Category: Cooperative Design

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Subordinated Debt: The Fastest Growing Balance Sheet Account in Credit Unions

In 2022 subordinated debt issued by credit unions grew to $3.381 billion, a 257% increase from December 2021.

The number of credit unions using this form of temporary capital grew from 105 to 150. They represent about 7.3% of total system assets.

While still a very small percentage (1.4%) of the system’s total year end capital, its use is highly concentrated in a few credit unions.

NCUA is presenting a final rule on subordinated debt at this Thursday’s board meeting.  A point of interest will be how much detail is given the board and public about how credit unions used the funds, the various sources, and the reliance on this debt to meet capital compliance ratios.

These details are especially relevant today when bank failures wiped out not only all stockholder equity and retained earnings, but also all bond debt.

Rented Capital or Buy Now, Return Later

By rule subdebt is an unusual financial instrument.

Subdebt is reported as a liability, that is a borrowing, on the credit union’s books.  But because of the structure of the debt, NCUA considers it to be capital when calculating net worth for RBC-CCULR and low-income credit unions.

Subdebt can be sold to other credit unions as well as outside investors. Purchasers perceive it to be an investment, but technically it is a loan to the credit union which makes it as an eligible “investment”  for credit unions to hold.

In the event of credit union failure, the subdebt is at risk if all the credit union’s capital is depleted.

A Financial Growth Hormone

Unlike traditional retained earnings capital, subdebt is not free, with the interest rate varying depending on the structure and the credit union’s financial situation.

Because its inclusion in computing capital ratios is time-limited, the most common justification given by credit unions for raising the debt is to accelerate balance sheet growth.  Book the capital upfront, then leverage it for additional ROA to have increased earnings to repay the “borrowed” capital down the road.

This financial leverage requires raising more funds matched with earning assets to achieve a spread, or net interest margin, to make the process earning accretive. Buying whole banks is one obvious tactic to accomplish both balance sheet growth goals at once.

The process refocuses credit union financial priorities from creating member value to enhancing institutional financial performance through leverage.

Most Use Is by a Few Large Credit Unions

Community development credit unions are major issuers of subdebt.   The two charters under the Self-Help brand have together raised over $700 million.  Hope FCU in Mississippi and Latino in North Carolina have issued over $100 million each.

Bank purchases have been an important part of other credit union’s use of debt:  VyStar, GreenState, and George’s Own for example.

In other situations where the amounts are more modest, the intended use is less clear.  Is it just a form of “capital insurance” to meet the increased capital ratios of RBC/CCULR?   Is it to “test the waters” to see how the process works? Issuing subdebt is not a simple effort as for example, opening a FHLB account.

The Most Important Missing Rule Requirement

Subdebt has been bought by banks, insurance companies, investors and even other credit unions.

Sometimes the events are announced publicly either by the broker facilitating the transaction or the credit union.   The purpose is rarely specified other than to seek new opportunities for. . .  and then fill in the blank with a generality.

It is the members who pay the cost of the debt. The interest on the debt is an operating expense that comes before dividends.  If the only use is capital insurance or assurance, then the members should be informed as to the terms, cost and role of this approach to meeting regulations.   It is a management and board responsibility to be transparent and accountable to their owners.

If the goal is more ambitious, to capture new growth possibilities, the disclosure is even more critical.   Financial leverage, especially non-organic growth, increases risk.

In both instances the commitments undertaken can extend as far as ten years.  That term reinforces the need for full disclosure so members are aware of the commitments being made on their behalf.

The most important requirement that should be part of the revised subdebt rule is for full transparency for each transaction.  The purchasers of the debt are given all the details of the borrowing as their funds are at risk should the credit union fail.

Shouldn’t the member-owners also be informed of the commitments and terms made using their long-standing loyalty which, in reality, is underwriting the transaction’s terms?

It’s an opportunity for credit union members to be treated as actual owners, not just customers.

 

 

 

 

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What Do This Weekend’s Bank Failures Mean for Credit Unions?

Over the weekend banking regulators closed two banks, the $206 billion Silicon Valley Bank (SVB) and the $110.4 billion Signature Bank in New York.

The precipitating events  were runs by depositors.  In each bank over 90% of depositor  funds exceeded the FDIC’s $250,000 insured limit.

Earlier in the  week, SVB announced its intent to raise additional capital after reporting  sales of long-term treasury securities at a loss of several billion dollars.   The bank had a significant duration mismatch between its customer deposits and long term treasury investments when the Fed began its monetary tightening in March 2022 .

The bank is reported to have lost over $40 billion in deposits sparked by social media posts  (a “twitter run”) advising the bank’s tech startups and venture fund customers to withdraw their deposits.

Signature Bank had a concentration of business with crypto clients and legal firms and was likewise vulnerable to large deposit outflows.

The banks’ failures will erase all shareholder and debt capital.  Depositors’ balances will be insured in full and available for immediate withdrawal.   The FDIC as conservator will attempt to find buyers for the books of business, so intends to keep operating their services. Any losses from the resolution of the banks will be paid by the FDIC through its assessments on the entire system.

More Than a Problem Bank Rescue

To prevent a system wide financial crisis-a contagion-from occurring in institutions with  similar balance sheets of underwater securities and high amounts of uninsured deposits, the regulators announced a special lending program for all banks.

Loan terms will be up to one year, not the normal 90 days.  The amount borrowed can be the par, not market value, of pledged securities (no haircuts).

This will give banks time to work through their duration mismatches by raising more capital or portfolio rebalancing.  The cost of borrowings will be high.   Earnings may be adversely affected if  loans become a large source of funds.

The quick action by the Fed, FDIC and Treasury is intended to prevent a  loss of market confidence leading to  panicky withdrawals from regional banks which have comparable balance sheet situations.

What does This Mean For Credit Unions?

Before this weekend, liquidity was growing tighter for all credit unions. Share growth was negative in the second half of 2022.

The early results from 2023 show continued  deposit challenges.  Consumers are once again learning about the returns and liquidity in money market funds.

As reported in 2022 yearend numbers,  1,193 credit unions had borrowed a total of $99.6 billion, or 4.6% of total system assets.  Within these totals, 797 credit unions reported $92.3 billion from the FHLB system, up 318% from the year earlier.

In contrast  436 credit unions reported loans of  $2.3 billion from the corporates. Several corporate CEO’s reported that their overnight short term settlement loans had risen from only a couple of dozen a year ago this time, to over 250 per day in the recent months.

In Callahan’s Trend Watch call for Q4 2022, a whole new section of charts portrayed the  system’s changing liquidity picture:  the drawdown of investments and increased levels of external funds.  The presentation  reported that  borrowing credit unions’ loan to share ratio was 82%.  For  those without borrowings, the ratio was 58%.

The Risks for Credit Unions

Credit unions are part of the country’s financial system.  If consumers or the public begin to doubt the system’s reliability, these concerns will also affect credit union members.  This is the fear of a financial “contagion” which the Fed’s borrowing plan is meant to forestall.

For example, I was sent an email from San Mateo Credit Union to its members on Friday afternoon after the SVB failure.  It read in part:

Dear member name,

Amid today’s news of the closure of Silicon Valley Bank, I want to take this opportunity to assure you that San Mateo Credit Union (SMCU) remains safe, sound, highly liquid, and in excellent financial condition.

Our financials as well as our investments are structured very differently from Silicon Valley Bank. As one of the top performing community financial institutions in the state, SMCU has a very solid liquidity position. . .

CU Challenges and Advantages

Some of the same balance sheet factors causing these bank failure are present to a limited degree in several credit unions.   These factors include underwater securities,  duration mismatches with longer term loans, and a potential for an ROA earnings squeeze competing for funds.

The advantage credit unions have versus these failed banks is there are minimal amounts of uninsured deposits versus the  90%+ they held.  The vast majority of credit union core deposits are “sticky,” unlikely to run off at a twitter post.

Like banks, credit unions have yet to see a major uptick in problem loan credits.   The two weekend failures were not from credit defaults.

Rather investments and loans were made in a low cost of funds environment that now look less sound.  The resolution  of these situations will depend on how the broader economy trends.

Learning from the FDIC, Fed and Treasury

A major gap in the credit union system  is the coordination and use of NCUA resources supplied by credit unions.  The federal or state banking regulators worked in common purpose to respond to specific incidents and create a systemic plan to manage potential ongoing concerns.

Even though the cooperative regulatory tools are managed by a single NCUA board, they have not been positioned for a similar response.

The first line of liquidity mobilization for credit unions is the corporate system.  However its lending ability options are severely  limited by regulations imposing balance sheet duration caps and funding options from 2010.   Less than 2% of borrowings at December 2022 were from corporates.

The second most important source of funding is the FHLB system, eleven  cooperative institutions that are directed and owned by their members.   There has been no comparable credit union operational partnership or planning with the Central Liquidity Facility.   The CLF has not had a loan outstanding since 2009.

NCUA board members have called out Congress for failing to extend the CLF’s COVID era borrowing and membership flexibility.   But it is unclear how those reinstatements would make the CLF any more relevant than it has been in the past.

The CLF is supposed to be a public/private partnership, but the reality is one sided.   NCUA seeks more credit union members’ shares, but wants to retain all say in how the facility is used and any programs developed.

Finally the NCUSIF has fallen prey to the same duration misjudgments as the failed banks.

As of January 2023 only 7.7% (or $1.7 billion) of the $21.8 billion fund was in cash.  The fund’s average weighted maturity was over 3.2 years.  Its market, or immediate liquidity value, was below par by over $1.1 billion.

The credit union system was built on multiple forms of self-help and self-financing-not private capital or government funding.   Capital from retained earnings acts as a financial “governor” on ambitious growth plans.   The NCUSIF and CLF (when operational) were jointly designed  and cooperatively funded.  The system did not rely on taxpayer resources or bailouts as credit unions are exempt from federal taxation.

In addition to the cooperative  FHLB model and this past weekend’s federal regulatory coordination, there is another lesson for credit unions.

The FDIC and Fed stepped in with funding  to save these institutions’ operational capabilities so that  customer payrolls and transactions could continue as normal.   Ultimately the regulators are seeking a buyer for the firms’ business customers.  And  as noted by  one commentator, to make a profit on the situation.

This approach minimizes any loss to the FDIC while continuing service to customers  some of whom have relied on these institutions for decades.

The Overriding Unsettled Issue

The prospect of a “financial  contagion” may have been stopped.  Time will tell.  The overriding issue is what will the Fed continue to do now with rates—keep raising? pause?   How will the greater caution these events imply for the financial community affect the economy?   How will the possibilities of a slow down, continued growth, or possible recession emerge?

While institutional stability may have been achieved, the longer term economic and rate outlook is still uncertain.

History may be useful in this pivotal moment. The previous largest bank failure ever–Penn Square in 1982–was just a prelude to a much wider bank and S&L culling during deregulation.   And the 2008 Lehman Brothers and Bear Stern failures led to a period of extended “market dislocations” in terms of securities valuations and market transactions.

In one case the system responded with no failures even though over 80 credit unions and banks had uninsured deposits in Penn Square.   The CLF stepped up with loans, the insurance fund was redesigned, and NCUA examiners assisted in workouts.

In the 2008 crisis, NCUA went forward without credit union input, just insurance assessments.  Two years after the 2008 financial failures, it created a credit union specific crisis in September 2010 by liquidating five corporates.  That resolution continues on 13 years later. Surplus payouts are approaching $5 billion as opposed to loss projections of $13.5 to $16 billion for the system when the liquidations commenced.

In one case the agency worked with credit unions for solutions.  In the latter one, it did not.  Should there be credit union difficulties this year, that difference in approach will be critical to retaining member, credit union and public confidence in a separate cooperative financial system.

 

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The Art of Prudence

One writer’s key lesson from Sophocles’ “Antigone” is that fanaticism results when public actors fail to practice the one virtue capable of moderating the  excesses of human nature:  political prudence.

What is one of the most frequent excess? the Temptations of Power

The  American  Franciscan priest and writer on spirituality,  Richard Rohr, has described this all too human aspect  from his religious perspective.   I paraphrase his cautions.

One fatal snare is to misuse power. “Maybe we could say it’s a temptation to be spectacular, to be special, to be important, to be showy. The tempter says, “Tell these stones to become bread” (Matthew 4:3). When we’re young, we all want that. We all want to stand out. We want people to notice us. We want to be something special and to do something special.” 

Another excess is the temptations of power whether politically earned or from one’s professional position. “It’s not inherently wrong. There has to be a way we can use power for good. But until we’re tested, and until we don’t need it too much, we will almost always misuse it. If we’re not tested in the ways of power, very often we end up worshiping power to have power.”

When Prudence is Lacking

It is easy to confuse disagreement with a person in authority versus someone who  is  misusing or even failing in their position and accountability.

I would call out three  frequent symptoms of lapses in leadership:

  1. The explanation for an unfinished /failed effort that it was another person or organization that is responsible for what did or didn’t happen.
  2. The defense of a failed outcome asserting the cause was a lack of resources or authority.
  3. The resort to cliches to explain one’s actions such as: “better service for members”, “promoting  safety and soundness”  or  “the banks have this option and so should we.”

Positions of power are generally temporary.   The tenure can be especially problematic  if the responsibly of the role is not fully grasped.  Especially in situations in which a leader does not acknowledge agency-that is personal responsibility or accountability:  “staff, our consultant, our experts recommended this action; this is how others do it or, the classic, this is how we have always done it.”

Prudence is also a personal quality.  In successful leaders  it can be marked  by  both empathy and humbleness.

I  believe there are daily examples  from  peers or colleagues from which one can learn.  Especially when sharing initiatives, experiences and challenges of mutual interest.

My  former partner Bucky Sebastian would sometimes comment on  the views or actions of  persons in authority whom he believed in error:  “Everyone has a purpose in life, even if it is to serve as a bad example.”

Credit union leaders -CEO’s, boards, regulators, trades and even vendors-are public actors.  Prudence is cultivated  in public arenas  by the respectful exchange of arguments among those attuned to both their personal and their community responsibilities.

Identify  those leaders to make common cause.

Learn from those who fit Bucky’s description.

 

 

 

 

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Spring & Annual Meetings-A Time for Renewal

Have you been born again?  As a PK (preacher’s kid) I would occasionally get that question.  If affirmative, the follow up query, is when did it happen?

This view of spiritual life requires an awakening experience.  Preferably with a specific time and place.   A new starting point; a before and after  event.

Renewal, Not Replanting

My understanding is that awareness of the sacred in life is an every day possibility.  A parallel example for this reawakening is spring.

Plants are coming to life almost a month early this year.  Each flower has its own timetable with daffodils and crocus first- followed by tulips, camellias, alliums and many varieties of lilies and iris.

This reemergent beauty occurs in a sequence depending on the sun, how much rain falls, and of course the temperature.   All the conditions in February were favorable for an early spring flower show. The impact of nature’s role on timing will vary; but the  flowers  seem to adapt naturally to whatever conditions occur.

Importance of New Beginnings

Both organizations and plants operate on cycles.  In credit unions it is usually the annual plan with the yearend results showing the “flowering” of an organization’s purpose.  These outcomes could be  making money, growing a key metric, expanding service or products, or in rare instances, just coming through a difficult economic or leadership transition intact.

Following the annual report is a new forecast, a renewal or a focused extension, not starting from scratch all over.  Similarly one can add plants to a garden but most will come back naturally.

In credit unions, the  required Annual Meeting can both celebrate past results and promote new directions.  It is an opportunity  to gain members’ support,  both  in board elections and with thoughtful presentations about the credit union’s direction.

For cooperatives, the annual meeting should be a special occasion to report and honor the  owners.

Woodstock of Capitalism

Berkshire’s annual gathering in Omaha is an example of an Annual Meeting event in the private sector. The press calls the event attended by tens of thousand Berkshire stockholders, the “Woodstock of Capitalism.”

As a prelude, the firm releases its Annual Report.  The most talked about aspect is not the company’s yearend financials, but CEO  Warren Buffet’s introductory letter about the firm’s direction  and his bits of elderly  wisdom.

The Report for 2022 was released last week.  It contains discussions that credit unions might consider emulating.  The following excerpts reflect company  updates and principles Buffet follows. (I added some emphasis)

The opening:  Charlie Munger, my long-time partner, and I have the job of managing the savings of a great number of individuals. We are grateful for their enduring trust, a relationship that often spans much of their adult lifetime. It is those dedicated savers that are forefront in my mind as I write this letter. . .

The disposition of money unmasks humans. Charlie and I watch with pleasure the vast flow of Berkshire-generated funds to public needs and, alongside, the infrequency with which our shareholders opt for look-at-me assets and dynasty-building.

What We Do

Charlie and I allocate your savings at Berkshire between two related forms of ownership. . .

When large enterprises are being managed, both trust and rules are essential. Berkshire emphasizes the former to an unusual – some would say extreme – degree. Disappointments are inevitable. We are understanding about business mistakes; our tolerance for personal misconduct is zero. . .

Over the years, I have made many mistakes. . . Along the way, other businesses in which I have invested have died, their products unwanted by the public. Capitalism has two sides: The system creates an ever-growing pile of losers while concurrently delivering a gusher of improved goods and services. Schumpeter called this phenomenon “creative destruction.”

Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years – and a sometimes-forgotten advantage that favors long-term investors such as Berkshire. . .

The lesson for investors: The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders.

The Past Year in Brief

Berkshire had a good year in 2022. The company’s operating earnings – our term for income calculated using Generally Accepted Accounting Principles (“GAAP”), exclusive of capital gains or losses from equity holdings – set a record at $30.8 billion. Charlie and I focus on this operational figure and urge you to do so as well. The GAAP figure, absent our adjustment, fluctuates wildly and capriciously at every reporting date. . . The GAAP earnings are 100% misleading when viewed quarterly or even annually.

On Repurchases of Berkshire Shares

Every small bit helps if repurchases are made at value-accretive prices. Just as surely, when a company overpays for repurchases, the continuing shareholders lose. At such times, gains flow only to the selling shareholders and to the friendly, but expensive, investment banker who recommended the foolish purchases.

Almost endless details of Berkshire’s 2022 operations are laid out on pages K-33 – K-66. . . . These pages are not, however, required reading. There are many Berkshire centimillionaires and, yes, billionaires who have never studied our financial figures. They simply know that Charlie and I – along with our families and close friends – continue to have very significant investments in Berkshire, and they trust us to treat their money as we do our own. And that is a promise we can make.

Finally, an important warning: Even the operating earnings figure that we favor can easily be manipulated by managers who wish to do so. Such tampering is often thought of as sophisticated by CEOs, directors and their advisors.

That activity is disgusting. It requires no talent to manipulate numbers: Only a deep desire to deceive is required. “Bold imaginative accounting,” as a CEO once described his deception to me, has become one of the shames of capitalism.

The Last  50  Years

Thus began our journey to 2023, a bumpy road . . . America would have done fine without Berkshire. The reverse is not true. . .

We will also avoid behavior that could result in any uncomfortable cash needs at inconvenient times, including financial panics and unprecedented insurance losses. Our CEO will always be the Chief Risk Officer – a task it is irresponsible to delegate.

Some Surprising Facts About Federal Taxes

During the decade ending in 2021, the United States Treasury received about $32.3 trillion in taxes while it spent $43.9 trillion. Though economists, politicians and many of the public have opinions about the consequences of that huge imbalance, Charlie and I plead ignorance and firmly believe that near-term economic and market forecasts are worse than useless.

Our job is to manage Berkshire’s operations and finances in a manner that will achieve an acceptable result over time and that will preserve the company’s unmatched staying power when financial panics or severe worldwide recessions occur.

I have been investing for 80 years – more than one-third of our country’s lifetime. Despite our citizens’ penchant – almost enthusiasm – for self-criticism and self-doubt, I have yet to see a time when it made sense to make a long-term bet against America.

Buffett’s Rule 

I will add to Charlie’s list a rule of my own: Find a very smart high-grade partner – preferably slightly older than you – and then listen very carefully to what he says.

A Family Gathering in Omaha 

Charlie and I are shameless. Last year, at our first shareholder get-together in three years, we greeted you with our usual commercial hustle. . .

Charlie, I, and the entire Berkshire bunch look forward to seeing you in Omaha on May 5-6. We will have a good time and so will you.

An Example for Credit Unions?

Buffet’s approach to his owners has multiple insights as credit unions prepare for their Annual Meeting.  Can it be a time for renewal?

His comments are honest, open and written to inform owners and reassure their trust.

His leadership principles are clear.  His business priorities are stated with conviction and promise.

His benchmark performance standard is the Report’s first page.  It shows Berkshire’s stock return vs the S&P 500 for every year since 1965. For 2022, Berkshire gained 4.0% and the S&P had an 18.1% decline.

Member-owners will reciprocate management’s respect with loyalty. Virtually every credit union today, like Berkshire, has positive stories to tell members, both financially and enabling self-help. The message is not a marketing campaign or commercial.  Rather the meeting is an opportunity to reaffirm who the credit is and renew the principles guiding leaders-as demonstrated in their own words.

This required process should be a moment of fresh hope, like spring flowers.  It should be a time to present the best of what the credit union does; and to reaffirm the ongoing opportunities to serve one’s community.

Also imitate Buffet.  Make it a fun, family gathering.

 

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What Can Be Done about the Drought of New Credit Union Charters?

There are financial deserts in towns and cities across America; there is also an absence of new credit union charters.

Since December of 2016, the number of federally insured credit unions has fallen from 5,785 to 4.780, at yearend 2022.  This is a decline of over 165 charters per year.  In this same six years, 14 new charters were granted.

Expanding FOM’s to “underserved areas” or opening an out of area credit union branch, is not the same solution as a locally inspired and managed charter.

Obtaining a new charter has never been more difficult for interested groups. Through its insurance approval, NCUA has final say on all new applications whether for a federal or state charter.

Today, credit union startups are as rare as __________ (you fill in the blank).

At this week’s GAC convention an NCUA board member announced the agency’s latest new chartering enhancement: the provisional charter phase.  This approach does not address the fundamental charter barriers.

Could an example from the movement’s history suggest a solution?

The Chartering Record of the First Federal Regulator

Looking at the record of Claude Orchard  demonstrates what is possible for an individual government leader.   He was the first federal administrator/regulator managing a new bureau within the Farm Credit Administration to create a federal credit union system.  He was recruited for this startup role by Roy Bergengren, who along with Edward Filene, founded the credit union movement.

The story of how and why he was chosen is told here.   Bergengren nominated Orchard because he had “the proper credit union spirit.” This had been demonstrated by his efforts to charter over 70 de novo state credit unions for his employer Amour.

Orchard accepted this government role in the middle of the depression using borrowed FCA staff.  The state chartered system was the only model of how to create a federal option.  That experience and belief in the mission is what  Orchard brought to this new role.

Unlike the banking and S&L industry there was no insurance fund for credit union shares/savings.   The coop model was based on self-help, self-financing and self-governance.  Self-starters provided the human and social (trust) capital; no minimum financial capital was needed.  Credit unions tapped into the quintessential American entrepreneurial spirit to help others.

Orchard’s critical tenure as the first federal regulator is described  in a special NCUA 50th Anniversary Report published in 1984:

“He emphasized organizing as much as supervision. ‘I think in general we tried in the beginning to avoid paperwork because it seemed to me like that was a waster of effort.  After all what we were out for was to get some charters and get some organizational work done.’

When Mr. Orchard stepped down in in 1953, federal credit unions numbered over 6,500.   During his 19 year he espoused a passionate belief in the ideals of creditunionism.  ‘It seems to me that we have here a tool. If it can be made to really be responsive and to really be, in the end, under the control of the members, it can teach people in this country something about democracy which could be taught in no other way.‘

Deane Gannon, his successor at the Bureau of Federal Credit Unions said to Mr. Orchard on the 30th anniversary of the Federal Credit Union Act, ‘If it hadn’t been for you none of us would be here to celebrate anything.‘”

That last observation echoes today.   How many charters will be left to celebrate the 100th anniversary of the FCU Act in 2034?

Alternatives  Are  Springing Up

For the credit union movement to remain relevant it will require modern day Claude Orchards. These are leaders who believe in creditunionism.  And possess the passion to encourage new entrants to join the movement.

Regulatory process or policy improvements may help.  But the real shortfall is leadership committed to expanding credit union options.

To address the continuing financial inequities throughout American communities, alternative solutions are being created.  Many of these startups are outside the purview of banking regulators.

These community focused lenders are listed in  Inclusiv’s 2022 CDFI Program Aware Book.  The firm introduces its role with these words:

Access to affordable financial products and services is a staple of economically sound communities. Yet at least one quarter of American households do not have bank accounts or rely on costly payday lenders and check-cashing outlets.

In recent years, the lack of access to capital investments for small businesses and other critical community development projects has also led to increased need for alternative and reliable sources of financing.

Mission-driven organizations called Community Development Financial Institutions–or CDFIs–fill these gaps by offering affordable financial products and services that meet the unique needs of economically underserved communities.

Through awards and trainings, the Community Development Financial Institutions Program (CDFI Program) invests in and builds the capacity of CDFIs, empowering them to grow, achieve organizational sustainability, and contribute to the revitalization of their communities.

Of the total $199.4 million awarded to 435 organizations, only 176 or 40% were to credit unions.  The rest of the field included 213 local loan funds, 43  banks and 3 venture capital firms.

Without credit union charters, alternative organizations will be created to serve individuals and their communities.   These lenders may not put credit unions out of business, but will  attract the entrepreneurs that would have  added critical momentum to the cooperative system.

Credit unions can qualify for CDFI status and grants.   But Inclusiv has a much broader vision for implementing Claude Orchard’s  playbook.

In their listing of 2022 total awards and grants, every amount of over $1.0 million went to an organization that was not a credit union.  A few were banks, but most were de novo local community lenders or venture capital firms.

Without credit union options, civic motivated entrepreneurs will seek other solutions, and slowly replace credit union’s role.

Today it is Inclusiv carrying out Orchard’s vision.

Should NCUA delegate its chartering function to those who have “the proper spirit” to secure credit unions’ future?

It will also result in “teaching people in this country something about democracy which could be taught in no other way.”

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  Whose Voices Should Shape SECU’s Future (Part III)

The author of a lengthy Business Journal article on SECU’s competing future visions wrote a brief follow up to his original story that began:

The North Carolina State Employees’ Credit Union is such an integral part of our state that it’s often taken for granted.

There’s nothing like it across the nation, I learned, while studying the $53 billion dollar enterprise for a story in the February Business North Carolina. In the ninth-most populous state, SECU dwarfs peers nationally other than the national Navy Federal Credit Union. . .SECU is a maverick.

When viewed in a broader context, this local controversy is more than competing approaches to a business model.

In many large credit unions today there is a growing distance between member priorities and institutional ambitions.  A number of credit union leaders aspire to an ever-expanding role in the financial services marketplace.  Organic growth is insufficient, too slow.  Executive strategies such as whole bank purchase and aggressive courting of merger partners everywhere are embraced, two initiatives often enabled by external sources of capital.

Members become merely the means to further institutional prominence.   The rhetoric continues about serving members, but often these expansion efforts  offer little or no member benefit.

There is a parallel example in current religious practice.  Some well-known and successful preachers promote faith with a vision of what is called the “prosperity gospel.”  It is little more than capitalism in ecclesiastical garments.   The equivalent happening in credit unions is full out banking strategies dressed in cooperative clothing.

There is a spreading “cooperative anemia” circulating in the credit union system.  Its basic symptom is the separation of institutional priorities from members well-being.

A Model that Transcends

The SECU which Jim Hayes joined as a leader in 2021 had been able to transcend these constant temptations to alter cooperative design into a proto-banking model.   Instead it became increasingly viewed as a “maverick” by credit unions.

The persons who invested most of their professional lives building this contrarian approach developed a certain stubbornness.  They both authored the effort and produced unprecedented results.  They continue to have a sense of stewardship, even as they become “just a member. “ As one writer has observed  “some of the best founders are difficult people.”

When institutional leadership is transferred to managers in today’s selfie world, there is an understandable perception that “me” is being put in front of membership.

A Path Forward: Investing in Members’ Ownership Responsibilities

Leadership of any institution is first and foremost a political task, not a business model problem. The concerns about changes in business direction, labelled “rumbles” by SECU staffer, have now morphed into public and opposing camps.

One side is represented by a person who self describes as “often wrong, but never in doubt.”  The other camp has retreated to their bunkers of incumbency, and adopted a tactic I call “brute legalism.”  This means “we’re in charge (with member approval), so we don’t have to accommodate contrary points of view.”

The coop process for resolving this debate is supposed to be democratic. An autocratic rejection of member concerns, may lead to increasing displays of public opposition.  It certainly makes CEO Jim Hayes’ leadership much harder.

If the separation of credit unions and member priorities is the core of the problem, then embracing the owners’ democratic engagement may be the solution.

Cooperative democracy is more than electing directors at the annual meeting.  Often this voting function has been reduced to an administrative formality as nominations by the incumbents just match the number of open seats.

Democracy depends on choice.  Real choice is more than putting more names on the ballot.  It requires continuous transparency, open communication, and ongoing dialogue with every internal and external level of the organization. This habit is more than press releases or marketing messages.

Cooperative democratic design is more than good governance, that is accountability to the owners. It is how trust and confidence in the leaders’ decisions are created.

The motions at the 85th Annual meeting were unusual but a proper exercise of member-owner rights. It has opened up conversations about decisions that have major member impact but little visibility.

Blaine’s motions were an act of courage and member duty.  He took the step of “walking to the front of the line” to find out who might be with him.  There is no more democratic act than members speaking out.

A Democratic Ampersand

Cooperative design is at its strongest when an ampersand is added to the member & owner role.  Otherwise the owners end up as being viewed as just customers.  Keep them satisfied, find more like them, and allow the “elected” leaders to shape the credit union’s future.

Many credit union managers believe they choose their members, especially encouraged by the regulatory concept of the common bond.  Nothing could be further from the truth.  It is the members who choose to join, support, or leave the coop.

In the American economy, it is called “consumer sovereignty.”

Member loyalty cannot be acquired in a merger or bank purchase.  That just cheapens any relationship.  Rather it is hard earned over generations.  When well done, the result creates the most important business and political advantage a movement could want.

A Public Purpose

Coop democracy is more than a process for accountability and acknowledging the owners’ roles.   It is core to credit union’s purpose.   That purpose is extending economic opportunity for all Americans, especially those at the mercy of for-profit providers.

Economic equality is vital to the continuation of the capitalist system. It is critical that all striving for financial security ( especially those living paycheck to paycheck) can have an institutional option that is fair and just, not discriminatory, in their transactions.

SECU’s board and leadership are in a unique moment for affirming the credit union’s continued commitment to furthering America’s promise of economic justice. This credit union will be fair to all who join SECU as members-owners.

Achieving that outcome will require more conversations and crafting additional business  options.  Without this effort member uncertainty and market forces will slowly erode the credit union’s position in its key markets and nationally.

A lesson from events to date is that sometimes it takes heading in the wrong direction in order to find the right one. Now is the time for SECU to make real the promises of coop democracy–in multiple ways.

No one has a monopoly on insight.  Being a maverick is tougher than jumping into the financial mainstream. Old and new members sitting down together offers a better chance of SECU sustaining its transcendent credit union performance.

As Robert Frost might counsel in the final verse of The Road Not Taken:

I shall be telling this with a sigh

Somewhere ages and ages hence:

Two roads diverged in a wood, and I—

I took the one less traveled by,

And that has made all the difference

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Differing Outlooks for SECU’s Future (Part II)

At the October 11, 2022 members’ Annual Meeting, SECU CEO Jim Hayes had been in his role since  August 2021. He arrived with 25 years of  senior credit union  and NCUA leadership experience.  He succeeded Mike Lord who in turn took over from  Jim Blaine in 2016.

All the persons involved were obviously  aware of Hayes’ “outsider” status. The hiring decision must have reflected a desire for a fresh look, and/or strategic change.

Here’s how SECU’s chief culture officer, Emma Hayes, explained the board’s choice in a talk to the AACUC conference in September 2022 in a CUToday report:

“We hired someone not only from outside the organization—there had never been for 85 years an external hire for CEO—but also someone who came from the wrong coast (the former Wescorp in San Dimas, Calif.) by way of somewhere up north (Andrews FCU in Maryland) to come down to North Carolina to lead the second-largest credit union,” explained Hayes, drawing laughs from the audience.  “The strategy for SECU for 85 years had been to grow talent from within. They had done that and done it well. Now they decided to open the organization and take a peek and see if there is someone out there.

‘Never Been Heard of Before’

“SECU runs like a well-oiled machine,” she continued. “But (Hayes) had new ideas for how to do things. One of the first things he did was send an email to all staff. In 85 years, no one who sat in that seat ever sent an all-staff email. In that email he says, ‘Let’s get rid of our ties.’ Imagine the shock and awe! Nobody believed this was real, like someone had hacked into his email address. We don’t take off our ties. We sleep in them. We go to the gym in them. It was unheard of! But Jim was like, ‘Let’s do something a little different.’ He then said, ‘I’d love to hear from you. Send me an email.’ People stared emailing him and he responded back. With his own hands he typed out messages! This also had never been heard of before!”

Shaking Things Up

The result, said Hayes, was word began to spread in the state of North Carolina where SECU is a highly visible and well-known brand that the new CEO was “shaking things up.”. . She said the changes created a “little rumble” within the organization and community.”

Those little rumbles culminated in the two resolutions , described yesterday, that members approved in the October 2022 Annual meeting

The 20 Credit Union Paladins (not a video game)

As of December 2022, twenty credit unions reported assets over $10 billion.  This threshold  subjects them to the scrutiny of the CFPB, reduces their debit card interchange, and includes special oversight by NCUA.

These twenty manage 23% of the industry’s assets, 24% of its loans and serve 23% of credit unions’ total reported 137 million members.  But they are just .4%  of all 4,495 credit union charters.

Their roles in the movement make them objects of emulation.  They are also, at times, examples of unveiled ambition.  Overseeing billions can sometimes lead to feelings of “cooperative triumphalism” and unlimited  growth aspirations.

Their business models vary widely.  Several have bought banks, sometimes more than one. Others have programs to acquired other credit unions across the country. Some have defined FOM’s; others say anyone can join.

Operating expense ratios vary widely:  Star One reported a 1.11% and Alaska USA 3.67% for 2022.  SECU’s was 2.16%.

SECU’s Rare Accomplishment

There are as many models in this group. However another factor distinguishes SECU’s performance.

There are state employee field of membership credit unions in almost every state.  These  charters share the same member economic profile of stable employment and a range of member demographics.  The motivations of state and local employees closely align with the not-for-profit service culture of credit unions.

But only SECU, the second largest credit union, achieved the market dominance serving this common employment group.

How Did SECU Become So Consequential?

SECU combined a unique strategy and culture which for some observers claim  is grounded in the 20th century.  It developed over decades.  The elements were highly  integrated and carefully chosen. Among the factors were these:

  • A limited North Carolina operational FOM with a branch in every county, and a statewide ATM network.
  • Branches were assigned local responsibility and accountability: for example, loan originations and collection, advisory boards for visibility in the community, local employment and personal service including routing member calls to their local branch;
  • A product and service profile that serves each member equally: same loan rate for all members (no tiered savings, no risk based pricing or indirect auto loans);
  • Staff receives only salaries, with no commissions or incentives for performance. Promote as much as possible from within.
  • Be low cost with a simple financial model: 3% net interest margin, 2% operating expense ratio and 1% ROA.  Minimize member fees.  No paid advertising.  Rely on word of mouth and the earned publicity from SECU’s Foundation grants.
  • Mortgage loans are the primary means for members to build financial security. 80% of SECU loans are first mortgages or real estate secured.
  • Provide a complete menu of low cost financial services beyond traditional consumer banking products. These include life insurance, a broker dealer for access to no load mutual funds at Vanguard, a 529 program open to all state residents, tax preparation,  trust services and even a CUSO for housing rehabilitation.
  • Avoid mergers; instead provide help to smaller or struggling credit unions.

The result was a no frills, plain vanilla product selection (no rewards cards) and long term member loyalty.  The focus was intentional—serve those demographic segments that have limited  financial choices. More simply, those that know the least or have the least.   Well to do members might find better loan or savings terms elsewhere.

By design SECU avoided imitating other financial providers.  Its purpose was to create a unique cooperative alternative for middle and low income Americans.  They wanted to avoid a strategy of becoming the competition to beat the competition.

The Issues Raised in the Annual Meeting

The six topics or business questions presented as the basis for the resolutions.

  1. SECU’s efforts to achieve an open field of membership.
  2. Merger discussions with Local Government Employees FCU, that would end a 40 year business partnership.
  3. Introducing risk-based lending for loans.
  4. Expanding business/ commercial lending.
  5. Elimination of the $75 per member tax preparation service.
  6. Regional expansion beyond North Carolina.

The full description of each topic is in the presentation. Blaine subsequently set up a web site blog which continues to expound on these points in almost daily posts.

Since the meeting, SECU has continued the ongoing implementation of the topics mentioned.

The tax preparation service has been discontinued.  Changes in loan administration are on going shifting responsibilities from branch to more centralized oversight. The volunteer, non-employee credit review committee is no more.

Recently Local Government FCU announced its decision to go on its own and dissolve their partnership with SECU.

The credit union continues its technology overhaul with a priority on digital services.

The issue dominating subsequent Blaine communications to the board is risk based lending. These multiple messages cite a number of studies showing the disparate impact of FICO score based loan pricing.

The credit union conducted a series of dialogues with staff and advisory board members.

 SECU’s December 2022 VisionPlan

Early in 2023 the credit union posted its  Strategic Plan, “Leading with Care” fulfilling the second resolution’s request.  It is 15 pages with four goal areas and key success factors.  The goals are generic, like many plans, and primarily descriptive.

It is well written.  Almost academic in structure. There is nothing controversial.  Many current public themes are included such as environmental awareness, DEIB, affordable housing and investing in staff.

If it had been available at the 2022 Annual Meeting, the presentations of the Chair and CEO would have been much enhanced.

The plan could be a prototype for almost any billion dollar credit union. There is no market analysis or history of prior trends.  No future financial projections were included.

The document has one statement referencing current events: Our commitment to embracing different perspectives creates the positive tension required to weigh business decisions and their potential outcomes.

It omits SECU’s traditional vision statement:  Send Us Your Moma.  And its former mission: Do the Right Thing.  It largely ignores  the policy issues raised in the Annual meeting such as a broader FOM and relationships with fellow credit unions.

The Plan presents settled decisions, such as  the ongoing implementation of RBL, without any explanation of how this benefits members.

An Earnestness of Views

How do these different judgments about business strategy get resolved– Blaine’s dominating logical critiques versus incumbents’ asserting the power of position.

Continued public debate will cause cleavages in the 7,800 employees, and among  advisory board volunteers,  directors, and ultimately members. The credit union’s financial and market momentum could falter.

The internal dynamics of SECU’s decisions are unknown. Had the board a plan ready and then tell Hayes to move quickly? Or did he understand his remit as move fast and address priorities as he assessed them?  Whatever the circumstances, did it consider the “wisdom of elders” as the plan was developed?

Or, is the fundamental difference in approach elsewhere? The new Plan states: “As a financial cooperative, we take to heart that prudent stewardship of our member’s money is of utmost priority.”   Is that all a financial cooperative is about?

Can a solution or process accommodate both points of view?   That’s the subject of tomorrow’s post.

 

 

 

 

 

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Democratic Disruption at SECU’s 85th Annual Meeting

SECU’s October 11, 2022 annual meeting was a rare example of democratic cooperative governance.

Following the traditional annual meeting agenda, approval of minutes, the Chair’s report, election of directors, audit summary and President/CEO Jim Hayes’ update,  the Chair asked if there was any new business.

There was.

A member-owner presentation proposed two resolutions for the members to discuss and vote upon.

The first asked the Board to consult with staff and advisory board members to learn how six  changes he described would benefit the member-owners.  The dialogues should  be published for all members.

The second requested the board provide members SECU’s Strategic Plan at least 90 days prior to the 2023 Annual Meeting.

The chair asked  for comments.  One volunteer advisory board member said he had heard nothing about the topics raised.   A second member commented that he didn’t want the credit union “to become a Piedmont Airline.”  (merged out of business).  A current director spoke up supporting the second motion.

Both resolutions were approved by the approximately 1,000 members, with virtually no opposition.

The meeting was broadcast live on YouTube.  Here are the timing of key events: 29:50 Chair report; 54: Foundation update; 1:05 CEO Hayes report; 1:21 Call for new business with two resolutions at 1:48 with open discussion and member vote.

Should Credit Unions Care about SECU’s Debate of its future?

SECU at $51 billion is America’s second largest credit union. Its membership covers an estimated 25% of North Carolina’s population.

This event was covered in  a lengthy NC Business article and  in the North Carolina’s Banking Association’s weekly update.

SECU’s success and size extends far beyond its members or its home state.  It’s a model others study. It has an outsized influence in both state and national credit union organizations.

SECU’s leaders’ duties are more than managing a business.  The credit union has a position of influence and power beyond its balance sheet.  Its actions will be viewed by outsiders, the public and competitors, as an example of what a credit union is capable of becoming.

SECU’s reputation and widespread operating network means its choices are followed  by many in the cooperative movement as an example of credit union competence.

Blaming the Messenger

As events unfold, many observers will have opinions. Some, I believe,  will reflect  a capacity for missing the point. It will be framed as a conflict between a current and a former CEO as in the following LinkedIn comment:

As I read this article, I was saddened that a CEO who has retired and handed off the reins goes public when the new leadership makes strategic moves, and the retired CEO disagrees. This willingness to fight the new leadership’s right to make strategic decisions is wrong on too many levels.

This happened recently at SECU when Jim Blaine disrupted the annual meeting with a lengthy letter he read in totality because he was against the strategic direction the new leadership was taking the credit union. CEOs need to realize that when they step away, it is now someone else’s turn to lead forward. #ceo #leadership #retired

This is a position with which many CEO’s would sympathize. It absolves commenters from examining the issues raised.   But I believe this position is far too shallow.  Here’s why.

Very few member-owners would be capable of preparing the in-depth analysis of this presentation. But this was not a solo effort. In his opening Blaine comments there had been widespread concern from both employees and members about SECU’s apparent changes of direction and culture.

When individuals working in or interacting with an organization believe it to be going “off course” counsel will be sought from former leaders.   In the corporate world  this approach is shown by examples such as Disney, Starbucks and Apple where there were call outs to prior leaders.

When credit union members and employees are deeply concerned about  an event such as the mergers of Cornerstone FCU in Carlisle PA or Vermont State Employees, they reach out to former leaders. What do you think?  Will you help?

Former leaders are not one-person shows.  They understand the politics of leadership.  Any public role is carefully considered.

They become the messenger and therefore the face for larger issues.  Their previous roles give credibility to the concerns whereas an individual employee, member, director, vendor or credit union collaborator would not have the standing to raise.

Raising questions about  a strategic pivot in a “courteous and respectful manner” at the owners’ annual meeting is a vital process for cooperative governance.

An Example of Coop Democracy

This required annual meeting is a critical process for democratic cooperative governance.  It is the opportunity for the board (chair) and CEO to inform members where the credit union is heading, the reasons for change, and how it will affect them.

After outlining six new policy or business initiatives, Blaine closed with two summary questions: Who are we? Where are you leading us? 

Those are questions every CEO and board should be willing to answer for their member-owners.

Tomorrow I will summarize the issues raised, the credit union’s responses, and how SECU aligns with the nineteen other credit unions over $10 billion in assets.

 

 

 

 

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A Return of $250 for Each $1 Invested

I recently received the best return ever on an investment: $250 in value for each $1 sent.

Late last year I read about a 501 C3 nonprofit (RPI Medical Debt) that bought unpayable medical debt using  donations and then retiring all the acquired debt for consumers.  Several news articles gave details about churches and local governments using this method to help members of their communities.

A December 20, 2022 New York Times’ article Erasing Medical Debt described how the program had extended to major cities such as Chicago and Pittsburgh.  The story stated that 18% of Americans have medical debt turned over to a collection agency.

I decided to test the RPI Medical Debt’s concept.   Was the payoff “leverage” as great as claimed? The 100 to 1 debt abolishment standard sounded too good to be true.

I also wanted to learn how targeted the program could be as a potential initiative for credit unions. Credit unions are significant originators of consumer debt.  They know how past due delinquencies on a credit report can undermine anyone’s financial options.

Contacting RPI Medical Debt, I asked to purchase and cancel all debt from Jasper County IN, whose county seat is Rensselaer.   Our family lived there for over five years while I was in high school.  The town is primarily a farming community, neither wealthy nor poor, but one where the population today is the same as when we were there 60 years earlier.

The Debt Fulfillment Report

Based on my pledge commitment, RPI retired all the available outstanding delinquent medical debt for 423 residents of Jasper Country totaling $264,878.  They had no more access to debt available in the country right then, although more debt certainly exists.

However, with the funds remaining the non-;profit acquired debt from at least one resident in every Indiana county.   The total consumers helped were 2,291 with over $2.532 millions of their debt erased.

RPI had acquired the debt for less than a penny on the dollar.  The total accounts closed (not individuals served) was 4,396.  Of these 9.3% (409) were bought directly from hospitals.  The balance was from the secondary debt market.

Much of the debt (86%) was 5 to 10 years old– specifically 1,812 accounts with balances of $1.9 million.  Only 1.8% of the debt was less than five years;  1.2% of the debt had originated over 20 or more years earlier.

The average debt extinguished had a face value of $846. For me, an overwhelming proof of concept!  A financial “loaves and fishes” story.

The Consumer ‘s Experience

Consumers cannot apply to RPI for relief.  Rather the non-profit seeks to buy debt in the open market on behalf of funders who donate or make pledges to support their goal of abolishing medical debt for individuals and families burdened by the payments.

To qualify a “soft credit report” is run to determine each individual’s eligibility for relief.  Potential  portfolios are  prescreened by holders to identify those who qualify for  abolishment of debt.    A person must earn less than four times the local poverty level  (nationally an amount of  $111,000 for a family of four) or have debt that exceeds 5% of annual income determined by pulling a soft credit report.

With these qualifications, the debt is excluded from income and not subject to IRS taxation.  The transaction is considered an act of charity by donors who support RIP’s mission.

Each consumer is sent a letter announcing the relief.  The total debt abolished, number of accounts and  creditor are identified.

The “good news” letter says there are no strings attached and  encloses a  page of FAQs  to answer  questions.   Recipients may, but are not required, to share their story about what this relief means to their circumstances.

The RIP Organization: People helping People

This nonprofit was founded in 2014 with a threefold mission:

  • Initiate a high volume of debt relief to reduce financial and mental stress for individuals;
  • Offer health care providers a way to strengthen their communities;
  • Highlight the problems of medical debt to seek a more affordable and transparent health care system.

Since inception the firm has provided $8.5 billion of debt relief helping 5,493,000 individuals and families.

The Credit Union Opportunity

The immediate possibility is straight forward: strengthen members of their primary communities by offering to retire consumers medical debt. When fulfillment data are known, celebrate the relief impact.  Invite  consumers to learn more about another people-helping-people organization, the credit union.

Such an effort is a “win” on many levels:  for the consumer, the credit union, the community and even medical providers with outstanding debt.

If interested  contact RIP Medical Debt and make a pledge for a test project.    I would be glad to share my contact and the reports and information I received.  My project was completed in under 45 days from initial contact  to finish.

Credit Unions Ringside

As vital consumer lenders credit unions are at ringside knowing the debt burdens members carry.

Three days ago a Washington Post article reported the story of a 72year old still struggling to pay off his $5,000 student debt from the 1970’s.  This is just one area where a similar approach for  relief may be prudent and desirable.  An example from the article reported:

Years of administrative failures and poorly designed programs have denied many borrowers an off-ramp from a perpetual cycle of debt.

There are nearly 47,000 people like Hamilton who have been in repayment on their federal student loans for at least 40 years, according to data obtained from the Education Department. . . About 82 percent of them are in default on their loans, meaning they haven’t made a voluntary payment in at least 270 days. . . 

The Supreme Court will shortly hear a challenge to the Biden administration’s efforts to forgive up to $20,000 per borrower in federal student loans. The Court many not allow the initiative to proceed.

Why not design a program similar to RIP Medical Debt and approach the Department of Education about purchasing the loans with the intent of  extinguishing them?

Credit unions would  be helping resolve the financial and mental stress of longstanding student debt for eligible borrowers (to be defined).   Even at a penny or two on the dollar, the government would be receiving more versus 100% forgiveness.

The program could be targeted where relief is most needed.   It could happen fast.  A  “scholarship-in-reverse” plan  where college debt continues to burden individual’s lives.

Can the cooperative movement demonstrate their collaborative entrepreneurial capacity and address a critical public need?

Two final data points from the Post article on student debt:

From the time student loan borrowers’ first loans enter repayment, the median length of time it takes to pay in full is 15½ years. .  . Federal student loans are discharged upon death.  

Must individuals wait till death for common sense relief?