Category: credit union data

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The Borrowing-Liquidity Trends in Credit unions

From a September 2023 CEO’s team memo update:

Liquidity

“We remain laser focused on managing liquidity risk in this environment of aggregate decreasing money supply.  

“We finally sold our $18 million pool of auto loans that we’ve been marketing  for two months.  As with all other loan sales, we will service the pool in order to maintain and grow member relationships.  The transaction generated cash of just over $15.3 million.  

“We expect to end the month at a loan to deposit ratio in the 102% neighborhood, down from a high of 106.41% in July.  Our goal remains to reduce this ratio to no more than 100% by year end.  

The best way to accomplish this is through acquisition of core deposits from our friends and neighbors in our primary market.  We’re also marketing another pool of loans so that we don’t have to slow our lending origination machine any further.”

This not an isolated event.  Yesterday’s Credit Union Times summarized  auto loan  securitizations by credit unions since 2019, with two totaling $501 million in this past week.

Economic Forces Drying Up Liquidity

Two factors have disrupted normal  credit union ALM liquidity management over for the year ending June 2023.

The first is the 18 month long increase in interest rates by the Federal Reserve to reduce inflation.  The process began on March 17, 2022. The Fed raised its overnight  Fed Funds target from effectively zero to today’s range of 5.25-5.50%.

The Fed’s intent is to slow the economy, lower demand for financing and lower inflation to 2%.

The second was the sudden bank crisis in March of this year.  Here is the cascading sequence of events from one summary report:

In the lead-up period to the crisis, many banks within the United States had invested their reserves in U.S. Treasury securities, which had been paying low interest rates for several years. As the Federal Reserve began raising interest rates in 2022,  bond prices declined, decreasing the market value of bank capital reserves, causing some banks to incur unrealized losses. To maintain liquidity, Silicon Valley Bank sold its bonds and realized steep losses.

The first bank to fail, cryptocurrency-focused Silvergate Bank, announced it would wind down on March 8, 2023 due to losses suffered in its loan portfolio. Two days later, upon announcement of an attempt to raise capital, a bank run occurred at Silicon Valley Bank, causing it to collapse and be seized by regulators that day. Signature Bank, a bank that frequently did business with cryptocurrency firms, was closed by regulators two days later on March 12, with regulators citing systemic risks. . .

The collapses of First Republic Bank, Silicon Valley Bank and Signature Bank were the second-, third- and fourth-largest bank failures in the history of the United States.

The Fed created a new lending option to cope with the uncertainties resulting from these failures. To calm rattled financial markets and support banks, the Bank Term Funding Program (BTFP) began on March 13, offering maturity dates of up to one year.

The BTFP’s role was focused on  firms that had large unrealized losses on their government bonds and potentially at risk of large-scale deposit withdrawals.  The intent was to prevent losses from forced sales of underwater securities to fund deposit outflows.

The new program charges a higher rate than the discount window.  One other important difference  is that while the BTFP requires banks to offer collateral, it values the collateral at par, rather than on a mark-to-market basis.

The Credit Union System’s  Borrowings at June 2023

Credit unions did not have the lending or deposit concentrations of the failed banks. But like all financial institutions, their term investments have declined in value.

Members were seeing very competitive savings rates in money market  funds and CD specials.  Share growth for the year ended June 2023  was just 1.4%.  At June 2022, the 12-month growth was 8.1%.

Loans however are still increasing at double digit rates (12.8%). Short term liquid funds are declining.

One response to tightening liquidity was increased borrowings. The table below shows the five most recent quarter-ending  borrowing totals and their  source for the credit union system.

Total Credit Union System Borrowings    (June ’22 to June ’23)

Source:  NCUA call reports

The trends from the data show:

  • Total number of credit union borrowers grew 50% from 838 to 1,260 in one year.
  • Outstanding loans increased by $90.1 billion or 300%.
  • The Fed Reserve Bank (FRB) became a significant new source growing from 1.6% to funding 25.5% ($30.8 billion) of credit union borrowings.
  • The largest lender was the FHLB system increasing from $26.1 billion (86%) to $84 billion (69.7%) of total loans.

Total borrowings of $120.4 billion are 5.4% of total industry assets (compared to 1.4% at June 2022) and 55% of June 2023 capital.

System liquidity is tightening. The second observation is that in the market uncertainty following the banking failures and continuing liquidity demand, the credit union funded facility, the NCUA-managed CLF still has zero borrowings.

The last CLF loans were paid off in  2010.  There has not been a single borrowing in the thirteen years since.

The Federal Reserve loan window stepped up quickly and creatively to respond to events.  The FHLB system expanded its traditional lending role.  The CLF has the borrowing capacity and legal authority to match the needs being served by these two primary lenders. But it is “missing in action.”

Tomorrow I will evaluate what the CLF’s absence means for NCUA and the credit union system.

 

 

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Reporting Coop Success In the Glare of Live Market Updates

This is the season for reporting quarterly earnings by all public companies.  Even credit unions must file their 5300 financial updates with the regulator which are then open to the public.

These many forms of quarterly financial reports are required by law and regulation.   For stock companies, shareholders, traders, investment funds and market analysts, the daily news is dominated by the ups, or downs, in company performance. Here is one example of this reporting frenzy:

Earnings season marches on

This week brings another busy slate of quarterly earnings reports, from tech giants to restaurant stocks. Apple and Amazon are the biggest names due up, along with Starbucks and CVS Health. Earnings this season have so far defied expectations and have been somewhat stronger than expected. Here are the big names on deck . . .

None of those big names will be credit unions.  Credit unions are required in their bylaws to post a monthly financial report in a conspicuous place in the credit union and file the quarterly 5300, but few will provide a public description of these results.

Credit union have shareholders, as do all public companies.  The members’ interest in the performance of their firm is the same as the owners of a bank or any other firm.   How is my ownership benefitting me versus other options?

For stock companies, the market readily evaluates this performance as documented by changes in the daily stock price.   Analysts evaluate the current results and make their “calls” about whether a stock is a buy, hold or sell.  Explaining a firm’s quarterly performance to all market participants is an important skill for CFO’s and CEO’s of all companies, even the smallest.

Credit unions generally provide no such reports or future forecasts (guidance). There is no stock price to provide market feedback.   But is the interest of the member-owners any less deserving than those of public companies?  Is the responsibility to coop shareholders by the credit union’s professional staff any less than to a publicly traded or even a private firm?

When Credit Unions Did Speak Up

In the March-April closures of three banks led by Silicon Valley’s failure, credit unions launched major PR campaigns to assure their members that they were sound.  CEO’s stated there were no parallel circumstances in the coop industry.  Some credit unions devoted a major part of the Annual Meeting to this public concern.  Some of these updates highlighted the credit union’s percentage of insured shares, or capital levels, or liquidity.  The message was to assure members the credit unions were able and willing to continue meeting their needs.

I believe each quarter’s financial filing is another opportunity for credit unions to tell their special story.

What Do the Numbers Mean For Me?

Numbers matter and presenting the credit union’s financial position and key trends is a beginning.   The most important message, just like a public company, is to tell what the numbers mean to the individual owner.

How has the credit union enhanced the value it brings to members?  What investments has the credit union made and what was the member benefit?  As the interest rate environment remains high, what changes has the credit union made to its rates?

Members will assume their credit union is safe and sound, or they would have left.  Credit unions will often announce events, such as branch openings, sponsorship with a local sports team or venue, and even the comings and goings of senior management.  These PR events and community engagements matter, but are not the same as the quarterly status report.  At this time everyone presents their financial results-so how did our members specifically benefit?

The Radical Cooperative Model

Since the 2008-2009 financial crisis, there has been a singular focus within financial systems on stability.  Financial outcomes are all that matter.  The more capital the better.  The only equity that matters is net worth, not social responsibility.

Financial performance is evaluated by the money made, not by the people served.  The relevance of a coop is becomes  its size, its growth and its superior numbers.   A credit union that focuses on what it helped members accomplish becomes a radical act.

Transparency is the key to member-owner confidence and trust.  And competitive advantage.  It is as important for coop leaders as it is for those whose performance is judged daily by the fluctuation of share price in the market.

However credit union’s quarterly numbers are not merely about financial outcomes but for how the performance aligned with the aspirations of members.  Coops should be presenting the values and partnerships that demonstrate their role in communities beyond the conventional financial success measures.

We should be holding up a model that is better for individuals, especially those often unaware of better opportunities.  The quarterly updates should show how a credit union’s purpose is more than making money.   It is a report on the difference made for the members.

A Renewed Commitment to Using Numbers to Say Who We Are

As all three major U.S. stock indices closed higher for July, the S&P 500 and the Nasdaq mark their fifth consecutive months of gains, and the Dow is riding a 14-day winning streak, its longest since 1987; however  cooperatives have a different benchmark to report.

Our momentum is not market driven, but member focused.  There will be a big new batch of corporate earnings the rest of this week not to mention the July jobs report due Friday.

Instead of  live market updates, we should be offering our reports of improved member lives and opportunity.   That is the difference coops should make.

 

 

 

 

 

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A Big Deal: The 990’s Are Here for State Charters

Candid, the company which publishes the 990 IRS returns for non-profits, announced that it has loaded over one million returns for the filing years 2020, 2021 and 2022.  Candid includes the previous service provided by Guidestar.

Because state chartered credit unions receive their federal tax exemption from an IRS ruling, they must file this report annually with the IRS. The form is due  on the 15th day of the 5th month following the end of the organization’s taxable year. For most credit unions whose fiscal year ends in December, the Form 990 is required by May 15th of the following year.

Credit unions and other nonprofits with gross revenue  of less than $50,00 or total assets of smaller than $500,000 are not required to file.  A firm failing to file for three consecutive tax years will automatically lose its tax-exempt status.

In addition to the balance sheet and income statement, the report also contains details of financial, governance/compensation, business relationships and donations available nowhere else.  For credit unions some of this new information includes:

  • Officers and directors total compensation. All current and former key employees who earned over $100,000 must be listed in Part VII with the total number who were paid more than $100,000. Schedule J Parts I and II gives much more detail of compensation policies and benefits including first class travel, club fees and gross up to cover tax expenses.  Compensation is shown in multiple categories of benefits.
  • Political contributions and lobbying expenditures in Schedule C.
  • Statements with the number of directors, affirmations of policy oversight and questions of family relationships in Part VI.
  • Section C sets out how the 990 filing will be publicly disclosed.
  • Section B of Part VII lists the names of the five highest independent contractors paid $100,000. Examples would be PSCU, MasterCard, Fiserv, and Microsoft along with the total number of all firms paid more than $100,000.
  • Part IX shows expense details, not in the 5300 report, such as compensation by category of employee, travel and conference expenses, even taxes paid.
  • Schedule I provides a listing of grants to individuals, organizations and the total number of all such grants.

Transparency and Accountability

The 990 information is much more comprehensive than the financial data NCUA collects primarily for safety and soundness monitoring.   It tries to pull back the covers on a nonprofit’s use of funds both internally and with external parties.

The form runs almost 40 pages.   The additional schedules listed above provide greater details for the summary  information first shown.

Every member would be much better informed about their credit union’s operations and use of funds from this report versus the 5300.

There are two areas where the current process could be improved.

  1. The 990 filing is almost a year and a half old by the time the form is published. At the moment the latest filings are for the year ending 2021.
  2. There is only one form per year, so that multiple years are necessary to see trends, rather than just a single point in time disclosure.

Why This is a Big Deal

The following is from the June 15 Candid press release about the availability of this recent data:

Before the COVID-19 pandemic, Candid received comprehensive IRS 990 data about 1.5–2 years after the end of a given calendar year. But IRS extensions, process changes, and delays during the pandemic slowed this timeline to a frustrating crawl. We’ve dubbed this the data/crisis catch-22—the fact that the pandemic made up-to-date data more critical to access and yet also more difficult to come by.   

In fact, between August 2022 and April 2023, the IRS released very little 990 data at all. Because of this, we have been considering 990 data for fiscal years 2020 onward “incomplete”i; research leveraging 990 data for years 2020 and on required the caveat that data collection was ongoing.

Between May 5–18, 2023, the IRS released around a million 990 files. To put these numbers into perspective, in April 2023, Candid could only account for about 60k 990 filings for fiscal years 2021 and 2022 combined. 

Here is one link to either login or subscribe to look up information.  The basic look up is free.

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A Milestone, or Turning Point, from the Past

The Lead: Almost all CU savings are now insured

“More than 99% of the total savings at CUs are now insured by either NCUA or a state share insurance fund, according to the 1983 State Share Insurance Yearbook.  That translates into about $75.5 billion.

“By mid-1983, the yearbook says, only about 200 CU’s in the entire U.S. will be without share insurance.  Only 319 of the almost 20,000 CUs in operation at the end of last year were not insured.  That number will decline this year as share insurance becomes mandatory in Indiana, Nebraska, and New Jersey.   Insurance  is now required of state CUs in 44 states and Puerto Rico. 

“NCUA insurance covered  all FCUs in 1982 (11,631 active charters)  and 5,036 state CUs, while 17 state insurance plans were provided for 3,121 state CUs  in 21 states and Puerto Rico.” (Total all insured credit unions 19,788)

Source:  Credit Union Magazine, June 1983, pg. 18.

An advertisement for one of the 17 state-chartered insurance funds.

Milestone or Turning Point?

Today, the NCUSIF is an insurance monopoly for all but a few state chartered credit unions.

The  insurer has become the regulator.   NCUA leaders routinely pronounce  their number one priority-“North Star”- is to protect the fund.

The NCUSIF approval is now the biggest entry barrier for new charters.

This prioritization of insurance  has changed the focus of many credit union leaders.   Instead of a social movement designing alternatives for members’ financial needs, credit unions have become me-too financial providers.

Credit unions are now fully entitled members of America’s financial system with access to governmental and market options similar to most banks.

Some continue to prioritize member well-being and their challenges of financial equity.   Others embrace the open-ended opportunities to pursue the market ambitions of their competitors.

A number of credit union leaders and academics have interpreted the insurance requirement (primarily NCUA) as the most important factor in the evolution of the cooperative financial system-for good or otherwise.

I will look at these assessments in later blogs.

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A Case Study of a $96 Million Turnaround: Safe Harbor, Cannabis Banking, and Partner Colorado Credit Union

On year ago I described the announcement that  Colorado Partner Credit Union (CPCU) had arranged to sell its wholly owned CUSO (Safe Harbor), specializing in cannabis banking, to a Special Purpose Acquisition company (SPAC), or publicly traded company.

Serving the cannabis business has been a priority for some credit unions in states where the sale is licensed for several years.  This past week credit union leaders and trade associations announced their continued support of changes in  federal law to allow all financial institutions to serve the trade-which is now legal only on a state by state basis.

“CUNA said it supports the Secure and Fair Enforcement (SAFE) Banking Act, a bipartisan bill introduced in both chambers in April that would provide a safe harbor for financial institutions serving legal cannabis businesses.-from CU Today.

The Sale of Safe Harbor, a Cannabis CUSO

CPCU was to receive $185 million for selling its CUSO, $70 million in cash and $115 million in stock. Sundie Seefried – who created Safe Harbor cannabis business while the credit union’s CEO– would be the CEO of the new public company (NASDAQ: SHFS).

A $96 Million Turnaround In 90 Days

An immediate result of this September 28, 2022 closing was PCCU reporting a $55 million net income and an 8.7% ROA for the year ending December 2022.

This extraordinary gain occurred even as SHFS  reported a $35.1 million loss for the year ended December 2022, compared to net income of $3.2 million in 2021.  This result was described as “primarily due to the loss in value of several of the financial instruments placed in connection with the Business Combination.”

SHFS’s December 2022 balance sheet position  resulted in the following “going concern” comment by auditors:

Liquidity and going concern

As of December 31, 2022, the Company had $8,390,195 in cash and net working capital of ($39,340,020), as compared to $5,495,905 in cash and net working capital of $5,922,023 at December 31, 2021.

Included in the working capital deficit at December 31, 2022 is $25,973,017 current portion of the long-term payable owed to the seller, PCCU, from the aforementioned business combination, and $14,359,822 deferred consideration current portion related to the Abaca acquisition. The Company has also incurred a significant cumulative consolidated operating loss for the year ended December 31, 2022.

Based upon these factors, management of the Company has determined that there is a risk of substantial doubt about the Company’s ability to continue as a going concern for a period of at least twelve months from the date these consolidated financial statements have been issued.

Results at March 2023

In  the March quarter of 2023 CPCU reversed much of the 2022 gain on Safe Harbor’s sale resulting in a $41 million loss.  The credit union’s net worth ratio between the two quarter ends went from 20.9% to 14.7% as of March 2023.  Its total assets were $699 million which included new subordinated debt of $3.1 million and notes payable of $27.5 million.

The loss was due to a restructuring of the sale terms  for CPCU as described in an SEC filing and company press release:

On March 29, 2023, the Company and PCCU entered into a definitive transaction (Refer to Note 22, “Subsequent Events,” of the consolidated financial statements) to settle and restructure the deferred obligations, including $56,949,800 into a five-year Senior Secured Promissory Note (the “Note”) in the principal amount of $14,500,000 bearing interest at the rate of 4.25%; a Security Agreement pursuant to which the Company will grant, as collateral for the Note, a first priority security interest in substantially all of the assets of the Company; and a Securities Issuance Agreement, pursuant to which the Company will issue 11,200,000 shares of the Company’s Class A Common Stock to PCCU.

This restructure was driven by the SHFS’ financial position.  CPCU is now the majority owner of voting stock (55%) and CEO Douglas Fagan  is  on the SHFS’s board.

SHFS’s First Quarter Earnings Call

On Tuesday SHFS reported its first quarter earnings with an 8-page press release.  The financial results show revenue of $4.2 million, operating expenses of $5.8 million and an operating loss of $1.6 million.

The release also provides operational highlights and a 2023 financial outlook.  During all of  SHFS’s nine years building the cannabis business, CPCU has been the primary banking partner.  This means revenue from all the deposits, loan funding and investment returns are shared with the credit union under a services agreement detailed in the company’s SEC filings.

Credit Union and banking partners are key to SHFS’s business model. As descried on the website, the firm is a  “financial technology company, not a bank. Banking services are provided by contracted NCUA or FDIC insured financial institutions. Some non-deposit products and services are not covered by FDIC or NCUA.” 

On May 11, 2023 SHFS announced another  partnership with Five Star Bank in New York that it said will add up to $1 billion in additional deposit capacity.  SHFS plan  is to scale the business.

External Contexts & Cannabis Opportunity

SHFS’s future is uncertain.

The firm’s stock price is reported daily on its website.  The stock’s value since the “business combination” has declined from a peak of just over $10 to yesterday’s close of $.38.   The total market capitalization  of the company has fallen from over $300 million to $15.7 million at yesterday’s close.

However, SHFS is not alone in its extended financial condition.

SHFS’s  public offering via a SPAC transaction was a way to truncate the time, expense and investor scrutiny of a traditional public offering (IPO).   As reported in an April 27 WSJ article, SPAC’s Are Running Out of Money.”  The story’s lead reads:  ”The SPAC boom took hundreds of risky companies to the stock market. The next stop for many is bankruptcy court.”

The article’s implication is that the SPAC process to take a private company public, may short cut a more rigorous traditional IPO due diligence and valuation process.

Another external factor could also be important.  SHFS is the front end, or entry platform, for cannabis related businesses accessing financial services.  The following is SHFS’s business value proposition:  Our services allow Cannabis Related Businesses (herein referred to as “CRBs”) to obtain services from financial institutions that allow them to run their business more efficiently and effectively with improved financial insight into their business and access to resources to help them grow.

Due to limited availability of payment and other banking solutions for the cannabis industry, most businesses transact with high volumes of cash. Our fintech platform benefits CRBs and financial institutions by providing CRBs with access to financial institutions and financial institutions access to increased deposits with the comfort of knowing that those deposits have been compliantly monitored and validated. . .

A recent WSJ news story suggest that Legal Cannabis Can’t Compete  because licensed sellers are facing steep taxes and regulation.  In states like California (and New York) the article reported unlicensed sales were almost eight times licensed sales.

In many states cannabis began and still is an underground business. So even when either federal or state authorization is achieved,  suppliers may wish to retain their business  anonymity.

Tomorrow I will analyze what some of the learnings credit unions may take from this the effort to “spin off” this credit union created business to become a publicly traded company.

How did cash decline so quickly following the combination?  How dependent is the CPCU on SHFS’s business?

The details of SHFS’s history from SEC filings for this transaction and subsequent updates  offer, I believe, instructive insights for others who may harbor similar ambitions.

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What Solid Cooperative Performance Looks Like

Recent bank failures, growing liquidity pressures, interest rate uncertainty and falling consumer savings have created uncertainty about  credit unions’ financial outlook.

The first quarter 2023 call reports are in.  There are a range of results, as usual.  Below is Wright-Patt’s CEO Tim Mislansky’s summary of the numbers for his team.  He opens with a one sentence conclusion.

Solid Performance

“We ended the first quarter with solid financial results.

Loans to members were up a whopping $70.7MM from February, were up $724.9MM from a year ago and are $177.8MM above our budget.

Member deposits jumped a big $182.8MM from February (due to the month end on a Friday payday), were up $445.7MM from a year ago and are $70.8MM over budget.

While both are results to be excited about, it is important to remember that we fund our loan growth with deposits. Continuing a pace where loan growth is significantly higher than deposit growth is not sustainable.

Net income for March was $8.7MM and year-to-date is $25.3MM. This is $6.5MM above our budget, but $2.2MM behind last year.”

He proceeds to review key items for the month and changes year-over-year including net interest income, non interest income, loan loss provisions and operating expenses versus budget.  He concludes: “We remain pleased with our early progress in financial results.”

How Were These Results Achieved?

The important issue is not what the results are, but how they were accomplished amidst so much  macro economic uncertainty.

To understand these financial outcomes, one must  look at the other parts of  CEO Mislanksy’s monthly report.  He opens with two recognitions.

The first honors a 47-year retiring employee, Kathy Denniston, in the Member Help Center. The credit union was chartered in 1932.  This employee has been serving members for more than half the credit union’s existence, and arguably during the most difficult  competitive time frame.  Sold performance starts with culture, the commitment of the employees.

The second comment relates a story which Tim calls Moments of Impact.  They are brief descriptions of exceptional responses by employees (partners), in this case the  Enterprise Risk Manager:

I often say that it is everyone’s job to take care of members and Corey did just that recently. Corey is a part of the security team that deals with incident reports – which are commonly sent through if a member or Partner has an accident, gets hurt in one of our centers, or if there is erratic behavior.

A couple of weeks ago, an MHC Partner submitted an incident report because a member who was declined for a mortgage started making some comments about depression and wanting to end his life. When Corey saw this, he replied to the larger group and asked what we typically do in these situations, because he wanted to help. Honestly, we do not have a standard protocol for this situation.

Rather than let it go, Corey took it upon himself to call the member to see if he was okay. He made sure the member had some resources and contacts that he could call for help. Taking that extra step just showed how much Corey cared and the type of people we have here at WPCU.”

The Performance that Really Counts

While financial numbers are one way of tracking performance, for Wright-Patt the focus is not on growing assets, loans or deposits. Growth results from doing the right things. Rather the credit union starts with impact, what it can do for its  members, potential members and  employees.

While over 90% of its deposit are insured, its share stability is due to member loyalty, not insurance. The credit union is trusted by members.  Their loyalty underwrites the credit union’s ongoing success that started  91 years ago and continues to expand quarter by solid quarter. member by member.

(I thank Tim for allowing me to use this example from his monthly report to his team)

 

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Spring’s Abundance & Credit Union Bouquets

Cherry tree

Cupid keeps watch over his beauty.

Azalea

Cherokee Dogwood

Tulips

Plox with pansies, carnation and daffodils.

Redbud flowers growing on tree trunk.

Easter Lilly transplanted after church.

Spring Flowers from Government

On Monday April 10  U.S. Department of the Treasury’s Community Development Financial Institutions Fund (CDFI Fund) announced over $1.73 billion in grants to 603 Community Development Financial Institutions (CDFIs) across the country.

CDFI Equitable Recovery Program (CDFI ERP) grants are intended to strengthen the ability of CDFIs to help low- and moderate-income communities recover from the COVID-19 pandemic and invest in long-term prosperity.

The release said 203 credit unions received $590.3 million in awards.  Peoples Advantage FCU in Petersburg, VA and four Puerto Rican Cooperativas were  each awarded $6,197,097, the largest single amount to a credit union.

Also getting in on springtime action the NCUA on April 5, announced it would take applications in five categories to award a total of $3.5 million from its Community Development Revolving Loan Fund (CDRLF).  Amounts will range from $5,000 for training to $50,000 “Underserved Outreach and MDI Capacity Building.”

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

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

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

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

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

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

Rented Capital or Buy Now, Return Later

By rule subdebt is an unusual financial instrument.

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

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

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

A Financial Growth Hormone

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

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

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

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

Most Use Is by a Few Large Credit Unions

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

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

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

The Most Important Missing Rule Requirement

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

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

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

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

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

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

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

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

 

 

 

 

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Differing Outlooks for SECU’s Future (Part II)

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

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

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

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

‘Never Been Heard of Before’

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

Shaking Things Up

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

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

The 20 Credit Union Paladins (not a video game)

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

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

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

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

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

SECU’s Rare Accomplishment

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

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

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

How Did SECU Become So Consequential?

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

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

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

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

The Issues Raised in the Annual Meeting

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

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

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

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

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

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

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

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

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

 SECU’s December 2022 VisionPlan

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

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

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

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

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

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

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

An Earnestness of Views

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

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

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

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

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

 

 

 

 

 

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Two Positive Updates & a Disheartening Decision

Callahan’s Trend Watch industry analysis on February 15 was a very informative event. It was timely and comprehensive.

Here is the industry summary slide:

The numbers I believe most important in the presentation are the 3.4% share growth, the 20% on balance sheet loan growth and the ROA of .89.

The full 66 slide deck with the opening economic assessment and credit union case study can be found here.

The Theme of Tighter Liquidity

A theme woven throughout the five-part financial analysis was tighter liquidity and the increased competition for savings.   Slides documented the rising loan-to-share ratio, the drawdown of investments and cash, the increase of FHLB borrowings, and the continuing high level of loan originations, but lower secondary market sales.

These are all valid points.   However liquidity constraints are rarely fatal.  It most often just means slower than normal balance sheet growth. That is the intent of the Federal Reserve’s policy of raising  rates.

Credit Unions’ Advantage

I think the most important response to this tightening liquidity is slide no. 24 which shows the share composition of the industry.  Core deposits of regular shares and share drafts are 58.3% of funding.  When money market savings are added the total is 80%.

This local, consumer-based funding strategy is credit unions’ most important strategic advantage versus larger institutions.  Those firms rely on wholesale funds, large commercial or municipal deposits and regularly  move between funding options to maintain net interest margins.  These firms are at the mercy of market rates because they lack local franchises.

In contrast, most credit unions have average core deposit lives from ALM modeling of over ten years. The rates paid on these relationship based deposits rise more slowly and shield institutions from the extreme impacts of rapid rate increases.   In fact the industry’s net interest margin rose in the final quarter to 2.86% (slide 56) and is now higher than the average operating expense ratio.

Rates are likely to continue to rise.  There will be competition at the margin for large balances especially as money market mutual funds are now paying 4.5% or more.  If credit unions take care of their core members, they will take care of the credit union.

The February NCUA Board Meeting

The NCUA Board had three topics:  NCUSIF update, a proposed FOM rule change, and a new rule for reporting certain cyber incidents to NCUA within 72 hours of the event.  The NCUSIF’s status affects every credit union so I will focus on that briefing.

We learned the fund set a new goal of holding at least $4.0 billion in overnights which it is projected to reach by summer.  Currently that treasury account pays 4.6%.  With several more Fed increases on the way the earnings on this $4.0 billion amount alone (20% of total investments) would potentially cover almost all of the fund’s 2023 operating expenses.

Hopefully this change presages a different  approach to  managing NCUSIF.  Managing  investments using weighted average maturity (WAM, currently 3.25 years) to meet all revenue needs, versus a static ladder approach, means results are not dependent on the vagaries of the market.

At the moment the NCUSIF portfolio shows a decline from book value of $1.7 billion.  This will reduce future earnings versus current market rates until the fund’s investments mature, a process that could take over three years at current rate levels.

Other information that came out in the board’s dialogue with staff:

  • Nine of the past thirteen liquidations are due to fraud. Fraud is a factor in about 75% of failures;
  • More corporate AME recoveries are on the way. Credit unions have been individually notified. The total will be near $220 million;
  • If the NOL 1% deposit true up were aligned with the insured deposit total, yearend NOL would be about .003 of lower at 1.297% versus the reported 1.3%. Share declines in the second half of the year will result in net refunds of the 1% deposits of $63 million from the total held as of June;
  • Staff will present an analysis next month of how to better align the NOL ratio with actual events;
  • The E&I director presented multiple reasons for NCUSIF’s not relying on borrowings during a crisis, but instead keeping its funds liquid;
  • The E&I director also commented that the increase in CAMELS codes 3, 4, 5 was only partly due to liquidity; rather the downgrades reflected credit and broader risk management shortfalls;
  • NCUSIF’s 2022 $208 million in operating expenses were $18 million below authorized amounts;
  • The funds allowance account ($185 million) equals 1.1 basis points of insured shares. The actual insured loss for the past five years has been less the .4 of a basis point.

Both the Callahans Trend Watch industry report and NCUA’s  insured fund update with the latest CAMELS distributions suggest a very stable, sound and well performing cooperative system.

A Disappointing NCUA Response

Against this positive news, is a February 15  release from the Dakota Credit Union Association.   It stated NCUA had denied claims of 28 North Dakota credit unions for their $13.8 million of US Central recoveries from their corporate’s  PIC and MCA capital accounts.

These credit unions were the owners of Midwest  Corporate which placed these member funds in the US Central’s equity accounts, a legal requirement for membership.   The NCUA claimed that the owners of Midwest Corporate had no rightful claim, even though a claim certificate for these assets was provided by NCUA.

Nothing in this certificate says that the claim is no longer valid if a corporate voluntarily liquidates.

Under the corporate stabilization program corporate owners were forced to choose between recapitalizing after writing off millions in capital losses in 2009, merge with another corporate, or voluntarily liquidate.

Both the Iowa  and Dakota corporates chose to voluntarily liquidate versus facing the prospect of further corporate capital calls.

The NCUA oversaw the liquidation of both Corporates in 2011. The NCUA’s liquidating agent knew  that claim certificates were issued, that there was no wording that voluntary liquidation would negate future recoveries for the corporates’ owners and that NCUA’s legal obligation is to return recoveries to the credit union’s owners, whether in voluntary or involuntary liquidation.

The claim receipt specifically states: “No further action is required on your part to file or activate a liquidation claim.”  Yet that is just the opposite of what NCUA is now saying the credit unions must do.

For example NCUA continues to pay recoveries to the owners of the four corporates who were conserved and involuntarily liquidated by the agency.

According to Dakota League President Olson, NCUA has failed even to inform the league  in what accounts these funds are now held.  Are they being distributed to all other US Central owners? To the NCUSIF? Or held in escrow?

“This is a clear case of obstruction through bureaucratic hurdles and complicated language where the process is the punishment, and does not provide justice,” stated Olson.

These funds  ultimately belong to the member-owners of these credit unions  The NCUSIF is in good shape.  This is not a legal issue.  It is common sense.

NCUA controlled all the options for every corporate through through its stabilization plan. It took total responsibility for returning funds-no further action required. No one will critique returning members’ money.  But failure to do so undermines trust in the Board ‘s judgment, its leadership of staff, and its fiduciary responsibility for credit union member funds.

The NCUA board should do the “right thing” for these credit unions and their members.