Category: NCUA

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Chevron, NCUA’s Authority, and Democracy’s Vulnerability

NCUA is an independent agency–in many senses of that term.  The most important is that the only governance oversight is via the three board members who serve 6-year terms ( or longer) once confirmed by the Senate.

NCUA raises all of its own revenue by taxing credit unions. It sets its own internal policies, manages  four separate funds, passes rules and regs requiring only two board votes, and enforces its own supervisory findings including starting and ending credit union charters.

The agency prepares its own legislation (rules), interprets its own authority and executes its supervision. There is no separation of these distinct functions as in the national government.

In individual credit union actions, NCUA is the prosecuting attorney, judge, jury and sentence enforcer.  There is no independent appeals process.  Congress has no control except the spotlight of public hearings-but no standing authority to make change.

Even in situations as mundane as FOIA denials, the same legal office that made the initial determination rules on the appeal.

This unlimited executive, legislative, judicial and enforcement activity all within a single bureaucracy has been described as the “fourth branch” of government or the “Administrative State.”

The Chevron Ruling

A new book on this issue has just been released.  The Chevron Doctrine describes  bureaucratic “rule” and the role of this Supreme Court precedent.

I outlined this topic in a blog NCUA and the Supreme Court calling attention to the current case (American Hospital Association (AHA) v. Becerra ) which could substantially reinterpret how courts defer to agency’s exercise of their authority.

One reviewer of Merrill’s book comments:  The author says the business of delegation is settled. He has to say this because the Constitution says Congress does not have right to delegate its powers, which it does every time it creates a new agency.

Instead of making the rules as required, it charges the agency with making the rules for itself, because Congress is dysfunctional and couldn’t possibly do this. But it’s illegal. And these agency-made rules then act as enforceable laws, which only Congress can create, at least according to the Constitution. Instead, Americans are enduring a fourth branch — the Administrative Branch — unrecognized in the Constitution.

The ruling this week by a Florida judge that the Center for Disease Control’s (CDC) mask requirements for public transportation was illegal, is a rare example of a court overturning an agency’s requirements.

How This Affects Credit Unions

Credit unions have learned there is no recourse to NCUA’s actions or inactions. The agency’s directives from onerous exam DOR’s, financial interpretations imposing PCA ratios, and rules issued outside traditional statutory authority (e.g. the RBC/ CCULR capital regulation approved in December 2021) are the most obvious example of  NCUA’s unchecked authority.

However just as important as acts of commission are omissions, when NCUA fails to enforce its own fiduciary interpretations.  If a CEO and Chair of a credit union want to transfer $10 million of members’ capital to their own private firm upon merger, that’s OK with NCUA.

In merger after merger, members are misinformed, or not informed of the consequences of their vote. NCUA continues to approve rhetorical statements of good intentions in the required Member Notice with significant omissions of material facts, as a sufficient basis for member-owners to vote on their charter’s future.

One example: in  2021 members lost their voting rights for the board or approving  other corporate actions such as merger, when combing with a specific state charter and giving up their federal voting options.  There was no mention of this change in the merger material.

The Only Constraint

The only check and balance on NCUA’s actions or inactions is at the board level.   If individual board members do not raise the question of proper authority or about acts of omission, there is no accountability at the agency.

When Board member Mark McWatters, a lawyer, twice presented his legal analysis opposing  the agency’s risk based capital proposals as not authorized by statue, his reasoning was “overruled” twice by a simple board vote, 2 to 1.

Democracy is hard work.  The processes sustaining it are fragile.  Personal ambition and ideological views can override traditional norms of transparency, accountability and even term limits.

The motivations for the transition in 1977 of NCUA from a single Administrator to a three-person board was due to credit union concerns over the power of one person to determine the future of credit unions. Especially one who had a prior career as a Marine general.

The Supreme Court may limit the Chevron precedent and the unchecked administrative power of government agencies. In the interim this means the responsibility of individual board members is especially critical if some semblance of democratic accountability is to govern NCUA’s conduct.

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Learning from the Past

History is vital to interpreting human experience and meaning.   Understanding  where we have been helps us appreciate the present  and what the future may hold.

Our perspective of the past can change as events unfold.   What may have seemed wise or foolish at the time can now be viewed with greater clarity.  This capacity for self-reflection is critical when making decisions today.  It is called wisdom.

Calling for Wisdom by a Board Member

At the March NCUA Board meeting during the staff’s update on the Corporate Resolution Plan,  Rodney Hood observed:

But with any significant challenge, there are opportunities to learn lessons.  One lesson I would take away from the failed corporates is patience in the resolution process.  So I am glad that we are going to look back at the failed corporates, not to second guess or question decisions, but to learn from this experience as history can repeat itself. 

The Largest Loss Ever for Credit Unions

The liquidation en masse of five corporates was the largest projected loss ever.  NCUA said it would cost credit unions between $13.5-$16.0 billion.  The latest corporate AME numbers estimates the actual loss to the NCUSIF will be just over $2.0 billion and that is from just one corporate, WesCorp.

Absent an effort to understand how these projections were made, everyone will offer stories and interpretations that may be totally at odds with the facts as they unfolded.  In the desire to portray the resolution as a success, the most important lessons may be lost.   The seeds for future mistakes, remain unrecognized.

One example where the learning might begin is the liquidation of Southwest Corporate FCU.

Modeling for Failure

Unlike US Central and WesCorp, Southwest was not in conservatorship when seized.  It was being managed by its board and senior managers who made extensive monthly disclosures about the status of their credit union and every aspect of its investments.  The last report they issued was for July 2010 and was 21 pages of detailed information.

On September 24, 2010 NCUA issued an Order of Conservatorship on Southwest.  It was exercised “without notice” and warned that “Any business following service of this Order may subject members of the Board of Directors and management to civil or criminal liability.”  An explicit threat not to contest the Order.

A second document Grounds for Conservatorship included the following facts:

The credit union was solvent with “$88.6 million or 1.06% of  Southwest’s daily 12 month average net assets.”

The $88.6 million in remaining capital was after having “recorded OTTI charges totaling $496,258.357.” The Grounds document did not point out, as did the corporate in is July 2010 update, that only $49.7 million of actual losses (10%)  had been incurred. These investment write downs were based on modeling of  projected cash flows years, even decades,  into the future.

OTTI is not an allowance account.  It is a reduction in the value of an asset.  Under the accounting treatment at the time, improving loss projections based on the same modeling may not be recognized or netted with increasing loss projections.

In addition to its low solvency ratio NCUA declared it “marked to market” the investment portfolio resulting in a Net Economic Value (NEV) shortfall of ($718 million). This determination was accompanied by the statement that there was “with minimal opportunity for material improvement.”

Yet in the six-month period ending June 30, 2010 the negative NEV had improved by $382 million (35%).  The recovery had been underway since September 2009 and the market dislocations affecting the values of securities had begun to normalize.

But NCUA rejected these recent improvements asserting ‘future OTTI losses will continue to deplete its capital, negatively affect NEV, negatively affect its overall risk profile and decrease member confidence.  Even if NEV continued its recent slight improvement, the losses are more than Southwest’s balance sheet can absorb.” 

It further claimed: “Though a slight improvement in the increase in the fair value of the investment portfolio, the NEV increase is overwhelmed by the enormity of losses and the potential for additional OTTI charges from high risk investments.  The prospect of significant and sustained NEV improvement remains bleak.”  

A $1.5 Billion Modeling and Forecasting Error

 

Instead of a $718 million negative  NEV outcome and dire predictions of greater losses, the December 2021  projection is that SW Corp shareholders will receive $736 million in returned capital and liquidating dividends.  This is a $1.454 billion change in the actual economic value of the credit union.

The projected $736 million now being returned to shareholders equals 8.8% of the assets at the time of the seizure, or more than eight times the 1% solvency asserted by NCUA when placing the corporate in liquidation.

The projections and modeling were wrong.  The credit union had expensed hundreds of millions in  unrealized  OTTI losses that never took place, but were based on faulty assumptions.

Three of the other corporates had similar circumstances  Even in WesCorp’s situation, in which there will be no payment to shareholders, the estimated loss to the NCUSIF has gone from $6.2 million to just over $2.0 billion.

Next Steps in Understanding

 

A first review effort would be to update the projected versus actual loss experience on Southwest’s legacy assets.  The complete spreadsheet of legacy assets updated through September 2017 (when the TCCUSF was merged with the NCUSIF) is here.

How accurate were the OTTI write downs? What percentage of the $736 million payouts are from recoveries in the value of  “legacy assets”?

What can we learn further from the corporate resolution plan?   Especially in today’s economic circumstances?

Certainly the value of patience, in that there is a cycle of value with almost all assets in a dynamic economy.   This perspective could be especially important in this time of rapidly rising interest rates.  These increases  will temporarily depress the market value of many loan and investments assets on the books prior to Fed’s change in monetary policy.

The lessons should be more profound than relearning about fluctuations in economic value.  These might include the shortcomings of relying on “experts” like Black Rock and PIMCO for understanding what management options might be; or hiring Wall Street to design cooperative solutions; or even the native intelligence and insights of some of the corporate leaders who were summarily dismissed.

“No reasonable alternatives to conservatorship are evident.”

This assertion about the future of Soutwest in NCUA’s Order is perhaps the most important factor to assess.   What alternatives were evaluated?   By whom?  When?

One of the significant advantages of cooperative design versus private organizations is their dependence on member support and trust.   This factor is embodied in their democratic governance structure.

However, if those who lead an organization directly or through regulation do not honor this capability, then the advantage is loss.   The temptation to ignore, overrule or act based on solely on position and authority will sacrifice the long-term viability of an institution or even a system.

If NCUA demonstrates the ability to reflect on its own actions, transparently and in common cause with the industry, it could result in a leadership action that could resonate throughout the cooperative system—and perhaps beyond.

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

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

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

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

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

Harper’s Idealization of the FDIC

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

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

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

NCUSIF’s “Tall Tree” Problem

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

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

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

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

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

Credit Unions will support the merger because:

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

Members will support the move because:

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

Why the FDIC will support the plan:

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

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

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

CUNA/NAFCU will support the merger:

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

Congressional Democrats will support the merger:

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

Congressional Republicans will support the plan:

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

Two Paths for Implementing Harper’s Merger Plan

 

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

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

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

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

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

In conclusion

Readers.  It is April 1.

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

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

I’m just saying that it could happen.

And that it almost certainly will happen.

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

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

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

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

 

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NCUA CAMEL”S” Rating Goes Live on April 1, 2022

In the October 2021 Board meeting, NCUA approved adding an “S” to the CAMEL examiner rating system.

In announcing this action Chairman Harper stated: “The NCUA’s adoption of the CAMELS system is good public policy and long overdue.  It will allow the NCUA to better monitor the credit union system, better communicate specific concerns to individual credit unions, and better allocate resources.”

The rule’s effective date is tomorrow, April 1.  I have been critical of some agency actions in the past. But, this rule is imaginative, even revolutionary, in its implications.

However,  its significance may have been lost do to the recently  implemented RBC/CCULR, on January 1, with the first calculations due as of March 31.  External events such as cyber alerts, the Ukraine war crisis, growing inflation and the run up of interest rates also divert attention.

Special Training for Examiners

The rule’s innovative “S” component required extensive examiner training.  As announced in its 22-CU-05  March 2022 Supervisory letter: NCUA staff will receive training on how to evaluate the new ‘S’ component and the updated system.  In addition, the training will be made available to state regulators’ offices, for those that elect to use the CAMELS rating system.  There is also an industry training webinar planned for credit unions, which seeks to provide a greater understanding of the updates to credit union stakeholders.

Some credit unions may have missed the agency’s transparency efforts, so a brief summary is provided below.

The Imaginative “S” for CAMELS-A Seven Part Analysis

This innovative “S” approach will have significant benefits for all stakeholders—members, other credit unions,  regulators, even the public.  The questions include safety and soundness criteria that align with cooperative principles.  The final ratings are fully comparable with every other credit union regardless of asset size.

Each of the seven “S” criteria are scored independently. These scores are then added for a Grand Total.

Part 1 is traditional. It reviews a credit union’s field of membership process and how open and valued members are.  Market demographics and FOM strategy are assessed.

Parts 2 and 3 look at members’ financial participation, how capital is deployed for their benefit, and members’ involvement in credit union governance and volunteer roles.

Two critical safety and soundness factors are next. Part 5 reviews the credit union’s education and training for  staff and members. It documents external certifications, degrees and recognitions earned (Best Place to Work).  The cooperative section appraises the credit union’s role in CUSO’s and other organizations, such as fintechs, to build a stronger financial system.

The final section 7 reviews all aspects of a credit union’s Concern for Community.  Community is more than geographic boundaries.  It includes partnerships with organizations which “share common goals or opportunities and who choose to work together for everyone’s success.”

Objective, Comparable and Fully Transparent

The overall “S”  1 through 5 rating is determined by the Grand Total Score.   As shown on page 11, a score of over 100 results in a CAMEL 1.  The scores are intended to be shared industry-wide and can be posted in the credit union with the monthly financial statement.

In his March 5, 2022 Supervisory letter cited above, Chairman Harper encouraged dialogue:

The NCUA’s policy is to maintain open and effective communication with all credit unions it supervises. Credit unions, examiners, and regional and central office staff are encouraged to resolve disagreements informally and expeditiously.

As with any change in a supervisory approach, we understand credit unions and other stakeholders will have questions.

Long Overdue

This “S” addition breaks new ground.  It is “long overdue.”   A copy of the entire 11 page form with  descriptions of each section and the individual scoring components is here.  It  is interactive and can be completed online now.

Achieving a high CAMEL”S” score should not be any burden for most credit unions.  Service has been an integral part of the credit union model from the beginning.

Most importantly, the “S” highlights the cooperative difference.  It documents how credit unions  are poles apart from banks.  I believe credit unions should applaud NCUA’s alignment of its examinations with credit union  purpose.

For additional information, NAFCU has also posted this brief, more  prosaic analysis of the rule.

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Subdebt: The Fastest Growing Balance Sheet Account for Credit Unions

Outstanding subdebt (subordinated debt) for  credit unions grew 51% in 2020 to total $452.1 million.  In 2021 the increase was 109% and with credit unions reporting  $938.9 million.

The number of credit unions using this financial option grew from 64 in 2019 to 104 credit unions at December 2021.  The total assets of these credit unions was $96 billion or about 5% of the industry’s yearend total.

A Product with Many Facets

This financial instrument has many characterizations. 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 all 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.

“A Watershed Moment”

Earlier this month Olden capital announced the largest placement yet: a $200 million borrowing sold to 41 investors including credit unions, banks, insurance companies and asset managers.

The process as described in the release required: The coordination of a team that included leaders from the credit union, investment bankers, lawyers, other consultants and service providers. . . Olden labelled it “a watershed moment, notable for its size and breadth.”

Certainly considering size that is an accurate statement.  This one placement exceeds 40% of the total of all 2021 debt issuance.  Credit union demand is certainly picking up and more intermediaries are getting into the business to arrange transactions.

Olden did not name its client, although the purchasers were aware that it was Vystar Credit Union.

Why the Rapid Subdebt Growth?

This borrowing is a form of “Buy Now, Pay Later” capital for credit unions.   The terms of the debt are generally ten years with no repayment the first five, and level amortization of 20% each in the remaining years.

The interest paid is based on several factors including market rates and the credit union’s overall financial position.

Traditional credit union capital comes only from retained earnings. Maintaining well capitalized net worth means that comes only  from earnings means the process places a “growth governor” on a credit union’s balance sheet.

By raising subdebt this organic “growth governor” is removed in the short term.  Some credit unions have been bold to say that their intent is to use the newly created capital for acquisitions.  Both VyStar and GreenState ($60 million in subdebt) have been active buyers of whole banks.

The overnight increase in the well capitalized net worth category from 7% to 9% by NCUA on January 1, 2022 is also causing credit unions to look at ways to comply with this higher requirement.

Others believe it will help them accelerate investments that might otherwise be spread over several years.

Getting into the Leverage Business

Because subdebt has a price, unlike free retained earnings, and its function as capital is time-limited, its use requires increased asset growth to be cost effective.

It refocuses credit union financial priorities from creating member value to enhancing financial performance through leverage.   This leverage requires both increased funding and  matching earning assets to achieve a spread over the costs of these increased funding.  Buying whole banks is an obvious strategy to accomplish both growth goals at once.

The Unintended Consequences

The use of subdebt as a source of capital was provided as a sop to help credit unions meet NCUA’s new higher and much opposed RBC capital standards.

The irony is that its use will entail a more intense focus on balance sheet growth to pay the cost of this new source of net worth.  Unlike retained earnings, the benefit is only for a limited period.

The event will impose a new set of financial constraints or goals that have no direct connection with member well being.  It converts a credit union’s strategy from “member-centric” to maximizing balance sheet financial performance.

In later blogs I will explore some financial model options for subdebt, the transaction costs and other factors in its use.

One of the most important needs at the moment is for greater transparency for individual transactions.

These are ten-year commitments that may exceed the tenure of the managers and boards approving the borrowings. The financial benefits and impact on members will  not be known for years.  This is  especially true when the primary purpose is to acquire capital as a “hunting license” to  purchase other institutions.

This rapid and expanded use will have many consequences for the credit union system, some well-meant, others unintended.   It is a seemingly easy financial option to execute that the cooperative system will need to monitor.

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‘It’s the End of the World as We Know It’ (and I Don’t Feel Fine)

The title is from a Commentary by William Reinsch written four days after Russia’s invasion of Ukraine.

He is the Scholl Chair in International Business at the Center for Strategic and International Studies. His professional specialty within government and outside is international commerce and trade policy.

His article projected the end of the rules-based system of international trade that had been developed post WW II.

He foresees the war causing economic chaos, a return of power politics, and resurgence of authoritarianism.  The world will not be the same; unintended consequences will proliferate.

Turning Points in History

In individual, organizational and country’s histories there are moments that are eventually understood as turning points.  Sometimes these are sudden and instantly consequential.  Like Ukraine.

Other changes occur slowly, but inexorably, in a new direction with the outcome unseen for years.   For example the evolving demographic composition of the American population; or even the  inevitable forces leading to the deregulation of financial services in the 1970’s and 80’s.

I believe the century long credit union movement is in one of these transformational periods. This  involves significant changes in the regulator’s role,  credit union business priorities, accepted performance norms and the ambitions of leaders.

These cooperative developments are occurring as economic trends are moving away from the two decade  experience  post 9/11.   Inflation is nearing 8%, unemployment is at historic lows, worker shortages are occurring in many sectors, and interest rates  are projected to rise to potentially the highest level this century.

The juncture of these economic and industry changes could significantly alter the institutional makeup of the cooperative system. They could result in the loss of credit union’s independent identify and purpose.

The Breakdown in the Regulatory-Industry Relationship

The seeds were sown in the disruption of the Great Recession in 2008-2010.  The scope of the potential corporate problem created a rupture between NCUA and the industry.

NCUA leaders whether through fear, inexperience or bureaucratic instinct distanced itself from credit unions.   The agency took  the sole role of developing one all encompassing solution for five distinct corporate balance sheets.  The results were disastrous for credit unions, the corporate system and the credit unions that relied on them.  Additionally, 30-year industry partnership for the CLF was ended.

The most critical long term loss however was not financial, but the agency’s ability or willingness to work collaboratively with the industry—on all issues and in all circumstances.

Instead of viewing their role as empowering a system of cooperatives, NCUA positioned itself as rulers over the credit union system.

At the March 2022 Board meeting this view was expressed by Chairman Harper in comments on the agency’s Annual Performance Plan:  With the geopolitical crisis unfolding in Ukraine, the NCUA will also continue to prioritize cybersecurity and guide the credit union system through the economic uncertainty caused by inflation, rising gas bills, and continued supply chain woes.

This paternalistic or in loco parentis approach to regulation and supervision emerged from the agency’s ability to impose solutions and rules unilaterally following  the corporate crisis.

The agency publicly proclaimed its independence under Chairman Matz from both credit union involvement and external oversight.  No one at the board or staff has been able to replace the critical experience and knowledge credit unions brought to all issues.

Credit union experience is absent in the regulatory bureaucracy. Credit unions manage over $2.0 trillion for over 100 million members but they have little to no voice in policy priorities.   Stakeholders, both members and the professional leaders, are viewed simply as recipients of perceived regulatory wisdom.

Increasingly credit unions are developing new financial schemes with the regulator seemingly oblivious to their impact on these credit unions or the member owners.   The wheeling and dealing in mergers, bank purchases and raising external capital is accelerating.

The makeover of a number of credit unions from member-centered to financial strategists, gamesman, hustlers and horse-traders is well underway.

This failure to interact removes NCUA’s most important resource – the industry’s professional leadership experience.   Mistakes will continue to be made and paid for by credit unions due to the missing counsel of those who make the system work on a daily basis.

Overcoming the Schism

Credit unions created NCUA and designed and passed in Congress all of its constituent capabilities specifically the NCUSIF and CLF.

Board members seem divided between two binary positions:  let the free market determine outcomes or, NCUA must pass rules to micromanage every credit decision and balance sheet IRR risk.

Effective NCUA regulatory policy is not democratic or republican, or even bipartisan; it is pragmatic supported by facts, logic and cooperative purpose.

Rules and manuals in the thousands of pages cannot replace business judgments and may in fact result in reducing sound operational choices.

Mutual respect is missing.  Credit unions are intimidated or consider fruitless any effort to critique ineffective agency actions.   NCUA’s most frequent justification for more rules is comparison with other financial regulators.

Mutual dialogue creates respect and enhances understanding of shared responsibility.  Future posts will describe changes in priorities, norms and professional ambitions shaping industry character.   All are examples of events occurring without the benefit of public dialogue.

 

 

 

 

 

 

 

 

 

 

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A Fee that Credit Unions Should Review for Appropriateness

Increasing attention is being given to all financial institution’s overdraft/courtesy-pay/nsf fee structures.   An excellent summary of many of the issues is in this article from CUSO magazine.

After the reassessments of these fees, there is another one that credit unions may want to proactively review.

The Unclaimed Property/Inactive Account Fee

A member recently told the story about learning of this fee the hard way.   She had been a loyal credit union member for over two decades and had left a small balance of $500 in case a family member needed to borrow.

The regular savings account paid interest of .05%, offered only online statements and had no activity for over two years.  When checking her 2021 yearend balance online she discovered that the amount had fallen by 20%.

The explanation: a $3 per month inactive account fee was being assessed.  She knew nothing about the fee or how long it had been in place.  In essence she felt the credit union had effectively free use of her money and was charging her on top of that!

When contacted, the credit union explained the fee and offered to refund the money for the last two years, which was as far back as their system would go.

Credit Union’s Responsibility for Inactive Accounts

When Ed, Bucky and I went to NCUA in 1981, I can remember credit unions approaching the agency about charging inactive account fees, which in essence was the step prior to forwarding these accounts to the states as unclaimed property.

In Illinois the Department of Financial Institutions was responsible for administering the unclaimed property act and ensuring funds were properly reported, returned to the state after five years of inactivity so the owners’ names could be publicly listed to  reclaim their funds.

My colleagues believed charging a fee during this inactive period was counter to both the spirit of the act and for a cooperative financial institution.

Credit unions claimed  the accounts were costing them money: maintaining the account, mailing monthly or quarterly statements and plus interest.  Even as they tried to reactivate them, they wanted to be reimbursed for the operational “costs” of the accounts.

For others, the not so hidden motive was to fee the account to $0, especially smaller balances,  close out the member, and not worry about reporting it as unclaimed property.

Others asserted that the fee was in fact an incentive for members to reactivate their accounts.

Inactive accounts come in all flavors:  parents opening accounts for their children, now long gone; accounts left when members move out of the area; the account opened for an indirect loan member, etc.

The common characteristics are there is no member-initiated account activity, the relationship is static, and there is high probability the owner is unaware of any fees being charged.   Therefore it is an easy fee to assess as it is mostly invisible to the account holder.

Other Credit Union Examples

One CEO I talked with said they charge $3 a month on about 500 accounts generating $1,500 in revenue.   At any point in time about 40% of the accounts will be sent to the state.

Another CEO said the credit union charges $10 per quarter.   In both cases the fee had not been evaluated for decades.

Both recognized that in an era of virtual accounts, minimal interest on savings and near zero marginal operating costs, the credit union should focus on contacting members, not seeing the issue as a revenue item.

I would urge credit unions to look at their current inactive account policy and fees.   It may not be as consequential as overdrafts, but if a class action attorney situation arrives, just looking up the years of records, charges and potential refunds, would seem to suggest any income is not worth the potential cost.

Also don’t forget abandoned safety deposit boxes must also be reported as unclaimed after the statutory period of inactivity.

NCUA’s Unclaimed Policy

Just as a footnote, NCUA also acquires unclaimed insured share accounts when liquidating credit unions.

It is interesting to note that the agency’s policy is contrary to the legal practice required of credit unions.

As stated on the website, if NCUA cannot locate the party after 18 months, it converts them to “uninsured” and retains the balances for use by the insurance fund.

Invariably, some items may remain unclaimed. Some checks are never cashed; or the credit union’s address information was incomplete. There are also cases when we don’t have a recent address and are unable to get a forwarding address from the post office.

Share accounts claimed within the 18-month insurance period are paid at their full-insured amount. At the expiration of the 18-month insurance period, shares that are not claimed are considered uninsured and written down to share in the loss to the National Credit Union Share Insurance Fund. Even if shares are uninsured when they are claimed, there may still be a distribution.

On rare occasions, the liquidation of a credit union may result in surplus funds. If a surplus remains, a distribution to the shareholders is required. This may occur several years after the credit union is liquidated and it is sometimes difficult to locate these members.

This is another example where NCUA exempts itself from the rules credit unions are required to follow to protect member’s assets.

 

 

 

 

 

 

 

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RBC Update: 257 Credit Unions in NCUA’s “Hotpot”

In two weeks, credit unions will be able to calculate their newly imposed capital ratios.  Three different calculation requirements are now in effect.

Using yearend 2021 data, there are 212 credit unions over $500 million that will likely have to use RBC (risk based capital) because they had net worth below 9% at December 31.  Another 45 credit unions between $400 and $500 million reported net worth below 9%.  They will be subject to RBC when their total assets exceed $500 million.

This total of 257 credit unions is probably the minimum number as credit union share growth is usually seasonal, concentrated in the first four months of the year.  That is, assets will increase faster than capital can be earned at the same pace.

RBC’s Impact

RBC has still not hit home for some. These credit unions are telling members they are well capitalized because they exceed the 7% net worth level. Those so doing often fall short of the new 9% minimum.

The impact of RBC is best described with the boiling frog analogy.  A frog put in boiling water will immediately jump out. But put the frog in a pot of cold water, slowly raise the temperature and the frog will hot-pot to death.

Many large credit unions view RBC similar to  a pond Kermit.  As the RBC multiplex calculations slowly engulf quarter by quarter many will find themselves in unfathomable amounts of  creeping normality.

Some will immediately jump to the seeming sub debt life preserver to stay above the 9% threshold.   Soon they will realize that  option itself requires more leverage just  to  breakeven.  Sub debt  just made the water deeper and harder to jump out of the pan.

RBC and NCUA’s Record of Risk Analysis

In an April 30, 2010 speech to the Illinois Credit Union League 80th Annual Convention Chairman Matz  offered these remarks on the corporate crisis:

“Let me start by assuring that I fully recognize the legitimate anger many of your feel.  The anger has come through loud and clear. . .I have heard directly about the pain you have felt. I know that many of you blame NCUA: After all, two examiners were on-site at US Central and WesCorp.  NCUA definitely shares some of the blame (and then comes the big qualifier) but there is plenty of blame to go around.”

What she forgot is that the regulator’s role is because crises are to be expected.  And when they occur, to be managed prudently.

The Irony of the RBC rule which is supposed to “protect the insurance fund” is that NCUA is often the source of the problem.  As one veteran CEO observed:

“All the losses -excluding a relatively low level of cu management  fraud – that NCUA has incurred is the result of errors in risk analysis by NCUA. They don’t like to acknowledge that fact, but the logic is inescapable.

By decreeing that most assets are now in complex credit unions, the industry is far more subject to the whims of a less than stellar team of NCUA executives who are increasingly enthralled by the “predictive” accuracy of astrologically and phrenologically based statistical models.”

The most catastrophic error in risk analysis is the Corporate crisis referred to by Chairman Matz. NCUA is now projecting a minimum of $5.7 billion in recoveries from the corporate AME’s.  Over $1.2 billion is still due shareholders of the four corporates.

This is the exact opposite result projected for years after the conservatorship when total costs of $13.5 to $16 billion  were estimated by NCUA.  The agency never revealed their analysis always referencing the results of their “engaged securities expert, Black Rock.”

 Learned Helplessness and the Actions of Others

With RBC it is easy to slip into a state of “learned helplessness.” That is  behavior exhibited when a person is repeatedly exposed to negative stimuli beyond their control.  Think regulatory burden.

The term describes experiments in which humans subject to loud noises, did nothing. seemingly helpless to change.

Not all the human participants responded the same way. Many blamed themselves for “failing,” but others blamed the way the experiment was framed. They knew it set them up for failure. In other words, not everyone is equally susceptible to learned helplessness.

Those who do not become passive when confronted with apparently uncontrollable situations are because they see others act with courage, overcoming difficult odds.  These leaders actions inspire others not to give up.

There is an initial segment of 257 credit unions who will be subject to the sophistry and real burden of RBC.  Some will throw in the towel, some will try to comply, and others will look for an “out” such as RBC or shrinking the balance sheet.

The hope is that most will have the courage and resilience to persevere until wiser heads prevail in Alexandria.

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The Fix is In: Members Act When Denied the Right to Stand for the Board

Credit union’s democratic member voting is a critical feature of cooperative design.

However the practice of democracy can become a charade if those in control fail to follow long standing practices to make it a reality.

A Board Controlling Their Re-election

At December 2021 yearend Virginia Credit Union (VACU) reported $5.0 billion in assets with 310,000 members, 22 branches and 731 employees. The net worth ratio was 9.8%.

In yesterday’s post I shared the member Notice from my credit union’s annual meeting and the fact there would be no voting for four open board seats.  The number of nominations equals the number of vacancies.

Then I received this email from a credit union member about the board of VACU trying to control their own reappointment.  And members’ response.

“Are you aware of this? [link] It appears that VACU needs a mechanism for members’ self-nomination for board elections. Find that hard to believe but VACU is a state-chartered CU and the VA credit union act gives them much discretion.

“Although the nominating committee can send forward more than one candidate for each board vacancy, if they don’t, then nominations from the floor are not allowed and the vote at the meeting shall be by voice vote – which precludes any write-in votes!

“Under any circumstances, if only the uncontested nominees selected by the board appointed nominating committee are eligible to run…it ain’t right…talk about the destruction of cooperative principles?!?!?.

“The fix is definitely in!”

We Own VACU

The link in the email is to a petition in which four members of VACU state their interest in serving on the board.  They describe their efforts as follows:

The Virginia Credit Union Board is trying to rig their election so that YOU lose your right to vote for four amazing community leaders who are running for the board. 

Credit unions are financial cooperatives. They are owned equally by the members with a democratically elected board of directors – one member, one vote. The Virginia Credit Union (VACU) is a Community Development Finance Institution (CDFI) with a responsibility to invest federal dollars alongside private sector capital in the nation’s most distressed communities.

Four outstanding Richmond community leaders and VACU member-owners filed paperwork by last year’s deadline to run for the board in the March 23rd elections — Frank Moseley, Kati Hornung, Richard Walker, and Tori Jones — to bring a different direction, a different relationship with the Richmond community, and accountability for VACU’s atrocious pandemic response to an out-of-touch board of directors that needs all three.

VACU’s board has not only refused to allow their names on the ballot, it didn’t bother to interview or respond to the candidates. Instead the board is planning to hold a Soviet-style election at our annual member meeting on March 23rd, with three board-chosen candidates running unopposed for three seats. You can read the full story here, and learn more about the candidates here.

Tell VACU this is not democratic ownership and we will fight for our voting rights at the credit union the same as anywhere else they are under attack. 

A longer  post called We Own VACU provides the back story of their efforts.  They show the board chair appointed the nominating committee, which in  turn nominated the chair as one of the candidates for the four open seats.

Complaint Filed with NCUA

Where can members go if their efforts are denied?  Who is to call a foul on those in charge if they do not follow their own rules?

The members appealed to NCUA.  Yesterday they filed a formal complaint which can be read in full. The complaint gives the history of their attempts to be nominated starting in September 2021 and the repeated no responses or rebuffs by the board.

They attach their documentation and ask NCUA to vacate the “sham election scheduled for March 23 and require a new election with all four names included on the ballot.”

However their most important request is that NCUA make a policy statement declaring  that:

No credit unions in the country will be permitted to remove member owner oversight, participation in governance, or democratic control, thereby removing the temptation of misguided boards to try.

NCUA has published many such interpretations of acceptable bylaw implementation such as this:

  1. Nomination procedures: Under all options under this Article, the nominating committee must widely publicize the call for nominations to all members by any medium. This requirement can be satisfied by publicizing the information to a large audience, whether by newsletter, email, or any other satisfactory medium that reaches as many members as possible. The NCUA emphasizes that member participation is important during an election, and FCUs must make sure that members are aware of the nomination process. (emphasis added)

But in practice the Agency has shown no interest in member rights even when confronted with documented evidence of board manipulation of voting and annual meeting misconduct. A prime example is the denial of member rights in the Cornerstone Credit Union merger with Belco Community Credit Union.

As a result member participation in annual elections is increasingly a shadow exercise with no substance.  With more virtual annual meetings, the process becomes even more controlled.

As members are removed from the governance process, board and management are free to follow whatever course they alone believe is in the members’ interest. Even when this means giving up sound charters via merger or using member’s collective reserves to buy troubled banks.

Regulatory Leadership or Continued Neglect?

Chairman Harper in last week’s GAC address gave this view of his regulatory approach:

One of my favorite quotes by Molly Ivin’s reads: “I think government is a tool, like a hammer. You can use a hammer to build with or you can use a hammer to destroy with. Whether government is good or bad depends on what you use it for and how well you use it.

He then says how he intends to use his regulatory hammer as Chairman:

Protecting Consumers

Since joining the Board, I have focused on strengthening the NCUA’s consumer financial protection and fair lending resources. Given the consumer compliance examination program for comparably sized community banks, our program’s scope is insufficient, especially for those credit unions between $1 billion and $10 billion in assets. We should be doing more, and we can do more.

I understand this is not a popular opinion in this room. Many within the industry maintain that the NCUA should primarily focus on its safety-and-soundness mission or that the agency has not demonstrated a significant rationale for a stronger consumer compliance program.

Some also contend that the cooperative nature of credit unions prevents their lending practices from being discriminatory because their primary purpose is to serve their members’ needs. However, the logic that credit unions do not discriminate because they are owned by their members is a dangerous myth and one that should end.

Confusing Consumers with Member-Owners

Chairman Harper wants to protect consumers but not coop member-owners who are his primary responsibility.  The GAC comment suggests he has yet to grasp what it means to regulate cooperatives with their system of member governance.

The VACU members’ complaint and the ever-spreading practice of board’s ignoring the critical role of member’s franchise role will demonstrate whether the NCUA Board believes in member rights—or just wants credit unions to see their owners as only consumers.

The VACU members requested a straight forward policy statement that all credit unions could embrace.   It’s much shorter than a GAC speech. It doesn’t require a hammer. Just a reminder of who credit unions are.

I bet such a statement, recognizing members’ governance role,  would also enhance whatever shortcomings there might be in consumer compliance!