Author: Chip Filson

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Credit Union CEO Joins Iowa Bank Board

Iowa is home to a very  rambunctious  credit union system.  A total of 80 credit unions manage over $33 billion in assets growing at double digit rates.

Several larger Iowa coops have bought banks to expand their franchises faster.  63 are suing NCUA over the agency’s failure to honor the plain language on its Corporate Claims Certificates.

Then there is a relatively small credit union who is currently suing Apple for restrictions in its Apple Pay product.  This same CEO has joined the board of a local bank.

The bank has two major centers in Des Moines and Ottumwa from which it serves affiliates in 55 counties throughout the state.

The board director is Jim Dean. CEO of Affinity Credit Union.  The bank is Food Bank of Iowa, a 501 C 3.  It reaches over 300,000 children, seniors, veterans and persons who experience food insecurity during the year.  In 2022 it distributed over 1.2 million pounds of food per month through 700 frontline partners.

The administrative offices, warehouse, and distribution-delivery capabilities are supported by volunteers who come daily to prepare boxes for local delivery.  To carry out its mission, the Food Bank relies on almost 10,000 persons who freely give their time and labor.

A Common Cause

On factor in food insecurity is the inability of many to earn a living wage. The issue “comes and goes” for individuals as economic circumstances affect individuals’ opportunities.

When asked why the Food Bank  partnered with Affinity Credit Union, Vice President  Bergetta Beardsley, who is responsible for fund raising, replied simply, “There is a natural relationship with those we both serve.”

Why Is Affinity Involved?

Food banks have been an important part of Jim’s volunteer work during his credit union career. In addition to the overlaps of those facing financial and/or food insecurity, these two organizations share the same values.

Volunteer activity is part of Affinity’s culture. The credit union provides employees with two days paid leave per year to serve their community. The CEO’s participation raises awareness with staff about the Food Bank’s multiple roles.

The credit union promotes the Food Bank with special 30 second radio spots and ads on their delivery  trucks.  In some instances, the credit union has assisted with food pantries for schools in their communities.

Even more strategic isAffinity’s example.  It connects the financial reach and capacity of the coop system to this critical organization serving over 10% (300,000) of Iowa residents with food.

An Ever-Expanding Effort

Credit unions, like individuals, are known by the company they keep.  Two nonprofits, Affinity and Food Bank of Iowa, are joined in a common purpose of service and personal well being.

Across the country today, many families help their local communities with food drives.  Schools arrange canned food collections for holidays; there are special hunger offerings and food drop-offs at churches and community centers.

But experiencing the scale and scope of this central wholesale operation  (55,000 square feet) is an eye opener.  It provides food to schools, day care centers, senior and community commons, church pantries and other institutions.  The operating budget is approximately $30 million.

A Visit in Photos

Here are some of the pictures from my visit to the Food Bank’s Des Moines’ office, volunteer center and warehouse.  Our guide was Bergetta.

The volunteer reception area with mission, vision and values:

A wholesale delivery of potatoes to be repackaged.

Converted to individual sized quantities..

Just one of several volunteer groups for the day who helped pack boxes for delivery.

Pallet being loaded for delivery to a Day Care.

Bergetta showing pasta provided in bulk from a corporate donor.

Another pallet ready for delivery.

Part of the massive warehouse.  Storage racks with supplies and  shrink-wrapped deliveries.

Food delivery trucks backed into loading dock.

Affinity Credit Unions adds its support on the back of the delivery trucks.

Even if an individual stops by the head office needing  food, a box is always ready.

Organizations write thanking Affinity volunteers.

Isn’t this a Bank we all might like to join?

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U.S. Treasury’s Payday Loan Rate

 

From Yahoo Finance:

“The Treasury Department auctioned $15 billion in one-day cash management bills on Friday as its cash balance remains under pressure.

The bills, which carry a 5.145% investment rate, will be issued Monday (June 6) and mature on Tuesday, according to the Treasury. Bids totaling $61.6 billion were tendered.

This is the first time since 2007 that one-day bills were auctioned, according to CNN.”

Moral of the story:   When liquidity is tight, everybody has to pay up. even Uncle Sam.

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Why an Oath for Credit Union Directors and Officers is Desirable

Boy Scouts have a pledge.  Couples exchange wedding vows.  Deacons, elders and lay ministers all affirm belief before the laying on of hands and becoming church officers. Naturalized American citizens take an oath-even agreeing to bear arms.

These ceremonies signify individual commitment in a public setting for the people they serve or community they join.  There are responsibilities in an oath, whether occasioned by election, by appointment or by personal choice.

Faithfully Discharge the Duties:NCUA’s Oath for Employees

All NCUA employees are required to take an oath upon accepting their positions.

This oath is administered by an NCUA employee, usually in the HR division, during new employee orientation on an employee’s first official day. Here is the text:

I, [state your name] do solemnly swear (or affirm) that I will support and defend the Constitution of the United States against all enemies, foreign and domestic; that I will bear true faith and allegiance to the same;  that I take this obligation freely, without any mental reservation or purpose of evasion; and that I will well and faithfully discharge the duties of the office on which I am about to enter. So help me God.  (emphasis added)

Duties, faithfully carried out.  Faithful performance is itself one aspect of the standard liability bond for credit union coverage.

A State Example:  OATH OF A CREDIT UNION DIRECTOR

Pursuant to Revised Code 1733.10, I, the undersigned director of NAME Credit Union, located in City, Ohio, do solemnly swear/affirm that I will diligently and honestly administer the duties of the office of director and that I will not knowingly violate, or permit to be violated, any law applicable to the Credit Union.

As a director, I have a legal responsibility and a fiduciary duty to credit union members to administer the Credit Union’s affairs faithfully and to oversee its management.  In carrying out my duties and responsibilities, I shall exercise reasonable care and place the interests of the Credit Union before my own interests.  I shall fulfill my duties of loyalty and care to the above named Credit Union.

I shall ensure that I learn of changes in statutes, regulations and policies of the Division of Financial Institutions and other applicable regulatory agencies affecting the Credit Union which affect my duties, responsibilities or obligations as a director and regulated person of the Credit Union.

I understand it is my responsibility to attend meetings of the Board of Directors and participate fully on all committees of the Board to which I am appointed.  I understand it is my responsibility to review the examination reports of the supervisory authorities at the next succeeding board meeting after the receipt of the reports.

Signed and notarized by each director.

The Current Status of an FCU Oath

The following was the response when I asked NCUA if FCU directors were required to have an oath:

The answer is no. There isn’t a required oath of office for federal credit union boards of directors in the Federal Credit Union Act or Federal Credit Union Bylaws.

Our legal team reviewed the current bylaws, the previous version (Timeframe of the mid to late 1990s, with amendments), and even earlier versions of the Bylaws from the 1930s to 1940s. None of these documents require an oath of office.

Also, an oath of office is not something we track in regulatory reporting like the Call Report or Profiles. As such, I don’t have any information on which federal credit unions, if any, administer an oath of office.

While we don’t have specific rules on this topic, the NCUA has received and considered the question of an oath of office before. The attached 1985 NCUA legal opinion says an oath of office is allowed because it would not conflict with the Federal Credit Union Act or Bylaws for a federal credit union to require directors to take an oath of office. 

Why An Oath is Desirable

Leadership of a credit union is a responsibility to  members, the community and those who in generations past created the cooperative as an enduring organization to pass forward its legacy of wealth and service.

Sometimes the concept of a “volunteer” has connotations of a position that can be taken or left at will.   Duty is voluntary.  Anyone can step up.  The responsibility is institutional and collective, not individual.   Except for a number of state charters, directors are not paid, which is sometimes interpreted as an absence of individual accountability.

Cooperative board leadership now involves oversight of trillions of dollars member-owned assets.  The directors’ roles are becoming more consequential for members and communities.

Moreover there are unique aspects in cooperative leadership:

  • Awareness and implementation of cooperative principles;
  • Recognition and respect for democratic member governance;
  • Adherence to bylaws and numerous regulations specific to credit unions;
  • The absence of any federal tax liability.

Moreover, the traditional director duties also still pertain including the standards of loyalty, care and the fiduciary obligation to act in good faith.

An Oath as Promise

An oath ideally in public at the annual meeting would be an act of honor and commitment.  It signifies both responsibility and accountability even as volunteers.

Credit unions are a part of a society that at times has differences about the priorities of their leaders.   Oaths remind all of our common obligations.

An oath is a promise.  In the NCUA’s example it comes with a sacred commitment-so help me God.  It would elevate the moral and communal character of cooperatives.

A person when taking an oath acknowledges the responsibility, not merely the public honor,  of their role.  The commitment is elevated beyond the routine director tasks of attendance and oversight.

All oaths remind us of who we are and what we want to be.

They show a solemn undertaking with commitments to the past and future, not just today’s agenda.  It is another way to show how the cooperative model stands apart from for-profits.

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Two Trends Deserving Debate

At the NCUA’s May board meeting, one trend jumped out at me.  Not new, but accelerating and read without comment.

In the first 90 days of 2023 there were 59 NCUSIF charter cancellations.  That is a rate of almost 5 per week, one every business day.  Without exception these charters are decades old, some surviving and most thriving.   Why?

These charters are the handiwork of generations of volunteers, whose current leadership have decided to give up.  It is a morale and ethical problem.   For it undercuts the coop premise that pays forward the members’ collective legacy for which the present leaders are  now the steward.

Many will suggest that the credit unions members are in better hands.  However these hands are not the leaders they know or elected, nor the organization that created their collective reserves.  Every charter cancellation eliminates an example of economic self help, self finance and self governance.

In most cases these are locally focused institutions which created unique relationships with their communities.   Financial services may continue, but not from the same roots.   Another civic organization so essential to a vibrant democratic political economy is no more.

What Can Be Done

Regulators should put the same time and effort into requests to cancel charters that  they extend to new charters.  If a merger is the strategy, show us the plan.  If the volunteer leadership is giving up, ask members for new volunteers.  If the sponsor has moved away, then seek a new group for re-energizing the charter.

Today the regulators have endorsed an exit strategy that benefits only the senior leaders who leave the membership in the lurch.  And retiring CEO’s especially, are taking advantage by transferring their legacy to another credit union, often for just a few more silver coins.

When quitting a business or long standing effort is easier than getting in, the movement will continue to close future growth options, create higher concentrations of risk, and remove financial services away from their local connections and knowledge.

No charter should be cancelled without an effort to find others who are willing to pick up the opportunity.

A Second Trend to Be Re-energized

No brand, business or opportunity can continue without the support of the next generation of consumers.

Student run and led credit unions have been part of the educational and financial services of cooperatives from the beginning.

Yesterday I learned about a scholarship program to identify young persons often from disadvantaged backgrounds (poverty, refugees, disabled) who are given the opportunity to become part of a special education effort.

The premise is that brilliance is equally distributed in persons,  but opportunity is not.  The focus is on 15-17 years old.  This is an age when  “ideation,” the willingness to consider new ideas and become doers is formed.

This educational support is for four years.   The time frame for measuring success is in decades.  It may take ten years or more to see if those chosen in the program will become leaders in their chosen professions.

The program called Rise recognizes that leadership will be manifested in many different ways but over time.  But the investment in this generation must be made now.

The cooperative model is designed to attract this kind of self starter.  But today again, the regulatory community discourages new charters.  The application has become a compliance drill, not support for people with passion to serve a community.  The next student chartered credit union will be the first since the 1980’s.

In the meantime these young change makers are engaging their start up  fervor elsewhere sometimes in other innovative finance-related endeavors.

The Common Thread

Credit union leaders, regulators and professional staffs, have become captured by the short term focus that drives most performance reporting.   What are the latest quarterly numbers?  How will we expand the market reach of our FOM?   What Fintech partner will give us short erm lead on innovation?

All these efforts while necessary overlook the longer term outcomes.   Without  this awareness, the movement will become just another increasingly concentrated, and limited,  financial service option in ten years.  The number of active charters will be halved.

Tomorrow’s  innovative financial models will have been created by the high school and college generation outside the movement. Credit unions will be seen as  old fashioned “banking” firms just tending to their own, stand alone, self interests.

Both of these trends today are shaping what the movement will be a decade from now. There will be other cooperative solutions designed to serve consumers’ financial needs; however they may not be called credit unions.

 

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A Perspective On Credit Union Leadership & Human Nature

“It’s probably been happening in the ranks of American business since the first corner office was built, the first board was elected and the first regulatory body was created.  But the unceremonious departure of well-known chief executives is also occurring a lot more frequently in the CU movement, lately.

“These are people you know, or at least know something about.  You see them at national credit union conferences.  They are the ones who have their photos in the program book because they are on the board of the sponsoring group or are speakers.  They are the first ones to the floor microphones to challenges speakers.  They write articles and have articles written about them.  Their credit unions are also in the press a lot for innovations and achievement.

But they are gone.  Not because they wanted to leave, either.  Boards asked them to resign or fired them.  Regulators asked them to sept down.  Officers of the law escorted them into custody.  Staff pressures forced them out.  Some simply couldn’t cut it any more.  Some left kicking and screaming.  Others left quietly, never to be seen or heard from again.

“It seems a shame that a long and apparently successful career ends with a headline, factual story and mug shot in the press.  It happens to corporate titans all the time. But we’re talking about credit union people here.   They’re supposed to be different, but I guess they really aren’t. . . Although the reasons for departure vary greatly, it is apparent that one more sign of the growth and maturity of the credit union industry is that the “here today and gone tomorrow” syndrome is alive and well. . .

“Collectively the moral of their stories should be to acknowledge when you are doing something that could be viewed as a questionable business practice and stop it immediately.  CU CEO’s and for that matter their boards, don’t have to be rocket scientists to understand that eventually, hefty insider loans, conflict of interest . . . transactions, or sweetheart compensation packages are going to get them in trouble and into the unemployment line at beast and the appropriate jailhouse at worst.  . .

“Who’ll be next?  I suspect some out there already know who and why, too!”

 

(Source:  by Mike Welch, Editor and Publisher, Credit Union Times, April 22, 1992, Page 6)

 

 

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Summertime: 90 Degrees Today

Second day of summer. Have to start watering the yard.  The flowers are blooming.  Lots of color.

A red poppy.

 

Peony in full bloom.

Late blooming azalea.

Blueberry bush ready to start picking. Net to keep bird freeloaders away.

A late Easter Lilly.

Phlox

Branch of a white Kousa dogwood-flowers come after leaves are out.

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The More Things Change, the More Things Stay the Same

The NCUA’s May board meeting’s most important item was the NCUSIF update.  One slide  highlights why many credit unions are skeptical of the agency’s ability to evaluate its actions as circumstances change.

This  slide states that the Agency’s investment policy will go back to the same 10-year ladder in effect before the current banking and liquidity crises.

Since the March 2022 Federal Reserve  rate increases to counter inflation. many portfolio managers reported large declines in  the market value of  longer term investments.

In most cases, credit unions can  choose to “wait out the cycle” rather than sell and realize an investment loss.  This is because credit unions have multiple balance sheet options to ameliorate the impact on net interest income from holding assets with below market earnings.

However, over this last 18 months of rate increases, many portfolio managers have reviewed their policy assumptions that led to this illiquid situation. When cash flows again generate excess investable funds, I know of no one going back to what they were doing before this cycle began. Lessons are being learned.

This latest interest rate cycle has overturned many market assumptions drawn from the historically low rates in the post 2008-9 financial and then covid crises.  One expected outcome is a higher “normal”yield curve than experienced over the past decade.

The More Things Change  . . .

In the May NCUSIF update, the data show that the NCUSIF’s portfolio has a market loss in each  tranche of its investment ladder. This includes even the very short term amounts under one year.

Yet, as stated in the policy above, the intent is never to have to borrow or sell at a loss.   A difficult goal with ten year investments, a period which will likely experience several interest rate cycles.

The Fund’s  yield for the March quarter is 1.75% or approximately 3% below the overnight rates in the same quarter.

Every 1% below market yield results in an annual revenue loss to the fund of $200 million. NCUA’s only change in its portfolio ladder strategy was announced last fall.  It  paused term investments until the overnights reached $4 billion.  How this amount was determined was not explained.  Nor its impact on overall return or weighted average life.

Below Market Returns Lasting Years

In the May meeting, no board member commented on the Fund’s below market returns and unrealized losses. Board member Hood asked how long it would take for the portfolio to return to par value if the current rate structure became the new normal.  The response was three years, which is the portfolio’s current weighted average life.

Whatever the time frame for a new normal to settle in,  the NCUSIF and its credit union owners are facing below market returns for many more months, if not years.  The portfolio yield is the Fund’s principal, and in most years, only revenue source. The portfolio’s positioning hurts both fund performance and credit union potential dividends.

The only IRR/ALM analysis the NCUSIF provides in its monthly updates is the total portfolio gain or loss versus the current market.  Since December 2021, this indicator has been negative reaching a peak of  $1.8 billion in 2022.  At March 2023 the valuation loss was still $1.4 billion.  Why this very  obvious trend did not cause an assessment of the strategy before the pause in late 2022, is not clear.

The More Things Stay the Same

So what is the staff and board changing as a result of this eighteen months of  NCUSIF’s declines in portfolio value and below market yield returns?

The answer in the Slide is clear: “Once overnight target ($4.0 billion) is met, plan to return to slow buildout of (ten-yer) ladder.”   No board member questioned this approach.  By remaining silent, the board members consented to going back to the same practice that is leading to years of underperformance.

The Distressing Part of NCUSIF Oversight

The dilemma is more than hundreds of millions of lost annual revenue  from a below par portfolio. Those numbers are large and do matter to the Fund’s soundness.

But there is  a much larger challenge: no one is accountable for NCUSIF performance.

Even though CFO Schied presents the numbers he  references other offices when giving specific responses:  the economist for share growth estimates; E&I for the loss expense numbers using an undisclosed model; and legal for lack of clarity for true up options, etc.

The NCUA board  speaks with different views on the fund’s situation.  The Chair says he learned in school that when interest rates rise, bond prices fall. Therefore the Fund’s decline is just what we should expect.  That remark overlooks the whole IRR  risk management responsibility.

Vice Chair Hauptman characterizes any change to the ladder strategy as “trying to time the market.”  Hood’s questions are more targeted, but their import often seems lost on staff.  Example: why the true up mattes.

The distressing aspect is that any real changes to this extended underperformance seem to be fading off into the sunset. In contrast,  the entire industry is actively evaluating its ALM investment assumptions and policies.

Within NCUA committees are formed, policies reviewed, expert and even sometimes cu opinion sought, but there is no person sitting where the buck stops. It’s how bureaucracy functions.  When staff doesn’t know what to do, or the Board can’t agree, nothing changes.

If May’s NCUSIF update is  the best NCUA can do, credit unions should worry about the future of their Fund.

A Past Lesson

After the recapitalization in 1984 there was one practice that may resolve the current status quo approach. One person was responsible for the monthly update and explaining all expenses, reserves and future outlooks.  That person was not the CFO or the head of E&I, but Mike Riley,  He had total performance accountability even when it involved recognizing losses from problem cases.

Today the ideal solution would be for the Executive Director to provide the NCUSIF update. Regardless of how inputs are gathered the process needs a single point of responsibility.

Now no one is accountable.   By dividing NCSIF inputs  into multiple reporting sources, the CFO update  is merely a reporting role.  There is no  responsibility assumed even for accounting issues.

Appointing a single person for Fund accountability is the most critical change the Board could make.  Then the numbers might have real coherence.

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A Disturbing Slide in May’s NCUA Board Meeting

If the CFO came to your May board  with a forecast that the credit union’s retained earnings margin would fall by 50% in the first six months of this year, it would get your attention.

That is what CFO Schied presented in the slide below showing a decline in the NOL from December’s 1.3% to 1.25% by the end of this June.  That would be halfway to the 1.20 NOL floor at which the NCUA must come up with a restoration plan.

As summarized in my earlier report, all of the actual credit union CAMELS data, the NCUSIF financial position and other accompanying information was good news.  Especially in the context of the first quarter banking failures and the continuing risk in interest rates.

Board members acknowledged the actual resilience of the cooperative system but then picked up the forecasted alarm.

Chairman Harper suggested the actual data was just “the calm before the storm.”

Vice Chair Hauptman opened his comments stating his objective was to protect “the taxpayers” from NCUSIF failure.

Only board member Hood attempted to get behind the numbers.  He asked how the $12 million  loss reserves expense was determined and the status of proper presentation of the 1% true up.  The answers were a polite stonewall.

Similar to a credit union’s net worth, the NCUSIF’s reserve ratio is an easy shorthand for its financial position.  The calculation is straight forward.   The ratio is simply retained earnings divided by the insured shares at the same date.

This ratio was 29.1 basis points or .291% of insured shares at December 2022.  As of March 2023 the ratio was 28.8 basis points. This .3 of one basis point minimal decline in the first 90 days is a far cry from the 5 basis points projected above.

The projected ratio in slide 8 is a made-up number. Its relevance depends on the assumptions used.  The estimated growth of insured shares to $1.75 trillion is a 7.2% twelve month increase from 2022.  The actual rate of increase as of March 2023 from the year earlier was 2.2%.

The addition to retained earnings for the quarter ending June is just $6 million versus a net income of $41.7 million in the NCUSIF’s just reported March quarter.

The final number in the numerator is the 1% deposit.  The calculation above reverts back to the six-month-old December 31, 2022 total deposits. By using this out-of-date number this invented ratio understates the actual 1% deposit total due from credit unions.  Including this six-month-old deposit liability misstates  the actual ratio and cash due.

The slide’s 1.25%  manufactured outcome became the lead in several press reports. It misinforms about the trend in the NCUSIF’s financial position. The ratio’s assumptions were not explained even though they were significantly different from actual trends through March.

Monitoring an accurate Fund equity ratio matters.

Per stature, the actual NOL is calculated at yearend to determine whether a dividend must be paid should the fund’s reserves exceed the NOL cap. The number is also the floor from which a potential premium could be assessed to increase the NOL to a maximum of 1.3% of insured shares.  Getting this NOL right is vital for every credit union.

More critically the use of a number from an earlier accounting period to compare with a current period’s insured risk total does not align with standard GAAP accounting practice.

Two Accounting Examples

There are direct accounting precedents with GAAP for how the 1% true up should be reported.  They show that the concurrent presentation of insured risk and the legally required true up of the capital deposit base is standard industry practice.

The first example is Deloitt & Touche’s audit of  ASI’s required deposit an identical structure to the NCUSIF.  From the December 2022 ASI audited financials:

In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the Company as of

December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.   Deloitte & Touche, LLP April 11, 2023

And regarding the deposit requirement:

Participants’ capital contributions that are receivable or payable as of December 31, 2022 and 2021, are presented on a gross basis in the accompanying consolidated financial statements. Included in participants’ equity at December 31, 2022, is a receivable for capital contributions of Primary-insureds of $2,530,000 (no payable). The receivable and payable balances result from annual growth or shrinkage in participating credit union shares and the receivables were substantially collected subsequent to December 31, 2022.

Included in participants’ equity at December31, 2021, is a receivable for net capital contributions of Primary-insureds of $25,200,000. The receivable and payable balances result from annual growth or shrinkage in participating credit union shares and the receivables were substantially collected subsequent to December 31, 2021.  (page 13, Notes to the Consolidated Financial Statements)

The second example is the recognition in the NCUA’s Operating Fund of an “account receivable,” on the balance sheet and the income statement in its monthly statements postings.

From the January 30, 2023 NCUA Operating Funds monthly financial statements:

The cash position is considered sufficient to cover current and future budgetary obligations of the Fund through April 2023, at which time the Fund will collect the 2023 operating fees from its credit union members. . . Operating fee revenue reflects one twelfth of the 2023 Operating Fees.

A longer explanation of this accounting presentation for the expense receivable in the January 2022 statement:

Other accounts receivable, net had a month-end balance of approximately $10.5 million. Its balance increased by approximately $10.2 million from prior month primarily due to the unbilled receivable for the 2022 Operating Fee. The Operating Fee will be invoiced in March and collected in April.

In other words the Operating Fund recognizes a net receivable and records one twelfth of the total operating fee as income each month even though the fee is not invoiced till March and collected in April.

In these instances the amounts legally due are presented as receivables in ASI and NCUA’s    respective audited financial statements and monthly financial presentations.

The 1% True Up Topic Raised Again

Board member Hood asked again about the status of the external assessment of accounting options the NCUA board requested in 2021. CFO’s Schied characterized this external memo saying:  “Each option was “non-optimal.”  An unusual accounting conclusion.

NCUA has refused to publicly release this expert review under FOIA.  What options were reviewed, what data or precedents referenced, and how were the pros and cons presented?

The current practice leads users of the information astray. It potentially shortchanges credit unions’ dividends. NCUA self-interest is keeping the status quo.  The memo should be published for all to evaluate.

The credibility of NCA’s oversight of the insurance fund is a function of the legitimacy of the numbers and explanations it provides. If NCUA is not able to present the Fund’s position accurately, at a minimum it leads to misleading conversations.

How an Inaccurate Number Distorts Discussion

The fabricated 1.25 NOL ratio forecast as of the end of next month led to several illusory discussions and unfortunate public headlines.

One board member commented how the Fund’s “margin was narrowing” before “taxpayers will have to pay.”  That unfortunate characterization shows the importance of knowing real numbers.  In the first 90 days of 2023 the ratio had changed by just .03 of one basis point.

Moreover the only “taxpayers” who are legally bound to support the NCUSIF are members of credit unions. Each sends 1 cent of every savings dollar in their credit union’s 1% deposit in the Fund.

The board member’s observation that “there is not a lot of room between 1.2 to 1.3 equity” unfortunately mischaracterizes the fund’s actual operating performance since 1984.  The long term insured loss rate for the fund is just over 1 basis point.   Even in the 2008-2010 the net cash losses from natural person credit unions were 3.5, 2.0 and 3.0 basis points of insured shares.  The highest cash losses in the three years was $228 million, nowhere close to the “billions” response in the meeting.

In the most recent four years (2019- 2022) which includes the Covid crisis, the economy’s total shutdown and a rising rate cycle, the highest loss from “old school failures” was .3 of one basis point.  In 2021 the Fund reported actual net cash recoveries.

An accurate presentation of past and current NCUSIF performance is important in understanding the unique design and resilience of the NCUSIF.  Because of this collaborative resource, the credit union cooperative system is much more stable than FDIC insured bank premiums.

The Fund’s relative size to insured risks remains stable in all circumstances.   The 10 basis point guardrails (the 1.20-1.30 operating ratio range) today equates to almost $1.8 billion. For comparison, the NCUSIF’s entire total insured losses from 2008 through 2022 were $1.9 billion.   The operating expenses in this same period were over $2.4 billion.

The legislative guardrails were put in for a reason.  Credit unions feared that open ended funding would just lead to unchecked spending by NCUA.  This is what has occurred through increasing the Overhead Transfer Rate allocation to shore up the agency’s ever increasing budgets.

Constantly rising expenses, not insured losses, are the Fund’s largest drain on reserves.

Everyone Can Project NCUSIF Yearend Outcome

Forecasting the NCUSIF’s yearend NOL ratio is simple.  Here is the link to a spreadsheet anyone can use. If any difficulty using, please email.

The inputs are portfolio yield, share growth, NCUSIF net income, insured loss and whatever assumptions a user believes are consistent with present trends.  The current numbers include the latest actual NCUSIF updates through March 2023. It projects a yearend NOL of 1.2917.

Tomorrow I will review one other slide that is vital to understanding the Fund’s management.

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Memorial Day 2023-Words in War’s Time

Since the Russian invasion of Ukraine in February 2022, every day has been a “Memorial Day “ for a family somewhere in that country.

Four days ago Ukrainian President Volodymyr Zelenskyy gave a surprise commencement address to graduates of Johns Hopkins University by a live video link.

His country is in a war for its freedom.  Yet he took time to speak to 10,00 students and families of an American university’s graduating class.

The following are short excerpts from his ten minute speech in English.  They offer insight for how he views his leadership role.  These are words of discernment and character.

To the Johns Hopkins University Graduating Class of 2023:

Time is of the essence, and it is that essence that I would like to talk about today. One of the most common truisms on Earth is the advice to value, or at least not waste time. Why has it become so widespread?

Every person eventually realizes that time is the most valuable resource on the planet, not oil or uranium, not lithium or anything else, but time. Time.

The very flow of time convinces us of this. Some people realize this sooner, and these are the lucky ones. Others realize it too late when they lose someone or something. People cannot avoid it. This is just a matter of time. . .

Will you be able not to waste this time of your life? This topic seems trivial, but these are very, very difficult questions for every person. How you answer them is how you live. And while it is still possible to find new deposits of oil or lithium, and if in the future humanity can start mining resources in space, it is still purely science fiction to live longer than has been given. . .

Of course, I do not wish anyone to feel like they are in my shoes, and it’s impossible to give a manual on how to go through life so as not to waste its time.

However, one piece of advice always works. You have to know exactly why you need today and how you want your tomorrows to look like. You have to know this when you are a politician and have to achieve a certain goal for your country. You have to know this when you are a soldier and you have to defend your position so that the whole country is protected.

You have to know this when you just have to go through life. Sometimes, however, when you are young and when you are a student, you still need to waste some time. What is life without it? But only sometimes, and when no one else depends on you.

And I’m certain you, as your forefathers, will continue to lead the free world. And this century will be our century, a century where freedom, innovation, and democratic values reign. A century where tyrannies that repress their own and seek to enslave their neighbors will vanish from us once and for all.

But all of our tomorrows, and the tomorrows of our children and grandchildren, depend on each of our todays. On each of our todays.”  END of speech.

A Prophecy

From the Book of Haggai:  “The glory of this latter house  shall be greater than of the former. . .and in this place will I give peace.”

We  can pray that this is Ukraine’s destiny on this day of memories of lives lost in past and present wars.  Dona Nobis Pacem

(https://www.youtube.com/watch?v=OSdGW_HBrLE)

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A Commentary on  NCUA’s May Public Board Meeting

Even though NCUA’s public board meeting yesterday had a minimal agenda of two items, comments completely scripted, and outcomes pre-determined by design, there is still much to be learned from the live session.

As one NCUA Board member stated, all who are subject to the board’s authority can see if  it is carrying out its  “fiduciary duties” in a thoughtful manner.

Were the presentations documented with relevant and timely information? Were key issues raised? How knowledgeable were staff and board with the subjects?

While reports of the prepared remarks or occasional comment are helpful, there can be much more to be seen from the public “performance.”

The Context for the Meeting

The two agenda items were the quarterly NCUSIF update and a proposed change to the charitable deduction accounts (CDA’s).

However the external context was especially relevant. In addition to the continuing economic and financial uncertainty there is the current government debt ceiling political impasse.  Would the many  government employee focused credit unions  be affected by a temporary halt of payments?  This topic was not raised.

The Good News

Despite political and financial uncertainties, NCUA’s field  examiners reported the lowest percentage of code 4 and 5 rated credit unions in decades: just .29% of insured shares.

How did this happen? Are credit union leaders just better managers than their competitors? NCUA a more effective regulator? Or credit unions just lucky at this moment?  What one board member cryptically called the “calm before the storm.”

Only Hood provided an analysis for the current state of the system:

 Our public financial postings and disclosures and credit union performance highlight the unique character of the cooperative system—a system that was the basis for rejecting the FDIC premium models in years past and still in use today and designing a uniquely cooperative approach. The credit union system is a unique financial system, and our regulatory and Share Insurance Fund framework should reflect this.

Certainly the data summarized is great news in the current context. But end of story?  No.  A number of explanations and  data points offered were unexamined.  Questions would have demonstrated a better grasp of several critical areas of NCUA board oversight.

Issues Left open and Questions Not Asked

 

CFO Schied’s fund NCUSIF update was a literal reading of numbers from ten slides with no accompanying analysis.

He did point out that the number of NCUSIF insured had declined by 59 in the quarter.  In contrast the board complimented staff on granting a new charter.

However no board member spoke to  the critical question.  Is this rate of  annual decline of over 200 credit union charters acceptable?  For any industry opening 1-3 new locations a year while shutting down 200 which existed for decades, raises the question: is the system sustainable?

Some would respond that this trend is OK because these are mostly smaller mergers and total credit union members keep growing.

However from the member-owners’ perspective, these are 200 charter failures. Suggesting a chairman’s award for a new charter or two would seem a miss-focus compared to the oversight of 200 charter closures.  Reducing charter cancellations would seem to be the first priority; getting a new one is a multiyear ordeal.

The CLF and Credit Union Liquidity

 

All three members mentioned the need for  Congress to again restore the CLF’s temporary Covid era authority.  This has been supported by the assertion that over 3,000 credit unions under $250 million now lack CLF access.  A status only Congress can fix.

I believe this constant tossing the ball to Congress’ lap for CLF coverage overlooks NCUA’s primary responsibility for the situation:

  • For four decades all credit unions were CLF members under existing legislation that is still in place. It was NCUA’s actions that closed down this solution.
  • There has been no credit union borrowing from the CLF since 2009. That borrowing was via the NCUSIF for US Central and WesCorp.
  • Today smaller natural person credit unions rely on two primary sources: the corporate system and FHLB.  Even when the recent banking liquidity crisis occurred, there was no CLF effort to match the Fed’s Bank Term Funding Program (BTFP) which offered all comers loans up to one year in length.

The CLF has been missing in action for two decades. The NCUA has not  collaborated with corporates or credit unions to design a CLF  that credit unions would see as vital and relevant. The FHLB system, a cooperative model, has done this well. The CLF’s liquidity design is not a Congressional legislative issue.  It is an NCUA leadership and management  responsibility.

The NCUSIF’s Performance

The single most critical aspect of NCUSIF performance is the management of its investment portfolio, its primary revenue source.

For the first quarter revenue grew by 49% versus the year earlier.   However the YTD yield was only 1.75% or roughly 3% below the first quarter’s overnight rate.  In November 2022 NCUA staff announced it was pausing its ladder strategy until overnight funds reached $4 billion.  There was little information how this amount was determined and why?

The critical topic is what has NCUA learned during this ongoing rate cycle that would affect how it approaches future activity. When asked about this, CFO Shied said the fund followed a SLY investment policy.  After the $4 billion level is reached it would then go back to the 10-year ladder.

When asked how long it would take the fund to achieve par value in the current rate environment, he replied three years. He listed the required cash flows of $400 million, $700 million and $1.0 billion in that period. That corresponds to the current wighted average life (WAL) of 3.0 years.

Should the current rate situation become a new normal, then  NCUSIF revenue will have recorded below market returns for over four years since the Fed began raising rates in March 2022.

Every 1% of below market yields costs credit unions $200 million annually on the NCUSIF’s $21 billion portfolio.  The current 3% under market yield results in a $500-600 million annual revenue shortfall that will continue until rates normalize and the portfolio reprices.

This revenue gap is twice NCUA’s total annual budget.  It is a performance shortcoming keeping credit unions from reaping the returns from their fund 1% underwriting.  This revenue shortfall is a safety and soundness concern that affects the system’s overall stability. It is not a design flaw, but a management responsibility.

Managing IRR risk, and related fund revenue, is the NCUSIF’s top responsibility.  It should be guided by two questions:

  1. How soon will I need the money? Ans. There is no way to know this, which means there should be a bias toward more, not less liquidity, whatever the interest rate outlook.
  2. What is the earning’s goal for the portfolio? Ans. We know from the fund’s loss history, long term rate of share growth and budgeted operating expenses, that a yield of 2.5-3.0% would  maintain a 1.3% NOL in virtually all scenarios.

Moreover in years of low losses the Fund should pay a dividend. That was the mutual commitment for credit unions to support the NCUSIF’s perpetual underwriting with a 1% deposit.

The essential NCUSIF management skill is IRR monitoring.  Compared with a  credit union’s ALM challenge of managing the two sides of a balance sheet and forecasting net interest income or the economic value of equity, the NCUSIF responsibility is a straight forward.  How should the WAL be adjusted given the two questions above and rate outlook?

The Fed’s rise in rates was announced in advance.  The speed and amount may have caught many portfolio managers flat footed, but the take away should be to enhance IRR, not revert back to a rote formula that is costing credit unions hundreds of millions in lost revenue.

To not address this critical aspect of NCUSIF performance and just accept the intent to go back to the old ways of doing things once the $4 billion goal is reached, is an oversight failure.

The CDA Proposal’s Data Omission

 

The second board item was one page long.  It was a proposal to add more eligible organizations for CDA donations beyond 501 C 3’s.  The specific suggestion was 501 C 19,  nonprofit groups serving veterans.

The proposal would seem reasonable.   However the discussion was made in a vacuum. There was no information provided about this ten year old incidental power to know the scope of the policy decision.   How many credit unions have this account?  How much do they contribute?  What data indicate this authority is actually working as intended?

The 5300 quarterly report has some data. At March 2023 there were 278 credit unions holding  $1.4 billion in CDA accounts.  Seventy-four credit unions had added this account during the past year, and thirteen had dropped it.  Total balances had increased by $85 million or 6.5%

When asking for public comment, it is important to provide  data relevant to the issue at hand. How is this authority benefitting members?

One board member stated the rule’s intent was to provide higher returns by allowing investments not authorized for the credit unions to use in their own portfolios.  The theory was that the expected higher return would allow credit unions to make donations without impacting their net income.  Is that what is happening?

In making policy recommendations there should be a data context, especially when information is easily available, so that commenters can know the impact of what is being discussed.

Next week I will return to the most important discussion that didn’t happen with the NCUSIF.