Category: NCUA

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Learning from Past Mergers to Design a Stronger Coop Future

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

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

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

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

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

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

The Banking Industry Is Looking at Merger Practices

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

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

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

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

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

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

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

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

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

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

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

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

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

The Comptroller outlined enhanced regulatory reviews such as:

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

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

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

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

Putting Market Forces Back In transactions

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

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

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

Putting Members Back in Charge

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

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

 

 

 

 

 

 

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

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

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

365,700 Members Lose their Credit Union

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

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

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

Check the Box Explanations

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

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

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

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

The Largest Three

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

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

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

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

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

A Game without Rules or Umpires

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

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

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

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

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

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

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

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

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

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

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

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

 

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“They’re Coming In to Bayonet the Wounded” Part II

This is the rest of CEO Joy Peterson’s concerns with the regulatory environment and six suggested changes.

Part I can be read here.

Pivoting from COVID to DEI

The pandemic saw record sums of COVID inspired money pouring into banks and credit unions.  Global fear and confusion were rampant.  Businesses were shuttered-some temporarily and some forever.  The global economy began a free fall.

There were reports of billions lost to PPP and unemployment fraud.  Where was NCUA?  One would expect nearly daily guidance regarding concentration risk and fraud prevention and best practices regarding NACHA rules.

Instead, the talking heads at NCUA started scolding credit unions about Diversity, Equity and Inclusion.  Rather than real concern for our members-the salt-of-the-earth member/owners of our financial institutions who feel a common bond to a financial institution  with their co-workers or their community-NCUA decided we are evidently racist and somehow elitist.

Our color chart no longer satisfies their hunger for diversity.  They alone are responsible for how our charters read but, in hindsight, they have decided we are perhaps too white or not serving enough underserved?!

In reality it doesn’t matter what color or gender our members are.   It doesn’t matter whether they are rich or poor or anywhere in between.  If we spend all of our time and most of our income trying to satisfy NCUA’s constantly changing view of what makes credit unions valuable to our members, we are no longer serving our members at all.

If we aren’t provided with the leverage to protect their money and their identity and their financial privacy, we are no longer good stewards of the faith 129.6 million people have placed in us.

The Most Needed Change: Respect for Credit Unions

Small credit unions are wounded and struggling to maintain our relevance and profitability in today’s economy.  From one CEO to the CEOs of the thousands of smaller Federally insured credit unions, the next time you are notified that your examiner is due to arrive, make sure you look carefully behind their back as you usher them in.  There could be a bayonet that will be driven firmly into your back as they write up yet another list of tail-chasing requirements to be deemed “safe and sound”.

I think it’s time all of us ask our regulators to be more constructive in their approach to the industry.

Here’s how  NCUA can demonstrate respect for our efforts to serve members, the reason why we exist:

  1. Recognize that small credit unions are, in fact, different from large ones. Their capabilities are not the same, but our service to members can still be extraordinary, needed and valued.
  2. NCUA should support credit unions instead of fighting them. Statements by NCUA spokespersons often include comments critical of credit unions. Our members decide whether we are “good enough”.
  3. Stop labeling our members. NCUA likes to call them marginalized, disadvantaged, underserved and low-income.  They refer to “minority communities” and recently “Other Targeted Populations or OTPs”.  While we happily serve ALL members of our community, these terms give the impression that only people who are “less than” or “other than” belong to credit unions.  They are just people.
  4. There needs to be more transparency from NCUA regarding its own management. Losses to the Share Insurance fund caused by thefts went on for years without raising any red flags to NCUA examiners. Were there any adjustments to NCUA examinations to address these limitations? NCUA should also be expected to manage their own investments at least as well as they expect us to manage ours.  Our credit union members pay for NCUA’s management failures.
  5. NCUA shouldn’t expect more of small credit unions than they expect of themselves. NCUA “recommended” that credit unions allow no-cost loan payment deferments and the waiving of overdraft fees during the pandemic.  My credit union gave up more than $15,000 in income to help our members.  What did NCUA do?
  6. So many mixed messages. Don’t tell credit unions we need to do more lending to people with lower credit scores and then criticize us because our delinquency goes up.  Don’t take away our ability to earn non-interest income from overdraft fees and interchange income and then wonder why we aren’t more profitable.  Part of the reason for all the mergers is the demanding, overbearing NCUA requirements as well as the utter lack of support  from our regulators.

Respect for members is what makes us different.  That is also what makes us sound.  It doesn’t work the same, the other way around.

 

 

 

 

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“THEY’RE COMING IN TO BAYONET THE WOUNDED” Part I

Ten days ago I received a positive comment on a post.  I asked what aspect spoke to the writer.

In return the CEO Joy Peterson of Bessemer System FCU, Grenville, PA sent an article written earlier that she hoped to publish in the credit union press.

I read it.  Her voice is authentic; her coop commitment lifelong; and her frustration with the regulatory environment, clear.

In her lament, I hear echoes that  concern many about leaders in Washington, especially those in positions of authority.

I suggested she add recommendations to her critique.  She did.  They are in the second part of this blog to be presented tomorrow.   Here is part I.

From Joy Peterson:

As a lifelong accountant, my Dad had a sign hanging in his office that said “Auditors are the ones who come in after the war to bayonet the wounded”.  His clients would all chuckle at the sign and nod in agreement.  As a child, I didn’t quite understand the meaning.  As the CEO of a small credit union, I understand completely.  Our regulator, NCUA can be thought of as the auditor in the equation.  It’s quite possible that FDIC and CFPB are members of the same group although I don’t have enough direct contact with them to speak to them specifically.

 Membership Growing, Credit Unions Declining

At the end of 2013, there were 6,554 Federally insured credit unions in the U.S according to ncua.gov statistics.  By the end of 2021, the number had declined by an astounding 1,612 to 4,942.  During that same time period, the number of credit union members actually increased from 96.3 million members to in 2013 to 129.6 million members in 2021.  Since the membership numbers grew, it seems evident that the decline in the number of credit unions is not due to consumer dissatisfaction.

What then, does explain the loss of so many credit unions at a time when Americans are searching for value and safety in the financial industries?  Even with fewer credit unions to choose from, 129.6 million Americans still seem to find solace in member-owned financial services.  Evidently, they still believe in the prospect of pooling their money for the good of all of the members that make up their charter.  Based on results, our regulator doesn’t hold that same high opinion of Federally insured credit unions and their mission of service.

Serving NCUA, Not Members

I’ve been a lifelong member of my credit union and an employee since 2001. In that time, I’ve seen substantial regulatory changes in my credit union as well as the industry as a whole but none as significant and harmful as the ones I’ve noted from 2013-2022.  Our members are not being served by their credit unions.  Instead, our credit unions are serving NCUA.

Based on the numbers, many have been unable to continue to do so successfully.  Some have been dissolved involuntarily and many others have been “encouraged” to merge in order to fulfill NCUA’s crushing requirements for what is deemed to be “safety and soundness.”

It seems NCUA would much rather provide oversight to a few giant credit unions than have to provide guidance and oversight to thousands of us little guys.  Is that really what the millions of members of both small and large credit unions want?  Do our members really understand that there will come a time when belonging to a credit union is no different than being an account holder with Bank of America or Wells Fargo as their individual control over their financial institution is being diluted at a record pace?

The Compliance Burden: Boards as Scapegoats

Today, trying to comply with NCUA’s ever growing list of compliance requirements is like trying to herd cats.  Are those requirements making credit unions safer and more productive and efficient?  Based on the numbers, the answer is a very clear and unequivocal NO.

Each NCUA audit results in additional requirements for volunteer board members and supervisory committee members.  These completely uncompensated volunteers are now expected to review employees’ accounts, verify the vault, balance the checking account, review corporate accounts, attend meetings and training on Bank Secrecy and on and on and on.

When volunteers resign in frustration, NCUA demands they be replaced.  Replacing volunteers encumbered with such overwhelming responsibility is becoming nearly impossible.  Not only are they not compensated, they frequently aren’t even able to receive some of the benefits the rest of the membership are granted like the waiving of fees for an incidental overdraft or a request for a stop payment.

They are reminded with every NCUA contact of their culpability for any insider fraud or failure to mitigate risk appropriately.  Rather than volunteers, they are becoming potential scape goats for NCUA.  In order to rope in replacements, we have to overstate the “service to your community” aspect and seriously understate the actual responsibility of it all.

The Big Three DP Monopoly

Beginning around 2014, NCUA started a nearly constant drumbeat regarding “Vendor Due Diligence”.  We are cautioned on the growing threat of losses caused by the numerous outside vendors we use for everything from data processing to corporate account services to network security.

We chase our tails trying to verify these vendors are properly insured and sustainable and are abiding by regulatory requirements in terms of security.  We make lists and check boxes and retrieve SOC I and II reports.  We even hire other vendors to help us keep track of us monitoring our vendors.  We spend thousands upon thousands of dollars and hundreds and hundreds of hours trying to make sure our vendors are safe.

In reality, small credit unions have very little choice of vendors and almost no control of their behavior, particularly in regard to information security.  The Big Three data processors have become so big and so powerful. They have not only access but also control of every bit of our members’ financial information.

They refuse to provide security audit information on the pretense that doing so would compromise their own security.  They refuse to return our data without hundreds of thousands of our members’ hard-earned dollars in “de-conversion fees” if we attempt to cut ties with them.  They hold our data hostage and simply refuse to allow our exit until we meet their demands. Rather than a contract termination, our dissatisfaction is relegated to a hostage negotiation scenario.

Does NCUA intervene on our behalf as we attempt to comply with their demands surrounding vendors?  Absolutely not.  In whispers they admit that they have no oversight of these giants either.

Yet small and large credit unions alike are expected to demonstrate that we are overseeing these bullies.  The really large credit unions at least have the benefit of the substantial sums they pay to these vendors to use their leverage to obtain Service Level Agreements when signing contracts.

Small credit unions like mine have no such advantage.  The Big Three don’t care what I demand in terms of service on behalf of my members.  When their shoddy security practices put my members’ information at risk, they shrug their shoulders and basically dare me to find an alternative.

Rather than contrition and embarrassment regarding their failure to maintain adequate security against current threats, these Fortune 500 companies threaten legal action for disclosing their rookie mistakes.  They aren’t sorry they failed to use their superior security resources to provide superior security.  They are only sorry we found out about it and demanded that we deserve better.

End part I.

Part II tomorrow, includes a recent additional concern and six recommendations for improving the regulatory relationship.

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Needed: A Coop Pulitzer Award for the Credit Union Press

In America the press is often called the “Fourth Estate.”  The term places the press’s role as critical as the three branches of government: legislative, executive and judicial. It signals the watchdog role of the press, so vital to a functioning democracy.

What is the state of press coverage of credit unions?  Especially now that coops are the second largest depository system in the economy, serving over 100 million members and managing $2.2 trillion assets.

A Brief Credit Union Press History

 

Today’s independent coverage of the credit union system evolved from newsletters that emerged in the 1970’s and 1980’s as the credit union system become more coherent with national ambitions and organizations.

These startups included CUIS, Report on Credit Unions, NCUA Watch.  These newsletters relied on subscriptions versus the free in-house updates from league and trade associations.

In 1986 ASI established the first printed newspaper format called Credit Union Week.  Shortly thereafter Mike Welsh, former CUES President, launched Credit Union Times offering original reporting and commentary.  In following years Credit Union News and Credit Union Journal were launched as competitors.   All used a combination of advertising and subscriptions to support their free-spirited reporting.

Today the independent credit union news media is largely virtual, publishing daily online summaries relying extensively on press releases from the industry.

More than Aggregators

With small staffs, limited budgets and daily posts, opportunities for original reporting or even investigative efforts are limited.

But there are periodic examples of the traditional press role of speaking “truth to power.”   Power refers both to the actions of NCUA and other government agencies, as well as events within credit unions and trade organizations.

Peter Strozniak of the Credit Union Times has a talent for tracking legal proceedings involving credit unions.  His articles have provided valuable insight into NCUA’s regulatory shortcomings, as revealed in court records.  A recent example is his story of a credit union’s suing NCUA for failure to prudently manage its interest in taxi loan participations.  The opening paragraph:

The $390 million Nassau Financial Federal Credit Union is suing the NCUA for nearly $1 million for allegedly breaching an agreement to settle defaulted taxi medallion loans for a mere fraction of what they were worth.

Many observers questioned NCUA’s disposition of the taxi medallion loans sold to a hedge fund in February 2020.  The agency refused multiple FOIA requests for details.  This example further adds to the impression of an NCUA coverup in its actions in the $750 million sale  of loan participations to a Wall Street hedge fund.

The Members’ Interests: Sunlight as a Disinfectant

CU Today has published a series of original articles about member’s efforts to participate more openly in their credit union’s governance.

One series discussed the efforts of four members of Virginia State Employees Credit Union to seek nomination for open board seats.  Their efforts were totally ignored. The credit union elected the board’s self-selected candidates including the current chair with no outside nominees permitted.

More recently CU Today has followed the efforts of former directors and  CEO to challenge the announcement of Vermont State Employees to merge their very successful credit union into the larger New England FCU.

CU today publisher Frank Diekmann editorialized about his goal of “pulling back the curtains.” He explained why reporting the merger information provided members when charters are ended and the payouts to management that sometimes accompany such efforts matters.  It read in part:

We also got to see how many CUs opted to return net worth to the people who own it (in some cases, obviously, there was little to reserve from the reserves). We further got a peek into which were not offering any payout, with a few citing odd reasons such as the acquiring CU has more branches or, bafflingly, offers Apple Pay and Google Pay. Eh?

One CU did announce it would be paying out some of the excess capital, but in this case only to savers, with more than $2 million being distributed in all. I’m not suggesting the members of the board all had savings/CDs at the credit union and that few if any were borrowers. I’m just saying. 

Sunlight may indeed be the best disinfectant, but not if no one never opens the curtains. CUToday.info has made a commitment to reporting on all the merger disclosure forms sent to NCUA, meaning we will continue to give the curtains a pull. 

Needed:  A Pulitzer for Credit Union Reporting

At last week the White House Correspondent’s dinner the comedian Trevor Noah’s public roast of many public figures ended with this close about the never-ending importance of a free press.

While the international press coverage of the war in Ukraine was top of mind that night, a domestic event happened the following day proving Noah’s thesis.

The national press released a draft of a Supreme Court decision that would reverse the Roe vs Wade fifty-year precedent giving women the right to an abortion. The coverage took  the debate from behind the hermetically sealed Supreme Court process, to the public sphere.

If credit unions are to fulfill their purpose of bringing more economic democracy to their members and greater choice for all consumers, one of the most important ways to monitor this role is an independent press.  One that reports its successes and exposes its failures.

In addition to Herb Wegner awards honoring credit unions leaders who exemplify the best in cooperative commitment, I believe an equally important moment would be to award “Coop Pulitzers” to press coverage of credit unions.

These would recognize the writers and stories from within and without the industry who take the risks and invest the time to hold those in positions of leadership to public scrutiny.  Especially for those with public authority. For unlike the White House Press, in credit union land there is only one estate, the NCUA.

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Sharing  Exam Stories Helps All Credit Unions

The post describing NCUA examiner’s arbitrary imposition of IRR tests causing a credit union loss of $10 million resulted in other readers sharing their experiences.

Their long-standing frustrations suggest the need for a more balanced, common sense, exam process.

Story 1: LOC’s and Liquidity

“I remember conversations about our investments during the time of your most recent article.  Fortunately, the vast majority of our investments was in CDs  so there was very little to even talk about in terms of unrealized losses.  We did have one or two securities, but they were near maturity so even unrealized losses were minimal.

“This was around the same time that the examiners demanded we establish some kind of borrowing capacity in case liquidity suffered.  I set up a LOC with our corporate and “borrowed” just to be sure everything was set up correctly.  When the examiner saw the tiny bit of interest I paid for this test, the furrowed brows and disapproving scowl came out.  Why would I do such a thing?  It appeared as though our liquidity was fine so why did I use our LOC?

“I said it was a new product and I wanted to make sure it would function correctly in the event we ever needed it.  The only way to prove that was to actually test it.  All this ruckus over a charge of less than $100 interest for the less than 30 days we had the money.  In the process, I wrote up specifically how to borrow from it, how to book the GL entries, how to pay the money back, etc. so that if the line ever had to be accessed, we would know how to do it.  We have never used it.  Not once.

“During my last exam NCUA recommended we increase the limit on it.  GRRRR.  Keep in mind, our last exam was at the height of the pandemic when we literally had liquidity dripping from every corner of the credit union and they were recommending we increase our LOC.  I can’t imagine being the credit union that lost millions because of misguided “guidance”.

“I’m afraid I would have spontaneously combusted.  Credit to them for staying in the industry because those are the kinds of things that cause us to lose some of our best advocates.”

Story 2: Ending a Profitable Business

“A related horror story about examiners making short-sighted decisions…  A credit union right after the great recession was told by their regional examiner that their expense to asset ratio was too high and they must shut down their insurance division to get things in line.

“The insurance division was profitable.  It was throwing off $360k of profit a year – profit with no strain on net worth – and profit from any perspective (GAAP, Free Cash Flow, Cash Basis).  There was no funny business in the numbers.  It was showing steady growth in earnings as it was finally hitting its stride.

“What the examiner failed to understand was the fastest way to restore capital is with an income source that requires no regulatory capital to begin with.

“I told the CEO he needs to die on that hill and fight hard.  He complied however, and shut down the insurance operation.

The Moral of Stories

Sharing stories, good or not so good, is how credit unions learn from each other’s experiences.  This is one way change for the better can occur in NCUA’s interactions with the industry.

 

 

 

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Tantrums and a $10 Million Credit Union Loss

As interest rates continue their upward cycle to reduce inflation, credit unions will manage this year-long transition process with multiple tactics and product adjustments.

There is no one operational formula to be universally applied because every credit union’s balance sheet and market standing is different.

But a simple model was the core of NCUA’s response in 2013 and 2014 when Fed Chairman Ben Bernanke announced a policy change to reduce support for the recovery after the Great Recession.   The reaction to his June 2013 announcement was an abrupt rise in rates, referred by some writers as  a “market tantrum.”

The following  is one credit union’s experience as NCUA  pursued its own regulatory tantrum as recalled by the current CEO.

A Case Study from a Prior Period of Increasing Rates

Today’s rapidly increasing interest rate environment is very reminiscent of the 2013-2014  period when Federal Reserve Chair Ben Bernanke’s “Taper Tantrum” led to a great deal of market volatility.  While Bernanke’s comments in May of 2013 touched off the increase in rates, it really took until the next year for the full effect to be felt.

NCUA’s response to this period of rising rates was nothing short of a panic.  Any credit union holding bonds whose value declined due to the increase in market yields was heavily criticized for having too much interest rate risk.  This critique was despite the fact that most natural person credit union had more than adequate liquidity to hold the bonds. 

The use of static stress tests, which showed dire results from up 300, 400 or 500 basis points, was used as a reason to force credit unions to sell some of their holdings turning unrealized losses, with no operational reason to act, into realized ones.  These forced sales unnecessarily depleted capital, the very thing that an insurer/regulator should be trying to preserve.

Things got so heated at our credit union that the Regional Director called a special meeting. Only our Board of Directors could attend; management was forbidden to be there. NCUA lectured them about the evils of excessive interest rate risk.  This sent many of them and our CEO into a full-scale panic. 

We sought advice from outside experts but finally settled on the dubious strategy of selling bonds at losses as well as borrowing funds from the FHLB that we did not need.  These were done to bring the results of these static stress tests in line with the NCUA’s modeled projections.  We calculated these actions caused us unnecessary losses of over $10 million before we stopped counting.  These came from both the realized losses, the added expense of unneeded borrowings, and the lost revenue on assets sold.

In the aftermath of that debacle, the credit unions senior management and two board members travelled to Alexandria, Virginia to meet a top NCUA regulator to explain our frustration at the loss.  After waiting for hours for our scheduled appointment, he heard us out.  We never heard back; however, the Regional Director soon departed.  Perhaps our message had at least been partially received.

The Problem with Static Tests

Fast forward to today.  We find ourselves in the “extreme risk” rating at the end of the first quarter due to the rapid rise in rates.  The glaring problem with static stress tests is that non-maturity deposits (which make up a large part of most natural person credit unions’ share liabilities) are limited to a one year average life. 

Several third-party studies document our share’s average life to be in excess of ten years.  Despite this, the asset side of the balance sheet is written down while the long-standing member relationships, on which most credit unions’ balance sheets are built, doesn’t get much credit at all.  For example, if a two-year average life on savings and checking accounts were used, the results of the static test wouldn’t even put us in the high interest rate risk category. 

Closing Thoughts

While we have authorization to utilize derivatives (something we didn’t have back in 2014), this could help lower the costs of compliance if we are forced to take action. However, I’m adamant against doing illogical things just to pass a static stress test this time around.

I’ve wondered how it’s OK for the NCUSIF to hold similarly long-term bonds in their portfolios without any concern during periods of volatility like this. We have the strength of our core share relationships and capital positions to withstand periods of rising rates.  NCUA just keeps reporting growing unrealized  losses transferring their IRR risk to credit unions to make up any operating shortfalls.

I also believe that NCUA should really be much more worried about very low interest rate environments.   These periods of very narrow yield curve pickups are actually much worse for financial intermediaries to navigate than periods like the one we’re now in. Overall the industry’s net margin should generally benefit from rising rates, shouldn’t it?

Two Observations

1. One expert’s view of  the situation today:  As you know, but people often forget, there is no ‘unrealized loss’ if a bond or loan is held to maturity.  There is an interest rate risk component that needs to be managed.  But if I am holding some 4% mortgages 10 years from now, and the overnight rate is 4%, then I am not upside-down.  I just have some of my assets earning the minimum rate of return. 

This is why I prefer net income simulation over IRR shock.  We don’t live in a static world, it’s a dynamic one.

2. During the November 2021 Board meeting the following interaction took place on the agency’s management of the NCUSIF portfolio and stress tests:

Board Member Hood: Thank you, Myra.  And again, I do have another question and this is for the record.  Do we all have an interest rate risk shock test to the fund (NCUSIF)  like we do for our credit unions under our supervision rule?  And also, do we do a cash flow forecast on a regular basis as well?

Eugene Schied: This is Eugene Schied, and I’ll take that question Mr. Hood.  Yes, we shock the – we do perform a shock test and perform cash flow analysis for the share insurance fund.  These are both reviewed by the investment committee on at least a quarterly basis.  The investment committee looks at the monthly cash flow projections for the upcoming 12 months as part of this regular analysis.  That concludes my answer, sir.

Board Member Hood: Great.  Thank you, Eugene.  I would just say that as I consider our investment strategy, we should note that examining portfolios and managing investments in the portfolio are two separate and distinct skillsets.  The NCUA today has over $20 billion, with a capital B, in investments under management; so I think we should have an even greater focus on this during our upcoming Share Insurance Fund updates.

 

 

 

 

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The Past as Prologue & Interest Rate Cycles

Tomorrow the Federal Reserve will announce an increase in its overnight Fed Funds target rate by at least 50 basis points.   This will be the second in a series of raises  to “normalize” the yield curve.  The goal is to curb inflation by increasing rates so that the “real” cost of borrowing exceeds the rate of inflation.

Bond prices have anticipated some of this increase.  Headlines reported the “rout” in bonds as market values fell and yields rose in the first quarter.  Yesterday’s lead story in the WSJ was “Bond Yield Rise Steepest since ’09.”

Interest rate cycle increases are not new.  In 1994 Fed Chairman Greenspan raised overnight rates from 3% to 6% in six 50 basis point jumps to cool an Internet driven economy.

Even though interest rate cycles are an ever-present factor in a market economy, for some leaders of credit unions this will be their first time navigating a cycle.  Learning from past events, can help with this process.

“Never say Never”

In late 1978, the US economy was entering a period of increasing inflation with short term rates rising close to 10%.   This increase was leading to some disintermediation to the newly created money market mutual funds.  But another credit union concern was the 12% usury ceiling on loan rates which was incorporated in most enabling statues.

In our discussions at the Illinois Department of Financial Institutions, I told Ed Callahan that 12% was like a law of nature.  Rates would never get above that level as we had fifty years of precedent to prove my point.  Ed’s response was “never say never.”

Short term rates went above 14% in December of 1979, by which time the Illinois Credit Union Act had been re-codified to remove the 12% ceiling. “Never” had taken place.

A Visit to NCUA by the ICU Funds

Short term and long-term rates continued to spike into 1980.  Chairman Volcker was committed to stopping the double-digit inflation resulting in short term rates of nearly 20% in June of 1981.

In early 1982, I had a visit from two senior executives from Madison to discuss the circumstances this had created for the two ICU investment  funds managed by CUNA Mutual.  Examination and supervision policy fell under the Office of Programs which I held.

I can’t recall all the details. The two funds had investments from several thousand credit unions, many of whom were small.  The market value of the two funds had declined dramatically.   The question they asked, would NCUA force the credit unions take a loss by writing down their investments to the current  market value?

They had taken steps to minimize withdrawals and believed that the decline would prove temporary.

I discussed the request with Ed who was now chairman of NCUA and Bucky the General Counsel.   There were many issues confronting the agency and credit unions.  A number of large credit unions had invested in GNMA 8’s, that were far underwater.  Their solvency was in questions and 208 NCUSIF guarantees were keeping some of them operating.  Shares were leaving credit unions as members withdrew funds for the double-digit yields offered by mutual funds.

Federal credit union share rates had not been deregulated as we had been able to do for Illinois credit unions. Jim Williams President of CUNA told Ed before his February 1982 speech to CUNA’s Governmental Affairs Conference that credit unions had only one issue on their minds, “survival.”

As we looked at the situation I can remember Ed’s comment in response to whether NCUA would require a write down of the ICU investments.  His words: “Leave it alone.”  Credit unions and the agency had more than enough concerns without adding to the moment.  Interest rates will change and today’s circumstances will not be tomorrow’s.

The ICU funds did recover their value.  By then the corporate credit unions had evolved into an option where they could meet the investment needs of credit unions. The ICU funds were eventually closed later in the decade.

Bernanke’s Taper Tantrum

 

In 2013 Fed Chairman Ben Bernanke announced that the central bank would begin pulling back its stimulus efforts by reducing bond purchases.  As summarized in a CNBC article in June:

Mr. Bernanke continued the theme into his press conference, stating again that if economic conditions continue to improve, the Fed will begin tapering its bond purchases at the end of the year.

He did put a little more flesh on the bond tapering plan: “may gradually reduce purchases later this year…will continue to reduce purchases through next year…may end in the middle of next year…will end purchases when unemployment is near seven percent.”

But time and again he emphasized the pace was data dependent: if conditions improve faster than expected, reduction in bond purchases can accelerate. If conditions worsen, purchases could even increase.

Why is the bond market over-reacting? Because they believe diminished tapering means higher yields. I agree, but to what extent?

NCUA Reacts

The taper tantrum carried over into the broader market as yields rose, bond prices fell.  The NCUA took up the issue. It imposed its internal interest rate shock and NEV tests on credit unions believing that this event presaged an ever-increasing interest rate cycle.

NCUA examiners created DOR’s on credit unions from by their models.  They required the sale of longer-term fixed rate loans and investments at a loss and borrowings from the FHLB, when the cash was unneeded, in order to comply with the model’s forecasts.

Tomorrow I will share one credit union’s story of how these modeling-induced DOR’s resulted in a loss of over $10 million.   The model’s assumptions were wrong.

This precedent is important because, unlike 2013 and 2014, inflation is here and the Fed is committed to raising rates until the trend is reversed.

The issue is whether NCUA will allow credit unions to manage their transitions through this cycle using their experience and operational options, or impose their modeling judgments on them?

 

 

 

 

 

 

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What Are Credit Unions to do When NCUA Messes Up?

Many NCUA management actions have limited direct impact on credit unions.  But when mistakes are made in a critical system component, the NCUSIF,  they can cost credit unions dearly.

The NCUSIF’s sole source of revenue is the earnings on its $20.5 billion investment portfolio of government securities.

The objectives of the NCUSIF’s current investment policy are clear:

The investment objectives of the NCUSIF are:

  1. To meet liquidity needs resulting from the operations of the Fund; and
  2. To invest, on a daily basis, any excess cash in authorized Treasury investments seeking to maximize yield.

The Investment Committee has fallen increasingly short of these objectives for at least the past 15 months. Results  have been contrary to these clearly stated goals.

The Numbers: $10 billion in New Investments in Two Years

At December 2019, the NCUSIF’s portfolio size was $16.02 billion of which $5 billion matured in two years or less.   At February 2022, the portfolio had increased to $20.5 billion.

Since  interest rates declined to historic lows in March 2020 at the start of the national economic shutdown, the NCUSIF has invested more than $10 billion ( 50% of its current portfolio) following a robotic 7-year ladder.

Today these $10 billion investments are worth less than par.  They cannot be sold without incurring market losses constraining the NCUSIF’s liquidity options as stated in objective 1.

At February 2022, the portfolio reports a total unrealized market loss of $343 million, a decline in value of over $ 800 million since December 2020.   The current unrealized loss will increase as rates  rise.  These declines since December 2020, easy to  see from the monthly market value disclosure. They also indicate that the portfolio’s yield is increasingly  falling behind market rates.

A $45 Million Dollar Mistake and Still Growing

The most recent investment of $650 million on February 15, 2022 for seven years at a fixed yield of 2.01% continues this mismanagement in the face of unanimous market indicators and Fed statements pointing to rising rates.

Today the seven year T-Note is near 3% yield.   Not only is this investment from just 60 days earlier worth less than par, the loss of income over the seven-year term is currently over $45 million. That is 1% (or higher yield pickup) times $650 million times seven years.

Credit unions and their members will pay the cost for these and other misjudgments that have resulted in at least half of the NCUSIF’s portfolio below market.  With a 3.5 year effective price duration, the portfolio will continue to decline in value by 3.5% for every 1% increase in the yield curve going forward.

The NCUSIF Investment Committee

The Board’s Policy delegates the implementation of the its two policy objectives to four of the agency’s most senior staff including:

Director of Office of Examination and Insurance, Chair

Chief Financial Officer

Director, Division of Capital and Credit Markets

Chief Economist

One would have hoped given the first quarter’s “Rout in the Bond Market” (WSJ headline), the continued inflation projections, the Federal Reserve’s frequent announcements of policy change, that someone would have called a timeout on this robotic investing ladder. The declines in market value are in plain sight; but more critical are  increasing constraints on future income possibilities, objective 2.

What Can Credit Unions Do?

The reason for monthly NCUSIF financial disclosures is so the fund’s owners who rely on NCUA management, can see the results and raise concerns with the board.

Credit union’s first responsibility is to speak up.  Directly communicate your views of this performance failure.  For your members will pay the cost of these misjudgments ($45 million and higher) potentially for years.

The reported results fall way short of policy.  What will the board do?   The committee seems unable to follow market trends, its own NEV data or internal IRR analysis (if any), or even to be aware of different portfolio options.

In public board meetings, staff is dismissive of change calling alternatives “market timing” when in fact the real issue is simply “investment management.” This is a responsibility every credit union is expected to perform in all phases of the interest rate cycle.

Assuming the board is incapable of monitoring and implementing its stated policy, then Congress is the next recourse.

The Damage to NCUA and the System’s Reputation

 

When NCUA and senior employees are oblivious to market trends, the situation raises questions about competency in many other areas of operational assessments and regulatory approvals.

Supervision requires judgments.  Policies nor rules can prescribe detailed actions. Ratio calculations can be written down but determining the correct numbers entails seasoned analysis.

The economy is in an inflationary period which some say has not been experienced for 40 years.  The Federal reserve’s balance sheet and its increase in money supply has never been larger.   Short term overnight rates are priced in forward markets as high as 3% in a year’s time.

There will be significant adjustments as credit unions transition their balance sheets to the new environment and as member’s see rising rate options.

There will be lots of hyperbolic forecasts and many forebodings in forthcoming months. After all, “preaching negativity makes you an expert” as one colleague used to say.

But credit union’s track record in the most extreme crises has been one of patient, experienced adjustments even when markets seemed to have lost all logic.

As NCUA’s enters this new cycle of interest rates, will its ability to make reasoned adjustments match credit union’s own track record?  This initial response in the comparatively simple management of a treasury portfolio, with just two clear policy goals, is not encouraging.

Can the agency learn from its own misjudgments?

 

 

 

 

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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.