Uber and Taxis: Competitors or Partners?

The first question Hawaiian League President Dennis Tanimoto asked following my zoom speech to a conference in late November, had nothing to do with my talk. It was about an event two years earlier at NCUA.

His question: Do you think NCUA’s sales of the taxi medallion loans was a fortuitous decision?

NCUA had announced the sale pf the medallion borrowers’ loans on February 19, 2020 to Marblegate Asset Management LLC a hedge fund specializing in buying “distressed assets.’

I called the sales of these 4,500 loans a betrayal of the borrower-members in a post four days later. NCUA refused multiple FOIA requests for information the board claimed to have used when approving the decision. The cash payment for the portfolio’s book value I estimated at 31 cents per $1 from numbers in a WSJ article.

Marblegate received the discounted loans, NCUA got cash, the NCUSIF (credit unions) were charged for the difference ($700-800 million) and the borrowing members, nothing. Just more payments, at the loans’ remaining value.

NCUA’s McWatters said the agency would follow up to make sure the “winning bidder works with the taxi medallion loan borrowers in a transparent, good-faith manner and in full compliance with all applicable consumer protection laws.”

McWatters is gone. No such efforts were reported. NCUA declined multiple FOIA requests to provide the documents used in their decision. One month later, March 2020, Covid closed down the economy and with it virtually all transportation needs.

I assumed that was the context for the question. Did NCUA in retrospect make the right decision?

My response had two parts. The first was from whose point of view was it fortuitous? NCUA’s in exchanging cash for assets of uncertain value in the insurance fund? The borrowers, who were hit by the economic shutdowns? Marblegate, the purchaser?

I also responded that any assessment depended on what period of time you evaluate the outcome ? Here’s why.

In early November 2021 an agreement between the city, taxi owners and Marblegate was reached as reported in the press:

NYC taxi workers celebrate after medallion debt relief agreement reached; hunger strike over

Under the new agreement, Marblegate will restructure existing loans to a principal of $200,000, with $170,000 as a guaranteed loan and the remaining $30,000 as a grant from the city and a 5% interest rate. The restructured loans will be on a 20-year plan with scheduled monthly payments, which will be capped at $1,122 for “eligible medallion owners.” The city has said they will act as a guarantor for the principal and interest — a longtime demand of the NYTWA — and will negotiate with other lenders to work out the same agreement.

The bailout applies to owners of fewer than three medallions. For those, Marblegate has gained an earning asset worth at least $200,000. This consists of a New York city guaranteed loan for $170,000, a $30,000 cash payment, and a fully collateralized earning asset at 5% for 20 years.

NCUA refused to disclose any details about the portfolio’s sale, but a Wall Street Journal article suggests the loans were sold at an average price between $75 to $100,000.

If accurate, Marblegate doubled their money in about 18 months while earning some interest and principal pay downs on top of this in the meantime.

These borrowers now have a reasonable opportunity to pay off their loans and own the medallion outright.

Only NCUA and credit unions are left with no upside. The NCUSIF loss remains fixed at $750 million in return for $350 million in cash earning 25 basis points (.25%) for assets with a face value of over $1.1 billion.

The hedge fund owners, not the members, received the benefit of this discounted loan sale.

The NCUSIF underwrote the deal in which the Wall Street purchaser more than doubled their money while putting member-borrowers’ fates in the hands of the same for-profit firm.

Credit unions had asked to manage the portfolio on behalf of borrowers, the industry and NCUA. McWatters response: The agency carefully considered a proposal for a public-private partnership to purchase the loans; however, with a firm offer already in-hand and no assurance when, if ever, the proposed partnership might be able to act, the agency could not risk losing its qualified bidder.

Credit unions have seen this picture before. It is direct from the corporate credit union playbook. The industry was denied the chance to resolve its problems as NCUA sought Wall Street financiers to take the responsibility off their hands.

Why Review This Decision Now?

Credit union and NCUA can learn how ignoring options can cost hundreds of millions in recovery potential when selling at the bottom of a market. NCUA continues to miss out on the critical advantage of cooperatives when resolving problems.

Cooperative structure allows time and patience so better options can be developed as markets change and cycles of value recover. As Warren Buffet noted:

“The true investor welcomes volatility. A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly.” (emphasis added)

But if we extend the window out farther, might taxi owners still lose the “solid business” battle and the medallion ownership still remain devalued?

The competition in the on-demand public ride and delivery market is intense. Taxis are in a market disrupted by UBER/Lyft, among others. Can medallion owners compete with these billion dollar unicorns, venture-backed technology platforms relying on hundreds of thousands of gig workers to produce revenue?

One long time CEO medallion lender said the issue will be decided by the drivers, not institutional financial power. He suggested a way to think about the future is to ask: if given a choice between being an owner or an employee, which option would you choose?

UBER’s Yearend Financial Report

His question resonated as I reviewed the latest Uber financial updates as of December 31, 2021.

Uber’s mission statement is now generic, not just ride share: “to create opportunity through movement.” The following are some operating and financial highlights from the report:

Cannabis pick-up: Announced an exclusive partnership with Canadian cannabis retailer, Tokyo Smoke, to provide consumers with the ability to place orders from Tokyo Smoke’s catalog and unique accessories on the Uber Eats app. Tokyo Smoke is the first cannabis merchant to list itself on the Uber Eats platform.
Membership: Officially launched Uber One in the U.S. in November as our single cross-platform membership program that brings together the best of Uber. For $9.99 per month, members have access to discounts, special pricing, priority
Monthly Active Platform Consumers (“MAPCs”) reached 118 million: MAPCs grew 8% QoQ and grew 27% YoY to 118 million.

While interesting examples of the firm’s operating efforts, UBER has never made a profit and accumulated total operating losses of $23.6 billion.

From the company’s unaudited December 31, 2021 Balance Sheet

Accumulated deficit: $23.6 billion

Stockholders equity: $14.5 billion (total stock issued $38.6 billion)

Goodwill as an asset: $ 8.4 billion

Loss from operations in 2021: $3.834 billion

And one of UBER’s latest innovations to reach profitability?

Uber Taxi

Local taxis at the tap of a button

No need to try to hail a taxi from the curb. Request a ride from your phone with Uber Taxi.

Licensed, local taxi drivers
Pay with cash or card
Track your ride

That’s right, they now want to partner with the taxi drivers in various cities. I clicked on the button to see if any of the over 100 cities listed included a taxi option. I could not find an example. Or maybe they are just trying to hire the drivers, and lure them to abandon the quest to own their own medallion.

So if you can’t beat them, why not join them?

One further thought with this taxi partnering effort. To whom do you think Marblegate will try to sell their fully performing, guaranteed 3,000 to 4,000 medallion loans, to make another quick gain on the restored book value? UBER still holds over $4.0 billion in cash.

February 14, 2022February 14, 2022

O Black and Unknown Bards

The author of this poem is perhaps best remembered as the composer of Lift Every Voice and Sing, often referred to as the black national anthem.

This 8 minute version by the students at Pearl-Cohn entertainment magnet high school in Memphis is a very contemporary arrangement with rap.

Weldon’s poetic spirit is combined with his love of music in the stanzas below calling out spirituals.

For me spirituals have a wholly different feeling than most other music. When sung, they are communal, emotional and revelatory. They tell of hope or longing. And they invite everyone into the experience.

This poem celebrating these songs from the soul was published in 1922.

O Black and Unknown Bards

by James Weldon Johnson – 1871-1938

O black and unknown bards of long ago,
How came your lips to touch the sacred fire?
How, in your darkness, did you come to know
The power and beauty of the minstrel’s lyre?
Who first from midst his bonds lifted his eyes?
Who first from out the still watch, lone and long,
Feeling the ancient faith of prophets rise
Within his dark-kept soul, burst into song?

Heart of what slave poured out such melody
As “Steal away to Jesus”? On its strains
His spirit must have nightly floated free,
Though still about his hands he felt his chains.
Who heard great “Jordan roll”? Whose starward eye
Saw chariot “swing low”? And who was he
That breathed that comforting, melodic sigh,
“Nobody knows de trouble I see”?

What merely living clod, what captive thing,
Could up toward God through all its darkness grope,
And find within its deadened heart to sing
These songs of sorrow, love and faith, and hope?
How did it catch that subtle undertone,
That note in music heard not with the ears?
How sound the elusive reed so seldom blown,
Which stirs the soul or melts the heart to tears.

Not that great German master in his dream
Of harmonies that thundered amongst the stars
At the creation, ever heard a theme
Nobler than “Go down, Moses.” Mark its bars
How like a mighty trumpet-call they stir
The blood. Such are the notes that men have sung
Going to valorous deeds; such tones there were
That helped make history when Time was young.

There is a wide, wide wonder in it all,
That from degraded rest and servile toil
The fiery spirit of the seer should call
These simple children of the sun and soil.
O black slave singers, gone, forgot, unfamed,
You—you alone, of all the long, long line
Of those who’ve sung untaught, unknown, unnamed,
Have stretched out upward, seeking the divine.

You sang not deeds of heroes or of kings;
No chant of bloody war, no exulting pean
Of arms-won triumphs; but your humble strings
You touched in chord with music empyrean.
You sang far better than you knew; the songs
That for your listeners’ hungry hearts sufficed
Still live,—but more than this to you belongs:
You sang a race from wood and stone to Christ.

February 13, 2022February 12, 2022

A Prayer on Sunday Morning

Praying is a mysterious human activity. It can be experienced in many ways.

Sometimes more happens than listening to words whether said aloud or thought silently. There can occur moments of new awareness.

My internal concerns are intwined with a greater reality. In that larger space beyond our ego’s view, we find meaning. Perhaps purpose. Maybe a feeling referred to as Thou.

Last Sunday listening to a broadcast service and the morning prayer, I was moved.

The minister lifted the daily events we all share into greater hope.

Reading words apart from their live context may not be as poignant. I believe these below are worth a moment of your attention.

Prayers of the People

God in our future, we come before you each week reminded that we are not as we wish to be, reminded that we do not yet live in the world you desire. We pray each week, “Thy kingdom come.”

Free us from our illusions that we are separate from other people, from the earth, and from you. Teach us a new way. Let us hear the old lessons one more time. Call us into your work, together.

God in our past, we bring with us today all the hurts we carry and all the hurts we caused. Help us, in our own time, to put them down. Show us what we need to heal. Give us the courage to mend what we have broken.

Remind us that we have more to give the world than the worst things we have ever done. Let us be humble enough to think ourselves worthy of your presence. Deliver us from our false notion that anything we could do could make us any less deserving of grace, of care, of forgiveness, of redemption.

God in the news cycle, God in the aftermath, be with all those in crisis this morning. Keep watch over hospital rooms and under bridges. Bear divine witness on borders and in prison cells. Carry your people into another day when their burdens are not so heavy and their hope does not seem so far.

God in history repeating itself, God in unprecedented times, strengthen all those who try to help; who work in sixteen hour shifts to turn the power back on, who hold the hands of those who suffer, who cry out for accountability and against injustice. Let all of us who are inspired by and indebted to their courage also find it within ourselves to do what is right, to help where we can.

God in our midst, you see your church and you know who is missing. You search our hearts and you know whom we are missing. This morning, we lift up the blessed memories of those this community has lost. We lift up Sally Hansen. We lift up Howard Kay. We lift up Vincent Lee. We lift up Jim Roche. We lift the names of all who dwell in our hearts. Strengthen their memories in each of us. Let all who were touched by their lives carry their legacies always. Grant all of us – those who are grieving and those who are gone – peace.

Thank you, God.

Amen.

Harvard Memorial Church – Sunday, February 6, 2022 by Cheyenne Boon, MDiv II

February 11, 2022February 16, 2022

Three Strikes and RBC/CCILR Should Be Out: Failing the Test of Comparability

My earlier posts described how NCUA ignored two of the three explicit criteria in the PCA law when imposing RBC/CCULR rules on credit unions.

Before looking at the third constraining feature, “comparability,” there is a procedural violation in NCUA’s actions. The agency’s Federal Registration filing for CCULR and amended RBC was December 23,2021; the act took full effect on January 1, 2022.

The PCA act directs how these changes are to occur:

Adjusting net worth levels -Transition period required

If the Board increases any net worth ratio under this paragraph, the Board shall give insured credit unions a reasonable period of time to meet the increased ratio.

Credit unions were given 9 days to comply with CCULR’s 29% increase (from 7% to 9%) to attain a well-capitalized rating.

The Third Criteria for PCA Implementation

At its core, NCUA has only one explanation for its new RBC/CCULR joint rules:

Harper: The final rule is a balanced approach that gives complex credit unions a risk-based capital framework comparable to those developed by other federal banking agencies.

The combined rules’ minute details and hundreds of risk weightings are explained with multiple variations of one idea: “to ensure comparability with the banking industry.”

Nowhere is comparable defined.

If comparable means “the same as,” credit unions’ 10.6% net worth ratio at December 2021 already exceeds either banks’ core capital leverage ratio of 8.86% or equity capital ratio of 10.06% as reported by FDIC in their September 30 quarterly report.

Must credit unions now reduce their capital level to be comparable to banks’ average?

Obviously not. NCUA’s intent is that credit union net worth be measured with the exact same accounting details as the bank’s follow. Except banks have many more capital options for the numerator.

The rule’s 70+ risk weighting formulas, and multiple variations, applied to credit union assets were lifted directly from the banking model.

The rule duplicates bank regulations at every point even though the asset composition and financial roles of the two systems are drastically different.

This literal interpretation of comparable accomplishes one goal—NCUA now controls credit unions with the same power bank regulators enjoy. This should be no surprise as Chairman Harper has repeatedly praised FDIC bank regulation as the de facto standard he intends for credit unions and the NCUSIF.

This approach was followed ignoring the two system’s different histories, legislative purpose, financial design and most importantly, financial performance.

What did comparable mean when Congress mandated this new cooperative capital standard in 1998?

For 90 years credit union capital adequacy was based on a flow concept, setting aside a required percentage of total income before dividends, rather than a balance sheet, net worth ratio, measured at points in time. This new ratio standard was significantly different from credit unions’ prior practice of building reserves over time as a percentage of total income.

The Act explicitly required NCUA to “design the system, taking into account” the not-for-profit cooperative structure which cannot issue capital stock and relies only on retained earnings for reserves. When requiring a balance sheet ratio test versus a set aside from revenue, NCUA’s process must consider the listed differences in reserve structure and even the board volunteer composition.

The second change under PCA for credit unions is in a different section of the act:

d) Risk based net worth requirement for complex credit unions.

The agency is directed to include ” a risk-based net worth requirement for insured credit unions that are complex.”

Banks have no call out for complex. Risk based weightings are universal for all banks.

The new coop PCA model required a risk-based factor (weighting) for a defined set of complex situations which “take account any material risks against which the net worth ratio . . . may not provide adequate protection.”

These words clearly establish a different PCA model for credit unions than required of banks.

Cooperative PCA standards are clearly intended to be different. To assert that comparable means to duplicate, copy or be the same as banks practice is a misinterpretation of the Act.

Twisting a Law Reducing Burden to Impose a New Regulation

The most recent example of this misinterpretation of NCUA’s authority is Chairman Harper’s description justifying the CCULR option proposed by NCUA in July 2021, five months earlier.

Harper: We must, however, also recognize several legislative, regulatory, and marketplace developments since the NCUA Board approved the final Risk‑Based Capital Rule in 2015. For example, in 2018, Section 2001 of the Economic Growth Regulatory Relief and Consumer Protection Act directed the other federal banking agencies to propose a simplified alternative measure of capital adequacy for certain federally insured banks. The result of that effort became known as the Community Bank Leverage Ratio framework which became effective in January 2020.

There is a supreme irony citing President Trump and the Republican-sponsored Main Street Relief Act, to reduce regulation burden. Then to expand its application to NCUA’s rule making authority over credit unions.

Here is a summary of the reference Harper cited:

Title II Regulatory Relief and Protecting Consumer Access to Credit

Section 201. Capital Simplification for Qualifying Community Banks. This section requires that the Federal banking agencies establish a community bank leverage ratio of tangible equity to average total consolidated assets of not less than eight percent and not more than 10 percent. Banks with less than $10 billion in total consolidated assets who maintain tangible equity in an amount that exceeds the community bank leverage ratio will be deemed to be in compliance with capital and leverage requirements.

There is no mention of NCUA anywhere. NCUA had not even implemented RBC when the bill was signed in May 2018. There was no basis for credit unions to ask for regulatory relief from a rule not in effect and deferred three times at that point.

The congressionally enacted CCULR option was a banking industry effort for an alternative to a flawed and burdensome RBC rule. FDIC’s vice chair Thomas Hoenig had been a long standing vocal critic of RBC.

Further evidence that this section 201 did not include NCUA is that NCUA is specifically named in two other parts of the bill that explicitly provide regulatory relief for credit unions:

Section 212. Budget Transparency for the NCUA. This section requires the National Credit Union Administration to publish and hold a hearing on a draft budget prior to submitting the budget.

Section 105. Credit Union Residential Loans. This section provides that a 1- to 4-family dwelling that is not the primary residence of a member will not be considered a member business loan under the Federal Credit Union Act.

To claim NCUA’s authority for CCULR, Harper refers back to the 1998 PCA bill. He then uses the “comparability” reference to presume authority in a bill passed twenty years later and in a section specifically omitting any reference to NCUA .

The result of this newly found authority is to increase credit unions’ restricted capital. As stated in the Board memo: ”The Board believes that a CCULR of nine percent is appropriate because most complex credit unions would be required to hold more capital under the CCULR framework than under the risk-based capital framework.”

A False Narrative

NCUA was not given CCULR authority. It is a false narrative permeating RBC/CCULR that credit unions’ rules can exactly copy bank rules.

This duplication-interpretation overlooks the two-decade reality that credit unions were fully compliant with their PCA risk based net worth (RBNW) model and repeatedly surpassing banks in financial performance under it.

The staff perpetuates this duplicating justification in its board memo: A special note that most, if not all, of the components of the CCULR are similar to the federal banking agencies’ CBLR.

The Consequences of Unconstrained Regulation

There are immediate and long-term unfortunate consequences when authority is improperly interpreted and asserted. This erroneous RBC/CCULR precedent will undermine the credit union system’s unique role and diversity, directly contrary to PCA’s intent to respect cooperative character.

It sets an example of agency interpretation independent of fact, statutory language and prior compliance precedent.

Board Member Hood pointed out this long-term risk in his December board comments:

We now have (PCA compliance) with our risk-based network requirement. This law gives this board serious responsibilities which we must faithfully uphold, but this does not mean that since the bank regulators established a risk-based capital regime, we must follow them.

I actually worry that once we decree that 7% may no longer be adequately capitalized, then whether it’s this board or a future board that settles on an 8%, 9%, 10% net worth in the complex credit union ratio, as some say in North Carolina, the barn door is now open to that interpretation or that change.

I worry that we may have set an arbitrary standard above the law that a future board can easily change at any time.

There is much more at stake from RBC/CCULR than approximately $30-40 billion of forced sequestration and newly required credit union capital. And the rule’s faulty legal standing.

The central issue is whether the NCUA board is willing or able to support the continuing evolution of a unique cooperative financial system in its regulatory actions.

February 10, 2022February 10, 2022

CCULR/RBC Unconstrained by Statute: An Arbitrary Regulatory Act

The new RBC/CCULR rule must meet two administrative procedural tests, as any other rule, when NCUA claims to be implementing a law. The first was outlined yesterday: Was there substantial objective evidence presented to justify the rule?

As I described, NCUA presented no systemic data or individual case analysis whatsoever. In fact, the credit union performance record shows an industry well capitalized and demonstrating prudent capital management over decades.

In the December board meeting Q&A , staff confirmed that in the last ten years, only one failed credit union would have been subject to RBC. But today 83% of the industry’s assets and 705 credit unions are now subject to its microscopic financial requirements.

The second test is whether the rule conforms to Congress’s legislative constraints when giving this rule making “legislative” authority to an agency. The PCA law was very specific in this regard when extended to the credit union system.

NCUA’s PCA implementation must meet three tests: that it apply only to “complex” credit unions, “consider the cooperative character of credit unions,” and be comparable to banking requirements.

NCUA had already passed these PCA implementation tests before. In 2004 GAO reviewed NCUA’s risk based net worth (RBNW) implementation of the 1998 PCA requirement and concluded:

The system of PCA implemented for credit unions is comparable with the PCA system that bank and thrift regulators have used for over a decade. and,

. . . available information indicates no compelling need. . . to make other significant changes to PCA as it has been implemented for credit unions.

At that time the risk based capital (RBC) requirements had been in place for banks since 1991.

Today NCUA’s new RBC/CCULR rules clearly fail all three of these constraining criteria.

A “Simple” Interpretation of “Complex”

NCUA 2015 RBC rule declared that the complex test include all credit unions over $100 million. After the full burden of the rule was apparent, in 2018 the board changed complex to mean only credit unions over $500 million in assets.

Some credit unions clearly undertake operational activities or business models that are more involved than what the majority of their peers might do.

Examples could include: widespread multi-state operations, conversion to an online only delivery model, lending focused on wholesale and indirect originations, high dependence on servicing revenue, using derivatives to manage balance sheet risk, funding reliant on borrowed funds versus consumer deposits, innovative fintech investments, or even the recent examples of credit unions’ wholesale purchases of banks.

The agency did not define “complex” using its industry expertise and examination experience to identify activities that entail greater risk.

Instead, it made the arbitrary decisions that size and risk are the same. In fact, most data suggests larger credit unions report more consistent and resilient operating performance than smaller ones.

In changing its initial ”complex” definition by 500%, it demonstrated Orwellian logic at its most absurd. Complex turns out to be whatever NCUA wants it to mean, as long as the definition is “simple” to implement.

Universal for Banks; Targeted for Credit Unions

For banking PCA compliance, RBC was universally applied. Every bank must follow, no complex application was intended.

By making size the sole criterion for “complex” the board reversed the statute’s clear intent that its risk-based rule be limited in scope and circumstance when applied to credit unions.

The absurdity of this universal, versus particular, definition is shown in one example. The rule puts $5.6 billion State Farm FCU, a traditional auto and consumer lender with a long-time sponsor relationship, in the same risk-based category as the $15.1 billion Alliant, the former United Airlines Credit Union. Alliant has evolved into a branchless, virtual business model with an active “trading desk” participating commercial and other loans for other credit unions.

NCUA’s “complex” application of the PCA statute is totally arbitrary based on neither reason nor fact.

Capital design: the most important aspect of “Cooperative Character”

The PCA authority additionally requires that the Board, in designing the cooperative PCA system, consider the “cooperative character of credit unions.” The criteria, listed in the law are that NCUA must take into account: that credit unions are not-for-profit cooperatives that:

(i) do not issue capital stock;

(ii) must rely on retained earnings to build net worth; and

(iii) have boards of directors that consist primarily of volunteers.

The single most distinguishing “character” of credit unions is their reserving/capital structure. Virtually all credit unions were begun with no capital, largely sweat equity of volunteers and sponsor support.

The reserves are owned by the members. They are owed to them in liquidation and even partially distributed, in some mergers.

These reserves accumulate from retained earnings, tax exempt, and are available for free in perpetuity-that is, no periodic dividends are owed. Many members however can receive bonuses and rebates on their patronage from reserves in years of good performance.

Most products and services offered by credit unions are very similar to those of most other community banking institutions. The most distinctive aspect of the cooperative model is its capital structure, not operations.

Cooperative Capital Controlled by Democratic Governance

This pool of member-owner reserves is overseen by a democratic governance structure of one-member one- in elections. The reserves are intended to be “paid forward” to benefit future generations. This reserving system has been the most continuous and unique feature of cooperative “character” since 1909.

This collective ownership forms and inspires cooperative values and establishes fiduciary responsibility. Management’s responsibility for banks is to maximize return to a small group of owners; in coops the goal is to enhance all members’ financial well-being.

This capital aspect of the cooperative charter is so important that if credit union management decides to convert to another legal structure, a minimum 20% of members must approve this change. No other financial firm has the character of a coop charter with its member-users rights and roles. Not even a mutual financial firm.

Bank’s Capital Structure Very Different from Cooperatives

For banks, capital funds are raised up front, usually from private offerings or via public stock. Owners expect to profit from their investments. Dividends are paid on the stock invested as part of this anticipated return. Today shares represent about 50% of total bank capital. In credit unions, it is zero.

Bank capital stock, if public, can be traded daily on exchanges. The market provides an ongoing response to management’s performance.

This capital is not free as most owners expect a periodic dividend on their investment. As an example, in the third quarter of 2021, the banking industry distributed 79% of its earnings in dividends to owners.

There is no connection between a bank’s capital owners, and the customers who use the bank, unless customers independently decide to buy shares in the bank. In credit unions, the customers are the owners.

The remaining component of bank capital is retained earnings. However, every dollar of earnings before added to capital, is subject to state and federal income tax. Credit union retained earnings are the only source of reserves as noted in the PCA act. These coop surpluses accumulate tax free.

In design, accumulation, use and governance credit union reserves are of a totally different “character” than bank capital. Their purpose is to support a cooperative financial option for members and their community.

Bank capital is meant to enrich owners through dividends and/or future gains in share value. Credit unions’ collective reserves are to benefit future generations of members.

Credit unions are not for profit. Banks are for profit.

In a capitalist, private ownership dominated market economy, the cooperative’s capital structure is the most distinctive aspect of credit unions. This is not because of its amount or ratio. It is its “character,” from its origin, perpetual use and oversight by members.

Nothing in the CCULR/RBC rules recognizes this especial “character” of credit union capital. By not addressing this issue, the rule ignores this constraint of the PCA enabling law.

The historical record demonstrates that credit union reserves are not comparable to bank capital. Rather they are a superior approach tailored to the cooperative design.

Tomorrow I will look at the third test, whether RBC/CCULR conforms to the PCA’s requirement of comparability.

February 9, 2022February 16, 2022

RBC/CULR: The Most Destructive, Unsupported Regulations Ever Passed by NCUA

(Source for quotes below: the December 16, 2021 NCUA board video: https://www.youtube.com/watch?v=zstCJgfdYTM)

In two prior blogs I outlined several problematic aspects of the new CCULR/RBC rules:

The instant implementation, nine days after posting, raising the “well capitalized” standard by 29% on January 1, 2022
The immediate imposition of three capital tests replacing one, long-standing, easy to understand 7% leverage ratio. The RBC tools are not yet available for credit unions to know where they stand.
The inane rationale justifying CCULR as a regulatory “off ramp” from the admitted draconian compliance burden of RBC
Imposing additional capital requirements in the $ billions on credit unions below the new 9% standard
Restricting credit unions’ use of their reserve buffers, created over decades, above 7%. If every CCULR eligible credit union elects this 9% well capitalized minimum, they must sequester over $26.8 billion in spending for member benefit. To regain control, they must submit to RBC.
The abrupt disruption of long approved credit union plans by these new financial constraints
The financial downgrade of hundreds of credit unions from their previous “well capitalized” net worth standing

Combining RBC/CCULR in one package is the ultimate regulatory hubris. NCUA’s new higher capital requirement, was to mitigate the extraordinary burden of the RBC. Both remain. As Board member Hood commented: The RBC rule is so tragic, that yes, it needs an off ramp.

Only a myopic, closed bureaucracy, completely indifferent to its impact on credit unions, could create such a convoluted compliance outcome.

Never in the history of NCUA has so great a regulatory burden been imposed on so many credit union members with such groundless reasoning and data.

The Absence of Substantive Objective Data

When implementing a statutory requirement as NCUA claims to do with these intertwined deformities, the federal administrative procedure process requires there be substantial objective data to support the action.

The legal principle is simple: if the government is going to restrict the choices people are making under their own agency, then the regulation must document the harm either taking place or to be prevented. In this case ,the issue is the credit union system’s safety and soundness. One board member stated the regulatory requirement in December this way:

Rodney E Hood: The framing of the issue today is really about capital adequacy and if credit unions have shown through history that they have sufficient capital to serve member-owners while facing various risks.

Have the financial outcomes of credit unions failed to meet NCUA’s safety and soundness standards prior to this?

NCUA presented neither past failures nor current inadequacy to support these increased capital changes. Credit unions’ track record since the implementation of PCA in 1998, following the RBNW (risk-based net worth) rule, is one of increasing safety and soundness even during the peak of the Great Recession.

Unnecessary, Unjustified and Unneeded

For 110 years credit unions’ reserving results, in good years and bad, have proven prudent, adequate and responsive to changing market risks.

In the traumatic GDP drop during 2020’s first quarter’s national economic shutdown (the largest fall on record) and the subsequent multiple economic uncertainties due to COVID, the NCUSIF recorded zero net cash losses in both 2020 and 2021.

Credit unions achieved record two-year share growth, increasing levels of capital, and even stronger performing loan portfolios during this unprecedented crisis.

Throughout the last two decades credit unions have maintained a reserve buffer of over 300 basis points above the required well capitalized 7% standard, as pointed out by Vice Chairman Hauptman in his comments about the rule. The following chart shows the capital levels during these two decades, including the years of the Great Recession.

Only One Credit Union Failure in the Last Ten Years Would Have Come Under RBC

The most critical fact about why the rule is unnecessary was given by staff in response to a question by board member Hood.

Rodney E. Hood: . . . what have been the largest five losses to the Share Insurance Fund over the last ten years, and what were those losses to be specific?

Kathryn Metzker (staff): When reviewing credit union losses of natural person credit unions in the last — I actually looked back about ten years . . .The risk-based capital framework would only apply to one of the (five) failed institutions as mentioned earlier, one credit union over $500 million as the remaining four have assets less than the complexity thresholds.

Earlier in the dialogue, she identified the additional capital requirement shortfall under RBC in this one case as $77 million.

Hood’s other comments on the rules are illuminating and cogent:

After serious study and consideration, my preference is to consider repealing the RBC rule outright and fine tuning our existing risk based net worth rule.

The reality is that RBC should be a tool and not a rule, and if it is effective in identifying risk, then it should be put in the examiner’s toolbox.

But the last thing I think the NCUA should do is impose it on credit unions as an operating model. The juice isn’t worth the squeeze for risk-based capital, because this is a regulatory burden with what I believe is limited benefit.

I think risk is something that you manage each and every day. It’s not a formula you can run on your balance sheet.

Chairman Harper’s Defense of CCULR

Chairman Harper is the author of this action. He asserts that RBC/CCULR is required under his interpretation of the PCA statute. To defend his support of a 9% CCULR minimum versus his original 10% proposal, he cites Goldilocks and the Three Bears’ logic.

Harper: Our biggest decision in finalizing this rule was at what level to set the CCULR. In reaching a consensus, we looked at the lessons of the famous children’s story. Some wanted the leverage ratio to be 8%. I view that as too soft. I wanted the final CCULR level to rise over time and reach 10%, a level that others considered too hard, so we compromised and permanently set the CCULR at 9%. That ratio turned out to be just right. While lowering a credit union’s capital risk‑based compliance requirements, CCULR actually increases the system’s capital buffer.

The RBC complex burden was so clear even to NCUA that it proposed the CCULR “off ramp.” The 9% “just right” number was selected because the Board did not want to make it too easy “to move between the two capital options” or what it called “the potential for regulatory arbitrage between the two frameworks.”

From both a macro and a micro data perspective, there are no facts to support raising the credit union system’s capital requirements. The RBNW approach with the long standing 7% minimum required by PCA and has proven sufficient time and again.

The absence of objective data is important for future corrective action. Once this rule becomes embedded in NCUA and credit union actions, there could be reluctance to give up this expanded financial comfort cushion, no matter how damaging to members it might be in the meantime.

A Fast-Burning Fuse of 500+ pages of rules

Both in substance and process these rules are an extraordinary and unprecedented immediate regulatory burden.

The rules were approved with a short burning fuse of just 9 days. If the 10% standard in the proposal had been adopted, it would have been with a two-year phase in. But 1% lower, no phase-in needed.

There was no recognition that the only source of credit union capital is retained earnings which are only built up over time. There was no crisis or need for immediacy. RBC was first proposed in 2014, seven years earlier.

RBC/CCULR is a failure of regulatory discretion and judgment. NCUA’s RBNW rule had been in effect for over 20 years. It embraced limited certainties from observed experience.

The new rules present unlimited certainties about every asset’s potential risk. These risk weightings are projected into the indefinite and unknowable future. It did so ignoring all “substantive objective evidence” of the cooperative system’s capital adequacy and sound performance under the existing RBNW.

February 8, 2022February 16, 2022

TheDisruptive Costly Reach of CCULR/RBC: $30-$40 Billion For Initial Compliance & No longer Available for Members

The direct immediate impact of the new CCULR/RBC rule requires credit unions to hold between $30 to $40 billion more in reserves. These funds cannot be used for daily operations such as expenses to increase member value or lower fee income or loan rates.

A major portion of these newly restricted funds is in credit unions that follow the 9% CCULR minimum required reserves versus the RBC option. The $24.3 billion CCULR “off ramp” means these funds are unavailable for operations but required to stay in reserves.

This is from the December 16, 2021 Board Action Memo:

Of the total 680 complex credit unions as of June 30, 2021, 473 have a net worth ratio greater than nine percent and would be well capitalized under a nine percent CCULR standard. Of those 473 credit unions, the Board estimates that all of them meet the qualifying criteria, and are thus eligible to opt into the CCULR framework.

Under the CCULR, if all 473 credit unions opted into the CCULR and held the minimum nine percent net worth ratio required to be well capitalized, the total minimum net worth required is estimated at $111.8 billion, an increased capital requirement of $24.3 billion over the minimum required under the 2015 Final Rule. This additional capital would strengthen the system’s ability to absorb any future financial losses and economic shocks.

(Note: the 493 credit unions over $500 million and 9% net worth or greater, held $1.340 trillion in assets at yearend 2021. Therefore, when NCUA raised their net worth well capitalized requirement from 7 to 9%, the rule placed a total of $26.8 billion in restricted retained earnings. These extra funds are no longer available for credit unions to use as they choose-or else lose their CCULR option.)

The Disruptive Spread of the New Red Line

The new rule in theory applies only to the 83% of credit union assets with over $500 million. However, this 29% higher CCULR option will not be available to approximately 210 credit unions with $386 billion in assets. Before this rule they were considered “well capitalized.” And only three of the 210 would have been below the 7% well capitalized level.

All now fail the revised “well capitalized” ratio. The immediate regulatory sanction is to subject them to RBC, an entirely different more complicated process under the never implemented rule.

All these, 24% by assets (30% by number), of this $500 million class are in an RBC never-never land of capital measurement. However the immediate impact is much broader than these 210 below the new 9% red line.

RBC’s Shadow Extends Beyond 9%

Every credit union over the 9% threshold is now on notice that any short term run-up in assets could result in their ratio falling below this new minimum.

As an example, there were 70 credit unions between 9 and 9.35% net worth at yearend. Any time their asset growth exceeds the capital growth, the ratio will fall.

Historically, the highest amount of share growth occurs in the first two quarters. If a credit union has 9.3% at the beginning of a month and grows 3% in assets, the net worth ratio falls to 9.0% by month end.

Since capital increases only through retained earnings, at an average of 1% of assets per year, every credit union between 9 and 10% faces a dilemma: either limit growth or increase ROA by amounts above traditional returns.

There are 173 credit unions in the 9-10% net worth range that will be in a state of unending compliance uncertainty as their ratio moves up and down in monthly variations.

CCULR’s Shadow Hovers Over Those Below $500 Million

Many credit unions below $500 million must now closely monitor their growth and capital because when they cross this size threshold, the old 7% well capitalized rating no longer applies.

An example: At 2021 yearend there were 119 credit unions in the $400-500 million asset segment. They managed $52.7 billion in assets. Forty-five of these, with $20 billion in assets, reported net worth below 9% and would not be CCULR eligible when passing $500 million.

Assuming this entire segment grows by the industry’s long-term average of 7%, then 13 credit unions with $465 million assets (or higher) at January 1 this year will be over the $500 million threshold by yearend. They must monitor and calculate three capital measures simultaneously: the current 7%, the new 9% CCULR minimum, and failing that, the arcane rabbit hole of RBC.

An estimate of the total number of these three groups of credit unions that must immediately put net worth at the top of their business priorities is over 502, holding approximately 35 to40% of total industry assets.

This sudden new financial priority will turn upside down established business plans, pricing initiatives, and investments in new service capabilities.

Credit unions are being forced to turn away from serving their members to complying with NCUA’s needs.

To this point in time, the industry’s average 2021 yearend capital ratio of 10.6% would be evidence of prudent capital management. That ratio is 360 basis points (3.6%) above the long standing well capitalized 7% benchmark. (see buffering discussion below) Financial uncertainty now permeates every business decision where there was none before.

The Tens of Billions Taken Away from Member Value

It is the members who will pay the cost.

To comply with this new capital standard, credit unions have two broad options. First, closely limit all growth. NCUA’s habitual approach to capital restoration plans is to require “downsizing” of assets to fit the available capital.

The second option is to ask members to pay more: no more over draft or other fee reductions, higher loan rates, or accept lower savings than would be the possible under the long standing 7% standard.

If the choice is downsizing, fewer members will be served with fewer loans and services. If the choice is to require members to pay more, the direct additional costs are easy to calculate.

The 210 credit unions not in compliance with the 9% CCULR minimum, are collectively $2.7 billion short of capital under the new standard. That shortfall assumes no growth in assets. Before the 7% benchmark was eliminated, these credit unions collectively maintained a margin of 1.31% above that old standard.

For these 210 with the $2.7 billion shortfall, setting a net worth goal just 1% above the 9%, would require another $3.9 billion. This $6.6 billion total for more capital just repositions them relative to where they were under the old standard.

How easy is this to accomplish? In 2021 the entire movement grew total capital by 6.7% to $221 billion. The $6.6 billion more to exempt these 210 credit unions from RBC requires an increase of 21% in their current net worth. This is roughly three times the growth rate of capital in the industry. And that assumes these 210 have no asset growth while they are building this new capital level.

Total Business and Financial Disruption Costing Members Tens of Billions

The other 292 credit unions above $500 million in the 9-10% net worth range, and the 119 credit unions in the $400-$500 million below the new red line, will face similar challenges to their business model. For example, in the $400 million plus segment, 45 are below 9% now by a total of amount of $195 million.

All these 502 credit unions face the same urgency of modifying previously approved business plans. Now they must either limit growth or charge members more. Either choice is done at the members’ expense.

Before this apocalyptic rule took effect, at yearend 2021 only six credit unions in the $400 million and above category were below the 7% well capitalized standard. And five were considered “adequately capitalized.”

By changing the rules of the game overnight, NCUA has created a perception of financial weakness. At the same time the regulator has prevented credit unions from using literally tens of billions in existing reserves in the manner boards think best to compete in the market. These funds were prudently set aside for the proverbial rainy day. But now are restricted from use.

The cooperative system has been called to a financial halt by NCUA. It reputation has been turned upside down in member and public perception in a mistaken effort to make credit unions appear safer.

The outcome will be just the opposite. The rule’s complexity and RBC uncertainty will just cause more sound, long serving credit unions to throw in the towel.

Capital is not and has never been the critical component of credit union success. It is the resilience of leaders. It was the founders’ passion that began these enterprises with no capital.

This newly imposed costly regulatory burden will lead current volunteers and professionals to feel they can no longer make the critical business decisions about how to best serve their members.

The government-NCUA-has now asserted by rule, that they know more than credit union’s leaders about how to manage business decisions.

Appendix: The Buffering Mentality Will Raise the Member Costs Further

The $30-40 billion cost estimate in new capital requirements does not include the credit unions “normal” buffering behavior. Here is how Vice Chairman Hauptman raised the issue at the December board meeting.

Kyle S Hauptman: And we do know that . . .they keep a buffer of 3% right now, a little over 3%. Do you have any reason to believe they will not continue to keep a buffer of around 3% in the future?

Tom Fay(staff): I don’t think I could estimate that, Vice Chair.

Kyle S Hauptman: Okay, well, we can agree they do, now, have a ratio. All I’m trying to say is, when we say oh, no, this isn’t going to affect somebody because most of them, you know, if you already have 9.5%, you’re in the clear, but we already know that they like to have a buffer.

So, I think we just need to acknowledge that based on the way the credit unions operate, that being just above 9% does not mean you’re in the clear to meet our 9% CCULR because we know that they want to have a buffer for the reasons you just eloquently said. . .

. . we shouldn’t be doing this without acknowledging that we are making credit unions hold substantially more capital because they’re going to have a buffer.

You think it’s good to have a buffer; so do I. We are raising the standards for credit unions. I just think we need to be clear about that. We shouldn’t be disingenuous to say, oh, no, look how many of them have over 9%. They should be fine with CCULR.

Well, we already know they have a buffer, so there’s no reason to think the operations of the credit unions will suddenly change; and we are raising capital for the vast majority of these because they will have — that number of 10.2%, at least for those subject to RBC and CCULR. I’m happy to bet you that that number will go up because of what we are doing today.

February 7, 2022February 7, 2022

NCUA’s Apocalyptic New Year’s Surprise for Credit Unions

On December 23, 2021, NCUA filed a new rule, RBC/CCULR, in the federal register. It took full effect just 9 days later on January 1, 2022. This rule is the most consequential ever passed by NCUA, and the most damaging.

The change immediately affects 83% of 2021 yearend credit union assets.

Using a purported rationale of improving the safety of the system, the rule will result in the opposite outcome. It significantly handicaps the ability of credit unions to make decisions about how best to serve their members using their own experiences and judgments.

This catastrophic new burden will accelerate the merger of sound, well-run credit unions approaching the $500 million starting line for CCULR/RBC. It will energize this culling of hundreds of successful medium-sized local institutions now facing an overnight fundamental change in compliance burden.

The New Year Shock

Credit Union 1, Rantoul, Illinois, wins the award for the first credit union to publish its full 2021 Annual Report including year-end financial data and ratios.

The President’s Report by Todd Gunderson, CEO, contains the following upbeat assessment:

CU 1 loan portfolio growth was 15% as we extended $ 916 million in loans to our members throughout the year—an increase of 43%–and $276 million from the 2020 year. The additional loan interest income helped CU 1 achieve a record net income amount for the 2021 year, bringing net capital rate or our rainy-day fund up to 8.71% of assets. This keeps CU 1 well in excess of what regulators call a well-capitalized credit union, defined as 7% net capital.

CU 1’s total assets had increased to $1.226 billion or by 4.8%. At the same time, it raised its net worth ratio from 8.21% in 2020 to 8.71%.

Chair Bob Eberhert was equally proud of CU 1’s regulatory standing: “. . . our future . . .is about having the trust of membership by being a sound member-oriented financial institution that propels CU 1 to be awarded the highest rating that can be bestowed upon a bank or credit union by banking supervisory regulators.

These statements were accurate for exactly one day, December 31, 2021, when the books were closed.

CU 1 is the first of hundreds of credit unions that entered the New Year believing their past performance was at the highest standard. They will now find they are in a literal regulatory net-worth “no-man’s land” where no coop has ever been.

Enter Three Capital standards

Every credit union over $500 million in assets saw their minimum ratio for “well capitalized” raised from 7% to 9%, a 29% increase, on January 1, 2022.

No phase in, no transitions, no analysis of the consequences, and imposed despite no demonstrated need at the individual credit union or system level by NCUA.

From one simple, easy to compare century-long standard, these institutions are now subject to three interlocking capital requirements. These rules entail multiple options for calculating the numerator for “capital reserves” under the three standards.

The denominator, or “total assets,” now requires hundreds of specific math calculations as well as evaluating alternative methods. These factors include whether the asset is on and off the balance sheet, multiple time periods for determining “average” assets, and every asset’s relative risk calibrated precisely to a government mandated and calibrated formula.

The chart below presents this new tri-part capital era. The system has gone from the left column of clearly understood and applied net worth of 7% with five gradations, to the completely open-ended 500+ page-RBC/CCULR formulas and criteria.

A Direct Member Tax

The rule handicaps credit unions from spending money to lower fees (eg. overdraft charges), offer better savings or loan rates or even initiate critical programs such as cyber security or ESG initiatives.

Instead, this income must now be put into reserves where the amounts already set aside have proven more than sufficient through every previous financial crisis.

Every one of the 100 million plus members in a credit union subject to, or nearing this rule’s reach, will pay the direct costs of this regulatory tax in higher fees, lower savings or higher loan rates.

The members most affected will be those at the margin, with lower credit, just starting out after leaving school, or returning to the labor force; that is those traditionally perceived as higher risk.

Hundreds of Credit Unions Impacted

Hundreds of credit unions like CU 1 now find their “well-capitalized” regulatory standing downgraded overnight. From understanding and complying with a capital standard proven over 100 years, they are immediately thrown into a regulatory purgatory.

RBC/CCULR is a purgatory of changeable definitions and formulas in which every asset decision is now subject to a government-dictated risk rating.

Every credit union over $500 million in assets (83% % of total assets) can now be whipsawed between two different capital standards. NCUA reserved the authority to impose the capital model they want, regardless of the credit union’s choice.

No more respect for credit unions’ four-decade track record of demonstrated risk management honed in the marketplace since deregulation.

These two draconian rules of 500 pages are in effect now. No phase in, no transitions, no analysis of the consequences, and implemented with no reference to the actual capital soundness of the industry.

It is a regulator taking an action because it can. The traditional due processes and institutional checks and balances, at the board level, failed.

Uncertainty About Cooperative Soundness Undermines Public Confidence

The agency gave itself the authority to micro-manage every asset decision made daily by 5,000 credit unions. It is the most extreme example of an independent regulator asserting control over every aspect of a credit union’s operations.

This rule is the worst kind of regulatory putsch possible. It is an assumed authority run amok.

It throws the credit union system into a public relations debacle. For credit union leaders it creates a compliance wonderland of uncertainty about the rules of the game.

Will all CAMEL 1 rated credit unions below 9% now become CAMEL 2?

Will this incentivize the sale of subordinated debt with members paying the added cost of capital to be compliant?

How does anyone– the regulator, the members, the public– compare credit union performance with three very different ways of measuring “well capitalized”?

Will this intrusive regulatory grading of every asset decision override credit unions’ learned experience? And inhibit serving members and making investments required to stay competitive?

In upcoming posts I will show why RBC/CCULR is “the fruit of a poisonous tree.”

February 4, 2022February 4, 2022

Bon Mots IV-The Power of Local

“A place belongs forever to whoever claims it hardest, remembers it most obsessively, wrenches it from itself, shapes it, renders it, loves it so radically that he remakes it in his image.” Joan Didion

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Maurice Smith, CEO, LGEFCU: “What if credit unions could crack the code for sustainable, scalable wealth-creation for disenfranchised communities? It’s really anchored in the notion that we as credit unions should focus on the people who need us the most.”

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Linda Bodie CEO of Element FCU as reported by Denise Wymore:

Bodie: “I can offer a lot more products, services and solutions even though I’m small. There’s no reason to sit back and not do something because of your size. Size doesn’t matter … not when you have the power of a cooperative system.”

Denise: Here are the three things your credit union can learn from the team at Element FCU:

Bigger is NOT better. In spite of what our industry is obsessed with.
Live the 6th cooperative principle: cooperation among cooperatives to gain economies of scale. There are alternatives to mergers if we just work together!
Stay loyal to your brand and your target. Make your competition irrelevant by doing something that your competitors WILL NOT copy.

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Notre Dame FCU President/CEO Tom Gryp: “Our ability to pay above-market wages to our incredible partners (employees) is a direct reflection of the loyalty and support of our members. My deepest thanks go out to our growing membership base, who without their ever-increasing utilization of our services, none of this would be possible.”

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Jared Brock, self described author, PBS documentarian, and cell-free futurist podcaster; a “free market” sceptic on “what we desperately need right now:”

Invest in your community — IE, start a family business, co-operative, community-owned company, not-for-profit, for-benefit, or partnership with one or more competent entrepreneurs with complementary skillsets such as:

Local, sustainable, organic food producers.
Local, sustainable, organic hemp clothing manufacturers.
Geothermal, mini-wind turbine, and micro-hydro installers.
House renovators to transform aging units into ultra-efficient eco-homes.
Builders of owner-occupier-only houses, neighborhoods, and cities. (We need to build 750+ million houses in the next 28 years or three billion people will be living in slums in our lifetime.)
Experienced political operatives to fundraise and start new, pro-democracy, pro-sustainability, anti-corporate political parties.

The reality is that we need a generation to build companies that give instead of take, that contribute instead of extract, that cement communal stability instead of undermining its foundations.

I sometimes wish we could get rid of grow-forever corporations and move forward solely with local/regional companies and partnerships and co-ops and for-benefits.

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In The Speechwriter (2015), Barton Swaim remarks that South Carolina Governor Mark Sanford, whom he worked for, “knew bad writing when he saw it, except when he was the author.”

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Weekend listening, 5 minutes. Ancin Cooley, credit union consultant: “give someone else a shot at leadership before merging.” https://www.youtube.com/watch?v=pUWkTZe-sgg

February 3, 2022February 3, 2022

NCUA’s Merger Supervision is Failing Members

In the June 2018 merger rule update, the board action memo (BAM) outlined the circumstances requiring an updated regulation. The staff listed examples where self-dealing was rampant and decisions not made in the member’s interest.

This rule had been preceded by numerous press accounts of “credit unions for sale” and merger votes that were railroaded through with minimal notice to avoid any member opposition.

Any government intervention in the decisions made in a market economy should address failings that market action alone will not correct. The explanation that these mergers were just the “free market” at work, is not true.

Most credit union mergers are non-market transactions. They are negotiated privately between two parties, there is no bidding or competitive offers sought, and the member meeting and voting requirement is treated as a mere administrative formality.

Before the new rule, mergers of sound, long standing and successful credit unions were routinely benefitting senior employees, and members rarely presented with objective data of any superior benefits.

The Two Aspects of Due Process

The most fundamental step in a merger is the member-owners’ vote to approve or not the proposal of the board. The one member, one vote democratic governance is an integral part of cooperative design.

The new rule was to insure members were protected by a process which would allow them to make an informed decision in giving up their unique relationship and future direction to another institution.

The final rule’s requirements for this approval process had two different, but complimentary components:

Procedural due process prescribed the formal steps, timelines, documents and other requirements to give the member-owners the chance to vote;
Substantiative due process describes the kinds of information and options that credit unions were to consider and present to NCUA and members.

NCUA’s rule gave it authority over both aspects of due process. However in its oversight it has failed this second responsibility which was the primary reason for the rule’s update.

NCUA has supervisory approval on many aspects of credit union operations from initial chartering, changes in fields of membership, use subordinated debt and derivatives and in multiple other operational actions. For these the NCUA requires detailed plans, financial projections, and proof of the capacity to carry out the requested action in a manner that will keep the members’ interests safe.

In these many operations NCUA requires credit unions to thoroughly document their policies and goals. Except for one action: giving up the charter.

In the vast majority of formal member merger notices there is little specific detail. Instead, rhetoric about scale and competition, better service and sometimes a listing of added locations, is the norm.

The actual merger agreements submitted along with the certification of the vote are single paragraphs. Just a statement of intent or transfer all assets and liabilities to the continuing credit union. There are no plans.

NCUA posts all the Member Notices, along with approved member comments here.

Mergers have become an administrative rubber stamp with no effort to verify the reasons or assertions of inability to serve members in a competitive manner.

By rule NCUA must review the minutes of both parties for the prior 24 months to learn what work has been done by the boards to reach their conclusion to enter into merger. The applicants must send:

Board minutes for the merging and continuing credit union that reference the merger for the 24 months before the date the boards of directors of both credit unions approve the merger plan

Presumably a reviewing examiner would look at the discussions, forecasts, options to learn if the member owners interests were in fact considered. And how. What outside expertise was consulted?

This is the same supervisory process established for the changes in power or activities described above. One presumes, for example, it is the same detailed review of requests to purchase whole banks.

Best Interests of the Member

The 62 page merger rule BAM provided multiple reasons for NCUA’s substantive, not just procedural review, of mergers:

“The Board acknowledges, however, that not all boards of directors are as conscientious about fulfilling their fiduciary duties . . .

The Board confirms that, for merging FCUs, the NCUA’s regional offices must ensure that boards and management have fulfilled their fiduciary duties under 12 C.F.R. § 701.4 to:

Carry out his or her duties as a director in good faith, in a manner such director reasonably believes to be in the best interests of the membership of the Federal credit union as a whole, and with the care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances;
The duty of good faith stands for the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act with a conscious regard for their responsibilities as fiduciaries.

“Several commenters suggested . . .that the NCUA’s role is limited to safety and soundness concerns. These comments are inaccurate. . .

“the statutory factors the Board must consider in granting or withholding approval of a merger transaction include several factors related to safety and soundness, such as the financial condition of the credit union, the adequacy of the credit union’s reserves, the economic advisability of the transaction, and the general character and fitness of the credit union’s management. . .

The net worth of a credit union belongs to its members. Payments to insiders, especially in the context of a voluntary merger where a credit union could choose to liquidate and distribute its net worth among its members, are distributions of the credit union’s net worth. . .

“. . the fact that ownership of a portion of a credit union’s net worth is less negotiable than a share of stock in a public company is irrelevant at the time of a proposed merger transaction. A credit union in good condition has the option of voluntary liquidation instead of voluntary merger. . .

The Board agrees that mergers should not be the first resort when an otherwise healthy credit union faces succession issues or lack of growth. . .

The rule’s procedural requirements were to protect the members: The revised member notice will also clearly convey how the proposed merger will affect access to locations and services. These changes give members greater ability to assess whether the proposed merger is in their best interests.

NCUA stated that its authority in mergers was comparable to its authority over credit union conversions to banks, mergers with banks or with non-NCUSIF insured credit unions: Applying all portions of the merger rule to all FICUs conforms to the approach the Board has taken in these other regulations promulgated under the same authority in the FCU Act.

Member Best Interests

NCUA has outsourced its responsibility for the asserted future member benefits to the continuing credit union. However it has no process for validating whether this has occurred. It routinely accepts generalized assertions about “a wider range of products and services, benefits of scale, and improved technology” as if these are merely routine operational upgrades.

One simple way would be to examine how many members remained active with the continuing credit union one year later. What happened to those relationships, along with the merged members’ equity?

Yet in situations where credit unions have made multiple mergers, there is no evidence NCUA has assessed the member impact when the new merger requests are presented.

NCUA is not responsible for the respective judgments of the boards about whether to merge. However it is responsible that when the requests are submitted that the plans, alternatives, financial projections and planned organizational changes were completed with professional thoroughness and thought. That is, with substantive due process.

This is the same process for most NCUA approvals. But that process appears missing in mergers. NCUA takes years and hundreds of pages of documentation and projections to award a new charter whose benefits will be far into the future.

It requires no such effort for a credit union board and CEO to give up a charter and its accumulated member relationships and goodwill built over generations. And the requests appear processed quickly, approved within weeks of submission of the required member notice.

The standard for a common sense review of any merger request and documentation should be: Are the transparency and plans sufficient to enable a member, with reasonable capacity and interest, to make an informed decision?

If the review of minutes, plans and forecasts do not support the decision to give up the charter, then NCUA should ask the credit union to meet its fiduciary responsibilities of loyalty and care and resubmit before sending Notice to the members.

Members are led to believe this supervisory due diligence has taken place when receiving the Notice of Members Special Meeting. There is rarely any evidence of this supervisory due diligence did occur. Most member Notices wording suggest just the opposite.

Congress is Interested in Mergers

In a recent hearing Senator Warren attacked banking regulators for their routine approval of mergers.

“Community banks being gobbled up. The market is being dominated by big banks. There is more concentration, higher costs for consumers, and greater systemic risk, and it is happening in plain view of the federal agencies whose job it is to keep our communities safe.

“The FDIC has a searchable database of all merger applications received since 2013, and there have been 1,124 such applications. Out of those, how many has the FDIC denied? The total number of denials for any reason whatsoever?”

“It’s zero. This is not just a problem at FDIC. The FDIC, Federal Reserve and OCC combined have not formally denied a single bank merger in 15 years.

Merger review has become the definition of a rubber stamp and the banks know it, and it’s time for some changes. Just saying we’re going to get tougher on this is not likely to dissuade anyone, especially billion-dollar banks.

“This has turned into a check the box exercise where the outcome is predetermined.

“Our regulators have a job to do and it’s our job here in Congress to make sure they do it,”

Credit UnionMergers are Not Like Banks

There is a difference however between bank mergers and credit unions. As one CEO observed:
Maybe the biggest difference and advantage, unfortunately, to the cooperative CU model these days is that the management can exploit the assets for its own self-interest without effective check…as opposed to the for-profit banks who are rigorously (often ruthlessly!) and transparently scrutinized by the marketplace.

With no market discipline and regulatory neglect, credit union mergers have become enterprises for extracting personal benefit.

This story is an example of how regulatory failure can result in the members’ interest compromised by self-dealing by the CEO’s of the merging and continuing credit unions.