Chip Filson
The Seated Boxer, an iconic ancient Greek work of art, shows a grizzled veteran of the ring, equal parts resigned and ready to spring into action.
What I like is a sense of respite from competition, the powerful athletic physique and the tiredness that surrounds his humanity. Is he a winner this day? Are there more fights to go? How will his efforts be remembered?
These are questions that all of us encounter, in literal or figurative ways, in our daily efforts.
Even though NCUA’s public board meeting yesterday had a minimal agenda of two items, comments completely scripted, and outcomes pre-determined by design, there is still much to be learned from the live session.
As one NCUA Board member stated, all who are subject to the board’s authority can see if it is carrying out its “fiduciary duties” in a thoughtful manner.
Were the presentations documented with relevant and timely information? Were key issues raised? How knowledgeable were staff and board with the subjects?
While reports of the prepared remarks or occasional comment are helpful, there can be much more to be seen from the public “performance.”
The two agenda items were the quarterly NCUSIF update and a proposed change to the charitable deduction accounts (CDA’s).
However the external context was especially relevant. In addition to the continuing economic and financial uncertainty there is the current government debt ceiling political impasse. Would the many government employee focused credit unions be affected by a temporary halt of payments? This topic was not raised.
Despite political and financial uncertainties, NCUA’s field examiners reported the lowest percentage of code 4 and 5 rated credit unions in decades: just .29% of insured shares.
How did this happen? Are credit union leaders just better managers than their competitors? NCUA a more effective regulator? Or credit unions just lucky at this moment? What one board member cryptically called the “calm before the storm.”
Only Hood provided an analysis for the current state of the system:
Our public financial postings and disclosures and credit union performance highlight the unique character of the cooperative system—a system that was the basis for rejecting the FDIC premium models in years past and still in use today and designing a uniquely cooperative approach. The credit union system is a unique financial system, and our regulatory and Share Insurance Fund framework should reflect this.
Certainly the data summarized is great news in the current context. But end of story? No. A number of explanations and data points offered were unexamined. Questions would have demonstrated a better grasp of several critical areas of NCUA board oversight.
CFO Schied’s fund NCUSIF update was a literal reading of numbers from ten slides with no accompanying analysis.
He did point out that the number of NCUSIF insured had declined by 59 in the quarter. In contrast the board complimented staff on granting a new charter.
However no board member spoke to the critical question. Is this rate of annual decline of over 200 credit union charters acceptable? For any industry opening 1-3 new locations a year while shutting down 200 which existed for decades, raises the question: is the system sustainable?
Some would respond that this trend is OK because these are mostly smaller mergers and total credit union members keep growing.
However from the member-owners’ perspective, these are 200 charter failures. Suggesting a chairman’s award for a new charter or two would seem a miss-focus compared to the oversight of 200 charter closures. Reducing charter cancellations would seem to be the first priority; getting a new one is a multiyear ordeal.
All three members mentioned the need for Congress to again restore the CLF’s temporary Covid era authority. This has been supported by the assertion that over 3,000 credit unions under $250 million now lack CLF access. A status only Congress can fix.
I believe this constant tossing the ball to Congress’ lap for CLF coverage overlooks NCUA’s primary responsibility for the situation:
The CLF has been missing in action for two decades. The NCUA has not collaborated with corporates or credit unions to design a CLF that credit unions would see as vital and relevant. The FHLB system, a cooperative model, has done this well. The CLF’s liquidity design is not a Congressional legislative issue. It is an NCUA leadership and management responsibility.
The single most critical aspect of NCUSIF performance is the management of its investment portfolio, its primary revenue source.
For the first quarter revenue grew by 49% versus the year earlier. However the YTD yield was only 1.75% or roughly 3% below the first quarter’s overnight rate. In November 2022 NCUA staff announced it was pausing its ladder strategy until overnight funds reached $4 billion. There was little information how this amount was determined and why?
The critical topic is what has NCUA learned during this ongoing rate cycle that would affect how it approaches future activity. When asked about this, CFO Shied said the fund followed a SLY investment policy. After the $4 billion level is reached it would then go back to the 10-year ladder.
When asked how long it would take the fund to achieve par value in the current rate environment, he replied three years. He listed the required cash flows of $400 million, $700 million and $1.0 billion in that period. That corresponds to the current wighted average life (WAL) of 3.0 years.
Should the current rate situation become a new normal, then NCUSIF revenue will have recorded below market returns for over four years since the Fed began raising rates in March 2022.
Every 1% of below market yields costs credit unions $200 million annually on the NCUSIF’s $21 billion portfolio. The current 3% under market yield results in a $500-600 million annual revenue shortfall that will continue until rates normalize and the portfolio reprices.
This revenue gap is twice NCUA’s total annual budget. It is a performance shortcoming keeping credit unions from reaping the returns from their fund 1% underwriting. This revenue shortfall is a safety and soundness concern that affects the system’s overall stability. It is not a design flaw, but a management responsibility.
Managing IRR risk, and related fund revenue, is the NCUSIF’s top responsibility. It should be guided by two questions:
Moreover in years of low losses the Fund should pay a dividend. That was the mutual commitment for credit unions to support the NCUSIF’s perpetual underwriting with a 1% deposit.
The essential NCUSIF management skill is IRR monitoring. Compared with a credit union’s ALM challenge of managing the two sides of a balance sheet and forecasting net interest income or the economic value of equity, the NCUSIF responsibility is a straight forward. How should the WAL be adjusted given the two questions above and rate outlook?
The Fed’s rise in rates was announced in advance. The speed and amount may have caught many portfolio managers flat footed, but the take away should be to enhance IRR, not revert back to a rote formula that is costing credit unions hundreds of millions in lost revenue.
To not address this critical aspect of NCUSIF performance and just accept the intent to go back to the old ways of doing things once the $4 billion goal is reached, is an oversight failure.
The second board item was one page long. It was a proposal to add more eligible organizations for CDA donations beyond 501 C 3’s. The specific suggestion was 501 C 19, nonprofit groups serving veterans.
The proposal would seem reasonable. However the discussion was made in a vacuum. There was no information provided about this ten year old incidental power to know the scope of the policy decision. How many credit unions have this account? How much do they contribute? What data indicate this authority is actually working as intended?
The 5300 quarterly report has some data. At March 2023 there were 278 credit unions holding $1.4 billion in CDA accounts. Seventy-four credit unions had added this account during the past year, and thirteen had dropped it. Total balances had increased by $85 million or 6.5%
When asking for public comment, it is important to provide data relevant to the issue at hand. How is this authority benefitting members?
One board member stated the rule’s intent was to provide higher returns by allowing investments not authorized for the credit unions to use in their own portfolios. The theory was that the expected higher return would allow credit unions to make donations without impacting their net income. Is that what is happening?
In making policy recommendations there should be a data context, especially when information is easily available, so that commenters can know the impact of what is being discussed.
Next week I will return to the most important discussion that didn’t happen with the NCUSIF.
What does it mean to be brave? Many people consider bravery an act of courage, often in the face of physical danger.
At some point almost all credit union leaders will confront financial, personnel and political challenges. Facing up to these, in most cases, is just part of the job. Cooperative bravery I believe entails a very different character.
Aristotle believed that bravery was the highest of all virtues because it guaranteed all the others. “I count him braver who overcomes his desires than him who conquers his enemies; for the hardest victory is over self. You will never do anything in this world without courage.”
Bravery is rarely cited in conjunction with credit union activities. For cooperative culture is based on relationships. Differences of opinion, whether major or minor, are resolved by following the path of least resistance.
That path in awkward situations may entail quietly resigning from a position of responsibility. Other times one may voice dissent but not formally oppose in deference to the “majority” view.
In cooperatives, it just makes life easier to get along, by going along.
Courage can be especially important at critical decision points in an organization’s direction. It is a “call” that can motivate after one’s formal professional role has ended. A person responds, drawing from their life’s experiences and values, to a summons that others do not feel.
Two individuals of unusual bravery are retired CEO’s that took public and extended efforts to oppose the decisions of their successors.
These two people are David Keffer who retired from Cornerstone FCU in 2014 and Steve Post who retired from Vermont State Employees (VSE) in 2013. In their executive roles. Dave was CEO for thirty-three years and Steve for twenty-four.
Their successor CEO’s were in their responsibility for two and six years respectively before initiating actions with their boards to end their credit unions’ independence.
Both retired CEO’s sought out family, former directors and officers, longtime members and community organizations to oppose the effort to cancel their credit unions’ charters. Both organizations had served and earned the loyalty of over three generations of members
The Vermont State Employees example is described in several posts written at the end of 2022. The first describes the closest vote ever in a merger contest. The follow up stories highlight the issues involved.
Votes Counted: Closes Election Ever
The Tragedy of the Commons: The End of a Movement?
If George Bailey were a Credit Union Member
The VSE Merger: Will “Potters” Take Over the Movement?
The outcome of the Cornerstone merger contest in 2017 can be read here: Credit Unions As a “Cornerstone” Of Freedom
This blog includes a link to The Committee for Cornerstone Indpendence, a Facebook page which contains a running record including videos from members opposing the merger. The vote took place less than four weeks from the mailing of the member notice following NCUA rules at that time.
Both men and many of their supporters had devoted decades of their personal and professional lives to these local cooperatives. The institutions successfully served their members through multiple economic cycles and business innovations. As noted in the articles, both institutions were leaders in their communities achieving financial success whatever measure of performance one used.
Both former CEO’s efforts to prevent the mergers by urging members to vote NO, lost. One on a margin of less than 1% of votes cast. At Cornerstone, the mail in ballots were in favor even though over two-thirds of members voted against at the required members’ meeting.
Why single out these retired individuals as “brave” in openly opposing the merger plans of their immediate successors?
All of the odds for defeating the merger were stacked against them. The current credit union rulers control all the financial resources, the members’ media channels and enticed employees with future promises to support their plans. They even claim to have received the regulator’s blessing.
The time to mobilize opposition before Cornerstone’s vote was very limited. In VSE’s situation the debate extended over several months. The merger opponents had only their personal not institutional resources to draw upon.
Still working professional colleagues would stay distant at best, or be critical of their taking a stand abut the credit union “in retirement.”
So what motivated them to to speak out, to organize and ask their fellow members reject these proposals?
Both men strongly believed the merger’s rhetorical statements misled members about any possible future benefits. From their professional perspective, they understood that ending the charters was not in the members’ best interests.
The members received no merger benefit. Their generations of loyalty and accumulated resources passed totally to the control of a firm with a different business plan and leaders with no connection to the existing credit union. Or even a role in creating the accumulated wealth.
They saw the trust and goodwill of the members being taken advantage of. There was no immediate gain except for the leaders, who initiated the change.
In life we will sooner or later encounter a situation where bravery is required. We may risk reputation and resources to do what we believe is right.
These moments are rarely scripted, let alone anticipated. There may not even be time to think about all the implications of taking a stand. Reaction can be as much intuitive as logical.
This “call” can arise from a lifetime of practiced belief. Or from witnessing the bravery of others responding to another of life’s ever unfolding equity challenges.
The motivation emerges from one’s deepest beliefs, spoken or not. It is the feeling that, “while ships are safe when in harbor, that is not why they were built.”
These two men took a stand when they perceived the values of the credit union members they served to be at a moment of maximum danger. They were right.
Their point of view was formed from serving members honorably for decades, not for just the length of a first employment contract.
But they lost, so what kind of a “brave” example is this? By circumstance bravery often requires confronting superior power, a majority public opinion or even accepted protocols of behavior.
By opposing the merger plans, these individuals pointed to values much more vital than arguments for scale. They believed that members’ best interests should be criteria for all decisions. Management’s ambitions are not the purpose of a credit union—that is the cooperative difference versus for profit options.
There is growing awareness that events such as these mergers are compromising the future of the movement and members’ trust.
These examples of principled opposition will inspire others. Those who are now silent in the face of happenings with which they do not agree may take a stand: directors, employees, retirees or even those in regulatory roles.
What is the advantage of a cooperative charter if its supporters are not willing to pursue their democratic duty to speak up?
This capability is a learned skill, not one found in any person’s position description.
David Keffer and Steve Post retired from their jobs, not their principles.
Their standing up for their life’s work by opposing these mergers may be the cooperative example for which they will be most honored in years to come.
“What’s in a name? That which we call a rose, by any other word would smell as sweet.” Juliet compares Romeo to a rose saying that if he were not named Romeo he would still be handsome and be Juliet’s love.
Shakespeare’s metaphor might not work as well today. For there are numerous varieties of ornamental rose that produce little or no fragrance.
And so it is with credit union names. Some are closely linked with the founding charter: State Employees, Stanford, American Airlines, Utility Employees. Some reflect an enhanced market ambition: Affinity, Summit, Community, or even Global.
Finally there are some that are just plain head scratchers–made up words meant to convey an impression or feeling that is not immediately clear.
Names can inform and enhance a credit union’s legacy relationships; or they can signal an effort to begin a new future, unbounded by previous limitations. Two examples follow.
The headline caught my attention: $5 million Naming Rights Deal Signed by Oakland University Credit Union (Credit Union Times, April 21, 2023)
Oakland University is real with 15,000 students. The agreement gives the credit union branding exposure with the newly christened OU Credit Union Arena.
OUCU has a website with pictures of the campus branch. It announces that so far in 2023 “we’ve saved our members $10.2 million in loan interest by refinancing their high-rate loans from other institutions to OU Credit Union.”
Despite these visual cues, OU is not a credit union. Rather it is a trade name created in 2013 by the $7.3 billion MSU FCU. The OU web site continues with this dual personality. The About Us link goes directly to MSU’s home page. The OU Credit Union Community shows pictures and events focusing on campus life.
The name and marketing examples in the website certainly communicate a commitment to this segment. MSU also operates two generic digital only brands, Collegiate and AlumniFi, to serve other college groups with “white label” (non-MSU) names.
The OU trade name would seem to be an effective way to focus on a specific group, one that would seem very similar to MSU’s institutional experience. One could suggest this dba is similar to a co-branded credit card from an airline or other retailer. It is not the airline doing the financing, but just providing a marketing introduction to its consumers for the bank which is responsible for all the underlying transactions.
With its 10-year, $5 million sponsorship and on site services, MSU is certainly investing in this partnership. The only rub might come if a OU member decides to exercise some of the other aspects of member-ownership such as run for the board or express a concern about an aspect of the credit union’s service.
Can the dba marketing model lead to member misimpressions about their role or credit union relationship? This example of branding has worked well for almost a decade. It is still hard to avoid the feeling that this is not the “full credit union monty” even with the linked disclosures on the website.
Another example is retaining the name, even after a merger, to respect the power of member loyalty. It also suggests an ongoing commitment to preserve the best aspects and local responsiveness despite the merger which transfers full control and resources to another credit union.
In March 2021 I described the proposed merger of Maine’s oldest credit union, chartered in 1921 as Telephone Workers, renamed Infinity, with Deere Employees in Moline, IL.
Describing the reason for merging the $341 million credit with almost 10% capital, CEO Elizabeth Hayes gave the following logic and commitments in a January 31, 2021 Credit Union Times interview:
Hayes said when local credit unions merge there is often “overlap” that can reduce the effectiveness of the combination.
“Merging with a credit union out-of-state gives you advantages,” Hayes stated. “One is the increase in intellectual capital. I can’t stress that enough.”
Hayes said with the out-of-state combination there is going to be no reduction in offices, no reduction in staff, and the chance for her existing 90-person team to be part of a larger organization with greater opportunities to grow and remain with the credit union.
Infinity FCU will keep its name and local control. Hayes will stay on as Maine market president.
Hayes said keeping the credit union’s name was important to Infinity. “We can keep our brand, which is important. There are a lot of members who feel very vested in their credit union and they will continue to feel vested with Infinity.”
Recently several Maine credit unions sent an update on the merger regarding the name, local control and feeling vested.
Hayes tenure as the Maine market president lasted about one year. There has been much employee turnover and Deere staff has moved from Moline to help Infinity fulfill its ambition to serve all “Maine-kind,” as stated on Infinity’s website.
However this spring brings a more consequential update especially when compared with the original justifications for the merger. Infinity and its Deere parent are changing to use a common name and brand: EMPEOPLE.
From the website:As we look forward, we have a vision for growth that builds on this legacy with an even stronger focus on financial empowerment for our members. It is important that our brand reflects our path forward. One that honors our history and represents a strong future. With a legacy of service and a vision for growth, our focus is on creating a path to financial health for our members, their families, and the communities we serve.
It would appear that the Infinity’s merger commitments of an independent operation, “keeping its name and local control,” and respecting “members who feel vested in this credit union” is now gone.
“Keeping the credit union’s name was important to Infinity,” said former President Hayes in her interview.
Given all the Infinity-Deere’s post-merger actions, it would certainly be reasonable for members to question these new rhetorical statements and rebranding. One wonders what happens if the EMPEOPLE member-owners became skeptical of all this verbosity and simply walk away.
Credit union names matter. Both case studies are examples that can be found throughout credit union land.
In the first case, the credit union is investing in creating a brand to build relationships with a community partner. In the second the credit union is walking away from its past into a future with a name that causes one to ask, what were they thinking?
In Shakespeare’s play Romeo and Juliet die. While the families reconcile, it has a price as the Prince states: “For never was a story of more woe / Than this of Juliet and her Romeo.”
What’s in a name? Contrary to Juliet’s poetic assertion, they matter, for better or worse.
The on-again, off-again commentaries about whether the banking industry’s challenges are over is the context for an important NCUA board update on Thursday.
The only agenda item is the state of the NCUSIF. As context for this report NCUA also summarizes the state of the credit union system as graded by its on site examinations.
Did the proportion of CAMELS ratings deteriorate from previous quarters? What do these supervisory in-depth contacts report on the financial health of credit unions? As interest rates have risen, has credit union performance gone “wobbly”?
We know from Callahan’s May 17 Trend Watch call from March 2023 data that share growth has slowed to just 2.2%. Almost all other macro indicators are positive.
In many operational respects the $2.2 trillion cooperative system appears very similar to consumer banks. So does the cooperative design make a difference especially when it relates to the system’s resilience?
The 100+ years of cooperative history suggests that this industry based on communal ownership, not private profit, is more stable. There is another important difference versus banks. The direct market oversight of all public banking companies creates incentives for financial players to “short” troubled firm’s stocks or even aspire to takeovers when market value is much below book.
Even as some transactional activities appear to be whittling away at the differences with banks, the coop model has developed a unique market ”space.” This “space” relies on long traditions of self-help, self-finance, and self-governance. The focus on member well-being vs institutional performance is also a powerful heritage.
Is it possible that the cooperative credit union model is the best alternative design for resolving the obvious financial uncertainties and internal contradictions of stock-owned depository financial institutions?
The industry’s cycle of severe losses requires the FDIC to always increase premiums on the survivors following the failures of their peers.
This cyclical bout of problem losses is not the cooperative experience. In theory and principle the motivations and incentives are different. However coops are managed by humans, so they are not always a veil of purity.
That is where NCUA’s role comes in. This Thursday we will hear NCUA’s report of its examiner evaluations. Hopefully it will be a rallying cry for the industry during a time of multiple economic and national uncertainties.
Will it demonstrate the power of member ownership and coop uniqueness? Will it highlight the NCUSIF’s special design to give back to its credit union underwriters their share of collective success at a time when banks see only increasing premiums?
The board meeting report can be an affirmation of the future of the cooperative model based on NCUA’s experience and expert field exams, not just the quarterly 5300 trends.
It will hopefully deliver a message that rallies all observers to see clearly again the credit union difference. In performance, in consumer focus and most importantly in leaders’ belief that the most critical competitive advantage is cooperative uniqueness.
As pundits, regulators and congress have looked at what should be changed in the wake of the three recent large bank failures, one focus is how FDIC insurance is structured.
A precipitating event was mass withdrawals by uninsured customers, prompted by social media alarms. Using their Dodd-Frank “systemic risk authority,” the FDIC took over the banks and covered all depositor balances while it worked to find a least cost resolution.
This customer behavior has prompted suggestions for changing FDIC coverages to reduce this risk potential. CUNA and NCUA have publicly stated that the NCUSIF should have “parity” in any changes to FDIC insurance.
Here is one trade’s position: Credit unions must receive parity with banks in any deposit reform legislation, CUNA wrote to House Financial Services and Senate Banking, Housing, and Urban Affairs Committee leadership Monday. Congress and the Federal Reserve have indicated interest in deposit insurance reform in the wake of recent high-profile bank collapses.
“Our primary concern regarding any deposit insurance reform legislation passed by Congress is to ensure that credit unions receive parity, fair treatment, and equal protection with banks,” stated CUNA President Jim Nussle in his letter to Congress.
I believe this public posturing is dangerous to the future of the NCUSIF and to credit unions separate financial system. Here is why.
The first proof of this basic difference is that 92% of credit union savings are covered by NCUSIF, whereas only 44% of bank deposits were FDIC insured. This point was presented in Callahan’s Trend Watch analysis this week in the following graph.
The obvious Congressional question is why do credit unions need whatever changes FDIC might make if the balance sheet structures of cooperatives are fundamentally different from the banking industry?
Since the NCUSIF’s financial redesign in 1984 into a cooperatively-funded deposit model, credit union insurance has not required federal backing, even during the corporate crisis. By legislative intent, the NCUSIF is backed entirely by members sending 1% of every savings dollar to the fund. This capital base grows along with insured risk. This base provides sufficient revenue so that premiums are rare. That revenue option is a last resort and can be used only when Congressionally established financial levels are reached.
As a cooperative, the fund is required to pay dividends when reserves exceed the Normal Operating Level, historically 1.3%. The FDIC’s structure gives it only one means to cover increased risk—charge ever higher premiums on an expanded asset, not just the insured savings base.
There is nothing in the NCUSIF history that would support this desire for a larger fund. The Fund has performed though multiple economic cycles and financial crises that forced the FDIC to resort to multiple special premiums. The FDIC has no cap on how large its fund can be relative to its insured risk.
The downside of the NCUSIF’s financial success is that it has become a “piggy bank” from which NCUA draws increasing amounts to pay for its expanding operating budgets. Instead of paying for insurance losses, the majority of fund revenue is used for NCUA’s operating expense. This overhead transfer rate is currently 62.4 %, even though federally chartered credit unions are only 50% of insured risk.
The legislative constraints that are a part of the redesign passed in 1984 were to address credit unions’ fundamental concerns with an open-ended perpetual deposit underwriting commitment. The apprehension was: “If we just keep sending 1% of deposit to NCUA every year, what prevents them from just spending it.”
Credit unions, who in their own analysis, say they are unlike banks, would become a part of this new regulatory avalanche. One need only think back to 1998 when bank PCA was mandated by the Credit Union Membership Access Act which had nothing to do with the Act’s primary FOM issue. But it was included, saddling credit unions with PCA (RBC/CCULR) requirements in 2022 that NCUA cloned from the banking regulator’s rules.
For credit unions the debate on insurance coverage should be an opportunity to substantiate the differences and soundness of the NCUSIF, and its extraordinary record of success since 1984. Before that time, the NCUSIF did follow the FDIC model. As an FDIC financial twin over two decades, the NCUSIF never came close to achieving the legislative goal of a 1% fund. This was even after using double premiums, the only option available, for several years.
A major risk to credit unions is a NCUSIF-managed Fund without an awareness by leaders of its differences and why these matter. The changes requested by Chairman Harper not only abandon the explicit legislative guarantees made to credit unions in return for their perpetual 1% underwriting in 1984. It would most certainly entail more FDIC look alike regulations.
Here is Chairman Harper’s request to Congress this week:
If Congress does decide to act in this area, the NCUA has two requests. The first is to maintain parity between the share insurance provided by the NCUA and the deposit insurance provided by the FDIC. Share and deposit insurance parity ensures that consumers receive the same level of protection against losses regardless of their financial institution’s charter type.
And second, if coverage levels are adjusted in any way, there will be costs associated with those adjustments, such as the need to increase reserves. Accordingly, the NCUA requests additional flexibility for administering the Share Insurance Fund.
Specifically, the NCUA requests amending the Federal Credit Union Act to remove the 1.50-percent ceiling from the current statutory definition of “normal operating level,” which limits the ability of the Board to establish a higher normal operating level for the Share Insurance Fund. Congress should also remove the limitations on assessing Share Insurance Fund premiums when the equity ratio of the Share Insurance Fund is greater than 1.30 percent and if the premium charged exceeds the amount necessary to restore the equity ratio to 1.30 percent.25
Together, these amendments would bring the NCUA’s statutory authority over the Share Insurance Fund more in line with the FDIC’s authority as it relates to administering the Deposit Insurance Fund. These amendments would also better enable the NCUA Board to proactively manage the Share Insurance Fund by building reserves during economic upturns so that sufficient money is available during economic downturns.
In sum, insurance parity is a false objective based on contradictory logic and a failure to understand the cooperative financial model. Credit unions should be careful what they wish for.
As one former NCUA Chair observed, the greatest threat to credit unions is parity.
Within 90 days of Safe Harbor, Colorado Partner Credit Union’s CUSO subsidiary becoming a public company, the December 2022 financial result showed a negative retained earnings of $39.7 million.
The company’s stock has fallen from a peak of over $10 per share in October 2022 to close at $.39 yesterday. Auditors have raised a going concern footnote as a result of its December 2020 financial position.
Partner Colorado Credit Union the CUSO’s founder and owner, has restructured its initial sale terms of $185 million in cash and stock. This resulted in PCCU recording a $44 million dollar loss in the March quarter, to offset the gains from the sale recognized in the 4th quarter of 2022.
Except for ongoing revenue from its operating service agreements with SHFS, the credit union has yet to receive any payments from this sale closed in September 2022.
How could such an initial optimistic announcement turn south so quickly?
No one knows how this start up effort to transform a private, relatively small Fintech front-end platform for introducing cannabis related businesses (CRB’s) to financial partners will turn out.
However, CPCU’s effort to tap into the public market’s fervor for “Fin Tech-Cannabis” related startups has multiple lessons for credit unions. One can see possible parallels in the continued interest and fund raising today in credit union for FinTech labeled businesses.
One topic is scalability. Safe Harbor was started in 2015 with the full support of all of CPCU’s operational capabilities, especially branches.
The credit union offices were able to open accounts, receive cash deposits, make loans and provide transaction services. Is this geographically based start up model scalable outside the jointly operated locally-incubated context?
Is the compliance process and technology support so unique, that other local financial institutions and FinTechs would be unable to develop their own capabilities?
“At the end of last year, there were 168 credit unions, 479 banks and 126 non-depository institutions that were serving marijuana-related businesses, according to FinCEN.” (CU Times)
One observation at this stage is that there is no “free” market. The credit union is learning that a private firm using the SPAC process has to “pay to play” to become publicly traded.
Reviewing some disclosures form the May 2023, 10-Q SEC filing suggest why this is the situation.
The first is to note that this sale was structured as Safe Harbor buying out the NLIT SPAC, not the reverse as suggested in the $185 million announcement.
Secondly it is impossible to tell which investors got paid what in this transaction. Certainly the brokers, accountants, lawyers and other facilitators were paid fees. But which SPAC shareholders were paid what return?
What is known is that the seller, CPCU, has not received anything from the sale. Moreover It has converted a significant amount of the debt portion to stock and extended the much reduced debt payments further out.
The new entity’s first major transaction was to acquire in November 2022 another cannabis business for $30 million in stock and cash. The tangible assets in this acquisition were minimal. The contribution to immediate earnings, unstated. It would seem to be a transaction negotiated before the full financial impact of the CPCU sale was known.
SHFS continues to compare in its filings the current financials with its pre-public quarterly results. This previous financial performance, under the credit union’s auspices, reveals a very modest business, albeit, with a positive financial bottom line.
The credit union appears well capitalized. The cannabis business relationships from SHFS are important. About $35-40% of its deposit base appears to be from CRB’s-much probably held in share draft accounts.
Prior to the public sale, CPCU recorded its CUSO investment at $8.0 million. To date the credit union has not received any of payments, including the $3,143,388 in cash and equivalents held by Safe Harbor prior to the sale.
As stated throughout the SEC filings, CPCU is the SHFS’s primary banking partner.. “Currently the Company substantially relies on PCCU to hold customer deposits and fund its originated loans. As of this time, substantially all of the Company’s revenue is generated by deposits and loans hosted by its PCCU pursuant to various services agreements.”
Concentration limits for the deployment of loans are further categorized as i) real estate secured, ii) construction, iii) unsecured and iv) mixed collateral with each category limited to a percentage of PCCU’s net worth. In addition, loans to any one borrower or group of associated borrowers are limited by applicable National Credit Union Association regulations to the greater of $100,000 or 15% of PCCU’s net worth. Page 27
Further disclosures show that the credit union has limits on the amounts of total CRB related loans it will hold as part of its service agreements: PCCU’s Board of Directors has approved aggregate lending limits at the lessor of 1.3125 times PCCU’s net worth or 60% of total CRB deposits.
CRB deposit limits: (page 27) Under the Support Services Agreement PCCU will continue to allow its ratio of CRB-related deposits to total assets up to 65% unless otherwise dictated by regulatory, regulator or policy requirements. Actual CRB deposits at March 31, 2023 $214 million and $161 at December 31, 2022.
CPCU’s CEO and CFO are members of SHFS board; the credit union owns 55% of the voting stock from the restructuring. The credit union’s current operations certainly benefit from SHFS’s clients apart from what may be received from the sale of the CUSO.
SHFS’s SEC filings provide many details of its business history and financial twists and turns. The latest 10-Q filed May 15, 2023 can be found here; and the definitive proxy statement Schedule 14 A, filed April 23, 2023 for the firm’s annual meeting is here.
Two financial questions are partially answered in these documents. If the SPAC held $100 million in cash, how did the working capital become so depleted by yearend? How did the SHFS end up with over $39.7 million in negative retained earnings at December 2022 requiring the complete restructuring of the transaction with CPCU?
Below are some excerpts from these documents. The story is complex. There is not a single narrative point of view as the filings show different elements of the financials in various footnotes.
I have selected some to illustrate the information available. There is both quantitative and qualitative (business risk factors) information provided.
One positive note that may bode well for the future is that Safe Harbor’s web site and links are one of the most comprehensive examples of transparency I have reviewed. The stock valuation information is detailed both currently and historically. All of the required SEC and financial reports can be accessed on line at SHFS website.
On its investor relations page the firm makes this commitment: Safe Harbor Financial (Nasdaq: SHFS) seeks to enhance shareholder value not only through exceptional business performance and practices, but also through responsible and effective communication with its shareholders. The latest company information relevant to the individual and institutional investor includes stock price and history, upcoming events and presentations and financial documents. Safe Harbor Financial trades on the Nasdaq under the ticker symbol SHFS.
That is an example credit unions should totally embrace as well.
(emphasis added)
From Note 3, the Business Combination detailed in Note 1 above was accounted for as a reverse recapitalization, with no goodwill or other intangible assets recorded, in accordance with GAAP. Under this method of accounting, NLIT (the SPAC) was treated as the acquired company for financial reporting purposes. Accordingly, for accounting purposes, the Business Combination was treated as the equivalent of SHF issuing shares for the net assets of NLIT, accompanied by a recapitalization.
For tax purposes, the transaction is treated as a taxable asset acquisition, resulting in an estimated tax basis Goodwill balance of $44,102,572, creating a deferred tax asset reported as Additional Paid-in Capital in the equity section of the balance sheet as of the date of the business combination.
In November, 2022 SHFS acquired Abaca together with its proprietary financial technology platform in exchange for $30,000,000, paid in a combination of cash and shares of the Company.
The November press release stated: the acquisition increases Safe Harbor’s customer base to include more than 11,000 unique depository accounts across 40 states and U.S. territories; adds Abaca’s fintech platform to Safe Harbor’s existing technology; increases Safe Harbor’s financial institution client relationships and access to balance sheet capacity to five unique financial institutions strategically located across the United States ; increases Safe Harbor’s projected monthly revenue by approximately 40%; increases Safe Harbor’s lending capacity; and nearly doubles Safe Harbor’s team, adding to the existing talent pool of the cannabis industry’s foremost financial services and financial technology experts. (note 4 10-Q provides the fair value presentation for the transaction page 20)
Page 20 in the 10-Q shows what NLIT’s fair value assets it offered to support the $185 million CPCU purchase valuation. The key point is that $80 million was held in shares subject to possible redemption and the remaining cash of $19 million was held in trust.
It is not clear how many common A shares were redeemed, or how the money in trust was used. The result is that at December 2022 SHFS had only $8 million in cash and negative working capital (current assets less current liabilities) of $39 million.
The details of the restructure of the $185 million for CPCU was reported on March 23, 2023. Page 26 shows that exchange of debt for common stock resulted in $38.4 million for issuance of common shares. These are subject to a Lockup agreement restricting their sale.
Also CPCU acquired a first lien on all of the company’s assets as a result of the restructure. SHFS issued a five-year Senior Secured Promissory Note (the “Note”) in the principal amount of $14,500,000 bearing interest at the rate of 4.25% and a Security Agreement pursuant to which the Company will grant, as collateral for the Note, a first priority security interest in substantially all of the assets of the Company.
Contributing to the loss in 2022 from note 17 Forward Purchase Agreement page 35:
The trading value of the common stock combined with preferred shareholders electing to convert their preferred shares to common stock triggered a lower reset price embedded in the forward purchase agreement, or FPA. As of December 31, 2022, the Company had already called a special meeting to lower the make-whole price under the preferred share purchase agreement to $1.25/share. . . These events significantly reduced the FPA receivable to approximately $4.6 million, from approximately $37.9 million reported at the end of the September 2022 quarter. The loss in value resulted not only in a compression of the balance sheet, but also $42.3 million charge to other expense on the statement of operations in the fourth quarter of 2022.
At March 30, 2023, SHFS’s balance sheet shows negative retained earnings of $47 million offset by $91 million of additional paid in capital from the restructure of the $180 million initial terms and other stock transactions.
81% of SHFS’s March 2023, $89 million assets are $19 million in goodwill, $10.2 intangible and a deferred tax asset of $42.6 million.
On year ago I described the announcement that Colorado Partner Credit Union (CPCU) had arranged to sell its wholly owned CUSO (Safe Harbor), specializing in cannabis banking, to a Special Purpose Acquisition company (SPAC), or publicly traded company.
Serving the cannabis business has been a priority for some credit unions in states where the sale is licensed for several years. This past week credit union leaders and trade associations announced their continued support of changes in federal law to allow all financial institutions to serve the trade-which is now legal only on a state by state basis.
“CUNA said it supports the Secure and Fair Enforcement (SAFE) Banking Act, a bipartisan bill introduced in both chambers in April that would provide a safe harbor for financial institutions serving legal cannabis businesses.-from CU Today.
CPCU was to receive $185 million for selling its CUSO, $70 million in cash and $115 million in stock. Sundie Seefried – who created Safe Harbor cannabis business while the credit union’s CEO– would be the CEO of the new public company (NASDAQ: SHFS).
An immediate result of this September 28, 2022 closing was PCCU reporting a $55 million net income and an 8.7% ROA for the year ending December 2022.
This extraordinary gain occurred even as SHFS reported a $35.1 million loss for the year ended December 2022, compared to net income of $3.2 million in 2021. This result was described as “primarily due to the loss in value of several of the financial instruments placed in connection with the Business Combination.”
SHFS’s December 2022 balance sheet position resulted in the following “going concern” comment by auditors:
Liquidity and going concern
As of December 31, 2022, the Company had $8,390,195 in cash and net working capital of ($39,340,020), as compared to $5,495,905 in cash and net working capital of $5,922,023 at December 31, 2021.
Included in the working capital deficit at December 31, 2022 is $25,973,017 current portion of the long-term payable owed to the seller, PCCU, from the aforementioned business combination, and $14,359,822 deferred consideration current portion related to the Abaca acquisition. The Company has also incurred a significant cumulative consolidated operating loss for the year ended December 31, 2022.
Based upon these factors, management of the Company has determined that there is a risk of substantial doubt about the Company’s ability to continue as a going concern for a period of at least twelve months from the date these consolidated financial statements have been issued.
In the March quarter of 2023 CPCU reversed much of the 2022 gain on Safe Harbor’s sale resulting in a $41 million loss. The credit union’s net worth ratio between the two quarter ends went from 20.9% to 14.7% as of March 2023. Its total assets were $699 million which included new subordinated debt of $3.1 million and notes payable of $27.5 million.
The loss was due to a restructuring of the sale terms for CPCU as described in an SEC filing and company press release:
On March 29, 2023, the Company and PCCU entered into a definitive transaction (Refer to Note 22, “Subsequent Events,” of the consolidated financial statements) to settle and restructure the deferred obligations, including $56,949,800 into a five-year Senior Secured Promissory Note (the “Note”) in the principal amount of $14,500,000 bearing interest at the rate of 4.25%; a Security Agreement pursuant to which the Company will grant, as collateral for the Note, a first priority security interest in substantially all of the assets of the Company; and a Securities Issuance Agreement, pursuant to which the Company will issue 11,200,000 shares of the Company’s Class A Common Stock to PCCU.
This restructure was driven by the SHFS’ financial position. CPCU is now the majority owner of voting stock (55%) and CEO Douglas Fagan is on the SHFS’s board.
On Tuesday SHFS reported its first quarter earnings with an 8-page press release. The financial results show revenue of $4.2 million, operating expenses of $5.8 million and an operating loss of $1.6 million.
The release also provides operational highlights and a 2023 financial outlook. During all of SHFS’s nine years building the cannabis business, CPCU has been the primary banking partner. This means revenue from all the deposits, loan funding and investment returns are shared with the credit union under a services agreement detailed in the company’s SEC filings.
Credit Union and banking partners are key to SHFS’s business model. As descried on the website, the firm is a “financial technology company, not a bank. Banking services are provided by contracted NCUA or FDIC insured financial institutions. Some non-deposit products and services are not covered by FDIC or NCUA.”
On May 11, 2023 SHFS announced another partnership with Five Star Bank in New York that it said will add up to $1 billion in additional deposit capacity. SHFS plan is to scale the business.
SHFS’s future is uncertain.
The firm’s stock price is reported daily on its website. The stock’s value since the “business combination” has declined from a peak of just over $10 to yesterday’s close of $.38. The total market capitalization of the company has fallen from over $300 million to $15.7 million at yesterday’s close.
However, SHFS is not alone in its extended financial condition.
SHFS’s public offering via a SPAC transaction was a way to truncate the time, expense and investor scrutiny of a traditional public offering (IPO). As reported in an April 27 WSJ article, SPAC’s Are Running Out of Money.” The story’s lead reads: ”The SPAC boom took hundreds of risky companies to the stock market. The next stop for many is bankruptcy court.”
The article’s implication is that the SPAC process to take a private company public, may short cut a more rigorous traditional IPO due diligence and valuation process.
Another external factor could also be important. SHFS is the front end, or entry platform, for cannabis related businesses accessing financial services. The following is SHFS’s business value proposition: Our services allow Cannabis Related Businesses (herein referred to as “CRBs”) to obtain services from financial institutions that allow them to run their business more efficiently and effectively with improved financial insight into their business and access to resources to help them grow.
Due to limited availability of payment and other banking solutions for the cannabis industry, most businesses transact with high volumes of cash. Our fintech platform benefits CRBs and financial institutions by providing CRBs with access to financial institutions and financial institutions access to increased deposits with the comfort of knowing that those deposits have been compliantly monitored and validated. . .
A recent WSJ news story suggest that Legal Cannabis Can’t Compete because licensed sellers are facing steep taxes and regulation. In states like California (and New York) the article reported unlicensed sales were almost eight times licensed sales.
In many states cannabis began and still is an underground business. So even when either federal or state authorization is achieved, suppliers may wish to retain their business anonymity.
Tomorrow I will analyze what some of the learnings credit unions may take from this the effort to “spin off” this credit union created business to become a publicly traded company.
How did cash decline so quickly following the combination? How dependent is the CPCU on SHFS’s business?
The details of SHFS’s history from SEC filings for this transaction and subsequent updates offer, I believe, instructive insights for others who may harbor similar ambitions.
With all the daily news about pending crisis– debt ceilings, immigration reform, banking failures, and numerous other government responsibilities– I believe it is time for some perspective.
Two engineers were standing at the base of a flagpole, looking at its top. A woman walked by and asked what they were doing
“We’re supposed to find the height of this flagpole,” said Steve, “but we don’t have a ladder.”
The woman took pliers from her purse, loosened a couple of bolts, and laid the pole down on the ground. Then she took a tape measure from her purse, took a measurement, announced, “21 feet,” and walked away.
One engineer shook his head and laughed, “A lot of good that does us. We ask for the height and she gives us the length!”
Both engineers have since quit their jobs and gone into government.
Decades ago, radio broadcaster Paul Harvey provided millions of listeners his unique blend of news and views. After reporting an important event he would often promise to tell “the rest of the story” but only after an advertising break.
The member testimonial below from Affinity Credit Union, Des Moines, is used in TV commercials and social media to illustrate their efforts for personal service with members.
This two-minute story of a real member going from near bankruptcy to an 800 FICO score is very effective, even moving.
(https://youtu.be/0PXPcuGnAkc)
But there is more to the story. James Reasoner, the member in the video, is a recovering alcoholic. Several times he refers to making poor decisions, but stays silent about the context.
About two decades ago he woke up in a jail cell after a second DUI arrest. Something happened in the cell. He describes it as a spiritual awakening resulting in an effort to change his life.
James says of this decision, “It all started with a little trust and lots of hope.”
Today he attends daily 7:00 AM sessions with his mentor. In turn he mentors other alcoholics both in person and during Covid, on zoom. He speaks at periodic recovery meetings while still working at the Firestone tire plant where he is in his 28th year of employment.
His credit union relationship has also evolved beyond this video testimonial.
Last week at the members’ Annual Meeting James was elected to an initial three-year term on the board. Below, in the middle, he raises his hand with fellow volunteers while taking the director’s oath.
The Affinity video is more than an advertising promotion. It is comparable to a public service announcement. It illustrates this credit union’s efforts to respond to a member’s unique circumstances.
Beyond the video’s specific example, there is an even broader impact. It is also the back story of a relationship experience that motivated James to give back more of himself to others.
What a powerful witness for economic democracy when a long-time member volunteers for credit union leadership!
The video’s universal message is that “every member has a story.” When we listen, that’s when we can truly serve them.
(Note: Personal story of James Reasoner used with permission. Thanks also to Misty Haley, who was James’ helper. She was recognized for 26 years of service at this year’s Affinity Annual Meeting. )
Earlier this week I spent three days with Affinity Credit Union. I was invited to speak at their Annual Members meeting. This would be my first live, in- person speech in years, to a credit union with which I had no prior connection.
I asked to come a day early to learn about why this $140 million, 74-year state charter in Des Moines, IA wanted me to speak. The CEO’s response was simple: I want you to see what we do. In other words, for me to learn.
I accepted. In later posts I will share some of the things I experienced. But one event was totally unique. I had never seen it in my 45+ years with credit unions. It is an example that other credit unions should consider.
The members’ meeting began at 5:30 with a buffet dinner for the over 200 people in attendance. The agenda was long running, from “A” to “Q” in the outline given with the Annual Report. There were three speeches by outside guests (I was one), six high school scholarships presented, recognition of three employees who had passed twenty-five years each in service all before the business portion of the meeting.
At the conclusion of the business meeting, the Chair Cindi asked all the newly elected and continuing directors to stand for their oath of office. The oath was administered by a former chair and director. He read the phrases and they would repeat together following him.
The oath begins with the words “do solemnly swear” and included the following commitments:
I will diligently, faithfully honestly and impartially perform the duties imposed upon me by the bylaws
I will not knowingly violate. . .any of their provisions
I further swear that I will. . .properly discharge the duties of any office or committee to which . . .I am appointed
I will not discuss the affairs of this credit union or any of its members wit anyone except credit union officials
I will give all possible assistance to any person who may succeed to any office which may hold. .
The nine directors stood together at the front of the room, hands raised, repeating the oath in unison before their families, friends and hundreds of members and guests. An important and solemn moment of a public commitment to their fellow owners and community.
As I had never heard about this happening in credit unions, I asked how it became a part of the Annual Meeting. Was it required in the bylaws? By their state charter? By some other tradition?
The practice had been followed long before the current leadership team was in place. Even prior to the former director and chair who administered the oath this year. He recounted:
It was given long before I got on the board. I was told that it was because it was swearing an oath to the local 310 members (the credit union’s original union chartering group at the Firestone plant) that they would take care of the credit union when it was members and family only. Local 310 still swears an oath to protect our brothers and sisters to respect and do no harm with actions or pen.
Unfortunately, in today’s environment not every union member thinks it’s necessary to swear an oath to watch out for each other. So it probably goes all the way back to the lunch box (when the credit union was chartered in 1947.) That lunchbox symbolizes a resource created by workers, for workers, that feeds families, futures and trust.
Vows, oaths or formal swearing ins are rare in organizations today. Perhaps when joining a church (statement of belief) or wedding vows or perhaps a pledge such as when joining the Boy Scouts.
There is however one universal practice where an oath is administered, when a person joins the military or becomes a federal employee. The constitution requires the practice as explained in this article:
The reason is simple – public servants are just that – servants of the people. After much debate about an Oath, the framers of the U. S. Constitution included the requirement to take an Oath of Office in the Constitution itself. Article VI of the Constitution says, “The Senators and Representatives before mentioned, and the Members of the several State Legislatures, and all executive and judicial Officers, both of the United States and of the several States, shall be bound by Oath or Affirmation, to support this Constitution . . .;
The author states the intent: One purpose of the Oath of Office is to remind federal workers that they do not swear allegiance to a supervisor, an agency, a political appointee, or even to the President. The oath is to support and defend the U.S. Constitution and faithfully execute your duties. The intent is to protect the public from a government that might fall victim to political whims.
As volunteers, directors are often seen as an eleemosynary activity, an act of charity. Therefore the demands of a director should not be the same as in a formal, paid position of responsibility.
This characterization is even noted in federal legislation as recently as the Membership Access Act in 1998. In setting the new PCA reserve requirements, the legislation directed that the NCUA consider the volunteer nature of credit union leadership when imposing capital standards.
I believe that an annual oath taking in front of members and community, would not only be good practice, but honor and enhance the tradition of credit union volunteer leadership. The requirement could be made a standard part of the bylaws, which is the governing document, as noted in the oath above.
As a public event following the business meeting, it formalizes their accountability to the members whose authority has elected them to their positions.
Most critically the oath taking represents a transparent commitment to one of the most important tenents of cooperative design: the democratic member voting process. It reaffirms the trust members expect and are properly owed by their elected directors.
If you would like to receive a full copy of the Affinity Oath, contact Kris Laufer at klaufer@affinitycuia.org.