NCUA CAMEL”S” Rating Goes Live on April 1, 2022

In the October 2021 Board meeting, NCUA approved adding an “S” to the CAMEL examiner rating system.

In announcing this action Chairman Harper stated: “The NCUA’s adoption of the CAMELS system is good public policy and long overdue. It will allow the NCUA to better monitor the credit union system, better communicate specific concerns to individual credit unions, and better allocate resources.”

The rule’s effective date is tomorrow, April 1. I have been critical of some agency actions in the past. But, this rule is imaginative, even revolutionary, in its implications.

However, its significance may have been lost do to the recently implemented RBC/CCULR, on January 1, with the first calculations due as of March 31. External events such as cyber alerts, the Ukraine war crisis, growing inflation and the run up of interest rates also divert attention.

Special Training for Examiners

The rule’s innovative “S” component required extensive examiner training. As announced in its 22-CU-05 March 2022 Supervisory letter: NCUA staff will receive training on how to evaluate the new ‘S’ component and the updated system. In addition, the training will be made available to state regulators’ offices, for those that elect to use the CAMELS rating system. There is also an industry training webinar planned for credit unions, which seeks to provide a greater understanding of the updates to credit union stakeholders.

Some credit unions may have missed the agency’s transparency efforts, so a brief summary is provided below.

The Imaginative “S” for CAMELS-A Seven Part Analysis

This innovative “S” approach will have significant benefits for all stakeholders—members, other credit unions, regulators, even the public. The questions include safety and soundness criteria that align with cooperative principles. The final ratings are fully comparable with every other credit union regardless of asset size.

Each of the seven “S” criteria are scored independently. These scores are then added for a Grand Total.

Part 1 is traditional. It reviews a credit union’s field of membership process and how open and valued members are. Market demographics and FOM strategy are assessed.

Parts 2 and 3 look at members’ financial participation, how capital is deployed for their benefit, and members’ involvement in credit union governance and volunteer roles.

Two critical safety and soundness factors are next. Part 5 reviews the credit union’s education and training for staff and members. It documents external certifications, degrees and recognitions earned (Best Place to Work). The cooperative section appraises the credit union’s role in CUSO’s and other organizations, such as fintechs, to build a stronger financial system.

The final section 7 reviews all aspects of a credit union’s Concern for Community. Community is more than geographic boundaries. It includes partnerships with organizations which “share common goals or opportunities and who choose to work together for everyone’s success.”

Objective, Comparable and Fully Transparent

The overall “S” 1 through 5 rating is determined by the Grand Total Score. As shown on page 11, a score of over 100 results in a CAMEL 1. The scores are intended to be shared industry-wide and can be posted in the credit union with the monthly financial statement.

In his March 5, 2022 Supervisory letter cited above, Chairman Harper encouraged dialogue:

The NCUA’s policy is to maintain open and effective communication with all credit unions it supervises. Credit unions, examiners, and regional and central office staff are encouraged to resolve disagreements informally and expeditiously.

As with any change in a supervisory approach, we understand credit unions and other stakeholders will have questions.

Long Overdue

This “S” addition breaks new ground. It is “long overdue.” A copy of the entire 11 page form with descriptions of each section and the individual scoring components is here. It is interactive and can be completed online now.

Achieving a high CAMEL”S” score should not be any burden for most credit unions. Service has been an integral part of the credit union model from the beginning.

Most importantly, the “S” highlights the cooperative difference. It documents how credit unions are poles apart from banks. I believe credit unions should applaud NCUA’s alignment of its examinations with credit union purpose.

For additional information, NAFCU has also posted this brief, more prosaic analysis of the rule.

March 30, 2022March 30, 2022

FOMO Business Decisions

One of the most common sales pitches in life is “hurry up and get this deal before someone else buys it.”

The Fear of Missing Out (FOMO) has many variations. For some it impels stocking up on toilet paper in a pandemic. For others it is a rush into NFT’s, crypto currencies, a meme stock or IPO offering. Home sales today are increasingly all cash offers, no contingencies-FOMO.

For the virtual generation, it is the sharing pictures on social media of a special meal or vacation adventures to stay in touch with peers-FOMO.

In credit unions, this tendency shows up most frequently in mergers and whole bank purchases. Both transactions are enabled by consultants, brokers and other experts who only get paid if a sale occurs. Creating a sense of urgency-FOMO- around each opportunity is part of the pitch.

This blog will focus on bank purchases. Many press announcements of another deal close with a momentum building observation such as: “The pioneer (arranger) for credit union purchases of banks, emphasized again that the speed of CU purchases of banks is quickening.” FOMO

FOMO Bank Purchases

A number of credit union bank purchases are repeat buyers. GreenState in Iowa during 2021 announced three bank purchases in a 12-month period. All were out of state and entering separate new markets. Three deals with different banks, requiring multiple system and cultural conversions all at once. To keep up with this purchased growth, the credit union has issued $60 million in subdebt to sustain its capital ratio.

Vystar’s purchase of Heritage Southeast Bancorporation, Inc. ( HSBI )is the largest bank acquisition by a credit union to date. HSBI is a holding company of three local community banks which together manage $1.6 billion in 22 branches across Southeast Georgia, through Savannah and into the Greater Atlanta Metro area.

To support this acquisition, the Jacksonville based Vystar just issued $200 million in subdebt to maintain its net worth ratio. The final closing has been postponed twice this year.

In early March he $2 billion Barksdale Federal Credit Union in Bossier City, La., agreed to buy the $74 million Homebank of Arkansas in Portland, Ark. Here are some details from the Credit Union Times story:

This is Barksdale FCU’s first bank purchase. Homebank was founded in 1908, employees 25 and has about 1,000 customers. The bank was issued FDIC Consent Orders in 2011 and 2019. The Bank reported a loss in 2020 of $419,000 and $50,000 in 2021. Capital is $7.4 million

In explaining the purchase which would seem to bail out the bank’s owners, Barksdale’s CEO stated: “We believe that the structure and policies we have in place with our operation will satisfy the consent order items.” One wonders what the members would think of this use of their funds.

The Risks in Bank Purchases

Buying whole banks at multiples of book value, or at prices much higher than recent market valuations, creates an intangible asset called goodwill. These are all cash purchases. The total member funds paid for the premium and net worth goes to the bank’s shareholders.

In almost every case, but especially in private bank purchases, there is very little transparency for members or analysts to evaluate how the decision will succeed financially. There is no expected ROI on the investment, nor business plans for achieving it. The incantation used is variations on the theme of scale.

In cases of very large transactions relative to the credit union’s assets (see Memphis-based Orion FCU’s efforts), or multiple acquisitions in a short time, or when the bank is underperforming, all of the normal risks are multiplied. Yet the actual outcome may not be known until years down the road.

A Former CEO’s Observations

I was copied on an email in which Jim Blaine, retired CEO of SECU (NC) highlighted some of the differences in community bank practice and credit unions. The dialogue began after a credit union member asked his impression of the $4.8 billion Summit Credit Union’s intent to buy the $837 million Commerce State Bank in West Bend Wisconsin. Here is a part of what Blaine wrote:

This is an example of the “other problem” floating around in CUs. As you’ll note, Summit is not merging, it is “acquiring” an investor-owned bank. First, it is illegal for a CU to own a bank charter, so actually Summit is acquiring only the assets/liabilities of the bank (the loans and deposits, the buildings, computers, etc but not the capital!)…and after doing so the bank charter is cancelled.

To judge the fairness of the deal, look for the acquisition multiple…usually quoted as some multiple of the the bank’s net worth (i.e. capital)…if the bank’s net worth is $100 million for example and Summit is purchasing the assets/liabilities for a multiple of “1.5X”then Summit will pay $150 million to the bank stockholders. (Paying 150% of the book value!!)

Just as with CU mergers, these bank “purchases” can be open to significant valuation variance. In an investor-to-investor transaction the owners on both sides scrutinize whether or not the deal is for “fair value”. With a CU there is not an activist group of shareholders to protest a bad deal. Not too hard to imagine an insider “wink and nod” transaction…in the example above that $50million excess might lead to some “flexible ethics” …certainly happened with the mutual S&Ls!

Many folks question both the viability of small banks and those branches! (ed. Commerce is the 32nd largest bank in Wisconsin) And besides in banking, customers are loyal to the individual banker, not the bank. The officers and directors at the bank will usually collect on the sale of the bank stock and then as soon as possible leave and take their book of business to another bank…and of course refinance away those loans the CU bought! On the deposit side, many of the larger deposits are tied to loan customers who will also leave. Lastly, all the bank customers have always had the chance to join the CU…and didn’t…what does that tell you about their future loyalty?

A Different Kind of Deal

Other acquisitions this year include the $2.8 billion Arizona FCU (AFCU) purchase of the $539 million Horizon Community Bank in Lake Havasu City; Georgia’s Own purchase of Vining Bank; and Robins Financial acquisition of Persons Banking company.

AFCU’s activity is somewhat more public in that some of the financial information is available. It appears the credit union is paying about twice book value. In the year before the sale was announced, Horizon’s holding company stock traded between $8.20 and $10.40 per share. The bank’s sale announcement projects shareholders should receive approximately $18.91 per share when finalized.

In addition to the factual circumstances Blaine cites in his comments, there are two other operational challenges. Are credit unions acquiring matured/declining banking businesses especially when recent market valuations are substantially less than the purchase price?

The conversion of a community bank’s clientele to credit union control entails an “identity transplant” both internally and in the bank’s market. How will the value of the acquired assets and liabilities be affected by this change?

Finally in several examples above, the credit union’s loan to asset ratios ranged from the low 40% to just over 50%. If the leaders are unable to deploy existing funds in loans to members, how will they be more successful buying bank assets?

The lack of transparency in these purchases, the absence of any financial projections or specific business tactics suggest these are events based on good intentions but limited operational planning.

One CEO explained his purchase this way: “We believe that quality growth and diversification is essential to continued success in our industry, and we intend to achieve it both organically and through mergers or acquisitions.”

This sounds like a strategy driven by FOMO, not member focus.

March 29, 2022March 30, 2022

Subdebt: The Fastest Growing Balance Sheet Account for Credit Unions

Outstanding subdebt (subordinated debt) for credit unions grew 51% in 2020 to total $452.1 million. In 2021 the increase was 109% and with credit unions reporting $938.9 million.

The number of credit unions using this financial option grew from 64 in 2019 to 104 credit unions at December 2021. The total assets of these credit unions was $96 billion or about 5% of the industry’s yearend total.

A Product with Many Facets

This financial instrument has many characterizations. Subdebt is reported as a liability, that is a borrowing, on the credit union’s books. But because of the structure of the debt, NCUA considers it to be capital when calculating net worth for RBC-CCULR and all low-income credit unions.

Subdebt can be sold to other credit unions as well as outside investors. Purchasers perceive it to be an investment, but technically it is a loan to the credit union which makes it as an eligible “investment” for credit unions to hold.

“A Watershed Moment”

Earlier this month Olden capital announced the largest placement yet: a $200 million borrowing sold to 41 investors including credit unions, banks, insurance companies and asset managers.

The process as described in the release required: The coordination of a team that included leaders from the credit union, investment bankers, lawyers, other consultants and service providers. . . Olden labelled it “a watershed moment, notable for its size and breadth.”

Certainly considering size that is an accurate statement. This one placement exceeds 40% of the total of all 2021 debt issuance. Credit union demand is certainly picking up and more intermediaries are getting into the business to arrange transactions.

Olden did not name its client, although the purchasers were aware that it was Vystar Credit Union.

Why the Rapid Subdebt Growth?

This borrowing is a form of “Buy Now, Pay Later” capital for credit unions. The terms of the debt are generally ten years with no repayment the first five, and level amortization of 20% each in the remaining years.

The interest paid is based on several factors including market rates and the credit union’s overall financial position.

Traditional credit union capital comes only from retained earnings. Maintaining well capitalized net worth means that comes only from earnings means the process places a “growth governor” on a credit union’s balance sheet.

By raising subdebt this organic “growth governor” is removed in the short term. Some credit unions have been bold to say that their intent is to use the newly created capital for acquisitions. Both VyStar and GreenState ($60 million in subdebt) have been active buyers of whole banks.

The overnight increase in the well capitalized net worth category from 7% to 9% by NCUA on January 1, 2022 is also causing credit unions to look at ways to comply with this higher requirement.

Others believe it will help them accelerate investments that might otherwise be spread over several years.

Getting into the Leverage Business

Because subdebt has a price, unlike free retained earnings, and its function as capital is time-limited, its use requires increased asset growth to be cost effective.

It refocuses credit union financial priorities from creating member value to enhancing financial performance through leverage. This leverage requires both increased funding and matching earning assets to achieve a spread over the costs of these increased funding. Buying whole banks is an obvious strategy to accomplish both growth goals at once.

The Unintended Consequences

The use of subdebt as a source of capital was provided as a sop to help credit unions meet NCUA’s new higher and much opposed RBC capital standards.

The irony is that its use will entail a more intense focus on balance sheet growth to pay the cost of this new source of net worth. Unlike retained earnings, the benefit is only for a limited period.

The event will impose a new set of financial constraints or goals that have no direct connection with member well being. It converts a credit union’s strategy from “member-centric” to maximizing balance sheet financial performance.

In later blogs I will explore some financial model options for subdebt, the transaction costs and other factors in its use.

One of the most important needs at the moment is for greater transparency for individual transactions.

These are ten-year commitments that may exceed the tenure of the managers and boards approving the borrowings. The financial benefits and impact on members will not be known for years. This is especially true when the primary purpose is to acquire capital as a “hunting license” to purchase other institutions.

This rapid and expanded use will have many consequences for the credit union system, some well-meant, others unintended. It is a seemingly easy financial option to execute that the cooperative system will need to monitor.

March 28, 2022March 28, 2022

‘It’s the End of the World as We Know It’ (and I Don’t Feel Fine)

The title is from a Commentary by William Reinsch written four days after Russia’s invasion of Ukraine.

He is the Scholl Chair in International Business at the Center for Strategic and International Studies. His professional specialty within government and outside is international commerce and trade policy.

His article projected the end of the rules-based system of international trade that had been developed post WW II.

He foresees the war causing economic chaos, a return of power politics, and resurgence of authoritarianism. The world will not be the same; unintended consequences will proliferate.

Turning Points in History

In individual, organizational and country’s histories there are moments that are eventually understood as turning points. Sometimes these are sudden and instantly consequential. Like Ukraine.

Other changes occur slowly, but inexorably, in a new direction with the outcome unseen for years. For example the evolving demographic composition of the American population; or even the inevitable forces leading to the deregulation of financial services in the 1970’s and 80’s.

I believe the century long credit union movement is in one of these transformational periods. This involves significant changes in the regulator’s role, credit union business priorities, accepted performance norms and the ambitions of leaders.

These cooperative developments are occurring as economic trends are moving away from the two decade experience post 9/11. Inflation is nearing 8%, unemployment is at historic lows, worker shortages are occurring in many sectors, and interest rates are projected to rise to potentially the highest level this century.

The juncture of these economic and industry changes could significantly alter the institutional makeup of the cooperative system. They could result in the loss of credit union’s independent identify and purpose.

The Breakdown in the Regulatory-Industry Relationship

The seeds were sown in the disruption of the Great Recession in 2008-2010. The scope of the potential corporate problem created a rupture between NCUA and the industry.

NCUA leaders whether through fear, inexperience or bureaucratic instinct distanced itself from credit unions. The agency took the sole role of developing one all encompassing solution for five distinct corporate balance sheets. The results were disastrous for credit unions, the corporate system and the credit unions that relied on them. Additionally, 30-year industry partnership for the CLF was ended.

The most critical long term loss however was not financial, but the agency’s ability or willingness to work collaboratively with the industry—on all issues and in all circumstances.

Instead of viewing their role as empowering a system of cooperatives, NCUA positioned itself as rulers over the credit union system.

At the March 2022 Board meeting this view was expressed by Chairman Harper in comments on the agency’s Annual Performance Plan: With the geopolitical crisis unfolding in Ukraine, the NCUA will also continue to prioritize cybersecurity and guide the credit union system through the economic uncertainty caused by inflation, rising gas bills, and continued supply chain woes.

This paternalistic or in loco parentis approach to regulation and supervision emerged from the agency’s ability to impose solutions and rules unilaterally following the corporate crisis.

The agency publicly proclaimed its independence under Chairman Matz from both credit union involvement and external oversight. No one at the board or staff has been able to replace the critical experience and knowledge credit unions brought to all issues.

Credit union experience is absent in the regulatory bureaucracy. Credit unions manage over $2.0 trillion for over 100 million members but they have little to no voice in policy priorities. Stakeholders, both members and the professional leaders, are viewed simply as recipients of perceived regulatory wisdom.

Increasingly credit unions are developing new financial schemes with the regulator seemingly oblivious to their impact on these credit unions or the member owners. The wheeling and dealing in mergers, bank purchases and raising external capital is accelerating.

The makeover of a number of credit unions from member-centered to financial strategists, gamesman, hustlers and horse-traders is well underway.

This failure to interact removes NCUA’s most important resource – the industry’s professional leadership experience. Mistakes will continue to be made and paid for by credit unions due to the missing counsel of those who make the system work on a daily basis.

Overcoming the Schism

Credit unions created NCUA and designed and passed in Congress all of its constituent capabilities specifically the NCUSIF and CLF.

Board members seem divided between two binary positions: let the free market determine outcomes or, NCUA must pass rules to micromanage every credit decision and balance sheet IRR risk.

Effective NCUA regulatory policy is not democratic or republican, or even bipartisan; it is pragmatic supported by facts, logic and cooperative purpose.

Rules and manuals in the thousands of pages cannot replace business judgments and may in fact result in reducing sound operational choices.

Mutual respect is missing. Credit unions are intimidated or consider fruitless any effort to critique ineffective agency actions. NCUA’s most frequent justification for more rules is comparison with other financial regulators.

Mutual dialogue creates respect and enhances understanding of shared responsibility. Future posts will describe changes in priorities, norms and professional ambitions shaping industry character. All are examples of events occurring without the benefit of public dialogue.

March 27, 2022March 26, 2022

For Ukraine’s Hour of Need

From English composer John Rutter:

https://www.youtube.com/watch?v=lJl3kVwl2-U

Blue Skies Over Golden Fields of Grain

The Ukrainian flag is literally about grain

General Patton on prayer (December 8, 1944:

Chaplain, I am a strong believer in Prayer. There are three ways that men get what they want; by planning, by working, and by Praying. Any great military operation takes careful planning, or thinking. Then you must have well-trained troops to carry it out: that’s working. But between the plan and the operation there is always an unknown. That unknown spells defeat or victory, success or failure. It is the reaction of the actors to the ordeal when it actually comes.

Some people call that getting the breaks; I call it God. God has His part, or margin in everything, That’s where prayer comes in. Up to now, in the Third Army, God has been very good to us. We have never retreated; we have suffered no defeats, no famine, no epidemics. This is because a lot of people back home are praying for us. We were lucky in Africa, in Sicily, and in Italy. Simply because people prayed.

But we have to pray for ourselves, too. A good soldier is not made merely by making him think and work. There is something in every soldier that goes deeper than thinking or working–it’s his “guts.” It is something that he has built in there: it is a world of truth and power that is higher than himself. Great living is not all output of thought and work. A man has to have intake as well. I don’t know what you call it, but I call it Religion, Prayer, or God.

March 26, 2022March 28, 2022

Perspectives on War

John Donne:

”If a clod be washed away by the sea, Europe is the less, as well as if a promontory were, as well as if a manor of thy friend’s or of thine own were: any man’s death diminishes me, because I am involved in mankind, and therefore never send to know for whom the bell tolls; it tolls for thee.”

John Donne, Meditations XVII, 1623)

**********************************************

Walter Cronkite

***************************

Marina Ovsyannikova, an editor at Russia’s state-run Channel One network

March 14, holding sign on Russia’s Main TV Channel: “Stop the war. Don’t believe the propaganda. They are lying to you.”

March 25, 2022March 25, 2022

If You Can’t Beat’em, Better Join’em

Uber has never made money in its decade long existence. It has negative retained earnings of almost $24 billion as of yearend 2021.

It’s business tactics were to subsidize rides as it disrupted markets in the US and around the world to take market share from existing providers-primarily taxis. Then dominate those markets as competitors left using its monopoly pricing power to turn a profit.

The company’s ride sharing platform was innovative. It did offer a convenient easy-to-use service that was ubiquitous for consumers, many times at a lower, albeit below cost, fare.

But the model rested on two assumptions: that gig employees would cover all the expenses for the transportation vehicles and that drivers would value the flexible work opportunity as a non-employee or independent contractor.

The model worked for a while. Then COVID. Now the basic flaw in the model has become apparent. When drivers have a choice, they will prefer to be owners of their business efforts, not working for someone else as a gig or part-time piece-work wage earner.

Today the worker shortage has caused Uber to seek partnerships with taxi operators in the US and around the world.

Three Descriptions of this Strategic Partnering

Call for an Uber, Get a Yellow Taxi (New York Times)

Uber Reaches Deal to List all New York City Taxis on its App (Wall Street Journal)

But the most interesting analysis driving this change (no pun intended) is this article from CNBC’s Disruptor Column Once Rivals, Now Partners (March 24, 2022) highlighting added.

In 2015, CNBC’s Kate Rogers interviewed Safdar Iqbal, a New York City taxi medallion owner who was working to make ends meet as valuations for the likes of Uber and Lyft continued to soar.

Iqbal bought his medallion for $570,000 in 2009 and needed to earn about $5,000 a month to break even on insurance, the medallion mortgage and industry fees alone. The Queens, New York-based driver earned extra income by leasing his car to a second driver who worked the day shift.

“This was an investment in the long term,” Iqbal said at the time. Despite those challenges, the 48-year-old said he wanted to make his NYC medallion work. “It would help me raise my family, take care of the kids, pay the rent and later on, work as my retirement.”

“We need something for app hailing with yellow cabs, to have even arms with Uber,” he went on. “Then, I can compete with them.”

As of today, it turns out he may not have to.

This morning, Uber made a sizable shift in its business strategy that has faced opposition from traditional taxi services since its founding in 2009, announcing that it reached an agreement to list New York City taxis on its app.

Two taxi-hailing apps, operated by Curb and Creative Mobile Technologies, will integrate their software with Uber, allowing users to book taxi rides in the Uber app later this spring. (It’s worth noting that taxis are already available in other countries via the Uber app, including Spain, Germany and South Korea.)

“This is a real win for drivers – no longer do they have to worry about finding a fare during off peak times or getting a street hail back to Manhattan when in the outer boroughs,” said Guy Peterson, Uber’s director of business development, in a statement. “And this is a real win for riders who will now have access to thousands of yellow taxis in the Uber app.”

The deal comes as Uber, Lyft and other ride-hailing disruptors grapple with a shortage of drivers. After a dramatic decline in traveling due to the pandemic, ride-hailing companies have struggled to bring drivers back to full speed, which has made rides more expensive.

But several weeks ago, Uber said mobility demand has improved “significantly” through February, with trips back to 90% compared with its February 2019 figures.

Uber has also said figures have continued to improve when it comes to attracting and retaining new drivers, but as indicated by today’s move, there’s still room to grow. CEO Dara Khosrowshahi said as much last month when he teased plans to bring more taxis onto the Uber app, even beyond New York City.

“I will tell you we want to get every single taxi in the world onto our platform by 2025,” Khosrowshahi said in an interview with CNBC’s Andrew Ross Sorkin.

At their peak, the cost of many cab rides skyrocketed at the same time Uber was experiencing torrential growth — much of which was responsible for the company sitting atop 2016’s Disruptor 50 list, just a year after the value of yellow taxi medallions began to significantly decline.

Today, the company is preparing for its strongest travel season yet. Uber said airport gross bookings by the end of February were up over 50% month on month.

Still the broader concern remains the same it always has: whether Uber is taking on too much risk, too quickly with low tangible results. And that could spell trouble in a speculative market environment like the one some analysts believe we’re in now.

For Uber, there may be a level of risk management related to driver defections in the current decision making. As inflation, especially in gas prices, has hit drivers hard and they have pressed for more help from the company, some drivers have quit and recent research from Wall Street analysts and gig economy experts forecast more defections. And some of those quitting drivers are going to taxi companies.

Esterphanie St. Just, who started driving for Uber in 2015 in California, started working with the unionized taxi movement in California in 2019 as frustrations mounted over making the Uber economics work for her. She contends the longer a driver works for Uber, the less they make as more promotions and bonuses go to new drivers churning through the system (Uber denies this).

After hearing more from taxi drivers and learning more about being a yellow cab driver, finally, in December of last year, she started the process of getting a taxi license and began full time as a taxi driver about a month ago.

“The longer you have been in the Uber industry the more they take and you either quit now or quit later, but it will cost you, because you find out you are a rat in maze always chasing, chasing, chasing.”

Another Learning Opportunity

When NCUA announced its intent to sell credit union taxi borrowers’ loans to hedge fund in January 2020, the agency refused to look at options that would have given these member-borrowers a chance to earn their way out of the decline in collateral value from ride sharing disruption.

NCUA instead took cash at a fraction of the book value of the loans, recorded a $750 million dollar loss in the NCUSIF, and washed its hands of any further responsibility to these credit union members whose fates were turned over to a Wall Street hedge fund.

Earlier this year New York City entered into an agreement to cap the debt owed by individual drivers and extend terms so that remaining loan payments could be covered by earnings.

Drivers Will Determine the Future

Until autonomous taxis are deployed everywhere, the future of public transportation depends on what drivers want to do. For many people owning your own business, as described in the above article, is preferable to being someone else’s employee.

That was the opportunity that credit union taxi medallion lenders were underwriting. Assisting members to own their own business. NCUA washed its hands of the problem by selling at the low point in the cycle of value. Credit union’s paid for the losses and a hedge fund now has all the upside.

I admit that no one could have foreseen the New York City stabilization plan financed by Covid grants, nor the failure of Uber’s business model to be sustainable.

However NCUA’s challenge is internal, not external forces or events. If an organization is not willing to learn from prior difficulties, no one can help. If an organization is determined to learn, then no one can stop them from finding solutions.

If members’ interest are always front and center, NCUA and credit unions will ultimately find workable resolution for problem situations, no matter how seemingly intractable.

Liquidating problems is contrary to why coops were founded and their self-help ethos. The entire industry and its 100+ million members would benefit if NCUA would embrace this collaborative spirit as well.

March 24, 2022March 24, 2022

Welcome to the Omniverse

Two years ago I knew nothing about the company NVIDIA or even how to pronounce the firm’s name. Then my granddaughter received an internship followed by a full time offer when she finishes college.

But if you want to see where computing-networked technology is taking us, this may be a place to start.

The company built its reputation as the creator of graphic chips used in computer games. But as reported in the Wall Street Journal: its chips are now being snapped up for everything from game consoles to data centers to self-driving cars. . . Nvidia told analysts Tuesday (March 22) that it now sees a total addressable market of $1 trillion for its growing line of chips and related software.”

The firm is in the middle of its GTC annual developer conference. The keynote address by the President Jensen Huang also aired Tuesday.

His full talk is about 90 minutes and covers the firm’s recent product releases and latest innovations. The theme of the presentation is the creation and production of artificial intelligence (AI) “factories.”

These fully automated intelligent processes will change the way most businesses operate from driverless cars to digital biomedicine to warehouse management.

I was unable to follow many of the technical capabilities which NVIDIA will empower. However he recaps his talk near the end so you may wish to start with this overview before diving into the entire speech.

His opening described NVIDIA’s four layers (integrated stacks) for the networked world designed to “accelerate computing” resulting in “the creation and production of intelligence.” One example of a critical technical component is NVIDIA’s H100, an 80 billion transistor chip.

The Omniverse: Creating Digital Twins for Real World Events

The platform that combines all of these new technical designs and interfaces is NVIDIA Omniverse defined as an “easily extensible platform for 3D design collaboration and scalable multi-GPU, real-time, true-to-reality simulation.“

You can hear the Omniverse presentation by starting the keynote stream here. The session begins with the Apollo 13 “almost disaster” to demonstrate the power of a “replica,” or what Haung describes as today’s virtual equivalent, a “digital twin.”

As I understand, this simulation engine (Omniverse) enables the creation of a digital model that exactly duplicates the physical world. The two realities work together, the real with the virtual version. Companies across industries now have the power of “enhanced predictive analysis and software and process automation that maximize productivity and help maintain faultless operation.”

Prior AI was based on pattern recognition technology, with robotic programmed platforms. The new digital world provides autonomous platforms for applications such as driving, monitoring climate change, and even cell and molecular research.

The digital twin duplicates the real world’s physical environment, events and task management. The virtual model can then create new simulations beyond real world experiences. AI becomes a self-learning technology that can then be used to manage actual events.

One example: NVIDIA’s Earth-2 project is building a super computer dedicated to predicting climate change through simulations. This should encourage changes in human activity now versus waiting till the events actually occur.

Huang referenced several big companies using Omniverse Enterprise to create digital twins of their own operations. These include Amazon, the German Railway system-DB Netze, Kroger, Lowe’s and PepsiCo. NVIDIA’s integrated platform “builds physically accurate digital twins or develops realistic immersive experiences for customers.”

The Impact on Financial Services

Data-information management is the core of financial services. Today the use of AI inspired technology focuses on automated voice or chat bot responses, some enhanced data analytics and 24 by 7 connectivity.

Currently, NVIDIA’s financial service efforts include the use of deep learning, machine learning, and natural language processing to “boost risk management, improve data-backed decisions and security, and enhance customer experiences.”

I have no idea how this Omniverse capability will affect financial institutions beyond the known task functions for which it is used today.

If you want a simple future example however, CEO Jensen carries on a live, unscripted Q & A with his digital double (avatar) named Toy Jensen. I’m not sure which speaker was more credible!

March 23, 2022March 23, 2022

Irony

Voting is the life blood of democracy. For both political leadership and within organizations.

Some firms, such as IBM, encourage their stock holders to vote at the annual meeting:

To express our appreciation for your participation, IBM will make a $1 charitable donation to Opportunity@Work on behalf of every stock holder who votes.

Voting is integral to credit union design. This is the season for annual meetings with members electing their directors. Unfortunately actual voting is rare. Most vacancies are filled by acclamation as the number of candidates equals the open seats.

Now CUNA has begun a campaign to encourage member voting. As reported in CU Today:

WASHINGTON–CUNA has relaunched its “Credit Unions Vote,” a campaign focused on getting credit union members to vote in the 2022 midterm election. The campaign ties civic engagement to credit unions’ ability to improve financial well-being and advance local communities, CUNA said.

“Credit unions understand that elections affect their members’ financial well-being,” said CUNA Deputy Chief Advocacy Officer for Political Action Trey Hawkins. “With the Credit Unions Vote campaign, we will reach out to America’s credit unions providing them with resources to encourage their members to play an active role in both their primary and the November election.”

An Observation:

Yes, elections do indeed affect members well-being. Especially the choice of credit union directors.

If CUNA wants to encourage member’s good voting habits, why not begin by promoting elections at credit union’s annual meetings?

That would seem a more immediate way to illustrate the power of the franchise and their well being.

March 22, 2022April 19, 2022

Inflation, Interest Rates and Managing the NCUSIF’s $21 Billion Portfolio

Last week the Federal Reserve began its long-publicized tightening of monetary policy. The Board raised the overnight fed funds target rate to .25-.50% . Six more raises are planned which would take this rate at year end to around 2%.

The consensus of economists is the Fed’s plan may be a day late and dollar short. From MSNBC columnist Kelly Evans right after the announcement:

The Fed published a crucial update in its projections yesterday that showed members now expect the short-term Fed funds rate to hit 2.8% by the end of next year–up from only 1.6% in their December projections. In just three months’ time, in other words, as inflation has shot way higher than anyone at the Fed expected, the committee is signaling the need for almost ten rate hikes by late next year, roughly twice as many as they previously thought necessary.

In his March 21st speech to National Association of Business Economists (NABE) Fed Chairman Jerome Powell unveiled an even more hawkish view. Increases could be in .50% increments if needed to counter inflation.

Interest rate rises have substantial consequences for the management of the NCUSIF. All planned revenue for the NCUSIF is from earnings on its investment portfolio of Treasury securities. The portfolio will be almost $22 billion by 2022 yearend as credit unions keep sending in 1% of the increase in their share deposits.

Robotic Investing

As the public concern about inflation grew in 2021, the NCUSIF’s investment committee continued using a “ladder” approach. The resulting multiple investments had average durations of 5-6 years and average yields of less than 1%. This was done at an historically low point in the interest rate cycle.

Despite Board questioning, the staff defended their decisions by saying they don’t try to “time the market.” Whereas the record shows that the staff has substantially modified the portfolio’s average duration over the past seven years from 1,815 days in 2015 to as low as 901 days in 2018.

One consequence of the Board’s questions is NCUA has now published its NCUSIF investment policy. It can be found here with a last modified date of February 23, 2022. The substance appears unchanged from the previous February 2013 policy.

While NCUA did not formally request input, it is in the industry’s self-interest, even duty, to look at this document to suggest how the management of this $22 billion portfolio could be improved at this point in the market.

The NCUSIF’s Financial status as of January 2022

The most recent NCUSIF financials are at January 31, 2022. They show the $20.4 billion portfolio is $265 million underwater (market value less than book); the yield is 1.20% with an average weighted duration of 1,244 days or 3.5 years.

January’s total income was $21 million and expenses $17.4 million (up 20% from January 2021). Monthly net income is $3.6 million with no loss reserve expense or recoveries.

The portfolio is divided into identical $2.8 billion dollar maturity “buckets” spread over seven years through 2028. Just $431 million is held overnight.

One year ago, January 2021, the portfolio was $17.8 billion, with a 1.29% yield, weighted average maturity of 1,184 days or 3.3 years. The portfolio reported a gain in market value of $459 million.

In January 2020, two months before the COVID national economic shutdown and plunge in rates, the NCUSIF reported an average yield of 1.88% and a weighted average life of 2.9 years. Interest revenue was $25.5 million and operating expense of $16.9 million resulting in a bottom line of $9.5 million, or three times the January 2022 outcome.

The fund’s portfolio maturity extensions during COVID’s low rate stimulus environment have put the NCUSIF into a financial hole. Revenue is much less on a portfolio that is 25% larger ($ 5 billion) than two years ago; the portfolio has lost $724 million in market value due to its below market return and maturity extensions at the bottom of the interest rate cycle.

These circumstances suggest an urgent need for a review of NCUSIF portfolio management and reporting. The current policy implementation is not a positive outcome for NCUA or credit unions.

Changes to Enhance Transparency and Performance

There is investment expertise aplenty in credit unions. Some areas for commenting on the newly published policy might include:

How can investment return goals be better integrated with projected income and budgeted expense so that target for investment yield can be set objectively? For example a 2% portfolio yield and today’s fund size would cover all budgeted expenses and still leave over $200 million to grow equity or cover any new reserve expense.
How should the objective of paying a dividend to credit unions be incorporated in the fund’s policy objectives?
How can the fund’s investment decisions be more transparent especially the assumptions used when making decisions and changes to portfolio’s duration?
What additional information should be in the monthly reports posted and provided to the board to evaluate investment performance? For example shock tests?
What financial models does the fund use when making decisions? Can these be made public so that credit unions can comment on the projections and assumptions used?

There are many potential insights to this critical NCUA board policy that could lead to more effective oversight and performance. The critical success factor is sending these suggestions to NCUA to be evaluated for updating the policy.

Auspicious Timing

While there has been no formal request for comments, one approach would be to send suggestions to the investment committee’s new Chair which is the Director of E & I. Kelly Lay was just appointed to this position. This gives her an excellent opportunity to bring credit union experience to the investment process. Her email is klay@NCUA.gov.

The timing is also critical because rates will be rising, how fast and how far is anyone’s guess. Both domestic inflation and international events will create ongoing uncertainty. But the direction is certainly set.

To continue the robotic ladder when it is known rates will in all likelihood continue to rise, is folly. It brings no credit to the committee’s work and the board’s oversight.

Yesterday’s treasury coupon yields for 25 weeks was .95% and for one year, 1.31%. These are higher rates than any of the investment decisions made in 2021. A portfolio return increase of only 1% would double the fund’s annual revenue.

To decide when to extend out the yield curve should be based on analysis of what breakeven yield is needed to cover costs and equity growth and any loss reserves. Whether that is 2% or some other number, the goal should be to optimize yield taking into context the operating needs and sending excess earning back to credit unions.

Circumstances have given credit unions and NCUA a valuable moment to improve the management of this important, ever-growing industry asset. Will credit unions and NCUA take this opportunity?