Author: Chip Filson

From March 2020 until two years later when the Fed began its rate increases, overnight rates were near zero.  For these years and the decade prior, monetary goals were dominated by ZIRP, or zero interest rate policy.  Federal reserve actions were characterized by “easy money” to encourage growth almost at all costs.

TINA was the real world consequence of an ever expanding money supply seeking higher returns.  There is No Alternative led to speculation in every market sector from crypto and all of its virtual spinoffs, the stock market with historically high valuations (price/ earnings  ratios) and in most other forms of investing such as residential and commercial real  estate.

With near zero cost of funds and asset appreciation occurring in every category, how could an investment not pay off?  Holding cash or buying short term bonds was for fools when higher returns were possible from virtually any other  investment.

Now the bubbles are starting to burst as the Federal Reserve continues its interest rate hikes and as these flow through to longer term yields.

The combination of ZIRP and TINA meant that valuations in stock markets, or new ventures , as well as traditional collateral based lending on real estate or commercial  buildings became separated from actual earnings or cash flow analysis.  Money managers were drawn to these alternatives assured by the decade long monetary easing culminating in ZIRP.

Entrepreneurs, startups and even established firms made decisions not based on actual business performance but future projections. These choices were based of valuations underwritten with assumptions of low cost of funding.

Impact on Credit Unions

In 2020 and 2021 credit union shares  grew by double digits. Consumers were flush with cash from multiple government stimulus spending packages.   They used these new funds to pay down traditional borrowings.

With only a 5-10 basis points return on short term funds, credit unions looked for alternatives.  They extended investments out the yield curve, sought higher yields from longer loan maturities, commercial participations, or other forms of indirect lending pools and even new CUSO investments.

In 2023 credit unions will navigate the 1-2 year adjustment process to correct these prior decisions. With patience and prudent balance sheet management most will transition to this new rate era and recover unrealized market losses.

This rebalancing may entail paying below market dividends on core shares until asset returns adjust to higher yields.    If the institution has a strong service culture and earned  loyalty, this reliance on member’s patience should  be successful.

However there were other investments by credit unions where the process becomes more complicated.  The two areas most vulnerable to ZIRP/TINA overvaluations are whole bank purchases and mergers. Or any other transaction which resulted in the creation of significant accounting goodwill.

The Bank Purchase Challenge

Most credit union bank purchases, where information is public, have been at multiples of 1.5X to 2X book value.   For publicly traded banks, these credit union offers were often much in excess of the most recently quoted stock price.

Total cash paid to bank shareholders depends on the size of the acquisition.  But these outlays are large involving tens to hundreds of millions of dollars.

Credit unions book the difference between the cash paid and the net value of the assets as goodwill.  This is an intangible asset.  It is non-earning.   These valuations are based on forecasts about cost of funds, the credit union tax exemption and any market synergies that may be achieved.

Most sizeable bank purchases will take 3-5 years to determine if the price paid will result in an accretion to ROA or perhaps reduce the prepurchase financial performance.  Operational and market integrations alone will take several years.   For purchases made in the ZIRP environment, these forecasts will have to be rerun.   Is the goodwill premium “real” or was it miscalculated?

Similarly in mergers combined with purchase value accounting, a goodwill gain for amounts greater than book value may be added to “equity acquired in merger.”   But is that goodwill actually long term or just a momentary valuation bubble caused by the low interest rates paid on deposits versus market yields?

If the goodwill recorded is unrealistic for any reason, then the valuation write downs  come out of current  earnings.  In this case, members pay twice:  once by sending  out cash to bank shareholders and again for expensing the decline in goodwill from current income.

Looking at Case Studies

In future blogs I will examine several whole bank purchases looking at the credit union’s performance before and after, and by benchmarking with peers.

I am inclined to prefer cooperative strategy which prioritizes organic growth through continuous innovation and consistent market focus for member benefit.  Engineering growth through acquisitions is a very different financial and operational skill.

In the capital markets these transactions are most often done with “play money,” that is the stock of acquiring companies, not actual outlays of cash.  The market’s judgment via the stock price of  post-acquisition performance is constant and public.

There is no such accountability in similar credit union purchases.   CEO’s and boards  leave and their successors must then  prove that these “investments” with a long tail were wise.

Ultimately it is not the valuation at the time of purchase that reflects opportunity; rather it is the ability to convert externally acquired assets for real member benefit.

2023 will entail assessment of investments driven by ZIRP, TINA and consultant’s fees to see if they really enhance the cooperative difference. That reckoning could be more critical and harder than traditional cooperative balance sheet transformations.

When the economy shut down in March of 2020 due to Covid, many office workers went home.  Hybrid and remote work options were developed.  However essential workers stayed on the job:  the trash haulers, public transportation, police, fire, hospital, construction  workers.  These blue collar and middle class service workers make community life possible for the rest of us.

Today the key economic question is will there be a recession?  For hundreds of thousands of white collar workers in the technology, finance and venture capital startups the layoffs are here.

Goldman Sachs, Pepsi, Gannet, CNN, Door Dash, Carvana, Roku, Amazon and dozens of other previously industry high flyers are in the first rounds of layoffs.

The dominance of the four FANG (Facebook, Apple, Netflix, Google) and their stock market performance has fallen back to the mean of the rest of the market over the past five years.

The bankruptcies of the crypto, NFT industry and its offshoots have cost investors over $2 trillion in losses with more to come.

However in almost every other part of the economy, especially the service sectors, there are millions of unfilled jobs.  Wages are rising from both employer demand and more aggressive employee actions.

The Well Off and Essential Labor

America’s experience with capitalism has often been characterized as a society where the successful, the wealthy, the better educated have dominated their poorer classes.  Here is an excerpt from a Heather Cox Richardson description of why Lincoln strongly supported universal education:

But when they organized in the 1850s to push back against the efforts of elite enslavers like Hammond to take over the national government, members of the fledgling Republican Party recognized the importance of education. In 1859, Illinois lawyer Abraham Lincoln explained that those who adhered to the “mud-sill” theory “assumed that labor and education are incompatible; and any practical combination of them impossible…. According to that theory, the education of laborers, is not only useless, but pernicious, and dangerous.”

Lincoln argued that workers were not simply drudges but rather were the heart of the economy. “The prudent, penniless beginner in the world, labors for wages awhile, saves a surplus with which to buy tools or land, for himself; then labors on his own account another while, and at length hires another new beginner to help him.” He tied the political vision of the Framers to this economic vision. In order to prosper, he argued, men needed “book-learning,” and he called for universal education.  

Congress passed the Morrill Land Grant College Act in 1862 to focus on the teaching of practical agriculture, science, military science, and engineering—although “without excluding other scientific and classical studies”—as a response to the industrial revolution and changing social class.

The Question Today: Do Rich People Know?

Gian Carlo Menotti’s opera Amahl and the Night visitors tells of the night the Three Kings, following the star to Bethlehem, stop for shelter at the home of Amahl, a poor, crippled shepherd boy who lives with his widowed mother.  The opera was first performed in 1951 and regularly at Christmas since.

The climactic scene occurs as the three kings sleep. The mother consider if she dare take a piece  of gold from  the king’s treasure chest. She debates the rightness of her action:

MOTHER (thinking to herself) All that gold! All that gold! I wonder if rich people know what to do with their gold? Do they know how a child could be fed? Do rich people know? Do they know that a house can be kept warm all day with burning logs? Do rich people know? Do they know how to roast sweet corn on the fire? Do they know do they know how to fill a courtyard with doves? Do they know… do they know? Do they know how to milk a clover fed goat? Do they know? Do they know how to spice hot wine on cold winter nights? Do they know… do they know? All that gold… all that gold! Oh what I could do for my child with that gold! Why should it all go to a child they don’t even know? They are asleep. Do I dare? If I take some, they’ll never miss it… (moving towards the boxes of gold…) …for my child for my child… for my child… for my child…

2023: the Year of the “Essential Member”

Credit union’s purpose was to address those in society who have the least or know he least when seeking financial services, especially credit.

The cooperative model proved that consumers are indeed a market that all financial institutions can profitably serve.  Today financing options for consumers are available for those with no or damaged credit to the elite credit cards made of titanium, not mere plastic, for the most well off.

Since deregulation the credit union system has grown, attracted tens of millions of new members and provided ever expanding institutional and professional opportunities for coop leaders.

Some coop executives see their opportunities in buying banks or scooping up their smaller brethren.  Senior executive coop compensation routinely rewards in the mid six figures.  For the best well-paid leaders, annual compensation comes with two commas.

The challenge for coop leaders will be the question asked by the widow in Amahl:  I wonder if rich people know what to do with their gold?

Have leaders so aspired to emulate their banking counterparts that the essential members whose loyalty created the institutions they lead has been forgotten?

Yes, the white collar tech, financial and previously high flying company employees now being brought back to earth by rising interest rates, will need our help as well.

But let’s never forget those who brought us to where we are today-a $2.3 trillion tax exempt financial force with a special role in society.  This institutional success has enabled many coop managers and boards to become members of the white collar class.

Do they know that America’s essential workforce may indeed be the greatest opportunity for credit unions in this pivotal year of economic and market realignments.