Category: Lessons from For-Profits

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The Cooperative Liquidity Advantage of Member Ownership

The primary focus of credit union strategy is the member-owner. While business lending is growing, it is only a small percentage of loans. For almost all credit unions, member shares are the primary source of funding, not borrowings or large organizational deposits. The same is not true, on average, for banks.

Following is a comparison of insured deposits (balances less than $250,000) as a % of total deposits for banks and credit unions for the past five years:

Year-end:              Credit Unions % Insured Savings         Bank % Insured Deposits

2018:                                     93.0%                                                    59.6%

2017:                                     93.2%                                                    59.0%

2016:                                     93.6%                                                    59.2%

2015:                                     94.1%                                                    59.5%

2014:                                     94.5%                                                    61.0%

The $79.9 billion in savings in excess of the $250,000 NCUSIF insurance coverage are dispersed among 3,628 credit unions.

Over 40% of banks’ total funding is in uninsured deposits totaling $4.99 trillion at December 2018 year end. The peak year for insured deposits for banks was in 1991 at 82.1%.

In evaluating liquidity risk, the most common assumption is that consumer deposits, are the most dependable source of funding in a crisis.

The cooperative member-owner design further enhances this financial strategy. It is the member relationship, sometimes developed over generations, that is the intangible capital providing credit unions stability and relevance, especially when financial markets are disrupted. The value is real, even when unrecorded or perhaps unrecognized.

As a member, I trust the credit union values my participation as more than a consumer of products.

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Junk

This play by Ayad Akhtar is a story of the financial industry in the mid-1980s and the disruption caused by the creation of junk bond financing. The play is loosely based on the career of Michael Milken who perfected the technique of leveraged buyouts funded by high-risk high reward bonds.  It introduced a whole new means of financing outside the traditional options provided by the “white shoe” Wall Street investment firms that had dominated market access.

The play’s leading character describes this financial innovation by his repeated assertion that “debt is an asset.”

As credit unions increasingly push access to “secondary capital” to the top of their regulatory or strategic priorities, it may be useful to remember that “secondary capital” is nothing more than an unsecured term borrowing at rates much higher than credit unions pay their members for shares.

Calling these long term, high cost financial borrowings capital, because of payment priority in the very remote event of liquidation by NCUA, seems akin to calling “debt an asset.”

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The New Capital: Member Data

Member data is an asset. It is so potentially valuable that FDIC Chair Jelena McWilliams calls it the “new capital.” But that asset is nowhere on the balance sheet. However, it might be inferred from traditional institutional numbers such as average loan and share balances.

Because member data is not recorded financially, the necessity to convert this “capital” into a member service opportunity is often opaque. That is, until an outside party comes and wants access to some information to promote a new service or solution such as a software to manage an aspect of member’s life such as teen spending.

The member-owner design can help position credit unions as trusted fiduciaries with this information. Fintech innovators often view credit unions as valuable partners for targeted solutions because of their trove of member information and assumed trust.

What is the opportunity within the cooperative movement for the stewardship of this “capital?” How can credit unions both teach the value of and facilitate member benefit from their information?

Several countries including the United Kingdom have implemented the concept of “open banking.” https://www.americanbanker.com/opinion/us-way-behind-the-curve-on-open-banking

One way to explore this concept would be for credit unions to provide members the ability to grant permission of their financial data to other third parties. Under this concept, members would gain the ability to seamlessly and securely allow trusted third parties access to their member information.

Today this process is partially accomplished by aggregators such as Yodlee, but this is an uncertain process subject to operational disruptions. It is frequently limited to traditional product information available by screen scrapping.

By teaching members to value their data, credit unions can initiate member experiences that can help test new financial tools or solutions—thus enhancing the cooperative’s role as an intermediary.

As a member, I would certainly be interested in participating in these kinds of consumer innovations. Increasing my financial awareness, can only enhance my relationship to the cooperative.

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Understanding Disruption Within a Full Economic Cycle

At the FDIC’s April 23 Fintech conference, frequent reference was made to the growing role of “marketplace lenders”; firms using internet technology to reach customers directly versus traditional branch based, depository strategies.

Two frequent credit disruptors were cited: Quicken and peer lenders such as Lending Tree, Sofi, etc.

One estimate is that 40% of unsecured consumer credit was provided by fintech firms last year. Quicken was the number one mortgage originator in 2018.

While the advantages of internet based providers were easily listed–convenience, speed, ease of use, targeted market capabilities–the potential challenges were also noted. Most internet providers rely on external funding, which could disappear in a sectoral or broader economic downturn. Moreover the majority of marketplace lending innovation has been done in the very low and benign post-2008-crisis interest rate environment. Would their funding strategies be as viable in a higher or more volatile rate climate?

More importantly, the credit quality of most unsecured consumer lenders has not been subject to the stress of a economic downturn with rising unemployment. This part of the cycle is when capital adequacy is most tested.

There are real consumer benefits from financial innovation. However the lesson is to be careful about concluding that disruption in the short term will necessarily reshape markets over a full cycle. Market shakeouts may seem immediate, but the ultimate restructuring may not be known until incumbent firms and innovators experience a full cycle of financial competition.

Might such a perspective have informed credit unions’ and NCUA’s responses to the disruption of the taxi medallion industry? A subject for ongoing examination.

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Lessons from the For-Profit Sector: Corporate Governance

Following the financial crisis and the periodic failure of public companies (e.g. Enron), the expectations of corporate governance have steadily increased. This increase of mandated activities has occurred through both legislation (Dodd-Frank) and rule making by oversight bodies such as stock exchanges.

The enhanced expectations of corporate oversight provided by elected directors has focused on independence of directors and the structure of board governance.

The following is a partial list of the governance practices one company (Southwest Airlines) has adopted:

  • Qualifications of directors
  • Independence of directors
  • Size of Board and selection process
  • Board leadership
  • Board meetings, agendas and other materials
  • Director responsibilities
  • Executive sessions; communications with non-management directors
  • Board self-evaluation
  • Etc. for ten more policies

Today most credit unions adopt a standard set of bylaws which ordains some of the policies listed above. But beyond the formal requirements, how much policy substance is added? Should boards have a Code of Ethics ? Should there be requirements for directors’ share ownership? How is compensation and expense reimbursement defined?

A critical first step in the oversight of the board’s primary employee, the CEO, is its own self-governance ability. Without this awareness, the tendency is for the board to default to management by the CEO, thus reversing the intended governance relationship. When was the last time your board policy book was evaluated for relevance? What standard was used to determine sufficiency? Are the policies available for members who might wish to know how governance is practiced?

These are questions public companies must routinely disclose. Should members expect less?

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Learning from the For-Profit Sector: the CEO Pay Ratio

Cooperatives’ unique design uniting the member-owner as the single focus for corporate performance can provide some protections versus the potential conflicts of interests that every public corporation must balance between shareholders and customers. Regulation and rules for public companies are intended to promote this balance. One way this is done is through mandatory public disclosures in annual reports.

These disclosures may also provide insight about how cooperatives can better account for their stewardship of members’ interests.

I will be sharing a series of examples that credit union leaders may consider as we enter the annual member meeting season.

One example is the “CEO Pay Ratio”, a disclosure required of public companies by the Dodd-Frank Wall Street Reform and Consumer Protection Act. This SEC rule requires that the relationship of the median of the total of all annual compensation of all employees be compared to the total annual compensation of the CEO.

The following is the disclosure for the CEO of Southwest Airlines (page 42, 2018 annual report):

  • The total annual compensation of the company’s median employee was $78,494;
  • The total annual compensation of the company’s CEO was $7,726,455; and,
  • The ratio of the total annual compensation of the CEO to the median employee’s total compensation was 98.4 to 1.

Would such a comparison be useful for monitoring credit union CEO compensation trends? For members to have prior to the annual meeting whose primary purpose is to approve the election of the Board which oversees the CEO’s role? Let me know what you think in the comments below.