Underwriting Cooperative Designs

The list of the top 100 US cooperatives by total revenue lists only five credit unions.

Do you know the co-ops operating in your communities? How are credit unions supporting cooperative solutions especially with needed, local  startups?

A proposal  from Finland where 90% of the population belongs to a co-op

It would be fair to say that the American credit union movement was born from a unique way that Edward Filene did charity. He helped reduce obstacles people face when they try to help themselves by setting up cooperatives. As it became harder and more expensive to start new credit unions, this tradition started to fade away. It could be more complex for credit unions to help people set up cooperatives, other than credit unions, because it requires different expertise. But I hope credit unions would ask themselves – if we are not carrying on Filenes distinctive civic tradition of helping start new coops, who is? 

It’s common for credit unions to donate to food banks and other local charitable efforts.  

What if some of those donations would be used to give food cooperative coupons/vouchers to credit union members who are struggling economically? Ideally the food cooperative would also provide opportunities to get further discounts by volunteering to help run the business, as is common in grocery coops. 

I think many would find this sort of mutual self-help more dignifying than being given food from a food bank – not that there should be a stigma in doing so. Perhaps especially men who are reluctant to get assistance would find this psychologically more helpful. Abstract models of comparing the logistical cost-effectiveness of providing food through food banks or food cooperatives can’t capture this difference. But can credit unions? 

It could be used to demonstrate the cooperative difference of credit unions in a way no advertising campaign could. The Open Your Eyes campaign remaining budget was $50 million. What if there was an equally large campaign, where 5 million credit union members would use a $10 coupon in a new cooperative business?


It doesn’t have to be limited to food cooperatives either. Maybe a couple who open up a joint-account could be given a pair of movie tickets that could be used in a local cooperative cinema. The possibilities are endless.  

Leo Sammallahti

The Problem We All Share Part III: Addressing the Problem

A Solution: Open Up Market Participation and Transparency

I believe more open competitive forces must be added to a Board’s decision to give up their charter. All merger intentions should be announced in a public notice so that any interested party is able to participate when a board decides to end its independence.

For example, why should Post Office in Madison or Sperry Employees in Long Island negotiate their members’ future in secrecy and then announce their decision without other area credit unions able to “bid” for these long-standing, local, well-capitalized ”franchises?”

Why not give members a real choice of a convenient and familiar credit union as well as one that is remote, digital only, and with no connections to the community?

Bringing more market forces could add better options for members. If two large billion-dollar credit unions want to merge locally, why shouldn’t a large credit union from outside the market be able to participate and preserve a real choice for members?

If the members are informed by an open process, they are more likely to support the board’s recommendation. Now they are forced into a combination they know nothing about and where the results are approved by only a very tiny minority of members returning the requested mail ballot.

Mergers that Enhance Safety and Soundness

Opening up the merger process would make the credit union system more transparent, responsive and relevant for members and their communities. Facts and plans would have to be laid out, not merely bland marketing assurances of “ a better future.”

Credit union safety and soundness would be enhanced because members can make an informed choice. Interested credit unions must take their time to present a relevant option. Token payouts of members’ equity to achieve a positive vote could be replaced by considered bids for the credit union’s real value, including good well.

As presented in Part I, PenFed’s five-year performance has not been enhanced by its merger-growth efforts. Its asset growth rate is half that of its peers; expenses are rising and there are no obvious economies of scale. Asset quality challenges have heightened. There is no evidence members see better value. Member relationships are declining. PenFed’s ROA and asset growth increasingly depends on acquiring other credit union’s net worth. Mergers are disguising its underperformance and slowing internal growth.

Even more pernicious is that PenFed’s mergers have eliminated 20 credit union boards of directors, CEOs and senior management teams. Twenty seeds of future innovation are gone. Multiple long-term relationships with local communities are broken. Members’ loyalty is discarded. None of these outcomes enhances the cooperative system’s financial diversity or soundness.

Transferring the financial equity from generations of members to a board and senior management with no connections to the community’s surplus further removes members from their cooperative creation.

Directors’ view of their responsibility changes in mergers. Instead of acting as stewards of a legacy they inherited, they become deal makers. They routinely ratify payoffs to other credit union’s directors and employees as just the “the art of the deal.” Values be damned.

In the end, the current secret negotiations corrupt both credit union buyers and sellers. And in so doing, the cooperative model.

The Problem We All Have

The current merger practice promotes the privatizing of members’ common wealth and the degrading of credit unions’ role in their communities. Because participation in voting is so minimal, members are left with the feeling they were not informed, or maybe even tricked. The experience is no different than when a bank is sold. Instead of being the alternative to for-profit capitalism, the industry is becoming that which it was supposed to replace.

There are two traditional approaches to system problems. The first is, let the “free” market work it all out. Give the forces of competition loose rein so the magic of the invisible hand can create the best outcome. In the end, all will be right. Winners take all.

The second is that government must step up to regulate abuses, enact better rules and enhance its supervision of the current practice of routine signoff.

But I recommend a third solution built on cooperative principles. Let the members decide. One person, one vote. Put their interests truly front and center.

There are multiple current merger practices that would give member owners the information to have a real choice about the future of their credit union. Working with the industry, regulators should design a truly “cooperative” process that enhances members’ involvement and in so doing, their commitment to the outcome.

The revitalized process would seek traditional financial and operational proposals combined with the important qualitative values credit unions promote: community connections, local focus, giving back to members, and demonstrated track records.

For many Americans, the lack of trust of those in authority is based on their perception that leaders place their interests above their own and the community’s broader shared values. PenFed is a prime example of an outside organization hollowing out local communities by cashing out its leaders.

The social trust on which the cooperative model exists is enhanced by a more visible and transparent process. The public support for the industry’s tax exemption is upheld. The movement will be guided by the shared set of norms and values that created it.

Going from Spectators to Engaged Co-op Citizens

With over 99% of credit unions in NCUA’s lowest risk CAMEL ratings, it is easy to lose sight of the interdependence and cooperation on which the cooperative movement is established. The common good slowly recedes to second place versus individual institutional success.

Market forces are not motivated by the common good or subject to moral limits. Credit unions were to be a counterexample to Mark Twain’s assessment of human motivation:

“Some men worship rank, some worship heroes, some worship power, some worship God and over these ideals they dispute and cannot unite–but they all worship money.”

Current merger excesses are destroying the moral capital created by movement’s founders. Instead of active citizens we become spectators or voyeurs hoping the abuses will go away or maintaining that this is not my problem.

A Renewed Movement

However, movements are not simply a one-time past occurrence, but rather something we can all participate in our own time.

Individual economic isolation and the power of large monopolies which gave rise to the progressive movement at the turn of the 20th century is as pervasive today as 100 years ago.

Some label credit unions as an industry. They are no longer disrupters of the status quo, but a mature segment of financial services with resources, opportunities and influence to play like the big boys. Movements are a moment of history, not the current reality they argue.

Both views can be true, but when movement is left out, credit unions become identified with the status quo and its problems, versus innovators of trusted value to members.

In its finest expression, cooperative design is an ongoing experiment to address the shortcomings of unfettered capitalism. It takes only a few leaders to stand up for change to convert perverse merger activity to a more productive outcome for members. Who will have the foresight and courage to push this to the top of the movement’s agenda?

The Problem We All Share Part II: Mergers’ Impact on the Cooperative System

Part I documents the flailing financial performance of PenFed’s merger growth strategy. It increasingly depends on acquisitions of sound, well-capitalized credit unions to prop up its below average financial performance.

Why should this be a concern of other credit unions? Or industry leaders? Or regulators? Aren’t mergers independent decisions by CEOs and boards claiming to do the right thing for their members? Why should others get involved in these “consenting combinations” of two distinct firms? And if there is something untoward going on, isn’t that the responsibility of the regulators to address, not other credit unions?

So far, PenFed has acquired 20 credit unions, the vast majority of whom were exemplary models of how credit unions can make a difference for their members and local communities. This value established over decades is ended by PenFed mergers and replaced by a distant, virtual model devoid of local connection and relationships.

PenFed’s actions are not only a sham strategy, they also debase and weaken the cooperative system.

Induced Consent

The process by which this is done is to pay CEO and senior staff severance bonuses and other salary and benefit increases, provide one-time staff bonuses as much as 10%, and often offer a special bonus dividend of several hundred dollars to members—all contingent upon member approval of the merger.

These incentives ensure the required member vote is a mere administrative formality. It presumes the decades of member trust and loyalty can be relied upon so they will follow the recommended action of the board and familiar management team. The member vote is largely by mail and the required in-person meeting is always on the final day of voting. That timing eliminates the opportunity for discussion of alternatives by members.

This managed process virtually guarantees approval. The percentage of members who vote in favor are always in single digits, but none the less sufficient to meet the only legal requirement– that a majority of those voting must approve the merger.

The process is both dishonest and corrupting. Member voting is charade. NCUA’s merger regulation gives legal cover to the payment of personal incentives that by any objective criteria bear all the earmarks of payoffs.

The Falsehoods of the Participants

This duplicity is confirmed by other documents. There are written statements by the leaders which contradict the merger action recommended. For example, Sperry Associates FCU’s CEO, two weeks before the mailing of the Member Notice, published an op-ed in Credit Union Times, extolling the superior strategy and performance of his ”right-sized” credit union versus larger or smaller ones in the pandemic:

A larger firm would have had to schedule meetings, create committees and navigate the rough waters of corporate politics, while a smaller firm would be working to enter the market. For us in the middle, we were the right size to react appropriately, all while using our internal talents to ensure that due diligence was conducted, and our solutions were beneficial to those we serve.

Is This Who We Are? Part I: The Proposed Merger of PenFed and Sperry Associates FCU

PenFed’s merger eliminated this credit union’s single office and ended virtually all of the local activities and relationships. The 16,303 members are now required to transact all contacts virtually.

Sperry’s Chair had been honored as volunteer of the Year by the New York Credit Union League in June 2020. He readily accepted knowing that in January he had agreed to the PenFed merger, an action not disclosed until July, after the award.

The Proposed Post Office Merger in Madison WI

Corruption is a form of dishonesty or criminal offense undertaken by a person or organization entrusted with a position of authority, to acquire illicit benefit or abuse power for one’s private gain. Wikipedia

PenFed’s acquisition of the $35 million Post Office CU follows the same game plan as the Sperry Associates FCU merger. The Wisconsin credit union, chartered in 1934, has a net worth ratio of 22%, seven employees, one branch and serves all of Dane County. It is sound, well-run and long serving. https://www.pocu.com/our-story

In the October 15, 2020 Special Meeting Notice, the required disclosures show that the CEO will receive a five-year employment contract with an increase in annual salary to $125,000; the Vice president has a comparable gain. “Select” employees will get a 10% retention bonus and all, a three-year employment offer. If either the CEO or Vice President terminates employment, they are eligible for one-time payments of up to $614,900.

Each eligible member will get a one-time $200 capital distribution “if the merger is approved and consummated.” This would be from the credit union’s 22% net worth of $7.6 million and is estimated at only 8% ($640,000) of this total. The remaining $7.0 million reserves transfers to PenFed as other operating income, that is free money.

The payments are in plain sight, all contingent on a merger. The member notice provides not a single rate, fee or factual service benefit from this action. In Sperry, the single office is being closed. In Post office the wording is vague: “PenFed intends to maintain the current POCU branch at. . .” This is not a commitment.

While the objective evidence of financial inducements is clear, how can one know this is not a considered, well intentioned decision to enhance members’ future? After all, the Post Office board of directors affirmed in their Notice that the merger is desirable for the following reasons:

  • Our board evaluated strategic possibilities to ensure that you our member, will continue to receive the full range of products and service you deserve.
  • We have been diligently seeking to find alternatives.
  • Only one option meets the full range of our objectives: growth of membership, expansion of product offerings, infusion of investment in IT cybersecurity, improved training and enhanced community service. . .PenFed is in the best interests of our members.

The director’s closing assurance of its considered judgment is given in these words:

“It is the recommendation of your Board that you vote “yes” to approve the merger. Please be assured that you are our valued member, and we have every confidence that you will be pleased by the level of commitment service, and value that you will receive from PenFed etc. . . “

If the financial facts were not sufficiently self-incriminating, the words above expose the dishonesty of the Board’s actions. There was no due diligence of PenFed that caused them to choose this from “ a range of options.” How do we know? Because these are exactly the same representations word for word sent to the members by Sperry Associates and Magnify, PenFed’s two most recent mergers. And the explicit “assurance” contained in the Notice, “we have every confidence that you will be pleased,” is exactly the same as in these two prior mergers.

PenFed assisted in the drafting of these notices. Since NCUA approved these wordings in the past, it will do so in the future, regardless of their veracity. NCUA endorsed Post Office Board’s assurance of due diligence even though there are no facts in the notice that would confirm this assertion. NCUA’s dereliction in ratifying these exact duplicates of alleged diligent representations of member interests, raises the question whether the agency has any clue about events.

As in PenFed’s other mergers, the leaders of Post Office have compromised their responsibility to their members. The member-owners will now be shorn of their credit union through their directors’ and CEO’s indifference to their legal and fiduciary duties.

NCUA Greenlights PenFed’s Conduct

The ONES office at NCUA oversees the examination of PenFed and approves all its mergers. It has seen the member notices that repeat word for word the misleading claims of due diligence and member assurance. It examines and tracks PenFed’s subpar financial performance.

NCUA has all the facts and fictions presented in Part I above. But the agency has no interest in members’ best interests, the phrase used to describe its merger oversight role.

NCUA issued its proposed merger rule in 2017 with following preamble:

In granting or withholding approval for a merger, the board is required to consider the following statutory factors: . . . the general character and fitness of the FICU’s management, the convenience and needs of the members to be served by the FICU. . . and in the case of competing proposals, “management must appropriately evaluate which. . .would be in their members’ best interests in terms of member philosophy and continued or expanded products and services.”

General character obviously is irrelevant so long as management discloses their personal gains and words of assurance—words which carry no accountability. NCUA has been aware at the highest levels of PenFed’s activity since the Ft. Belvoir merger in 2016. The Agency greenlights this avarice as long as the financial incentives promised management are divulged.

The words, character and fitness, mean nothing. NCUA’s actions are complicit and derelict in this perversion of “members’ best interests.”

Why This Is a Problem We All Share

The related and irreversible outcomes exemplified by PenFed’s mergers is that it is shutting down strong, well-run, long-serving, locally focused credit unions. These actions undermine member trust in the cooperative model. They erode confidence in the unique member-owned financial system.

As the CEO of Atlanta Postal Credit Union recently stated: “Likewise, although members of national postal organizations from other states were eligible to join APCU, doing business with a financial institution that was not in their home state probably did not come across as very practical.” Apparently Wisconsin postal workers don’t care about this practicality.

https://www.cutimes.com/2020/11/25/atlanta-postal-cu-launches-consumer-facing-credit-union-for-growth-opportunities/

PenFed’s goal for Post Office is not scooping up isolated $35 million credit unions in states where it has no presence or even legacy connection. Rather, it wants to demonstrate to a new market and another set of credit union leaders that these self-serving merger arrangements are an option for their future as well.

By putting small minnows on the hook, PenFed hopes to bring in much larger combinations. As documented above, PenFed’s organic growth has dwindled to almost nothing, 3.1%. But if this merger option is validated far and wide, along with its misleading claims about size, then as PT Barnum said, there is one born every minute.

Peeing in the Cooperative Swimming Pool

The temptations for apparent “easy growth” fueled by self-interested gains are not limited to PenFed. Other credit unions look for options to emulate this superficial outcome. Consultants line up to create “change of control” clauses in management contracts. Accelerated payments are structured upon the termination of benefit plans in mergers.

When one credit union repeatedly pollutes the water by peeing in the cooperative swimming pool, it will become unfit for all, not just where the offender swims. Ultimately the pool will be closed for good.

Orwellian Merger Logic Spreads

Not all mergers disdain member interests. But the reverse logic does not apply–that all mergers are good for members and the cooperative system.

Increasingly, merger explanations offer contrived reasoning void of fact. Others are outright sales manipulated for personal benefit. NCUA is partly responsible due to its routine endorsements. NCUA is validating flat out falsehoods and conflicts of interests. It has “legalized” the personal payoffs previously done behind closed doors.

Common sense suggests dubious combinations completed or announced have little to do with “members best interests.” Recent examples of these contrived explanations are the following:

  • Why would members of a successful $350 million community federal credit union in Maine have any interest in merging with a John Deere focused credit union headquartered in Moline, IL, more than 1,230 miles away? Moreover, the surviving state credit union would eliminate the one member one vote FCU governance model. It would be replaced by proxy voting in all situations and in which all votes are weighted by the amount of member shares. The Maine CEO’s assertion that this merger would “retain local control” when DECU’s board, not the members, make all the decisions is nonsensical. https://www.cutimes.com/2020/10/20/maine-credit-union-seeks-merger-with-an-illinois-based-cu-again/
  • Why should the members and employees of NorthStar Credit Union be forced to follow their CEO by merging with the credit union their CEO joined for a significant pay increase? Due to proxy voting, the members had no say in this transaction as the NorthStar board controlled the votes via proxies. https://www.cutimes.com/2020/08/18/seven-credit-unions-in-six-states-announce-new-mergers/
  • How do members, employees or the community benefit when two strong, long-serving independent billion-dollar credit unions merge in Minneapolis? Why should they give up the freedom of choice and the cooperative system lose the diversity and contributions of two independent leadership teams? https://www.cutimes.com/2020/05/05/billion-dollar-minnesota-credit-unions-plan-2021-merger/

Mergers become an addiction, not a strategy. The fix needs to keep happening or the whole enterprise starts to decline. Unable to innovate for organic growth, merging creates only greater size and a temporary illusion of success.

Mergers based on rhetorical flourishes are not plans, but chimeras. They turn the credit union model upside down. Instead of pursuing common benefit, personal ambition and gain become paramount.

As administered by regulators today, the merger process has become a blueprint for larceny. Better rules might provide an improved process. However, laws preventing wrongdoing do not prevent robbery.

Part III will outline a solution to this growing merger exploitation.

The Problem We All Share Part I: PenFed’s Spurious Merger Strategy

The traditional reasons for mergers of sound, well-run credit unions are the following: the credit union must get bigger quickly, to achieve scale necessary for greater efficiency, and to acquire more resources and internal capacity to improve member value.

On the surface the logic seems plausible. The challenge is that it is not self-fulfilling in practice.

Pentagon FCU (PenFed) has been the preeminent practitioner of this business approach. But a review of its results demonstrates how shallow and dubious the logic of a merger “growth strategy” can be.

PenFed’s Five-Year Merger Efforts

From September 2015 through the third quarter 2020, PenFed has implemented a very public, nation-wide effort and acquired 18 other credit unions via merger. The largest was the $420 million McGraw Hill FCU in May 2019. This followed the emergency January 2020 merger of the $320 million Progressive CU–with its open NY state charter–which enabled PenFed to serve anyone anywhere in the US.

The final stand-alone call reports from these 18 credit unions showed total assets of $2.4 billion. This total does not include the addition of the $265 million Sperry Associates FCU finalized in October, nor the proposed December merger of the $34 million Post Office CU in Madison, WI.

The Results of PenFed’s Merger Strategy-Faster Growth?

Since September 2015 the compound annual growth (CAGR) in Pen Fed’s total assets is 6.4%. Without the added mergers and $1.2 billion in additional borrowings, its organic growth rate is only 3.1%. In the five years prior with no mergers, PenFed’s annual internal growth was 5.3%.

The five-year peer growth rate for the 14 credit unions over $10 billion at September 2020 is 11.22%. None has a merger strategy similar to PenFed’s. PenFed’s 6.4% growth is only 57% of the peer’s pace and places them 13th or at the bottom of the peer table.

Five Year Annual Asset Growth for Credit Unions over $10 Billion in assets

( data: September 2015 & September 2020 assets)

Asset Rank State Name 2015 assets 2020 assets 5 Year CAGR
7 TX Security Service $9,052,442,285 $10,081,370,509 2.18%
3 VA Pentagon $19,223,138,716 $26,257,438,559 6.44%
2 NC State Employees’ $31,162,020,508 $45,851,733,095 8.03%
8 IL Alliant $8,463,784,328 $13,027,161,832 9.01%
13 MA Digital $6,519,513,295 $10,469,689,635 9.94%
6 CA Golden 1 $9,508,199,852 $15,567,120,747 10.36%
9 CA First Tech $8,335,581,297 $14,404,660,260 11.56%
12 FL Suncoast $6,627,125,361 $12,026,016,187 12.66%
1 VA Navy $71,967,667,797 $131,620,239,595 12.83%
4 WA BECU $13,878,323,252 $25,637,148,406 13.06%
11 TX Randolph-Brooks $6,665,438,060 $12,550,850,662 13.49%
10 UT America First $7,002,583,992 $13,795,623,334 14.52%
5 CA SchoolsFirst $11,438,769,717 $22,597,939,638 14.59%
14 UT Mountain America $4,823,680,120 $11,404,026,075 18.78%
PG Credit Unions Over $10B $15,333,447,756 $26,092,215,610 11.22%

If the comparison is expanded to all 49 credit unions over $5 billion, PenFed’s growth is still much slower than this peer group’s 10.8%.

But what if a new strategy takes time? The September 2020 annual numbers show an even greater fall off from the peers’ results compared to the five-year trends:

September 2020

Annual Growth PenFed Peers
Share growth 5.9% 21.9%
Loans 5.3% 7.6%
Assets 6.0% 17.4%
Capital 6.0% 13.0%
Members 13.2% 8.2%
Operating Expense 18.9% 12.6%

Greater Efficiency?

The second reason for a merger strategy is that growth brings greater efficiency. PenFed is already the third largest credit union in America. So it should be at a high level of efficiency already. However, when comparing different measures of operational efficiency before and after these eighteen acquisitions, the operating results show a dramatic decrease in efficiency even as Pentagon has increased assets over $7 billion.

PenFed Efficiency Trends as of Sept 2015 and 2020

Ratio September 2015 September 2020
Efficiency Ratio 62.6% 80.8%
Op Exp/Avg Assets 1.35% 2.33%
Assets/FTE $12.5 mn $9.9 mn
Avg Acct Relationship $23,734 k $19,094 k
Loan/Share 118.6% 108.5%
Net Worth 10.06% 10.7%
Delinquency 0.26% 1.07%

The ratios show a dramatic deterioration in efficiency and productivity. With the same balance sheet structure and net worth as five years earlier, PenFed has higher costs, members have smaller average relationships, and the expense ratio increased 73%. Delinquency is four times higher.

Greater Member Value?

PenFed’s product driven focus may provide competitive choices for members in specific circumstances. Their credit card and first mortgages can be excellent value in some markets. Building member relationships is not the focus of its strategy, however.

Several numbers illustrate this product versus member-centric focus. The share draft penetration, ( a primary financial institution indicator) is 14.1% versus the peers’ 67.4%. The average member relationship has declined from $23.7K to $19.1K over the five years. The number of share accounts per member at 1.41 trails the peer’s of 2.03.

Rather than building member relationships, the credit union’s approach is akin to commercial financial firms that move in and out of markets pursuing different product priorities as suggested by circumstances.

Investments to Enhance Competitive Capabilities?

A final rationale for mergers is that more assets provide more capacity to underwrite greater investments in technology, staff and other fixed assets to maintain or enhance competitive position. The single largest investment by PenFed was in 2016 when it purchased a new head office in McLean VA. (https://patch.com/virginia/mclean/penfed-purchases-new-corporate-hq-tysons-0

PenFed CEO James Schenck explained the reasons for the purchase, which has resulted in a 580% increase in building and fixed assets in just four years:

“In order to attract the best and brightest employees, a firm needs to not only pay a competitive salary with benefits, but needs to offer a best-in-class work environment with a meaningful mission.

“PenFed has an insatiable appetite for talented, educated professionals to provide perfect service to our members. Locating our corporate headquarters in Tysons will continue to enhance our operational efficiency and it will be conducive to sustaining growth of the intellectual capital required to keep pace with our members’ needs and deliver exceptional value and superior service.”

Before the merger strategy, PenFed reported total building and fixed assets investments of $91 million (4.8% of net worth). Five years later the $530.5 million total equals 19.4% of net worth. In this same period, the number of fulltime equivalent employees has increased just 73% from 1,539 to 2,662.

The average salary and benefits per employee of the current staff is $101,969, a 5.1% annual growth from the $79,616 five years earlier.

In addition to this growth in average salary, the credit union has increased its balance sheet assets funding employee benefit and deferred compensation plans with investments not authorized under Part 703 of NCUA Rules. This five-fold increase over five years, from $126 million to $732.2 million, includes $130.1 million in Charitable Donation Accounts.

The Strategic Mirage

PenFed’s “growth via mergers” has resulted in slowing rates of both internal and total asset growth, increased expenses, reduced average member relationships and a dramatic increase in fixed investments with uncertain return. Instead of an example of improved performance from growth, the results are at the bottom of its peer group.

PenFed’s floundering performance is being propped up by taking in as other operating income (negative good will) the equity from other strong, long-serving credit unions. As described in the analysis of the Sperry Associates FCU merger:

For over five years “$0 cost acquisitions” have been a critical contributor to PenFed’s bottom line and balance sheet size. In 2019, it booked a total equity increase of $92.4 from mergers. “Bargain gains from mergers” (negative good will) totaled $74.2 million and $18.2 million was added equity value. Of the credit union’s $151 million 2019 net income, over half is from transferring the accumulated surplus from other well-capitalized, merged credit unions which PenFed recognized as “other operating income.”

This 2019 one-time income boost came from three mergers. . . PenFed’s reported asset growth was only $300 million. But without these three mergers it would show a balance sheet decline of $500 million.

Credit unions’ advantage is their relationship with members. PenFed’s mergers help disguise the pitfalls of its open field of membership. For it has no market focus, no niche, and nowhere to effectively mine for organic growth. Its minimal performance outcomes are a veneer. They can be sustained only by finding more sound, established and well-capitalized credit unions willing to become further victims of this Ponzi-like business model.

And that raises the second, and more consequential issue. That is the irreversible shutdowns of strong, well-run, long-serving, locally focused credit unions built on generations of member loyalty.

I will address this challenge in Part II: Mergers’ Impact on the Cooperative System

More Voting Results Announced by Credit Unions

The recent national elections demonstrated the essence of democracy is voting. Credit unions as co-ops are unique in their governance. All federal credit unions and most states establish member authority as “one person one vote.” The amount of one’s shares or size of loans  does not change this basic equality. Rather, that is how private corporate and public companies are governed.

No proxies are allowed for FCUs although seven states permit limited proxy voting for their charters. In one state (IL), proxy voting is permitted in all cases including merger. In states permitting proxies, members give their voting power to the board, unless specifically revoked prior to the vote.

Member voting primarily in the annual election of directors is the most frequent means cooperative governance is practiced. But it is especially critical when a board recommends the merging of a sound, long standing credit union into another institution.

A Multi-tiered Democratic Nation

Cooperative democracy is a micro example of the broader political society in which we live. One co-op commentator described this context as follows:

“Democracy is seen by the public as making decisions regarding laws, taxes and public spending. These tools are necessary, but alone are limited in their ability to improve society. We need to expand our tool-kit and harness our collective imagination and intelligence to utilize not just the mechanisms of democratic governments, but also in cooperatives.”

(https://coop.exchange/blog/5afea409-45ea-11ea-8997-06ceb0bf34bd/democracy-beyond-the-state-elections-in-trade-and-credit-unions-building-societies-and-co-ops-need-r)

Co-op democracy only works if members believe their role matters and they are encouraged to exercise their voice. This is not the process being followed in most mergers. If 90% or more voters failed to participate in any political election, many would consider it a façade. “My vote won’t matter so why bother.” Unfortunately this is the pattern in almost all credit union mergers. Two recent examples:

From Ypsilanti, MI : The CEO of Washtenaw announced that 457 or 8.0% of eligible members voted in an election to decide the future of the credit union’s potential merger with the $566 million Financial CU. The $50 million dollar credit union, chartered in 1949 reported 16% share growth, well-capitalized net worth of 7.54% and no delinquencies at September 30. 6.7% of the members voted yes, and 1.3% voted no. Over 92% of the member-owners did not vote to decide the credit union’s future.

The CEO explained the merger with CP Financial CU: “We are extremely proud of the lasting legacy that the good people and good work Washtenaw Federal Credit Union has provided the community for the past 70+ years. That BEST of who we are will still live and breathe at True Community Credit Union (new name); moreover, the sum of CPFCU and WFCU is greater than we were individually. Our credit union family is not dissolving, it is simply growing larger. CP FCU has welcomed us with open arms not solely because they are good people, but because “real recognizes real” and our members aren’t losing a credit union but gaining another one.”

From Garden City Park, NY: 1,843 members of the $265 million Sperry Associates FCU voted on the Board’s recommendation to merge with the $26 billion PenFed, located in Mclean, VA. 68.3% (1,166) of those voted in favor; 35.7% (677) voted no. Of the total membership of 16,303, only 11.4% of the share-owners participated in the merger decision which will end this charter issued in 1936.

The CEO’s justification for merger: “For over a decade, Sperry’s board and executive management team has worked to successfully strengthen the credit union’s standing, and this is the next step in that process.”

Co-op democracy or something else?

In both instances above, over 92% of members did not vote or voted against the merger of these two sound, long-serving credit unions with strong local presence. What does this lack of participation suggest about member interest in the surviving credit union? If they did not value their own institution’s service and record enough to participate, will they have any allegiance to their new one?

Is the so-called democratic process of member voting just an administrative fig leaf covering the naked ambitions and personal agendas of those in charge? What is the meaning of a “vote” when over 90% of eligible members do not participate?

If a credit union is sold to a bank or converts to private cooperative insurance, by rule a minimum of 20% of members must vote for the decision to be approved. There is no participation requirement, however, to end the life of a charter. If a minimal level of member awareness is required in these two situations, is it even more appropriate for the decision to end the life of a charter? Does the fact no required participation is needed, lead to a controlled process to ensure alternative points of view are not raised?

A Special Relationship?

As these consolidations routinely proceed with less than 10% member participation, is this just quickening the pace ending the distinctive credit union cooperative advantage? For if members are treated just like customers being told what is good for them, how is that any different from banks? The CEO’s rhetorical statements justifying their merger decisions contain no facts, no specific member benefits. Only the increase in financial gain by the CEO and senior staff is provided, and that only because it is required by regulation. Surely member owners deserve a fuller explanation than marketing mantras before giving away their institution.

Democracy is not a rule, set of bylaws, or even an idea. Rather it is a discipline requiring personal actions. That involvement was the essential good will that got almost all credit unions started as there was no start up capital. . Today the phrase member relationship is used to define this critical difference in cooperative design. It is a skill and capability that needs continuous effort to sustain this advantage not just once a year at the annual meeting.

Credit Unions Investing in Other Cooperatives

Responding to the listing of America’s top 100 cooperatives by total revenue, I received the following comment from Leo Sammallahti, marketing manager for the Coop Exchange:

“Credit unions do fantastic charitable work, but do we just try to do the type of charitable work that conventional banks do, but just more and better? How about we take a different, distinct approach. Let’s help our members help themselves by fostering creation of new cooperatives. Isn’t that what Filene was all about? If the 120 million member strong credit unions are not doing this, who is? We could find great ideas and energy among those members if we look for it.”

A Case Study of a Credit Union Investing in Coops

Leo then sent me this example:

“Matthew Cropp from the Vermont Employee Ownership Center recently rediscovered a little-known credit union statute applicable to state-chartered credit unions in eight states (Arkansas, Illinois, Kentucky, Montana, Nevada, New Jersey, New Mexico and Vermont). It allows credit unions to make equity investments into cooperatives, including worker cooperatives.

As a result of this discovery, one of the largest credit unions in Vermont (VSECU) has begun to offer equity to cooperatives in its region—an unprecedented move as most credit unions, if they offer any financing for coops, offer debt financing.

The Vermont statue’s language specifies that state-chartered credit unions are authorized to invest equity of up to 10% of the shares, deposits, and surplus of the credit union into cooperatives. These investments would not count against the 12.25% member business lending cap that most credit unions are currently subject to.

VSECU has decided to make 10% of their total equity available for equity investment in coops, roughly equal to $8.5M in 2020. It appears that the VSECU is the only credit union in any of these eight states that has started investing using this statute. Its co-op capital tool kit can be found at this link https://www.vsecu.com/community/resources/co-op-capital

Consequentially, cooperative advocates are working to identify credit unions in the other eight states to follow VSECU’s lead and invest equity capital in coops. There is also talk of lobbying other state’s legislatures, then eventually congress to “follow suit by broadening the range of credit unions that are legally permitted to make such investments.”

Are there other instances of this coop investment effort readers can share?

Chairman Hood’s House Testimony: Members’ Interest Only Matters When Selling to a Bank

In today’s cooperative system when a bank acquires a credit union, regulators require that a fully detailed, independently verified value be given members for the equity accumulated from their loyalty. There is no such protection for members in a credit union acquisition.

Chairman Rodney Hood’s House Banking Committee testimony on Thursday, November 12, 2020, included a summary of credit union bank purchases and credit union mergers. The import of his logic is devastating.

As outlined by Hood in his “state of the industry” presentation, the only way the agency will ensure members receive fair value for their equity is to be bought by a bank. The necessary action is self-evident: before any credit union board or CEO decides to end their charter and hand off their members’ future via a merger, contact a bank to determine what they think the credit union is worth. Otherwise, don’t count on NCUA ensuring members receive a fair deal.

The Chairman’s words

Bank acquisitions by credit unions were described as follows:

“. . .the number of credit unions purchasing banks is very small. Of the 36 NCUA-approved bank purchases by federally insured credit unions since 2012, 13 were banks with assets less than $100 million. Another 16 of the transactions involved banks with assets from $100 million to $250 million. Only seven of the approved transactions were banks with assets above $250 million.”

And these, he explained, are thoroughly regulated:

“The NCUA does not prohibit the transactions because credit unions are permitted by regulation to purchase banks. Additionally, bank-to-credit union transactions must also be approved by the Federal Deposit Insurance Corporation, per the Bank Merger Act, and the state credit union regulatory agency, for transactions involving a state-chartered credit union.”

In the reverse situation, where a bank acquires a credit union, it is carefully monitored to protect members’ interests:

“The NCUA has regulations to oversee the sale of a credit union to a bank. These regulations ensure the members’ equity is properly valued by an independent third party who establishes a market valuation of the credit union. The purchasing bank must pay the credit union at least that amount thereby ensuring the selling members are paid a fair value for their equity.” [emphasis added]

No Fair Value for Members in a Merger Acquisition

When one credit union acquires another through a merger, there is no such member protection. These acquisitions are merely a response to changing market conditions:

“. . .The majority of merging credit unions are comprised of smaller credit unions, and the most common reason for merging is to expand services, as larger credit unions tend to offer more complex products and services to their members. However, we have seen a growing number of larger credit unions use mergers and acquisitions as strategies to grow and increase market share.

Due to the pandemic, merger activity for federally insured credit unions has slowed, but may increase as conditions evolve. The NCUA will monitor these trends to ensure the continued consolidation of credit unions and system assets does not create new potential risks to the Share Insurance Fund.”

Members Short-Changed

NCUA’s monitoring of these intra-industry merger acquisitions does not include “ensuring members are paid a fair value for their equity.”

Wouldn’t credit union members be financially better served if their institution was sold to a bank for “fair value”? Then take their money and their savings to another credit union if they so choose? Or even purchase equity shares in the bank acquirer?

Mergers between credit unions are not “market-based transactions.” There is no transparency in the process. Those responsible negotiate their own self-interest behind closed doors. The opportunity for alternative “bidders” is not presented. No specific or meaningful benefits for members are detailed. Member voting is not a choice, but merely a request to ratify decisions that have already been made without their input.

A Weakening of the System

The first rule of safety and soundness is diversification, not putting all eggs in one basket. Concentration destroys diversification. The single strategy of the surviving firm replaces multiple ways of approaching the future.

While NCUA claims to monitor merger activity to verify that the continued consolidation of credit unions and system assets does not create new potential risks to the Share Insurance Fund, how it does so is a complete mystery. Even if the erosion of the industry’s soundness could be documented, what would the remedy be? Undo multiple mergers? Not practical. Stop mergers? Not realistic.

The three traditional solutions for a problem are to find a bigger healthy merger partner, liquidate, or sell to third party outsiders. Unless a more open, transparent, member-first merger process is created soon, future credit unions will reap the whirlwind of this growing short-term practice undermining system soundness.

Mergers and Growth: A Common Myth

The merging of sound, independently managed firms debases cooperative design, undermines member well-being and destroys credit unions’ reputation as the trusted alternative to market-driven financial options.

It also perpetuates the myth that somehow mergers enable growth and stronger competitive capabilities versus self-driven organic strategies. An analysis of credit unions with high profile merger efforts suggests just the opposite. This will be the focus of a later blog.

Bigger does not automatically create better value. Credit union mergers do not enlarge cooperative market presence. That requires innovative, purposed-based continuous management effort, a skill that atrophies when mergers become front and center.

A Ruinous Policy

The assumption in NCUA’s oversight of credit union acquisitions that credit union mergers are benign, whereas a bank purchase is predatory, is completely false. Multiple current examples contradict this belief.

The irony in Hood and NCUA’s differential regulatory approach to purchase acquisitions is disastrous. It requires a bank offer to activate NCUA oversight for credit union members to receive fair value. Only a bank bid brings real transparency to the insider’s merger games now being practiced. In either outcome, the members lose their credit union.

Students: Enrolling the Next Generation of Members

In 1974, Peggy Holliday, CEO of Burbank Schools FCU, started student run branches at two Burbank High Schools. Each campus had a Student Credit Union Treasurer, who would “work” the student credit union during lunch, opening accounts and performing basic deposit/withdrawal transactions.

After school, the Student Treasurer would come to Burbank Schools FCU and reconcile the deposits/withdrawals of the day and process the membership forms to open the accounts.

The experience taught students the real-life skills of money management, budgeting, balancing cash drawers, and basic financial transactions. Students learned the concept of compound interest and making loan payments. Some went on to build careers in the credit union industry.

In 2011, the student credit union branches were disbanded. As account access became available online, the need for in-person transactions diminished. Promoting loan products became challenging, due to regulations. Checking accounts required parental authorization, difficult during school hours. Additionally, as school security increased, hallways became locked down during lunch, and access to the dedicated student credit union room became an issue. Finding student volunteers also became challenging.

But the focus on offering great service to students continued with UMe Credit Union (formerly named Burbank Schools FCU). UMe has an ATM on the quad at Burroughs High School, offers scholarships to Burbank grads, provides a student intern program and offers financial workshops and “Bite of Reality” financial simulation experiences. Additionally, UMe has some student-centric savings products created to help the younger generation get a head start on saving money.

Growing loyal student members by helping teach smart money management is a continued business effort for UMe. They think of themselves more as “helpers” than bankers, which is why they believe in promoting the cooperative spirit to their next generation of members.

From High Schools to Universities

Credit unions, especially those with educational FOMs, continue to sponsor student run credit unions or branches in high schools throughout the country. Students gained financial skills and become part of a new generation of co-op members.

In 1982 to address a falloff in the number of new federal charters (only 114 in 1982), the NCUA launched a renewal program called Credit Union Expansion or CUE-84. The goal was to make credit unions available to many new members ahead of the 50th anniversary of the Federal Credit Union Act in 1984, The committee’s members were a who’s who of credit union CEOs, league and trade association leaders, and state regulators. The one surviving attendee of the 1934 founding of CUNA at Estes Park Colorado, Louise Herring, was on the committee along with Joe Scoggins, CEO of Navy Federal, the country’s largest credit union.

The three-pronged growth effort included chartering new credit unions, expanding FOMs and adding groups such as retirees to credit unions.

The College-University Initiative: Solving a Real National Problem

One important focus was organizing new charters at universities around the country. One example profiled by NCUA was New York University FCU for faculty, all university employees, trustees, alumni and students. Potential membership was 20,000.

The local poster child for this effort was Georgetown University Alumni and Students FCU (GUASFCU) in Washington D.C. Sponsored by the student government, it was open to students and alumni and managed by undergraduates who wanted the experience of running their own co-op.

NCUA changed policy to designate student credit unions as low income, enabling them to accept non-member deposits to fund low cost loans for books and tuition. As explained by NCUA Chairman Callahan:

“This opens the door to alumni through the corporations they work for to make contributions in the form of federally insured deposits which can be earmarked for student loans. Here is a vehicle that could provide a private enterprise approach to something that is a real national problem-the need for student loan funds.”

Of the 107 new charters approved in 1983, NCUA’s Annual Report included a picture of the GUASFCU’s first annual meeting. Also highlighted were charters for the University Student FCU (University of Chicago) and Skidmore Students FCU in Saratoga Springs, NY.

Recently GUASFCU’s Hoya Banking model with $17 million in assets announced a grant from the University to underwrite a secured loan for all incoming students so each could establish a credit score of 685 or greater by graduation.

Current Chartering Environment

From military recruiters, to political parties to businesses seeking the loyalty of new consumers for their products, high school and colleges are target markets for every institution that wants to remain relevant in society. Most major college campuses now have a bank branch on the grounds, or nearby, to serve students.

Gen Z and millennials embrace activism, engagement and technology to create new ways of participating in economic and social change. Starting new enterprises is one hallmark of this creative impulse.

Responding to this student interest, over 220 colleges and universities across the country provide innovation and entrepreneurship programs to encourage this activity. (https://www.acceleratorinfo.com/see-all.html)

These academic business accelerators respond to students wanting change, promote the traditional American spirit of innovation and, if successful, provide a financial return to the school. Many academic institutions now sponsor “shark tank” contests to incent new venture ideas offering dollars as well as in-kind support for winners.

One winner in the spring 2018 George Washington University’s new venture competition was a group of freshmen. They proposed a student managed credit union for their university community. They had three primary goals: provide better value services for the students; offer practical management opportunities for volunteer leaders; and create a prototype that could be easily replicated at other colleges around the country.

These students are business, finance, technical and liberal arts majors. They are volunteers in this multi-year effort receiving no pay or course credit. Now in their fourth year of trying to obtain a charter, they may earn their bachelor’s degree before NCUA approves their application.

The Problem for Credit Unions

If students are not part of credit unions’ recruiting efforts, the industry is losing the battle for the next generation of leaders and members. Unlike many areas of civic endeavor or business enterprise, cooperative solutions are best understood when experienced first-hand. They are not a dominant form of organizational design in America’s capitalist economy.

Earlier NCUA efforts, recognized the need to encourage the use and formation of credit unions for all groups. Especially students. Now less so. But the needs of Americans in 2020 and forward are not that much different from 1980.

A Cooperative Opportunity: HBCUs and NCUA

Chairman Hood has announced his ACCESS initiative (https://www.ncua.gov/access) to promote financial inclusion. To put real work, not just talk behind this concept, NCUA should reinvigorate the student credit union charter effort.

For example, there are 107 historically black colleges and universities (HBCUs) in the country. Fifty-six are private and fifty-one public. The democratic Vice-Presidential candidate is a graduate of Howard University whose credit union has charter # 648 (1935) but apparently does not include students.

Can here be a program with local credit union mentors (the Burbank Schools model) to launch credit unions at HBCUs around the country? It would bring a new generation into the cooperative experience as members and managers. Successful examples like GUSAFCU are operating. The benefits are known.

There is nothing more inclusive than the empowering persons through self-help. That is how all credit unions began.

The need is leaders willing to move forward. The ball lies in NCUA’s court. No one wants to wait four years to receive a license to start an enterprise. Especially a cooperative where community progress, not individual enrichment, is the motivation.

If NCUA were to initiate such an effort it would stop working its way out of business and start seeding the economy with a new generation of cooperators. It would also:

  • Turn the industry to a new vision for itself.
  • Extend the NCUAs role in the expansion and success of cooperative solutions.
  • Point credit unions to new heights for mutual benefit, versus consolidation.

The Top 100 Coops at Year-end 2019

For 30 years, the National Cooperative Bank (NCB) has published the annual NCB Co-op 100, America’s top 100 Cooperatives by total revenue. In 2019, these member-owned and controlled businesses had total revenues of $228 billion.

https://impact.ncb.coop/hubfs/assets/resources/NCB-Co-op-100-2020-final.pdf

Who is on the list?

Five credit unions are in the top 100. Navy is #7; State Employees (NC) #22; PenFed #30; BECU #57; and SchoolsFirst #78.

There are several well known consumer brand names of firms such as SunKist Growers, Land O’Lakes, Ocean Spray, Welch Foods and ACE hardware. In addition to finance, larger co-ops also serve the farming, energy, health care, grocery and hardware sectors.

The total assets of these leaders are $733 billion.

The compiler of the list, NCB, was created to address the financial needs of an underserved market niche: people who join together cooperatively to meet personal, social or business needs especially in low income communities. Chartered by Congress in 1978, NCB was privatized in 1981. Owned by its more than 3,100 customer-owners, it has $7.9 billion in assets under management. As part of its enabling legislation, NCB was tasked with ensuring that 35% of the capital it deploys will benefit low income communities.

A Credit Union Opportunity?

The question for the $1.7 trillion cooperative credit union community’s 5,200 institutions: What are we doing to enhance cooperative solutions for the American economy beyond consumer finance?

Democracy and Voting in Credit Unions: Does it Mean Anything?

In an election late last year 157,655 members were asked whether they should merger their eight-decade old, successful, super performing community charter with over $2.1 billion in assets.

Here are the voting results certified to the NCUA:

  • 7,331 or 4.65% of members voted
  • 6,658 or 4.4% voted in favor
  • 473 or .3% voted against the merger

150,324 or 95.35% of members did not vote on the future of their credit union.

Of those voting only two did so in person, the rest by mailed ballot.

Is This What Cooperative Democracy Should Be?

Is this “democratic” when only 4.6% of the share owners vote?

Were members even aware of what was happening to their credit union?

How could such low participation occur on such a consequential issue?

Most important, is this perfunctory, minimalist process right for members? Their community? The credit union system? And cooperatives’ role in America’s economy?

Does Your Vote or Even Voting Matter?

We are all living in an election season where everyone is being urged to vote. Court battles are being waged over time limits on early voting, number of drop boxes, how long after November 3rd ballots can be counted, and numerous other election processes.

Every media outlet is tracking not just candidate debates and policy positions, but the voting activity itself. Will the outcome be seen as fair? Are votes being suppressed by changing rules?

Voting matters. We all get this. In a democracy public acceptance of the outcome depends on the perceived legitimacy of an election. For every level of government. Or any other election determined event.

While people will have different interpretations of the numbers from Schools Financial’s member vote to merge with SchoolsFirst, I think we would agree on one observation: This is not what a democratically labeled outcome should look like.