Category: Cooperative Design

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Thoughts for Thursday

Feedback from the field:

Reverse Robin Hood: Bank Purchases by credit unions

A response to my comments in a recent conference call: Your points that really resonated were lack of transparency and accountability inherent in the cooperative governance structure.  Also  the fact that the bank acquisitions are taking money from CU members to line the pockets of bank shareholders, truly a reverse Robin Hood situation.

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“If My Words Can Convince One Credit Union”

I think CEOs just get tired. I think boards can get tired, too. And they think if our current CEO can’t make this place grow, who can? They see the simple solution is to merge out.

I am telling small credit unions that is a mistake; at least look for someone. I have had conversations with a number of CEOs who are retiring from small credit unions and they’re not even considering looking for somebody. They aren’t doing anything. They are not telling their boards to look for somebody. In fact, they’re telling the board the opposite—nobody can do this job at my pay.”

That type of thinking, and an unwillingness to “fight,” is hurting the movement.

“If my words can convince one credit union…if one credit union decides not to give up and says at least I will look for a replacement for the retiring CEO, I will feel good. I hope more small credit unions will follow what we are doing here.”  (source:  David Sawin, CEO, MN Catholic Credit Union, interview in  CU Today)

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What’s Missing?

“I am starting to think that credit unions are a waste of my time.

. . . as best I am able to ascertain, CUs are essentially just nonprofit banks – institutions that exist first and foremost to keep their employees employed and to keep the regulators happy.  The trappings of cooperation – invocations of principles, mechanisms for elections of board members, etc. – are either ignored or treated as empty formalities.

The new CEO of the CU on whose supervisory committee I serve told me that members simply don’t give a damn about that stuff; they just want convenience.

From my perspective, if CUs are just going to do exactly what the local banks are do, then I might as well just move my accounts over to banks.   What am I missing? (name withheld by request)

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 Response to They’re Coming with Bayonets

An uncomfortable change in the conversation (with regulators) will require incredible bravery.   I’ve been kicking around CU’s all my life.  My parents were members of a Teachers and a Manufacturing credit union.  I have been on Boards and now a CEO.

I have studied the history of the movement and the credo’s doled out as battle cries.  We were “choice”, we were “people helping people” – those goals were always color and socioeconomically blind as we emerged fighting against banking practices that were not–think redlining.

But we forgot one credo recently – “not for profit, not for charity, but for service.”  Since this credo does not make a singular virtue of  EQUITY, can we no longer espouse it?

The conversation change needs to be about DOI – Diversity, OPPORTUNITY, and Inclusion.  We were born out of opportunity and we are still built on it.  Will we be brave enough to say it?  We don’t need to be admonished with a new recitation.

We just need to remember our founding principles – which are both relevant and powerful.   (David. A. Jezewski,  President/CEO, CommStar Credit Union)

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Dear readers do not despair.   Tomorrow, Friday the 13th, is good news.  I will tell the story of a credit union that believes in the power of cooperative design.

 

 

 

 

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Tantrums and a $10 Million Credit Union Loss

As interest rates continue their upward cycle to reduce inflation, credit unions will manage this year-long transition process with multiple tactics and product adjustments.

There is no one operational formula to be universally applied because every credit union’s balance sheet and market standing is different.

But a simple model was the core of NCUA’s response in 2013 and 2014 when Fed Chairman Ben Bernanke announced a policy change to reduce support for the recovery after the Great Recession.   The reaction to his June 2013 announcement was an abrupt rise in rates, referred by some writers as  a “market tantrum.”

The following  is one credit union’s experience as NCUA  pursued its own regulatory tantrum as recalled by the current CEO.

A Case Study from a Prior Period of Increasing Rates

Today’s rapidly increasing interest rate environment is very reminiscent of the 2013-2014  period when Federal Reserve Chair Ben Bernanke’s “Taper Tantrum” led to a great deal of market volatility.  While Bernanke’s comments in May of 2013 touched off the increase in rates, it really took until the next year for the full effect to be felt.

NCUA’s response to this period of rising rates was nothing short of a panic.  Any credit union holding bonds whose value declined due to the increase in market yields was heavily criticized for having too much interest rate risk.  This critique was despite the fact that most natural person credit union had more than adequate liquidity to hold the bonds. 

The use of static stress tests, which showed dire results from up 300, 400 or 500 basis points, was used as a reason to force credit unions to sell some of their holdings turning unrealized losses, with no operational reason to act, into realized ones.  These forced sales unnecessarily depleted capital, the very thing that an insurer/regulator should be trying to preserve.

Things got so heated at our credit union that the Regional Director called a special meeting. Only our Board of Directors could attend; management was forbidden to be there. NCUA lectured them about the evils of excessive interest rate risk.  This sent many of them and our CEO into a full-scale panic. 

We sought advice from outside experts but finally settled on the dubious strategy of selling bonds at losses as well as borrowing funds from the FHLB that we did not need.  These were done to bring the results of these static stress tests in line with the NCUA’s modeled projections.  We calculated these actions caused us unnecessary losses of over $10 million before we stopped counting.  These came from both the realized losses, the added expense of unneeded borrowings, and the lost revenue on assets sold.

In the aftermath of that debacle, the credit unions senior management and two board members travelled to Alexandria, Virginia to meet a top NCUA regulator to explain our frustration at the loss.  After waiting for hours for our scheduled appointment, he heard us out.  We never heard back; however, the Regional Director soon departed.  Perhaps our message had at least been partially received.

The Problem with Static Tests

Fast forward to today.  We find ourselves in the “extreme risk” rating at the end of the first quarter due to the rapid rise in rates.  The glaring problem with static stress tests is that non-maturity deposits (which make up a large part of most natural person credit unions’ share liabilities) are limited to a one year average life. 

Several third-party studies document our share’s average life to be in excess of ten years.  Despite this, the asset side of the balance sheet is written down while the long-standing member relationships, on which most credit unions’ balance sheets are built, doesn’t get much credit at all.  For example, if a two-year average life on savings and checking accounts were used, the results of the static test wouldn’t even put us in the high interest rate risk category. 

Closing Thoughts

While we have authorization to utilize derivatives (something we didn’t have back in 2014), this could help lower the costs of compliance if we are forced to take action. However, I’m adamant against doing illogical things just to pass a static stress test this time around.

I’ve wondered how it’s OK for the NCUSIF to hold similarly long-term bonds in their portfolios without any concern during periods of volatility like this. We have the strength of our core share relationships and capital positions to withstand periods of rising rates.  NCUA just keeps reporting growing unrealized  losses transferring their IRR risk to credit unions to make up any operating shortfalls.

I also believe that NCUA should really be much more worried about very low interest rate environments.   These periods of very narrow yield curve pickups are actually much worse for financial intermediaries to navigate than periods like the one we’re now in. Overall the industry’s net margin should generally benefit from rising rates, shouldn’t it?

Two Observations

1. One expert’s view of  the situation today:  As you know, but people often forget, there is no ‘unrealized loss’ if a bond or loan is held to maturity.  There is an interest rate risk component that needs to be managed.  But if I am holding some 4% mortgages 10 years from now, and the overnight rate is 4%, then I am not upside-down.  I just have some of my assets earning the minimum rate of return. 

This is why I prefer net income simulation over IRR shock.  We don’t live in a static world, it’s a dynamic one.

2. During the November 2021 Board meeting the following interaction took place on the agency’s management of the NCUSIF portfolio and stress tests:

Board Member Hood: Thank you, Myra.  And again, I do have another question and this is for the record.  Do we all have an interest rate risk shock test to the fund (NCUSIF)  like we do for our credit unions under our supervision rule?  And also, do we do a cash flow forecast on a regular basis as well?

Eugene Schied: This is Eugene Schied, and I’ll take that question Mr. Hood.  Yes, we shock the – we do perform a shock test and perform cash flow analysis for the share insurance fund.  These are both reviewed by the investment committee on at least a quarterly basis.  The investment committee looks at the monthly cash flow projections for the upcoming 12 months as part of this regular analysis.  That concludes my answer, sir.

Board Member Hood: Great.  Thank you, Eugene.  I would just say that as I consider our investment strategy, we should note that examining portfolios and managing investments in the portfolio are two separate and distinct skillsets.  The NCUA today has over $20 billion, with a capital B, in investments under management; so I think we should have an even greater focus on this during our upcoming Share Insurance Fund updates.

 

 

 

 

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A Member Raises an Abiding Question Both Topical and Troubling

While traveling yesterday I was copied on an email between two credit union members.  The sender asked in part: 

“ I belong to five different credit unions.  I’ve clawed my way onto the supervisory committee of one of them. . . Alas, the Board of one has recently approved a deal by which it will be swallowed up by the biggest credit union in the state. . . When the deal was announced I wrote asking for whatever merger documents they could disclose.

I heard back directly from the CEO, who cheerfully explained they would be disgorging absolutely no documents.  It appears to me that the board and management actually expect the membership to ratify this deal entirely on a “trust me” basis. . . literally every justification that has been publicly offered comes down to some version of “bigger is better.”

His request:  “I am wondering if you would refresh my memory about what specific questions a concerned member ought to be asking about a deal like this.”

Topical and Troubling

If the situation is familiar, it is because it  happens  weekly.   Not mergers, but member-owners cut out of the process entirely.  Private deals supported by rhetorical promises and void of any objective facts.

Takeovers are an everyday event in capitalism and its anything-goes world of buyouts and mergers enabled by the financiers.

Here is how one long serving capitalist CEO described the process in his Annual Report:

Acquisition proposals remains a particularly vexing problem for board members.  The legal orchestration making deals has been refined and expanded (a word aptly describing attendant costs as well). But I have yet to see a CEO who craves an acquisition bring in an informed and articulate critic to argue against it.  And yes, include me in that category.

Overall, the deck is stacked in favor of the deal that’s coveted by the CEO and his/her obliging staff.  It would be an interesting exercise for a company to hire two “expert” acquisition advisors one pro and one con, to deliver his or her proposed views on the a proposed deal to the board—with the winning advisor to receive, say, ten times a token sum paid to the loser. 

Don’t hold your breath awaiting this reform:  the current system whatever its shortcomings for shareholders, works magnificently for CEO’s and the many advisors and other professionals who feast on deals.  A venerable caution will forever be true when advice from Wall Street is contemplated:  Don’t ask the barber whether you need a haircut.   (Source 2019 Annual Report, Berkshire Hathaway Inc. pgs 12-13)

A Game without Rules: Credit Unions Become Commodities

Mergers are being undertaken by sound, well established and stable credit unions not to better serve members.   But rather to make life easier for their leaders.

Instead of cooperative communities expanding long-time member relationships, these transactions treat credit unions like a commodity.  Leaders who give up their fiduciary positions to an outside third party without  engaging the owners prior to the decision and who must approve this charter cancellation.

This is the situation the member’s email describes.  And hundreds of thousands more members who end up becoming just consumer accounts to be bought and sold.

This is worse than the acquisition games Buffett describes in his Annual Report.  Credit unions and cooperative design is supposed to protect member-owners from self-dealing leaders and board toadyism.

Mergers lack transparency, public disclosures of strategy or benefits, and certainly no post acquisition accountability.  These are private deals negotiated by CEO’s putting their interests first and then announcing their intent to members.

The member vote is merely an administrative process without substance where very few members even bother to participate. All the messaging, resources and formal requirements are under the complete control of the persons benefitting from the transaction-not the members who must approve the decision.

What can members do?  How can the supposed democratic one member one vote governance model be revitalized to ensure member interests are front and center in these self-dealing transactions?

That is what the member is asking.  I will share your thoughts, and offer a few of my own.   Where is the Kristen Christian   when  members now need her to  save their own credit unions?

Buffett’s Merger Conclusion

“I’ve concluded that acquisitions are similar to marriage:  The start, of course, with a joyful wedding–but then reality tends to diverge from the pre-nuptial expectations.  Sometimes, wonderfully, the new union delivers bliss beyond either party’s hopes.  In other cases, disillusionment is swift.  Applying those images to corporate acquisitions, I’d have to say it is unusually the buyer who encounters unpleasant surprises.  It’s easy to get dreamy-eyed during corporate courtships.”

 

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An Observer on Freedom, Democracy and Credit Unions

“Alexis de Tocqueville shows that the capacity to choose the right thing is best understood in communal and political terms.

“Praising the New England townships of early Puritan America, he points out that the citizens made their decisions in common, framing laws, electing those who would govern them, setting taxes, providing for the poor, and in all things looking only to themselves and their own responsibility. These physically unimpressive settlements in the New World enacted self-government in ways that monarchical old Europe could hardly imagine in the 17th century. . .

“Tocqueville consistently reserves the word “freedom” for active engagement in public life and a concern for the common good that counters isolated self-interest. Citizens are free when they see and respect their dependence on each other. They can best continue to do what they know to be the right thing if they are committed to political self-rule.”

Source:  Glenn Arbery, A Taste of Freedom,

 

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How One Co-op Conducts Board Elections

Democracy is difficult to practice, especially when incumbents mange the process.

No one likes to give up positions or power, even if one is a volunteer.  This is true for local and national elections and in credit unions.

The press has reported on the attempt by four members of Virginia Credit Union to be considered for nomination to stand for election to the board.  Their efforts were ignored, and they were denied the chance to raise the issue at the March Annual meeting.

“The four people seeking to run for a board seat—Frank Moseley, Richard Walker, Tori Jones and Kati Hornung—have called the election a “sham” and alleged the process protected incumbent board members or their hand-picked candidates. The group said in earlier remarks that the CU’s chairman selects members of the Governance Committee that selected members to run for board seats, including the same CU chairman.”

An early account of their efforts can be found in this post,  The Fix is In.

A Shining Example of Democracy in a Coop

Shared Capital Cooperative is a lending and investment fund for co-ops of all types and sizes. They are cooperatively owned and managed by the co-ops that borrow from and invest in the firm. Borrowers and investors experience genuine cooperative finance—generating grassroots community wealth while building social, environmental, economic and racial justice.

The Coop’s vision is “building economic democracy.”

Founded in 1978, it is a Certified Development Financial Institution (CDFI) located in St. Paul, MN.   Its staff of 10 manages approximately $14 million in loans.  The board has eleven members elected from coops across the country.

The coop has both individual and 265 organizational members.  One board seat is voted by individuals and is not up this election.  There are six candidates for the three open board seats, each with a three-year term.

Board Election Ends Today

Voting is electronically from March 28 and ends today.   The link sent to me via email goes to an eleven-page listing of the candidates’ biographies.  The second link provides current board members’ backgrounds.   Here is an excerpt from the email:

Meet our candidates! For biographies and candidate statements of this year’s candidates please click here. For more information on our existing board, click here.

Cooperative members eligible to vote (not individual members like me) receive an email with their voting credentials. Annual meeting details are also given.

Shared Capital Cooperative’s Annual General Member Meeting and Cooperative Forum. It will be held virtually on Thursday, May 12th, from 12:00 pm to 1:30 pm CT.

The event will be free and open to the public. All are welcome! More details will be posted at www.sharedcapital.coop.

This relatively small, $16 million total assets organization, practices the democratic principles it committed to when formed.

Following Shared Cooperative’s Footsteps

This is an example of a board election/annual meeting that any credit union could emulate.   The process might prove enlivening and a confidence builder with members.  Especially as some credit unions struggle to involve members in this required annual democratic voting ritual.

This approach might result in more than a pro forma election; it could enhance member engagement and belief in the credit union!

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Learning from the Past

History is vital to interpreting human experience and meaning.   Understanding  where we have been helps us appreciate the present  and what the future may hold.

Our perspective of the past can change as events unfold.   What may have seemed wise or foolish at the time can now be viewed with greater clarity.  This capacity for self-reflection is critical when making decisions today.  It is called wisdom.

Calling for Wisdom by a Board Member

At the March NCUA Board meeting during the staff’s update on the Corporate Resolution Plan,  Rodney Hood observed:

But with any significant challenge, there are opportunities to learn lessons.  One lesson I would take away from the failed corporates is patience in the resolution process.  So I am glad that we are going to look back at the failed corporates, not to second guess or question decisions, but to learn from this experience as history can repeat itself. 

The Largest Loss Ever for Credit Unions

The liquidation en masse of five corporates was the largest projected loss ever.  NCUA said it would cost credit unions between $13.5-$16.0 billion.  The latest corporate AME numbers estimates the actual loss to the NCUSIF will be just over $2.0 billion and that is from just one corporate, WesCorp.

Absent an effort to understand how these projections were made, everyone will offer stories and interpretations that may be totally at odds with the facts as they unfolded.  In the desire to portray the resolution as a success, the most important lessons may be lost.   The seeds for future mistakes, remain unrecognized.

One example where the learning might begin is the liquidation of Southwest Corporate FCU.

Modeling for Failure

Unlike US Central and WesCorp, Southwest was not in conservatorship when seized.  It was being managed by its board and senior managers who made extensive monthly disclosures about the status of their credit union and every aspect of its investments.  The last report they issued was for July 2010 and was 21 pages of detailed information.

On September 24, 2010 NCUA issued an Order of Conservatorship on Southwest.  It was exercised “without notice” and warned that “Any business following service of this Order may subject members of the Board of Directors and management to civil or criminal liability.”  An explicit threat not to contest the Order.

A second document Grounds for Conservatorship included the following facts:

The credit union was solvent with “$88.6 million or 1.06% of  Southwest’s daily 12 month average net assets.”

The $88.6 million in remaining capital was after having “recorded OTTI charges totaling $496,258.357.” The Grounds document did not point out, as did the corporate in is July 2010 update, that only $49.7 million of actual losses (10%)  had been incurred. These investment write downs were based on modeling of  projected cash flows years, even decades,  into the future.

OTTI is not an allowance account.  It is a reduction in the value of an asset.  Under the accounting treatment at the time, improving loss projections based on the same modeling may not be recognized or netted with increasing loss projections.

In addition to its low solvency ratio NCUA declared it “marked to market” the investment portfolio resulting in a Net Economic Value (NEV) shortfall of ($718 million). This determination was accompanied by the statement that there was “with minimal opportunity for material improvement.”

Yet in the six-month period ending June 30, 2010 the negative NEV had improved by $382 million (35%).  The recovery had been underway since September 2009 and the market dislocations affecting the values of securities had begun to normalize.

But NCUA rejected these recent improvements asserting ‘future OTTI losses will continue to deplete its capital, negatively affect NEV, negatively affect its overall risk profile and decrease member confidence.  Even if NEV continued its recent slight improvement, the losses are more than Southwest’s balance sheet can absorb.” 

It further claimed: “Though a slight improvement in the increase in the fair value of the investment portfolio, the NEV increase is overwhelmed by the enormity of losses and the potential for additional OTTI charges from high risk investments.  The prospect of significant and sustained NEV improvement remains bleak.”  

A $1.5 Billion Modeling and Forecasting Error

 

Instead of a $718 million negative  NEV outcome and dire predictions of greater losses, the December 2021  projection is that SW Corp shareholders will receive $736 million in returned capital and liquidating dividends.  This is a $1.454 billion change in the actual economic value of the credit union.

The projected $736 million now being returned to shareholders equals 8.8% of the assets at the time of the seizure, or more than eight times the 1% solvency asserted by NCUA when placing the corporate in liquidation.

The projections and modeling were wrong.  The credit union had expensed hundreds of millions in  unrealized  OTTI losses that never took place, but were based on faulty assumptions.

Three of the other corporates had similar circumstances  Even in WesCorp’s situation, in which there will be no payment to shareholders, the estimated loss to the NCUSIF has gone from $6.2 million to just over $2.0 billion.

Next Steps in Understanding

 

A first review effort would be to update the projected versus actual loss experience on Southwest’s legacy assets.  The complete spreadsheet of legacy assets updated through September 2017 (when the TCCUSF was merged with the NCUSIF) is here.

How accurate were the OTTI write downs? What percentage of the $736 million payouts are from recoveries in the value of  “legacy assets”?

What can we learn further from the corporate resolution plan?   Especially in today’s economic circumstances?

Certainly the value of patience, in that there is a cycle of value with almost all assets in a dynamic economy.   This perspective could be especially important in this time of rapidly rising interest rates.  These increases  will temporarily depress the market value of many loan and investments assets on the books prior to Fed’s change in monetary policy.

The lessons should be more profound than relearning about fluctuations in economic value.  These might include the shortcomings of relying on “experts” like Black Rock and PIMCO for understanding what management options might be; or hiring Wall Street to design cooperative solutions; or even the native intelligence and insights of some of the corporate leaders who were summarily dismissed.

“No reasonable alternatives to conservatorship are evident.”

This assertion about the future of Soutwest in NCUA’s Order is perhaps the most important factor to assess.   What alternatives were evaluated?   By whom?  When?

One of the significant advantages of cooperative design versus private organizations is their dependence on member support and trust.   This factor is embodied in their democratic governance structure.

However, if those who lead an organization directly or through regulation do not honor this capability, then the advantage is loss.   The temptation to ignore, overrule or act based on solely on position and authority will sacrifice the long-term viability of an institution or even a system.

If NCUA demonstrates the ability to reflect on its own actions, transparently and in common cause with the industry, it could result in a leadership action that could resonate throughout the cooperative system—and perhaps beyond.

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‘It’s the End of the World as We Know It’ (and I Don’t Feel Fine)

The title is from a Commentary by William Reinsch written four days after Russia’s invasion of Ukraine.

He is the Scholl Chair in International Business at the Center for Strategic and International Studies. His professional specialty within government and outside is international commerce and trade policy.

His article projected the end of the rules-based system of international trade that had been developed post WW II.

He foresees the war causing economic chaos, a return of power politics, and resurgence of authoritarianism.  The world will not be the same; unintended consequences will proliferate.

Turning Points in History

In individual, organizational and country’s histories there are moments that are eventually understood as turning points.  Sometimes these are sudden and instantly consequential.  Like Ukraine.

Other changes occur slowly, but inexorably, in a new direction with the outcome unseen for years.   For example the evolving demographic composition of the American population; or even the  inevitable forces leading to the deregulation of financial services in the 1970’s and 80’s.

I believe the century long credit union movement is in one of these transformational periods. This  involves significant changes in the regulator’s role,  credit union business priorities, accepted performance norms and the ambitions of leaders.

These cooperative developments are occurring as economic trends are moving away from the two decade  experience  post 9/11.   Inflation is nearing 8%, unemployment is at historic lows, worker shortages are occurring in many sectors, and interest rates  are projected to rise to potentially the highest level this century.

The juncture of these economic and industry changes could significantly alter the institutional makeup of the cooperative system. They could result in the loss of credit union’s independent identify and purpose.

The Breakdown in the Regulatory-Industry Relationship

The seeds were sown in the disruption of the Great Recession in 2008-2010.  The scope of the potential corporate problem created a rupture between NCUA and the industry.

NCUA leaders whether through fear, inexperience or bureaucratic instinct distanced itself from credit unions.   The agency took  the sole role of developing one all encompassing solution for five distinct corporate balance sheets.  The results were disastrous for credit unions, the corporate system and the credit unions that relied on them.  Additionally, 30-year industry partnership for the CLF was ended.

The most critical long term loss however was not financial, but the agency’s ability or willingness to work collaboratively with the industry—on all issues and in all circumstances.

Instead of viewing their role as empowering a system of cooperatives, NCUA positioned itself as rulers over the credit union system.

At the March 2022 Board meeting this view was expressed by Chairman Harper in comments on the agency’s Annual Performance Plan:  With the geopolitical crisis unfolding in Ukraine, the NCUA will also continue to prioritize cybersecurity and guide the credit union system through the economic uncertainty caused by inflation, rising gas bills, and continued supply chain woes.

This paternalistic or in loco parentis approach to regulation and supervision emerged from the agency’s ability to impose solutions and rules unilaterally following  the corporate crisis.

The agency publicly proclaimed its independence under Chairman Matz from both credit union involvement and external oversight.  No one at the board or staff has been able to replace the critical experience and knowledge credit unions brought to all issues.

Credit union experience is absent in the regulatory bureaucracy. Credit unions manage over $2.0 trillion for over 100 million members but they have little to no voice in policy priorities.   Stakeholders, both members and the professional leaders, are viewed simply as recipients of perceived regulatory wisdom.

Increasingly credit unions are developing new financial schemes with the regulator seemingly oblivious to their impact on these credit unions or the member owners.   The wheeling and dealing in mergers, bank purchases and raising external capital is accelerating.

The makeover of a number of credit unions from member-centered to financial strategists, gamesman, hustlers and horse-traders is well underway.

This failure to interact removes NCUA’s most important resource – the industry’s professional leadership experience.   Mistakes will continue to be made and paid for by credit unions due to the missing counsel of those who make the system work on a daily basis.

Overcoming the Schism

Credit unions created NCUA and designed and passed in Congress all of its constituent capabilities specifically the NCUSIF and CLF.

Board members seem divided between two binary positions:  let the free market determine outcomes or, NCUA must pass rules to micromanage every credit decision and balance sheet IRR risk.

Effective NCUA regulatory policy is not democratic or republican, or even bipartisan; it is pragmatic supported by facts, logic and cooperative purpose.

Rules and manuals in the thousands of pages cannot replace business judgments and may in fact result in reducing sound operational choices.

Mutual respect is missing.  Credit unions are intimidated or consider fruitless any effort to critique ineffective agency actions.   NCUA’s most frequent justification for more rules is comparison with other financial regulators.

Mutual dialogue creates respect and enhances understanding of shared responsibility.  Future posts will describe changes in priorities, norms and professional ambitions shaping industry character.   All are examples of events occurring without the benefit of public dialogue.

 

 

 

 

 

 

 

 

 

 

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Irony

Voting is the life blood of democracy.  For both political leadership  and within organizations.

Some firms, such as IBM, encourage their stock holders to vote at the annual meeting:

To express our appreciation for your participation, IBM will make a $1 charitable donation to Opportunity@Work on behalf of every stock holder who votes.

Voting is integral to credit union design.  This is the season for annual meetings with members electing their directors.  Unfortunately actual voting is rare.  Most vacancies are filled by acclamation as the number of candidates equals the open seats.

Now CUNA has begun a campaign to encourage member voting. As reported in CU Today:

WASHINGTON–CUNA has relaunched its “Credit Unions Vote,” a campaign focused on getting credit union members to vote in the 2022 midterm election. The campaign ties civic engagement to credit unions’ ability to improve financial well-being and advance local communities, CUNA said.

thumbnail_Credit Unions Vote

“Credit unions understand that elections affect their members’ financial well-being,” said CUNA Deputy Chief Advocacy Officer for Political Action Trey Hawkins. “With the Credit Unions Vote campaign, we will reach out to America’s credit unions providing them with resources to encourage their members to play an active role in both their primary and the November election.”

An Observation:

Yes, elections do indeed affect members well-being. Especially the choice of credit union directors.

If CUNA wants to encourage member’s good voting habits, why not begin by promoting elections at credit union’s annual meetings?

That would seem a more immediate way to illustrate the power of the franchise and their well being.

 

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Inflation, Interest Rates and Managing the NCUSIF’s $21 Billion Portfolio

Last week the Federal Reserve began its long-publicized tightening of monetary policy.  The Board raised the overnight fed funds target rate to .25-.50% .  Six more raises are planned which would take this rate at year end to around 2%.

The consensus of economists is the Fed’s  plan may be a day late and dollar short.  From MSNBC columnist Kelly Evans right after the announcement:

The Fed published a crucial update in its projections yesterday that showed members now expect the short-term Fed funds rate to hit 2.8% by the end of next year–up from only 1.6% in their December projections. In just three months’ time, in other words, as inflation has shot way higher than anyone at the Fed expected, the committee is signaling the need for almost ten rate hikes by late next year, roughly twice as many as they previously thought necessary. 

In his March 21st speech to National Association of Business Economists (NABE) Fed Chairman Jerome Powell unveiled an even more hawkish view.  Increases could be in .50% increments if needed to counter inflation.

Interest rate rises have substantial consequences for the management of the NCUSIF.   All planned revenue for the NCUSIF is from earnings on its investment portfolio of Treasury securities.  The portfolio will be almost $22 billion by 2022 yearend as credit unions keep sending in 1% of the increase in their share deposits.

Robotic Investing

As the public concern about inflation grew in 2021, the NCUSIF’s investment committee  continued using a “ladder” approach.  The resulting multiple investments  had average durations of 5-6 years and average yields of less than 1%.   This was done at an historically low point in the interest rate cycle.

Despite Board questioning, the staff defended their decisions by saying they don’t try to “time the market.”  Whereas the record shows that the staff has substantially modified the portfolio’s average duration over the past seven years from 1,815 days in 2015 to as low as 901 days in 2018.

One consequence of the Board’s questions  is  NCUA has now published its NCUSIF investment policy.   It can be found here with a last modified date of February 23, 2022. The substance appears unchanged from the previous February 2013 policy.

While NCUA did not formally request input, it is in the industry’s self-interest, even duty, to look at this document to suggest how the management of this $22 billion portfolio could be improved at this point in the  market.

The NCUSIF’s Financial status as of January 2022

 

The most recent NCUSIF financials are at January 31, 2022.    They show the $20.4 billion portfolio is $265 million underwater (market value less than book); the  yield is 1.20% with an   average weighted duration of 1,244 days or 3.5 years.

January’s total income was  $21 million and expenses $17.4 million (up 20% from January 2021). Monthly net income is  $3.6 million with no loss reserve expense or recoveries.

The portfolio is divided into identical  $2.8 billion dollar maturity “buckets” spread over seven years through 2028.  Just $431 million is held overnight.

One year ago, January 2021, the portfolio was $17.8 billion, with a 1.29% yield, weighted average maturity of 1,184 days or 3.3 years.  The portfolio reported a gain in market value of $459 million.

In January 2020, two months before the COVID national economic shutdown and plunge in rates, the NCUSIF reported an average yield of 1.88% and a weighted average life of 2.9 years.  Interest revenue was $25.5  million and operating expense of $16.9 million resulting in a bottom line of $9.5 million, or three times the January 2022  outcome.

The fund’s portfolio maturity extensions during COVID’s low rate  stimulus environment have put the NCUSIF into a financial hole.  Revenue is much less on a portfolio that is 25%  larger  ($ 5 billion) than two years ago; the portfolio has lost $724 million in market value due to its below market return and maturity extensions at the bottom of the interest rate cycle.

These circumstances  suggest an urgent need for a review of NCUSIF portfolio management and reporting. The current policy implementation is not a positive outcome for NCUA or credit unions.

 Changes to Enhance Transparency and Performance

There is investment expertise aplenty in credit unions.   Some areas for commenting on the newly published policy might include:

  1. How can investment return goals be better integrated with projected income and budgeted expense so that target for investment yield can be set objectively? For example a 2% portfolio yield and today’s fund size would cover all budgeted expenses and still leave over $200 million to grow equity or cover any new reserve expense.
  2. How should the objective of paying a dividend to credit unions be incorporated in the fund’s policy objectives?
  3. How can the fund’s investment decisions be more transparent especially the assumptions used when making decisions and changes to portfolio’s duration?
  4. What additional information should be in the monthly reports posted and provided to the board to evaluate investment performance? For example shock tests?
  5. What financial models does the fund use when making decisions? Can these be made public so that credit unions can comment on the projections and assumptions used?

There are  many potential insights to this critical NCUA board policy that could lead to more effective oversight and performance.  The critical success factor is sending these suggestions to NCUA  to be evaluated for updating the policy.

Auspicious Timing

While there has been no formal request for comments, one approach would be to send suggestions to the investment committee’s new Chair which is the Director of E & I. Kelly Lay was just appointed to this position.  This gives her an excellent opportunity to bring credit union experience to the investment process.  Her email is klay@NCUA.gov.

The timing is also critical because rates will be rising, how fast and how far is anyone’s guess.  Both domestic inflation and international events will create ongoing uncertainty.  But the direction is certainly set.

To continue the robotic ladder when it is known rates will in all likelihood continue to rise, is folly.  It brings no credit to the committee’s work and the board’s oversight.

Yesterday’s treasury coupon yields for 25 weeks was .95% and for one year, 1.31%.    These are higher rates than any of the investment decisions made in 2021.  A portfolio return increase of only 1% would double the fund’s annual revenue.

To decide when to extend out the yield curve should be based on analysis of  what breakeven yield is needed to cover costs and equity growth and any loss reserves.   Whether that is 2% or some other number, the goal should be to optimize yield taking into context the operating needs and sending excess earning back to credit unions.

Circumstances have given credit unions and NCUA a valuable moment to improve the management of this important, ever-growing industry asset.   Will credit unions and NCUA take this opportunity?

 

 

 

 

 

 

 

 

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A Fee that Credit Unions Should Review for Appropriateness

Increasing attention is being given to all financial institution’s overdraft/courtesy-pay/nsf fee structures.   An excellent summary of many of the issues is in this article from CUSO magazine.

After the reassessments of these fees, there is another one that credit unions may want to proactively review.

The Unclaimed Property/Inactive Account Fee

A member recently told the story about learning of this fee the hard way.   She had been a loyal credit union member for over two decades and had left a small balance of $500 in case a family member needed to borrow.

The regular savings account paid interest of .05%, offered only online statements and had no activity for over two years.  When checking her 2021 yearend balance online she discovered that the amount had fallen by 20%.

The explanation: a $3 per month inactive account fee was being assessed.  She knew nothing about the fee or how long it had been in place.  In essence she felt the credit union had effectively free use of her money and was charging her on top of that!

When contacted, the credit union explained the fee and offered to refund the money for the last two years, which was as far back as their system would go.

Credit Union’s Responsibility for Inactive Accounts

When Ed, Bucky and I went to NCUA in 1981, I can remember credit unions approaching the agency about charging inactive account fees, which in essence was the step prior to forwarding these accounts to the states as unclaimed property.

In Illinois the Department of Financial Institutions was responsible for administering the unclaimed property act and ensuring funds were properly reported, returned to the state after five years of inactivity so the owners’ names could be publicly listed to  reclaim their funds.

My colleagues believed charging a fee during this inactive period was counter to both the spirit of the act and for a cooperative financial institution.

Credit unions claimed  the accounts were costing them money: maintaining the account, mailing monthly or quarterly statements and plus interest.  Even as they tried to reactivate them, they wanted to be reimbursed for the operational “costs” of the accounts.

For others, the not so hidden motive was to fee the account to $0, especially smaller balances,  close out the member, and not worry about reporting it as unclaimed property.

Others asserted that the fee was in fact an incentive for members to reactivate their accounts.

Inactive accounts come in all flavors:  parents opening accounts for their children, now long gone; accounts left when members move out of the area; the account opened for an indirect loan member, etc.

The common characteristics are there is no member-initiated account activity, the relationship is static, and there is high probability the owner is unaware of any fees being charged.   Therefore it is an easy fee to assess as it is mostly invisible to the account holder.

Other Credit Union Examples

One CEO I talked with said they charge $3 a month on about 500 accounts generating $1,500 in revenue.   At any point in time about 40% of the accounts will be sent to the state.

Another CEO said the credit union charges $10 per quarter.   In both cases the fee had not been evaluated for decades.

Both recognized that in an era of virtual accounts, minimal interest on savings and near zero marginal operating costs, the credit union should focus on contacting members, not seeing the issue as a revenue item.

I would urge credit unions to look at their current inactive account policy and fees.   It may not be as consequential as overdrafts, but if a class action attorney situation arrives, just looking up the years of records, charges and potential refunds, would seem to suggest any income is not worth the potential cost.

Also don’t forget abandoned safety deposit boxes must also be reported as unclaimed after the statutory period of inactivity.

NCUA’s Unclaimed Policy

Just as a footnote, NCUA also acquires unclaimed insured share accounts when liquidating credit unions.

It is interesting to note that the agency’s policy is contrary to the legal practice required of credit unions.

As stated on the website, if NCUA cannot locate the party after 18 months, it converts them to “uninsured” and retains the balances for use by the insurance fund.

Invariably, some items may remain unclaimed. Some checks are never cashed; or the credit union’s address information was incomplete. There are also cases when we don’t have a recent address and are unable to get a forwarding address from the post office.

Share accounts claimed within the 18-month insurance period are paid at their full-insured amount. At the expiration of the 18-month insurance period, shares that are not claimed are considered uninsured and written down to share in the loss to the National Credit Union Share Insurance Fund. Even if shares are uninsured when they are claimed, there may still be a distribution.

On rare occasions, the liquidation of a credit union may result in surplus funds. If a surplus remains, a distribution to the shareholders is required. This may occur several years after the credit union is liquidated and it is sometimes difficult to locate these members.

This is another example where NCUA exempts itself from the rules credit unions are required to follow to protect member’s assets.