Category: Mergers

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Credit Unions and Democratic Practice

Credit unions are strong proponents of democratic values.   Until they have to practice them.

I was reminded of this reluctance in a press story of a recent merger approval.  When asked about the vote tally, the credit union did not answer how many of its 9,870 members supported their charter cancellation:

Members of the $137 million Embark Federal Credit Union in Great Falls, Mont., voted to approve a merger with the $1.7 billion Horizon Credit Union, the Spokane Valley, Wash.-based financial cooperative said in a prepared statement Tuesday.

Horizon did not disclose the final vote tally. The credit union did not respond by deadline on Tuesday afternoon to CU Times‘ request for the member vote count.

Reporting the vote outcome, but not the actual numbers, suggests the credit union does not want the totals known.  The credit union provides the veneer of democracy but not the facts of how many member-owners actually participated in this required step to give up their charter.

To paraphrase a term from writer Jared Brock, credit unions have become “cooperative oligarchies.” The word comes from the Greek oligarkhía, meaning  “rule by the few.”

Merriam-Webster ‘s definition:  “a government in which a small group exercises control especially for corrupt and selfish purposes.”

Democracy has rarely been tried by capitalists.  Can credit unions really go against the incessant drive for corporate dominance and consolidation of power sought by firms in “free” market economies?

Many CEO’s and credit union boards don’t want democratic governance. They want silent customers who will passively accept the  leaders who achieved their roles years, or sometimes decades, earlier.

What they ignore is that members are the political constituency to whom  fidelity is owed. Boards and CEO’s are nothing without members.  Members deposit the funds, borrow for loans, pay the fees and generate transactions that keep the credit union revenue flowing.

Member-owners are the reason credit unions exist.
Members keep the lights on.
Members create 100% of the wealth for their cooperative.

One would think it required practice to tell members the vote tally in this management initiated effort to give up their independent credit union charter.  Especially as the CEO was awarded a $100,000 bonus and continued employment at an increased salary with the continuing credit union.

Horizon Credit Union assumes Embarks FCU’s member capital of $14 million, (approximately $1,500 per member).   The members get rhetorical promises about the future.

Is this the democratic model that will sustain members’ belief in credit unions?

 

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Learning from Past Mergers to Design a Stronger Coop Future

Since the NCUA updated its rule for mergers in 2017, almost 1,000 voluntary mergers have been completed.  In the first quarter of 2022, 41 mergers involving 366,000 members and $5.5 billion in assets were announced.

These were overwhelming strong, long-serving successful credit unions whose boards and CEO’s decided to turn their loyal members’ futures over to another firm.

The 2017 rule was intended to correct self-dealing transactions that were prompted by payouts to senior managers and staff to incent sound credit unions to give up their charters.

The rule required disclosure of all compensation related benefits that would not have occurred if the merger had not taken place.   The result has been some, but not all disclosures of promised payments.

The rule has not prevented enrichment, but ironically validated them.  The amounts and creativity of merged CEO payouts are growing.  Financial Center CU’s CEO and Chair transferred $10 million of the credit union’s capital to their private firm incorporated just prior to merger.-all with NCUA pre-approval.  In the merger  of Xceed CU the CEO negotiated a $1.0 million dollar merger bonus while promising members to look after their interest as President of Kinecta FCU for three years-only to leave within six months.

The CEO of Global negotiated a “change of control” clause in his contract that will pay him $875,000 upon merger with Alaska USA.  Change of control is used in stock corporations for managers who might lose their positions in a sale of the firm.  In this case the CEO negotiates the employment clause, seeks out a merger, retains employment post merger as  President, Pacific and International Markets, and pockets the money for the deal whose terms he set up.

The Banking Industry Is Looking at Merger Practices

In a May 9, 2022 speech at Brookings, the Comptroller of the Currency announced a review of bank merger approvals:

From my perspective, the frameworks for analyzing bank mergers need updating. Without enhancements, there is an increased risk of approving mergers that diminish competition, hurt communities, or present systemic risks.

Bank mergers should serve communities, support financial stability and industry resilience, enhance competition, and enable diversity and dynamism of the banking industry. Revisions to the bank merger framework would help to realize this goal.

NCUA’s rule 2017 merger rule was off target.   It did disclose self-enrichment, incentives  which were common place.  But it did not prohibit them..  The rule entirely missed the  Agency’s primary job which to protect members’ interests.

The evidence before and since the rule indicates that managers and boards act without consulting members, negotiate terms privately, and then present the events as final only needing the members’ perfunctory ratification.

Formal member approval is a foregone conclusion.  All of the resources, information and control was in the hands of those who set up the deal.  Members are unable to challenge let alone question the actions.

As members are shut out of the process, the concept of member owned financial institutions becomes a fiction.  Boards and management control the fate of a charter, its resources and relationships.  Members’ interests, loyalty and accumulated wealth are just pawns in management’s efforts to enhance their well-being.

As demonstrated yesterday, the majority of mergers are sound, long-serving and certainly capable of operating on their own.

How does one bring balance, objectivity and most importantly, member interests, to the fore in this increasingly wild west of uninhibited sellouts of cooperatives.

One writer, Denise Wymore,  has urged a greater commitment to purpose by credit union leaders.

Decisions, not conditions, determine your credit union’s future.

Do we look for the why behind a tough situation or do we just complain about it? Increased regulation, cost of technology, economies of scale, expanded products and services, lack of succession planning. Struggling to achieve a goal is normal and natural. Is it possible to work together to address the challenges facing “at risk” credit unions?

You have to find meaning, a purpose, something bigger than yourself. Reflect and think about your credit union’s purpose, passion, meaning…

The Comptroller outlined enhanced regulatory reviews such as:

 “Community feedback on the impact of a proposed merger also is important. . . .For example, for mergers involving larger banks, , the OCC is considering adopting a presumption in favor of holding public meetings.”  and,

“The OCC takes into account an acquiring bank’s CRA rating and performance. Banks with unsatisfactory CRA ratings are highly unlikely to receive merger approval.”  and,

Financial Stability in “too-big-to-manage is a risk with mergers, especially for banks engaged in serial acquisitions.”

Whether NCUA can reassess its role in mergers is questionable.   Unless political pressure from the Congress is exerted, NCUA seems oblivious to the reputational and safety and soundness implications of the wheeling and dealing now occurring, and the harm done to the communities who are losing their local institutions.

Putting Market Forces Back In transactions

I believe two changes in merger policy are required.  The first is make members’ interest the paramount criteria in any proposed charter cancellation via merger.  Secondly members should have the benefit of market forces to inform their decision.

Market choice would entail that all credit unions who decide to explore mergers would announce that intent publicly, invite all parties to express interest (both credit unions and non-credit unions) and then select the option the board believes meets the test of members’ best interest.  The full process would then be presented to the members for their approval or turn down.

The options for future employment, products and services, return of member capital would all be part of the public record and members would have the information needed to make an informed choice.   If a firm that is not selected wants to make a better offer, it would be able to do so and ask the members to turn down the board’s recommendation.

Putting Members Back in Charge

This change would place members in charge of the future of their credit union; not management and its personal preferences for future employment.

Mergers when sought should be a means to the end of enhancing member options and value. Today mergers alone have become the goal.  They are about self-dealing, power and control by a few.   It is time that members are given the choice about who they want in charge of their shares and loans.

 

 

 

 

 

 

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The First Quarter Score: 41 to 0:   Who Is Winning This Game?

This score is not the opening of an NBA playoff game.  It is the number of credit union charters given up versus new charters issued in the first three months of 2022.

What does the score mean?  Why is it so lopsided?  More importantly, are any members winning in these charter closures?

365,700 Members Lose their Credit Union

The 41 credit unions’ CEO’s and boards are transferring their 365,700 members to another credit union’s control.  These members did not choose this fate.  In fact they showed continued loyalty: total members increased by 2% and share grew by almost 11% for the year ended 2021.

These members have $3.3 billion in loans and have placed over $4.7 billion in savings  to benefit their fellow members. Collectively they have created over $540 million in common wealth, none of which will be distributed to them.  Their average ownership is $1,500 each.

There is no information that any of the members were consulted before the boards and CEO’s made these decisions.

Check the Box Explanations

The Credit Union Times article categorized  the 41 by the explanation NCUA provided when approving the  mergers as follows:

“34 credit unions that received the NCUA’s nod to consolidate for expanded services, two credit unions got the OK to merge because of poor financial condition, two for inability to obtain officials, two for lack of sponsor support, and one for loss or decline of field of membership.”

The continued growth in shares, membership and most importantly, the 47% increase in loan originations in 2021 suggest this group was more than competitive based on the latest performance data.  They ended the year with 9.9% net worth, delinquency of .55% and a collective ROA of 1.25%.

These 41 credit unions are sound performers which the members are loyally supporting.

The Largest Three

The three largest charter cancellations are the $2.5 billion Capital Communications FCU, the $612 million Global CU and $524 million People’s Trust FCU.  What they have in common is they are turning over the keys to their operations to credit unions already operating in their communities.

This means these six-decades old institutions are combining with other local credit union competitors.  The effect will be to reduce member choice, end opportunities for local leadership, close career options for employees, and extinguish the generations of earned loyalty and goodwill with members and local constituencies.

These credit union’s  hundreds of millions of collective capital will be under the control of directors the members did not elect and who will have broader corporate goals then just serving the newly acquired members and their transferred wealth.

These combinations eliminate local options and the diversity of models and service approaches that make credit unions successful.  Consolidation and concentration which reduces local competition may make life easier for managers.  It does not enhance member choice.

The most important math in credit union mergers is the 1 + 1 = 1.  There is no expansion of credit union coverage; the system did not grow market share; the members gained no immediate benefits.  But they will pay all the costs of merger including the cancelations of vendor contracts, employee benefits, and of course the help of professions who facilitate the deal making.

A Game without Rules or Umpires

Mergers of sound, well run credit unions are not benefitting members.  Rather they have become a sop for managers to game the system for self-benefit and boards who have lost any sense of fiduciary responsibility.

Writer-commentator Scott Galloway has characterized the motivations for mergers as:

Competition depends on rules, and rules depend on umpires. We should fight to protect competition — not winners. Because winners subvert the process. In the name of competition, they demand that their anticompetitive acts go unpunished. In the name of freedom, they insist on their right to shout down the dissenter’s voice.

His thesis is simple in capitalist economies:   No field sees winners try to retract the ladder behind them more aggressively than business or I might add, the CEO’s of sound merging credit unions.

The primary advantage of the credit union model is the member relationship grounded in democratic ownership.  Their unique advantage is their local knowledge and relationships that provide members a sense of agency over their lives and communities.

That goodwill, built up year by year over generations of members. is sacrificed in mergers.

NCUA requires new charters to survey potential members to demonstrate support, years of financial projections, vetting of proposed board members and employees with a process that takes hundreds of pages of documents and generally years to approve.

To give up a successful coop charter which took generations to succeed, is literally approved in weeks.  The form is perfunctory, there is no effort to validate the reasons given nor the rhetorical promises made.

The credit union system is failing the members who created it by routinely approving consolidations that mimic the activities of institutions for which credit unions were supposed to be an alternative.

At a time when individuals and communities are confronted by forces, events, private and governmental institutions over which they have no say, the credit union is supposed to be an option they  can count on.   Mergers destroy this sense of influence over events in one’s life.

The score this quarter is 41 to 0. At the moment, the members are losing this game.

Tomorrow I will provide some thoughts of others on what might be done.

 

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A Member Raises an Abiding Question Both Topical and Troubling

While traveling yesterday I was copied on an email between two credit union members.  The sender asked in part: 

“ I belong to five different credit unions.  I’ve clawed my way onto the supervisory committee of one of them. . . Alas, the Board of one has recently approved a deal by which it will be swallowed up by the biggest credit union in the state. . . When the deal was announced I wrote asking for whatever merger documents they could disclose.

I heard back directly from the CEO, who cheerfully explained they would be disgorging absolutely no documents.  It appears to me that the board and management actually expect the membership to ratify this deal entirely on a “trust me” basis. . . literally every justification that has been publicly offered comes down to some version of “bigger is better.”

His request:  “I am wondering if you would refresh my memory about what specific questions a concerned member ought to be asking about a deal like this.”

Topical and Troubling

If the situation is familiar, it is because it  happens  weekly.   Not mergers, but member-owners cut out of the process entirely.  Private deals supported by rhetorical promises and void of any objective facts.

Takeovers are an everyday event in capitalism and its anything-goes world of buyouts and mergers enabled by the financiers.

Here is how one long serving capitalist CEO described the process in his Annual Report:

Acquisition proposals remains a particularly vexing problem for board members.  The legal orchestration making deals has been refined and expanded (a word aptly describing attendant costs as well). But I have yet to see a CEO who craves an acquisition bring in an informed and articulate critic to argue against it.  And yes, include me in that category.

Overall, the deck is stacked in favor of the deal that’s coveted by the CEO and his/her obliging staff.  It would be an interesting exercise for a company to hire two “expert” acquisition advisors one pro and one con, to deliver his or her proposed views on the a proposed deal to the board—with the winning advisor to receive, say, ten times a token sum paid to the loser. 

Don’t hold your breath awaiting this reform:  the current system whatever its shortcomings for shareholders, works magnificently for CEO’s and the many advisors and other professionals who feast on deals.  A venerable caution will forever be true when advice from Wall Street is contemplated:  Don’t ask the barber whether you need a haircut.   (Source 2019 Annual Report, Berkshire Hathaway Inc. pgs 12-13)

A Game without Rules: Credit Unions Become Commodities

Mergers are being undertaken by sound, well established and stable credit unions not to better serve members.   But rather to make life easier for their leaders.

Instead of cooperative communities expanding long-time member relationships, these transactions treat credit unions like a commodity.  Leaders who give up their fiduciary positions to an outside third party without  engaging the owners prior to the decision and who must approve this charter cancellation.

This is the situation the member’s email describes.  And hundreds of thousands more members who end up becoming just consumer accounts to be bought and sold.

This is worse than the acquisition games Buffett describes in his Annual Report.  Credit unions and cooperative design is supposed to protect member-owners from self-dealing leaders and board toadyism.

Mergers lack transparency, public disclosures of strategy or benefits, and certainly no post acquisition accountability.  These are private deals negotiated by CEO’s putting their interests first and then announcing their intent to members.

The member vote is merely an administrative process without substance where very few members even bother to participate. All the messaging, resources and formal requirements are under the complete control of the persons benefitting from the transaction-not the members who must approve the decision.

What can members do?  How can the supposed democratic one member one vote governance model be revitalized to ensure member interests are front and center in these self-dealing transactions?

That is what the member is asking.  I will share your thoughts, and offer a few of my own.   Where is the Kristen Christian   when  members now need her to  save their own credit unions?

Buffett’s Merger Conclusion

“I’ve concluded that acquisitions are similar to marriage:  The start, of course, with a joyful wedding–but then reality tends to diverge from the pre-nuptial expectations.  Sometimes, wonderfully, the new union delivers bliss beyond either party’s hopes.  In other cases, disillusionment is swift.  Applying those images to corporate acquisitions, I’d have to say it is unusually the buyer who encounters unpleasant surprises.  It’s easy to get dreamy-eyed during corporate courtships.”

 

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Too Small, Too Short

There is an urban myth about a bet a group of writers and hangers-on made with Ernest Hemmingway one evening during a night of drinking in Paris.

His friends wagered that he could not write a short story in six words.  They each put over $100 in francs on the table.

Hemmingway took a napkin and wrote the following:

For sale. Baby shoes. Never worn.

He won the bet.

Too Small-An Obsession with Numbers

A similar mindset exists in many organizations about the value of size.   Growing larger is the basic criteria for success.

I was reminded of this obsession with numbers, not from the siren calls for mergers among credit unions, but rather from an observation on the decline of churches in America:

A church with 1,000 people can be a dysfunctional mess, filled with shallow believers, making zero impact in their local community.

And a church of 30 people can live out the faith, change lives and be true to the Gospel.

Is my church too small? That’s the wrong question to ask.

Instead, ask whether your church is healthy?

Insert the word credit union for churches; repeat the question.

 

 

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Why Chairman Harper Will Merge the NCUSIF into the FDIC Before His Term Ends

Let’s be frank.  Chairman Harper has yet to be confirmed by the Senate to his new term.  Therefore he is keeping his most important initiative under wraps until he officially has the job

But he has made no secret of his “Commander’s” ambition when he proclaimed at the March board meeting, “NCUA will guide the credit union system through the economic uncertainty caused by inflation, rising gas bills, and continued supply chain woes.”

After the Senate approves his appointment, he will reveal his “guide” plan: merging the NCUSIF into the FDIC.  There are two ways this can be accomplished, which I explain at the end.

It is important to understand why Harper sees this as his top priority.  Even more critical is recognizing how much support this merger proposition will have from credit unions and all other system stakeholders.

Harper’s Idealization of the FDIC

Since his appointment to the NCUA board Harper has continued to tout the FDIC as the gold standard for regulators.  He has repeatedly spoken of their consumer exam prowess (see GAC remarks), the FDIC’s financial flexibility, its support of MDI institutions and even their subsidized employee cafeteria.

In brief, he has concluded that NCUA cannot compare with the FDIC’s competencies, so his solution is to join with them.

But there is more than Harper’s FDIC-envy motivating the plan.  His core belief is that scale matters and that larger size means greater competence.  With the FDIC’s scale and NCUA’s mission driven purpose, the success of credit unions is virtually guaranteed.

NCUSIF’s “Tall Tree” Problem

The “tall tree” phenomena refers to risk underwriting when an organization represents a disproportionate amount of exposure.

The other board members sympathize with Harper’s view that  “bigger-is-better.”  They know that Navy FCU’s assets are over eight times as large as the NCUSIF.  If Navy’s NEV fell near zero in an examiner  shock test, the NCUSIF would face a bigger problem than all the corporates combined in 2009.

Adding the FDIC’s $123 billion and the $5.0 billion NCUSIF equity, the agency need no longer worry about “tall trees”  whenever examiners’ IRR modeling shows a PCA solvency shortfall.

Harper has other reasons for the merger in addition to his scale ambitions.

  • FDIC’s insurance fund has a superior financial model. Its premiums are risk based, open ended and there is no cap on fund size;
  • FDIC has no 1% deposit, so there is no controversy about “double counting” the fund’s assets:
  • FDIC has no accounting issues about true-ups, proper reserving and no independent private audit:
  • FDIC examiners are better at consumer compliance, technical analysis and asset liquidation management;
  • FDIC is a superior, more recognized brand than the NCUSIF;
  • The five person FDIC board has a vacancy that Harper will request be reserved for the NCUA Chair going forward (similar to OCC membership).

Credit Unions will support the merger because:

  • Transferring NCUA’s insurance activities will reduce its annual budget by at over $200 million, or 62%, the current OTR rate, for insurance related expenses;
  • Credit unions’ 1% deposit will be returned so they can once again earn a market yield;
  • FDIC’s premium expense is currently only 3 to 5 basis points per year which could be paid out of the yield on the 1% returned deposit if rates reach 3-5%;
  • Buying banks will be much easier for credit unions with only one insurer’s approval required;
  • FDIC’s logo will show members that credit unions are really on a level playing field with banks;
  • All credit unions already comply with FDIC’s capital requirements thanks to RBC/CCULR;
  • Credit union mergers show their belief that scale is the most important attribute to achieve cooperative purpose;
  • FDIC’s solvency has in fact been guaranteed by the US government, whereas the only proof for NCUSIF’s backing is a sentence in NCUA’s press releases.

Members will support the move because:

  • They were told the NCUSIF coverage was the same as the FDIC;
  • The FDIC is a better known brand;
  • The 1 cent of each share dollar members now send to fund the NCUSIF will be returned to the credit union;
  • Members have been told that credit unions offer “better banking”-this confirms that belief;
  • It doesn’t make any difference–insurance has never been the reason they joined the credit union in the first place. For the first 60 years of financial cooperatives there was no share insurance.

Why the FDIC will support the plan:

  • The $4.9 billion in NCUSIF equity to be added via the merger is more than 2 X the risk being transferred in the total assets of all CAMEL code 4 and 5 credit unions;
  • Eliminates an embarrassing financial comparison for the FDIC ‘s 90-year-old premium based model and its habitual inability to achieve its normal operating level;
  • The FDIC’s monopoly of deposit insurance will expand its power and influence especially within the cooperative system.

State regulators and NASCUS will support the merger as it will strengthen the dual chartering system:

  • It ends debates with NCUA about whether their rules apply to state charters or just FCU’s. Going forward, SCU’s will have just their one state regulator;
  • NASCUS will no longer have to argue about the Overhead Transfer Rate which caused state-chartered credit unions to pay a disproportionate share of NCUA’s operating expenses;
  • It eliminates the need to expand the NCUA board to include a state regulator;
  • The FDIC’s largess for examiner training is superior to NCUA’s;
  • It will activate state charters’ interest in cooperative insurance options. Credit unions in WI, FL, IA, MI and WA will seek to restore a choice of insurer.

CUNA/NAFCU will support the merger:

  • It certifies the level playing field for credit unions-a long term goal;
  • There are expanded opportunities for Lobbying for their DC staffs.

Congressional Democrats will support the merger:

  • All three NCUA board members were appointed by President Trump but democrats now are the majority on the FDIC board.  The party believesTrump holdovers should not control an agency in a democratic administration.

Congressional Republicans will support the plan:

  • It simplifies government and eliminates a federal agency overlap (NCUSIF) for the same activity;
  • Credit unions don’t pay taxes but this will require them to help pay for the federal government’s future FDIC bailouts during the next banking crisis;
  • It will relieve representatives of having to chose between their banking and coop constituencies as both will be under a common regulatory system.

Two Paths for Implementing Harper’s Merger Plan

 

One approach is to propose congressional legislation.  As Chair, Harper has already communicated to Congress his requests to change the NCUSIF’s financial model and modify CLF’s membership requirements.

While the legislative path is always uncertain, this effort could have bipartisan appeal as it is unlikely to have any opposition from credit unions or the banking industry.

Should this approach not prove feasible, then Harper will follow the same process used to implement the NCUA’s CCULR capital rule.  The banking industry required congressional legislation to add this option to the FDIC’s capital requirements.   NCUA was not mentioned in this CCULR enabling legislation.

However, Harper went back to the original PCA requirement from 1998 that said credit union safety and soundness requirements must be comparable to banks’.  NCUA said that bank regulators were authorized to offer CCULR, ergo credit union regulators have the same authority.  All three board members agreed with this legal reasoning.

Using this precedent, NCUA can mandate FDIC insurance  for credit unions by a rule based solely on the PCA requirement of “comparability.“ For there could be no greater comparability than a common insurer for both credit unions and banks.  The implementation could be done quickly,.  Credit unions were given just 9 days to comply with CCULR once it was passed.by the board.

In conclusion

Readers.  It is April 1.

I am not saying that NCUA should merge the NCUSIF with the FDIC.

It would likely be a shock for market-shy cooperatives to be in the same league as the profit-driven banks.

I’m just saying that it could happen.

And that it almost certainly will happen.

Because Harper has shown he gets what he wants. Moreover, credit unions could really end up screwing the banks using their newly won FDIC emblems while  holding onto their tax exemption.

After all, different charters are just legal fictions anyway. All financial institutions do the same things.

FDIC’s scale will facilitate even faster credit union growth from more bank buyouts and ever larger mergers.

And members will have peace of mind knowing that all along the NCUSIF was no different from the FDIC.

 

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Bon Mots V: Human Motivations

Whole bank purchases:

“We’ve heard from clients that the offers from credit unions are better in many cases,” Silvia says. “One of the most important things to think about is what is the best thing for the shareholders, which is generally getting the highest price.”

Not only do credit unions often offer the highest price, he says, they will likely pay in cash.” Garret Reich The Financial Brand

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Buying things is an installed habit, especially for Americans. I have friends who use shopping as a kind of therapy, and their homes are filled with trash.

And, as a result, we have a lot of stuff, stuff we really don’t need.

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Ockham’s razor (rule): Given multiple choices, the simplest explanation is usually the correct one. It’s also known as the principle of parsimony and is an academic’s way of saying, “When you hear hoof beats, don’t think zebras.”

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People can foresee the future only when it coincides with their own wishes.” George Orwell

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We are all quite capable of doing “horrid things,” especially in horrid situations. But before we do a horrid thing we must be quite certain that we actually are in a horrid situation.

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I’m convinced all of us, in one way or another—have an intense resistance to change. We like predictability and control. That’s one of the reasons addicts find it easier to have a relationship with a process or a substance rather than with people. Unlike objects, people are unpredictable.

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“The human person grows more, matures more and is sanctified more to the extent that he or she enters into relationships, going out from themselves to live in communion with God, with others and with all creatures.”  Pope Frances

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“I write entirely to find out what I’m thinking, what I’m looking at, what I see and what it means.” Joan Didion

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This Weekend’s Reading:  The story of why the Howard Johnson (28 flavors), America’s most popular roadside restaurant company, disappeared.

 

 

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NCUA’s Merger Supervision is Failing Members

In the June 2018 merger rule update, the board action memo (BAM) outlined the circumstances requiring an updated regulation.  The staff listed examples where self-dealing was rampant and decisions not made in the member’s interest.

This rule had been preceded by numerous press accounts of “credit unions for sale” and merger votes that were railroaded through with minimal notice to avoid any member opposition.

Any government intervention in the decisions made in a market economy should address  failings that market action alone will not correct.  The explanation that these mergers were just  the “free market” at work, is not true.

Most credit union mergers are non-market transactions.  They are negotiated privately between two parties, there is no bidding or competitive offers sought, and the member meeting and voting requirement  is treated as a mere administrative formality.

Before the new rule, mergers of sound, long standing and successful credit unions were routinely benefitting senior employees, and members rarely presented with objective data of any superior benefits.

The Two Aspects of Due Process

The most fundamental step in a merger is the member-owners’ vote to approve or not the proposal of the board.  The one member, one vote democratic governance is an integral part of cooperative design.

The new rule was to insure members were protected by a process which would allow them to make an informed decision in giving up their unique relationship and future direction to another institution.

The final rule’s  requirements for this approval process had two different, but complimentary components:

  • Procedural due process prescribed the formal steps, timelines, documents and  other requirements to give the member-owners the chance to vote;
  • Substantiative due process describes the kinds of information and options that credit unions were to consider and present to NCUA and members.

NCUA’s rule gave it authority over both aspects of due process.  However in its oversight it has failed this second responsibility which was the primary reason for the rule’s update.

NCUA has  supervisory approval on many aspects of credit union operations from initial chartering, changes in fields of membership, use subordinated debt and derivatives and in multiple other operational actions. For these  the NCUA requires detailed plans, financial projections, and proof of the capacity to carry out the requested action in a manner that will keep the members’ interests safe.

In these many operations NCUA requires credit unions to thoroughly document their policies and goals.  Except for one action: giving up the charter.

In the vast majority of formal member merger notices there is little specific detail.  Instead, rhetoric about scale and competition, better service and sometimes a listing of added locations, is the norm.

The actual merger agreements submitted along with the certification of the vote are single paragraphs.  Just a statement of intent or transfer all assets and liabilities to the continuing credit union.  There are no plans.

NCUA posts all the Member Notices, along with approved member comments here.

Mergers have become an administrative rubber stamp with no effort to verify the reasons or assertions of inability to serve members in a competitive manner.

By rule NCUA must review the minutes of both parties for the prior 24 months to learn what work has been done by the boards to reach their conclusion to enter into merger. The applicants must send:

Board minutes for the merging and continuing credit union that reference the merger for the 24 months before the date the boards of directors of both credit unions approve the merger plan

Presumably a reviewing examiner would look at the discussions, forecasts, options to learn if the member owners interests were in fact considered.  And how. What outside expertise was consulted?

This is the same supervisory process established for the changes in power or activities  described above.   One presumes, for example, it is the same detailed review of requests to purchase whole banks.

Best Interests of the Member

The 62 page merger rule BAM provided multiple reasons for NCUA’s substantive, not just procedural review, of mergers:

“The Board acknowledges, however, that not all boards of directors are as conscientious about fulfilling their fiduciary duties . . .

The Board confirms that, for merging FCUs, the NCUA’s regional offices must ensure that boards and management have fulfilled their fiduciary duties under 12 C.F.R. § 701.4 to:

  • Carry out his or her duties as a director in good faith, in a manner such director reasonably believes to be in the best interests of the membership of the Federal credit union as a whole, and with the care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances;
  • The duty of good faith stands for the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act with a conscious regard for their responsibilities as fiduciaries.

“Several commenters suggested . . .that the NCUA’s role is limited to safety and soundness concerns. These comments are inaccurate. . .

“the statutory factors the Board must consider in granting or withholding approval of a merger transaction include several factors related to safety and soundness, such as the financial condition of the credit union, the adequacy of the credit union’s reserves, the economic advisability of the transaction, and the general character and fitness of the credit union’s management. . .

The net worth of a credit union belongs to its members. Payments to insiders, especially in the context of a voluntary merger where a credit union could choose to liquidate and distribute its net worth among its members, are distributions of the credit union’s net worth. . .

“. . the fact that ownership of a portion of a credit union’s net worth is less negotiable than a share of stock in a public company is irrelevant at the time of a proposed merger transaction. A credit union in good condition has the option of voluntary liquidation instead of voluntary merger. . .

The Board agrees that mergers should not be the first resort when an otherwise healthy credit union faces succession issues or lack of growth. . .

The rule’s procedural requirements were to protect the members: The revised member notice will also clearly convey how the proposed merger will affect access to locations and services. These changes give members greater ability to assess whether the proposed merger is in their best interests.

NCUA stated that its authority in mergers was comparable to its authority over credit union conversions to banks, mergers with banks or with non-NCUSIF insured credit unions:  Applying all portions of the merger rule to all FICUs conforms to the approach the Board has taken in these other regulations promulgated under the same authority in the FCU Act. 

Member Best Interests

NCUA has outsourced its responsibility for the asserted future member benefits to the continuing credit union.  However it has no process for validating whether this has occurred.  It routinely accepts generalized assertions about “a wider range of products and services, benefits of scale, and improved technology” as if these  are merely routine operational upgrades.

One simple way would be to examine how many members remained active with the continuing credit union one year later. What happened to those relationships, along with the merged members’ equity?

Yet in  situations where credit unions have made multiple mergers, there is no evidence NCUA has assessed the member impact when the new merger requests are presented.

NCUA is not responsible for the respective judgments of the boards about whether to merge.  However it is responsible that when the requests are submitted that the plans, alternatives, financial projections and planned organizational changes were completed with professional thoroughness and thought.  That is, with substantive due process.

This is the same process for most NCUA  approvals. But that process appears missing in mergers.  NCUA takes years and hundreds of pages of documentation and projections to award a new charter whose benefits will be far into the future.

It requires no such effort for a credit union board and CEO to give up a charter and its accumulated member relationships and goodwill built over generations.  And the requests appear processed quickly, approved within weeks of submission of the required member notice.

The standard for a common sense review of any merger request and documentation should be: Are the transparency and plans sufficient to enable a member, with reasonable capacity and interest, to make an informed decision? 

If the review of minutes, plans and forecasts do not support the decision to give up the charter, then NCUA should ask the credit union to meet  its fiduciary responsibilities of loyalty and care and resubmit before sending Notice to the members.

Members are led to believe this supervisory due diligence has taken place when receiving the Notice of Members Special Meeting.  There is rarely any evidence of this supervisory due diligence did occur. Most member Notices wording suggest just the opposite.

Congress is Interested in Mergers

In a recent hearing Senator Warren attacked banking regulators for their routine approval of mergers.

“Community banks being gobbled up. The market is being dominated by big banks. There is more concentration, higher costs for consumers, and greater systemic risk, and it is happening in plain view of the federal agencies whose job it is to keep our communities safe.

 “The FDIC has a searchable database of all merger applications received since 2013, and there have been 1,124 such applications. Out of those, how many has the FDIC denied? The total number of denials for any reason whatsoever?”

 “It’s zero. This is not just a problem at FDIC. The FDIC, Federal Reserve and OCC combined have not formally denied a single bank merger in 15 years.

Merger review has become the definition of a rubber stamp and the banks know it, and it’s time for some changes. Just saying we’re going to get tougher on this is not likely to dissuade anyone, especially billion-dollar banks.

“This has turned into a check the box exercise where the outcome is predetermined.

“Our regulators have a job to do and it’s our job here in Congress to make sure they do it,”

Credit UnionMergers are Not Like Banks

There is a difference however between bank mergers and credit unions.  As one CEO observed:
Maybe the biggest difference and advantage, unfortunately, to the cooperative CU model these days is that the management can exploit the assets for its own self-interest without effective check…as opposed to the for-profit banks who are rigorously (often ruthlessly!) and transparently scrutinized by the marketplace. 

With no market discipline and regulatory neglect, credit union mergers have become enterprises for extracting personal benefit.

This story  is an example of how regulatory failure can result in the members’ interest compromised by self-dealing by the CEO’s of  the merging and continuing credit unions.

 

 

 

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A Coop Veteran on Opportunity

Randy Karnes led CU*Answers and its affiliates for over 25 years as CEO.   Combining network strategy in the Internet era with cooperative design was critical to the CUSO’s strategy.

He has stepped back from the CEO’s role and is heading to retirement.  He continues to share thoughts on what makes credit unions and CUSO’s successful.

Seeing Opportunities Within and Without

How do leaders rally their teams to moments of opportunity? Drive themselves to see others’ initiatives in a system as part of their own?

There have been times when inventorying the business problems in a marketplace was the right play to call out opportunity.  But when defining problems becomes more debilitating than inspiring as opportunities you have to change gears. 

This is a market of opportunity for employees and professionals – to open their eyes to the chance to be more.

Show everyone around you how to engage for opportunity, that they are the solutions and entrepreneurs with spirit.  Engage…..and corporate tricks like mergers, re-organization, and internal gambits will be far less inviting.  Engage your team one task at a time and watch your confidence in the way forward grow.

In my entire career I have never seen a marketplace so ready to reward people who are simply positive about the opportunity all around them. 

Cooperative Governance and Advisory Boards

Cooperative Business Designs and the drive for customer-owner governance:

Can 7 directors  (CU or CUSO) be seen as credible for 100,000 customers, 12-24 business lines, multiple product/service distinctions, and the intensity for cooperative passion? 

Our niche (cooperatives and credit unions) doubt it every day in pushing back against our competitive model.   But do we push back with actionable and tangible examples that overcome the issues?

There is a reason that Jim Blaine (SECU) had nearly 300 advisory boards – perception matters – the design and the faces of governance matter.  That is fundamental to a network’s success.  Our governance should be a meaningful platform for our competitive advantage and distinction.

This is not to say that there is a size limit for cooperatives. Rather this is to say that scaling governances, delineating the passions applied, and marketing customer-owner leadership closer to the delivery of the value, are the key to everyone’s seeing that cooperatives are different, no matter the size.

 

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A Theft of $10 million or Just Spreading Credit Union Goodwill: You be the Judge

This is a true story.  The lead characters are the CEO’s and boards of the two merging credit unions, NCUA’s Regional Office, CURE in DC and the California Department of Financial institutions.

The facts are from documents sent members, IRS 990 filings, FOIA data and public statements by those involved.  I give my point of view.  You can decide what your interpretation of the information would be.

The Story Begins

The first step was for the actors to draw up their scheme, include a lot of financial “chaff”  around the theft and then decorate the proposal with positive sounding future rhetoric  about “empowering people and economies of scale.”

Next, submit this draft proposal to NCUA’s Regional office for their OK.

No surprise there. NCUA approved the plan, detailed below.  Now it is full speed ahead.

With the regulator’s green light, the next step was to form a California based non-profit with initials mimicking the credit union’s name: FCCU2 Foundation.  The stated purpose is to “support charitable and educational activities for the betterment of the Stockton area.”  Despite the name, it is neither a foundation in traditional meaning nor tax exempt.

The two executives responsible for this new “charitable foundation” are the credit union’s CEO, Michael Duffy and the Board Chair Manual Lopez.   The organization was registered on June 25, 2021 with Lopez the CEO and Duffy the agent.  These two are also members of the five-person credit union board which approved these actions.

On August 6, or forty-two days after registering FCCU2, Board Chair Manual Lopez signs Financial Center Credit Union’s Notice of Special Meeting announcing the intent to merge with Valley Strong Credit Union.  Voting will end on September 23.

The Notice contains required information about the transfer of credit union reserves to this just created organization including:

  • the $10 million “capital distribution” to the newly formed non-profit FCCU2;
  • a new job for CEO Michael Duffy as Chief Advocacy Officer for the continuing credit union, Valley Strong;
  • Valley Strong Credit Union CEO Nicholas Ambrosini’s commitment to provide “an additional $2,500,000 to the FCCU2 Foundation over a term of ten years.” The wording is unclear whether this is $2.5 million in total or $2.5 million per year ($25 million) for ten years.

Other mandatory disclosures in the notice detail the additional financial benefits four of the five senior managers will gain from the merger.  A special  dividend will be paid to  members if the combination is approved in their vote.

This special dividend is feasible because the merging credit union’s net worth, over 16%, is double the 8.7% at Valley Strong.  The proposed dividend will be determined by a complicated proposal based on member tenure, most recent 12 month share balance with a maximum cap on the share balance.  The estimated payout is “approximately $14,973,948.00” in the Notice-an unusually precise number, suggesting a very detailed plan.

Members were given 48 days to cast their vote. On September 23, 2021, the called special meeting took place.  38 members attended in person.  Thirteen voted in favor and zero opposed. 2,667 members mailed ballots with 383 opposed and 2,284 in favor.

The final tally was 86% of members for and 14% opposed. Only 9% of the credit union’s 29,672 members voted on this request to give up their charter.

Financial Center’s Final Bottom Line

The merger was formally completed on October 1, 2021, seven days after the vote.

The financial results of the merger are reported in Financial Center’s last call report as of September 30, 2021. The loss for this final nine months  of the credit union’s 66-year life span is $23.7 million. This is due to the $10 million “capital distribution” to FCCU2 and recording the special dividend of approximately $15 million.

This one quarter’s loss reduced the credit union’s net worth ratio, accumulated over seven generations, to 12.4% from 17.2% one year earlier. That ratio was still 4% points (50%) higher than Valley Strong’s net worth at the same date.

Faking It Till You Make It

Recent events in California have highlighted the ethos of self-enrichment, especially in Silicon Valley startups.  A phrase used describing these unproven business ideas is: “faking it till you make it.“

This is the practice of promising future bold success even though past results do not support the vision.  When there is little or no objective evidence that a concept could succeed, a hyperbolic sales pitch is necessary to continue fund raising and keeping the effort going.

Michael Duffy has worked at Financial Center since 1993, the last 21 years as CEO.  His sister, Nora Stroh, also joined in the 1990’s.  She was Executive VP and COO, the number two position, all the time Michael was CEO.  In the 990 IRS filing for 2018, each reported total compensation of over $1.0 million.

During the final five years of their leadership, the credit union’s loans declined every year, from a peak of $176.5 million at December 2016 to $102 million at the merger date.  This is an annual growth of -10.3% (negative).  Total members fell by 2,700 or almost 2% per year in the same time frame.

However, the credit union continued to increase its net worth ratio reaching a peak of 20% at December 2018, before falling to 17% one year prior to the merger. Until January 1, 2022, regulators considered credit unions well capitalized with 7% net worth.

As net worth rose, falling loan balances resulted in the loan to asset ratio declining from 39% to 16% at the merger date. As these risk assets fell, the credit union continued adding unnecessary  reserves, reaching almost three times (300%) the well capitalized standard. This resulted in shortchanging members on their savings returns and/or charging higher loan rates than necessary for a safe operation.

The credit union’s leadership failed year after year in its most critical member service: making loans.  However, it piled up reserves relentlessly, until the leaders decided to bail out.  And take some of the surplus reserves with them.

Maintaining a Positive Public Profile

During this same period of decline, the credit unions maintained its public relations in high gear.  According to the 990 filings for 2017 and 2019, the credit union made political donations from members’ funds for local political campaigns, such as Stockton city council and mayor, and for statewide office, Newsom for California Governor.  Political donations in 2019 went to ten campaigns and $25,000 to the California Credit Union League Pac.

Maintaining the positive  image was important for Duffy. On June 1, 2020, the credit union announced a $1.0 million donation by the Michael Duffy Family Fund and the employees of the credit union.  An enlarged symbolic check to Stockton’s COVID-19 Response Fund was given by Duffy to the mayor, recorded for TV broadcast, and later published on social media.

The same press release also stated that the credit union had developed a Loan Holiday program to “alleviate financial burdens for its members.” Whatever the program’s intent, outstanding loans at the credit union fell by $40 million in 2020 from the prior year.

In the many years leading up to the merger, the credit union had been operating with the form but not the substance of a cooperative charter.  It was run as a family business, promoting the public profile of the CEO, not the well-being of members.

In contrast with the nationwide member and loan growth in the industry, Financial Center’s data shows it had ceased serving members as its primary activity. Instead, it added to a bigger and bigger reserve nest egg to dip into down the road. In other words, faking it till you can take it.

A Change of Perspective

Michael Duffy’s public  announcement of the merger intention at the end of May, 2021, was accompanied by uplifting logic and his recent strategic  insight:

“As the CEO of Financial Center Credit Union for the past 21 years, my perspective on mergers has evolved just as much as our industry has in that same time period. As credit unions built by select employee groups (SEGs) increasingly partner with community credit unions, I have marveled at what credit unions of today’s scale can accomplish when they join forces with their Member-owners and communities chiefly in mind.

In a financial services sector that is constantly evolving, this merger is a true embodiment of the credit union industry’s cooperative mind-set. At its core our partnership with Valley Strong represents us selecting the best credit union partner to help us achieve our goals faster than we could duplicate on our own.

The phrase ‘Growing Together,’ is a perfect adage, as this merger represents a strategic partnership between two financially healthy, future focused credit unions committed to providing unparalleled branch access, digital access, and amazing service for the Members and the communities they serve.

After three decades of leadership of the credit union, Duffy has concluded that the institution he led can no longer serve its members because it is not big enough ( “scale” )or “fast” enough.   His reward for this insight and merger endgame is a new position as Credit Union Advocate at Valley Strong. He gains control of  $10 million  funded by the credit union, a firm  no longer able to keep up with the times under his leadership.

It is more than self-dealing hypocrisy.  It is pilfering the members’ money.

Brain Dead Regulatory Oversight

One member who saw through this charade posted a comment on the NCUA’s member-to-member web sight, reviewed by NCUA’s CURE.  He urged a No Vote stating in part;

If Financial Center Credit Union is so flush with cash that it wants to give away $10 million, then that amount should be distributed to members. I’ve written to FCCU twice asking for the rationale for giving away $10 million. They have failed to answer me, obviously because there is no rational reason for giving away $10 million from its member-owners.

However, this brazen appropriation of members’ funds was condoned by the regulators-at every step.

NCUA’s multiple levels of review as well as California’s Department of Financial Protection and Innovation must have been braindead when reviewing this diversion to the control of Duffy and his board Chair, the two founders of FCCU2.

The magnitude of the grab and the cover story of good intentions diverted multiple regulators from their public responsibility.  Especially when accepting these future plans by leadership that had conned their members for years.

NCUA is fully aware of the self-dealing possible in mergers. It posted some of its  concerns when explaining its new merger regulation approved in June 2018.  The following are some of the reasons in the Board Action Memorandum supporting this updated rule:

“The Board acknowledges, however, that not all boards of directors are as conscientious about fulfilling their fiduciary duties (in a merger) . . .

The Board also confirms that, for merging FCUs, the NCUA’s regional offices must ensure that boards and management have fulfilled their fiduciary duties under 12 C.F.R. § 701.4.

Each Federal credit union director has the duty to:

  • Carry out his or her duties as a director in good faith, in a manner such director reasonably believes to be in the best interests of the membership of the Federal credit union as a whole, and with the care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances;
  • The duty of good faith stands for the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act with a conscious regard for their responsibilities as fiduciaries.

“Several commenters questioned the NCUA’s authority to regulate credit union mergers, or suggested that the NCUA’s role is limited to safety and soundness concerns. These comments are inaccurate. . .

“In contrast to commenters’ assertions, the statutory factors the Board must consider in granting or withholding approval of a merger transaction include several factors related to safety and soundness, such as the financial condition of the credit union, the adequacy of the credit union’s reserves, the economic advisability of the transaction, and the general character and fitness of the credit union’s management. . .

“Another (commentator) suggested that members have no role in considering merger-related payments to employees. These comments are legally inaccurate and philosophically off-base. The net worth of a credit union belongs to its members. Payments to insiders, especially in the context of a voluntary merger where a credit union could choose to liquidate and distribute its net worth among its members, are distributions of the credit union’s net worth. . .

“Further, the fact that ownership of a portion of a credit union’s net worth is less negotiable than a share of stock in a public company is irrelevant at the time of a proposed merger transaction. A credit union in good condition has the option of voluntary liquidation instead of voluntary merger. . .

(Note:  At June 30, 2021 the credit union reported $109.2 million in total capital.  Cash on hand was $138.9 million.  Net worth ratio was over 16%.  If the credit union were liquidated this would have given the greater Stockton community this immediate cash benefit. The 29,000 Members could choose to join another credit union or use the funds for immediate needs.   Instead the members received just 13.7% of their collective savings in a one time dividend.  Even though this option is referred to in the rule, there is no indication this was ever considered.)

“The Board agrees that mergers should not be the first resort when an otherwise healthy credit union faces succession issues or lack of growth. . .

If these specific statements are insufficient for exercising regulatory judgment, the common law understanding of fiduciary responsibility is even more clear:

The duty of good faith is the principle that directors and officers of a company in making all decisions in their capacities as fiduciaries must act with a conscious regard for their responsibilities as fiduciaries.  These include the duty of care, duty of loyalty and the duty to act lawfully.

Self-dealing is an illegal act that happens when a fiduciary acts in their own best interest in a transaction, rather than in the best interest of their clients.

“General Character and Fitness”

This misappropriation of $10 million of member funds by the CEO and Chair of Financial Center should bring the following actions by NCUA:

  • the full amount of the $10 million diversion should be clawed back from FCCU2 and distributed to the members;
  • the instigators at the board and in management who developed and implemented this scheme should be permanently barred from participating in credit union affairs;
  • the minutes and all other documentation relating to the additional required contribution(s) of $2.5 million by Valley Strong to FCCU2 for ten years should be reviewed. If this commitment was a quid pro quo (inducement) in return for the merger, then all parties approving this payment(s) should also be barred from engaging in the affairs of a credit union-board and management.

Every person in the regulatory approval process of this merger should have their actions reviewed to determine if they should continue to be in positions of responsibility.

Every participant will have an excuse. The creator and enablers of this transaction will defend their role by saying NCUA approved it.  Then they will point out that the members voted on it. NCUA staff will assert there was no safety and soundness basis to object-despite the many Board  statements quoted above.

Citing deeply flawed processes to defend one’s conduct, does not make the actions proper.

In presenting these defenses, the parties involved merely demonstrate incomprehension of one of the oldest rules of society: Thou shalt not steal.

Were such excuses offered, it would  confirm the absence  of fiduciary awareness and protecting member interests by the parties to this transaction.

These failures are not due to a rule needing updating. Rather it is an example of persons who lack commonsense judgment about accountability.

If NCUA fails to claw back the funds and do nothing it will demonstrate that it has neither foresight nor hindsight when it comes to protecting members. However, this would not be the first time such blindness has occurred; only the latest example.

Ignoring this case will just create a new benchmark for the next merger personal enrichment effort. It’s time to halt these sham merger member deprecations.