Category: Cooperative Design

Posted on

The Dangerous Goal of “Parity”

As pundits, regulators and congress have looked at what should be changed in the wake of the three recent large bank failures,  one focus is how FDIC  insurance is  structured.

A precipitating event was mass withdrawals by uninsured customers,  prompted by social media alarms. Using their Dodd-Frank “systemic risk authority,” the FDIC took over the banks and covered all depositor balances while it worked to find a least cost resolution.

This customer behavior has prompted suggestions for changing FDIC coverages to reduce this risk potential.  CUNA and NCUA have publicly stated that the NCUSIF should have “parity” in any changes to FDIC insurance.

Here is one trade’s position: Credit unions must receive parity with banks in any deposit reform legislation, CUNA wrote to House Financial Services and Senate Banking, Housing, and Urban Affairs Committee leadership Monday. Congress and the Federal Reserve have indicated interest in deposit insurance reform in the wake of recent high-profile bank collapses.

“Our primary concern regarding any deposit insurance reform legislation passed by Congress is to ensure that credit unions receive parity, fair treatment, and equal protection with banks,” stated CUNA President Jim Nussle in his letter to Congress.

I believe this public posturing is dangerous to the future of the NCUSIF and to credit unions separate financial system.  Here is why.

  1. Credit union CEO’s and industry leaders have rushed to assure their members, the public and Congress that credit unions do not have the problems that caused the banking failures. They are more financially resilient.

The first proof of this basic difference is that 92% of credit union savings are covered by NCUSIF, whereas only 44% of bank deposits were FDIC insured. This point was  presented in Callahan’s Trend Watch analysis this week in the following graph.

The obvious Congressional question is why do credit unions need whatever changes FDIC might make if the balance sheet structures of  cooperatives are fundamentally different from the banking industry?

  1. Politically it would seem unwise to request parity before any legislation has even been introduced.  For in drafting any change Congress can easily respond to credit unions’ request with a simple bipartisan solution.  They could  mandate there be only one federally managed deposit insurance fund, the FDIC.  That would be true parity.  For the FDIC already merged the separate S&L FSLIC fund.
  1. The factual response to this Congressional possibility is that the NCUSIF is different in both structure and purpose from the FDIC.

Since the NCUSIF’s  financial redesign in 1984 into a cooperatively-funded deposit model, credit union insurance has not required federal backing, even during the corporate crisis.   By legislative intent, the NCUSIF is backed entirely by members sending 1% of every savings dollar to the fund.  This capital base grows along with insured risk.  This base provides sufficient revenue so that  premiums are rare. That revenue option is a last resort and can be used only when  Congressionally established financial levels are reached.

As a cooperative, the fund is required to pay  dividends when reserves exceed the Normal Operating Level, historically 1.3%.  The FDIC’s structure gives it only one means to cover increased risk—charge ever higher premiums on an expanded asset, not just the insured savings base.

  1. The two federally managed “insurance” funds have fundamentally different roles which reflect the character of the institutions they cover.  The credit union model is a not-for-profit, member-owned  consumer focused coop. This system has a much different purpose than the for-profit commercial banking model.  The NCUSIF is also a source of temporary recapitalization to sustain a coop hit by uncontrollable financial events.  In banking, the FDIC cannot provide assistance to private owners.
  2. CUNA and other credit union support for “parity “ with the FDIC could unfortunately be used to buttress Chairman Harper’s stated intent, from his first day on the NCUA board, to build a larger fund. His proposals would abandon legislative guardrails and add premiums as a regular option to expand the fund’s size relative to credit union risk.

There is nothing in the NCUSIF history that would support this desire for a larger fund.  The Fund has performed though multiple economic cycles and financial crises that forced the FDIC to resort to multiple special premiums.  The FDIC has no cap on how large its fund can be relative to its insured risk.

The downside of the NCUSIF’s financial success is that it has become a “piggy bank” from which NCUA draws increasing amounts to pay for its expanding operating budgets.  Instead of paying for insurance losses, the majority of fund revenue is used for NCUA’s operating expense.  This overhead transfer rate is currently 62.4 %, even though federally chartered credit unions are only 50%  of insured risk.

The legislative constraints that are a part of the redesign passed in 1984 were to address credit unions’ fundamental concerns with an open-ended perpetual deposit underwriting commitment.  The apprehension was: “If we just keep sending 1% of deposit to NCUA every year, what prevents them from just spending it.”

  1. If Congress were to change how FDIC insurance coverage is based, it won’t be a single action. Legislation will come with additional rules and regs, increased financials tests, and stronger regulatory powers for examiners and supervisors to mandate changes when deemed necessary.   There will be a significant regulatory quid pro quo if coverage is changed.

Credit unions, who in their own analysis, say they are unlike banks, would become a part of this new regulatory avalanche.  One need only think back to 1998 when bank PCA was mandated by the Credit Union Membership Access Act which had nothing to do with the Act’s primary FOM issue.  But it was included, saddling credit unions with PCA (RBC/CCULR) requirements  in 2022  that NCUA cloned from the banking regulator’s rules.

  1. Should credit unions individually or in certain circumstances believe additional share insurance coverage is desirable, options already exist. In Massachusetts, state charters must cover 100% of their savings.  Amounts above the NCUSIF are insured by MSIC.                                                                            In multiple other states,  American Share Insurance offers additional coverage above the NCUSIF which credit unions can purchase.  These are options credit unions can design to  fit their own circumstances.  NCUSIF insurance coverage is based on the principle that one size fits all.
  2. If the recent banking failures cause a change to FDIC coverage, one of the factors is the market accountability publicly traded banks face. Market short sales can convert temporary problems into more serious runs.   Credit unions do not have this market accountability.  They also are not required to have the same public transparency required in SEC 10-Q and other filings for shareholders.

An Opportunity to Demonstrate the Cooperative Difference

For credit unions the debate on insurance coverage should be an opportunity to substantiate the differences and soundness of the NCUSIF,  and its extraordinary record of success since 1984.   Before that time, the NCUSIF did follow the FDIC model.   As an FDIC financial twin over two decades, the NCUSIF never came close to achieving the legislative goal of a 1% fund.  This was even after using double premiums, the only option available, for several years.

A major risk to credit unions is a NCUSIF-managed Fund without an awareness by leaders of its differences and why these matter.   The changes requested by Chairman Harper not only abandon the explicit legislative guarantees made to credit unions in return for their perpetual 1% underwriting in 1984. It would most certainly entail more FDIC look alike regulations.

Here is Chairman Harper’s request to Congress this week:

If Congress does decide to act in this area, the NCUA has two requests. The first is to maintain parity between the share insurance provided by the NCUA and the deposit insurance provided by the FDIC. Share and deposit insurance parity ensures that consumers receive the same level of protection against losses regardless of their financial institution’s charter type.

And second, if coverage levels are adjusted in any way, there will be costs associated with those adjustments, such as the need to increase reserves. Accordingly, the NCUA requests additional flexibility for administering the Share Insurance Fund.

Specifically, the NCUA requests amending the Federal Credit Union Act to remove the 1.50-percent ceiling from the current statutory definition of “normal operating level,” which limits the ability of the Board to establish a higher normal operating level for the Share Insurance Fund. Congress should also remove the limitations on assessing Share Insurance Fund premiums when the equity ratio of the Share Insurance Fund is greater than 1.30 percent and if the premium charged exceeds the amount necessary to restore the equity ratio to 1.30 percent.25

Together, these amendments would bring the NCUA’s statutory authority over the Share Insurance Fund more in line with the FDIC’s authority as it relates to administering the Deposit Insurance Fund. These amendments would also better enable the NCUA Board to proactively manage the Share Insurance Fund by building reserves during economic upturns so that sufficient money is available during economic downturns.

In sum, insurance parity is a false objective based on contradictory logic and a failure to understand the cooperative financial model.  Credit unions should be careful what they wish for.

As one former NCUA Chair observed, the greatest threat to credit unions is parity.

Never Ending Challenge

Posted on

First Lessons from a Credit Union’s CUSO’s Public Offering

Within 90 days of Safe Harbor, Colorado Partner Credit Union’s CUSO subsidiary becoming a public company, the December 2022 financial result showed a negative retained earnings of $39.7 million.

The company’s stock has fallen from a peak of over $10 per share in October 2022 to close at $.39 yesterday.  Auditors have raised a going concern footnote as a result of its December 2020 financial position.

Partner Colorado Credit Union the CUSO’s founder and owner, has restructured  its initial sale terms of $185 million in cash and stock.  This resulted in PCCU recording a $44 million dollar loss in the March quarter, to offset the gains from the sale recognized in the 4th quarter of 2022.

Except for ongoing revenue from its operating service agreements with SHFS, the credit union has yet to receive any payments from this sale closed in September 2022.

How could such an initial optimistic announcement turn south so quickly?

No one knows how this start up effort to transform a private, relatively small Fintech front-end platform for introducing cannabis related businesses (CRB’s) to financial partners will turn out.

However, CPCU’s effort to tap into the public market’s fervor for “Fin Tech-Cannabis” related startups has  multiple lessons for credit unions. One can see possible parallels in the continued interest and fund raising today in credit union for FinTech labeled businesses.

Is the Startup Scalable?

One topic is  scalability. Safe Harbor was started in 2015 with the full support of all of CPCU’s operational capabilities, especially branches.

The credit union offices were able to open accounts, receive cash deposits, make loans and provide transaction services.   Is this geographically based start up model scalable outside the jointly operated locally-incubated context?

Is the compliance process and technology support so unique, that other local financial institutions and FinTechs would be unable to develop their own capabilities?

“At the end of last year, there were 168 credit unions, 479 banks and 126 non-depository institutions that were serving marijuana-related businesses, according to FinCEN.”  (CU Times)

No Free Market

One observation at this stage is that there is no “free” market.  The credit union is learning that a private firm using the SPAC process has to “pay to play” to become publicly traded.

Reviewing some disclosures form the May 2023, 10-Q SEC filing suggest why this is the situation.

The first is to note that this sale was structured as Safe Harbor buying out the NLIT SPAC, not the reverse as suggested in the $185 million announcement.

Secondly it is impossible to tell which investors got paid what in this transaction.  Certainly the brokers, accountants, lawyers and other facilitators were paid fees.  But which SPAC shareholders were paid what return?

What is known is that the seller, CPCU, has not received anything from the sale.  Moreover It has converted a significant amount of the debt portion to stock and extended the much reduced debt payments further out.

The new entity’s first major transaction was to acquire in November 2022 another cannabis business for $30 million in  stock and cash.  The tangible assets in this acquisition were minimal.  The contribution to immediate earnings, unstated. It would seem to be a transaction negotiated  before the full financial impact of the CPCU sale was known.

SHFS continues to compare in its filings the current financials with its pre-public  quarterly results. This previous financial performance, under the credit union’s auspices, reveals a very modest business, albeit, with a positive financial bottom line.

The Impact on CPCU

The credit union appears well capitalized.  The cannabis business relationships from SHFS are important. About $35-40% of its deposit base appears to be from CRB’s-much probably  held in share draft accounts.

Prior to the public sale, CPCU recorded its CUSO investment at $8.0 million.  To date the credit union has not received any of payments, including the $3,143,388 in cash and equivalents held by Safe Harbor prior to the sale.

As stated throughout the SEC filings, CPCU is the SHFS’s primary banking partner.. “Currently the Company substantially relies on PCCU to hold customer deposits and fund its originated loans. As of this time, substantially all of the Company’s revenue is generated by deposits and loans hosted by its PCCU pursuant to various services agreements.”

Concentration limits for the deployment of loans are further categorized as i) real estate secured, ii) construction, iii) unsecured and iv) mixed collateral with each category limited to a percentage of PCCU’s net worth. In addition, loans to any one borrower or group of associated borrowers are limited by applicable National Credit Union Association regulations to the greater of $100,000 or 15% of PCCU’s net worth.  Page 27

Further disclosures show that the credit union has limits on the amounts of total CRB related loans it will hold as part of its service agreements:  PCCU’s Board of Directors has approved aggregate lending limits at the lessor of 1.3125 times PCCU’s net worth or 60% of total CRB deposits.

CRB deposit limits: (page 27) Under the Support Services Agreement PCCU will continue to allow its ratio of CRB-related deposits to total assets up to 65% unless otherwise dictated by regulatory, regulator or policy requirements. Actual CRB deposits  at March 31, 2023  $214 million and $161 at December 31, 2022.

CPCU’s CEO and CFO are members of SHFS board; the credit union owns 55% of the voting stock from the restructuring.  The credit union’s current operations certainly benefit from SHFS’s clients apart from what may be received from the sale of the CUSO.

The Transparency Opportunity

SHFS’s SEC filings provide many details of its business history and financial twists and turns. The latest 10-Q filed May 15, 2023 can be found here; and the definitive proxy statement  Schedule 14 A, filed April 23, 2023 for the firm’s annual meeting is here.

Two financial questions are partially answered in these documents.  If the SPAC held $100 million in cash, how did the working capital become so depleted by yearend?   How did the SHFS end up with  over $39.7  million  in negative retained earnings at December 2022  requiring the complete restructuring of the transaction with CPCU?

Below are some excerpts from these documents.   The story is complex.  There is  not a single narrative point of view as the filings show different elements of the financials in various footnotes.

I have selected some to illustrate  the information available.  There is both quantitative and qualitative (business risk factors) information provided.

One positive note that may bode well for the future is that Safe Harbor’s web site and links are one of the most comprehensive examples of transparency I have reviewed.  The stock valuation information is detailed both currently and historically.  All of the required SEC and financial reports can be accessed on line at SHFS website.

On its investor relations page the firm makes this commitment: Safe Harbor Financial (Nasdaq: SHFS) seeks to enhance shareholder value not only through exceptional business performance and practices, but also through responsible and effective communication with its shareholders. The latest company information relevant to the individual and institutional investor includes stock price and history, upcoming events and presentations and financial documents. Safe Harbor Financial trades on the Nasdaq under the ticker symbol SHFS.

That is an example credit unions should totally embrace as well.

Selected Excerpts from SEC 10-Q filings

(emphasis added)

From Note 3, the Business Combination detailed in Note 1 above was accounted for as a reverse recapitalization, with no goodwill or other intangible assets recorded, in accordance with GAAP. Under this method of accounting, NLIT  (the SPAC) was treated as the acquired company for financial reporting purposes. Accordingly, for accounting purposes, the Business Combination was treated as the equivalent of SHF issuing shares for the net assets of NLIT, accompanied by a recapitalization.

For tax purposes, the transaction is treated as a taxable asset acquisition, resulting in an estimated tax basis Goodwill balance of $44,102,572, creating a deferred tax asset reported as Additional Paid-in Capital in the equity section of the balance sheet as of the date of the business combination.

In November, 2022 SHFS acquired Abaca together with its proprietary financial technology platform in exchange for $30,000,000, paid in a combination of cash and shares of the Company.

The November press release stated:  the acquisition increases Safe Harbor’s customer base to include more than 11,000 unique depository accounts across 40 states and U.S. territories; adds Abaca’s fintech platform to Safe Harbor’s existing technology; increases Safe Harbor’s financial institution client relationships and access to balance sheet capacity to five unique financial institutions strategically located across the United States ; increases Safe Harbor’s projected monthly revenue by approximately 40%; increases Safe Harbor’s lending capacity; and nearly doubles Safe Harbor’s team, adding to the existing talent pool of the cannabis industry’s foremost financial services and financial technology experts.  (note 4 10-Q provides the fair value presentation for the transaction page 20)

Page 20 in the 10-Q shows what NLIT’s fair value assets it offered to support the $185 million CPCU purchase valuation.  The key point is that $80 million was held in shares subject to possible redemption and the remaining cash of $19 million was held in trust.

It is not clear how many common A shares were redeemed, or how the money in trust was used.  The result is that at December 2022 SHFS had only $8 million in cash and negative working capital (current assets less current liabilities)  of  $39 million.

The details of the restructure of the $185 million for CPCU was reported  on March 23, 2023.  Page 26 shows that exchange of debt for common stock resulted in $38.4 million for issuance of common shares.  These are subject to a Lockup agreement restricting their sale.

Also CPCU acquired a first lien on all of the company’s assets as a result of the restructure. SHFS issued a five-year Senior Secured Promissory Note (the “Note”) in the principal amount of $14,500,000 bearing interest at the rate of 4.25% and a Security Agreement pursuant to which the Company will grant, as collateral for the Note, a first priority security interest in substantially all of the assets of the Company.

Contributing to the loss in 2022 from note 17 Forward Purchase Agreement page 35:

The trading value of the common stock combined with preferred shareholders electing to convert their preferred shares to common stock triggered a lower reset price embedded in the forward purchase agreement, or FPA. As of December 31, 2022, the Company had already called a special meeting to lower the make-whole price under the preferred share purchase agreement to $1.25/share. . . These events significantly reduced the FPA receivable to approximately $4.6 million, from approximately $37.9 million reported at the end of the September 2022 quarter. The loss in value resulted not only in a compression of the balance sheet, but also $42.3 million charge to other expense on the statement of operations in the fourth quarter of 2022.

At March 30, 2023, SHFS’s balance sheet shows negative retained earnings of $47 million offset by $91 million of additional paid in capital from the restructure of the $180 million initial terms and other stock transactions.

81% of SHFS’s March 2023, $89 million  assets are $19 million in goodwill, $10.2 intangible and a deferred tax asset of $42.6 million. 

 

Posted on

“The Rest of the Story”

Decades ago, radio broadcaster Paul Harvey provided millions of listeners his unique blend of news and views. After reporting an important event   he would often promise to  tell “the rest of the story” but only after an advertising break.

The member testimonial below from Affinity Credit Union, Des Moines, is used in TV commercials and social media to illustrate their efforts for personal service with members.

This two-minute story of a real member going from near bankruptcy to an 800 FICO score is very effective, even moving.

(https://youtu.be/0PXPcuGnAkc)

The Way Back-More Than Financial Wellness

But there is more to the story. James Reasoner, the member in the video, is a recovering alcoholic.  Several times he refers to making poor decisions, but stays silent about the context.

About two decades ago he woke up in a jail cell after a  second DUI arrest.  Something happened in the cell. He describes it as a spiritual awakening resulting in an effort to change his life.

James says of  this decision, “It all started with a little trust and lots of hope.”

Today he attends daily 7:00 AM sessions with his mentor.  In turn he mentors other alcoholics both in person and during Covid, on zoom.  He speaks at periodic recovery meetings while still working at the Firestone tire plant where he is in his 28th year of employment.

Being There for Others

His credit union relationship has also evolved beyond this video testimonial.

Last week at the members’ Annual Meeting James was elected to an initial three-year term on the board.  Below, in the middle, he raises his hand with fellow volunteers while taking the director’s oath.

Knowing Each Member’s Story

The Affinity video is more than an advertising promotion.  It is comparable to a public service announcement.  It illustrates this credit union’s efforts to respond to a member’s unique circumstances.

Beyond the video’s specific example, there is an even broader impact.  It is also the back story of a relationship experience that motivated James to give back more of himself to others.

What a powerful witness for economic democracy when a long-time member volunteers for credit union leadership!

The video’s universal message is that “every member has a story.”  When we listen, that’s when we can truly serve them.

(Note:  Personal story of James Reasoner used with permission.  Thanks also to Misty Haley, who was James’ helper.  She was recognized for 26 years of service at this year’s Affinity Annual Meeting.  )

 

 

 

 

Posted on

The OATH

Earlier this week I spent three days with Affinity Credit Union.  I was invited to speak at their Annual Members meeting.  This would be my first live, in- person speech in years, to a credit union with which I had no prior connection.

I asked to come a day early to learn about why this $140 million, 74-year state charter in Des Moines, IA wanted me to speak.  The CEO’s response was simple: I want you to see what we do.  In other words, for me to learn.

I accepted.  In later posts I will share some of the things I experienced.  But one event was totally unique. I had never seen it in my 45+ years with credit unions.  It is an example that  other credit unions should  consider.

The OATH

The members’ meeting began at 5:30 with a buffet dinner for the over 200 people in attendance.  The agenda was long running, from “A” to “Q” in the outline given with the Annual Report. There were three speeches by outside guests (I was one), six high school scholarships presented, recognition of three employees who had passed twenty-five years each in service all before the business portion of the meeting.

At the conclusion of the business meeting, the Chair Cindi asked all the newly elected and continuing directors to stand for their oath of office.  The oath was administered by a former chair and director.  He read the phrases and they would repeat together following him.

The oath begins with the words “do solemnly swear” and included the following commitments:

I will diligently, faithfully honestly and impartially perform the duties imposed upon me by the bylaws

I will not knowingly violate. . .any of their provisions

I further swear that I will. . .properly discharge the duties of any office or committee to which . . .I am appointed

I will not discuss the affairs of this credit union or any of its members wit anyone except credit union officials

I will give all possible assistance to any person who may succeed to any office which may hold. .

The nine directors stood together at the front of the room, hands raised, repeating the oath in unison before their families, friends and hundreds of members and guests.  An important and solemn moment of a public commitment to their fellow owners and community.

The Oath’s Origins

As I had never heard about  this happening in credit unions, I asked how it became a part of the Annual Meeting.  Was it required in the bylaws?  By their state charter? By some other tradition?

The practice had been followed long before the current leadership team was in place.  Even prior to the former director and chair who administered the oath this year. He recounted:

It was given long before I got on the board. I was told that it was because it was swearing an oath to the local 310 members (the credit union’s original union chartering group at the Firestone plant) that they would take care of the credit union when it was members and family only.  Local 310 still swears an oath to protect our brothers and sisters to respect and do no harm with actions or pen.

Unfortunately, in today’s environment not every union member thinks it’s necessary to swear an oath to watch out for each other. So it probably goes all the way back to the lunch box (when the credit union was chartered in 1947.)  That lunchbox symbolizes a resource created by workers, for workers, that feeds families, futures and trust. 

A Vital Example for Cooperatives

Vows, oaths or formal swearing ins are rare in organizations today.  Perhaps when joining a church (statement of belief) or wedding vows or perhaps a pledge such as when joining the Boy Scouts.

There is however one universal practice where an oath is administered, when a person joins the military or becomes a federal employee.  The constitution requires the practice as explained in this article:

The reason is simple – public servants are just that – servants of the people. After much debate about an Oath, the framers of the U. S. Constitution included the requirement to take an Oath of Office in the Constitution itself. Article VI of the Constitution says, “The Senators and Representatives before mentioned, and the Members of the several State Legislatures, and all executive and judicial Officers, both of the United States and of the several States, shall be bound by Oath or Affirmation, to support this Constitution . . .; 

The author states the intent:  One purpose of the Oath of Office is to remind federal workers that they do not swear allegiance to a supervisor, an agency, a political appointee, or even to the President. The oath is to support and defend the U.S. Constitution and faithfully execute your duties. The intent is to protect the public from a government that might fall victim to political whims. 

Should Credit Union Directors Swear an Oath?

As volunteers, directors are often seen as an eleemosynary activity, an act of charity.  Therefore the demands of a director should not be the same as in a formal, paid position of responsibility.

This characterization is even noted in federal legislation as recently as the Membership Access Act in 1998.  In setting the new PCA reserve requirements, the legislation directed that the NCUA consider the volunteer nature of credit union leadership when imposing capital standards.

I believe that an annual oath taking in front of members and community,  would not only be good practice, but honor and enhance the  tradition of credit union volunteer leadership.  The requirement could be made a standard part of the bylaws, which is the governing document, as noted in the oath above.

As a public event following the business meeting, it formalizes their accountability to the members whose authority has elected them to their positions.

Most critically the oath taking represents a transparent commitment to one of the most important tenents of cooperative design: the democratic member voting process. It reaffirms the trust members expect and are properly owed by their elected directors.

If you would like to receive a full copy of the Affinity Oath,  contact Kris Laufer at klaufer@affinitycuia.org.

 

 

 

 

Posted on

Business and Life Wisdom from Warren Buffett (Part II of II)

Last Saturday’s Berkshire Hathaway’s Annual Meeting was preceded by a five hour Q & A with the two founders: Warrant Buffett and Charlie Munger.  Both are over 90 and answered multiple questions about the numerous business decisions at BRK as well as thoughts about life.

Many of their observations were relevant to any organization because of the scope and scale of the companies BRK owns.

However the most important lesson is their example of transparent leadership and accountability.  Buffett’s board is self-selected.  He is Chairman and CEO, roles that will be divided when he leaves.  The company has the fourth or fifth market capitalization of any publicly traded firm.  Its net worth of over  $500 billion is one of the largest in corporate America.

At age 92 with an unmatched  performance record over six decades, Buffet did not have to put himself into the public and shareholders’ conversation as he did. There was no script.  In addition to the tens of thousands in the live attendance there were hundreds of thousands following the life MSNBC telecast around the world.

His leadership example is one every credit union could follow.   In doing so, the CEO and Boards would honor their member-owners’ loyalty, communicate competence, and  fulfill the cooperative democratic governance model.

Following are few of his many insights.  However the most important message is this simple example of a CEO’s public dialogue with his owners.

Buffett’s Business Observations

  • Why problems with commercial real estate seem inevitable.  The value of any property is only what the buyer can borrow without signing their name to back the loan.  Market value depends on how much a buyer can borrow, that is the availability of credit. Downtown office buildings are being hollowed out and banks don’t want the properties.  Many properties have seen their value decline, and refinancing or sale in the new interest rate environment will be more difficult.
  • Money is too easy to raise—startups are selling ideas, not performance; People are just trying to outsmart each other not out-manage.
  • Opportunity comes to BRK when people do dumb things partly the result of easy money.
  • Wall street and company managers are overwhelmingly focused on the short-term, not how well you will be in five or ten years.
  • How well will a brand travel? Buffett gave numerous examples of learning about consumer behavior from his multiple retail businesses.  For example when trying to expand the See’s candy franchise, he learned that consumer’s preference for chocolate is different on the two coasts than in the Midwest.  The See’s brand has “limited magic” and does not fit well in other markets.
  • Why does BRK own so much of Apple? Consumer loyalty—users will give up their second car before they would their iPhone.
  • Because BRK pays no dividends and reinvests all earnings back into its businesses, it makes investments in its power companies that give it an advantage over its dividend paying utility competitors. This is especially important when new power sources and transmission capabilities are required to make renewables an increasing component of energy supply.
  • BRK’s secret to success: Keep a small headquarters staff (about two dozen people) and practice extreme decentralization for managers to run their business.

Life Wisdom

  • Live your life by writing your obituary and then reverse engineering it.
  • On AI: it will change everything except how people think and behave. AI does not replace the gene.
  • How American industry and society performed in WW II: Americans understood the challenge creating a unity of purpose and the mechanisms and urgency to organize capital and industry to win the war. That unity is lacking today.
  • Must refine our democracy -how to keep good parts and call out the worrying. The country has moved from partisanship to tribalism.
  • Charlie Munger on why he left law practice: “Working in a large law firm and moving up is like winning a pie eating contest where the prize is getting more pie.”
  • Why do formerly independent companies and managers agree to be bought out by BRK to become part of a large conglomerate. “We let them operate independently without worrying about analyst’ opinions, stock prices, bank lines, or trade associations’ priorities.  They can just run their business. There is nothing like working for yourself.”
  • Shouldn’t the second half of life be better than the first?
  • Society has trouble preparing for events that seem remote (another pandemic, climate change).

Full details of this live Q & A can be found here:  Buffett@response.cnbc.com, the Warren Buffett Watch.

 

Posted on

Warren Buffett’s Annual Meeting and Wisdom for Credit Unions (Part I of II)

Last Saturday was the annual meeting of Berkshire Hathaway (BRK) in Omaha, NB.  The event, called the “Woodstock of Capitalism” was attended by over 40,000 shareholders and broadcast live on MSNBC.

I believe there are valuable observations for credit unions.

Prior to the formal annual meeting agenda Warren Buffett (age 92) and Charlie Munger (age 99) answered questions from online and in-person shareholders for over five hours separated only by a short lunch break. Their goal was to take at least 60 questions.

They covered all aspects of company operations, long term strategy, and recent decisions (eg. selling TSMC stock after holding only two months) as well as questions on Fed fiscal policy, international relations and life’s most important decisions.

The full sessions and excerpts can be found from Saturday’s edition of Buffett@response.cnbc.com, the Warren Buffett Watch.

Three Important Lessons for Coops

Here are my top three takeaways with significance for credit unions.

  1. Respect for shareholders. Buffett: “For fifty-eight years we have regarded shareholders as the reason for our existence.”  The open-ended questions at the meeting came from young and old including families that had owned stock for generations.  No subjects were off limits.   The entire event was a celebration of the firm’s various businesses and designed to be both informative and a good time.

This model of dialogue with shareholders is one that can be emulated by credit unions.  It would increase cooperative transparency, confidence and good governance.  In Buffett’s words: “Management has an obligation to explain to shareholders everything. . .to say what they think is right.  We want owners to understand what they own. . .We are working for the people in this room, not a quarterly operating target from Wall Street.”

This question and answer with ordinary people from all over the country (and other countries) was direct and straight forward.  No talking down or 10-Q explanations.  No discounted cash flows or present value kinds of reasoning; only plain answers to hard questions.

  1. The entire US banking model is under review. After the runs caused the closures of three major banks, the two most frequent proposals have been to make deposit insurance unlimited in coverage or to eliminate short selling of public bank stocks.  Future uncertainty in the current environment seems probable.   Unlimited deposit insurance would make all deposit liabilities of shareholder owned banks an issue of federal government backing.  The second reform would reduce market discipline in the pricing of bank stock performance.

At another point in discussing property-casualty insurance (a market which operates on a margin of only 4%), Buffett noted his strongest competitor was one which created the last significant innovation: State Farm a mutual, not a stock company.  Here is his analysis from the 2019 Annual meeting:

“If you go to business school, you’re taught that it’s only because you have incentives and compensation, all kinds of things, that businesses can be successful. [But] Nobody really got rich outside of State Farm. They sat there, and they are the biggest insurance company,” he claimed.

“When Leo Goodwin started GEICO 80 years ago, he probably wanted to get rich,” he said, referring to GEICO’s founder. “And probably at Progressive, I know people wanted to get rich. And at Travelers and Aetna. You can name them, dozens and dozens of companies.

“And who wins? A mutual company,” Buffett concluded.

“In terms of presence, size, they are still the biggest company. If you omit Berkshire, they have the highest net worth by far. They have $140 billion or something in net worth,” Buffett said, speculating that Progressive’s net worth is about one-sixth that of State Farm.

“We’re spending $2 billion a year telling people the same thing we’ve been telling them for 70 or 80 years.” But when all is said and done, “State Farm still does more business than anyone else, and that shouldn’t exist under capitalism.”

“If you [had] a plan to start a state farm today and had to compete with Progressive, which would bring the capital [for] a mutual society from which you are not going to withdraw the profits? It makes no sense at all,” he said.

With the market driven banking model increasingly under question, and the example of State Farm’s mutual success, is it possible that  the cooperative credit union model is the best alternative design for resolving the uncertainties and internal contradictions of stock-owned depository financial institutions?

  1. How his insurance model benefits all BRK businesses. And why it suggests the FDIC is a flawed insurance model.

Insurance is a paid-in-advance business.  This gives a firm the ability to earn on the capital and invest the float before paying out claims expense.

As an example, last year BRK was earning 4 basis points on its $125 billion  cash, or about $50 million per year.   Recently the company bought a Treasury bill at 5.92%.  The company will earn about $500 billion this year on its cash.  This float from the insurance doesn’t cost anything. Capital stock is very expensive. Debt has to be repaid like deposits.  Importantly BRK has multiple options for investing its float.

The FDIC has no capital base.  Its primary revenue is from premiums.  The combined losses of an estimated $35 billion on the bank failures so far this year will be paid by the banking community. FDIC has not been able to accumulate earnings from its capital base to cover its risk.

The NCUSIF has a 1% capital base that matches-grows or declines-with the level of total insured shares. The earnings on this capital and additional retained earnings of .2-.3% of insured shares are sufficient to cover even the most extreme risk scenarios.  So long as the investment portfolio is well managed.  The NCUSIF’s breakeven earnings level is between 2.5%-3.0%.  That outcome should be the measure of NCUA’s management effectiveness.

The three areas above are a trifecta for credit union optimism:  the  public example of shareholder-owner engagement, the questions around the US banking model, and the sounder NCUSIF financial structure.  All three are inherent in cooperative design.

Tomorrow I will share some of Buffett and Mungers’ comments that have direct relevance for credit unions’ businesses.  As well as some of his wisdom about life.

Posted on

The Legacy Effect of Credit Unions

I’m 78 years old.  Many  requests for donations to support various organizations from prior years now come with a special option: Become a legacy member.

These institutions cover the entire spectrum of public and civic service: hospitals, colleges and universities, churches, choral groups, and local theaters.  The appeal here in D.C. even includes the many public museums, National Archives, Smithsonian institutions, Library of Congress et. al.  that are part of the Washington community.

A legacy commitment means that an individual will make a bequest to the organization in their will or via an estate planning vehicle such as a trust.   It is not an immediate contribution, but rather a commitment made upon passing to support an endowment-like fund for the organization’s continued operations.

These legacy commitments are shown separately in donor listings to recognize this future intention.  Last Sunday was Legacy Sunday at our local church.  The bulletin insert asked Are You a Member of CCPC’s Legacy Society, listed the names of both living and deceased members who had made a commitment along with statements of support by individuals such as:

“I pledge every year.  None of us know when we will pass away, but I feel like this is a last commitment to the church.  Think of it as my last pledge.”

Credit Unions’ Legacy Commitment

A credit union recently sent me their founding story from 74 years ago.  It reads:

On April 29, 1949 ten tire factory floor workers set their names together in a bond of common trust that lives today as the cornerstone of the credit union.  

Long on hope, but short on cash, the credit union charter members carried a few dollars around between work shifts in a lunch box distributing $5 and $10 loans for the small essentials of life.

On a factory floor or at a cafeteria table, in a quick exchange of papers and promises between shifts, the hushed request for a $10 loan for groceries, the nod of a head in answer, a review meeting after hours, a handshake-this was Local 310 Credit Union in action in the founders’ first days.

A plink of quarters in a metal lunch box carried from shift to shift sounded the word: here is a resource created by workers for workers, that feeds families, futures and trust.

That credit union still thrives today.   Those founders met not just current needs, but created a legacy that continues to serve members and communities generations later.

The Legacy Impact from a Lunchbox

Like all founders, these credit union incorporators created a perpetual legacy not just a financial intermediary for the present.  Today this credit union’s  board and members carry on the founders’ belief in serving their community through an organization “where they know your name.”

Some current members are the grandchildren of the first organizers.   Their legacy is to continue to “pay forward” what they inherited to their children’s children.

These members will soon celebrate their 74th Annual Meeting.  Almost 300 have signed up for the event with dinner. They are witnessing to the power of service, hope and trust that a cooperative brings to  members. Far beyond the current economic uncertainties or the latest fiscal year outcome.

These individuals both continue and increase the legacy they now celebrate, so the credit union can continue to be there for future members.

As stated in the credit union’s founding story:  we stand on the shoulders of legends who carried a crumpled dollar bills from lockers, to cafeteria, to work stations in a steel lunch box-symbol of a special bond between people who care about people.

That is a Living Legacy we should all want to support.  A unique benefit of cooperative design.

 

 

Posted on

Lessons From the Field: Sharing the Good and Bad

Managers’ monthly reports to staff are an important way of communicating both successes and short comings.

This April report includes a fraud effort recounted in detail.  The learnings prevented a second theft. The CEO  then characterizes the $125,000 loss as a tuition payment.

We processed a wire transfer request for a member on Friday, March 24 for $125,000 and unfortunately incurred a fraud loss.  The caller impersonated the member, knowing the answers to all out-of-wallet questions asked (e.g., name, address, account number, mother’s maiden name, etc.), and also knew the account’s code word and year that the account was opened.  The phone number was spoofed, making it appear to be the member’s phone number. 

The caller changed the contact information of the account, then called again to request the wire transfer.  Another wire request from that account was made on Monday, March 27 and the call was appropriately escalated by front line associates.  After determining that identity theft occurred, the account was locked down, law enforcement was contacted, the member was contacted, and appropriate affidavits of forgery forms were executed. 

Our fidelity bond which would typically cover insured perils such as this will not cover this loss because we didn’t place a verification call to the old number on file.  This step is required by the bond company and is documented in our wire procedure for all accounts with contact information changes within the past 30 days.  The wire transfer procedure was amended and training was being enhanced as appropriate. 

As is typical, losses such as this are thought of as tuition payments, making everyone on the team smarter as we move forward.

Everyone in the organization needs to be aware of this fraud threat. On April 25 the same fraudster called into the lending call center.  He had enough data (name, address, account number, last four of social, etc.) to convince the first associate he talked to that he was a legit member.  He then used social engineering techniques to obtain various other pieces of account information.  He accessed online banking and changed some contact information; he again requested a wire transfer. 

The fraud attempt was caught so no additional loss was incurred.  But we still have to deal with reputation risk with our member and establish a brand new account, which can be time consuming. 

Net Promoter Scores:  Both 10’s and 0’s Shared

Many credit unions rely on the net promoter score processes  to monitor operational performance in real time.

Often just the overall score, usually in the mid 80’s, is shared with staff and the overall trend.  Sometimes a compliment will be added to the update.

This credit union CEO believes both high and low scores can inform and lead to better service.  He shares the verbatim comments.  Here are a few examples from the 248 remarks submitted by members during the month:

  10. When I had my debit card number stolen my savings & checking accts were cleaned out, you all took care of me. I was very upset! I had all my money back in 2 days. I’ve always been a fan of credit unions instead of banks.

 10. The customer service was excellent and Palisha was amazing. She answered all of my questions and made sure I was comfortable with everything. She broke everything down for me and was very communicative.

 10. Gave me loans when my own CU turned me down.

And areas for improvement:

 8. Online banking is not user friendly, when I contact the branch no one is helpful. I set up a credit card payment years ago and want to increase the amount and no one seems to be able to help me. I bank at a few other institutions as well and I never have the same issues.

  0. Make it so the app is usable to pay car payments without having to have a bank account- sign in to car account. Same with website. Such a chore to make car payments.

 0. because I live in Tennessee now. Open a branch in Knoxville.

4. Work with me on my credit or a loan to build credit I have always paid loans off and now my income is more annually.

Transparency and effective leadership are interdependent.  Staff feels part of a team when occasional shortfalls, or even errors, are transformed into  lessons from which all benefit.

 

Posted on

University Student Entrepreneurs Win–but Credit Union Charter Still Distant After Six Years

The current generation of students is attracted to business and social startups.  Many major universities now offer competitions encouraging students to design and launch new business and non-profit ideas.

These efforts are so widespread that there are now multiple rankings of the leading programs at colleges and universities across the country.  Here is one showing the top 20 competitions.

One of the leading forums is at  George Washington University, here in DC.  The results of its annual New Venture Competition were just announced.

In their 2023 contest, 417 participants spread across 161 teams participated. Judges awarded $357,200 in prizes, including $163,000 in cash to the winners.

Twelve finalists received a minimum of $5,000, across four tracks: Business Goods and Services, Social Innovation, Consumer Goods and Services and Healthcare and Life Sciences Tracks.

Participants represented nine of the 10 GW schools resulting in a diverse range of innovative startup solutions.

GW President Mark S. Wrighton commented on the outcome: “If this is an indication of the next generation of problem solvers, then we are all in good hands. It is extraordinarily impressive to hear about the diverse set of new businesses.” 

The full profile of all winners in all five tracks and their ideas can be seen in this listing.

A Credit Union Winner

In April 2018 three GW freshman from  different academic schools devoted much of their first year in college to this competition.  They reached the finals and were awarded $10,000 to continue implementing their project.

Their new venture proposal was to charter a credit union for the GW students and community.  I recorded their five minute “pitch” on my iPhone from the audience.

Their words provide the promise that every credit union offers including the need and importance of financial literacy, member ownership and direction, online delivery, better rates, and strengthening the community with a firm “run by students for students.”  Their slides are in the background on stage.

https://www.youtube.com/watch?v=s_xCpDe9a3U

(https://www.youtube.com/watch?v=s_xCpDe9a3U)

What Happened?

Dozens of students volunteered their time to complete the charter application, the group raised over $100,000 in donated capital and recruited an experienced advisory board of credit union professionals and GW faculty.

NCUA has twice rejected hundreds of pages for the  charter applications.  The agency has requested updated market surveys, revised financials, and numerous other shortcomings, all the while hinting that more capital would be desirable.

Meanwhile the three freshman who devoted a significant part of their college career to this effort have graduated; however two still serve on the advisory board.  New student volunteers have persevered to carry on the founders’ original concepts.

NCUA has not assisted but rather stalled this six- year effort.

This status occurs despite the words in the February 28 presentation by NCUA’s Vice Chairman, Kyle Hauptman at this year’s CUNA’s GAC conference:

Our society isn’t the best at getting people to save and invest. This is where credit unions come in, with financial literacy and savings programs that improve their members’ financial wellness.

Financial wellness can save relationships. Financial wellness is a great product that we only buy if we value it more than all the cool ways to spend money. Credit unions help people achieve financial wellness. . . Financial issues can be a dry topic, but it’s not about the money itself – it’s about living your best life.

My three personal priorities for my term are:

  • Revamping the de novo chartering process. . .

I’ve good news on all three fronts.

On the issue of de novos, we’ve revamped and streamlined the chartering process. We will be rolling out a provisional credit union charter that fixes the chicken & egg problem, whereby a potential credit union wants to get its initial capital from a CDFI but can’t get that capital until we’ve issued them a charter. Still, we wouldn’t issue the charter until that credit union has the capital.

I’m proud of these improvements – I think it’s a part of facilitating true financial inclusion. I love seeing announcements about new charters. . .

Except this streamline chartering process does not exist. When asked about this “improvement” and the “provisional credit union charter”, there is no response.   That effort, like credit union chartering, is stillborn.

Instead of supporting the next generation’s startup energy and goals to serve their community via coops, the NCUA is teaching potential supporters about the age-old witticism, “I’m from the government and here to help you.”

Apparently even board members cannot accomplish their priorities.  How can de novo credit unions overcome the bureaucratic obstacles that even NCUA’s leadership is unable to move forward?

New credit unions are an endangered species.  The future of the coop system is at risk.  Not because the billion dollar segment which manages 75% of assets will disappear.

Rather it is because this generation of student entrepreneurs is unable to overcome government impediments.  The result is that  these motivated, creative individuals will find their opportunities for the benefits presented in the “pitch” above through other creative organizations.  I suspect they will be called FinTechs.

 

Posted on

American Pastimes:  Baseball and Credit Unions

The culture of credit unions-locally founded, community centered, volunteer led by committed fans-mirrors  the passion for baseball across America.

Recently I published the story of Day Air Credit Union’s support for the Dayton Dragons minor league franchise.  The team has the longest running consecutive sellouts of any professional sports team in America.

Credit unions are involved in the sport across the country.  From sponsorships of local Little Leagues to  university teams to minor league affiliations up to PenFed’s  support for the Washington Nationals, baseball and credit unions are natural allies.

Recently a baseball player at Springfield High (Illinois) where I graduated decades ago, wrote his thoughts on baseball’s lessons for life for the student newspaper, The Senator.  The author, Seth Impson, seems an excellent player based on his self description.

His thoughts about the sport show why baseball is often called The Game of Life.

Anyone who knows me knows I live for the game of baseball. There’s nothing better than the smell of pine tar and the sound of a ball hitting the bat. Nothing better than feeling the wind in your face as you round third base. Nothing better than dirt and dust flying everywhere as you slide into home. But it is more than just a game; baseball has taught me a lot about life.

  1. If it’s close, swing the bat.

Too many times in life fear keeps us from trying something new or different. We let opportunities pass us by because we’re afraid we might fail. Then later we wish we would have gone for it. In baseball, if a pitch is close, you have to take a chance and swing. It’s the same way in life– it’s better to give something your best shot and risk failure than to stand there looking while the perfect opportunity flies by.

  1. You’re only as good as the guys behind you.

I had a lot of success pitching last year. I struck out 79 guys, walked 17 and only gave up 54 hits. But I threw 65 innings. I faced 264 batters. Do the math- the guys on the field behind me made plays and got 114 guys out. Over 100 times, a batter hit the pitch I threw to him and someone else on my team made a play. Only 16 of those 264 players scored runs against us. Without those guys on the field with me, my season would not have been anything special. In life, surround yourself with people who have your back and will make those plays when you most need them.

  1. Practice makes better.

No, that’s not a mistake. I didn’t mean to say “practice makes perfect.” The fact is it doesn’t. No one can ever be perfect. There is always room for improvement. But if you put in the work, you will get better. Work each and every day to come further than you were the day before and bettering yourself. The goal of life is to make yourself a better person than you were the day before, baseball is the same way.  You will see growth.

  1. Don’t let them see you sweat.

There are moments in a baseball game where you find yourself under intense pressure. When your team is down by one with a runner on third and two outs and you’re up to bat. When you are on the mound about to face the best hitter in the conference. Whatever it is, you can’t let the other guys know you’re stressed. You can’t let someone else get in your head. Take a deep breath and focus on the task you need to accomplish.

  1. Failure builds character.

Baseball is a game of failure. In the MLB, a batting average of .300 or higher is considered good. That means a player gets a hit 3 out of every 10 tries. That also means 7 out of 10 times, that player gets out. On Tuesday I flew out, struck out and walked. I didn’t get a single hit. But the next day I hit two triples and a homerun.

In baseball, you will fail. Life is the same way. You just can’t let failure stop you from getting up and trying again, because the next day things might go your way and you’ll find yourself right where you want to be. This builds persistence and in every tough, successful person there are characteristics that sets them apart. Baseball brings out these certain things, builds them up and creates strong character.