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Inexplicably, the fund increased its derivatives in

February 1, 1995

Inexplicably, the fund increased its derivatives investments steeply toward the end of 1993 and last year, just as rates were beginning to turn upward. Cap Corp borrowed against its securities to buy more CMOs. By last summer, the face value of its CMO holdings exceeded $1 billion, according to NCUA officials _ more than the approximately $900 million in deposits made by individual credit unions. Cap Corp’s assets total about $1.4 billion.

``They were chasing yield and got into a trap,″ Mr. D’Amours says. ``In the end, their strategy looked more like a poker game than an investment strategy.″

Cap Corp’s spokeswoman, Carol Szaroleta, says it had to be aggressive to provide competitive returns. ``In this market, you can’t be competitive if you put your money in bank CDs,″ she adds.

But its strategy was apparently far more aggressive than that of any other credit union. Very few use significant amounts of leverage to increase returns.

The CMOs left Cap Corp with investments that not only declined in value but also are difficult to liquidate. Cap Corp should be ``a liquidity provider, but what it did was borrow short and lend long,″ an NCUA official says.

Although agency officials criticize Cap Corp’s investment strategy, they acknowledge that they themselves may be criticized for being slow to recognize the problems despite an examination of Cap Corp’s books late last September. ``That was a miss,″ Mr. D’Amours admits. ``The September exam should have caught the red flags, and that should have alerted us to what was going on.″

The chairman adds, ``We plan to take a better look at corporate credit unions in the future.″ He notes that the agency has recently acted to improve the quality of its examinations.

Cap Corp’s problems weren’t identified until late last November, when two CMOs were deemed to have overly long maturities under a ``stress test″ that evaluated their sensitivity to interest-rate changes. Following that test, the NCUA forced Cap Corp to sell the securities at a loss of $1.4 million. Cap Corp’s chief executive, J. Clayton Brooke, and its vice president and head of investments, Bruce Townsend, resigned soon afterward. Neither man could be reached for comment prior to publication of this story. Cap Corp is currently being run by Francis Lee, an executive on loan from Western Corporate Federal Credit Union (WestCorp), of San Dimas, Calif.

When the economy and the demand for loans picked up last year, Cap Corp faced a liquidity crunch. It initially responded by borrowing more money from the U.S. Central Credit Union, according to people at the NCUA. But its borrowing is limited to half of the amount of its deposits, and it reached that limit in early December; that led to the moratorium on withdrawals.

During the moratorium, members have been able to withdraw funds from the Central Liquidity Facility, which is the lender of last resort to the credit-union industry. A source at the agency says Cap Corp credit unions had borrowed more than $30 million from the facility as of Tuesday.

Cap Corp initially responded to its cash crunch by trying to arrange a merger with WestCorp, the largest of the corporate credit unions. WestCorp, a $12 billion credit union, was willing to take on the troubled CMO portfolio because a merger would have diversified its geographic base. However, according to Cap Corp officials, the NCUA opposed the merger.

``They have cut us off at the knees,″ one Cap Corp official complains. ``They have been incredibly hostile, and at every juncture they have made the situation worse than it has to be.″ Agency officials say they were eager to encourage the merger but didn’t think WestCorp should assume the CMOs.

Although credit unions don’t get as much attention as banks, they are a critical part of the nation’s financial system. More than 60 million Americans save and borrow at them. The NCUA supervises and insures nearly 8,000 federal credit unions, and it insures accounts at about 4,600 state-chartered credit unions. In each of the past 10 years, the American Banker, a trade publication, said credit unions rank No. 1 in customer satisfaction.

Credit unions were long limited to making unsecured personal loans and car loans. However, they were deregulated in 1980 and began offering more products; now they can offer the full range of financial services, everything from credit cards to checking accounts, home-equity loans and home mortgages. The banking industry has long been a bitter critic, mostly because of an inherent advantage of credit unions: They don’t pay taxes.

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