Category: NCUA

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An Irish Weekend and Remembrance

As Bucky Sebastian reminded me many times about this past weekend, “Everyone’s Irish.” St. Patricks Day comes in the middle of Lent because an Irishman could not go for forty days without a drink.

At least that’s one theory.

So I got out my best Irish hat and tried out his thesis with a dark lager and two helpings of shepherd’s pie. There was even a vegan option.  Here’s the outcome.

Ed Callahan Remembered

Which reminds us of the great Irishman who believed in his deepest being, the potential for credit unions. This is Jim Blaine’s, March 17, 2016 portrait of Ed.

“Always suspected that the problem with Ed Callahan was that as a youth he was beaten too often by Nuns in parochial school or, perhaps, not beaten enough. Well, whatever, either way the Nuns left their mark – an indomitable spirit!

Ed Callahan was Irish – brash, pugnacious, loud, hard drinking, fun loving – alive! But why be redundant? I said he was Irish!

For over a quarter of a century, we all watched and observed as Ed Callahan created shock waves in the credit union world. No one was neutral about Ed Callahan. His friends were fiercely loyal, his enemies equally committed. Ed inspired many and angered quite a few. Ed had style; he had presence. With Ed, you weren’t allowed to make contact without becoming involved, excited, immersed, engaged.

At Marquette, Ed must have played football in the same way he played life – without a helmet. You had no doubt that Ed Callahan always played for keeps. He had no intentions of losing, that was not one of the options. Ed was very straight-forward; your choices were always clear. The mission was defined; and, there was only one direct path to the goal. That path was either with you, around you, over you, under you, or through you; you could step aside or get on board. It was your choice; but your choice never changed the mission, nor the path, nor the goal.

Some said that Ed was a visionary…

… they were wrong. Ed Callahan was a revolutionary. Visionaries talk about change, revolutionaries take you there. Ed led from the front – a leader of conviction, rather than convenience; principles above posture – courageous. Revolutionaries, by definition, create problems; overturn apple carts; rebuke the status quo. That happened at NCUA. Appointed by President Reagan, Ed arrived at NCUA in the midst of turmoil. Ed defined the mission; he reformed and remolded the Agency. He taught a regulatory agency how to stop working to prevent the last crisis. He explained that a coach never executes a play and that on Monday morning it’s never hard to see what went wrong – but it is rarely relevant. Teacher, coach, lessons in life; hopefully well learned, hopefully still remembered.

But let me celebrate the essence of the man – that indomitable spirit – one last time, for those who never had the opportunity; for those who still have doubts; for those who never fully understood. One of Ed’s harshest critics, noted with much wryness, that even in death Ed “couldn’t get it right”. Why, I asked? “Because Callahan died on March 18th instead of on the 17th, his beloved St. Patrick’s Day.” You know this type of critic – cynical, smug, self-assured without much basis, not really worth the effort, but…

Just for the record, I would simply like to point out one final time that – first and foremost – Ed Callahan was a fully-fledged, fully-flagrant Irishman – body and soul! And, no self-respecting Irishman would ever celebrate the end of St. Patrick’s Day until the last bell at the pub had rung. That would have meant that Ed Callahan’s “last call” would have come sometime after 4:00 am – on the morning of the 18th. Style, presence, courage – true to the last! A shamrock of joyful vigor and purpose!  

And one last thought… in the final analysis you can say many things about a great man’s life… some men are admired, some are respected, some are envied, some are feared… and countless other adjectives and accolades. But, in the final analysis, the most important thing you can say about a great man is… he will be missed. ” 

And, Ed Callahan will be missed…  

 
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THE Credit Union Lesson from SVB and Regulation

In a news conference following the failed Bay of Pigs invasion of Cuba, President Kennedy remarked:  “Victory has a thousand fathers, but defeat is an orphan. “

The SVB’s failure proves this adage untrue.  The press and numerous pundits have already assigned multiple parentage: the CEO and management, the Fed’s rapid rate increases, regulatory and examination shortcomings, the external auditor’s clean opinion, the Silicon Valley customers $40 billion twitter run, Trump’s deregulation in 2018 and the Biden administration DEI policy objectives.

When everyone and everything is to blame, then no one is accountable.  Just another “black swan” event. With more investigations/hearings to come, each new revelation will just add to the piles of condemnations.  No lessons taken away.  More regulations of course, for this is the default response whenever the barn door is left open.

A Spotlight on One Factor

From all these commentaries, I want to highlight one aspect that contributed to overlooking this risky situation. This factor has just become a part of the credit union regulatory eco-system.

In responding to my analysis earlier this week, Doug Fecher, the retired CEO of Wright-Patt Credit Union in Ohio, commented:

This situation makes me wonder if NCUA’s new “RBC” standards would have flagged the risks to SVB’s balance sheet. From what I can tell, much (most) of SVB’s investments were in “risk-free” treasury bonds and high quality agency securities, which in NCUA’s RBC formula would have earned some of the lowest risk multipliers.

To me it is another example of the folly of RBC-style risk management regimes … and why NCUA was wrongheaded in its pursuit of RBC.

This point of view is not limited to Doug’s observation.

During his time as Vice Chair of the FDIC, Thomas Hoenig challenged the agency’s reliance on risk-based capital requirements.  He questioned both the theory and practice, pointing to the lending distortions which contributed to banking losses during the Great Recession.

He wrote about the SVB failure in this commentary:

The regulator apparently relied on the bank’s risk-weighted capital standard for judging SVB’s balance sheet strength. Under the risk weighted system government and government guaranteed securities are not counted as part of the balance sheet for calculating capital to “risk-weighted” assets.

This allowed the bank to report a ratio of around 16%, giving the appearance of strongly capitalized bank. However, this calculation failed to account for interest rate risk in its securities portfolio or the risk of having a highly concentrated balance sheet. It misled the public, and apparently the regulators.

In contrast, if the regulator had focused on SVB’s ratio of equity capital-to-total assets, including government securities, the ratio falls to near 8 percent; and if they had calculated the ratio as tangible capital-to-assets (removing intangibles and certain unbooked loses from capital) the ratio would have fallen to near 5%.

What this would have disclosed to the world is that the bank’s assets could not lose 16% of their value before insolvency but only 5%, a stark contrast.

Had the regulator not relied on the misleading risk-weighted capital measure, it might have take actions sooner. A simple capital-to-asset ratio, tells the regulator and public in simple, realistic terms how much a money a bank can lose before becoming insolvent. The regulatory authorities need to stop pretending that their complex and confusing capital models work; they don’t.

RBC and Credit Unions: A First Birthday

RBC became the surrogate capital ratio for all credit unions with assets greater than $500 million one year ago on January 1, 2022.

Before this in a September of 2021 analysis, Why Risk Based Capital is Far Too Risky. Hoenig is quoted:

“A risk-based system  inflates the role of regulators and denigrates the role of bank managers. 

We may have inadvertently created a system that discourages the very loan growth we seek, and instead turned our financial system into one that rewards itself more than it supports economic activity.”

RBC and Asset Bubbles

Shortly after the critique of regulatory incentives induced by risk weighted assets, in Asset Bubbles and Credit Unions (JANUARY 10, 2022) the consequences from potential Fed tightening were noted:

When funding looks inexpensive and asset values stable or rising, what could go wrong?

The short answer is that the Fed’s inflation response will disrupt all asset valuations and their expected returns.

The distorted results  caused by RBC was presented in Credit Unions & Risk Based Capital (RBC): A Preliminary Analysis in February of this year.  Among the findings:

The 304 credit unions who adopted RBC, manage $822.7 billion in assets.  But the risk weighted assets total only $479 billion.  That 58% ratio is the NCUA’s discounting of total assets total by assigning relative risk weights. and,

One credit union with assets between five and ten billion dollars, reports standard net worth of 12.5% and an RBC ratio of 48.3%.  

This February analysis using June 2022 data of RBC credit unions showed that:

250 of these 308 credit unions reported unrealized declines in the market value of investments that exceeded 25% of net worth.   Four credit unions reported a decline greater than 50% of capital.  This was before the five additional Federal Reserve’s  rate increases through the end of the year. 

RBC’s primary focus is credit risk, the loss of value from principal losses from loans or other assets.  Balance sheet duration mismatch is not captured as are other common management errors:  concentration in either product or market focus, limited or no diversification of product or market, or  just simple operational mismanagement.

These common challenges become amplified by insufficiently considered non-organic growth forays such as third party loan purchases or originations. Whole bank acquisitions are an example of such risks often accompanied (disguised?} by growing amounts of the balance sheet’s intangible asset, goodwill.

The RBC proxy indicator for safety and soundness creates a distorted impression of real institutional risks.   Managers learn to game the system so that boards, members, and regulators fail to understand the institution’s total financial situation.

And when along comes a change in underlying assumptions, like the Fed’s rate increases, the previously unrecognized vulnerabilities quickly appear.

RBC creates for some institutions a theoretical capital ratio that is nothing more than a “regulatory  house of cards.”  SVB will not be the last example.

As Doug Fecher recommended in his 2016 comment letter on the proposed rule, “RBC should be a tool, not a rule.”

To his credit,  Kennedy learned from the Bay of Pigs misjudgments when the Cuban missile crisis occurred in 1962.

 

 

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

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

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

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

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

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

Rented Capital or Buy Now, Return Later

By rule subdebt is an unusual financial instrument.

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

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

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

A Financial Growth Hormone

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

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

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

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

Most Use Is by a Few Large Credit Unions

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

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

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

The Most Important Missing Rule Requirement

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

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

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

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

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

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

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

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

 

 

 

 

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What Can Be Done about the Drought of New Credit Union Charters?

There are financial deserts in towns and cities across America; there is also an absence of new credit union charters.

Since December of 2016, the number of federally insured credit unions has fallen from 5,785 to 4.780, at yearend 2022.  This is a decline of over 165 charters per year.  In this same six years, 14 new charters were granted.

Expanding FOM’s to “underserved areas” or opening an out of area credit union branch, is not the same solution as a locally inspired and managed charter.

Obtaining a new charter has never been more difficult for interested groups. Through its insurance approval, NCUA has final say on all new applications whether for a federal or state charter.

Today, credit union startups are as rare as __________ (you fill in the blank).

At this week’s GAC convention an NCUA board member announced the agency’s latest new chartering enhancement: the provisional charter phase.  This approach does not address the fundamental charter barriers.

Could an example from the movement’s history suggest a solution?

The Chartering Record of the First Federal Regulator

Looking at the record of Claude Orchard  demonstrates what is possible for an individual government leader.   He was the first federal administrator/regulator managing a new bureau within the Farm Credit Administration to create a federal credit union system.  He was recruited for this startup role by Roy Bergengren, who along with Edward Filene, founded the credit union movement.

The story of how and why he was chosen is told here.   Bergengren nominated Orchard because he had “the proper credit union spirit.” This had been demonstrated by his efforts to charter over 70 de novo state credit unions for his employer Amour.

Orchard accepted this government role in the middle of the depression using borrowed FCA staff.  The state chartered system was the only model of how to create a federal option.  That experience and belief in the mission is what  Orchard brought to this new role.

Unlike the banking and S&L industry there was no insurance fund for credit union shares/savings.   The coop model was based on self-help, self-financing and self-governance.  Self-starters provided the human and social (trust) capital; no minimum financial capital was needed.  Credit unions tapped into the quintessential American entrepreneurial spirit to help others.

Orchard’s critical tenure as the first federal regulator is described  in a special NCUA 50th Anniversary Report published in 1984:

“He emphasized organizing as much as supervision. ‘I think in general we tried in the beginning to avoid paperwork because it seemed to me like that was a waster of effort.  After all what we were out for was to get some charters and get some organizational work done.’

When Mr. Orchard stepped down in in 1953, federal credit unions numbered over 6,500.   During his 19 year he espoused a passionate belief in the ideals of creditunionism.  ‘It seems to me that we have here a tool. If it can be made to really be responsive and to really be, in the end, under the control of the members, it can teach people in this country something about democracy which could be taught in no other way.‘

Deane Gannon, his successor at the Bureau of Federal Credit Unions said to Mr. Orchard on the 30th anniversary of the Federal Credit Union Act, ‘If it hadn’t been for you none of us would be here to celebrate anything.‘”

That last observation echoes today.   How many charters will be left to celebrate the 100th anniversary of the FCU Act in 2034?

Alternatives  Are  Springing Up

For the credit union movement to remain relevant it will require modern day Claude Orchards. These are leaders who believe in creditunionism.  And possess the passion to encourage new entrants to join the movement.

Regulatory process or policy improvements may help.  But the real shortfall is leadership committed to expanding credit union options.

To address the continuing financial inequities throughout American communities, alternative solutions are being created.  Many of these startups are outside the purview of banking regulators.

These community focused lenders are listed in  Inclusiv’s 2022 CDFI Program Aware Book.  The firm introduces its role with these words:

Access to affordable financial products and services is a staple of economically sound communities. Yet at least one quarter of American households do not have bank accounts or rely on costly payday lenders and check-cashing outlets.

In recent years, the lack of access to capital investments for small businesses and other critical community development projects has also led to increased need for alternative and reliable sources of financing.

Mission-driven organizations called Community Development Financial Institutions–or CDFIs–fill these gaps by offering affordable financial products and services that meet the unique needs of economically underserved communities.

Through awards and trainings, the Community Development Financial Institutions Program (CDFI Program) invests in and builds the capacity of CDFIs, empowering them to grow, achieve organizational sustainability, and contribute to the revitalization of their communities.

Of the total $199.4 million awarded to 435 organizations, only 176 or 40% were to credit unions.  The rest of the field included 213 local loan funds, 43  banks and 3 venture capital firms.

Without credit union charters, alternative organizations will be created to serve individuals and their communities.   These lenders may not put credit unions out of business, but will  attract the entrepreneurs that would have  added critical momentum to the cooperative system.

Credit unions can qualify for CDFI status and grants.   But Inclusiv has a much broader vision for implementing Claude Orchard’s  playbook.

In their listing of 2022 total awards and grants, every amount of over $1.0 million went to an organization that was not a credit union.  A few were banks, but most were de novo local community lenders or venture capital firms.

Without credit union options, civic motivated entrepreneurs will seek other solutions, and slowly replace credit union’s role.

Today it is Inclusiv carrying out Orchard’s vision.

Should NCUA delegate its chartering function to those who have “the proper spirit” to secure credit unions’ future?

It will also result in “teaching people in this country something about democracy which could be taught in no other way.”

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Two Positive Updates & a Disheartening Decision

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

Here is the industry summary slide:

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

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

The Theme of Tighter Liquidity

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

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

Credit Unions’ Advantage

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

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

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

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

The February NCUA Board Meeting

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

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

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

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

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

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

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

A Disappointing NCUA Response

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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Quick Takes on NCUA’s Four KPMG December 2022 Audits

On February 13, 2023 NCUA posted the December yearend audits of its four managed funds.

Publishing this audited information plus the interim monthly financial updates is an important resource for credit unions to monitor the Agency’s financial performance.

Today’s NCUA board meeting will include a public discussion of the NCUSIF, the largest and most critical report because it relies on the credit unions’  1% capital deposit as its funding base.

General Audit Observations

Three of the four funds are presented following GAAP accounting standards.  These three financial statements and footnotes are easy to follow.   However the NCUSIF is presented using Federal GAAP accounting.  There are fundamental differences in presentation and transparency between these two approaches.  I’ll address these below.

Total NCUA expenses in its three main funds (NCUSIF, Operating and CLF) total $ 332.1 million, an increase of $14.5 million (4.6%) from 2021.   The NCUSIF paid 63% of this expense total.   It should be noted that all NCUA’s revenue is from credit unions and interest on their funds held by the agency.

The smallest of the four, the community Development Revolving Loan Fund does not have allocated expenses and has minimal activity-only $1.5 million in “technical assistance grants.”

The NCUSIF’s Audit

The Board meeting is only discussing the NCUSIF today. It is the most consequential for credit unions in terms of credit union impact and support.

The NCUSIF had a  stable year.  Total expenses rose to $208 million or 4.5%.   Net cash losses were just over $10 million.  However $33 million additional expense was added to the reserve account raising its total by $ 23 million to $185 million.  That reserve balance  equates to 1.1 basis points of insured shares, a  ratio greater than the most recent five years net cash loss rate.

Several very important issues are not directly addressed in the audit.  But hopefully will be raised by Board members.

The first is the Federal GAAP presentation that uses completely misleading terms for a non-appropriated government entity.  Fed GAAP has no accounting concept of retained earnings, but rather presents “cumulative result of operations.”   This number includes any changes in the market value of the fund’s major asset-treasury securities as of the audit date.

Other accounting categories such as intragovernmental assets, exchange revenue, public liabilities, net position and order of presentation are completely foreign concepts for standard GAAP financial statements.  They obscure  understanding of financial performance.  Even NCUA staff converts the information to a standard GAAP format for the board.

The accounting term “cumulative results of operations”  which replaces “retained earnings” shows a decline  from $4.8 billion to $3.2 billion due to the $1.6 billion difference in market and book value of the NCUSIF’s investments.  Also the fund’s total capital which includes  the 1% deposit shows a fall from $20.6 billion to $20.2 billion.

This is how the balance sheet is reported even though the NCUSIF had a positive bottom line of $185 million using standard GAAP accounting.  Any reporter or other user of this statement would be left with a very negative impression of the Fund’s balance sheet financial position from this presentation.

Also Federal GAAP considers all AME and NCUSIF managed estates as “fiduciary” and therefore not part of the NCUSIF’s balance sheet.   As a result only the net amount of the corporate and natural person combined AME numbers is shown in footnotes.  Expenses are netted against income.  Tracking the reasons for increases and decreases in “net liabilities” is impossible as only totals are provided.

This off-balance sheet accounting means the corporate AME’s and NPCU estates are not part of the monthly NCUSIF updates.  Their  revenue and expenses are not reported.  And the amounts under management are large, in the hundreds of millions for the Corporate estates, that are still owed credit unions.

This is a situation ripe for error and mismanagement.  Timely and full disclosure of these off-balance sheet funds are material to understanding the fund’s actual performance.

The All Important NOL

The most important yearend result is the NOL calculation.  A footnote reports the “NCUA’s calculation” as 1.3% or below the board’s 1.33% cap.

This is a ratio composed of the June 2022, 1% capitalization balance, an audited retained earnings (note the switch to GAAP) at December 2022, and an unaudited insured shares total as of February 10, 2023.  Two different accounting dates are used in the numerator (June 30 and December 31) and an unaudited total in the denominator.   The result is a misleading NOL ratio.

Share growth in 2023 was just 3.4% with credit unions reported lower total insured shares at December 31 than at June 30.  However the larger June 1% deposit number is used in the denominator even though net deposit refunds will be sent from this total.   In essence the actual NOL is slightly overstated.

Moreover, It is easy to estimate what credit unions’ 1% deposit net liability is. Just take 1% of the denominator’s total for insured shares.   That is how private GAAP would present the ratio—and how the NCUA did the calculation until 2001.   As a consequence this  ratio misstates actual NOL and potentially, dividends due to credit unions.

The NCUSIF’s Investment Management

 

The fund’s most important asset is its $21 million of treasury investments.  The yearend audit shows a larger overnight cash position than in 2021.  However the fund’s weighted average life of 3.3 years has been largely unchanged during the past 12 months of Fed tightening.

The portfolio’s decline in market value is almost $1.7 billion at yearend.  This is important because the decline equates to over 10 basis points of the fund’s 30 basis point in retained earnings.  This  amount, on top of the 1% deposit, must remain at or above 1.2% or an equity restoration plan is required.

What is the fund’s interest risk management monitoring process?  Why would the NCUSIF keep investing long term in a rising rate environment?  Especially when there is an inverted yield curve?

As of Wednesday’s Feb 15’s market close, the one year treasury yield was 4.96% and the seven year was 1% lower at 3.94%.   This inverted yield curve has existed for almost six months.  All of the fundamentals suggest a shorter WAM for the NCUSIF’s portfolio.

The consequence of a 3.3 year weighted average maturity (WAM) is that NCUSIF investments will underperform market rates until the yield curve stabilizes at a new normal.   If today’s environment were representative of the future, it would take the fund over three years to recover its market losses.   During this adjustment, the NCUSIF revenue is shortchanged from current market returns.  Credit unions will suffer the shortfall either in lost dividends or, in a worst case scenario, a fee to maintain the NOL.

So today’s meeting is an important opportunity to see what the board and staff take away from this year’s NCUSIF performance.   The numbers are in, now what do they mean?  How can the fund’s presentation and management be more transparent to its credit union owners?   In short, how can performance be improved?

The Central Liquidity Facility

 

The CLF had a most interesting year financially as it reported $546 million in capital stock redemptions by agent corporates, partially offset by a $132 million increase in regular member shares.  Total capital declined by a net amount of $400 million due to these  stock paybacks and new purchases.

As has been the case since 2010, the CLF made no loans.  It paid out 97.3% of its $20.7 million net income in quarterly stock dividends totaling $3.69 per $50 share over the entire year.   That  equates to  a 7.4% annual dividend yield.

The CLF’s borrowing authority reverted to 12 times its capital and surplus with the expiration of the CARES Act temporary increase.   As a result, and also due to the decline in total capital , the CLF’s maximum borrowing amount fell from $35.7 in 2021 to $17.5 at yearend 2022.

All the CLF’s revenue is from interest on investments, which are kept at Treasury., even though CLF has broader statutory investment authority than the NCUSIF.   Income jumped from $4.5 to $22 million. Most of this increase was passed through as a dividend.

A point of inquiry would be why the liquidity facility had 7.6% of its investments in the 5-10 year maturity bucket.  Or why it keeps almost 40% in the 1-5 year range.   It would seem prudent that the CLF should place  investments no longer than the limit the NCUA places on corporates, or two years.

Operating Holds Fund Balance Exceeding Annual Expenses

 

The Operating Fund had expenses of $122.8 after all internal transfers, a $5.3 million (4.7%) increase over 2021.

The Fund retained an equity surplus of $133 million or 108% of 2022’s  total operating expenditures.  Interest on this fund balance did grow from nil to $2.4 million  as market rates rose.

Even though NCUA said it would reduce the credit union funds held by assessing a lower 2022 operating fee, the ending balance is still over three times the agency levels of earlier years.  It is far in excess of any cash flow coverage necessary  until the new year’s operating fees are received.

Transparency Only Matters if Credit Unions Pay Attention

One of the most important checks and balances credit unions requested in 1984 which NCUA committed to,  was an annual external CPA (not GAO) audit of the NCUSIF in return for the open ended 1% deposit funding base.

In addition, monthly financial updates would help monitor the fund’s expenses, reserves and overall management.

However, if the reports are not used by credit unions and only the press releases are followed, then the reporting and transparency model will not work.

For credit unions used to monthly financial analysis, this responsibility should be a “walk in the park.”   Take it.

 

 

 

 

 

 

 

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NCUA Board’s January Review of the 18% Usury Celling-A Shakespearian Event

Open board meetings are the public’s opportunity to see members officially at work.  Current practice is that all statements, questions, and staff answers are fully scripted in advance.

Even so these presentations demonstrate members’ grasp of issues, their knowledge of credit union operations and their view of cooperative’s role.

The one January topic with immediate effect was reviewing the 18% usury cap on  all FCU loan rates-except for PALS short term advances.

The Missing ALM Context

Setting loan and savings rates is an everyday event for credit unions.

The most important aspect of loan pricing is its ALM context.  The goal is to manage the net interest margin, the key factor in bottom line net income. That’s how credit unions “make their living.”

That fundamental ALM context was never introduced by either staff or board members.

As of September 30, the net interest margin for all credit unions was 2.79% up 20 basis points from the year earlier.   The average cost of funds to assets was 42 basis points.   As an approximation, a loan priced at 18% would have a spread of 17% over the average cost of funds.  Subtracting an average operating expense of 3%, would leave a net margin of 14%.

Loans are the fastest growing component of the credit unions’ collective balance sheet.  The year over year increase was 19% as of September 2022–the highest rate in decades.

There is scant evidence that the 18% is limiting credit union lending options or earnings.

The Board’s Discussion

Chairman Harper reported all three members had different positions on the ceiling.  He supported the 18%. The agency had obtained a letter from Treasury which concluded: As a result, we believe that presently there are not compelling reasons to change the current 18 percent loan rate ceiling for federal credit unions. 

This was the first time Treasury had ever commented on the topic.  Even more concerning was their offer to an “independent” agency:  Treasury is available to consult on any future consideration of the interest rate ceiling.  

Harper said he was willing to review the topic again in April along with the possibility of a floating rate cap.

The other two board members made no reference to the ALM context or operating margins.  Their intent seemed to find a way to give credit unions more leeway.

Both advanced an interesting economic theory: charging more for loans will actually increase demand.  To better serve members who pay high loan rates elsewhere, credit unions must charge higher rates themselves.  The cure for high member loan rates, is higher rates!

This view certainly supports the market’s practice that those who have the least or know the least, pay the most for financial services.

In the words of Vice Chair Hauptman:  Low-income and CDFI credit unions depend upon the ‘head room,’ the ceiling provides above the statutory rate of 15 percent. . . to serve their neediest members.

He then showed a bizarre slide of a personal example of the late fee assessed by a governmental authority when a required payment was not made on time. His apparent point was governmental authorities charge different late penalties which he equated to usury ceilings on loans.  He asked for further research and review of the issue in April.

Hood acknowledged: when you talk about the interest rate ceiling, we really need to think about how this impacts members. He gave several anecdotes such as:

One credit union told me that their concern is that if the NCUA maintains the interest ceiling at 18 percent, as rates continue to rise, they would have to deny potential credit card applications unless the credit union member had an excellent credit score.

NCUA staff seemed to embrace this view that higher rates are the only antidote for higher risk.

The reversion to a 15 percent interest rate ceiling would constrain an FCU’s ability to apply risk-based pricing to higher risk credits and reduce net interest margins in the current rising rate environment. In particular, a reduction in the interest rate ceiling would adversely affect a relatively large number of low-income designated FCUs (LIFCUs) and their members’ access to credit.

Much Ado About Nothing

Since 1987 the board has reviewed and approved the 18% cap twenty-four consecutive times.  All three board members voted for the 18% ceiling extension to September 2024.

This meeting displayed each board member’s understanding and approach to this hither to fore routine event. I can’t wait to see the sequel in April’s meeting.

 

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Re-Imagining Federal Credit Unions’ FOM

In NCUA’s 1982 Annual Report Chairman Callahan’s  opening Foreward presented his approach to the Agency’s priorities:

“One year ago we were in the midst of a dialogue with credit unions about deregulation. . .our sense was that government was doing too much.  In the name of safety and soundness, we the regulators, had become overzealous. . .

In acting to change this direction, we were not advocating that credit unions should “do something” . . .Instead we tried to give credit unions self-determination . . .we tried to get out of their way. Government can’t react quickly enough to allow credit unions . . .to remain competitive.”

In every speech Ed reminded: “Deregulation is not freedom.  It is responsibility.”  To  a NAFCU conference he stated: “I think the vitality (in credit unions) comes from the initiative and ingenuity of the individual boards. Hopefully they’ll all do it differently so that the country’s eggs are not all put in the same basket. “

Reexamining FOM “Groups”

After NCUA approved the total deregulation of share accounts in April 1982, attention focused on the agency’s interpretation of the FCU Act’s common bond definition.   Callahan described this review in the Annual Report :

“Traditionally the agency viewed that “groups” meant an occupational credit union would be one sponsor, one employer period.  Groups within a well-defined neighborhood, rural district or community meant 5,000 people, then it meant 25,000 people; then we weren’t sure how many people it meant.  But numbers were all it meant. 

“We believe that this very narrow interpretation was probably far more insidious than the rules and regulations promulgated over time.   We have taken a more liberal view.  We think that if the law does not say no, it certainly leaves room for yes.  . . And so we think this interpretation is a far more deregulatory action than doing away with rules and regulations.”

Ed looked at the full scope of credit union history. Open charters were present alongside more  restrictive common bonds.  The practice in Rhode Island for example, was that their state charters could apply for statewide authority  to serve anyone who lived, worked, or worshiped via a bylaw amendment.  Many states had much more responsive FOM interpretations than NCUA allowed.

The result was that beginning in 1982 federal fields of membership became more flexible through senior clubs, multiple group charters and  allowing members  to  select from multiple credit unions, that is overlapping charters.

Still today, federal FOM changes are much more deliberate than most state processes. NCUA common bond oversight has metastasized as a  vestige of bureaucratic control.  Numerous vendors including former NCUA employees still offer consulting services to help credit unions seeking FOM change.

The Context for Callahan’s Reappraisal

Ed’s  belief in the importance of deregulating the common bond was shaped by his life experiences.  These include his thirty years as a teacher and administrator in the parochial school system; his six years overseeing the Illinois credit union system as director of DFI; and his belief in the unique self-help possibilities of cooperative design.

In  Illinois there were almost 1,100 state charters in 1977 when he became Director. He saw first-hand the challenges of unprecedented short term double digit rates.  The old economic and regulatory order was passing;  the need to change how credit unions responded to their members was urgent.

For example  in 1978 Sangamo Electric Credit Union in Springfield lost its sponsor when the company moved to Georgia. I was credit union supervisor and said the law required that we close or merge the credit union as it no longer had a sponsor.

Ed’s reply was: “The company moved, not the people. They need their credit union now more than ever.”  We changed the credit union’s FOM so it could continue serving members.

In these initial years at DFI we  saw how government regulation and process  at all levels had become so slow and bureaucratic that the members, the people credit unions were meant to help, were the last to be considered.

More Than an FOM Interpretation

In his speeches Callahan called the credit union system a “sleeping giant.”  He believed that all Americans should have a cooperative financial option.

During his tenure as Chairman, field of membership flexibility was just one aspect of credit union expansion.

New chartering efforts were encouraged with universities and colleges a point of emphasis to bring the next generation into the movement.

In November 1982 a group of credit union leaders met in Philadelphia to plan CUE-84.  This stood for Credit Union Expansion.  The  goal was  50 million members by the 50th anniversary of the FCU Act in 1984.  The honorary Chairman was NCUA board member Elizabeth Burkhardt.  In addition to the presidents of national trade associations,  leagues and  NCUA staff, the committee included the credit union CEO’s of Navy, United Airlines and the president of CUNA Mutual.

Spreading the word about credit union opportunity was more than an FOM change.  It was the  belief that helping grow members was in everyone’s and the country’s interest.

FOM: Inclusive, not Exclusive

Before deregulation, the public impression was that one had to be a member of a sponsoring company, association, or church to join.  That was often the case.  Ed wanted to turn that traditional view upside down.

He believed credit unions should be inclusive, not exclusive.   As he was often quoted,”I do not believe in THE common bond.  I believe in a common bond.”  That “a” was the responsibility of each credit union’s board and management to define and serve.

Many Different Frames- One Goal

Today there are as many practices of the common bond as there are credit unions.  The FOM is like the frames in the National Gallery’s thousands of paintings.  Every picture, every frame is different.   That diversity is the credit union system’s strength.

To see the common bond as an advantage or not, is to misunderstand the core of credit union success.

Credit unions are a prime example of the “relationship economy.”  We all connect in our lives with some group(s) to fulfill  a sense of  purpose.  As human beings we aspire to join together in productive, self-fulfilling ways.  We rely on others and they depend on us.

Credit unions are one option.  When led well, they become much more than “just a job.”  Or when members use the phrase, “my credit union,” more than a financial alternative.

Ed believed in credit unions as a community just as John Tippet stated in his 2001 speech to Navy Federal.

Ed’s lifelong leadership of multiple organizations demonstrate  the special skills required  to build  “communities”  of shared purpose. The FOM should be a building block for credit unions, not a regulatory stumbling block.

Fields of membership are a “frame” for credit union performance.  What occurs, the painting within the frame, is what makes each credit union unique.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Field of Membership: How Important Is It ?

Field of membership (FOM )has been a legal characteristic of credit unions from the first charters.

Virtually all credit unions in operation today were started with no financial capital  The “common bond” of association, employment or community provided vital support along with organizers’ sweat equity to provide the critical “capital” to get the effort started.

As financial reserves were built over generations, credit unions grew increasingly independent of sponsor support.  In the case of many employer based credit unions, the FOM became a vulnerability. Especially when a company failed, moved away or laid off employees.

An example is the International Harvester sponsored coops.  At one time almost 20 credit unions served its factories, Chicago offices and subsidiaries such as the Wisconsin Steel Plant.  Today none of those businesses exist.

The FOM has come to be viewed by many as a constraint on credit union expansion.  Even with the multiple interpretations now possible by state and federal regulators.

The debate continues and practices evolve. FOM’s vary greatly from the very limited charter of State Farm FCU to the “anybody can join” definition of PenFed. Its reported FOM is 330 million potential members!

Is the FOM, which is  a legal requirement even if loosely interpreted, a strength or a constraint?

Below is  a traditional view.  This is an excerpt from John Tippet’s presentation on American Airlines FCU’s strategy to Navy FCU’s board in 2001.  John was CEO at the time and has since retired.*

Here is his opening comment focusing on the common bond:

Thank you for the opportunity to speak – this assignment has given me the challenge to organize my thoughts and better comprehend how membership common bonds have contributed to the success of credit unions, and to realize what the benefits of that principle are to us now and will be to who we are and what we do in the future.

A couple of years ago, the Credit Union National Association (CUNA) encouraged credit unions to participate in their “Project Differentiation.”  They asked us to prepare statements and other forms of documentation about what it is that we as credit unions do and why we are different than banks or other financial services providers.

We were then encouraged to share those materials with our members, Congressional representatives, and in other public forums.  In doing ours for American Airlines Federal Credit Union (AAFCU), we labeled it “Who We Are and What We Do.”

Who we are is the common bond shared by those described in our field of membership – employees, former employees, retirees, spouses, and children of those associated with American Airlines and the related companies originally created by American Airlines.

We’re very proud of our common bond and we’re grateful for the part it has played in defining who we are.

A Strategic Advantage

It is my conviction that common bond is a credit union’s strategic advantage.  Common bond  helps make us different, contributes to our operational efficiencies, helps make our branding effective, and is a catalyst to increased focus on who we are and what we do.

In fact, part of the 1925 Edward Filene quote in your advance reading materials reads, “Whatever the common bond uniting the members, the bond must exist.”

Mr. Filene understood the value of common bonds.  In those formative years of U.S. credit unions, they were already learning from their past and the, then current, real world of financial institutions.  Mr. Filene had seen the banking panics and failures of 1895 and 1907.  He also had seen credit union models working in other countries, so he learned from them both.

By trial and error, the current U.S. banking system has emerged, including regulatory structure, the role of federal insurance, and a new tradition of credit unions within that system. 

We are a product of an evolutionary process, having survived as a result of unique adaptations and specialized advantages, one of which has been the common bond – the shared interests and affinities of credit union members.  (end of excerpt)

This statement is only 5% of his strategic presentation.  The entire talk contains an additional twenty slides.  He covers branding, products and the credit union’s response to 9/11– offering to help finance a plane for the sponsor.

Tomorrow I will offer another perspective from Ed Callahan.  As NCUA Chairman (1981-1985) he played a critical role in enlarging the interpretation of the FCU Act’s requirements.  A decade later one aspect was taken to the Supreme Court by bankers where the multiple group policy was overturned in a 5 to 4 decision in 1998.

What was Ed’s underlying philosophy? How did he reference credit union history in his understanding?

* Tippet’s brief biography:

John worked for 25 years in the ‘for-profit’ world (American Airlines) before becoming the AAFCU CEO.  He was an Officer with Sky Chefs, an AA, Airport Restaurant and Concessions, and Airline Catering, subsidiary.

He served as the credit union’s CEO from 1991 to 2008.  When he left the credit union was in the top ten by total assets.  Today it is 23rd.

The one material change after this talk was to take advantage of the TIP (trade, industry, profession) FOM option. This allowed other employer’s co-workers at the Airports to become members.  Airports were the credit union’s “community.”

John’s email: johntippets@live.com
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Searching For Credit Union History

Three weeks ago I received a unique document.  It was John Tippet’s 2001 speech to Navy FCU’s board at their annual planning conference. John Tippets was then CEO of American Airlines FCU, now retired.

The presentation was typed in full along with the slides used.   John presented his credit union’s strategy and how he believed this implemented credit union’s unique design.

Ten years later (2011) Navy’s planning COO requested a copy. Now twelve years further on, I will share some of his thoughts. I believe they are an important example of a leader’s vision and provide important perspective today.

History Matters

The American historian David McCulloch wrote over a dozen books and countless speeches on transformative events (1776) and the people who played important roles.  His accounts are lively and compelling.  He drew upon stories from his subject’s diaries, letters, speeches as well as second hand press accounts recreating these past scenes.

As an author, he believed history was larger than life.   A country’s stories, he believed,  are its most critical  resource.  When well presented, often from original records, they enlarge the spirit and shape our understanding of who we are.  And what we aspire to become.

If one reads the Congressional Record transcript of Ed Callahan’s last testimony as NCUA chairman on April 24, 1985, there can be no question of his impact.  His eloquence, factual knowledge and even humor with the committee shows their respect of his leadership of NCUA during this very vital time for financial services.  The words recreate the event and provide, still today, insight into a leader’s talent.

Or read the July 16, 1982 hearing transcript of NCUA General Counsel Bucky Sebastian’s testimony before Chairman Rosenthal’s House Committee on Government Operations.  The Committee was investigating the failure of Penn Square Bank and its impact on credit unions. It had occurred just two weeks earlier. The back and forth between Sebastian and the Committee chair jumps off the page.  It shows clearly two very different understandings of the event and the role of government.   Bucky’s powerful argumentative style is on full display!

The Absence of Credit Union Records and Original Documents

The years 1981-1985 were pivotal in credit union evolution.  Their response to the economic crisis and the deregulation of America’s financial system was critically important for their members’ future.

These major events unfolded just as NCUA was still organizing itself as an independent agency with a three-person board appointed by the president.   Prior to this federal credit union oversight had been by a single Administrator housed within HEW.

In response to these changes, a separate credit union press of weekly or monthly newsletters was begun. These included CUIS (credit union information service), NCUA Watch, Report on Credit Unions and smaller commentaries. The trades wrote current stories in their weekly updates mailed to members.

These critical original documents from this period are hard to find.   I have contacted CUNA Mutual, CUNA, the Credit Union Museum and even the Library of Congress.  No copies of any of these written sources seem to be available.

Even more vital would be recorded speeches.  In this era all major credit union conferences would make cassette recordings of the keynote speakers and sell them to attendees to take home to boards and staff unable to attend.

A major event was CUNA’s Governmental Affairs Conference held every February at the Hilton Hotel. The NCUA chair’s speech would be a highlight.  I found a copy of Callahan’s 1983 and 1984 presentations.  But the most pivotal ones from 1982 and 1985 are missing.

State leagues and other conference organizers routinely recorded presentations by NCUA personnel as well.  Finding copies of these tapes is very difficult. The firms organizing the events have long ago moved on.  These live recordings are often seen as yesterday’s news when found in office records.

In this pre-internet period, NCUA communicated with its staff in six regional offices and the credit union community with a new media, VCR.   NCUA’s Video Network issued 21 productions over three years.  No copies can be found for many episodes. Neither NCUA nor the National Archives have the tapes of these critical updates.

Telling the Credit Union Story

Contemporary leaders are focused on creating their story rather than learning about the past.  Many of the participants from this critical 1981-1985 era have retired years ago.  Memories fade.  When their boxes of credit union experiences and keepsakes are opened by children or grandchildren, they rarely have any personal meaning for the family.  So out they go.

The founders of these earlier newsletters and conferences leave no legacy of their vital role of credit union events now forgotten.

But somewhere in a closet, garage, or basement storage area I believe some of these original records (newsletters, recordings, VCR’s) exist kept by those as memories of an important part of their lives—but even more consequential, I believe, as original sources of credit union history.

Can reader’s provide suggestions where some of this trove of credit union history exists?

I will be glad to digitize any records that a person wishes to keep.  The years of 1981-1985 are a turning point.

Parts of John Tippet’s 2001 statements on his credit union’s strategy will spark controversy.  It did then and it will today.   Some of the same challenges remain.  For the credit union story is always being updated.

Can you help me fill in some of the missing parts from an earlier era?  It will be entertaining, illuminating and educational.   Please let me know what you find or where I might look.