“The Public Purpose” of the Credit Union Cooperative System

In every new administration and most assuredly  following economic or other national crisis (Covid, natural disasters), the need to review governmental and agency responsiveness is raised.  Are changes needed?

Whether prompted by political priorities or  performance shortcomings, this is how existing policies are reassessed.

Another motivator is when market competition carries over to the political arena . Firms call out their rival’s more favorable regulatory  or tax status in their lobbying messaging.

In last week’s posts listed below, I noted the current absence of a policy framework at NCUA for the cooperative system.  I believe this leaves the system vulnerable to priorities set by others or to purely personal agendas.

The Reviews Begin

Last week the Director of the Federal Housing Finance Agency (FHFA) announced a review of the FHLB system.  FHFA, created in 2008, is the successor to the five person FHLB board.  This single administrator oversees the eleven FHLB’s and the conserved Fannie Mae and Freddie Mac.

The assessment of the 90-year old FHLB’s $ 1 trillion assets is to determine if  its modern day activities fully match its original mission of supporting mortgage lending.

FHFA Director Thompson’s purpose is to ensure the banks “remain positioned to meet the needs of today and tomorrow.”  One outside observer noted: “The home-loan banks lack a well-articulated contemporary purpose.”

Similar to credit unions, the FHLB cooperatives are exempt from corporate federal, state, and local taxation, except for local real estate tax.  For individuals, all FHLB bonds are also exempt from state and local taxes.

Credit Union’s Tax Exemption On the Agenda

A month earlier on July 27, columnist David Bauman wrote how the GAO was urging the OMB to study tax expenditures,  a budget category that includes the credit union tax exemption.  Are numerous tax exempt organizations still fulfilling their mission?

Bauman points out  the Treasury Department estimated the credit union tax immunity will cost the federal government $25.3 billion between 2022 and 2031.  This issue he wrote is “part of an ongoing battle between the banking and credit union industries.”

Scrutiny Not a New Process

From 1981 through 1985, the credit union system was part of four national studies directed by the Regan administration.  These were in  response to record high inflation, unprecedented interest rates,  disintermediation, financial innovation and growing concerns with institutional solvency.  For example, the Penn Square Bank’s 1982 failure was the largest FDIC liquidation post WW II.

In addition to the normal inter-agency or industry councils such as the FFIEC, NASCUS and multiple studies such as CUNA’s CapitalizationCommission, NCUA’s Chair was directly assigned to these four government-wide  assessments.

  1. The Depository Institutions Deregulation Committee (DIDC) was a six-member committee established in 1980 by Depository Institutions Deregulation and Monetary Control Act passed on March 31, 1980. DIDC’s primary purpose was phasing out interest rate ceilings on deposit accounts by 1986.

NCUA Chairman Callahan was one of five federal depository regulators. Chaired by Treasury Secretary Regan, all banks and S&L’s were given until June 1987 to end all federal controls on deposits.

NCUA chose not to follow the banking group’s timetable, eliminating all regulations in one new rule in May 1982. The decision effectively gave credit unions a five-year head start in the new market-facing era for financial intermediaries.

  1. The Garn-St Germain Depository Institutions Act of 1982, known as the “Deposit Insurance Flexibility Act” mandated that the three regulatory agencies study their insurance funds and make any recommendations for future changes.

On April 15, 1983, NCUA forwarded its 71-page, five-chapter study containing four policy recommendations.  This study became the foundation for the NCUSIF’s financial redesign approved by Congress in The Deficit Reduction Act  signed by the President  on July 18, 1984,

In Chairman Callahan’s forwarding letter to the study he noted:  “For credit unions there are very clear answers to the issues raised by Congress.  This is because credit unions . . .have actual experience with the options and alternatives suggested. . .Our responses are based on historical facts and current operational realities rather than academic theories or untried options. The credit union experience with insurance has been substantially different from the other agencies and our recommendations accordingly reflect this unique heritage.”

  1. The Private Sector Survey on Cost Control(PSSCC), commonly referred to as The Grace Commission, was an investigation requested by President Ronald Reagan, authorized in Executive Order 12369 on June 30, 1982.

The focus was waste and inefficiency in the US Federal government. Its head, businessman J. Peter Grace, asked the members of that commission to “Be bold and work like tireless bloodhounds, don’t leave any stone unturned in your search to root out inefficiency.”

The Grace Commission Report was presented to Congress in January 1984.  The Report included this observation:   “NCUA Chairman Callahan is a role model for government agency executives.  In one year NCUA reduced Agency staff 15% and its budget, 2.5%, while maintaining their commitment to preserving the safety and soundness of the credit union industry.” (NCUA 1983 Annual Report, page 3).

  1. The Vice President’s Task Group on the Regulation of Financial Services was formed in late 1982. Treasury Secretary Regan, the five financial regulators, the Attorney General, Directors of OMB, chairs of the SEC and FTC and state regulators raised the total principals to thirteen. The Group was given one-year to make recommendations to address the challenges of the emerging financial markets after deregulation and the potential repeal the Glass Steagall Act.

A final report was issued in November 1984. The Group’s recommendations were summarized by John Shad, Chairman of the SEC, in a later speech. He closed saying:

The lines of demarcation between the financial service industries have eroded. These activities should be regulated, and permitted to compete, according to their functions, rather than outmoded industry classifications.  

NCUA and the independent cooperative system were not mentioned in the Group’s regulatory recommendations.

NCUA and credit unions thrived in this transformative period of rapid financial change and increased scrutiny by completing the institutional, regulatory and policy foundations for a separate, unique and sound cooperative system.

Why a Cooperative Policy Framework is Essential

Without a clearly stated understanding of credit union’s role, every government study above could have drawn credit unions into their macro policy recommendations.

Instead NCUA demonstrated its ability to develop, document  and implement  how the deregulated cooperative system was successfully meeting its public purpose role serving members.

The cooperative system’s soundness was based of the values of self-help, self funding, and democratic volunteer leadership.  The “moral hazard” concern from FDIC/FSLIC insurance of private financial ownership  was absent in  cooperative’s creation of “common wealth.”

Today the ability to articulate this purpose is missing.  Regulations, especially the recently imposed RBC/CCULR were defended as being virtually identical to bank capital requirements.  New charters are rarely issued raising the question of credit union relevance today.  Whole bank purchases are routinely approved by NCUA even though  this use of member savings would seem contrary to why a cooperative system was created.

Absent an awareness of cooperative history and precedents, policy pronouncements or priorities of board members may just seem  like comfortable generalities.

In Harper’ July 2022 investiture address, he reflected on his year and half tenure as Chairman:

In achieving each of these things (regulatory activities), we have followed a philosophy that should guide all financial services regulators. Specifically, we were fair and forward looking; innovative, inclusive, and independent; risk focused and ready to act when needed; and engaged appropriately with stakeholders to develop effective regulation and efficient supervision. This philosophy will continue to drive our actions in the years ahead.

Is this the regulatory understanding that credit union cooperatives are seeking?

Sooner or later credit union’s special identity will be challenged by some governmental or political process.

The cooperative system navigated the multiple reviews from 1981-1985  because NCUA and credit unions earned a reputation for trust, expertise, mutual respect, shared purpose and performance.  This achievement was recognized by the industry and throughout the executive and legislative branches of both state and federal government.

NCUA Chairman Callahan in the Agency’s 1984 Annual Report observed:  The only threat to credit unions is the bureaucratic tendency to treat them, for convenience sake, the same as banks and savings and loans.  This is a mistake, for they are made of a different fabric.  It  is a fabric  woven tightly by thousands of volunteers, sponsoring companies, credit union organizations and NCUA-all working together. (page 3) 

Should  the movement aspire for anything less in this time?

 

 

A Rare New Species Sighted This Labor Day

Rare bird sightings are often front-page local news.  Such was the lead story on July 5, 2022  in Rockland, MI: Rare Eurasian bird spotted in Michigan, first sighting in US:

A Michigan birdwatcher made a once-in-a-lifetime discovery this weekend when he spotted a bird known as a common redshank in a marsh near Detroit, a few thousand miles from the bird’s usual home.

Equally rare among the financial species is discovering a new credit union charter.  The local news headline says it all:   Somebody Actually Started a New Credit Union. Here’s How They Did it.

This was the second sighting of a new credit union charter this year.  NCUA’s press announcement described the event as an example of credit union’s purpose: Supporting underserved communities and providing capital for community development is at the core of the credit union mission. 

Few in the credit union movement are actively trying to spot new charters.   CU*Answers and its CUSO challenge is one multi-year institutional effort.  Two individuals have been public in their pursuit of this rare activity:  Denise Wymore and NCUA Vice Chair Kyle Hauptman.

Because this event is so unusual, the joy, passion and hope embodied in a new credit union today are often overlooked.

Many persons’ deep desire to create something new to serve one’s community is a defining characteristic of American enterprise.

Entrepreneurs are central for a market economy, especially for new credit union charters that begin with limited financial capital.

On this Labor Day eve, I am reprinting this August 30 story as I believe it describes the dynamic human spirit new charters bring to the movement.  Enjoy this description of Community First Fund FCU’s creation by OSCAR PERRY ABELLO:

A Credit Union in the Neighborhood:  It Just Makes Sense

Leo Rodriguez knew all he needed was $10,000 in startup capital to open his own hair salon, something he’d dreamt about doing since he was four years old and saw a poster of legendary hair stylist Vidal Sassoon. Twenty-nine years and countless clients later, he is more excited than ever to invest back into the only institution that believed enough in him to make that loan.

The year was 1993. Rodriguez had already spent the previous several years studying cosmetology and hair styling in New York City and London. He returned to his home city of Lancaster, Pennsylvania, where he landed a job working at a new downtown hair salon founded by local legend Paula Severino Standish. After a wildly successful year, gaining his own influential clientele, he knew it was finally time for him to go out on his own.

He just needed that $10,000. But none of the banks he went to around town were interested in loaning him the money.

“I wasn’t looking to, like, renovate a building, I just needed a couple chairs, just to get started,” Rodriguez says. “There were a lot of banks that just didn’t want to give you any money. It was very hard to start a business. Also being a minority, that was difficult.”

A Personal Connection

But as fate would have it, one day Rodriguez was catching up with his childhood friend, Daniel Betancourt, who had recently left his job in commercial banking to join a new loan fund created by another local legend, a Black civic leader named James Hyson. Now called Community First Fund, it invests in Black, Hispanic, immigrant and other entrepreneurs whom traditional financial institutions weren’t interested in serving.

Not only did Community First Fund give Rodriguez his first $10,000 loan, it also taught him the ins and outs of running a business, creating a business plan, proper accounting, and profit and loss statements. He soon repaid that $10,000 and borrowed another $35,000, then $50,000. Every time he needed to expand or renovate or move his salon to a different location, he went back to Community First Fund. During his prime — he’s 63 now and expects to semi-retire in a few years — Rodriguez had 10 stylists working in his downtown Lancaster hair salon.

“I probably borrowed over three or four hundred thousand dollars from them in total over 30 years,” Rodriguez says. “They’ve never turned me down. They were always, always there for me.”

Loyalty and a Credit Union

Earlier this year, Community First Fund opened a traditional financial institution, a credit union. Why? Because after serving entrepreneurs like Rodriguez for 30 years, the fund found that the families and communities around those entrepreneurs either weren’t getting access to banking and affordable credit elsewhere or would prefer access to banking and affordable credit from a name and face they’ve come to trust.

Rodriguez was one of the first members of the new Community First Fund Credit Union. He’s moving all his personal and business accounts over.

“I’m into loyalty, man. I’m into taking care of people. it’s what I do,” Rodriguez says. “When Dan was telling me they were gonna open up this credit union, I’m like, ‘Oh, Jesus, thank God.’”

New Credit Unions Much Rarer

Starting up a new credit union is much rarer than it used to be. Prior to 1970, it was typical for federal regulators to charter 600-700 new credit unions every year. But since then, for multiple reasons, the number of new credit unions chartered every year began a long, slow decline. The new Community First Fund Credit Union was one of only four chartered in 2021. That’s as many new credit unions chartered over the previous five years combined. With so few new credit unions starting up, and scores closing or merging with others every year, the total number of active credit unions has declined from a high of 12,977 in 1970 to just 4,872 today.

The new Community First Fund Credit Union is also an even rarer example of something else. It’s modeled partly after Hope Credit Union, based in Jackson, Mississippi — which itself is really a replication of a model for banking that was birthed either on the South Side of Chicago or Manhattan’s Lower East Side, depending on who you ask. The model explicitly combines deposits from inside the community with deposits brought in from outside the community that might otherwise be deposited in bigger banks like those on Wall Street.

CDFI Plus a Credit Union

“The very fact that a new credit union is chartering is something noteworthy,” says Clifford Rosenthal, who helped establish Lower East side People’s Federal Credit Union in 1986. “And it’s especially significant in the CDFI world that this loan fund has used its resources to establish a credit union, which in the optimal scenario will operate side by side with the loan fund and hopefully achieve some real synergies.”

CDFI stands for “community development financial institution,” a U.S. Treasury designation for loan funds, credit unions, banks and venture capital funds that have a primary mission of serving low-to-moderate income, historically marginalized communities. Rosenthal helped craft the legislation passed in 1994 that created the CDFI designation as well as the CDFI Fund, an arm of the U.S. Treasury that provides grants, tax credits and other forms of support for CDFIs across the country. Community First Fund is a CDFI loan fund, and after it gets up and running, the new credit union can also seek its own separate CDFI certification.

Based on his own experience helping to start a credit union to serve a neighborhood other financial institutions were leaving behind at the time, Rosenthal expected that the new CDFI Fund would provide assistance to other groups starting either new credit unions or banks — regulated, depository institutions. But that isn’t how things turned out. Most of the CDFI Fund’s support has gone to loan funds like Community First Fund. And, with assistance from the CDFI Fund, some of those loan funds have grown very large, with assets in the billion dollar range.

“Some of the loan funds clearly have the capacity to launch a depository institution if they choose, but none of them have until now,” Rosenthal says.

Five Years Planning

Betancourt, now the CEO of Community First Fund and its credit union, says he started mulling over the idea maybe around five years ago. Clients of Community First Fund would occasionally ask if the loan fund could maybe help them or their families out with a home mortgage, or a used car loan, or alternatives to payday loans. Maybe they had tried getting those loans elsewhere and couldn’t, maybe they just wanted to deal with an institution they already knew and came to trust. At the time, Community First Fund had no way to help with those situations directly, it could only refer those requests to others.

Betancourt says he also started reading books like Lisa Servon’s “The Unbanking of America,” which gave him even more food for thought. Community First Fund also partnered with Lancaster’s Franklin & Marshall College to do a study of underbanked populations in Lancaster County.

More recent findings affirm what Betancourt was starting to grapple with. A study released last week from the Joint Economic Committee Democrats in Congress found Black and Hispanic Americans are more than twice as likely as white Americans to be unbanked or underbanked. Similarly, families at the bottom of the income distribution are more than six times as likely as families at the top of the distribution to be among the unbanked or underbanked. In 2021, 46% of Black Americans and 37% of Hispanic Americans reported that they had been denied credit or were approved for less credit than requested, compared to less than 25% of white Americans. Evidence shows that while new financial technologies show less bias than face-to-face lenders, they fail to eliminate discrimination.

Social Change with Transformational Deposits

The year 2020 ended up becoming the moment that provided the fuel for Betancourt’s credit union fire. Between the racial disparities laid bare by the COVID-19 pandemic, and the racial reckoning sparked by George Floyd, Breonna Taylor and other Black people killed at the hands of police, individuals and corporations were looking for something to do in response. One of the options that emerged was moving money into Black banks and credit unions.

Hope Credit Union received a $10 million deposit from Netflix and another $10 million deposit from PayPal, on the way to raising $100 million in deposits from corporations and philanthropy. CEO Bill Bynum started telling corporations his credit union actually didn’t need any more, but he could refer them to others like Betancourt who were looking to secure such big dollar corporate deposits — which Bynum started calling “transformational deposits.” They aren’t donations. These are part of the large pots of money that all corporations keep around on their balance sheets as part of managing their finances, but historically they’ve left those deposits in big banks or short-term Wall Street investments.

Finding Capital

But Betancourt needed more than just transformational deposits to charter a new credit union. Federal regulators require depository institutions to set aside a small portion of cash as a cushion against potential losses. For banks the minimum is $1 set aside for every $11 in assets, for credit unions it’s $1 set aside for every $16 in assets. New banks typically raise that initial small portion of cash from their shareholders. New credit unions can’t do that. So Community First Fund instead launched a capital campaign, in the traditional sense of a nonprofit or church group capital campaign in which donors are asked to make multi-year pledges.

For every corporation that called about making a transformational deposit, Betancourt also approached them about making a multi-year pledge as part of Community First Fund Credit Union’s capital campaign. And of course Community First Fund went around to its long list of previous donors to see who else might be interested in contributing to the capital campaign. A pledge of $500,000 could be spread out over five years, as $100,000 a year in retained earnings for the credit union to set aside as part of its regulatory requirements.

A Wealthy Donor

Community First Fund might have needed more time were it not for MacKenzie Scott’s surprise $10 million donation to the nonprofit, $2 million of which it plowed into the capital campaign for the new credit union. Thanks to the capital campaign pledges, stretched out over as many as five years, the new credit union projects it will have positive net income starting from year one. That’s unusual for any new depository institution, most of which anticipate negative net income during the first few years of getting up and running.

With its target customer base, letters of intent for transformational deposits and capital campaign pledge letters, not to mention its decades of experience making 5,592 small business loans and counting, Community First Fund submitted all of that as part of its charter application to the National Credit Union Administration in December 2020. The agency approved the application in just six months — lightning speed by normal chartering standards.

Since then, Community First Fund converted its headquarters into its first credit union branch, serving the Lancaster metropolitan area’s 550,000 residents. The credit union eventually plans to open six total branches and also leverage online and mobile banking to serve Community First Fund’s entire footprint, which now includes Philadelphia and crosses state lines into Delaware and parts of New Jersey.

The loan fund will continue to do what it has been doing, providing loans to underserved business owners, 71% of whom so far have been people of color. But now it has an affiliated credit union as a way to meet those requests for home mortgages, auto loans, emergency loans and other personal loan requests from its existing borrowers and their networks.

A Credit Union in the Neighborhood: “It Just Makes Sense”

“I’m so happy that they got the new credit union,” Rodriguez says. “It’s almost like the old way, you know, where you had a bank in the neighborhood and it knew everybody in the neighborhood and you knew the bank was there to help you. I believe every client that they ever had will open up an account there. It just makes sense.”

 

 

The Credit Union-Regulator Relationship

The basis for a shared cooperative regulatory policy framework:

“The relationship between credit unions and the regulatory agency is one founded on mutual self-respect, and on the realization that both sides share equally in the responsibility for the survival and future development of credit unions.”

(NCUA 1984 Annual Report, Page 14)

The Harm from an Absence of a Cooperative Policy Framework (Part II of II)

Yesterday (August 29) a press release from the North Dakota Credit Union League described NCUA’s turning a deaf ear to their request for their credit union members’ $10 million pro rata share of US Central’s AME surplus.

The final total may actually exceed $12.7 million based on NCUA’s March 2022 AME projected US Central distributions.

The NCUA’s Claim receipt states:  Upon final liquidation of the USC liquidation estate, this claim receipt will enable you to share  in the net proceeds, if any, to the extent of your PIC and MCA balances as of the record date.  No further action is required on your part to file or activate a liquidation claim.

The Dakota League’s title says it all: Time for NCUA to Do the Right Thing.  Its release points out Iowa credit unions are in the same situation. One might also ask how are all the corporate member shares of credit unions who were merged before AME payouts began being distributed? (example, Constitution Corporate)

Moreover, all credit unions  are still waiting for an update on the remaining $451 million of the reported $846 AME surpluses as of March 31, 2022.

These are just the most recent examples in which NCUA seems indifferent to its responsibilities to put credit unions and their members’ interests first.  This “me-first” approach is not lost on credit unions’ own activities.

Members’ Best Interests No Longer?

Lacking a cooperative policy framework, NCUA claims it is powerless when obvious conflicts of interest and direct subordination of fiduciary responsibilities by boards occur.   The members’ best interests becomes a forgotten standard.

For example, consultants overtly market “change of control” clauses for CEO’ contracts, a perverse interpretation of its real intent since coop CEO’s are the ones who initiate their own mergers.  The most recent example is a $750,000 payment in the merger of Global Credit Union. CEO contracts are a board responsibility.

A CEO and chair transferred $10 million of member equity to a private foundation they alone created upon merging.  The foundation is to be financed by another $2.5 million from the ongoing credit union-a clear conflict of interest. NCUA routinely approved this diversion of members’ equity to private party’s control.

Without a cooperative policy framework, the NCUA’s only test of a credit union’s sustainability is financial.  This is the “safety and soundness” mantra.

That standard is similar to saying that a person’s character and contribution is measured solely by their wealth. That is the value-agnostic success criteria that animates much of the capitalist system.

This policy vacuum undermines the unique advantages of the cooperative model and its long term safety and soundness.  Members become customers with profitability profiles.   A credit union’s resilience is nothing more than a quarterly tracking of net worth trends.

Soundness requires continual investments in members’ best interest, not merely fulfilling management’s personal ambitions.  A regulatory framework for cooperatives should be a collaborative effort.  It is not an NCUA internal task responsibility alone, like a budget, to be put out for comment.

Policy  would address current operational  issues that threaten the system’s character and integrity.  It will entail provocative conservations about current topics such as:

  • mergers of sound credit unions
  • the regulatory hurdles and lack of new charters
  • the suppression of members’ ability to vote for directors
  • the absence of member transparency on consequential decisions such as buying banks or adding ten-year debt/capital notes
  • reducing real regulatory burdens and enhancing NCUA transparency
  • the roles of CLF and NCUSIF-distinctly cooperative institutions reliant on credit union funding.
  • Increasing required disclosures for all credit unions including salaries for all federal credit union’s senior executives as is now required for state charters.

One outcome might even be a cooperative scorecard which would assess each credit union’s use of their charter’s unique abilities.

Not Perfection, but Setting Directions

A policy framework does not mean all the resulting regulatory judgments or approvals will be  uniform.   A regulatory framework should encourage better decisions  supported by objective data as well as the cooperative and legal documented processes of fiduciary oversight and care.  Conflicts of interest should be called out.

Experience suggests policy outcomes may be like the biblical parable of “weeds and wheat” grown together. That’s a risk but less so than the “anything goes” practices today.

Credit unions are and always will be a combination of good intentions and variable performance. They are run by human beings. Not all choices will be perfect. This mixed bag is the reality of freedom.

Both credit union leaders and regulators make mistakes. It is acknowledging when that happens.  Then  learning from the event, not defending the errors.

This mixed reality doesn’t mean regulators and credit unions can avoid the diligence and accountability that should characterize credit union decisions.  It’s not okay for self-interest to be the dominant standard for an action.

All are free to make mistakes and sometimes fail, but that does not mean there are no standards to be followed.

Cooperative assessments are important for another reason.  Credit unions, unlike their competitors, are not subject to the market’s daily judgments of management’s actions.   Coops lack bank’s  external check and balance on institutional performance whether through daily stock price fluctuations or the oversight of private ownership interests.

If cooperative standards are not part of the movement’s culture, then credit unions will tend to become just another financial option increasingly indistinct in a crowded marketplace. This will lead Congress to ask why this system should retain the tax exemption that would appear to be their only defining advantage.

The cooperative framework should enhance the never-ending task of credit unions becoming better cooperatives.  Nobody is perfect.  But reducing regulatory oversight to a standard that says  7% versus 14% net worth is better at meeting members’ needs is shallow and unhelpful.

Developing a Cooperative Policy Framework

In 1984 the credit union system redesigned its share insurance fund following 18 months of study, comment, and public dialogue about future options.  The recommended changes then required congressional approval.

This success was the product of extensive collaboration and interaction at every  level of the credit union system.  This effort was described in this brief introduction of NCUA’s implementation video by then chairman, Ed Callahan:

(https://www.youtube.com/watch?v=YjD0y6WRzOo)

A cooperative policy process should be collaborative, transparent and yes, controversial.  It should be democratic, public  and seek consensus on shared interests. Policy must encourage credit unions as communities of possibilities, not conformity.

An Alternative Path?

Without this policy framework, continuing examples of a “race to the bottom” business practices may put all credit unions on a path similar to the S&L industry with no turning back.

That does not mean credit unions (taxed or not) will disappear.   But it does suggest their separate regulatory apparatus will be absorbed by the FDIC, OCC and the FED. This is where the 602 institutions and $1.5 trillion savings industry is now regulated.

Why have a separate NCUA cooperative regulatory system if all it does is mimic the banking model?

 

 

 

The Missing Framework for NCUA Success (part I of II)

It is an accepted truism for NCUA board members presenting their credentials  for Senate confirmation, or whenever the agency is justifying a new rule, reg or policy, to state their ultimate goal is “to protect the insurance fund.”

Current board members have even called that objective their goal or North Star.  Their primary job.

This assertion turns upside down the logic of means and ends.

What is NCUA’s End Purpose?

NCUA’s primary responsibility, its purpose,  is encouraging and sustaining the resilience and integrity of a cooperative financial system for American consumers.  The FCU Act states:

The term Federal credit union means a cooperative association organized in accordance with the provisions of this chapter for the purpose of promoting thrift among its members and creating a source of credit for provident and productive purposes

To achieve this end, NCUA was given multiple means in the law:  chartering, examinations, supervision, administration of charter changes, issuing regulations and providing expert guidance.   The tool least used, as it is rarely needed, is calling upon NCUSIF.

Most importantly, the FCU act specifically states the NCUSIF’s financial solvency is protected by the full faith and credit of the credit union system.   All members must deposit and maintain 1 cent of each share dollar in a credit union with the NCUSIF.  Every member is part of this collective guarantee ensuring all other member shares are indeed safe. This is a cooperative movement commitment, unique to the NCUSIF.  It is the law.

If all of NCUA’s every day tools ( the other “means”) are effectively managed, then the members should never be called upon to provide additional resources.  That is how NCUA protects the Fund.

The first four-decades of regulatory responsibility to maintain cooperative system integrity from 1934-1971 did not require the share insurance tool.

One aspect of “integrity” was certainly promoting credit union solvency as there has always been reserving and net worth requirements in the law.

But just as important, system “integrity” (as a source of credit) also included vital cooperative components to provide a distinct financial alternative for members.  These  include democratic governance, values such as education and collaboration, volunteer leadership (unpaid directors and committee members), access for all Americans regardless of financial circumstance (capital), focus on community (common bond), and contrary to the capitalist model, building common wealth versus private equity, to be used by future generations .

Over time additional characteristics have been developed including interdependence (corporates and CUSO’s) and system support augmenting the critical initial role of sponsors.

A Reward for Performance

When Congress approved the NCUSIF for credit unions in 1971, it was a reward for their performance.  As stated at that time, insurance was not due to financial problems with credit unions or the cooperative system.  Rather it recognized their growing contribution to the American economy and that they might not perceived by the public as the equal of their FSLIC/FDIC alternatives.

A Cooperative Policy Framework Is Lacking

For NCUA to faithfully fulfill its mission to protect the integrity of this cooperative financial alternative, an appropriate regulatory policy framework is necessary. Such a framework should be nonpartisan and multi-administration.  Past examples are the deregulation of shares by NCUA or the redesign of the NCUSIF.

Without a thoughtful and evolving framework, NCUA becomes a mishmash of regulatory justifications or each Chairman’s personal priorities.  What do the banking regulators do?  Or let the “free market” work its will.  Or elevating suboptimal tasks and agency operations  to define priorities.

Absent a policy framework, the unique role of cooperatives becomes increasingly confused with all the other financial activity in the marketplace.   No longer are the well-being and rights of member-owners front and center.  Bright shiny objects such as innovation and new technologies take center stage.

The ambitions of managers and boards seeking to outgrow their for-profit competitors become the industry’s defining priority.  Some credit union leaders chart success not by developing a better alternative to attract members, but rather using their decades of member reserves for buying out bank owners at a premium.

That activity would certainly seem contrary to the spirit of the Act.  And therefore worthy of public debate.

Credit union CEO’s, nearing retirement, game the system for personal enrichment  “selling their credit union” via merger.  They capitalize on the transfer of members’ accumulated wealth and loyalty for additional bonuses and extended payments beyond those merited as CEO.

In these transactions, the financial and relationship legacy, its goodwill, is turned over to boards and CEO’s with no prior connection.  And justified only with vague future promises that bigger is better.  The unique character of the charter and its local legacy and traditional focus are eliminated.

Tomorrow Part II, developing a policy framework.

Abraham Lincoln and the Challenge Facing the Credit Union Cooperative Movement

In the Gettysburg Address Lincoln summarized the ever-present challenge of keeping alive the spirit of a  revolution’s  original intent.

Dr. Eva Braun’s essay describes Lincoln’s grasp of the declining motivation of later followers in his Gettysburg speech:

From Dr. Braun’s  analysis: Lincoln begins, “Four score and seven years ago.” “Four score,” With its long oh’s, sounds a more mournful, solemn note than could the words “eighty-seven years,” but the choice of the phrase is not only a matter of sound; it also carries a special meaning. It is the language of the Bible, as in Psalm 90:10:

The days of our years are threescore years and ten; and if by reason of strength they be fourscore years, yet is their strength labour and sorrow; for it is soon cut off, and we fly away.

With the psalm in mind the phrase implies: just beyond the memory of anyone now alive, too long ago for living memory.

Now, we know that from youth on Lincoln was concerned with a peculiarly American danger: the death of sound political passion. In his speech on “The Perpetuation of our Political Institutions,” of 1838, Lincoln drew a clear parallel with the early community of Christians, whose danger lay in the fact that the generation of disciples and eye-witnesses had been followed by a second generation which had only heard by word of mouth, by a third which had only read of Christ, and by a fourth which had begun to forget.

So in the American community; the scenes of the revolution, he said, “cannot be so universally known, nor so vividly felt, as they were by the generation just gone to rest.”  The men who had seen the Revolution, who were its “living history” are now gone.

“Beginning to Forget”  A Peculiarly American Habit

Remembering the contributions of earlier credit union founders is vital. Last week Jim Blaine described the legacy of Ralph Swoboda. As CUNA General Counsel and then President, he helped transform the movement through two system-wide challenges: business modernization and deregulation.

While leading NCUA in the early 1980’s, Ed Callahan and Bucky Sebastian in their presentations promoting deregulation would cite the original practice of common bond going back to the early years of state chartering.   They pointed out that some of the first fields of membership were often city-wide.  The intent was to be inclusive, not limiting,  for those who sought a cooperative financial choice.

But this reference to the spirit of the cooperative founders, where purpose surmounted existential challenges, can  dissipate as the “living history” passes on.

We cannot resurrect those who have left the playing field. But we can certainly rekindle passion for member advocacy in all its cooperative possibilities.   And in the process keep the “movement” alive.

The Current Challenge

When a motivated popular movement aligns itself with another cause to promote its  agenda, the hybrid effort can pervert its primary purpose.

An example is the tying of Christian nationalism with white nationalism.  Christianity becomes less about faith and more about political power.

A parallel confluence of activity is occurring in credit unions.  Since the imposition of PCA in 1998 through the Credit Union Membership Access Act, NCUA has increasingly equated credit union oversight  with banking practice.

The latest effort is the imposition of RBC/CCULR completely incorporating the full bank regulation in its rule. This embrace of banking models, a frequent standard cited by Chairman Harper, also includes the promotion of external capital.  It neglects the unique capabilities of cooperative design.

Collaborative institutions include the CLF and NCUSIF, both under NCUA management. CLF’s role is moribund.  As for the NCUSIF, NCUA has converted the insurer into an open-ended funding draw for the agency’s daily operations.

Another example of cooperative diminution is NCUA’s lockdown of the corporate network, especially its services for smaller credit unions.

Credit unions have read the regulatory signals.  “Treat us like banks, and we will follow that industry’s lead.”  Mergers, not collaboration, become a priority growth strategy.  Bank purchases, paying premiums to bank owners with credit union member capital, is promoted as an immediate expansion opportunity. In other words, “If we can’t beat ‘em, let’s just buy ‘em.”

The regulators are silent. As long as credit unions’ financials mirror bank’s, everything is OK.  Mergers, bank purchases and novel (SPAC) growth tactics are just the free market at work. Even when a CEO and Chair transfer $10 million of members’ funds to their control following a merger.

Let me be clear that these are not the actions of the majority of credit unions, but they  dominate the headlines.

Losing Faith

The credit union system’s unique capacities are simplified to  safety and soundness, defined by ROA and net worth with a dollop of growth thrown in.  Purpose becomes dressed as creative public relations campaigns and promotional branding efforts.

An example of this waywardness is VyStar Credit Union.  A member forwarded their most recent assessment of its recent flawed digital channel conversion:

In regards to VyStar, we have decided to move our account to another credit union.

Facebook posts (https://www.facebook.com/VyStarCU) have certainly slowed down.  I do not know if it is due to apathy or is X number of people who have just gone to other financial  institutions.

Login online has greatly improved.  There is little to no wait time.

They updated the mobile app on June 26th.  Many people had difficulty getting on the app, especially the android version.  

Getting a hold of someone in customer service is very difficult at best.  Very long wait times on the phone (in excess of two hours).  You can log into chat, I had almost an hour wait the other day.  While they have now added internal transfers, you still cannot do member to member (linked account) transfers (like to other family members).  You can only transfer funds internally within your savings, checking, MMA, etc.  

You still cannot see any account history prior to 05/13/2020 which was the day they shut down the system they used prior to the current one.  

You no longer get copies of your checks written online as before.  

I see no “Improvements” or new features in the new system whatsoever.  The new bill pay is cumbersome and not user friendly.  I filled in the bill payees into our new credit union with ease, it is almost exactly what  we used to have at VyStar before this poor unsatisfactory installation.  

Lastly, and most disappointingly, is the fact that the CEO has still not addressed the members directly.  I know of no statement to the press since about May 23rd.

I have no idea how many members have left and I am not sure we will ever know.  I hate leaving but, I have lost faith in them.

A Two-Way Street

The fundamental flaw in VyStar’s strategy is not a bungled conversion.  Many conversions have temporary problems.   Rather it is VyStar’s strategy that credit union membership is a one-way street.   Members just transact and are viewed as customers, not owners.  There is no respect for members’ “faith” which is the primary foundation for any credit union’s long-term success.

A two-way street means the owner’s role is understood, honored and continually enhanced.  The primary means  is seeking to expand the multiple ways value is created for members, especially those who have the least or know the least.

A Member Advocate

The credit union model is foremost an advocate for members’ well-being.   That was the original intent.

The vibe at VyStar is all about the institution and its size. This is a sentence from an April 2022 merger announcement before the digital debacle:  VyStar, which has more than 800,000 members and over $12 billion in assets, will remain the 14th-largest credit union in the country by asset size.

When the member relationship is always front and center, the owners return much more than transactions.  They give their loyalty, patience when necessary, and word of mouth endorsements with friends and family.

That was how the credit union movement achieved their current $2.3 trillion position while serving the fourth or fifth generation of members.   Members’ contributions are paid forward to benefit future members.

For the founding members’ spirit of purpose to prevail, it must  be constantly renewed in the words and actions of those leading cooperative charters now.

 

 

 

 

 

The $846 Million Missing Item From Thursday’s NCUA Board Agenda

While NCUA’s $350 million annual budget is the primary Board item, that is not the most important financial issue.   For there is unfinished business stretching back over a decade.  The agency owes credit unions an amount that is 250% greater than the budget it will be discussing.

Here’s the details.

In March 2009 NCUA Board member Rodney Hood along with Chair Michael Fryzel and member Gigi Hyland voted to conserve US Central Credit Union and WesCorp, the two largest corporate credit unions.

My hunch is that board member Hood never expected to be overseeing the continued distribution of US Central’s almost $2.0 billion surplus thirteen years later during a second term on the Board.

Credit Unions Due $846 Million

As of the March 2022 AME financial reports for the five liquidated corporates, NCUA projects over $846 million is remaining to be paid. The majority, $556 million, is from US Central’s estate.

When completed total AME payments to credit union member shareholders will exceed $3.2 billion.   As a comparison, the total capital of the eleven active corporates at December 2021 was only $2.5 billion.

Put bluntly, the collective funds returned by the four liquidated corporates is 132% great than all the equity in corporates active today.  Closing these solvent corporates was a catastrophic error in  judgment!

The March 2022 AME financials presents the total forecasted payments to the four corporate’s members and the remaining amounts due.

US Central:     $1.832 billion with $ 556 million due

Mbrs United:  $  622  million with $130 million due

Southwest:      $  613 million with $127 million due

Constitution:   $     48 million with $  32 million due

There are no payments for the $1.1 billion of credit union member capital at WesCorp.  NCUA projects a WesCorp deficit after all recoveries at $2.1 billion.  This is the only loss to the NCUSIF from the five corporate liquidations.  (from line B4-Due to Government March 2022 AME financials)

Total Corporate Surplus Now Tops $5.8 Billion

The above amounts do not include the $2.563 billion added to the NCUSIF when the TCCUSF surplus was merged on October 1, 2017.   Adding this amount brings total recoveries to almost $5.8 billion.

This surplus continues to point the need for an objective review of the entire corporate resolution effort.

When US Central was seized in March of 2009 NCUA Chair  Fryzel was quoted in a Wall Street Journal March 21 article:  “With us in control, we’d get honest numbers.”

If subsequent events have shown anything, it is that  “honest” numbers in an environment of uncertainty depends on who does the accounting.   Especially when the underlying process relies on valuation  models that claim to project the economic climate and related cash flows  years or even a decade into the future.

The Core Regulatory Failure

The problem is not the models or their incorrect assumptions, both of which were wrong.  The error is that predictions should not be the primary basis for resolution strategy.  All models are wrong; some are useful.

The required response is managing the daily dynamics as markets change.  Trying to predict the future  as the basis for today’s tactics led to disastrous decisions in NCUA’s  assessment of the corporate assets.

With NCUA’s ALM/NEV supervisory tests becoming more prominent in today’s rising rate environment, the limitations of financial modeling  is a much needed lesson to bear in mind.

The Need for a Look Back

But a look back is important for another reason.   Still today NCUA Chair Harper and senior staff use the apocalyptic estimates and conjectures thrown out in 2009 as NCUA  projected future events.  The hyperbolic forecasts were incorrect then; it is double injury to repeat them today when the actual facts are known.

In the same WSJ article above, Chairman Fryzel was quoted:  “regulators aren’t concerned about the health of any other wholesale credit unions besides the two brought into conservatorship.”  Yet just a year later when no longer chair, member Fryzel supported the liquidation of three more corporates, a decision that was devastating for the system and individual corporates.  Both Southwest and Members United are paying liquidating dividends on top of returning all their members’ capital shares.

By forecasting disaster, NCUA took unilateral action without any industry involvement except paying the bills.  There was no check and balance, no transparency and no alternative solutions developed.

Unfortunately, that unilateral regulatory mindset continues today.  It undercuts the unique cooperative advantage of collaboration represented in the common credit union funded resources  in the NCUSIF and CLF for individual turnarounds.

The most important takeaway from the corporate debacle is not estimation failures or the value of patience when resolving problems.  Rather it is NCUA’s failure to understand the unique cooperative capabilities when developing regulatory work out plans.

That lesson should include respect for the institutions in difficulty and a willingness to work together for solutions versus liquidating problems to make them go away.

The one board member who is best positioned to state the importance of this learning opportunity is Rodney Hood.  He was there at the Alpha and now hopefully, the Omega.

His counsel should be heard.  And credit unions should get their funds back ASAP. Enough delays!

PS:  I hope a board member will ask what the additional $10 million in liquidation expenses paid (outside the NCUA budget) in the first quarter from the AME recoveries was used for.

 

When Less Is More: NCUA Board’s Mid-Year Operating Budget Review

This coming Thursday the NCUA board will review the agency’s midyear budget.  To do so thoughtfully, it is useful to put the operating budget’s long term and recent trends in perspective.

Below is a summary of the growth rate of NCUA’s operating fund budget from 1999-2001.  The first column shows the compound annual growth (CAGR) for the entire period; the second column for the most recent five years.   Note the annual growth rate is per year.

  Annual Growth of NCUA’s Operating Fund Expenses (1999-2021)

 

Account CAGR’99-’21 CAGR ’16-’21
Beginning Cash Balance $MN 11.47% 22.43%
Operating Fee Receipts $MN 4.27% 8.97%
Operating Expenses $MN 3.66% 9.48%
Net Fund Bal at Yearend $MN 16.92% 26.01%
Ending Cash Balance $MN 12.32% 21.33%

What the Recent Numbers Mean: Expenses Out of Control

During these 22 years, NCUA has transferred ever higher amounts of its operating expenses to the insurance fund.    This is via the Overhead Transfer Rate (OTR) process. That rate of expense allocation has been as low as 52% in 2008 and as high as 73.1% in 2016.   Currently it is 62.7% an increase from 2021.

This overhead transfer has exceeded 50% even though state charters have always had fewer than 50% of total insured shares this entire time.  NCUA is subsidizing its regulation of federal charters by shifting costs  onto state credit unions.

Following this arbitrary, open-ended expense transfer however, operating expenses still increased 3.66% annually or faster than inflation for the entire period.  Most recently in the five years 2016-2021 this annual growth accelerated to 9.84 % or three times faster than the overall 22 year average.

NCUA invented inflation five years before the rest of the economy could catch up.

After this OTR allocation, the Operating Fee charged to FCU’s exceeded actual operating expenses by an average of 104.5% for this entire period– some years more than 100% and others less. Since 2015 however, the NCUA’s the operating fee collected has exceeded actual expenses every year.

Building NCUA Cash  from Credit Union Funds

The result of these excess fees is that yearend cash on hand has grown from $13 million to $129.6 million (or ten times-1000% ) in this 22 year period.   During these same years, while  annual expenses grew by just 3.6%, NCUA grew cash balances at 12.3%, or four times as fast.

The 2021 year end cash balance of $129 million was 110%  more than that year’s total expenses, and  double the 46% average for the entire period.

NCUA held cash balances for the first 16 years of this analysis  between 30-40% of the actual expenditures.  Since 2016 NCUA has retained  more and more credit union funds.  Yet there has been no change in either the agency’s ability to assess its fee or in its operations to require this ever growing cash and fund balance.

The Latest Numbers: May 2022

As of end of May, cash balances are $191.8 million slightly higher than 12 months earlier.   Operating expenses for the first five months are $48.3 million exactly the same as the prior year.

The net fund balance (equity) is at an all-time high of $141.3 million for this time of year.  In 1999 the net fund balance was just $6 million.   The numbers and trends suggest that  $75 million or more of this excess cash could be returned to credit unions and NCUA still have more than enough to cover all operating expense.

The Board’s Budget Review

American author Edward Abbey observed:  “Growth for the sake of growth is the ideology of the cancer cell.”

This Thursday if expenses lag budget, the NCUA’s habit is to repurpose unspent funds  and/or approve new positions not in the original budget.

Normal business practice would be to reduce the budget, not find new ways to spend a surplus.

How will the board view this ever-growing cash hoard? The traditional government mindset is to spend all the money on hand, whether that is necessary or effective.  Staff is always fearful that if money is left over, it will justify reducing the budget request for the following year.

Chairman Harper has been very public in of his ambition to grow staff, the NCUSIF and the budget at every opportunity.

Will the rest of the board go along with this six-year pattern of uncontrolled operating expenses and buildup of excess cash? Or will they stop the spread of NCUA’s operating fund cancer?

After all this is the members’ money.

 

 

 

 

A Review of the NCUA Board’s Oversight of the NCUSIF

NCUA’s open board meeting In May had only one agenda item, the quarterly staff update on the NCUSIF.

This was an opportunity to focus on many topics that have swirled around the management of the Fund over the past year.   These include:

  • The fund’s investment strategy especially in the rising rate environment;
  • The accounting confusions using  Federal not private GAAP presentation;
  • Projections for the fund’s operating outcomes later in the year;
  • Options to more accurately present the Normal Operating Level (NOL). The ratio now uses two separate accounting period’s data;
  • The prospect of lowering the NOL to its historic range of 1.2 to 1.3% from 1.33%.

The NCUSIF’s $22 billion  is its largest asset . The fund’s unique cooperative design means credit unions have a direct financial stake in its performance.  Credit unions  should receive a dividend in years of strong performance and pay a premium in the event of mismanagement or a catastrophic loss.

As noted by Vice Chair Hauptman in the meeting:  it’s a mutual asset of the credit union movement and NCUA. . . it’s worth reminding everybody that every dollar of that one percent contribution belongs to credit union members and no other.  NCUA has the obligation to credit unions and their members to manage that fund prudently and effectively.

Board member Hood reiterated:   The 1% capital deposit which comprises most of the Share Insurance Fund’s equity is also an asset of the credit union.  We should never forget this.

I would add that the unique coop design intended the 1% deposit be an earning asset for credit unions.

The Fed’s Response to the Current Economy

As reported by CNBS:  Minutes from the Fed’s June meeting, which were released Wednesday, revealed that the central bank is prepared to use even more restrictive measures to tame surging inflation. They indicated that July’s meeting would bring another rate hike of up to 75 basis points, and acknowledged that the economy could suffer a slowdown.

“Participants concurred that the economic outlook warranted moving to a restrictive stance of policy, and they recognized the possibility that an even more restrictive stance could be appropriate if elevated inflation pressures were to persist,” the minutes said. Treasury yields, meanwhile, continued to rise.”

This is not new news.   Since October 2021 the Fed has indicated that it would change its accommodative monetary policy in response to signs of growing inflation.   That intent became explicit in December with forecasts of interest rate hikes from the historically low levels engineered in 2020 to respond to the Covid economic shutdown.

The market’s response was swift.   Through this year’s second quarter,  bond  fund valuations have fallen almost 20% in market value. The NCUSIF has gone from a market gain of over $500 million in 2020 to a market valuation loss of $1.1 billion as of the April 2022 NCUSIF report.

The NCUSIF Staff”s Response to Rising Rates

The staff’s response to this dramatic change in rates was provided in May’s presentation:  Extend the investment portfolio further by going from a maximum term of 7 years to 10 years.   Rick Mayfield, capital market specialist. stated  this strategy would place approximately 10% of the portfolio in annual buckets over the 10 year range in a one to two year time frame.

The result would raise the average weighted duration from 3.5 years to almost 6 years—at a time when the overwhelming consensus and Fed intent is that rates will continue to rise.

The continuing decline in the NCUSIF’s market value in the past 18 months shows how far the portfolio is falling short of current rates.  This below market return is lost revenue in the tens of millions of dollars.  The continuing decline is a specific indicator of the portfolio’s performance gap from current market rates.

To mechanically continue  investing in equal “buckets” over ten years is a failure of  management.

This investment extension aligns with neither the current policy nor experienced investment judgment.   No objective data or analysis was offered to support this extension to a 5-6 year duration.

Extending a portfolio does not automatically bring higher rates.  Yield curves do not always slope upward.

As an example, when yield curves invert, that is the two year bond pays more than the 10 year,  how does purchasing the lower return 10 year bond “maximize yield” per fund policy?

Managing the portfolio’s duration is the most critical function to match the liabilities for which the fund is responsible.  These include  paying operating expenses, growing retained earnings in line with insured shares, and if necessary, covering insurance losses.   Those expense liabilities can be easily quantified and monitored monthly to align with investment earnings (yield) decisions.

For example, a 2% fund yield would generate $400+ million in revenue easily meeting the operating expense and projected equity growth goals.  A 3% earnings rate should result in a dividend to the owners if insurance losses are at, or below, long term trends.

This is the integrated ALM/IRR management NCUA expects all credit unions to practice.   This management responsibility is not a fixed formula followed routinely whatever the market conditions or future outlooks.  Rather modeling tools, forecasts and judgment are used to align asset returns and the cost of  liabilities as market events change.

No Free Lunch

Even more disappointing was the assertion by CFO Schied that the portfolio’s new extension to ten years would be initiated this quarter-despite the explicit forecast of further raises from the Federal Reserve.

“ . . .with respect to the investment portfolio and consistent with the existing board approved investment policy. the investment committee has decided last month to begin to extend the portfolio ladder out to 10 years.  This is not reflected in today’s quarter one presentation because the decision to do so does not show up until quarter two which will be evident in my quarter two presentation as well as our monthly reporting that we post on the website going forward.”

Naively extending investments to “chase yield” is a common examiner criticism of poorly documented credit union investing.  Such extensions  may produce a short term income jolt but at significantly increased ALM/IRR risk.

Vice Chair Hauptman remarked:   I can say as somebody who worked in fixed income markets for years you know there is no free lunch.  We can get more income by taking more risk and in no other fashion.

There was no data presented to justify a decision to extend from 7 to 10 years in a rising rate environment, an action contradictory to traditional sound portfolio practice.  This extension was also taken in the face of increasing market losses.  This mechanical approach underperforms in the current interest rate environment.

Making a fixed rate 10-year investment  in the face of inflation and other economic uncertainties, is extremely speculative.  It severely limits management options for responding to market events and any changes in credit union insurance needs. It results in  a fixed revenue cap for an even longer period than the current practice.

The result is that NCUA’s hands are tied responding to events during this extended average life of almost 6 years. The Fund becomes dependent on other sources for liquidity or revenue, a contradiction in the fund’s fundamental financial role.

This extension announcement doubles down even after the mounting evidence of NCUSIF investment management shortcomings.  The investment policy referenced has not been updated since 2013.   But most concerning is that there appears to be no ability to objectively evaluate investment practice.

Projecting the Equity ratio And Slowing Share Growth

In addition to presenting the current investment approach, CFO Schied’s projected the NCUSIF’s NOL to June 30, providing two interesting data disclosures.

The first is that he projects an operating loss of $68 million for the NCUSIF  in the second (June) quarter versus a net income of $54.4 million in the March quarter.  That is a $122 million reversal in operating results.

Since investment revenue more than offsets operating expenses, the only possible reason for such a reversal is insurance loss reserves.  Yet all the CAMEL results are positive.  There was no indication of any major unaddressed issues.  So why this dismal forecast?

Secondly Schied also gave the agency’s 12-month insured share growth forecasts for 2022.  Actual share growth was 9.3% for the March quarter.  The projections are  7% growth at June 30, year over year; and only 4.3% for the full calendar 2022.  A significant slowdown from the past two years.

A Board Meeting with Mixed Outcomes

 

The Agency’s mechanical NCUSIF investing in the face of dramatic rate changes and increasing portfolio devaluations was a disappointment.  Extending the investment duration to almost six years (versus current 3.5 years), will only reduce the Fund’s flexibility responding to changing rates and future industry risk events.

Both Chair Harper and CFO Schied downplayed or even denied there was any real risk to extending the portfolio. Here is the Chairman’s summary observation:

The changes in the value of these(investment) assets were expected. That is because as interest rates go up the value of these bonds go down. I learned that in my finance 301 class back in college.

These unrealized losses fortunately do not impact the equity ratio and do not increase the likelihood of a premium just as unrealized gains do not increase the equity ratio. What the unrealized losses signal is a change in the interest rate environment. We are moving forward to address this issue.   The NCUA is adjusting its investment strategy from a seven year ladder to a ten-year ladder. . .

This observation is incorrect in two respects:

  1. Extending the ladder increases the portfolio’s risks, especially as it relates to meeting its matching  liability/expense requirements.
  2. As the portfolio continues to carry underwater investments, that is returns below market, then the fund’s revenue is short changed. It is credit unions that may have to pay a premium for NCUA’s mismanagement due to potential  revenue shortfalls.

Confusing Financial Presentations

The staff continues to present financial information following Federal GAAP that both confuses and misinforms readers about the actual state of the NCUSIF.

The federal presentation of the balance sheet shows that both the assets and Fund equity  have fallen this year from yearend.  That is because the decline in market value is is subtracted from both investment assets and the cumulative results of operations (equity) on both sides  of the balance sheet.  This understatement is $1.1 billion as of April 30 and increasing each month as portfolio valuations decline further.

To the user of this information, the NCUSIF appears to be reducing in size and value.

The accounting category, year to date retained earnings, is not reported under Federal GAAP.  Calculating  the Fund’s NOL trends requires this number.  However it  is not  presented in the financial statements, but must be derived from the information presented.

Finally the issue of how the NOL is being calculated using numbers from two different accounting periods was again raised by Board Member Hood. He referenced the Cotton accounting firm’s review from  2021 and its reported description of several ways the 1% true up could be presented in the  Fund’s yearend financial statements.

CFO Schied’s response to Hood’s query was:

We are reviewing and doing the due diligence over alternative approaches including that pro forma idea that you’ve mentioned in order to have a complete picture of the relative costs and benefits and to understand any potential hidden implications of any alternatives. 

Because I’m not sure back then that they realized that the change was going to lead to the timing gap that we have today.  I would look forward to updating you on these findings over the summer.

Credit unions will certainly be looking for this review!

Overall  this single-topic open board meeting identified, but failed to resolve, these ongoing  issues of NCUSIF investment management, fund financial presentation and more accurate NOL calculation.

(Editor’s note:  Later updates corrected earlier spelling error of Vice Chair Hauptman’s name)

The Supreme Court,  The Administrative State and NCUA’s RBC/CCULR Rule

The new RBC/CCULR net worth rule is the most comprehensive, intrusive and costly regulation ever passed by NCUA.

The agency’s staff’s initial estimate of the funds now restricted from increasing member value is over $24 billion. From  their December 2021 board presentation:

Under the CCULR, if all 473 credit unions opted into the CCULR and held the minimum nine percent net worth ratio required to be well capitalized, the total minimum net worth required is estimated at $111.8 billion, an increased capital requirement of $24.3 billion over the minimum required under the 2015 Final Rule. 

This is a minimum 30% increase of capital, restricting its use for members, and imposed just nine days after the rule’s printing in the Federal register.

RBC/CCULR is both procedurally and substantively deeply flawed. Instead of implementing the  legislative intent that PCA be applied to a limited number of “complex” credit unions, the regulation passed covers 85% of all credit union assets.

But what can be done especially as the NCUA board composed of different philosophies approved the rule 3-0?

A Future Opening

The recent Supreme Court 6-3 ruling in the West Virginia v. EPA case suggests there is another opportunity to withdraw the rule or to challenge its validity.

The EPA case is about much more than regulating pollution.  The 89 page opinion is here.

As summarized in a New York times article:

It . . . signals that the court’s newly expanded conservative majority is deeply skeptical of the power of administrative agencies to address major issues facing the nation and the planet.

Chief Justice Roberts, employing the phrase for the first time in a majority opinion, said it applied in cases of unusual significance and was meant to address “a particular and recurring problem: agencies asserting highly consequential power beyond what Congress could reasonably be understood to have granted.”

Another account of the decision in The Hill explains the broader significance of the Court’s reasoning:

In reaching its conclusion, the court relied on the controversial “major questions doctrine.” The major questions doctrine is a relatively new interpretative maxim that directs courts to presume that Congress does not intend to vest agencies with policymaking authority over questions of great economic and political significance.

Only Congress’s “clear statement” that it did intend to confer the claimed authority can overcome this presumption. When a court employs this maxim, it reads statutes narrowly, stripping the agency of the power to address the major question that the statute, on its face, gives the agency the authority to address.

Unsurprisingly, the main focus of the media, scholars and the public is on the consequences of the court’s move for the size and contours of the federal administrative state.  . . 

The impact of the court’s ruling on federal agency authority and power cannot be overstated.

A lawyer friend when asked,  opined: “what I’ve read about it suggests the Court is going to take a very restrictive view when assessing agency claims of regulatory authority (effectively dispensing with Chevron deference).  When the authority to regulate is clear, I have no idea how much discretion the agencies will be afforded when exercising that authority.  I’m not sure what category the RBC rules fall into.”

The  RBC/CCULR rule’s flaws include the following;

  • The agency provided no “substantial objective evidence” that the system’s capital levels were inadequate under the existing RBNW rule. Staff admitted that only one troubled credit union in the past ten years would have been subject to RBC’s higher net worth ratio.
  • The agency wrongly applied the “comparable” standard to implement a clone of bank regulations. This approach clearly contradicted the statutory intent that RBNW cover only an identified small number of “complex” credit unions that presented unusual risks. As staff confirmed in its board action memo: A special note that most, if not all, of the components of the CCULR are similar to the federal banking agencies’ CBLR.
  • There was no statutory authority for a CCULR option which Congress, in legislation, authorized only for banking regulators.
  • Nine days for implantation violates the “reasonable period of time” statutory requirement for a change in PCA capital levels.
  • The rule imposes significant financial harm to members by reducing the value they receive,  beginning with the $24 billion staff estimate. That is just the initial number. It will grow every year.
  • The compliance burden is unreasonable. It mandates a one-size-fits-all mathematical capital formula for every credit union independent of hundreds of individual risk circumstances.

A Way Out of the RBC/CCULR Morass

Credit unions can sue the agency for the substantive violations noted.  But that takes years and the harm done members will just continue in the meantime.

The most feasible course of action will be for a more informed NCUA board, responsive to the needs of credit union members, to use this Supreme Court precedent to withdraw the rule entirely.

That will require leadership, courage  and insight from current or future board members.   The first test is to ask the sitting members their views on this deregulation opportunity.

What would Hood, Harper and Hauptmann say in response to this Supreme Court interpretation?