Category: credit union data

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 20^th 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.

 

 

 

 

 

From the June 30, 2022 call reports, NCUA reported:

• 399 CUs opted into the Complex Credit Union Leverage Ratio (CCULR) framework with an average CCULR of 11.35%, or 26% higher than the 9% floor.
• 304 CUs reported under the Risk-Based Capital (RBC) framework with an average RBC ratio of 15.39%, or 54% higher than the 10% minimum.

The 500 page, RBC rule and its almost 100 ratio calculations became effective January 1, 2022.  Just two weeks after NCUA board approval.

It was intended to provide greater insight about a credit union’s risk profile and capital adequacy. What can an analysis of the RBC adopters tell us from this initial implementation?

The Macro Totals

The 304 credit unions plus 4 ASI-insured who adopted RBC, manage $822.7 billion in assets.  But the risk weighted assets total only $479 billion.  That 58% ratio  is the NCUA’s discounting of total assets total by assigning relative risk weights.  For example some assets have zero “weight” (cash, treasuries) or negligible emphasis ( GSE’s 20%).

Compared to the traditional well-capitalized 7% of assets standard, this group holds $20.5 billion in excess capital above this ratio.

Using the minimum RBC ratio of 10%, this same group holds $26 billion in excess of the minimum.  As shown above, their average RBC is 15.4%.

The bottom line is that this group of credit unions is well capitalized whether using the 7% traditional level or the new RBC 10%.

Other Initial Findings

One intriguing fact is that 149 of these credit unions, or almost half, have traditional net worth exceeding 9%.  That  suggests most could opt out of the RBC calculations as they exceed the CCULR 9% compliance minimum.

For example, one credit union with assets between five and ten billion dollars, reports standard net worth of 12.5% and an RBC ratio of 48.3%.   Why did they report RBC versus CCULR?

One way CEO’s can use RBC is to show that even with a low traditional net worth  they are still more than well-capitalized.  A CEO holding 7.5% net worth may want to allocate future earnings for greater member value and avoid the 2% tax on net income  to maintain the 9% CCULR minimum.  Showing a high RBC to your board and members is a powerful defense of the lower traditional net worth measure.

A Look at Ratio Methodologies

However as shown by the banking example below, RBC captures very few risk factors. Its focus is solely on potential credit and/or principal losses on loans and investments.

One example: 250 of these 308 credit unions reported unrealized declines in the market value of investments that exceeded 25% of net worth.   Four credit unions reported a decline greater than 50% of capital.  This was before the five additional Federal Reserve’s  rate increases through the end of the year.  This situation is not recognized in RBC.

To compare peers and their capital performance is very confusing.  RBC credit unions can choose four different ways of calculating the ratio’s denominator.   Seventy two credit unions opted for a ratio  that did not use June quarter ending assets.  They chose one of three other options that  results in a lower total asset amount, and therefore a higher RBC outcome.

RBC ratio comparisons are further complicated when 152 of the RBC credit unions had a combined risk weighting of less than 60% of total assets.  In one case the risk weighted assets were just 24% of the total balance sheet.

Another difficulty in  comparisons is that there are other options for capital creation than retained earnings.  Seventy-six credit unions report that less than 95% of their “capital” came from their own earnings.  Twenty-four reported subordinated debt as capital and the majority of the remaining group were from equity acquired in a merger.

As a result RBC net worth ratios  reflect different capital strategies.  There is a difference in operating capabilities between institutions who rely solely on retained earnings and those who purchase capital.

Performance Outliers

The RBC spread sheet easily identifies those near the 7% minimum requirement-one is below 7% and 12 between 7 and 7.5%.

Using the 10% minimum RBC net worth, eight credit unions fall below this ratio and 15 have 10.5% or lower, and are close to the minimum.

These screens would be one way of assigning exam priorities.

Initial Observations About RBC

From both the macro numbers and the micro analysis, RBC does very little to inform about safety and soundness.

1. The calculation is a backward looking indicator of soundness. It is at a point in time and includes no dynamic ratios.
2. Comparisons of peer capital adequacy using ratio analysis is virtually meaningless because of the range of calculations possible and distribution of risk weighted assets.
3. No current, critical performance indicators are included. No delinquency, no expense ratios, no liquidity indicators, no IRR or ALM measures, and certainly no growth factors of any kind.

Ironically, is it possible that a very high RBC ratio indicates very poor value creation for members? The very opposite outcome for a credit union to sustain success?   Are the 33 credit unions with RBCs in the 20%, 30% and 40% ranges really serving members as their below average  loan/share ratios leads to higher reported RBC?

A Preliminary Look

The above analysis is as of June 30, 2022.  I will revisit the RBC reporting credit unions at December 2022  to see if the numbers have significantly changed.  For example, how many of  the 148 above 9% net worth opt for CCULR?  Credit unions will then have a full year’s and four quarters experience exploring the pros and cons of using RBC.

At this preliminary analysis, RBC looks like an exercise for credit unions to select their most favorable capital presentation. It may even create perverse regulatory incentives  that undercut initiatives for enhanced member value.

A Case Study of RBC and Bank Reporting

The following is an excerpt of RBC analysis of a bank serving the crypto industry and its reported capital adequacy.  This was written by Todd Baker, 1stSenior Fellow, Richman Center at Columbia University. (#capital #regulation)

Silvergate Bank has officially reported, and there is a big lesson there for regulators about the failure of risk-based capital standards to adequately address the risks of #banks serving the #cryptotrading gambling emulation of finance.

The wisdom of hard equity leverage capital requirements for banks is clearly demonstrated. They lost a billion dollars and their risk-based capital ratios increased! . .

Again, kudos to whomever managed the process of securities sales, reclassifications, borrowings, etc. at Silvergate. He/she did an amazing job bringing the plane onto the landing strip with one engine in flames and half the tail falling off while keeping the Tier 1 leverage ratio over the 5% “minimum” (which is actually way below the minimum in practice). . .But they still have the need to raise new capital, and fast, because their Tier 1 leverage ratio is way, way too low for the inherent risk from the business, as everyone now knows.

Despite losing a billion dollars (likely more than the company made cumulatively in it’s entire history) in the quarter, driving its holdco ratio of common equity to total assets down to 3.61%, from 8.84% at the end of 2021, and immolating half of the bank’s Tier 1 leverage capital, the bank’s risk-based capital ratios are actually higher (!) than they were at the end of the prior year.

 

Why? Most of Silvergate’s assets were and are still government securities that are treated as riskless (0% risk weighting) or GSE securites that carry a 20% risk-weighting. Riskless, that is, until you have to sell them in a rising rate environment…

Compare these two disclosures, from year-end 2022 and 2021:

“At December 31, 2022, the Bank had a tier 1 leverage ratio of 5.12%, common equity tier 1 capital ratio of 53.89%, tier 1 risk-based capital ratio of 53.89% and total risk-based capital ratio of 54.07%. These capital ratios each exceeded the “well capitalized” standards defined by federal banking regulations of 5.00% for tier 1 leverage ratio, 6.5% for common equity tier 1 capital ratio, 8.00% for tier 1 risk-based capital ratio and 10.00% for total risk-based capital ratio.” Versus,

“At December 31, 2021, the Bank had a tier 1 leverage ratio of 10.49%, common equity tier 1 capital ratio of 52.49%, tier 1 risk-based capital ratio of 52.49% and total risk-based capital ratio of 52.75%.”