Category: Cooperative Design

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Yesterday the Most Important GAC Speaker Missed His Scheduled Appearance

In the gaggle of bipartisan congress speakers, the nobility of CUNA praising attendees, the inside the beltway literati’s wisdom, and the obligatory regulatory updates, there is one person who  missed his scheduled talk.

Chef and humanitarian José Andrés was to participate in a fireside chat with National Credit Union Foundation Executive Director Gigi Hyland on Monday.  The public purpose was to talk “how he lives out the ‘people helping people’ mission through his global humanitarian efforts as a passionate human rights advocate.

Chef Andres is not in Washington DC.  He was on the ground feeding refugees at the Polish-Ukrainian border where his World Central Kitchen has served more than 8,000 meals.

In a TV interview last night, his destination today was to go into Ukraine.

Chef Andres work in places of natural disaster such as Haiti, flood and hurricane regions of the American south and throughout the world have been widely reported.

In March 2020 I witnessed his work locally.   The entire economy had been shut down.  Restaurants were closed, but Chef Andres kept his Bethesda location, Jaleo open.  His staff was still employed providing free meals for several hours each day to workers and anyone else who needed access to food.

The occasion for his absence may say more than an appearance at GAC could have ever accomplished.

For Jose Andres embodies an aspect of “people helping people” that is often overlooked: he runs, not walks, toward danger, need and human suffering.

Walking Toward Member Problems in Credit Unions

Some of the most powerful examples of the cooperative model at work are when leaders walk toward, not away from their member’s needs.  Here are some examples:

  • In 2009 a Dayton credit union continued and expanded its dealer lending program when all other lenders backed out because the traditional car title collateral was suspect as the auto manufacturers faced bankruptcy.
  • A Florida credit union rewrote first mortgages with payments extending out 50 years to keep members in homes as  incomes were reduced by over half by job loss;
  • Credit unions in Lowell, MA (Cambodian), in St Paul MN (Hmong) and in Missoula, MT (sub-Saharan Africa) serve refugees from all over the world who are new to this country’s financial options.
  • The New York City taxi lender who divided his loans into A and B notes.  A was pay what you earn; B-we’ll worry about later.

Two Crises

In the national Covid economic shutdown in March 2020 there are thousands of examples of credit unions willing to walk in the members’ shoes, share their collective capital by waiving fees and giving loan payment holidays all the while setting up remote delivery options literally overnight.  Employees worked from new home offices and kept their full pay.

Perhaps the most consequential example was when I watched the CEO of the second largest credit union in America offer the senior management of NCUA a solution to the Corporate crisis in early 2009.  He said his credit union and his peers would buy all the legacy assets and carry them on their books if NCUA would guarantee no loss of principal.  He was turned down.  NCUA instead guaranteed wall street investors in the NGN program so they could walk away from the problem.

A Unique Capability

The cooperative model is unique in its capacity to walk the extra mile for its members when they are in harm’s way.   That is what self-help means.  Putting member needs first in all circumstances.

I don’t know what Chef Andres would have said in a “fireside chat” at the GAC.  However I believe his personal witness is more important than any words he may have used.

I would hope his example might inspire everyone to ask again what our slogan of “people helping people” means in today’s world.

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Two Reactions to NCUA’s Proposed Succession Rule

In January the NCUA board in a 2-1 vote issued a proposed rule to implement new requirements for succession planning.  Two observers’ responses follow.

One approach to succession planning.

Credit union consultant Ancin R. Cooley’s solution.

Her name is Asha Monroe Cooley.  There are two interpretations of this strategy.

  1. Ancin is hoping Asha will be his business partner and successor.
  2. He is perpetuating the Cooley brand, but in another context.

The message for credit unions:  either perpetuate yourself or create new models to sustain the movement.

The Most Important Thing is Not the Person in Charge  (excerpt from CUSO Magazine by Randy Karnes)

“I agree with planning for leadership changes, planning your response to them, organizing for the potential deer in the headlights look you get when your leader decides or has it decided for them now is the time to step off.

“But I do not agree with many of the things that succession consultants and “we can fix it people” will cast upon organizations in the quest to “predict the future and pick people now.”

“By forcing your hand to do something, NCUA has made it all too easy to simply check the box (possibly at great expense) and move on. But succession planning is important for an organization’s longevity. To be successful at succession/continuity planning and its execution:

  • Create an organization that expects, demands, and wills the organization to have a future that needs a leader. Build that expectation every day.
  • Present a firm to the marketplace, candidates, and stakeholders that is based on a dynamic mission worthy of its individual contributors’ time and efforts.
  • Focus on the key processes to complete the task more than you are on the subjective evaluations of human social tradeoffs. It’s a project with tasks to manage, not a social dilemma for the ages.
  • Focus on expected outcomes and their priorities more than the way to achieve them. A prospective CEO needs the assignment as the compass and goal more than a blank page to assign leadership skill to.
  • You need everyone to lighten up and avoid the drive for certainty and perfection from ensuring the paralysis and regrets of failure. It’s a 50/50 proposition picking a new leader, and one that gets better with doing it multiple times, not just once.

“Have plan, budget a course of action, and trust the future. And then get back to building the will, the confidence, and the positive belief that your organization will survive. Because the most important thing to your team’s future is not the person in charge; it is the confidence that your design, your stakeholders, and your membership can sell their intent to survive.

“I hate that so few credit unions today can proudly declare we are valuable, we are the ones our members need, and we see this mission as important, intoxicating, and something to hand off to our future leaders.

“Please do not see this as a task to simply put a new butt in a seat… it’s not. It is a constant culture of building a case to always be in the game and trust the future to those willing to lead.”

 

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Military Credit Unions in Wartime

War has broken out in Ukraine.  All of Eastern Europe is on alert.  Some credit members are on the move.  Others wait to learn what’s next.

When a geo-political crisis occurs, America will be involved.   How much and when depends on events.

One sector of our society at the leading edge of these situations are military credit unions.   Many have spent years planning to help their member’s financial preparedness for whatever comes next.

Frontwave Credit Union’s Military Relations Team

The credit union’s self-description: There aren’t many communities like this one. One foot in the Pacific, the other in the desert. Home to the world’s greatest fighting forces — and a community of blue-collar fighters.

Five years ago, CEO Bill Birnie established the Military Relations Team.  He hired Chip Dykes and two other former marines to lead this group which focuses directly on the financial well-being of military members and their families.

Over 50% of the credit unions 117,000  members are current or former military members and family.

Front wave has been the credit union on base at Camp Pendleton since 1952.   It also serves at three other bases in the area.

Camp Pendleton is the location for all initial basic training on the West Coast for over 17,000 new marine recruits each year.  Bill was concerned about retention of these new military members, many of whom would be assigned out of the area after training.

Chip’s team are all certified financial counselors.  Their purpose is education  on all aspects of money management and financial planning for the new recruits and during every phase of subsequent training.

This counseling is especially important prior to deployment.  For example how do you follow your finances when in an area with no Internet?

The team focuses on member’s financial needs at all levels of the service at each of the four bases where they have branches.   In 2021 they provided over 10,000 marines and family members with basic and more advanced financial courses.

Helping Credit Union Staff Understand the Military Member

Just as important is helping credit union staff understand the needs of the military member with whom they work with daily.

Bill and all three team members are marines.  Many staff have had little direct experience of military life.  The team’s internal mission is to help customer service personnel understand needs from the military member’s perspective.

The Ukraine Crisis

When events such as the Ukraine invasion occur, “our ears perk up,” says Dykes.  The European theater is served from units located on the East Coast, so it may not immediately affect West coast units.

When there are relocations,  the team works directly with  all units on the ground to ensure their financial and personal affairs are in order.  And to offer help to family while the service member is away.

Following Events in Ukraine

This article provides a current visual map of Ukraine and the population of its major cities which are now referenced in hourly news updates.  Facts on the country’s demographic trends, its major natural resources and a short history of its relations with the Russian Bear are summarized after the large scale country portrait.

Solzhenitsyn on Ukraine-Russia Relations

(from an essay written June 2014 when Russia annexed Crimea)

“It pains me to write this as Ukraine and Russia are merged in my blood, in my heart, and in my thoughts. But extensive experience of friendly contacts with Ukrainians in the camps has shown me how much of a painful grudge they hold. Our generation will not escape from paying for the mistakes of our fathers.”

There are several terrific English language websites which provide news directly from Ukraine, which are updated frequently.  One is Kyiv Independent and the second the English section of the Ukrainian Information Agency.

The Independent includes minute by minute stories from across the country.

I will share other examples of credit unions serving their members who are or will be on the front lines of this crisis.

 

 

 

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A Credit Union Archetype

Last Wednesday (February 16)  in their 2021 yearend industry analysis Trend Watch, Callahan & Associates included a 12 minute case study of  a credit union’s strategic transformation.

The CEO’s presentation  was one of the most concise, informative and inspiring I have experienced.

He describes this effort as a two-phased journey. The second phase transformed the  credit union’s performance  on three critical dimensions:  purpose, scale and financial performance.

The final slide shows how this strategic approach is both powerful and inherent in credit union design.

Please listen now.

https://iframe.dacast.com/vod/c94cf664f6abb2621f07f249b463a648/e05560a9-729c-7118-b2ac-4a2c170f0e8d

My Reaction

Everyone will listen from their singular perspective.  Takeaways may be different.  I would add two thoughts to ones you may have.

The first: a good example can be very contagious.

It’s hard to get a feel for the cooperative difference until we have met a person grounded in that effort.    When we see purpose enacted, we become more purpose driven. When we learn the impact of values on employees and community, we become more value centered. When we hear someone discern clearly, we become clearer about our own metrics. 

Secondly, powerful communication is more than a good story.  It requires radical transparency.  No topic is off limits. There is respect for differing views when values shared by all become the focus of common effort.

Clearwater’s results validate its vision, What We Believe.

Together, we own

Together, we empower

Together, we include

Together, we matter

Examples matter.  Good examples inspire more. Great ones are rare.

They reawaken us to what can be accomplished- together.

**************************************************

PS: This post from October 2021 tells the story of Clearwater’s role assisting the refugee community coming to the community.

One Photo, Hearts on Fire, a Credit Union and Community Respond to a Vital Human Need

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Three Strikes and RBC/CCILR Should Be Out: Failing the Test of Comparability

My earlier posts described how NCUA ignored two of the three explicit criteria in the PCA law when imposing RBC/CCULR rules on credit unions.

Before looking at the third constraining feature, “comparability,” there is a procedural violation in NCUA’s actions. The agency’s Federal Registration filing for CCULR and amended RBC was December 23,2021; the act took full effect on January 1, 2022.

The PCA act directs how these changes are to occur:

Adjusting net worth levels -Transition period required

If the Board increases any net worth ratio under this paragraph, the Board shall give insured credit unions a reasonable period of time to meet the increased ratio.

Credit unions were given 9 days to comply with CCULR’s 29% increase (from 7% to 9%)  to attain a well-capitalized rating.

The Third Criteria for PCA Implementation

At its core, NCUA has only one explanation for its new RBC/CCULR joint rules:

Harper: The final rule is a balanced approach that gives complex credit unions a risk-based capital framework comparable to those developed by other federal banking agencies.  

The combined rules’ minute details and hundreds of risk weightings are explained with multiple variations of one idea: “to ensure comparability with the banking industry.”

Nowhere is comparable defined.

If comparable means “the same as,” credit unions’ 10.6% net worth ratio at December 2021 already exceeds either banks’ core capital leverage ratio of 8.86% or equity capital ratio of 10.06% as reported by FDIC in their September 30 quarterly report.

Must credit unions now reduce their capital level to be comparable to banks’ average?

Obviously not.   NCUA’s intent is that credit union net worth be measured with the exact same accounting details as the bank’s follow.  Except banks have many more capital options for the numerator.

The rule’s 70+ risk weighting formulas, and multiple variations, applied to credit union assets were lifted directly from the banking model.

The rule duplicates bank regulations at every point even though the asset composition and financial roles of the two systems are drastically different.

This literal interpretation of comparable accomplishes one goal—NCUA now controls credit unions with the same power bank regulators enjoy.  This should be no surprise as Chairman Harper has repeatedly praised FDIC bank regulation as the de facto standard he intends for credit unions and the NCUSIF.

This approach was followed ignoring the two system’s different histories, legislative purpose, financial design and most importantly, financial performance.

What did comparable mean when Congress mandated this new cooperative capital standard in 1998?

For 90 years credit union capital adequacy was based on a flow concept, setting aside a required percentage of total income before dividends, rather than a balance sheet, net worth ratio, measured at points in time. This  new ratio standard was significantly different from credit unions’ prior practice of building reserves over time as a percentage of total income.

The Act explicitly required NCUA to “design the system, taking into account” the not-for-profit  cooperative structure which cannot issue capital stock and relies only on retained earnings for reserves. When requiring a balance sheet ratio test versus a set aside from revenue, NCUA’s process must consider the listed differences in reserve structure and even the board volunteer composition.

The second change under PCA for credit unions  is in a different section of the act:

d) Risk based net worth requirement for complex credit unions.

The agency is directed to include ” a risk-based net worth requirement for insured credit unions that are complex.”

Banks have no call out for complex.  Risk based weightings are universal for all banks.

The new coop PCA  model required a risk-based factor (weighting) for a defined set of complex situations which “take account any material risks against which the net worth ratio . . . may not provide adequate protection.”

These words clearly establish a different PCA model for credit unions than required of banks.

Cooperative PCA standards are clearly intended to be different.  To assert that comparable means to duplicate, copy or be the same as banks practice is a misinterpretation of the Act.

Twisting a Law Reducing Burden to Impose a New Regulation

The most recent example of this misinterpretation of NCUA’s authority is Chairman Harper’s description justifying the CCULR option  proposed by NCUA in July 2021, five months earlier.

Harper: We must, however, also recognize several legislative, regulatory, and marketplace developments since the NCUA Board approved the final Risk‑Based Capital Rule in 2015. For example, in 2018, Section 2001 of the Economic Growth Regulatory Relief and Consumer Protection Act directed the other federal banking agencies to propose a simplified alternative measure of capital adequacy for certain federally insured banks. The result of that effort became known as the Community Bank Leverage Ratio framework which became effective in January 2020.

There is a supreme irony citing President Trump and the Republican-sponsored Main Street Relief Act, to reduce regulation burden.  Then to expand its application to NCUA’s rule making authority over credit unions.

Here is a summary of the reference Harper cited:

Title II Regulatory Relief and Protecting Consumer Access to Credit

Section 201. Capital Simplification for Qualifying Community Banks. This section requires that the Federal banking agencies establish a community bank leverage ratio of tangible equity to average total consolidated assets of not less than eight percent and not more than 10 percent. Banks with less than $10 billion in total consolidated assets who maintain tangible equity in an amount that exceeds the community bank leverage ratio will be deemed to be in compliance with capital and leverage requirements.

There is no mention of NCUA anywhere. NCUA had not even implemented RBC when the bill was signed in May 2018.  There was no basis for credit unions to ask for regulatory relief from a rule not in effect and deferred three times at that point.

The congressionally enacted CCULR option was a banking industry effort for an alternative to a flawed and burdensome RBC rule.   FDIC’s  vice chair Thomas Hoenig had been a long standing vocal critic of RBC.

Further evidence that this section 201 did not include NCUA is that NCUA is specifically named in two other parts of the bill that explicitly provide regulatory relief for credit unions:

Section 212. Budget Transparency for the NCUA. This section requires the National Credit Union Administration to publish and hold a hearing on a draft budget prior to submitting the budget.

Section 105. Credit Union Residential Loans. This section provides that a 1- to 4-family dwelling that is not the primary residence of a member will not be considered a member business loan under the Federal Credit Union Act.

To claim NCUA’s authority for CCULR, Harper refers back to the 1998 PCA bill.  He then uses the “comparability” reference to presume authority in a bill passed twenty years later and in a section specifically omitting any reference to NCUA .

The result of this newly found authority is to increase credit unions’ restricted capital. As stated in the Board memo:  ”The Board believes that a CCULR of nine percent is appropriate because most complex credit unions would be required to hold more capital under the CCULR framework than under the risk-based capital framework.”

A False Narrative

NCUA was not given CCULR authority.  It is a false narrative permeating RBC/CCULR that credit unions’ rules can exactly copy bank rules.

This duplication-interpretation overlooks the two-decade reality that credit unions were fully compliant with their PCA risk based net worth (RBNW) model and repeatedly surpassing banks in financial performance under it.

The staff perpetuates this duplicating justification in its board memo: A special note that most, if not all, of the components of the CCULR are similar to the federal banking agencies’ CBLR.

The Consequences of Unconstrained Regulation

There are immediate and long-term unfortunate consequences when authority is improperly interpreted and asserted.  This erroneous RBC/CCULR precedent will undermine the credit union system’s unique role and diversity, directly contrary to PCA’s intent to respect cooperative character.

It sets an example of agency interpretation independent of fact, statutory language and prior compliance precedent.

Board Member Hood pointed out this long-term risk in his December board comments:

We now have (PCA compliance) with our risk-based network requirement. This law gives this board serious responsibilities which we must faithfully uphold, but this does not mean that since the bank regulators established a risk-based capital regime, we must follow them.

I actually worry that once we decree that 7% may no longer be adequately capitalized, then whether it’s this board or a future board that settles on an 8%, 9%, 10% net worth in the complex credit union ratio, as some say in North Carolina, the barn door is now open to that interpretation or that change.

I worry that we may have set an arbitrary standard above the law that a future board can easily change at any time.

There is much more at stake from RBC/CCULR than approximately  $30-40 billion of forced sequestration and newly required credit union capital. And the rule’s faulty legal standing.

The central issue is whether the NCUA board is willing or able to support the continuing evolution of a unique cooperative financial system in its regulatory actions.

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CCULR/RBC Unconstrained by Statute: An Arbitrary Regulatory Act

The new RBC/CCULR rule must meet two administrative procedural tests, as any other rule, when NCUA claims to be implementing a law.  The first was outlined yesterday:  Was there substantial objective evidence presented to justify the rule?

As I described, NCUA presented no systemic data or individual case analysis whatsoever. In fact, the credit union performance record  shows an industry well capitalized and demonstrating prudent capital management over decades.

In the December board meeting Q&A , staff confirmed that in the last ten years, only one failed credit union would have been subject to RBC.  But today 83% of the industry’s assets and 705 credit unions are now subject to its microscopic financial requirements.

The second test is whether the rule conforms to Congress’s legislative constraints when giving this rule making “legislative” authority to an agency.  The PCA law was very specific in this regard when extended to the credit union system.

NCUA’s PCA implementation must meet three tests: that it apply only to “complex” credit unions, “consider the cooperative character of credit unions,” and be comparable to banking requirements.

NCUA had already passed these PCA implementation tests before. In 2004 GAO reviewed NCUA’s risk based net worth (RBNW) implementation of the 1998 PCA requirement and concluded:

The system of PCA implemented for credit unions is comparable with the PCA system that bank and thrift regulators have used for over a decade. and,

. . . available information indicates no compelling need. . . to make other significant changes to PCA as it has been implemented for credit unions.

At that time the risk based capital (RBC)  requirements had been in place for banks since 1991.

Today  NCUA’s new RBC/CCULR rules clearly fail all three of these constraining criteria.

A “Simple” Interpretation of “Complex”

NCUA 2015 RBC rule declared that the complex test include all credit unions over $100 million.  After the full burden of the rule was apparent, in 2018 the board changed complex to mean only credit unions over $500 million in assets.

Some credit unions clearly undertake operational activities or business models that are more involved than what the majority of their peers might do.

Examples could include: widespread multi-state operations, conversion to an online only delivery model,  lending focused on wholesale and indirect originations, high dependence on servicing revenue, using derivatives to manage balance sheet risk, funding reliant on borrowed funds versus consumer deposits, innovative fintech investments, or even the recent examples of credit unions’ wholesale purchases of banks.

The agency did not define “complex” using its industry expertise and examination experience to identify activities that entail greater risk.

Instead, it made the arbitrary decisions that size and risk are the same. In fact, most data suggests larger credit unions report more consistent and resilient operating performance than smaller ones.

In changing its initial ”complex” definition by 500%, it demonstrated Orwellian logic at its most absurd.  Complex turns out to be whatever NCUA wants it to mean, as long as the definition is “simple” to implement.

Universal for Banks; Targeted for Credit Unions

For banking PCA compliance, RBC was universally applied.  Every bank must follow, no complex application was intended.

By making size the sole criterion for “complex” the board reversed the statute’s clear intent that its  risk-based rule be limited in scope and circumstance when applied to credit unions.

The absurdity of this universal, versus particular,  definition is shown in one example. The rule puts $5.6 billion State Farm FCU, a traditional auto and consumer lender with a long-time sponsor relationship, in the same risk-based category as the $15.1 billion Alliant, the former United Airlines Credit Union. Alliant has evolved into a branchless, virtual business model with an active “trading desk” participating commercial and other loans for other credit unions.

NCUA’s “complex” application of the PCA statute is totally arbitrary based on neither reason nor fact.

Capital design: the most important aspect of “Cooperative Character”

The PCA authority additionally requires that the Board, in designing the cooperative PCA system, consider the “cooperative character of credit unions.” The criteria, listed in the law are that NCUA must take into account: that credit unions are not-for-profit cooperatives that:

(i) do not issue capital stock;

(ii) must rely on retained earnings to build net worth; and

(iii) have boards of directors that consist primarily of volunteers.

The single most distinguishing “character” of credit unions is their reserving/capital structure. Virtually all credit unions were begun with no capital, largely sweat equity of volunteers and sponsor support.

The reserves are owned by the members. They are owed to them in liquidation and even partially distributed, in some mergers.

These reserves accumulate from retained earnings, tax exempt, and are available for free in perpetuity-that is, no periodic dividends are owed.  Many members however can receive bonuses and rebates on their patronage from reserves in years of good performance.

Most products and services offered by credit unions are very similar to those of most other community banking institutions. The most distinctive aspect of the cooperative model is its capital structure, not operations.

Cooperative Capital Controlled by Democratic Governance

This pool of member-owner reserves is overseen by a democratic governance structure of one-member one- in elections.  The reserves are intended to be “paid forward” to benefit future generations.  This reserving system has been the most continuous and unique feature of cooperative “character” since 1909.

This collective ownership forms and inspires cooperative values and establishes fiduciary responsibility.  Management’s responsibility for banks is to maximize return to a small group of owners; in coops the goal is to enhance all members’ financial well-being.

This capital aspect of the cooperative charter is so important that if credit union management decides to convert to another legal structure, a minimum 20% of members must approve this change. No other financial firm has the character of a coop charter with its member-users rights and roles. Not even a mutual financial firm.

Bank’s Capital Structure Very Different from Cooperatives

For banks, capital funds are raised up front, usually from private offerings or via public stock. Owners expect to profit from their investments. Dividends are paid on the stock invested as part of this anticipated return. Today shares represent about 50% of total bank capital.  In credit unions, it is zero.

Bank capital stock, if public, can be traded daily on exchanges. The market provides an ongoing response to management’s performance.

This capital is not free as most owners expect a periodic dividend on their investment.  As an example, in the third quarter of 2021, the banking industry distributed 79% of its earnings in dividends to owners.

There is no connection between a bank’s capital owners, and the customers who use the bank, unless customers independently decide to buy shares in the bank. In credit unions, the customers are the owners.

The remaining component of bank capital is retained earnings. However, every dollar of earnings before  added to capital, is subject to state and federal income tax. Credit union retained earnings are the only source of reserves as noted in the PCA act.  These coop surpluses accumulate tax free.

In design, accumulation, use and governance credit union reserves are of a totally different  “character” than bank capital. Their purpose is to support a cooperative financial option for members and their community.

Bank capital is meant to enrich owners through dividends and/or future gains in share value.  Credit unions’ collective reserves are to benefit future generations of members.

Credit unions are not for profit.  Banks are for profit.

In a capitalist, private ownership dominated market economy, the cooperative’s capital structure is the most distinctive aspect of credit unions.  This is not because of its amount or ratio.  It is its “character,” from its origin, perpetual use and  oversight by members.

Nothing in the CCULR/RBC rules recognizes this especial “character” of credit union capital.  By not addressing this issue, the rule ignores this constraint of the  PCA enabling law.

The historical record demonstrates that  credit union reserves are not comparable to bank capital.  Rather they are a superior approach tailored to the cooperative design.

Tomorrow I will look at the third test, whether RBC/CCULR conforms to the PCA’s requirement of comparability.

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RBC/CULR: The Most Destructive, Unsupported Regulations Ever Passed by NCUA

(Source for quotes below: the December 16, 2021 NCUA board video:  https://www.youtube.com/watch?v=zstCJgfdYTM)

In two prior blogs I outlined several problematic aspects of the new CCULR/RBC rules:

  • The instant implementation, nine days after posting, raising the “well capitalized” standard by 29% on January 1, 2022
  • The immediate imposition of three capital tests replacing one, long-standing, easy to understand 7% leverage ratio. The RBC tools are not yet available for credit unions to know where they stand.
  • The inane rationale justifying CCULR as a regulatory “off ramp” from the admitted draconian compliance burden of RBC
  • Imposing additional capital requirements in the $ billions on credit unions below the new 9% standard
  • Restricting credit unions’ use of their  reserve buffers, created over decades, above 7%. If every CCULR eligible credit union elects this 9% well capitalized minimum, they must sequester over  $26.8 billion in spending for member benefit.  To regain control, they must submit to RBC.
  • The abrupt disruption of long approved credit union plans by these new financial constraints
  • The financial downgrade of hundreds of credit unions from their previous “well capitalized” net worth standing

Combining RBC/CCULR in one package is the ultimate regulatory hubris.  NCUA’s  new higher capital requirement, was  to mitigate the extraordinary burden of the RBC.  Both remain. As Board member Hood commented:  The RBC rule is so tragic, that yes, it needs an off ramp.

Only a myopic, closed bureaucracy, completely indifferent to its impact on credit unions, could create such a convoluted compliance outcome.

Never in the history of NCUA has so great a regulatory burden been imposed on so many credit union members with such groundless reasoning and data.

The Absence of Substantive Objective Data

When implementing a statutory requirement as NCUA claims to do with these intertwined deformities, the federal administrative procedure process requires there be substantial objective data to support the action.

The legal principle is simple: if the government is going to restrict the choices people are making under their own agency, then the regulation must document the harm either taking place or to be prevented. In this case ,the issue is the credit union system’s safety and soundness.  One board member stated the regulatory requirement in December this way:

Rodney E Hood:  The framing of the issue today is really about capital adequacy and if credit unions have shown through history that they have sufficient capital to serve member-owners while facing various risks.

Have the financial outcomes of credit unions failed to meet NCUA’s safety and soundness standards  prior to this?

NCUA presented neither past failures nor current inadequacy to support these increased capital changes.  Credit unions’ track record since the implementation of PCA in 1998, following the RBNW (risk-based net worth) rule, is one of increasing safety and soundness even during the peak of the Great Recession.

Unnecessary, Unjustified and Unneeded

For 110 years credit unions’ reserving results, in good years and bad,  have proven prudent, adequate and responsive to changing market risks.

In the traumatic GDP drop during 2020’s first quarter’s national economic shutdown (the largest fall on record) and the subsequent multiple economic uncertainties due to COVID, the NCUSIF recorded zero net cash losses in both 2020 and 2021.

Credit unions achieved record two-year share growth, increasing levels of capital, and even stronger performing loan portfolios during this unprecedented crisis.

Throughout the last two decades credit unions have maintained a reserve buffer of over 300 basis points above the required well capitalized 7% standard, as pointed out by Vice Chairman Hauptman in his comments about the rule.  The following chart shows the capital levels during these two decades, including the years of the Great Recession.

Only One Credit Union Failure in the Last Ten Years Would Have Come Under RBC

The most critical fact about why the rule is unnecessary was given by staff in response to a question by board member Hood.

Rodney E. Hood: . . . what have been the largest five losses to the Share Insurance Fund over the last ten years, and what were those losses to be specific?

Kathryn Metzker (staff): When reviewing credit union losses of natural person credit unions in the last — I actually looked back about ten years . . .The risk-based capital framework would only apply to one of the (five) failed institutions as mentioned earlier, one credit union over $500 million as the remaining four have assets less than the complexity thresholds.

Earlier in the dialogue, she identified the additional capital requirement shortfall under RBC in this one case as $77 million.

Hood’s other comments on the rules are illuminating and cogent:

After serious study and consideration, my preference is to consider repealing the RBC rule outright and fine tuning our existing risk based net worth rule.

The reality is that RBC should be a tool and not a rule, and if it is effective in identifying risk, then it should be put in the examiner’s toolbox.

But the last thing I think the NCUA should do is impose it on credit unions as an operating model. The juice isn’t worth the squeeze for risk-based capital, because this is a regulatory burden with what I believe is limited benefit.

 I think risk is something that you manage each and every day.  It’s not a formula you can run on your balance sheet.

Chairman Harper’s Defense of CCULR

Chairman Harper is the author of this action. He asserts that RBC/CCULR is required under his interpretation of the PCA statute.  To defend his support of a 9% CCULR minimum versus his original 10% proposal, he cites Goldilocks and the Three Bears’ logic.

Harper: Our biggest decision in finalizing this rule was at what level to set the CCULR. In reaching a consensus, we looked at the lessons of the famous children’s story. Some wanted the leverage ratio to be 8%. I view that as too soft. I wanted the final CCULR level to rise over time and reach 10%, a level that others considered too hard, so we compromised and permanently set the CCULR at 9%. That ratio turned out to be just right. While lowering a credit union’s capital risk‑based compliance requirements, CCULR actually increases the system’s capital buffer.

The RBC complex burden was so clear even to NCUA that it proposed the CCULR “off ramp.” The 9% “just right” number was selected because the Board did not want to make it too easy “to move between the two capital options” or what it called “the potential for regulatory arbitrage between the two frameworks.”

From both a macro and a micro data perspective, there are no facts to support raising the credit union system’s capital requirements. The RBNW approach with the long standing 7% minimum required by PCA and has proven sufficient time and again.

The absence of objective data is important for future corrective action.  Once this rule becomes embedded in NCUA and credit union  actions, there could be reluctance to give up this expanded financial comfort cushion, no matter how damaging to members it might be in the meantime.

A Fast-Burning Fuse of 500+ pages of rules

Both in substance and process these rules are an extraordinary and unprecedented immediate regulatory burden.

The rules were approved with a short burning fuse of just 9 days.  If the 10% standard in the proposal had been adopted, it would have been with a two-year phase in.  But 1% lower, no phase-in needed.

There was no recognition that the only source of credit union capital is retained earnings which are only built up over time. There was no crisis or need for immediacy.  RBC was first proposed in 2014, seven years earlier.

RBC/CCULR is a failure of regulatory discretion and judgment.  NCUA’s RBNW rule had been in effect for over 20 years. It embraced limited certainties from observed experience.

The new rules present unlimited certainties about every asset’s potential risk.  These risk weightings are projected into the indefinite and unknowable future.  It did so ignoring all “substantive objective evidence” of the cooperative system’s capital adequacy and sound performance under the existing RBNW.

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TheDisruptive Costly Reach of CCULR/RBC: $30-$40 Billion For Initial Compliance & No longer Available for Members

The direct immediate impact of the new CCULR/RBC rule requires credit unions to hold between $30 to $40 billion more in reserves.  These funds cannot be used for daily operations such as expenses to increase member value or lower fee income or loan rates.

A major portion of these newly restricted funds is in credit unions that follow the 9% CCULR minimum required reserves versus the RBC option. The $24.3 billion CCULR “off ramp”  means these funds are unavailable for operations but required to stay in reserves.

This is from the December 16, 2021 Board Action Memo:

Of the total 680 complex credit unions as of June 30, 2021, 473 have a net worth ratio greater than nine percent and would be well capitalized under a nine percent CCULR standard. Of those 473 credit unions, the Board estimates that all of them meet the qualifying criteria, and are thus eligible to opt into the CCULR framework.

Under the CCULR, if all 473 credit unions opted into the CCULR and held the minimum nine percent net worth ratio required to be well capitalized, the total minimum net worth required is estimated at $111.8 billion, an increased capital requirement of $24.3 billion over the minimum required under the 2015 Final Rule. This additional capital would strengthen the system’s ability to absorb any future financial losses and economic shocks.

(Note: the 493 credit unions over $500 million and 9% net worth or greater, held $1.340 trillion in assets at yearend 2021. Therefore, when NCUA raised their net worth well capitalized requirement from 7 to 9%, the rule placed a total of $26.8 billion in restricted retained earnings. These extra funds are no longer available for credit unions to use as they choose-or else lose their CCULR option.)

The Disruptive Spread of the New Red Line

The new rule in theory applies only to the 83% of credit union assets with over $500 million. However, this 29% higher CCULR option will not be available to approximately 210 credit unions with $386 billion in assets. Before this rule they were considered “well capitalized.” And only three of the 210 would have been below the 7% well capitalized level.

All now fail the  revised “well capitalized” ratio.  The immediate regulatory sanction is to subject them to RBC, an entirely different  more complicated process under the never implemented rule.

All these,  24% by assets (30% by number), of this  $500 million class are in an RBC never-never land of capital measurement.  However the immediate impact is much broader than these 210 below the new 9% red line.

RBC’s  Shadow Extends Beyond 9%

Every credit union over the 9% threshold is now on notice that any short term run-up in assets  could result in their ratio falling below this new minimum.

As an example, there were 70 credit unions between 9 and 9.35% net worth at yearend.  Any time their asset growth exceeds the capital growth, the ratio will fall.

Historically, the highest amount of share growth occurs in the first two quarters.  If a credit union has 9.3% at the beginning of a month and grows 3% in assets, the net worth ratio falls to 9.0% by month end.

Since capital increases only through retained earnings, at an average of 1% of assets per year,  every credit union between 9 and 10% faces a dilemma: either  limit growth or increase ROA by amounts above traditional returns.

There are 173 credit unions in the 9-10% net worth range that will be in a state of unending compliance uncertainty as their ratio moves up and down in monthly variations.

 CCULR’s Shadow Hovers Over Those Below $500 Million

Many credit unions below $500 million must now closely monitor their growth and capital because when they cross this size threshold, the old 7% well capitalized rating no longer applies.

An example: At 2021 yearend there were 119 credit unions in the $400-500 million asset segment. They managed $52.7 billion in assets. Forty-five of these,  with $20 billion in assets, reported net worth below 9% and would not be CCULR eligible when passing $500 million.

Assuming this entire segment grows by the industry’s long-term average of 7%, then 13 credit unions with $465 million assets (or higher) at January 1 this year will be over the $500 million threshold by yearend.  They must monitor and calculate three capital measures simultaneously: the current 7%, the new 9% CCULR minimum, and failing that, the arcane rabbit hole of RBC.

An estimate of the total number of these three groups of credit unions that must immediately put net worth at the top of their business priorities is over 502, holding approximately 35 to40% of total industry assets.

This sudden new financial priority will turn upside down established business plans, pricing initiatives, and investments in new service capabilities.

Credit unions are being forced to turn away from serving their members to complying with NCUA’s  needs.

To this point in time, the industry’s average 2021 yearend capital ratio of 10.6% would be evidence of prudent capital management. That ratio is 360 basis points (3.6%) above the long standing well capitalized 7% benchmark. (see buffering discussion below) Financial uncertainty now permeates every business decision where there was none before.

The Tens of Billions Taken Away from Member Value

It is the members who will pay the cost.

To comply with this new capital standard, credit unions have two broad options.  First, closely limit all growth.  NCUA’s habitual approach to capital restoration plans is to require “downsizing” of assets to fit the available capital.

The second option is to ask members to pay more: no more over draft or other fee reductions, higher loan rates, or accept lower savings than would be the possible under the long standing 7% standard.

If the choice is downsizing, fewer members will be served with fewer loans and services.  If the choice is to require members to pay more, the direct additional costs are easy to calculate.

The 210 credit unions not in compliance with the 9% CCULR minimum, are collectively $2.7 billion short of capital under the new standard. That shortfall assumes no growth in assets.  Before the 7% benchmark was eliminated, these credit unions collectively maintained a margin of 1.31% above that old standard.

For these 210 with the $2.7 billion shortfall, setting a net worth goal just 1% above the 9%, would require another $3.9 billion.  This $6.6 billion total for more capital just repositions them relative to where they were under the old standard.

How easy is this to accomplish? In 2021 the entire movement grew total capital by 6.7% to $221 billion. The $6.6 billion more to exempt these 210 credit unions from  RBC requires an increase of 21% in their current net worth.  This is roughly three times the growth rate of capital in the industry.  And that assumes these 210 have no asset growth while they are building this new capital level.

Total Business and Financial Disruption Costing Members Tens of Billions

The other 292 credit unions above $500 million  in the 9-10% net worth range, and the 119 credit unions in the $400-$500 million below the new red line, will face similar challenges to their business model.  For example, in the $400 million plus segment, 45 are below 9% now by a total of amount of $195 million.

All these 502 credit unions face the same urgency of modifying previously approved business plans. Now they must either limit growth or charge members more.   Either choice is done at the members’ expense.

Before this apocalyptic rule took effect, at yearend 2021 only six credit unions in the $400 million and above category were below the 7% well capitalized standard. And five were considered “adequately capitalized.”

By changing the rules of the game overnight, NCUA has created a perception of financial weakness. At the same time the regulator has prevented credit unions from using literally tens of billions in existing reserves in the manner boards think best to compete in the market.  These funds were prudently set aside for the proverbial rainy day.  But now are restricted from use.

The cooperative system has been called to a financial halt by NCUA.  It reputation has been  turned upside down in member and public perception in a mistaken effort to make credit unions appear safer.

The outcome will be just the opposite.  The rule’s complexity and RBC uncertainty will just cause more sound, long serving credit unions to throw in the towel.

Capital is not and has never been the critical component of credit union success.  It is the resilience of leaders.  It was the founders’ passion that began these enterprises with no capital.

This newly imposed costly regulatory burden will lead current volunteers and professionals to feel they can no longer make the critical business decisions about how to best serve their members.

The government-NCUA-has now asserted by rule, that they know more than credit union’s leaders about how to manage  business decisions.

Appendix:  The Buffering Mentality Will Raise the Member Costs Further

The $30-40 billion cost estimate in new capital requirements does not include the credit unions “normal” buffering behavior.  Here is how Vice Chairman Hauptman raised the issue at the December board meeting.

Kyle S Hauptman: And we do know that . . .they keep a buffer of 3% right now, a little over 3%. Do you have any reason to believe they will not continue to keep a buffer of around 3% in the future? 

Tom Fay(staff): I don’t think I could estimate that, Vice Chair. 

Kyle S Hauptman: Okay, well, we can agree they do, now, have a ratio. All I’m trying to say is, when we say oh, no, this isn’t going to affect somebody because most of them, you know, if you already have 9.5%, you’re in the clear, but we already know that they like to have a buffer.

So, I think we just need to acknowledge that based on the way the credit unions operate, that being just above 9% does not mean you’re in the clear to meet our 9% CCULR because we know that they want to have a buffer for the reasons you just eloquently said. . .

. .  we shouldn’t be doing this without acknowledging that we are making credit unions hold substantially more capital because they’re going to have a buffer.

You think it’s good to have a buffer; so do I. We are raising the standards for credit unions. I just think we need to be clear about that. We shouldn’t be disingenuous to say, oh, no, look how many of them have over 9%. They should be fine with CCULR.

Well, we already know they have a buffer, so there’s no reason to think the operations of the credit unions will suddenly change; and we are raising capital for the vast majority of these because they will have — that number of 10.2%, at least for those subject to RBC and CCULR.  I’m happy to bet you that that number will go up because of what we are doing today.

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NCUA’s Apocalyptic New Year’s Surprise for Credit Unions

On December 23, 2021, NCUA filed a new rule, RBC/CCULR, in the federal register. It took full effect just 9 days later on January 1, 2022. This rule is the most consequential ever passed by NCUA, and the most damaging.

The change immediately affects 83% of 2021 yearend credit union assets.

Using a purported rationale of improving the safety of the system, the rule will result in the opposite outcome. It significantly handicaps the ability of credit unions to make decisions about how best to serve their members using their own experiences and judgments.

This catastrophic new burden will accelerate the merger of sound, well-run credit unions approaching the $500 million starting line for CCULR/RBC.  It will  energize this culling of hundreds of successful medium-sized local institutions now facing an overnight  fundamental change in compliance burden.

The New Year Shock

Credit Union 1, Rantoul, Illinois, wins the award for the first credit union to publish its full 2021 Annual Report including year-end financial data and ratios.

The President’s Report  by Todd Gunderson, CEO, contains the following upbeat assessment:

CU 1 loan portfolio growth was 15% as we extended $ 916 million in loans to our members throughout the year—an increase of 43%–and $276 million from the 2020 year.  The additional loan interest income helped CU 1 achieve a record net income amount for the 2021 year, bringing net capital rate or our rainy-day fund up to 8.71% of assets.  This keeps CU 1 well in excess of what regulators call a well-capitalized credit union, defined as 7% net capital.   

CU 1’s total assets had increased to $1.226 billion or by 4.8%.  At the same time, it raised its net worth ratio from 8.21% in 2020 to 8.71%.

Chair Bob Eberhert was equally proud of CU 1’s regulatory standing:   “. . . our future . . .is about having the trust of membership by being a sound member-oriented financial institution that propels CU 1 to be awarded the highest rating that can be bestowed upon a bank or credit union by  banking supervisory regulators.

These statements were accurate for exactly one day, December 31, 2021, when the books were closed.

CU 1 is the first of hundreds of credit unions that entered the New Year believing their past performance was at the highest standard.  They will now find they are in a literal regulatory net-worth “no-man’s land” where no coop has ever been.

Enter Three Capital standards

Every credit union over $500 million in assets saw their minimum ratio for “well capitalized” raised from 7% to 9%, a 29% increase, on January 1, 2022.

No phase in, no transitions, no analysis of the consequences, and imposed despite no demonstrated need at the individual credit union or system level by NCUA.

From one simple, easy to compare century-long standard, these institutions are now subject to three interlocking capital requirements.  These rules entail multiple options for calculating the numerator for “capital reserves” under the three standards.

The denominator, or “total assets,” now requires hundreds of specific math calculations as well as evaluating alternative methods. These factors include whether the asset is on and off the balance sheet, multiple time periods for determining “average” assets, and every asset’s relative risk calibrated precisely to a government mandated and calibrated formula.

The chart below presents this new tri-part capital era. The system has gone from the left column of clearly understood and applied net worth of 7% with five gradations, to the completely open-ended 500+ page-RBC/CCULR formulas and criteria.

Capital Options Table

A Direct Member Tax

The rule handicaps credit unions from spending money to lower fees (eg. overdraft charges), offer better savings or loan rates or even initiate critical programs such as cyber security or ESG initiatives.

Instead, this income must now be put into reserves where the amounts already set aside have proven more than sufficient through every previous financial crisis.

Every one of the 100 million plus members in a credit union subject to, or nearing this rule’s reach, will pay the direct costs of this regulatory tax in higher fees, lower savings or higher loan rates.

The members most affected will be those at the margin, with lower credit, just starting out after leaving school, or returning to the labor force; that is those traditionally perceived as higher risk.

Hundreds of Credit Unions Impacted

Hundreds of credit unions like CU 1 now find their “well-capitalized” regulatory standing downgraded overnight.  From understanding and complying with a capital standard proven over 100 years, they are immediately thrown into  a regulatory purgatory.

RBC/CCULR is a purgatory of changeable definitions and formulas in which every asset decision is now subject to a government-dictated risk rating.

Every credit union over $500 million in assets (83% % of total assets) can now be whipsawed between two different capital standards.  NCUA reserved the authority to impose the capital model they want,  regardless of the credit union’s choice.

No more respect for credit unions’ four-decade track record of demonstrated risk management honed in the marketplace since deregulation.

These two draconian rules of 500 pages are in effect now. No phase in, no transitions, no analysis of the consequences, and implemented with no reference to the actual capital soundness of the industry.

It is a regulator taking an action because it can. The traditional due processes and institutional checks and balances, at the board level, failed.

Uncertainty  About Cooperative Soundness Undermines Public Confidence

The agency gave itself the authority to micro-manage every asset decision made daily by 5,000 credit unions.  It is the most extreme example of an independent regulator asserting control over every aspect of a credit union’s operations.

This rule is  the worst kind of regulatory putsch possible. It is an assumed authority run amok.

It throws the credit union system into a public relations debacle.  For credit union leaders it creates a compliance wonderland of uncertainty about the rules of the game.

Will all CAMEL 1 rated credit unions below 9% now become CAMEL 2?

Will this incentivize the sale of subordinated debt with members paying the added cost of capital to be compliant?

How does anyone– the regulator, the members, the public– compare credit union performance with three very different ways of measuring “well capitalized”?

Will this intrusive regulatory grading of every asset decision override credit unions’ learned experience? And inhibit serving members and making investments required to stay competitive?

In upcoming posts I will show why RBC/CCULR is “the fruit of a poisonous tree.”

 

 

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Bon Mots IV-The Power of Local

“A place belongs forever to whoever claims it hardest, remembers it most obsessively, wrenches it from itself, shapes it, renders it, loves it so radically that he remakes it in his image.​”   Joan Didion

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Maurice Smith, CEO, LGEFCU:  “What if credit unions could crack the code for sustainable, scalable wealth-creation for disenfranchised communities? It’s really anchored in the notion that we as credit unions should focus on the people who need us the most.”

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Linda Bodie CEO of Element FCU as reported by Denise Wymore:

Bodie:  “I can offer a lot more products, services and solutions even though I’m small. There’s no reason to sit back and not do something because of your size. Size doesn’t matter … not when you have the power of a cooperative system.”

Denise: Here are the three things your credit union can learn from the team at Element FCU:

  1. Bigger is NOT better. In spite of what our industry is obsessed with.
  2. Live the 6th cooperative principle: cooperation among cooperatives to gain economies of scale. There are alternatives to mergers if we just work together!
  3. Stay loyal to your brand and your target. Make your competition irrelevant by doing something that your competitors WILL NOT copy.

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Notre Dame FCU President/CEO Tom Gryp: “Our ability to pay above-market wages to our incredible partners (employees) is a direct reflection of the loyalty and support of our members. My deepest thanks go out to our growing membership base, who without their ever-increasing utilization of our services, none of this would be possible.”

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Jared Brock, self described  author, PBS documentarian, and cell-free futurist podcaster; a “free market” sceptic on “what we desperately need right now:”

Invest in your community — IE, start a family business, co-operative, community-owned company, not-for-profit, for-benefit, or partnership with one or more competent entrepreneurs with complementary skillsets such as:

  • Local, sustainable, organic food producers.
  • Local, sustainable, organic hemp clothing manufacturers.
  • Geothermal, mini-wind turbine, and micro-hydro installers.
  • House renovators to transform aging units into ultra-efficient eco-homes.
  • Builders of owner-occupier-only houses, neighborhoods, and cities. (We need to build 750+ million houses in the next 28 years or three billion people will be living in slums in our lifetime.)
  • Experienced political operatives to fundraise and start new, pro-democracy, pro-sustainability, anti-corporate political parties.

The reality is that we need a generation to build companies that give instead of take, that contribute instead of extract, that cement communal stability instead of undermining its foundations.

I sometimes wish we could get rid of grow-forever corporations and move forward solely with local/regional companies and partnerships and co-ops and for-benefits.

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In The Speechwriter (2015), Barton Swaim remarks that South Carolina Governor Mark Sanford, whom he worked for, “knew bad writing when he saw it, except when he was the author.”

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Weekend listening, 5 minutes.  Ancin Cooley, credit union consultant:  “give someone else a shot at leadership before merging.”  https://www.youtube.com/watch?v=pUWkTZe-sgg