I am skeptical about whether a politically chosen advisory board is an effective venue for credit unions to influence NCUA. Both the Federal Reserve and CFPB have advisory boards in which credit unions are members.

Whether these forums are more than a public relations event is difficult to determine. Therefore, I thought listening to an actual proceeding of the FDIC’s Advisory Committee could be useful.

A Four-Hour Advisory Board Experience

On July 28, the FDIC held its semiannual meeting of its 18-person Advisory Committee on Community Banking. Established in 2009, the representatives are CEOs from stock, mutual and private community banking firms. Due to the Covid situation, the meeting was held virtually with video so anyone could watch. Normally the dialogue would be private.

The meeting began with the CEOs’ descriptions of the state of their institutions and local economies. Reports were from smaller communities in New Hampshire, North Carolina, Kentucky and Iowa, to name a few. These five-minute updates were impressive. These senior executives talked about internal responses to Covid shutdowns, the distribution of PPP loans, buildups of cash savings, requests for loan deferrals and other shared experiences in the current environment.

The CEOs were articulate and prepared. Their firms ranged in size from $100 million to just over $1 billion in assets. Three specifically mentioned credit union competition. The North Dakota CEO gave the example of a credit union making a $1 million commercial real estate loan for a property in foreclosure at a rate of 1%. “We can’t compete with that.”

Many spoke of margin compression from the declines in market rates. This revenue loss being partially offset by loan origination fees, especially mortgages, and gains on investment sales.

Each gave updates on their local economies: the loss of revenue from tourism, the prospects for good crop harvests, the decline from local unemployment peaks and one example of refinancing a loan to their local municipality thus saving the city over $500,000 in interest.

Several offered recent exam experiences, one with the new “remote” process. Comments on FDIC policy were suggested. For example, a request the agency keep a moratorium on new ILC banking charters for firms like Walmart.

All in all, these brief financial, economic and management summaries were thoughtful, detailed and eloquent testimonials about community bankers’ multiple roles in the current climate.

Then Two Hours of Agency Updates

The rest of the four-hour meeting was centered around FDIC briefings including:

• An economic outlook with a focus on commercial real estate and agricultural sectors;
• A report from a subcommittee on Minority Depository Policy;
• Updates on deferral accounting changes mandated under the CARES act, the lowering of the bank leverage ratio requirement from 9% to 8%, loan appraisal deferrals and related call report revisions;
• A CECL update by a FASB board member;
• FDIC’s diversity and inclusion program information;
• Changes in how the FDIC insurance fee would exempt CARES Act loans;
• A description of the Rapid Prototyping Project. The goal is to make the current call report process obsolete by using the latest technology. There were 30 companies invited to provide concept papers, followed by a 90-day period to develop a demo, and another 90 days to prototype the new model.

Was the Advisory Board Example Instructive?

The most informative or “real” part of the day for me were the bankers’ conversations. The FDIC presentations were dry, general policy updates with little interaction. They elaborated on decisions already in place. They were staff briefings. There was little give and take. The two hours of staff slides were a useful reminder of how regulatory “burdens” do not lessen even in a pandemic.

My assessment was that the bankers were more in touch with the realities in their communities than what the FDIC presented. Each FDIC update, even the pandemic “accommodations,” ended with the same caveat: “subject to proper risk management.” Even though the CEOs had spent several hours demonstrating their management competencies, the FDIC’s focus was on more rules or reinterpretations of existing ones.

The proceedings were polite. Both sides  appreciated the event. But the impression I was left with was while the FDIC might hear, they do not listen. This was not a democratic or collaborative process.

I don’t believe this is a model for credit unions. For the NCUA has a different structure, oversees a unique financial design, and manages cooperative resources meant to benefit the industry.  To be a meaningful process, it would have to be collaborative in both design and outcomes.

However even if an advisory board were  just for show, a live virtual open meeting could still be an eye opener for viewers.

 

 

 

What works – and what doesn’t – is the subject of virtually any study of organizations, whether political, business or nonprofit. The topic of governmental leadership is even more critical in a crisis. Survival of an organization or even a movement could be at stake.

Many sectors of American society face existential challenges now. Can credit unions navigate these events with their mission and system intact?

Two Case Studies of Crisis Response

The word “change” traditionally signifies something new. But the ultimate irony is that transformation, what today’s protesters might call “real change,” most often occurs not when something new begins, but when something old falls apart.

In addressing current economic, pandemic and financial uncertainties, understanding how credit union regulators reacted in two previous economic downturns is enlightening.

The first economic disruption, 1981-1985, accelerated the deregulation of financial services. This change occurred in the midst of double-digit inflation and unemployment. Interest rates reached the mid-teens, their highest level since establishment of the Federal Reserve in 1913. Voters chose new national political leadership.

The second event was the Great Recession in 2008-2009. This was characterized by a bubble in home prices exacerbated by investment products (CMOs) leveraging unsustainable spikes in property values. Again Presidential political leadership changed.

Two Different Outcomes

In the first case, credit unions came out winners. In the decade 1979-1989 the industry achieved compounded annual growth in shares of 12.9%; in capital, 10.9%; and steady member expansion, 3.9%.

For the decade ending 2019, the annual compounded growth was much lower: shares, 5.3%; capital, 6.8%; and membership, 2.8%.

Why this difference in outcomes following these two economic downturns? What can they teach us about responding to current events?

Case I. Regulatory Leadership and Deregulation (1981-1985)

Ed Callahan became Chair of NCUA after a career as an educator and an administrator in the Illinois state government. From 1977-1981 he was Director of the Department of Financial Institutions. The Credit Union division supervised the largest number of credit union charters in any state.

Working cooperatively with Illinois’ 1,000 credit unions, the industry navigated the regulatory and economic changes characterized as “deregulation.” Callahan understood the old system of legacy guidelines and rules wasn’t working. The regulator had to let go of traditional thinking to give boards and managers the responsibility for their own business decisions.

When Callahan left the state for NCUA, the Illinois Credit Union League presented him with a framed slogan characterizing his tenure which read: We Don’t Run Credit Unions.

Chairman Callahan took the words and philosophy to NCUA in October 1981. The traditional regulatory system wasn’t working there either. “Survival” during these unprecedented economic events was the most pressing concern for the entire industry.

Deregulation–putting responsibility for business decisions in the hands of boards and managers, those closest to the member–meant doing away with the old rule-making concepts. In one short paragraph, the agency in April 1982 eliminated all prior rules and practices controlling the rates and terms on all share accounts. The agency reinterpreted the common bond to be more flexible and inclusive, participated in and endorsed a capital adequacy study by CUNA, and eliminated dozens other regulations accumulated over the years.

Two Institutional Makeovers

In his prior educational and state leadership roles, Chairman Callahan was regarded as an outstanding administrator. He enjoyed managing people and institutions even in bureaucracies enveloped by politics and patronage. He transformed organizations to be more effective and efficient.

At NCUA this management emphasis resulted in two major priorities.

The first was a multifaceted effort at transparency and continuous dialogue with credit unions. So that credit unions could see the agency at work, board meetings were taken on the road to cities in each of NCUA’s six regions. The NCUA Video Network was created to send credit unions video updates on major issues or policy changes.

Open press conferences were held after each Board meeting. Senior agency personnel spoke at credit union conferences across the country. The agency’s publications were issued with full details of key events for the three areas of NCUA’s responsibilities: the CLF, NCUSIF, and FCU chartering and supervision.

The pinnacle of this cooperative industry engagement was the December 1984 credit union conference in Las Vegas organized by the Agency. Over 3,000 attendees including state and federal regulators and examiners, and credit unions from all over the country joined to hear and attend breakouts on multiple topics of industry importance.

Callahan knew that for NCUA to succeed with deregulation, credit unions must step up and assume responsibility for their future.

Reforming the Agency

Callahan’s second priority was to upgrade all aspects of the agency’s internal administration and restructure critical functions. Ed practiced careful stewardship of credit union resources which fund all the agency’s activities.

The agency instituted an annual exam cycle of all FCUs. Operational responsibility for exams and supervision was put in the hands of the regional directors; and headquarters staff were transferred to support field operations. External audits by CPA firms were started for all three agency funds to ensure accurate reporting. Call reports were collected from all credit unions and the information formatted into peer analysis for each credit union. The agency’s internal operations were automated. Operating expenses were reduced annually, and the operating fee scheduled for FCUs was lowered four consecutive years.

Two of the agency’s most important functions were reconfigured to make them more responsive in the deregulated era. Through a partnership with the corporate network, the CLF was organized so that all credit unions would be members. The NCUSIF was capitalized emulating the member owner cooperative model. Every credit union now sent 1% of member share accounts as a capital deposit in the fund.

By eliminating the regulator’s traditional “controlling” mindset, credit unions were free to make their own decisions of how best to serve their members. The change initiated a growth boom for the cooperative system.

As the first financial sector to fully deregulate deposit rates, credit unions had a head start in the art of setting rates based on market pricing. The result was a five-year compounded annual share growth of over 15% from 1982 through 1987. Banks and S&Ls were not given this full freedom until 1987.

This period of transformative change through effective public leadership rested on two pillars: the efficient management of agency resources and continuous, open communication to enlist credit union support.

Case II. Responding to the 2008-2009 Great Recession

NCUA responded exactly opposite in the next economic crisis, the Great Recession of 2008-2009. Because of uncertainty about the ultimate value of investments by corporates, the entire corporate network was required to sign a single letter of understanding and agreement with NCUA, effectively putting them under government control.

The agency conserved the two largest corporates in April 2009 and appointed their chosen managers reporting only to NCUA staff. This approach resulted in the liquidation of five corporates in September 2010.

Multiple extra premiums for the NCUSIF and the newly created TCCUSF were assessed to pay for liquidations and ever-increasing agency budgets.

Staff and agency expenditures grew without limit, justified by the economic emergency. A new CPA firm was brought in for the NCUSIF to modify the accounting standard to avoid private sector disclosures mandated by GAAP.

The agency’s supervisory actions were unilateral. Workout plans were developed behind closed doors for the $100 billion in the five liquidated corporates. Credit union expertise and interests were shunted aside. New corporate rules were imposed that neutered the network’s critical roles in aggregation, payments and liquidity.

The CLF was eviscerated. A new liquidity rule was passed to substitute for the prior system-wide CLF safety net. A 400-page risk-based capital rule was imposed in 2016 over the widespread objections of the industry.

Instead of transformation, the agency forced its determinations on the industry. Individual credit unions were required to implement examiner dictates or merge. The agency believed money, not management, solved problems. Even after the crisis was long over, the agency doubled down on its regulatory fiats.

In the great recession, the agency ignored the critical lesson from the 1981-85 crisis: members’ relationship with their credit unions are the foundation of sustainable success, not government diktats. NCUA imposed its judgmental certitudes even when faced with contrary facts and better options. Resolving problems through patient workouts was not acceptable. Instead of the CLF and NCUSIF partnerships helping credit unions, the industry learned that credit unions were on their own when it came to addressing problems.

Two Crises, Two Contrasting Outcomes

At the core of Callahan’s philosophy, “We Don’t Run Credit Unions,” was a deeply held belief about human nature. Freedom is a powerful motivator. It enables innovation and sacrifice. It affirms purpose for those with leadership responsibilities. The results are much more positive than when government dictates solutions. The data prove it.

Public leadership is more than good management. Political regulatory appointments involve a relationship between persons in authority and those they supervise. Effectiveness means both are positively transformed by their interactions. Productive democratic governance requires reaching consensus among groups with different perspectives and interests.

The best example of how this process works is an excerpt from NCUA’s first Video Network presentation on deregulation. The 24-minute discussion features Ed Callahan in conversation with a panel of credit union industry representatives.

Jim Barr, CUNA, to Chairman Callahan: How much input will the credit union response actually have to your [deregulation] proposal?

Callahan: It will have everything to do with what we ultimately do on this subject. While I am philosophically opposed to government making these business decisions, should the majority of credit unions say they want things to stay the way they are, I’ll support them and I’ll back them. In fact, I will read every single letter credit union people send to me addressing this subject. (Source: The NCUA Review, February 1982, pg 6)

I believe the results of these two regulatory approaches offer a startling contrast. One positioned credit unions to prosper for the next 25 years. The second severely hurt the industry’s capabilities.

In this crisis the future of a distinct cooperative financial system may be at stake, depending on how NCUA decides to interact with the industry.

“The agency should diligently work to preserve small credit unions, as well as minority and women-operated credit unions. In addition, the agency should require all merger solicitation documents to provide, without limitation, a discussion of any change-in-control payments and other management compensation awards and agreements, and that such disclosures are written in plain language and delivered to voting members in a reasonable time prior to the scheduled merger vote.”

Has NCUA heard of Zoom? The July meeting with audio presentation and downloads does not seem technically up to date.

As churches, schools, book clubs and even families have mastered the art of live video conferences, it would seem the minimum skill for a government agency which overseas a $1.6 trillion credit union system.

Maybe  credit unions could offer to set up a system for them? Makes one wonder what the remote exam experience is like…

At NASCUS conference, October 22, 2015, a news summary:

Regarding the new risk-based capital rule, McWatters repeated the statement he made during the board meeting that he believes the final rule is “illegal.” “A future new NCUA board may take a different view (than the current board) with respect both to the legality and approach of the new rule.”

April 2016 from NCUA’s Newsletter: “NCUA and credit unions will need to keep an eye on the House Financial Services Committee, which is reviewing capital standards for community banks. NCUA will need to watch this process very carefully as it unfolds, and the board may need to reconsider our risk-based capital rule. . . I dissented to the adoption of this rule because I found many aspects of it were not justified under the Federal Credit Union Act. As credit unions for the most part are thriving without the rule, I continue to challenge this action, and nothing has dispelled my very serious concerns about its impact when it takes effect in January 2018.”

RBC Status

Today the rule is still on the books with the implementation date pushed out to 2022. (https://www.ncua.gov/newsroom/press-release/2019/board-proposes-delaying-risk-based-capital-rule-until-2022)

A reporter asked me what was Mark McWatters’ legacy of his six years on the NCUA Board.

My answer from a credit union point of view: “His promising potential was unmet, and he was a major disappointment in the way he led us on.”

However, there could still be an important lesson for Kyle Hauptman, should he wish to learn from his predecessor’s experience.

The Initial Enthusiasm

When McWatters came to the NCUA Board in August 2014, his critiques of agency practice and policies were well reasoned, documented and on target.

His concerns included a lack of transparency on NCUA’s budget, the OTR calculation, the failure to detect fraud resulting in NCUSIF losses, and the condescending approach of the agency and examiners.

He voted against the agency’s budgets and against the “illegal” RBC rule which were nonetheless approved 2:1.

His most stinging rebuke of NCUA’s leadership was in a May 2015 speech to the Pennsylvania League’s Annual Meeting:

NCUA should not treat members of the credit union community as Victorian era children–speak when you are spoken to and otherwise mind your manners and go off with your nanny—but should, instead renounce its imperious “my-way-or-the-highway” approach and actively solicit input from the community . . .With the strong visceral response within the agency against budget hearings, it seems that some expect masses of credit union community members to charge the NCUA ramparts with pitchforks and flaming torches to free themselves from regulatory serfdom. I, conversely, welcome all comments and criticism from the community.

Regulatory wisdom is not metaphysically bestowed upon an NCUA board member once the gavel falls on his or her senate confirmation. NCUA should not accordingly pretend that it’s a modern-day Oracle of Delphi where all insight of the credit union community begins once you enter the door at 1775 Duke Street in Alexandria, Va.”

Credit unions welcomed this honest assessment. It was their lived experience. At the 2015 GAC, he described his vision for NCUA as having “confidence, courage, and conviction to chart a regulatory path for the credit union community. . . based upon a transparent and fully accountable appreciation of the unique structure and attributes of the cooperative, not-for-profit business model.” He called on NCUA and the credit union community to work together in a new direction through a “collaborative and collegial process with the goal of building trust and inclusiveness.”

Upon being appointed Chairman by President Trump he said, “We best fulfill our obligation to protect America’s $1.3 trillion credit union community. . . by making the NCUA more efficient, effective, transparent and fully accountable.”

Good Intentions Not Realized

All of his intentions to change the agency’s culture were unrealized. Budgets increased every year even after closing two of six regional offices. The largest fraud ever discovered, the $40 million loss at CBS Employees FCU, was addressed only in an IG whitewash. RBC was not repealed, but just kicked down the road. Credit unions were closed and conserved without comment or explanation.

As for the promised annual review of the NCUSIF’s normal operating level, raised in 2017 to 1.38% as a temporary action using unsubstantiated numbers, two more budget cycles have passed with no efforts to reduce back to 1.3%.

Most importantly, when the opportunity came to close the TCCUSF and return up to $3.0 billion to credit union members, he instead kept the funds in the NCUSIF promising future dividends. This action was taken despite more than 2,000 comments opposing the proposal in whole or in part, and only 6 in favor. The era of Victorian Children and regulatory serfdom was fully back.

What Happened to McWatters’ Promise?

I believe two factors contributed to his leadership failures. The first was that his heart did not seem to be in the job. Twice his name was announced for other political appointments, once in a Presidential nomination for the EXIM bank board; and second, as a rumored director for the CFPB.

Throughout this tenure, the Washington Post reported he was working from home in Texas, traveling to DC only for Board meetings or testimony. He was in effect an absentee landlord.

Whether the result of his professional style, his philosophy of the board’s role or just ennui, he ended up adopting the agency thinking he had so decisively and accurately critiqued.

He defended selling 4,000 member loans to a hedge fund. When members showed up at a board meeting, they were shunted to a separate room (with their placards, not pitchforks). He waffled on rescinding the “illegal” RBC: “I concluded this was not the right time for a material diminution in the RBNW capital requirement for credit unions.” (June 2020) He publicly advocated for more resources: self-funding liquidity options for the CLF and a larger NCUSIF.

In August 2018 he spoke to the African American Credit Union Coalition: “ The NCUA has a statutory obligation to preserve minority depository institutions and encourage the creation of new ones, and that it is one we take seriously.” In his June 25, 2020 NCUA board meeting his recommendations for the future of MDIs were merger, merger and merger: “for example five $100 million MDI credit unions could consolidate into one $500 million MDI institution and economies of scale and market force.” So much for statutory obligation.

In leadership, he gave up. No efficiency, effectiveness, transparency, or full accountability achieved.

Why is open to interpretation. Mine would be that he lost any commitment to the credit union mission. His primary goal was protecting the agency and its resources. He became the bureaucrat he had initially challenged so eloquently in Pennsylvania in 2015.

What Kyle Hauptman Might Learn

There are critical questions Hauptman will have to answer that will influence his role as an NCUA board member. Bureaucracies do not like change. There will be constant pressure to conform to the traditional agency verities. That is the option McWatters took.

1. Is it a part-time or fulltime job? What is my personal commitment to the position?
2. How do I learn about the different approaches to board members’ responsibilities?
3. How do I learn most effectively about the history of the industry and agency I am regulating?
4. What kind of personal staff resources am I given and how do I select them?
5. To whom am I accountable for my decisions?
6. What role, if any, do I perform in overseeing the performance of agency staff? What duties are delegated, and which are retained by the board?
7. What is my view of credit unions’ mission? How do credit unions differ from banks?
8. How will I measure my effectiveness as a board member?
9. How will I interact with the industry?
10. What is my contribution to the agency’s agenda?

How Hauptman approaches his learning curve, the constituencies and resources he approaches and the lessons he takes away in the next six months, will likely determine the direction of the rest of his tenure.

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