining

NCB, protect its credibility as a regulator.

FCA Board members and senior officials emphasized in March 1994

meetings with us, and previously to banking committee officials, that

NCB

is functioning satisfactorily. FCA has found that NCB is adequately

capitalized, and

NCB cooperates in addressing any FCA-identified

weaknesses. Nevertheless, the

FCA Board members and senior officials

believed comprehensive regulation of

NCB is warranted and will become

more important if

NCB grows and undertakes new activities. The FCA Board

had no official position on which government agency should regulate

NCB,

but the Board maintained that

FCA has the requisite experience.

FCA’s NCB examination team leaders told us they generally were able to talk

through issues with

NCB officials and reach an acceptable settlement. We

saw evidence of this in examination reports and correspondence between

FCA and NCB. In the four examinations we reviewed (for calendar years

1990 through 1993),

NCB sometimes made incremental changes over the

4-year period to address

FCA’s safety and soundness-related concerns.

Essentially, the FCA officials told us that they must rely on moral suasion to

convince

NCB to make a change because FCA has no regulatory or

enforcement authority.

FCA can only suggest that NCB address any

deficiencies it believes exist; without regulatory and enforcement power,

FCA cannot compel NCB to take any action or cease any activity.

As noted previously,

FCA is required to forward examination reports to

Congress;

FCA submits the reports to the House and Senate banking

committees. The reports we reviewed provided information that enabled

us to compare

NCB’s current condition with the previous year and to

evaluate

NCB’s responsiveness to FCA. The examination reports discussed

NCB’s current conditions relative to safety and soundness and

mission-related requirements of the act.

FCA described and evaluated

actions taken by

NCB to address weaknesses noted in past examinations. It

noted additional weaknesses that needed to be addressed. Other useful

We did not provide specific examples to illustrate this point because the examinations are

confidential documents and their contents cannot be publicly disclosed.

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information was provided as well. For example, circumstances that

mitigated or contributed to an identified risk were discussed.

NCB

management’s responses to the examiners’ findings were reported. At

times,

NCB management agreed during the course of an examination that

changes in some policy or procedure were needed, and

FCA reported their

position. Appendixes to the reports provided financial data for the past 2

years, included comments on selected loans

FCA reviewed, and provided

other information.

Although it lacks enforcement authority,

FCA has explicitly directed NCB to

correct weaknesses and respond by a certain date.

FCA’s letters

transmitting the reports to the

NCB Board Chairman directed the board to

address each concern or weakness identified in the examination report,

and the letters also listed specific issues for the

NCB Board to address in a

written response to

FCA. FCA asked for a written response within a specific

time after the next

NCB Board meeting.

In addition,

FCA has communicated with the relevant congressional

committees as needed. It appears to us that this direct line of

communication strengthens

FCA’s role as NCB’s examiner. On two

occasions, as we noted previously, a congressional committee requested

us to provide legal opinions on the issues that concerned

FCA.

The examination reports are not publicly released. However,

NCB issues

publicly available annual reports, which include audited financial

statements and quarterly reports as required by the securities laws.

The

FCA Board cited two undesirable consequences of the agency’s

continuing as

NCB’s examiner without regulatory authority. The FCA

officials said FCA could be criticized if NCB had serious problems that

remained unresolved, even though

FCA has no power to compel NCB to

address problems. In addition, the officials said the Farm Credit System

could be harmed if

FCA’s reputation as an effective regulator were

questioned. Because the System raises debt in the capital markets, the

FCA

officials believed that any damage to FCA’s reputation could translate into

higher cost debt for the System and, ultimately, for farmers.

The first potential negative consequence—criticism of

FCA—reflects FCA’s

concern about its reputation and the resultant standing in the regulatory

community and with Congress. It is our opinion that

FCA’s limited

responsibility regarding

NCB is clear. Therefore, if NCB did not resolve

problems that

FCA identified, we think that NCB would be subject to

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criticism, not FCA. The act requires FCA to examine NCB and report to

Congress, and our review showed that

FCA is providing Congress with

detailed information on

NCB’s financial condition in its annual examination

reports. It is clear to us that if

NCB did not resolve problems identified by

FCA, FCA can, as it has in the past, convey its concerns to Congress. Once

informed, it becomes Congress’ responsibility to act, as it has in the past.

We discussed the second potential consequence—higher debt costs for the

Farm Credit System—with the head of the corporation that markets

System debt. He said the possibility of any negative impact on the System

from

FCA’s inability to require NCB to take any necessary actions would be

remote because creditors would understand that

NCB is not part of the

System. We concur that it is unlikely that the cost of System debt would

increase due to any unresolved problems at

NCB because it is clear NCB is

not part of the System. In commenting on our draft report,

FCA officials

said they had no substantive disagreement with this position.

Conclusions

The government’s current arrangement for overseeing NCB’s safety and

soundness appears to be working satisfactorily. Given

NCB’s weak ties to

the government, the markets’ apparent perception that there is no implied

government guarantee of

NCB’s debt, and the significant discipline imposed

NCB by its creditors, there does not appear to be any need for a different

oversight arrangement.

However, there is a need for closer monitoring of

NCB’s plans to repay its

debt to Treasury.

NCB has a unique position as a federally chartered,

private entity that is cooperatively owned by its stockholders with

subordinated debt held by Treasury. The act makes

NCB responsible for

maintaining a schedule to ensure full repayment of the class A notes no

later than October 31, 2020. During the course of our review,

NCB adopted

a new plan. However, no representative of the government is charged with

approving the plan. In the past, Congress required government oversight

when it provided loans or loan guarantees to several private firms. To

safeguard the public funds loaned to

NCB, we believe the government

should ensure that

NCB makes and follows a plan for repaying the full

amount of its outstanding debt that is acceptable to Treasury. We believe a

government-approved plan is especially important now that the statutory

provision for repaying a portion of the debt each year has been effectively

eliminated by

NCB’s policy change on the sale of class B stock.

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Although FCA encouraged NCB to adopt a new plan for repaying its

Treasury debt, it is not responsible for approving

NCB’s repayment plans.

FCA’s role is to review NCB’s safety and soundness through annual

examinations and report to Congress. To charge

FCA with approving NCB’s

repayment plan could lead to confusion about

FCA’s limited role of

examining and reporting. In addition, as

FCA acknowledges, there could be

a perceived conflict between

FCA’s examination function and its

involvement in the design or approval of the debt repayment plan.

Treasury is

NCB’s creditor and has a responsibility, as a matter of good

financial management, to ensure that debts owed to the government are

repaid. As

NCB’s creditor, Treasury currently administers the loan and

receives the interest payments. Therefore, it seems appropriate to us that

Treasury should be responsible for approving and monitoring

NCB’s

compliance with a plan for principal repayment. Once Treasury has

approved

NCB’s plan, FCA should include in its annual examination a review

NCB’s performance against the approved plan. Thus, Treasury could use

FCA’s work to monitor NCB’s compliance with the plan.

The National Consumer Cooperative Bank Act does not, however, require

Treasury to approve or monitor

NCB’s plan to repay the debt. The act does

allow the president, with the advice and consent of the Senate, to appoint

3 members of

NCB’s 15-member Board. The government has not appointed

a representative to the

NCB Board for almost 4 years. Since Treasury holds

NCB’s debt on behalf of the government, one of the government’s

representatives could be from Treasury.

Recommendations to

Congress

We recommend that Congress amend the National Consumer Cooperative

Bank Act to require the Department of the Treasury to approve

NCB’s plan,

including any future revisions, for repayment of the class A notes.

Treasury should also, through

FCA, monitor NCB’s performance against the

plan and require revisions as needed. The amendment should provide for

FCA to evaluate and report NCB’s compliance with the terms of NCB’s

approved repayment plan as part of

FCA’s annual examination process and

provide Treasury, as well as Congress, with the reports of examination.

We also recommend that Congress require that the government’s

representative on the

NCB Board be a representative of Treasury.

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Agency Comments

and Our Evaluation

We requested comments on a draft of this report from NCB, FCA, and

Treasury. The written comments of each entity and our responses appear

in appendixes II through IV.

NCB did not disagree with the substance of our

recommendations. However,

NCB prefers that the recommendations be

accomplished without statutory amendments.

NCB expressed a desire to

avoid any matter, such as pending congressional action, that might pose

concerns to the private capital markets regarding

NCB’s status. We

continue to believe that the changes we recommended should be made

through statutory amendments to better ensure their consistent

implementation in future years despite changes in personnel and other

intervening factors. For example, before the

NCB debt is due in 2020,

changes in the economy and

NCB’s performance could necessitate

revisions to

NCB’s debt repayment plan. Treasury’s duty to approve any

revisions, and to require revisions if necessary, should be provided for in

the law and not left to the judgment of future officials.

NCB’s status as a

congressionally chartered financial institution with subordinated debt held

by Treasury is well known to the private capital markets. Our

recommendations to Congress do not propose any change in

NCB’s status.

Thus, while we cannot predict the reaction of the capital markets, we see

no reason for our recommendations to pose concerns to them.

FCA reaffirmed its opinion that regulatory and enforcement authority

should be given to some federal financial institution regulator. However,

FCA officials said they would offer no further objections to the current

arrangement whereby they examine

NCB and report to Congress, and they

did not object to providing examination reports to Treasury, as we

recommend.

FCA agreed with our finding that Treasury is the appropriate

entity to approve

NCB’s plan for repaying the Treasury debt. FCA agreed that

evaluating and reporting on

NCB’s compliance with a Treasury-approved

NCB repayment plan is an appropriate part of its examination function. FCA

expressed concern about our description of this FCA role in some portions

of our draft; we clarified the language where appropriate.

Treasury did not object to monitoring an

NCB repayment plan, but noted

that without specific legislation requiring

NCB to meet the conditions of

such a plan, it would have no authority to hold

NCB to the plan’s

conditions. We recognize that Treasury would not have such authority and

expanded our recommendation to say that it should be given authority to

require revisions. Congress, unless it chose otherwise, would continue to

retain the responsibility for taking any action warranted against

NCB. This

is the same arrangement Congress has relative to

NCB’s safety and

soundness—

FCA monitors NCB’s performance and reports to Congress.

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Also, Treasury did not object to our recommendation that Congress

require the government’s representative on the

NCB Board to be from

Treasury. However, Treasury noted this representation would not

necessarily be an effective way to ensure

NCB’s repayment of the Treasury

debt. We believe a Treasury representative could assist the Board in

considering the effects of

NCB policies and practices on its long-term

financial health, including provisions for repaying the Treasury debt. A

Treasury representative could provide valuable expertise in other areas as

well. While many factors will affect

NCB’s ultimate ability to repay its debt,

we continue to believe a Treasury representative on the Board could be

effective in ensuring repayment of the debt.

Finally, although Treasury did not directly object to our recommendation

that Congress require Treasury to approve

NCB’s repayment plan, the

Department stated that such a requirement and having a Treasury official

NCB’s Board could create a conflict of interest. In Treasury’s opinion,

such involvement could cloud its role as an “arms-length creditor.” We

note, however, that in the past, Treasury representatives have served on

the boards of entities with outstanding Treasury loans or loan guarantees.

For example, the Secretary of the Treasury served on the boards that

oversaw federal programs to assist Lockheed and Chrysler. As we discuss

in our report, it is appropriate for Congress to require oversight of

outstanding government loans, and it is appropriate for Treasury, as

NCB’s

creditor, to fulfill this role. Good financial management calls for such

oversight.

NCB’s financial health and its ability to repay the debt owed

Treasury are inextricability linked. Thus, we see no reason why Treasury’s

role as

NCB’s creditor would be compromised by having a Treasury

representative on

NCB’s Board.

We are sending copies of this report to the Chairman of the NCB Board, the

Secretary of the Treasury, and the Chairman of the

FCA Board. We will also

make copies available to other interested parties upon request.

GAO/GGD-95-63 National Consumer Cooperative BankPage 25

B-258190

Please contact me on (202) 512-8678 if you have any questions concerning

this report. Major contributors to this report are listed in appendix V.

James L. Bothwell

Director, Financial Institutions

and Markets Issues

GAO/GGD-95-63 National Consumer Cooperative BankPage 26

GAO/GGD-95-63 National Consumer Cooperative BankPage 27

Contents

Letter

Appendix I

List of NCB

Subsidiaries and

Affiliates

Appendix II

Comments From the

National Cooperative

Bank

Appendix III

Comments From the

Farm Credit

Administration

Appendix IV

Comments From the

Department of the

Treasury

Appendix V

Major Contributors to

This Report

Table

Table 1: Selected Financial Data for NCB, Its Subsidiaries, and

NCBSB, as of December 31, 1993

GAO/GGD-95-63 National Consumer Cooperative BankPage 28

Contents

Abbreviations

CAMEL capital adequacy, asset quality, management, earnings, and

liquidity management

FCA Farm Credit Administration

GSE government-sponsored enterprise

NCB National Cooperative Bank

NCBSB National Cooperative Bank Savings Bank

OTS Office of Thrift Supervision

SAIF Savings Association Insurance Fund

GAO/GGD-95-63 National Consumer Cooperative BankPage 29

Appendix I

List of NCB Subsidiaries and Affiliates

NCB Mortgage Corporation, a majority-owned subsidiary, originates, sells,

and services real estate and commercial loans.

NCB Financial Corporation is a wholly owned subsidiary established as the

holding company of

NCB Savings Bank.

NCB Business Credit Corporation, a wholly owned subsidiary, provides

equipment lease financing and financial services.

Cooperative Funding Corporation, a wholly owned subsidiary of the

NCB

Business Credit Corporation, is a registered broker-dealer and provides

corporate financial services.

NCB Investment Advisers, Inc., a wholly owned subsidiary of the NCB

Business Credit Corporation, offers investment management services

tailored to the needs of cooperatives.

NCB I, Inc., a wholly owned subsidiary of NCB, is a special purpose

corporation that holds credit enhancement certificates related to the

securitization and sale of cooperative real estate loans.

NCB Development Corporation, an NCB affiliate, is a nonprofit organization

that provides loans and technical support to cooperatives.

NCB Savings Bank, located in Hillsboro, OH, is a federally chartered and

insured savings bank.

GAO/GGD-95-63 National Consumer Cooperative BankPage 30

Appendix II

Comments From the National Cooperative

Bank

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

See comment 1.

GAO/GGD-95-63 National Consumer Cooperative BankPage 31

Appendix II

Comments From the National Cooperative

Bank

See p. 23.

GAO/GGD-95-63 National Consumer Cooperative BankPage 32

Appendix II

Comments From the National Cooperative

Bank

The following are GAO’s comments on the National Cooperative Bank’s

(

NCB) December 14, 1994, letter.

GAO Comments

1. We added information about NCB’s newly adopted plan to repay the

Treasury debt. See pages 2 and 12 through 14.

GAO/GGD-95-63 National Consumer Cooperative BankPage 33

Appendix III

Comments From the Farm Credit

Administration

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

See comment 1.

GAO/GGD-95-63 National Consumer Cooperative BankPage 34

Appendix III

Comments From the Farm Credit

Administration

See comment 2.

GAO/GGD-95-63 National Consumer Cooperative BankPage 35

Appendix III

Comments From the Farm Credit

Administration

The following are GAO’s comments on the Farm Credit Administration’s

(

FCA) December 16, 1994, letter.

GAO Comments

1. FCA’s additional comments included suggestions to further clarify or

expand on portions of the draft report. We modified the text as

appropriate.

2. We modified the text to clarify our position, with which

FCA agrees,

that it is appropriate for

FCA to evaluate NCB’s compliance with a

Treasury-approved plan for

NCB’s repayment of Treasury debt.

GAO/GGD-95-63 National Consumer Cooperative BankPage 36

Appendix IV

Comments From the Department of the

Treasury

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

See comment 1.

See comment 2.

See comment 3.

GAO/GGD-95-63 National Consumer Cooperative BankPage 37

Appendix IV

Comments From the Department of the

Treasury

See comment 4.

See p. 25.

GAO/GGD-95-63 National Consumer Cooperative BankPage 38

Appendix IV

Comments From the Department of the

Treasury

The following are GAO’s comments on the Treasury’s December 23, 1994,

letter.

GAO Comments

1. Our draft report noted our agreement with Treasury’s position that

under present law Treasury is not obligated to ensure

NCB has and follows

an acceptable repayment plan. (See p. 15.) We recognize that without

explicit legislation, Treasury has no authority to hold

NCB to the conditions

of any plan. We added Treasury’s reiteration of this point on page 24.

2. We did not suggest in our draft report that Treasury challenge

NCB’s

current policy not to sell class B stock. Our draft noted Treasury’s finding

that the

NCB policy is not inconsistent with the act, and we did not take

issue with this position. (See pp. 14 and 15.) Treasury proposed that it

likewise could not challenge

NCB if it decided to deviate from its class A

note repayment plan in the future. We do not disagree with Treasury, and

we again note our recommendation that Congress give Treasury authority

to approve and, through

FCA, monitor a repayment plan.

3. Our draft report noted that Treasury was monitoring the interest

payments and renewal of

NCB’s class A notes. (See p. 15.)

4. We clarified Treasury’s position regarding its treatment of

NCB, or

other borrowers who might fail to pay principal owed when due, by adding

the additional information provided. (See pp. 15 and 16.)

GAO/GGD-95-63 National Consumer Cooperative BankPage 39

Appendix V

Major Contributors to This Report

General Government

Division, Washington,

D.C.

Thomas M. McCool, Associate Director

William J. Kruvant, Assistant Director

M. Kay Harris, Evaluator-in-Charge

Office of the General

Counsel, Washington,

D.C.

Rosemary Healy, Senior Attorney

(233411) GAO/GGD-95-63 National Consumer Cooperative BankPage 40

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