Author: Chip Filson

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A Simple Solution for NCUSIF Revenue

At the November NCUA board meeting, two members responding to the NCUSIF update made “the sky is falling” projections about whether the fund will have adequate resources in 2021.

One board member confidently predicted that the assessment of a premium is not a question of if, but when.

Neither forecast was supported by factual analysis.

Relevant Facts

Before offering a simple, immediate solution to these future seers’ concerns it is important to affirm basic facts about the NCUSIF’s financial strength and record.

  • As reported by Chairman Hood to Congress the fund’s NOL is 1.32, which is above the legal cap of 1.3%. Anytime the fund exceeds this cap, a premium cannot be charged.
  • The current NOL is 12 basis points above the 1.20 floor below which a restoration plan must be prepared. This is a financial margin of almost $2 billion.
  • In the last 12 years of operations, the total insurance losses for the entire period Is $1.887 BN or less than the current NOL “surplus” margin.
  • NCUA’s transfer of its fixed operating expenses to the NCUSIF via the overhead transfer rate (OTR) in this same 12 years is $1.968 BN or more than the total insurance losses.
  • NCUSIF’s operating expenses have grown at a CAGR of 8.06% versus the growth of insured shares of only 5.6% in this time span. It is this fixed operating expense, not insurance losses, that eat up the fund’s revenue.
  • The fund’s average insurance 12-year loss is 1.727 of insured savings. This includes the entire years of the Great Recession. The current 12 basis point NOL margin is seven times (700%) this average annual rate of loss.
  • The September 2020 NCUSIF financials show an allowance reserve already funded for both general and specific losses. Moreover, the total assets of all code 4 and 5 credit unions is only .64% of the industry’s assets, that is less than 1%. This is the lowest level in the past decade.

Full details of the NCUSIF’s operations can be found on this spread sheet.

2019 NCUSIF Performance Spreadsheet_AJ1

 

The NCUSIF 1% semi-annual deposit “true up” underwriting means the NCUSIF is entirely countercyclical in its structure. The NOL range of 10 basis points(1.20 to 1.30) provides flexibility no matter the uncertainties that might occur. It is the ever-increasing fixed expense charged the NCUSIF in the OTR, not the variable insurance losses, that take the majority of NCUSIF income.

The fund’s financial architecture has proven its resilience since 1984 a period of time in which the FDIC has gone negative three times. The FSLIC failed and was merged into the FDIC in the 1990’s. In spite of these failures, the FDIC is still based on the same premium financial model that has led to its repeated failure.

A Ready, Easy Source of Additional Revenue-Not Premiums

As of September 30, the market value of the NCUSIF investment portfolio exceeded its book value by $586 million. This is due to the precipitous fall in interest rates engineered by the Federal Reserve at the beginning of March responding to the pandemic and economic shut down.

By selling these securities and staying short, the fund would book immediate revenue in the hundreds of millions, become more liquid and be better positioned for the inevitable rise in rates from present historic lows.

This market premium disappears if the securities are held to maturity. The time to realize this gain is now. It will add immediately to equity if the board truly believes the NCUSIF must sustain an NOL above 1.3. A premium cannot be levied if the NOL is above 1.3%

But what about the future revenue possibly foregone when the bonds are sold and reinvested at today’s lower rates? That is a contingency easily modeled, but ultimately relies on the assumptions made about how long the current rate environment is likely to continue.

The NCUSIF reported the following fixed rate investments by the NCUSIF in September:

Term   Rate
4 yrs    .20%
5 yrs    .27%
6 yrs    .36%
7 yrs     .45%

Is there any CFO or CEO who would make investments for their credit union at these terms and fixed rates into the future? While no one knows the future, the preponderance of experience suggests that it will take only one move by the Fed from its current 0-25 bps overnight range, to a first step raising it to 25-50 bps, for all of these investments to be underwater, that is less than book value.

Yes, there is a risk of some foregone revenue next year, but a reasonable forecast suggests that a strong recovery will bring with it higher rates. And if the opposite happens and economic disaster occurs, then the liquidity would be readily available.

The Action Needed and the Precedent

If the NCUA board decides to keep the NOL above the 1.3% current cap, then sell some of its investments, take the gains and recognize the revenue now. When rates rise, the market premium goes away. This is an opportunity that will decline if not disappear in the not-too-distant future.

The precedent is 2008 when the NCUSIF sold longer term securities to prepare for the potential contingencies brought by the Great Recession. This boosted income so that no premium was necessary with the fund reporting net income of $24 million and an NOL of 1.26.

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The Pervasive and Invasive Power of Social Media

In September Netflix released the film The Social Dilemma.

The documentary portrayed the ever expanding influence of social media platforms focusing on Google and Facebook. These services track everything we do online. They store our activity, use AI to create individual profiles, and use algorithms to influence our future behaviors.

Your time on their sites is converted into advertising dollars for marketers, politicians, and influencers seeking specific consumer interests or needs.

The film builds its credibility with interviews from many individuals who worked on the inside of these companies as well as examples showing real world impact. Fake news, for example, spreads six times faster than true stories. One result is growing disinformation and conspiracy falsehoods.

The message is how the computer power in your pocket is changing your behavior, even to the point of addiction.

The film should make a viewer more aware of the manipulative and darker potential of our dependence on technology.

A Close To Home Example

Platforms using AI to inform or influence are not limited to social media. My wife belongs to several book clubs, Her preference is to read books online versus hard copy.

The public library is her fist choice as e-books are free even though time limited in check out.

Recently she received he following email updating her most recent on line borrowing:

A Benefit or a Concern?

She showed the email to me and asked my reaction. The idea the library was monitoring her reading activity raised concern. Meant to be informative, it also demonstrated how a third party can tell you something about yourself that you may not be aware of. What else might the library be tracking and who has access to this data from a public institution?

Every day credit unions store data on their members’ activity that they analyze to better serve them individually and collectively. How members perceive this proactive use of their information can help build or undermine the trust foundation essential in all relationships. Even if intended to be a positive, helpful suggestions can raise concerns. Fr example, how did you know I was laid off?

One way to enhance trust is to be transparent by announcing in advance how you will try to add value beyond traditional transactions. My wife’s concern was due in part because she had no knowledge this reading summary was available. Would your members be surprised by any of your communications that rely on the selected knowledge you compiled about their financial activities?

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Early Views from McWatters All Credit Unions Would Still Echo

In an October 6, 2015 CU Times op ed, then new board member McWatters presented his approach to credit union regulation. He resigned his board seat last Friday. Below are selected verbatim excerpts of his original policy priorities that I believe should stand the test of time and party.

Credit unions are best served by having a regulator that understands the not-for-profit, cooperative business model. . .

Rick Based Capital Rule

Last week, by a bipartisan margin of 50-9, the House Financial Services Committee sent an undeniable message to the NCUA: Take more time to review the law, assess the need for additional regulation, evaluate alternatives and consider the real impact now and into the future before moving ahead with the Risk-Based Capital 2 final rule.

This is a message I welcomed and championed in my written dissent (available on the agency’s website) to the issuance by the agency of its proposed RBC2 rule last January as contrary to a plain reading of the Federal Credit Union Act.

Regulatory Burden

I think the agency would do well to heed this message for other major regulatory issues as well, most notably how the agency deals with the growing regulatory burden confronting credit unions, particularly small credit unions. The increasing number, scope and costs associated with regulatory requirements, not just from the NCUA but from all agencies, that credit unions must manage is a concern that the NCUA must take more seriously and devote more resources toward addressing in a meaningful way. , ,

Fraud Losses Cost to NCUSIF

We should also more rigorously address the dramatic losses, year in and year out, to the National Credit Union Share Insurance Fund caused by fraudulent activity committed by a limited number of bad actors within the credit union community. . .

Editorial note: All these issues are still live in the industry today.

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Revisiting NCUA’s Mission Statement

With a new leadership team on the horizon, might a first task be to review the NCUA’s Mission Statement?

As now worded:

“Provide, through regulation and supervision, a safe and sound credit union system, which promotes confidence in the national system of cooperative credit.”

Proposed Reframing: Putting  Ends First

Promote a national system of cooperative credit by chartering and supervising a safe and sound credit union network. 

Thoughts?

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 Wisdom from the Field

When you label your peers competition and fear them as such you are on the road to simply going it alone.

My confidence comes from the fact that traditionally “competition” is defined by two players racing in the same race.

I have no competition.  For the race I am running is my own- my communities – our own reward.

 

 

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 A Covid Test & The Paradox of  Bureaucracy

To ensure a safe Thanksgiving, my wife and I lined up Friday night for our Covid tests at the county recreation center. The test was free. The line took about an hour. Everyone stood six feet apart as the temperature got cooler as night came.

We were given clipboards to complete our registration—name, email, age, race. One of the staff helping with sign ins came by to ask the obligatory questions. Have you had any Covid symptoms? Been around anyone who has tested positive?

It was the last question that was memorable, however. She qualified it by saying “I think I know the answer, but I have to ask anyway. Are you pregnant?”

An NCUA Exam Risk Rating

The predictable routine of bureaucracy is an important factor in performance. We rely on formulaic responses especially by those in authority. But it can also result in actions that contradict common sense.

In a conversation with a CEO about how to respond to his most recent exam, this same anomaly was present.

The credit union has been a CAMEL 1 for almost two decades. It has navigated the pandemic with improving performance. Liquidity is 500% the policy minimum, delinquency is down and most loans in forbearance are back making payments. ROA and net worth are way above peer averages. A consistent track record of exceptional performance in the present and the past, through thick and thin.

So, I asked given these documented facts why the risk rating for “credit” and “liquidity” were judged “moderate” versus the “low” ranking on every other factor. The CEO’s observation was “It feels like we are being punished for what could happen in the future.”

The Culture of Bureaucracy

This is the difficulty with bureaucratic culture. When facts don’t fit a program’s priorities, the instinct is to assert future scenarios that do. This tendency is not limited to examiners. Listening to last week’s NCUA board meeting, two members confidently predicted the future financial downturn of credit unions in 2021 and with it, the necessity of collecting more money for the NCUSIF. This was after the staff updated the distribution of CAMEL ratings that showed the continuing reduction in code 4 and 5 classifications in both total assets and number of credit unions.

Facts will not deter the inevitable government instinct to always seek more money. This prediction of future NCUSIF premiums reflects a bureaucratic mindset similar to asking all males if they are pregnant.

After getting our Covid tests, we walked out by the admin line and everyone wished me a safe pregnancy. For I had answered yes to the question. We all enjoyed the humor of this bureaucratic incongruity.

Common sense, humor and a negative test. Good ingredients for a safe 2020 Thanksgiving. For it is my hunch that 2021 could be the best year credit unions and their members have ever enjoyed.

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Credit Unions Investing in Other Cooperatives

Responding to the listing of America’s top 100 cooperatives by total revenue, I received the following comment from Leo Sammallahti, marketing manager for the Coop Exchange:

“Credit unions do fantastic charitable work, but do we just try to do the type of charitable work that conventional banks do, but just more and better? How about we take a different, distinct approach. Let’s help our members help themselves by fostering creation of new cooperatives. Isn’t that what Filene was all about? If the 120 million member strong credit unions are not doing this, who is? We could find great ideas and energy among those members if we look for it.”

A Case Study of a Credit Union Investing in Coops

Leo then sent me this example:

“Matthew Cropp from the Vermont Employee Ownership Center recently rediscovered a little-known credit union statute applicable to state-chartered credit unions in eight states (Arkansas, Illinois, Kentucky, Montana, Nevada, New Jersey, New Mexico and Vermont). It allows credit unions to make equity investments into cooperatives, including worker cooperatives.

As a result of this discovery, one of the largest credit unions in Vermont (VSECU) has begun to offer equity to cooperatives in its region—an unprecedented move as most credit unions, if they offer any financing for coops, offer debt financing.

The Vermont statue’s language specifies that state-chartered credit unions are authorized to invest equity of up to 10% of the shares, deposits, and surplus of the credit union into cooperatives. These investments would not count against the 12.25% member business lending cap that most credit unions are currently subject to.

VSECU has decided to make 10% of their total equity available for equity investment in coops, roughly equal to $8.5M in 2020. It appears that the VSECU is the only credit union in any of these eight states that has started investing using this statute. Its co-op capital tool kit can be found at this link https://www.vsecu.com/community/resources/co-op-capital

Consequentially, cooperative advocates are working to identify credit unions in the other eight states to follow VSECU’s lead and invest equity capital in coops. There is also talk of lobbying other state’s legislatures, then eventually congress to “follow suit by broadening the range of credit unions that are legally permitted to make such investments.”

Are there other instances of this coop investment effort readers can share?

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Chairman Hood’s House Testimony: Members’ Interest Only Matters When Selling to a Bank

In today’s cooperative system when a bank acquires a credit union, regulators require that a fully detailed, independently verified value be given members for the equity accumulated from their loyalty. There is no such protection for members in a credit union acquisition.

Chairman Rodney Hood’s House Banking Committee testimony on Thursday, November 12, 2020, included a summary of credit union bank purchases and credit union mergers. The import of his logic is devastating.

As outlined by Hood in his “state of the industry” presentation, the only way the agency will ensure members receive fair value for their equity is to be bought by a bank. The necessary action is self-evident: before any credit union board or CEO decides to end their charter and hand off their members’ future via a merger, contact a bank to determine what they think the credit union is worth. Otherwise, don’t count on NCUA ensuring members receive a fair deal.

The Chairman’s words

Bank acquisitions by credit unions were described as follows:

“. . .the number of credit unions purchasing banks is very small. Of the 36 NCUA-approved bank purchases by federally insured credit unions since 2012, 13 were banks with assets less than $100 million. Another 16 of the transactions involved banks with assets from $100 million to $250 million. Only seven of the approved transactions were banks with assets above $250 million.”

And these, he explained, are thoroughly regulated:

“The NCUA does not prohibit the transactions because credit unions are permitted by regulation to purchase banks. Additionally, bank-to-credit union transactions must also be approved by the Federal Deposit Insurance Corporation, per the Bank Merger Act, and the state credit union regulatory agency, for transactions involving a state-chartered credit union.”

In the reverse situation, where a bank acquires a credit union, it is carefully monitored to protect members’ interests:

“The NCUA has regulations to oversee the sale of a credit union to a bank. These regulations ensure the members’ equity is properly valued by an independent third party who establishes a market valuation of the credit union. The purchasing bank must pay the credit union at least that amount thereby ensuring the selling members are paid a fair value for their equity.” [emphasis added]

No Fair Value for Members in a Merger Acquisition

When one credit union acquires another through a merger, there is no such member protection. These acquisitions are merely a response to changing market conditions:

“. . .The majority of merging credit unions are comprised of smaller credit unions, and the most common reason for merging is to expand services, as larger credit unions tend to offer more complex products and services to their members. However, we have seen a growing number of larger credit unions use mergers and acquisitions as strategies to grow and increase market share.

Due to the pandemic, merger activity for federally insured credit unions has slowed, but may increase as conditions evolve. The NCUA will monitor these trends to ensure the continued consolidation of credit unions and system assets does not create new potential risks to the Share Insurance Fund.”

Members Short-Changed

NCUA’s monitoring of these intra-industry merger acquisitions does not include “ensuring members are paid a fair value for their equity.”

Wouldn’t credit union members be financially better served if their institution was sold to a bank for “fair value”? Then take their money and their savings to another credit union if they so choose? Or even purchase equity shares in the bank acquirer?

Mergers between credit unions are not “market-based transactions.” There is no transparency in the process. Those responsible negotiate their own self-interest behind closed doors. The opportunity for alternative “bidders” is not presented. No specific or meaningful benefits for members are detailed. Member voting is not a choice, but merely a request to ratify decisions that have already been made without their input.

A Weakening of the System

The first rule of safety and soundness is diversification, not putting all eggs in one basket. Concentration destroys diversification. The single strategy of the surviving firm replaces multiple ways of approaching the future.

While NCUA claims to monitor merger activity to verify that the continued consolidation of credit unions and system assets does not create new potential risks to the Share Insurance Fund, how it does so is a complete mystery. Even if the erosion of the industry’s soundness could be documented, what would the remedy be? Undo multiple mergers? Not practical. Stop mergers? Not realistic.

The three traditional solutions for a problem are to find a bigger healthy merger partner, liquidate, or sell to third party outsiders. Unless a more open, transparent, member-first merger process is created soon, future credit unions will reap the whirlwind of this growing short-term practice undermining system soundness.

Mergers and Growth: A Common Myth

The merging of sound, independently managed firms debases cooperative design, undermines member well-being and destroys credit unions’ reputation as the trusted alternative to market-driven financial options.

It also perpetuates the myth that somehow mergers enable growth and stronger competitive capabilities versus self-driven organic strategies. An analysis of credit unions with high profile merger efforts suggests just the opposite. This will be the focus of a later blog.

Bigger does not automatically create better value. Credit union mergers do not enlarge cooperative market presence. That requires innovative, purposed-based continuous management effort, a skill that atrophies when mergers become front and center.

A Ruinous Policy

The assumption in NCUA’s oversight of credit union acquisitions that credit union mergers are benign, whereas a bank purchase is predatory, is completely false. Multiple current examples contradict this belief.

The irony in Hood and NCUA’s differential regulatory approach to purchase acquisitions is disastrous. It requires a bank offer to activate NCUA oversight for credit union members to receive fair value. Only a bank bid brings real transparency to the insider’s merger games now being practiced. In either outcome, the members lose their credit union.