Author: Chip Filson

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The Ups and Downs in Consumer Credit “Hardship”

The chart from TransUnion below shows how quickly consumer credit defaults rose and then suddenly declined from March through October 2020.

The September credit union data shows the industry has not seen dramatic upticks in total delinquency and charge offs. However some of these deferrals and forbearance accounts may not have been included as past due.

Key questions include why the sudden turn around? Was it stimulus relief programs? Economic recovery?

Depending on how one interprets these rises and falls will provide some guidance about future trends. For example if Congress fails to pass additional relief, will the down turns reverse? Or is the employment recovery the key to lower rates of credit hardship?

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It’s NOT a Wonderful Life or Can Miracles Still Happen?

On December 28th,  the Monday after Christmas, the 85-year, $35 million  Post Office Credit Union (POCU) in Madison may come to an end.   The savings and loans of its 3,196 members and their abundant reserves (22% net worth) will be transferred in due course to the $26 billion PenFed Credit Union in Virginia.  Their new financial “partner” is 850 miles distant and 742 times larger. They would join an already existing membership of over 2 million.

Why should credit unions care?  After all UPS, Federal Express, DHL and even Amazon can fill the needs if the local Post Office itself were to close.  Same with financial options–aren’t there plenty?

Member-owned cooperatives fill a special niche in every community.  The members pool their savings to provide loans to members and businesses with local control and leadership.  Founded during the Depression, POCU serves member needs with services guided by familiarity and circumstance.  Especially in a pandemic.

It’s Madison, Not Bedford Falls

But alas, Madison is not the Bedford Falls of the Christmas film It’s A Wonderful Life. No Clarence, or guardian angel, has appeared to “ring a bell” asking  for a public hearing.  Or to demonstrate what the future for  members and the community will be without POCU.

And there is no George Bailey to stand against Potter’s acquisitiveness.  For the CEO of POCU will choose between receiving a five-year $650,000 sinecure or  immediate cash severance of $437,000 while turning over his leadership responsibility to another firm via merger.

Will there Be a Rerun?

Three generations of members have supported POCU to be always present for them.  But no rerun of It’s A Wonderful Life may happen next year.

Unless there is an unexpected intervention. Do I hear a bell ringing signaling another angel’s presence?  A real life Clarence to help members see  life without POCU?

Such an event would  fulfill the spirit of this timeless movie. Except it would be a real-world “Madison miracle”  this Christmas time.

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Seeking 25 Wisconsin Credit Union Faithful

On December 28th, the 85-year, $35 million Post Office Credit Union (POCU) in Madison, Wisconsin will cease to be an independent charter. After voting, the 3,196 members and their savings, loans and abundant reserves (22% net worth) will be transferred to the $26 billion PenFed Credit Union in Virginia.

Why care? After all UPS, Federal Express, DHL and even Amazon can fill the needs if the Post Office itself were to close. Same with financial options–aren’t there plenty?

Members Uninformed What Their Vote Enables

The members are not informed about what is happening by their required vote. The intent of the organizers of this action is to announce the deed as late as possible, limit the voting period to minimum required interval, and make the process appear as just another routine event in the life of the credit union—as the members are asked to drink the cooperative Kool Aid.

What POCU’s members are approving in surrendering their charter via merger is:

  • A new board of directors, whom they do not know and have never been told about.
  • A new senior management team who has not been identified or even presented.
  • A new business model (virtual), very different from their current one—PenFed is 742 times larger and serves over 2.1 million members.
  • Accepting a service profile with no specific information of any changes in prices, services and fees. The five examples given are all INCREASES in fees.
  • Loss of all control for any local service, employment, or business initiatives. All references to such are open-ended and subject to PenFed future review, including the $50,000 per year local contribution.

Joining a Harem

In summary, this is an arranged marriage, agreed in secret in April. The bride was informed in October. And still knows nothing about the groom and what will happen after the wedding. POCU will become just another junior member of PenFed’s credit union harem of 19 other charters.

Oh, and the broker of the deal, who had the authority to sign for the bride to protect her best interests, will then get to choose between a five-year $650,000 sinecure, or an immediate $437,500 payoff for his actions. PenFed is paid a dowry of $7 million to marry this unwitting bride. The family of bride will go away empty and the community will no longer recognize them as members.

Whose Responsibility?

The reaction to this situation in Wisconsin reminds me of a story that Dick Cavett once told. During a performance of Hamlet in Central Park, NY City, when they got to the part where he stabs Polonius, eight people got up and left because they didn’t want to get involved.

If those with the power, position or privilege fail to speak about this event, will these members ever trust credit unions again? Or as another American leader once said, “In the end, we will remember not the words of our enemies, but the silence of our friends.”

No matter our intentions or inattention, we are all stained. We watch an anti-democratic process fueled by self-interest not member well-being. Statutory terms such as “good faith,” “specific plans,” “best interests of the members” and the legally required “consent” of regulators is devoid of meaning. As the precedents of these calculated takeovers expand, credit union leaders shrug their shoulders accepting this as just the way of the world.

By our inaction we endorse the preying upon our industry by our own.

This acquisitive behavior is an assault on everything cooperatives stand for. It brings the capitalist model’s full range of animal spirits with none of the market’s checks and balances.

The Wisconsin statute requires a petition by 25 residents to require a public hearing on this event, should the DFI not do so on its authority. That hearing would give all those interested in the future of cooperatives to give the Board of POCU and PenFed to make their case publicly not behind closed doors.

Are there 25 credit union believers who are willing to ask that this activity be done in the full light of public debate and request the DFI hold a hearing?

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The Nose of the Camel?

At FDIC’s December meeting, the Board approved an updated regulation relating to interest rate limits on banks that are less than well capitalized.

The changes are intended to provide flexibility for institutions subject to the interest rate restrictions and ensures that those institutions will be able to compete for deposits regardless of the interest rate environment.

One way this flexibility is enhanced according the explanatory Fact Sheet is:

MORE COMPREHENSIVE NATIONAL RATE – The final rule defines the National Rate to include credit union rates for the first time.

  • “National Rate” is defined as the weighted average of rates paid by all IDIs and credit unions on a given deposit product, for which data are available, where the weights are each institution’s market share of domestic deposits.

The Level Playing Field

Is this what bankers mean by “a level playing field?” To implement this rule, the FDIC camel must poke its nose into co-ops’ tent to track credit union rates on “given deposit products.” Be alert for more “leveling” activities in the future.

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Underwriting Cooperative Designs

The list of the top 100 US cooperatives by total revenue lists only five credit unions.

Do you know the co-ops operating in your communities? How are credit unions supporting cooperative solutions especially with needed, local  startups?

A proposal  from Finland where 90% of the population belongs to a co-op

It would be fair to say that the American credit union movement was born from a unique way that Edward Filene did charity. He helped reduce obstacles people face when they try to help themselves by setting up cooperatives. As it became harder and more expensive to start new credit unions, this tradition started to fade away. It could be more complex for credit unions to help people set up cooperatives, other than credit unions, because it requires different expertise. But I hope credit unions would ask themselves – if we are not carrying on Filenes distinctive civic tradition of helping start new coops, who is? 

It’s common for credit unions to donate to food banks and other local charitable efforts.  

What if some of those donations would be used to give food cooperative coupons/vouchers to credit union members who are struggling economically? Ideally the food cooperative would also provide opportunities to get further discounts by volunteering to help run the business, as is common in grocery coops. 

I think many would find this sort of mutual self-help more dignifying than being given food from a food bank – not that there should be a stigma in doing so. Perhaps especially men who are reluctant to get assistance would find this psychologically more helpful. Abstract models of comparing the logistical cost-effectiveness of providing food through food banks or food cooperatives can’t capture this difference. But can credit unions? 

It could be used to demonstrate the cooperative difference of credit unions in a way no advertising campaign could. The Open Your Eyes campaign remaining budget was $50 million. What if there was an equally large campaign, where 5 million credit union members would use a $10 coupon in a new cooperative business?


It doesn’t have to be limited to food cooperatives either. Maybe a couple who open up a joint-account could be given a pair of movie tickets that could be used in a local cooperative cinema. The possibilities are endless.  

Leo Sammallahti

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AN EYE-OPENER: New Study on Size and Cost Efficiency

This month the FDIC released a 27-page study entitled “Economies of Scale in Community Banks.”

The authors analyze all community banks less than $10 billion in assets from 2000 to 2019 to measure their actual trends in economies of scale and productivity by asset size.

The major findings are below. Over two thirds of the paper present the analytical method and data used to develop their conclusions. The most significant conclusion in my view is:

“. . .our results suggest efficiency gains accrue early as a bank grows from $10 million in loans to $3.3 billion, with 90 percent of the potential efficiency gains occurring by $300 million”

The Relevance for Credit Unions

The average credit union size on September 30, was $345 million. That is the sweet spot for peak operating gains in the study. While credit unions would not mirror the balance sheet and business model of a typical community bank, the overall conclusions seem applicable.

Moreover, it is probable that the greatest gains in efficiency occur at an ever lower average asset range in coops for three reasons. Credit unions have a consumer-focused lending specialty, which the authors cite as a factor in greater efficiency. They do not have to manage the complexity of paying federal or state income tax. Finally, credit unions achieve economies of scale and efficiencies by cooperating in local and national CUSOs that bring members convenience no single bank or firm could duplicate with its own resources.

Credit unions are undergoing some of the same consolidation pressures described for banking. The study provides needed insight for two much talked about issues in the credit union system. One is what is the ideal size for operational competitiveness. The finding that a range of $300-600 million in assets achieves 95% of efficiency gains, is easily within reach for many credit unions’ business models. Secondly, larger size does not create major gains in efficiency.

In fact, there may even be a cap on size ($3.3 billion) after which diseconomies of scale occur, that is increasing expense ratios. An example of this would be the dramatic performance decline in PenFed, the industry’s third largest institution, as it grew by $7.5 billion over the past five years. This is documented in the analysis “PenFed’s Spurious Strategy.”

The Problem We All Share Part I: PenFed’s Spurious Merger Strategy

In the extracts below, emphasized (bolded) text focuses on the most important conclusions presented by the FDIC authors.

Abstract Summary

Using financial and supervisory data from the past 20 years, we show that scale economies in community banks with less than $10 billion in assets emerged during the run-up to the 2008 financial crisis due to declines in interest expenses and provisions for losses on loans and leases at larger banks. The financial crisis temporarily interrupted this trend and costs increased industry-wide, but a generally more cost-efficient industry re-emerged, returning in recent years to pre-crisis trends. We estimate that from 2000 to 2019, the cost-minimizing size of a bank’s loan portfolio rose from approximately $350 million to $3.3 billion. Though descriptive, our results suggest efficiency gains accrue early as a bank grows from $10 million in loans to $3.3 billion, with 90 percent of the potential efficiency gains occurring by $300 million.

Introduction

Economies of scale occur when the per-unit cost of production falls as the number of units produced increases. In the context of banking, scale economies exist when the cost per dollar of loans (or assets) declines as the number of loans (or assets) increases. An efficient bank is operating at the lowest cost per dollar of assets or loans, , , ,

Our estimates are not causal and do not predict how a bank’s costs would change were it to change in size. We find evidence, however, that the overwhelming majority of any gains from increasing a bank’s loan production from $10 million to the cost-minimizing loan portfolio size of $3.3 billion accrue early in the growth process. Our nonparametric results suggest that once a loan portfolio reaches approximately $300 million, a bank has achieved about 90 percent of the potential efficiencies from increased scale; by $600 million, a bank has achieved about 95 percent of potential efficiencies. . . .

Our analysis focuses on community banks—banks with less than $10 billion in assets—as these banks comprise the vast majority of banking organizations. Approximately 97 percent of all banks in the United States have less than $10 billion in assets, and roughly 90 percent of those have less than $1 billion in assets. The consolidation trend in the industry has differentially affected community banks. The number of small institutions—those with less than $100 million in assets—has declined by 92 percent since 1985. Much of the debate about bank consolidation centers on the largest financial institutions, primarily those some argue are “too big to fail.” But as consolidation in the industry has persisted in recent years, some have begun to turn the “too big to fail” designation on its head and question whether small community banks are “too small to succeed.”

Conceptual arguments that support this notion are often based upon the economics of scale. Some have suggested that increased regulatory burden affects small banks in particular because regulatory compliance cost is a relatively larger item in a small bank’s finances. Likewise, banks that operate in limited geographical areas may find expansion into new product lines less profitable. Another possibility is that technological investments, for example in credit scoring and model-based lending, may not offer enough upside to justify the investment cost for small banks to transition from slower, more cost-intensive business practices (i.e., relationship lending).

Consolidation that shifts assets from small to large banks is more than just a rearrangement of resources. Small and large banks are not interchangeable; a single $1 trillion bank is not the same as one thousand $1 billion banks. Small banks are often built around a relationship-lending business model. Bankers acquire costly but valuable private information about their customers and make lending decisions using this expertise. In contrast, large, remote banks often lack personal relationships with customers and knowledge about the local community, instead relying on a standardized approach to lending. Customers that are good credit risks to a small bank may be unable to obtain credit from a large bank that lacks local knowledge.

As the number of small banks has declined, concern about the future of small banks has extended to the future of small businesses. Small businesses generally obtain loans from small banks, especially when the businesses are in their infancy. The report of findings from the FDIC’s Small Business Lending Survey states that large banks are more than five times more likely than small banks to require minimum loan amounts for the primary loan products provided to small businesses and eight times more likely to use standardized small business loan products. Small banks are also roughly five times more likely than large banks to underwrite loans to start-up small businesses differently These businesses are sometimes described as the engine of economic growth in the United States, so a decline in credit availability to such businesses could affect the real economy.

The fate of small banks also portends that of the communities in which they operate: Kandrac (2014, p. 23) finds meaningful feedback from the failure of a bank and local economic performance, stating, “The disruption of banking and credit relationships is an important channel through which bank failures affect economic performance.” Scale economies in banking thus transcend the domain of business policy into that of public policy. . . .

Conclusion

Consolidation and growth have been hallmarks of the banking industry since the 1980s. The number of institutions has decreased by more than two-thirds while the size of the remaining institutions has increased. Although the problem of “too big to fail” has been frequently discussed within the corridors of government, academia, and the media, community bankers have begun to question if a “too small to succeed” problem also exists. Such concerns are commonly motivated by notions of economies of scale, whether due to cost efficiencies, expanded business opportunities, or the allocation of regulatory costs across a wider asset base.

Using financial and supervisory data on banks and thrifts with less than $10 billion in assets, we study economies of scale within the banking industry using nonparametric kernel regression and translog cost estimation. Our estimation period spans both sides of the financial crisis, enabling us to distinguish pre-crisis trends from post-crisis trends. We find that total costs have generally been declining over time. The crisis temporarily halted this trend, at least for some institutions, but the trend resumed in force post-crisis. With economies of scale, lending specializations matter: agriculture banks show less evidence of scale economies than commercial banks, while mortgage banks display the strongest signs of economies of scale.

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A Historical Perspective for NCUA’s 2021 Budget Discussion

If the NCUA board approves a reduction in NCUA’s budget for 2021, it will be the first time in 35 years the budget has been reduced, not increased. In fact, the Agency was able to cut its budget for three years in a row, 1982-1985. Here is how NCUA did it as documented in Agency records.

The Credit Union System 1984 and 2020: 10,229 Fewer Charters

To comprehend the unprecedented nature of NCUA’s prior management achievement, it is helpful to compare the scale of the Agency’s operations in 1985 versus today. At September 30, the end of fiscal 1984, NCUA with six regional offices examined annually 10,640 federal charters, and insured 4,722 state charters, a total of 15,362 active credit unions.

Thirty-six years later, September 30, 2020, NCUA oversees 3,213 federal charters and insures

1,920 state charters for a total of 5,133 or a reduction of 10,229 federally insured credit unions. There are three regional offices.

The following two NCUA press releases from 1984 provide budget details and the benefits the savings brought to federal credit unions enabling a 64% reduction in the FCU operating fee scale over these three years.

From an NCUA Press Release, July 25, 1984:

NCUA 1985 Budget Down 4.9%

The National Credit Union Administration board approved a fiscal year 1985 budget that is 4.9% below the Agency’s 1984 budget. This is the third consecutive year in which the budget has been cut. It is he largest reduction to date.

. . . the fiscal year 1985 budget , totaling $32 million, is down $1.7 million or 4.9% from the 1984 budget of $34.7 million

“We won’t forget that credit unions provide the primary source of funding the Agency,” said Board Chairman Edgar Callahan. “Deregulation and decentralization have enabled us to provide better and faster service to credit unions at less cost and to concentrate our efforts on our primary mission—safety and soundness. “

Despite the trimmed down budget, money for training and education has been increased because the Agency believes a better trained examiner force is essential in a deregulated environment. . . The bulk of the increase will go to a training session for new examiners and for the NCUA’s National Examiners’ Meeting in December. This week-long educational session will bring together federal and state credit union examiners. It is the first meeting of its kind. . .

From a September 15, 1984, NCUA press release announcing the reduction in its annual operating fee.

FCU Operating Fee Slashed 24%; Scale Cut 64% Over Three Years

The National Credit Union Administration Board today slashed by 24% the operating fee scale for federal credit unions in 1985, bringing to 64% the total fee scale cuts over the past three years.

The dramatic 24% cut will save federal credit unions more than $4.3 million in 1985 and has saved them more than $15 million since 1983, the first year in the NCUA’s history that the fee scale was cut. . . .

Previously the operating fee scale had risen by 9% in 1980, 8% in 1981, and 7.5% in 1982

“For the third straight year the efficient operations of the Agency have allowed us to put money back into the pockets of federal credit unions,” said NCUA Chairman Callahan. “This is an impressive track record, one that the agency and the entire credit union system can be proud of.. ..”

The NCUA board attributed the Agency’s success in keeping costs down to high productivity by NCUA staff, personnel reductions and a shifting of resources from the central office to the field where they are needed most.

For example, NCUA for the second year in a row has completed an annual examination of each federal credit union, an achievement not seen since the mid-1970’s. Although total agency employment has been reduced by 15%, the number of examiners has increased to an all-time high (369). Getting back to a once-a-year exam cycle exemplifies the Board’s desire to promote safety and soundness while leaving management decisions in the hands of credit unions. . .

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The Problem We All Share Part III: Addressing the Problem

A Solution: Open Up Market Participation and Transparency

I believe more open competitive forces must be added to a Board’s decision to give up their charter. All merger intentions should be announced in a public notice so that any interested party is able to participate when a board decides to end its independence.

For example, why should Post Office in Madison or Sperry Employees in Long Island negotiate their members’ future in secrecy and then announce their decision without other area credit unions able to “bid” for these long-standing, local, well-capitalized ”franchises?”

Why not give members a real choice of a convenient and familiar credit union as well as one that is remote, digital only, and with no connections to the community?

Bringing more market forces could add better options for members. If two large billion-dollar credit unions want to merge locally, why shouldn’t a large credit union from outside the market be able to participate and preserve a real choice for members?

If the members are informed by an open process, they are more likely to support the board’s recommendation. Now they are forced into a combination they know nothing about and where the results are approved by only a very tiny minority of members returning the requested mail ballot.

Mergers that Enhance Safety and Soundness

Opening up the merger process would make the credit union system more transparent, responsive and relevant for members and their communities. Facts and plans would have to be laid out, not merely bland marketing assurances of “ a better future.”

Credit union safety and soundness would be enhanced because members can make an informed choice. Interested credit unions must take their time to present a relevant option. Token payouts of members’ equity to achieve a positive vote could be replaced by considered bids for the credit union’s real value, including good well.

As presented in Part I, PenFed’s five-year performance has not been enhanced by its merger-growth efforts. Its asset growth rate is half that of its peers; expenses are rising and there are no obvious economies of scale. Asset quality challenges have heightened. There is no evidence members see better value. Member relationships are declining. PenFed’s ROA and asset growth increasingly depends on acquiring other credit union’s net worth. Mergers are disguising its underperformance and slowing internal growth.

Even more pernicious is that PenFed’s mergers have eliminated 20 credit union boards of directors, CEOs and senior management teams. Twenty seeds of future innovation are gone. Multiple long-term relationships with local communities are broken. Members’ loyalty is discarded. None of these outcomes enhances the cooperative system’s financial diversity or soundness.

Transferring the financial equity from generations of members to a board and senior management with no connections to the community’s surplus further removes members from their cooperative creation.

Directors’ view of their responsibility changes in mergers. Instead of acting as stewards of a legacy they inherited, they become deal makers. They routinely ratify payoffs to other credit union’s directors and employees as just the “the art of the deal.” Values be damned.

In the end, the current secret negotiations corrupt both credit union buyers and sellers. And in so doing, the cooperative model.

The Problem We All Have

The current merger practice promotes the privatizing of members’ common wealth and the degrading of credit unions’ role in their communities. Because participation in voting is so minimal, members are left with the feeling they were not informed, or maybe even tricked. The experience is no different than when a bank is sold. Instead of being the alternative to for-profit capitalism, the industry is becoming that which it was supposed to replace.

There are two traditional approaches to system problems. The first is, let the “free” market work it all out. Give the forces of competition loose rein so the magic of the invisible hand can create the best outcome. In the end, all will be right. Winners take all.

The second is that government must step up to regulate abuses, enact better rules and enhance its supervision of the current practice of routine signoff.

But I recommend a third solution built on cooperative principles. Let the members decide. One person, one vote. Put their interests truly front and center.

There are multiple current merger practices that would give member owners the information to have a real choice about the future of their credit union. Working with the industry, regulators should design a truly “cooperative” process that enhances members’ involvement and in so doing, their commitment to the outcome.

The revitalized process would seek traditional financial and operational proposals combined with the important qualitative values credit unions promote: community connections, local focus, giving back to members, and demonstrated track records.

For many Americans, the lack of trust of those in authority is based on their perception that leaders place their interests above their own and the community’s broader shared values. PenFed is a prime example of an outside organization hollowing out local communities by cashing out its leaders.

The social trust on which the cooperative model exists is enhanced by a more visible and transparent process. The public support for the industry’s tax exemption is upheld. The movement will be guided by the shared set of norms and values that created it.

Going from Spectators to Engaged Co-op Citizens

With over 99% of credit unions in NCUA’s lowest risk CAMEL ratings, it is easy to lose sight of the interdependence and cooperation on which the cooperative movement is established. The common good slowly recedes to second place versus individual institutional success.

Market forces are not motivated by the common good or subject to moral limits. Credit unions were to be a counterexample to Mark Twain’s assessment of human motivation:

“Some men worship rank, some worship heroes, some worship power, some worship God and over these ideals they dispute and cannot unite–but they all worship money.”

Current merger excesses are destroying the moral capital created by movement’s founders. Instead of active citizens we become spectators or voyeurs hoping the abuses will go away or maintaining that this is not my problem.

A Renewed Movement

However, movements are not simply a one-time past occurrence, but rather something we can all participate in our own time.

Individual economic isolation and the power of large monopolies which gave rise to the progressive movement at the turn of the 20th century is as pervasive today as 100 years ago.

Some label credit unions as an industry. They are no longer disrupters of the status quo, but a mature segment of financial services with resources, opportunities and influence to play like the big boys. Movements are a moment of history, not the current reality they argue.

Both views can be true, but when movement is left out, credit unions become identified with the status quo and its problems, versus innovators of trusted value to members.

In its finest expression, cooperative design is an ongoing experiment to address the shortcomings of unfettered capitalism. It takes only a few leaders to stand up for change to convert perverse merger activity to a more productive outcome for members. Who will have the foresight and courage to push this to the top of the movement’s agenda?