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War Stories or How Creative Leaders Save Credit Unions: Part 1

“History is not the past. History is the present. We carry our history with us.” -James Baldwin

From 1978 through 1982, the US economy went through a financial wringer.

The precipitating event was the rise in oil prices that threw all 20th century assumptions about financial markets into doubt.

Double digit inflation and interest rates arrived at the end of the decade. They were the components of Reagan’s misery index which he used in the 1980 campaign to characterize the incumbent President Jimmy Carter’s economic results.

The Impact on Credit Unions

Credit unions were struggling mightily in this unprecedented interest rate environment. Most states and federal credit unions had a 12% usury loan ceiling in the law. Likewise, FCUs and most state charters were limited by regulation as to the rates they could pay on savings. These limits were based on long standing market assumptions that were being upended.

The balance sheet management problems were acute. Member savings were flowing out the door to money market mutual funds which passed to consumers the rising market rates. As rates soared to double digits, mutual funds and other securities such as Treasuries which paid these unprecedented rates, were draining {disintermediating} the accounts of insured depository institutions.

The cooperative systems liquidity safety net, the CLF had just been passed by congress but was still in formation. Credit unions were not eligible to join either the Fed or the FHLB systems. The Corporate network was still coming together and did not yet have a strong point of focus subsequently brought by US Central.

Moreover, both loans and savings accounts at credit unions were much simpler than several decades later. Savings were in a regular (passbook) account or short-term CDs. No share drafts. Most loans were short term unsecured personal or auto borrowings.

But the most pressing problem was that a number of large credit union balance sheets were loaded down with long term, fixed rate securities, primarily GNMA 8’s. These were mortgage backed investments offered at 8%, a yield no one ever expected rates on short term savings to exceed. The spread seemed locked in. Yet in the late 1970s overnight rates were in double digits. All fixed income securities market values were under water, and there seemed to be no way out of the interest rate (income) squeeze and the liquidity challenge, except failure.

Into this economic maelstrom stepped a 32-year-old, former First Lt in the US Army who left in 1970. His first civilian experience was managing an investment portfolio and retail branch for an S&L during this time of rising rates from 1973-1978.

His First Turnaround of the 5th largest FCU-In his words

In December 1978, a lawyer friend asked me if I would apply and interview for Eglin FCU’s (EFCU) Investment Director. At the time EFCU was the largest financial institution in Fort Walton Beach.

What closed the deal is when FCU’s GM offered me $24,000 a year which was $2,000 more than I was making. However, I did not do any due diligence on the financials and or problems that led to the firing of the former CEO. Further, three years earlier they had built a four-story office tower, 100,000 sq. ft., with inland waterway access and a view of the Gulf of Mexico. Finally, in my former job as a banker we had to compete with EFCU’s 6% annual share dividend.

When I got to EFCU (age 32) I found that the $150 million asset CU, had $40 million borrowing as reverse repo using $50 million of Federal Agency MBS investments as collateral. $90 million of total loans and under $5 million of daily liquidity. The real liquidity kicker was EFCU had $100 million of unfunded future forward contracts to purchase GNMA’s or FNMA’s MBS.

As of January 1979, the market loss on the funded portfolio was approximately $10 million and the loss on the forward contracts were an additional $20 million. Note the mark to market pricing in January averaged 20% principal loss but by July 1979 this had increased to 35% of the par value.

July 1979 NCUA comes in and removes the General Manager and tells the Assistant General Manager that he had until year end to find another job. One month later, EFCU with the agreement of the Atlanta Regional Director hires an Alabama League Staffer, Jim Appleton. He and I then begin the back and forth with the Special Actions Examiner called John Ruffin (who later became an NCUA Regional Director).

In those days it was common that step one was to lower the share dividend, step two was to liquidate the “bad/underwater” assets. However, NCUA did not have any experience in dealing with liquidating long-term assets which had declined in value in a rising interest rate scenario.

The GM and I went to Washington and we pitched a unique Letter of Understanding and Agreement. Instead of selling out at the moment with the losses locked in, I crafted a workout plan. We would take the total of MBS on EFCU’s books plus the total of unfunded forward MBS and divided it by 30 months. That amount was the “required’ MBS sales per month. If market values declined 1% or more, we were required to sell 1.5 times the required sell. If market values rose 1% or more, we were allowed to sell ½ of the required sales.

With luck and favorable markets, I was able to liquidate all of the on-book investments plus the forward MBS contract and pay off the debt of the reverse repos by November 1980. Note we took capital losses but EFCU never went insolvent. Given the EFCU was the 5th largest FCU and one of the worst financially troubled NCUA insured CU; I had solved their investment and borrowing problem.

The Reward

Then I had an unexpected surprise, the General Manager told me since we no longer had any investments, he no longer needed my services but there was a Credit Union in Tennessee that was looking for a new GM.

But that is for another blog.

Footnote: At December 31, 2019 Eglin FCU served 121,309 members with 347 “full time equivalent” employees, $2.05 billion in assets and a net worth ratio of 12.3%.

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