Author: Chip Filson

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One More Time: Why Risk Based Capital is a Bad Idea

In the June 2020 NCUA board meeting, Chairman Hood’s latest RBC proposal was withdrawn from the agenda at the last moment. It did not receive the light of day, so we do not know what was in it. Even so, outgoing board member McWatters indicated his opposition to any change in a June 29 credit union press release stating; “this was not the right time for a material diminution in the RBNW capital requirement for credit unions. . .”

Even though all three banking regulators ended RBNW as a valid approach for community banks in September 2019 and McWatters earlier opposed the rule as “illegal” it appears this destructive concept has somehow come back to life.

With that prospect in mind, I think it is useful to remember some of the reasons why the concept Is so flawed. The article excerpt below urged credit unions to comment on the second RBC proposal by NCUA in 2015. It looks as if the battle may have to be fought again.

Training Fleas and RBC
Escape the circus and live beyond the limits of the imaginary lid. (March 2015 Creditunions.com)

This YouTube video demonstrates how to train fleas. This column urges credit unions not to behave the same way when it comes to NCUA’s redrawn risk-based capital proposal.

The sequence of events the video illustrates are as follows:

  • The fleas are placed in a glass jar.
  • A lid is placed on the jar and left undisturbed for three days.
  • When the lid is removed, the fleas will never jump out of the jar; their behavior has been set for the rest of their lives.
  • Moreover when the fleas reproduce their offspring will follow their example.

Policy Lessons For Risk-Based Capital

The NCUA’s RBC #2 proposal lists more than 70 categories for which credit unions would be required to calculate capital according to their legally mandated rule’s risk weighting.

These weightings — like the lid on the jar — become the primary screen for filtering decisions such as what assets a credit union should hold, how loans should be priced, and the composition of the balance sheet.

This one-size-fits-all formula will reduce the diversity of credit union activity and in so doing, change the focus from serving members needs first, to meeting examiner expectations.

Two Comment Letters Address This Outcome

Chuck Bruen, CEO of First Entertainment Credit Union ($1.1B, Hollywood, CA) wrote this in his Feb. 13 comment letter:

“The NCUA’s risk-based capital rule is overly complex and inappropriate for credit unions and their business model. … NCUA’s risk-weights also experimentally incent and dis-incent credit union lending and investment behaviors in unprecedented and untested ways.”

This steering of balance sheet decisions was also a concern in a comment posted by Randy Karnes, CEO of CU*Answers:

“I believe the revised RBC rule penalizes credit unions for specific activities such as real estate lending, member business lending, and credit unions chartered to assist the un-bankable, by placing a capital tax on the resulting assets from low income or credit lending to the poor.

“We believe the end result will be thousands of homogenous balance sheets in 2025 that the NCUA can easily understand from a supervisory perspective. However, this current risk posture of the NCUA cannot but fail to lead credit unions to shy away from diversity or the cooperative reason for the charter and field of membership.

“This rule would ultimately force credit unions into potential areas of investment and lending in which the credit union lacks experience, or create industry-wide concentrations that could be impacted by similar economic variables. In and of itself, this rule creates more risk than it proposes to control.”

FDIC Vice Chairman Analyzes RBC And Finds It Flawed

These concerns are not theoretical. The banking industry’s reliance upon the RBC formula already shows how it creates results that do not enhance safety and soundness. The outcome can even undermine the critical economic value contributed by financial intermediaries.

FDIC vice chairman Thomas Hoenig noted this in a speech to the International Association of Deposit Insurers in April 2013:

“If the Basel risk-weight schemes are incorrect — which they often have been — this too could inhibit loan growth, as it encourages investments in other more favorably, but incorrectly, weighted assets.

“Basel systematically encourages investments in sectors pre-assigned lower weights — for example, mortgages, sovereign debt, and derivatives — and discourages loans to assets assigned higher weights: commercial and industrial loans.

“We may have inadvertently created a system that discourages the very loan growth we seek, and instead turned our financial system into one that rewards itself more than it supports economic activity.”

RBC Comments Needed More Than Ever

The second comment period is even more critical than the response to RBC #1. The debate now is not about risk weights, ratios, phase-in periods, etc., but whether this new rule is good public policy for cooperatives.

The impact of the rule will be to create behaviors contrary to credit unions’ purpose and their role in the market place. It will decrease diversity and increase asset concentrations.

Credit union leaders must not become fleas in a jar. Comments on RBC#2 are more critical than ever — or this new rule could become a lid on the future of your credit union and the credit union movement.

Source: Training Fleas And RBC | Credit Unions https://www.creditunions.com/blogs/chip-filson-on-credit-unions/training-fleas-and-rbc/#ixzz6T48VFVHt

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McWatters’ Legacy and FDIC’s Implementation

In his maiden speech to the GAC in March 2015, then minority NCUA Board Member McWatters closed with the following suggestion:

“The NCUA board should establish not less than three formal advisory committees with the mandate to advise the NCUA Board about:

  • NCUA’ s budget and budgetary process,
  • NCUA’s examination programs and appeals process, and
  • Areas where NCUA may expedite regulatory relief for the credit union community without compromising safety and soundness. . .”

Nothing happened then or later when he became Chair.

An Example of an Advisory Board and its Agenda

In 2009, the FDIC established an Advisory Committee on Community Banking to provide input on bank policy and regulatory matters. It has 18 members from across the country. The Committee meets this week. The meeting is webcast live as detailed in the following:

On July 28, 2020, the Advisory Committee will meet to address a wide range of issues. The agenda includes: a discussion of local banking conditions; a briefing on the FDIC’s Rapid Prototyping Competition; an update on supervision matters; a report from its Minority Depository Institutions Subcommittee; and a discussion of diversity and inclusion at community banks. This meeting of the Advisory Committee on Community Banking will be Webcast live at http://fdic.windrosemedia.com beginning at 1 p.m. EDT.

In addition to seeing the advisory concept at work, I thought the rapid prototyping report would be of immediate relevance to the credit union community. NCUA has spent years trying to improve its quarterly reporting process, mostly making it longer.

Here is the FDIC’s innovative approach to making this technological improvement happen quickly and why you may want to tune in:

On June 30, FDIC announced the start of a rapid prototyping competition to help develop a new and innovative approach to financial reporting, particularly for community banks.

Twenty technology firms from across the country have been invited to participate in the competition. The competitors will develop proposed solutions over the next several months that will be presented to the FDIC for consideration, similar to an extended version of a “tech sprint” or “hackathon.” Competing firms represent leaders in the financial services, data management, data analytics, and AI/ML fields.

These modern tools – and lessons learned in future competitions – will help make financial reporting seamless and less burdensome for banks, provide more timely and granular data to the FDIC on industry health, and promote more efficient supervision of individual banks.

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Nine Years to Make Their First Loan

In 2011 several Maine residents began to explore a credit union charter to serve the small farms of the state. In 2019 they received a federal charter. This year they made their first loan described below.

The following story is from the credit union’s website. Do you remember what your credit union’s first loan was for?

Celebrating our First Loan

We closed on our first loan in March, financing a delivery truck that will connect a network of Maine farmers with critical distribution services.

Misty Brook Farm is a diversified, grass-fed livestock and raw milk dairy farm in Albion. Katia and Brendan Holmes started Misty Brook in 2005 and moved to Albion in 2013. The couple markets their dairy products, meat, grains, livestock and eggs to local community members through their farm store and distributes to more than 50 wholesale customers, including health food stores, restaurants, and aggregated CSA’s. In addition to delivering their own goods, Misty Brook provides critical distribution services to a network of farmers throughout Maine.

When Katia and Brendan wanted to add another delivery truck to their fleet, the couple struggled to secure financing. Despite the business’s history of successfully paying back loans, their bank could not meet their request. The couple explored dealer financing, but the interest rate did not meet the mark. When the couple approached Maine Harvest with their loan request, the conversation changed. With more than 25 years of experience in Agricultural lending, our Chief Lending Officer, Patty Duffy, understands farm businesses and the way back-to-back droughts impacted Mistybrook’s bottom line. Patty recognized Katia and Brendan as strong financial managers, with well-established sales channels and strong brand recognition. Because Katia and Brendan came prepared with a complete set of financials, we were able to provide a fast turnaround on the loan request. Closing took place just as Maine and the country shut down in response to COVID-19, quite a feat.

We know that traditional financing is not always available for small farmers and food producers. At a time when COVID-19 threatens the wholesale market for local food, financing this delivery truck will keep a network of Maine Farms connected to critical distribution services.

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Another Tastee Diner Lesson

Readers of this blog may recall the first time I wrote about Bethesda’s oldest, continually operating restaurant. In it I asked the question how this old fashioned restaurant model, serving comfort food, open 24 hours a day could survive in the affluent, high-end dining market now dominating Bethesda. Moreover, the new 27 story international headquarters of Marriott International is going up cheek and jowl on three sides. Why didn’t they just move out? The owner’s answer was simple: “We own the land.”

Normally the diner closes only one day per year, Christmas. But when Maryland went into a state-wide stay-at-home order, the diner closed just as every other retail establishment. Two weeks ago, Maryland entered Phase 2. The diner reopened following the state’s covid guidelines.

I visited Sunday morning to see how they were doing. Was there another lesson for credit unions from this locally owned business landmark?

The Menus: Phase 2, Printed on Paper, Used Once , and Thrown Away

Construction work continues on Marriott’s new headquarters. Eleven stories done, sixteen more to come:

Covid warriors/waitstaff clean every table and benches after each customer. Every other booth is closed. Nothing on tables except napkin holder and sugar packets.

Approximately twelve employees: cooks, wait staff, clean up, owner and cashier. Only four customers at normal peak breakfast time. Covid’s seating capacity is 75 socially distanced.

Tastee Diner’s Challenge is the Country’s

When will guests return? Being open is not sufficient. Customers must feel safe to venture out. That is something Tastee cannot control, but requires consumer confidence in their public officials. Only then can the economy become self-sustaining.

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STOP THE PRESSES: MEMBERS VOTE DOWN MERGER 66% TO 34%

Yesterday the Credit Union Journal broke a unique story. The members of N.W. Iowa CU ($58 million) voted against a merger with Siouxland FCU ($206 million) by an overwhelming margin of over 2 to 1.

Unprecedented Event

Every year, several hundred voluntary mergers of sound, well-run credit unions occur. Under the cooperative democratic structure, these mergers must be approved by a majority of members voting on the request to end the charter.

However, the voting can hardly be described as democratic in any traditional understanding of the term. For the process is akin to a “one party state.” All of the narrative, timing, ballot and ongoing messaging are controlled by the credit union’s board and management, backed by all of its resources and marketing capabilities. There is no “opposition party.” No contrary information or alternatives are ever mentioned.

The majority of ballots are submitted by mail. The “campaign period” is 45 days or less. Anyone opposed has neither resources, time, or expert knowledge to counter the party line. The decision is a simple yes or no vote on the merger. The option to remain independent is not even present on the ballot.

Members overwhelmingly mail in ballots, as requested, approving the board’s recommended action. After all, if members didn’t believe in the board leaders they elected at some point, why would you trust them with your money to begin with?

Since becoming involved with credit unions in 1977, there have been over ten thousand such voluntary mergers. I am unaware of any time that members turned down this board/CEO recommendation to end a credit union charter.

Information Provided to Members

The public information from N.W. Iowa follows this traditional process. The required Notice of Balloting dated April 20, 2020 was sent to the 5,000+ members outlining the reasons for merger.

These included the convenience of five Siouxland branches and “advanced products and services with competitive rates.”

Other details noted the credit union would continue to operate under its own name (as a division of); the current CEO would retire but continue to work as an advisor; employment would be offered to current staff; two directors would join Siouxland’s board; and a charitable account would be set up to receive “at least 51% of earnings” to build engagement with the Iowa community.

The four-page document lists the new main office in South Sioux City, Nebraska, and its five branches.

The required merger related financial disclosures included bonuses for all merged employees plus severance if terminated without cause in the next two years. Four senior loan managers would be entitled to additional benefits totaling over $330,000.

The credit union’s Facebook page (https://www.facebook.com/NWIACU/) still shows the video of the two CEOs promoting the merger as well as an announcement from the chairman: Thank you for being engaged. Your credit union will remain independent.

Why the No Vote?

We don’t yet have information why opposition developed their point of view and how they organized to overwhelmingly reject this merger event.

N.W. Iowa is a very strong credit union. Its growth of shares (8.4%) and loans (7.9%), operating expense ratio (0.53% of revenue) , ROA (0.94%) and delinquency (0.35%) are all better than Siouxland’s March 2020 numbers. By any standard, this charter granted January 1, 1966, is a strong performer.

Was it some information in the notice? A perceived lack of any relevant benefits from the merger? The payment of employee bonuses in a time of economic uncertainty?

Outsiders generally know two things about Iowa: It is the first state to hold a presidential primary every four years, and it grows lots of corn and hogs. The state is middle west conservative with a legacy of rural small towns and farming communities–not the likely source of a populist uprising.

Le Mars, the home of the credit union, is called the Ice Cream Capital of the World. Were residents upset at the loss of a community pillar with its local focus, relationships, reputation and over 50 years of service?

Reemergence of the “Grass Roots”

In this time of crisis, is this event another example of popular protest emerging in other areas of society. The traditional obedience to authority and status quo behavior is being challenged as COVID concerns and economic uncertainty grow. The people want to be heard, not taken for granted. They want the institutions to serve them not the parochial interests and rationales of their leaders.

The no vote was announced on July 1, just in time for Independence Day. Can this be the spark for a revolution to return the focus of credit unions to serving their members? And challenge the unprincipled pursuit of mergers when members need their credit union relationships more than ever?

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Getting the Best Leadership for NCUA: A Case Study

For the last decade the appointments, or repeats, to the NCUA board have been a total surprise to the credit union community. New names, no industry references.

After the fact, we learn the selections arose primarily from their Washington insider connections. Their lack of credit union cooperative understanding and/or management experience is glaring.

With no vision or expressed views on the unique role of credit unions, appointees instead swear an oath to safety and soundness. That mantra is used to justify whatever actions, regulations or policy changes are subsequently proposed.

Appointees lacking credit union experience has not always been the case. Until credit unions reassert their collective interest in NCUA board nominations, these three positions will continue to be consolation prizes for party loyalists seeking a government sinecure.

Appointing the First Federal Regulator

When the Federal Credit Union Act was passed in 1934, the responsibility for creating a new federal system was placed in the Farm Credit Administration (FCA). The concern of Roy Bergengren (a founder with Filene of the credit union system) was that there should be a single integrated movement, not dueling state and federal charter designs.

The Governor of the FCA asked his first assistant, Herbert Emmerich (who had helped draft the federal legislation and coincidentally, was a credit union member) to serve as interim director of the credit union division, until he hired an assistant to devote full time to this new responsibility.

Who did Emmerich ask for leadership recommendations? Roy Bergengren. They had worked together on the final legislation.

Bergengren knew that the new legislation must be implemented by a credit union advocate or end up stillborn. He gave Emmerich seven recommendations. Bergengren was in turn asked to determine each person’s interest.

The “Proper Credit Union Spirit”

Bergengren’s first choice was Claude Orchard, who when approached, said he would accept the $4,600 per year job. He thought Orchard had “the proper credit union spirit.”

In his July 17, 1934, response to Bergengren’s outreach, Orchard wrote: “I hope the “assistant director” will be permitted the chance to get out into the field to actually set up a few key credit unions and have the opportunity to train organizers both paid and volunteer. That would be a fine sort of job for me.” (Moody & Fite, page 167)

Once on the job, Orchard got Emmerich’s permission to actively encourage the founding of both state and federal charters. His main goal — to increase the number of credit unions in the United States — was a spectacular success. One example of his public advocacy is a speech to the New York Credit Union League in 1937 as reported in the New York Times.

Who Was Claude Orchard? Why was he so successful as the first Federal Regulator?

Claude Orchard began working at Armour and Company in Omaha, Nebraska in 1903. He was intimately acquainted with the financial problems of the company’s employees, many of whom were poorly educated blacks and immigrants working for 17-18 cents per hour.

He first heard about credit unions in 1929 from a lawyer sent by Bergengren to help organize credit unions in Nebraska. The two quickly organized the first Armour credit union which so impressed the company that management freed Orchard to travel to other Armour plants to organize more credit unions. By 1933 the number of Armour credit unions had grown to 70.

The Takeaway for Today: Speak Out

Ed Callahan, NCUA chair (1981-1985), frequently observed “people do what they know.”

Experience matters especially for those in positions of senior leadership. It frames relationships, brings life’s hard-earned lessons and shapes the values a leader follows in the job.

Two of the most sought-after outcomes in secular life today are money and power. But cooperative design is based on an inversion of these traditional market driven ambitions.

For credit unions to continue as a unique resource for America will require modern day Claude Orchards. These leaders must define and implement policies to bring renewed purpose to a movement whose regulatory institutions are desperately short of cooperative belief and understanding.

Isn’t it time for credit unions to SPEAK OUT before NCUA board openings are filled — rather than spending years trying to educate board members about the industry they supervise? Or more likely, to be totally dependent on the bureaucracy’s recommendations?

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A Suggested Virtual Annual Meeting on July 8

Last year I invested $100 and became a member-owner of Shared Capital Cooperative. Founded in 1978, it is a Community Development Financial Institution (CDFI) organized as a coop with both individual and cooperative members.

Its purpose is funding cooperative enterprises and housing.

Their annual meeting is July 8th and is open to the public.

Why attend? I believe this example of a financial firm may inspire ideas about how cooperative design can transcend current credit union models. Notice follows:

2020 Annual Member Meeting & Cooperative Forum: July 8, 2 – 3:30 pm CT

Click here to register now to join us virtually on July 8 at 2 pm CT

Shared Capital Cooperative is excited to share our impact over the past year and to feature cooperatives across the country that are innovating and inspiring in their response to COVID-19. The event will include: 

· A brief Business Meeting reporting on our activities and impact;

· Annual Cooperative Forum, featuring cooperatives’ resilience, innovation and inspiration in how they continue to serve their members and their communities during the pandemic. 
For more information please click here.

The event is free, and everyone is welcome to attend.. Click below to register: https://register.gotowebinar.com/register/3140026396343107343

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Ben Franklin: Declaration Signer, Creator of Civic Enterprises and Proponent of Community Values

Benjamin Franklin (born January 17, 1706, Boston, Massachusetts, died April 17, 1790, Philadelphia, Pennsylvania) was a person of extraordinary talent. He made lasting contributions to multiple areas of human endeavor including practicing the cooperative principle of Paying It Forward.

As a signer of the Declaration of Independence, he played a major role in getting the document approved and adopted by the Continental Congress. Perhaps more critical, he served as Ambassador to France from 1777 to 1785. securing France’s financial and military assistance in the Revolutionary War.

His Areas of Intellectual and Social Enterprise

One of 17 children, he went to work at age twelve in a print shop run by his older brothers. He published his insights in Poor Richard’s Almanac, many of which are still recited today: “A penny saved is a penny earned.”

As a tradesman and inventor his ambition, intellectual energy and sociable nature, made him a natural leader of public projects. His lifelong commitment to self-improvement also manifested in his civic initiatives to upgrade living conditions in mid 18th Century Philadelphia.

Beginning in 1727, Franklin and his associates enhanced community life establishing a lending library, hospital, school, fire brigade, insurance company, learned society, and militia. To advance public safety: he supervised the lighting, cleaning, and paving of Philadelphia streets and designed a fireplace that conserved fuel while avoiding house fires.

These civic endeavors were in addition to his work as an inventor (bifocals and Franklin stove), scientist (theorist about electricity), musician and author of timeless insights on human nature and society.

The Cooperative Foundation: Pay It Forward

Much of Franklin’s multifaceted contributions from his discipline and hard work, arise from a value centered life focused on the question, how can I help?

“Pay it forward” is the concept that when someone does something for you, instead of paying that person back directly, you pass the kindness on to another person.

In a letter to Benjamin Webb (April 25, 1784) who’d requested to borrow money, Franklin asked his friend to repay the debt by lending to someone else in need down the road. Instead of receiving repayment, he sought to do a world of good with what little he had to give. 

I do not pretend to give such a deed; I only lend it to you. When you meet with another honest Man in similar Distress, you must pay me by lending this Sum to him; enjoining him to discharge the Debt by a like operation, when he shall be able, and shall meet with another opportunity. I hope it may thus go thro’ many hands, before it meets with a Knave that will stop its Progress. This is a trick of mine for doing a deal of good with a little money.

One outgrowth of his “doing a deal of good with a little money” is today’s cooperative credit union movement. Another enduring legacy from the nation’s founders.

As we celebrate this 244th anniversary of the 4th of July Declaration, Franklin’s reflection on our nation’s governance remains timeless:

The U.S. Constitution doesn’t guarantee happiness, only the pursuit of it. You have to catch up with it yourself.

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Issues Bigger Than Regulator’s Rules

In 1978, Sangamo Electric Company announced the closing of its Springfield, IL manufacturing plant and head office to move to Georgia.

The company had its own credit union. I had been Illinois Credit Union Division Supervisor for one year. My dad had worked at the company in the 1950s, so I felt an interest in the situation. The issue: what should happen now to Sangamo Employees Credit Union?

For me, the answer was simple. The sponsor and all its direct support, plus the members’ jobs, no longer existed. The employer-based “common bond” was gone. Therefore, it no longer complied with the state’s chartering requirements . It should be closed.

That was not the view of my boss, Ed Callahan, the Director of the Department of Financial Institutions. His logic was that with the company’s closing, the members needed their credit union more than ever. Their jobs were gone. The credit union would be more vital to their future than before.

He suggested we find a way to modify the charter so that the members, not the company or the regulator, could determine their credit union’s future. And that is what we did ­.

Regulators and the Current Pandemic

This incident came to mind when a CEO sent me NCUA’s interagency joint announcement: “Examiner Guidance for Assessing Safety and Soundness Considering the Effect of COVID-19 Pandemic on Institutions.”

The purpose of its eleven pages: “to promote consistency and transparency across the agencies, examiners will continue to assign supervisory ratings in accordance with the applicable rating system. . . CAMELS.”

“. . .it is essential that examiners maintain a clear understanding of the financial condition of each institution.” And “. . .examiners will distinguish between problems caused by the institution’s management and those caused by external factors beyond management’s control.”

Why is NCUA Sending this “Guidance”?

The paper appears self-serving, citing circumstances familiar to everyone. It reads more like a warning notice, than “guidance.”

Its bottom line is “we are telling you, be careful.” Is this a prelude to circumventing normal supervisory due process, using the pandemic’s uncertainty as an excuse?

There are three concerns with NCUA’s forwarding this directive to “promote consistency and transparency across agencies.”

  1. Why did NCUA believe this bank-drafted warning message was even appropriate for credit unions?

Credit unions are different from banks in fundamental ways. Their cooperative design, tax exemption, “common wealth” and reserve/capital options are intentionally unlike privately owned firms created to profit shareholders.

Credit unions fulfill a different purpose, one of which is to be an antidote to the shortcomings of for-profit financial options. The CLF and NCUSIF’s designs incorporate these cooperative differences.

  1. At this time every other arm of government including Congress, Treasury, the IRS, SBA and even the FED are crossing all their traditional “red lines.” Why is NCUA joining bank regulators to announce “business as usual” contrary to the activities of every other government entity?
  2. This “examiner guidance” makes no mention of the special credit union role in times of economic distress. Every day credit unions are waiving fees, lowering rates, providing forbearance and other special accommodations for members. These actions reduce a credit union’s “normal camel ratio ” outcomes. That is what coops are supposed to do with their members’ collective savings.

A current example is how 15 Vermont credit unions have provided $385 million in member relief, so far. Isn’t this the special “guidance” NCUA should be highlighting?

Rising Above Rules

While hitching NCUA’s wagon to other regulators may seem to enhance NCUA’s image, it diminishes credit unions’.

Credit unions were well positioned financially entering this crisis. The cooperative regulator is most effective when knowing how to see beyond the letter of the law and support the spirit of the movement. That is the Sangamo lesson Ed Callahan helped me to see.

This instinct to put members first lives in most credit unions. In this time, shouldn’t NCUA’s “examiner guidance” be to promote this essential mission? And even co-develop special programs with the industry to help members recover financially?