Month: May 2022

This is the rest of CEO Joy Peterson’s concerns with the regulatory environment and six suggested changes.

Part I can be read here.

Pivoting from COVID to DEI

The pandemic saw record sums of COVID inspired money pouring into banks and credit unions.  Global fear and confusion were rampant.  Businesses were shuttered-some temporarily and some forever.  The global economy began a free fall.

There were reports of billions lost to PPP and unemployment fraud.  Where was NCUA?  One would expect nearly daily guidance regarding concentration risk and fraud prevention and best practices regarding NACHA rules.

Instead, the talking heads at NCUA started scolding credit unions about Diversity, Equity and Inclusion.  Rather than real concern for our members-the salt-of-the-earth member/owners of our financial institutions who feel a common bond to a financial institution  with their co-workers or their community-NCUA decided we are evidently racist and somehow elitist.

Our color chart no longer satisfies their hunger for diversity.  They alone are responsible for how our charters read but, in hindsight, they have decided we are perhaps too white or not serving enough underserved?!

In reality it doesn’t matter what color or gender our members are.   It doesn’t matter whether they are rich or poor or anywhere in between.  If we spend all of our time and most of our income trying to satisfy NCUA’s constantly changing view of what makes credit unions valuable to our members, we are no longer serving our members at all.

If we aren’t provided with the leverage to protect their money and their identity and their financial privacy, we are no longer good stewards of the faith 129.6 million people have placed in us.

The Most Needed Change: Respect for Credit Unions

Small credit unions are wounded and struggling to maintain our relevance and profitability in today’s economy.  From one CEO to the CEOs of the thousands of smaller Federally insured credit unions, the next time you are notified that your examiner is due to arrive, make sure you look carefully behind their back as you usher them in.  There could be a bayonet that will be driven firmly into your back as they write up yet another list of tail-chasing requirements to be deemed “safe and sound”.

I think it’s time all of us ask our regulators to be more constructive in their approach to the industry.

Here’s how  NCUA can demonstrate respect for our efforts to serve members, the reason why we exist:

1. Recognize that small credit unions are, in fact, different from large ones. Their capabilities are not the same, but our service to members can still be extraordinary, needed and valued.
2. NCUA should support credit unions instead of fighting them. Statements by NCUA spokespersons often include comments critical of credit unions. Our members decide whether we are “good enough”.
3. Stop labeling our members. NCUA likes to call them marginalized, disadvantaged, underserved and low-income.  They refer to “minority communities” and recently “Other Targeted Populations or OTPs”.  While we happily serve ALL members of our community, these terms give the impression that only people who are “less than” or “other than” belong to credit unions.  They are just people.
4. There needs to be more transparency from NCUA regarding its own management. Losses to the Share Insurance fund caused by thefts went on for years without raising any red flags to NCUA examiners. Were there any adjustments to NCUA examinations to address these limitations? NCUA should also be expected to manage their own investments at least as well as they expect us to manage ours.  Our credit union members pay for NCUA’s management failures.
5. NCUA shouldn’t expect more of small credit unions than they expect of themselves. NCUA “recommended” that credit unions allow no-cost loan payment deferments and the waiving of overdraft fees during the pandemic.  My credit union gave up more than $15,000 in income to help our members.  What did NCUA do?
6. So many mixed messages. Don’t tell credit unions we need to do more lending to people with lower credit scores and then criticize us because our delinquency goes up.  Don’t take away our ability to earn non-interest income from overdraft fees and interchange income and then wonder why we aren’t more profitable.  Part of the reason for all the mergers is the demanding, overbearing NCUA requirements as well as the utter lack of support  from our regulators.

Respect for members is what makes us different.  That is also what makes us sound.  It doesn’t work the same, the other way around.

Ten days ago I received a positive comment on a post.  I asked what aspect spoke to the writer.

In return the CEO Joy Peterson of Bessemer System FCU, Grenville, PA sent an article written earlier that she hoped to publish in the credit union press.

I read it.  Her voice is authentic; her coop commitment lifelong; and her frustration with the regulatory environment, clear.

In her lament, I hear echoes that  concern many about leaders in Washington, especially those in positions of authority.

I suggested she add recommendations to her critique.  She did.  They are in the second part of this blog to be presented tomorrow.   Here is part I.

From Joy Peterson:

As a lifelong accountant, my Dad had a sign hanging in his office that said “Auditors are the ones who come in after the war to bayonet the wounded”.  His clients would all chuckle at the sign and nod in agreement.  As a child, I didn’t quite understand the meaning.  As the CEO of a small credit union, I understand completely.  Our regulator, NCUA can be thought of as the auditor in the equation.  It’s quite possible that FDIC and CFPB are members of the same group although I don’t have enough direct contact with them to speak to them specifically.

 Membership Growing, Credit Unions Declining

At the end of 2013, there were 6,554 Federally insured credit unions in the U.S according to ncua.gov statistics.  By the end of 2021, the number had declined by an astounding 1,612 to 4,942.  During that same time period, the number of credit union members actually increased from 96.3 million members to in 2013 to 129.6 million members in 2021.  Since the membership numbers grew, it seems evident that the decline in the number of credit unions is not due to consumer dissatisfaction.

What then, does explain the loss of so many credit unions at a time when Americans are searching for value and safety in the financial industries?  Even with fewer credit unions to choose from, 129.6 million Americans still seem to find solace in member-owned financial services.  Evidently, they still believe in the prospect of pooling their money for the good of all of the members that make up their charter.  Based on results, our regulator doesn’t hold that same high opinion of Federally insured credit unions and their mission of service.

Serving NCUA, Not Members

I’ve been a lifelong member of my credit union and an employee since 2001. In that time, I’ve seen substantial regulatory changes in my credit union as well as the industry as a whole but none as significant and harmful as the ones I’ve noted from 2013-2022.  Our members are not being served by their credit unions.  Instead, our credit unions are serving NCUA.

Based on the numbers, many have been unable to continue to do so successfully.  Some have been dissolved involuntarily and many others have been “encouraged” to merge in order to fulfill NCUA’s crushing requirements for what is deemed to be “safety and soundness.”

It seems NCUA would much rather provide oversight to a few giant credit unions than have to provide guidance and oversight to thousands of us little guys.  Is that really what the millions of members of both small and large credit unions want?  Do our members really understand that there will come a time when belonging to a credit union is no different than being an account holder with Bank of America or Wells Fargo as their individual control over their financial institution is being diluted at a record pace?

The Compliance Burden: Boards as Scapegoats

Today, trying to comply with NCUA’s ever growing list of compliance requirements is like trying to herd cats.  Are those requirements making credit unions safer and more productive and efficient?  Based on the numbers, the answer is a very clear and unequivocal NO.

Each NCUA audit results in additional requirements for volunteer board members and supervisory committee members.  These completely uncompensated volunteers are now expected to review employees’ accounts, verify the vault, balance the checking account, review corporate accounts, attend meetings and training on Bank Secrecy and on and on and on.

When volunteers resign in frustration, NCUA demands they be replaced.  Replacing volunteers encumbered with such overwhelming responsibility is becoming nearly impossible.  Not only are they not compensated, they frequently aren’t even able to receive some of the benefits the rest of the membership are granted like the waiving of fees for an incidental overdraft or a request for a stop payment.

They are reminded with every NCUA contact of their culpability for any insider fraud or failure to mitigate risk appropriately.  Rather than volunteers, they are becoming potential scape goats for NCUA.  In order to rope in replacements, we have to overstate the “service to your community” aspect and seriously understate the actual responsibility of it all.

The Big Three DP Monopoly

Beginning around 2014, NCUA started a nearly constant drumbeat regarding “Vendor Due Diligence”.  We are cautioned on the growing threat of losses caused by the numerous outside vendors we use for everything from data processing to corporate account services to network security.

We chase our tails trying to verify these vendors are properly insured and sustainable and are abiding by regulatory requirements in terms of security.  We make lists and check boxes and retrieve SOC I and II reports.  We even hire other vendors to help us keep track of us monitoring our vendors.  We spend thousands upon thousands of dollars and hundreds and hundreds of hours trying to make sure our vendors are safe.

In reality, small credit unions have very little choice of vendors and almost no control of their behavior, particularly in regard to information security.  The Big Three data processors have become so big and so powerful. They have not only access but also control of every bit of our members’ financial information.

They refuse to provide security audit information on the pretense that doing so would compromise their own security.  They refuse to return our data without hundreds of thousands of our members’ hard-earned dollars in “de-conversion fees” if we attempt to cut ties with them.  They hold our data hostage and simply refuse to allow our exit until we meet their demands. Rather than a contract termination, our dissatisfaction is relegated to a hostage negotiation scenario.

Does NCUA intervene on our behalf as we attempt to comply with their demands surrounding vendors?  Absolutely not.  In whispers they admit that they have no oversight of these giants either.

Yet small and large credit unions alike are expected to demonstrate that we are overseeing these bullies.  The really large credit unions at least have the benefit of the substantial sums they pay to these vendors to use their leverage to obtain Service Level Agreements when signing contracts.

Small credit unions like mine have no such advantage.  The Big Three don’t care what I demand in terms of service on behalf of my members.  When their shoddy security practices put my members’ information at risk, they shrug their shoulders and basically dare me to find an alternative.

Rather than contrition and embarrassment regarding their failure to maintain adequate security against current threats, these Fortune 500 companies threaten legal action for disclosing their rookie mistakes.  They aren’t sorry they failed to use their superior security resources to provide superior security.  They are only sorry we found out about it and demanded that we deserve better.

End part I.

Part II tomorrow, includes a recent additional concern and six recommendations for improving the regulatory relationship.

The post describing NCUA examiner’s arbitrary imposition of IRR tests causing a credit union loss of $10 million resulted in other readers sharing their experiences.

Their long-standing frustrations suggest the need for a more balanced, common sense, exam process.

Story 1: LOC’s and Liquidity

“I remember conversations about our investments during the time of your most recent article.  Fortunately, the vast majority of our investments was in CDs  so there was very little to even talk about in terms of unrealized losses.  We did have one or two securities, but they were near maturity so even unrealized losses were minimal.

“This was around the same time that the examiners demanded we establish some kind of borrowing capacity in case liquidity suffered.  I set up a LOC with our corporate and “borrowed” just to be sure everything was set up correctly.  When the examiner saw the tiny bit of interest I paid for this test, the furrowed brows and disapproving scowl came out.  Why would I do such a thing?  It appeared as though our liquidity was fine so why did I use our LOC?

“I said it was a new product and I wanted to make sure it would function correctly in the event we ever needed it.  The only way to prove that was to actually test it.  All this ruckus over a charge of less than $100 interest for the less than 30 days we had the money.  In the process, I wrote up specifically how to borrow from it, how to book the GL entries, how to pay the money back, etc. so that if the line ever had to be accessed, we would know how to do it.  We have never used it.  Not once.

“During my last exam NCUA recommended we increase the limit on it.  GRRRR.  Keep in mind, our last exam was at the height of the pandemic when we literally had liquidity dripping from every corner of the credit union and they were recommending we increase our LOC.  I can’t imagine being the credit union that lost millions because of misguided “guidance”.

“I’m afraid I would have spontaneously combusted.  Credit to them for staying in the industry because those are the kinds of things that cause us to lose some of our best advocates.”

Story 2: Ending a Profitable Business

“A related horror story about examiners making short-sighted decisions…  A credit union right after the great recession was told by their regional examiner that their expense to asset ratio was too high and they must shut down their insurance division to get things in line.

“The insurance division was profitable.  It was throwing off $360k of profit a year – profit with no strain on net worth – and profit from any perspective (GAAP, Free Cash Flow, Cash Basis).  There was no funny business in the numbers.  It was showing steady growth in earnings as it was finally hitting its stride.

“What the examiner failed to understand was the fastest way to restore capital is with an income source that requires no regulatory capital to begin with.

“I told the CEO he needs to die on that hill and fight hard.  He complied however, and shut down the insurance operation.

The Moral of Stories

Sharing stories, good or not so good, is how credit unions learn from each other’s experiences.  This is one way change for the better can occur in NCUA’s interactions with the industry.

Tomorrow the Federal Reserve will announce an increase in its overnight Fed Funds target rate by at least 50 basis points.   This will be the second in a series of raises  to “normalize” the yield curve.  The goal is to curb inflation by increasing rates so that the “real” cost of borrowing exceeds the rate of inflation.

Bond prices have anticipated some of this increase.  Headlines reported the “rout” in bonds as market values fell and yields rose in the first quarter.  Yesterday’s lead story in the WSJ was “Bond Yield Rise Steepest since ’09.”

Interest rate cycle increases are not new.  In 1994 Fed Chairman Greenspan raised overnight rates from 3% to 6% in six 50 basis point jumps to cool an Internet driven economy.

Even though interest rate cycles are an ever-present factor in a market economy, for some leaders of credit unions this will be their first time navigating a cycle.  Learning from past events, can help with this process.

“Never say Never”

In late 1978, the US economy was entering a period of increasing inflation with short term rates rising close to 10%.   This increase was leading to some disintermediation to the newly created money market mutual funds.  But another credit union concern was the 12% usury ceiling on loan rates which was incorporated in most enabling statues.

In our discussions at the Illinois Department of Financial Institutions, I told Ed Callahan that 12% was like a law of nature.  Rates would never get above that level as we had fifty years of precedent to prove my point.  Ed’s response was “never say never.”

Short term rates went above 14% in December of 1979, by which time the Illinois Credit Union Act had been re-codified to remove the 12% ceiling. “Never” had taken place.

A Visit to NCUA by the ICU Funds

Short term and long-term rates continued to spike into 1980.  Chairman Volcker was committed to stopping the double-digit inflation resulting in short term rates of nearly 20% in June of 1981.

In early 1982, I had a visit from two senior executives from Madison to discuss the circumstances this had created for the two ICU investment  funds managed by CUNA Mutual.  Examination and supervision policy fell under the Office of Programs which I held.

I can’t recall all the details. The two funds had investments from several thousand credit unions, many of whom were small.  The market value of the two funds had declined dramatically.   The question they asked, would NCUA force the credit unions take a loss by writing down their investments to the current  market value?

They had taken steps to minimize withdrawals and believed that the decline would prove temporary.

I discussed the request with Ed who was now chairman of NCUA and Bucky the General Counsel.   There were many issues confronting the agency and credit unions.  A number of large credit unions had invested in GNMA 8’s, that were far underwater.  Their solvency was in questions and 208 NCUSIF guarantees were keeping some of them operating.  Shares were leaving credit unions as members withdrew funds for the double-digit yields offered by mutual funds.

Federal credit union share rates had not been deregulated as we had been able to do for Illinois credit unions. Jim Williams President of CUNA told Ed before his February 1982 speech to CUNA’s Governmental Affairs Conference that credit unions had only one issue on their minds, “survival.”

As we looked at the situation I can remember Ed’s comment in response to whether NCUA would require a write down of the ICU investments.  His words: “Leave it alone.”  Credit unions and the agency had more than enough concerns without adding to the moment.  Interest rates will change and today’s circumstances will not be tomorrow’s.

The ICU funds did recover their value.  By then the corporate credit unions had evolved into an option where they could meet the investment needs of credit unions. The ICU funds were eventually closed later in the decade.

Bernanke’s Taper Tantrum

In 2013 Fed Chairman Ben Bernanke announced that the central bank would begin pulling back its stimulus efforts by reducing bond purchases.  As summarized in a CNBC article in June:

Mr. Bernanke continued the theme into his press conference, stating again that if economic conditions continue to improve, the Fed will begin tapering its bond purchases at the end of the year.

He did put a little more flesh on the bond tapering plan: “may gradually reduce purchases later this year…will continue to reduce purchases through next year…may end in the middle of next year…will end purchases when unemployment is near seven percent.”

But time and again he emphasized the pace was data dependent: if conditions improve faster than expected, reduction in bond purchases can accelerate. If conditions worsen, purchases could even increase.

Why is the bond market over-reacting? Because they believe diminished tapering means higher yields. I agree, but to what extent?

NCUA Reacts

The taper tantrum carried over into the broader market as yields rose, bond prices fell.  The NCUA took up the issue. It imposed its internal interest rate shock and NEV tests on credit unions believing that this event presaged an ever-increasing interest rate cycle.

NCUA examiners created DOR’s on credit unions from by their models.  They required the sale of longer-term fixed rate loans and investments at a loss and borrowings from the FHLB, when the cash was unneeded, in order to comply with the model’s forecasts.

Tomorrow I will share one credit union’s story of how these modeling-induced DOR’s resulted in a loss of over $10 million.   The model’s assumptions were wrong.

This precedent is important because, unlike 2013 and 2014, inflation is here and the Fed is committed to raising rates until the trend is reversed.

The issue is whether NCUA will allow credit unions to manage their transitions through this cycle using their experience and operational options, or impose their modeling judgments on them?