Chip Filson
The basis for a shared cooperative regulatory policy framework:
“The relationship between credit unions and the regulatory agency is one founded on mutual self-respect, and on the realization that both sides share equally in the responsibility for the survival and future development of credit unions.”
(NCUA 1984 Annual Report, Page 14)
Yesterday (August 29) a press release from the North Dakota Credit Union League described NCUA’s turning a deaf ear to their request for their credit union members’ $10 million pro rata share of US Central’s AME surplus.
The final total may actually exceed $12.7 million based on NCUA’s March 2022 AME projected US Central distributions.
The NCUA’s Claim receipt states: Upon final liquidation of the USC liquidation estate, this claim receipt will enable you to share in the net proceeds, if any, to the extent of your PIC and MCA balances as of the record date. No further action is required on your part to file or activate a liquidation claim.
The Dakota League’s title says it all: Time for NCUA to Do the Right Thing. Its release points out Iowa credit unions are in the same situation. One might also ask how are all the corporate member shares of credit unions who were merged before AME payouts began being distributed? (example, Constitution Corporate)
Moreover, all credit unions are still waiting for an update on the remaining $451 million of the reported $846 AME surpluses as of March 31, 2022.
These are just the most recent examples in which NCUA seems indifferent to its responsibilities to put credit unions and their members’ interests first. This “me-first” approach is not lost on credit unions’ own activities.
Lacking a cooperative policy framework, NCUA claims it is powerless when obvious conflicts of interest and direct subordination of fiduciary responsibilities by boards occur. The members’ best interests becomes a forgotten standard.
For example, consultants overtly market “change of control” clauses for CEO’ contracts, a perverse interpretation of its real intent since coop CEO’s are the ones who initiate their own mergers. The most recent example is a $750,000 payment in the merger of Global Credit Union. CEO contracts are a board responsibility.
A CEO and chair transferred $10 million of member equity to a private foundation they alone created upon merging. The foundation is to be financed by another $2.5 million from the ongoing credit union-a clear conflict of interest. NCUA routinely approved this diversion of members’ equity to private party’s control.
Without a cooperative policy framework, the NCUA’s only test of a credit union’s sustainability is financial. This is the “safety and soundness” mantra.
That standard is similar to saying that a person’s character and contribution is measured solely by their wealth. That is the value-agnostic success criteria that animates much of the capitalist system.
This policy vacuum undermines the unique advantages of the cooperative model and its long term safety and soundness. Members become customers with profitability profiles. A credit union’s resilience is nothing more than a quarterly tracking of net worth trends.
Soundness requires continual investments in members’ best interest, not merely fulfilling management’s personal ambitions. A regulatory framework for cooperatives should be a collaborative effort. It is not an NCUA internal task responsibility alone, like a budget, to be put out for comment.
Policy would address current operational issues that threaten the system’s character and integrity. It will entail provocative conservations about current topics such as:
One outcome might even be a cooperative scorecard which would assess each credit union’s use of their charter’s unique abilities.
A policy framework does not mean all the resulting regulatory judgments or approvals will be uniform. A regulatory framework should encourage better decisions supported by objective data as well as the cooperative and legal documented processes of fiduciary oversight and care. Conflicts of interest should be called out.
Experience suggests policy outcomes may be like the biblical parable of “weeds and wheat” grown together. That’s a risk but less so than the “anything goes” practices today.
Credit unions are and always will be a combination of good intentions and variable performance. They are run by human beings. Not all choices will be perfect. This mixed bag is the reality of freedom.
Both credit union leaders and regulators make mistakes. It is acknowledging when that happens. Then learning from the event, not defending the errors.
This mixed reality doesn’t mean regulators and credit unions can avoid the diligence and accountability that should characterize credit union decisions. It’s not okay for self-interest to be the dominant standard for an action.
All are free to make mistakes and sometimes fail, but that does not mean there are no standards to be followed.
Cooperative assessments are important for another reason. Credit unions, unlike their competitors, are not subject to the market’s daily judgments of management’s actions. Coops lack bank’s external check and balance on institutional performance whether through daily stock price fluctuations or the oversight of private ownership interests.
If cooperative standards are not part of the movement’s culture, then credit unions will tend to become just another financial option increasingly indistinct in a crowded marketplace. This will lead Congress to ask why this system should retain the tax exemption that would appear to be their only defining advantage.
The cooperative framework should enhance the never-ending task of credit unions becoming better cooperatives. Nobody is perfect. But reducing regulatory oversight to a standard that says 7% versus 14% net worth is better at meeting members’ needs is shallow and unhelpful.
In 1984 the credit union system redesigned its share insurance fund following 18 months of study, comment, and public dialogue about future options. The recommended changes then required congressional approval.
This success was the product of extensive collaboration and interaction at every level of the credit union system. This effort was described in this brief introduction of NCUA’s implementation video by then chairman, Ed Callahan:
(https://www.youtube.com/watch?v=YjD0y6WRzOo)
A cooperative policy process should be collaborative, transparent and yes, controversial. It should be democratic, public and seek consensus on shared interests. Policy must encourage credit unions as communities of possibilities, not conformity.
Without this policy framework, continuing examples of a “race to the bottom” business practices may put all credit unions on a path similar to the S&L industry with no turning back.
That does not mean credit unions (taxed or not) will disappear. But it does suggest their separate regulatory apparatus will be absorbed by the FDIC, OCC and the FED. This is where the 602 institutions and $1.5 trillion savings industry is now regulated.
Why have a separate NCUA cooperative regulatory system if all it does is mimic the banking model?
It is an accepted truism for NCUA board members presenting their credentials for Senate confirmation, or whenever the agency is justifying a new rule, reg or policy, to state their ultimate goal is “to protect the insurance fund.”
Current board members have even called that objective their goal or North Star. Their primary job.
This assertion turns upside down the logic of means and ends.
NCUA’s primary responsibility, its purpose, is encouraging and sustaining the resilience and integrity of a cooperative financial system for American consumers. The FCU Act states:
The term Federal credit union means a cooperative association organized in accordance with the provisions of this chapter for the purpose of promoting thrift among its members and creating a source of credit for provident and productive purposes
To achieve this end, NCUA was given multiple means in the law: chartering, examinations, supervision, administration of charter changes, issuing regulations and providing expert guidance. The tool least used, as it is rarely needed, is calling upon NCUSIF.
Most importantly, the FCU act specifically states the NCUSIF’s financial solvency is protected by the full faith and credit of the credit union system. All members must deposit and maintain 1 cent of each share dollar in a credit union with the NCUSIF. Every member is part of this collective guarantee ensuring all other member shares are indeed safe. This is a cooperative movement commitment, unique to the NCUSIF. It is the law.
If all of NCUA’s every day tools ( the other “means”) are effectively managed, then the members should never be called upon to provide additional resources. That is how NCUA protects the Fund.
The first four-decades of regulatory responsibility to maintain cooperative system integrity from 1934-1971 did not require the share insurance tool.
One aspect of “integrity” was certainly promoting credit union solvency as there has always been reserving and net worth requirements in the law.
But just as important, system “integrity” (as a source of credit) also included vital cooperative components to provide a distinct financial alternative for members. These include democratic governance, values such as education and collaboration, volunteer leadership (unpaid directors and committee members), access for all Americans regardless of financial circumstance (capital), focus on community (common bond), and contrary to the capitalist model, building common wealth versus private equity, to be used by future generations .
Over time additional characteristics have been developed including interdependence (corporates and CUSO’s) and system support augmenting the critical initial role of sponsors.
When Congress approved the NCUSIF for credit unions in 1971, it was a reward for their performance. As stated at that time, insurance was not due to financial problems with credit unions or the cooperative system. Rather it recognized their growing contribution to the American economy and that they might not perceived by the public as the equal of their FSLIC/FDIC alternatives.
For NCUA to faithfully fulfill its mission to protect the integrity of this cooperative financial alternative, an appropriate regulatory policy framework is necessary. Such a framework should be nonpartisan and multi-administration. Past examples are the deregulation of shares by NCUA or the redesign of the NCUSIF.
Without a thoughtful and evolving framework, NCUA becomes a mishmash of regulatory justifications or each Chairman’s personal priorities. What do the banking regulators do? Or let the “free market” work its will. Or elevating suboptimal tasks and agency operations to define priorities.
Absent a policy framework, the unique role of cooperatives becomes increasingly confused with all the other financial activity in the marketplace. No longer are the well-being and rights of member-owners front and center. Bright shiny objects such as innovation and new technologies take center stage.
The ambitions of managers and boards seeking to outgrow their for-profit competitors become the industry’s defining priority. Some credit union leaders chart success not by developing a better alternative to attract members, but rather using their decades of member reserves for buying out bank owners at a premium.
That activity would certainly seem contrary to the spirit of the Act. And therefore worthy of public debate.
Credit union CEO’s, nearing retirement, game the system for personal enrichment “selling their credit union” via merger. They capitalize on the transfer of members’ accumulated wealth and loyalty for additional bonuses and extended payments beyond those merited as CEO.
In these transactions, the financial and relationship legacy, its goodwill, is turned over to boards and CEO’s with no prior connection. And justified only with vague future promises that bigger is better. The unique character of the charter and its local legacy and traditional focus are eliminated.
Tomorrow Part II, developing a policy framework.
In the Gettysburg Address Lincoln summarized the ever-present challenge of keeping alive the spirit of a revolution’s original intent.
Dr. Eva Braun’s essay describes Lincoln’s grasp of the declining motivation of later followers in his Gettysburg speech:
From Dr. Braun’s analysis: Lincoln begins, “Four score and seven years ago.” “Four score,” With its long oh’s, sounds a more mournful, solemn note than could the words “eighty-seven years,” but the choice of the phrase is not only a matter of sound; it also carries a special meaning. It is the language of the Bible, as in Psalm 90:10:
The days of our years are threescore years and ten; and if by reason of strength they be fourscore years, yet is their strength labour and sorrow; for it is soon cut off, and we fly away.
With the psalm in mind the phrase implies: just beyond the memory of anyone now alive, too long ago for living memory.
Now, we know that from youth on Lincoln was concerned with a peculiarly American danger: the death of sound political passion. In his speech on “The Perpetuation of our Political Institutions,” of 1838, Lincoln drew a clear parallel with the early community of Christians, whose danger lay in the fact that the generation of disciples and eye-witnesses had been followed by a second generation which had only heard by word of mouth, by a third which had only read of Christ, and by a fourth which had begun to forget.
So in the American community; the scenes of the revolution, he said, “cannot be so universally known, nor so vividly felt, as they were by the generation just gone to rest.” The men who had seen the Revolution, who were its “living history” are now gone.
Remembering the contributions of earlier credit union founders is vital. Last week Jim Blaine described the legacy of Ralph Swoboda. As CUNA General Counsel and then President, he helped transform the movement through two system-wide challenges: business modernization and deregulation.
While leading NCUA in the early 1980’s, Ed Callahan and Bucky Sebastian in their presentations promoting deregulation would cite the original practice of common bond going back to the early years of state chartering. They pointed out that some of the first fields of membership were often city-wide. The intent was to be inclusive, not limiting, for those who sought a cooperative financial choice.
But this reference to the spirit of the cooperative founders, where purpose surmounted existential challenges, can dissipate as the “living history” passes on.
We cannot resurrect those who have left the playing field. But we can certainly rekindle passion for member advocacy in all its cooperative possibilities. And in the process keep the “movement” alive.
When a motivated popular movement aligns itself with another cause to promote its agenda, the hybrid effort can pervert its primary purpose.
An example is the tying of Christian nationalism with white nationalism. Christianity becomes less about faith and more about political power.
A parallel confluence of activity is occurring in credit unions. Since the imposition of PCA in 1998 through the Credit Union Membership Access Act, NCUA has increasingly equated credit union oversight with banking practice.
The latest effort is the imposition of RBC/CCULR completely incorporating the full bank regulation in its rule. This embrace of banking models, a frequent standard cited by Chairman Harper, also includes the promotion of external capital. It neglects the unique capabilities of cooperative design.
Collaborative institutions include the CLF and NCUSIF, both under NCUA management. CLF’s role is moribund. As for the NCUSIF, NCUA has converted the insurer into an open-ended funding draw for the agency’s daily operations.
Another example of cooperative diminution is NCUA’s lockdown of the corporate network, especially its services for smaller credit unions.
Credit unions have read the regulatory signals. “Treat us like banks, and we will follow that industry’s lead.” Mergers, not collaboration, become a priority growth strategy. Bank purchases, paying premiums to bank owners with credit union member capital, is promoted as an immediate expansion opportunity. In other words, “If we can’t beat ‘em, let’s just buy ‘em.”
The regulators are silent. As long as credit unions’ financials mirror bank’s, everything is OK. Mergers, bank purchases and novel (SPAC) growth tactics are just the free market at work. Even when a CEO and Chair transfer $10 million of members’ funds to their control following a merger.
Let me be clear that these are not the actions of the majority of credit unions, but they dominate the headlines.
The credit union system’s unique capacities are simplified to safety and soundness, defined by ROA and net worth with a dollop of growth thrown in. Purpose becomes dressed as creative public relations campaigns and promotional branding efforts.
An example of this waywardness is VyStar Credit Union. A member forwarded their most recent assessment of its recent flawed digital channel conversion:
In regards to VyStar, we have decided to move our account to another credit union.
Facebook posts (https://www.facebook.com/VyStarCU) have certainly slowed down. I do not know if it is due to apathy or is X number of people who have just gone to other financial institutions.
Login online has greatly improved. There is little to no wait time.
They updated the mobile app on June 26th. Many people had difficulty getting on the app, especially the android version.
Getting a hold of someone in customer service is very difficult at best. Very long wait times on the phone (in excess of two hours). You can log into chat, I had almost an hour wait the other day. While they have now added internal transfers, you still cannot do member to member (linked account) transfers (like to other family members). You can only transfer funds internally within your savings, checking, MMA, etc.
You still cannot see any account history prior to 05/13/2020 which was the day they shut down the system they used prior to the current one.
You no longer get copies of your checks written online as before.
I see no “Improvements” or new features in the new system whatsoever. The new bill pay is cumbersome and not user friendly. I filled in the bill payees into our new credit union with ease, it is almost exactly what we used to have at VyStar before this poor unsatisfactory installation.
Lastly, and most disappointingly, is the fact that the CEO has still not addressed the members directly. I know of no statement to the press since about May 23rd.
I have no idea how many members have left and I am not sure we will ever know. I hate leaving but, I have lost faith in them.
The fundamental flaw in VyStar’s strategy is not a bungled conversion. Many conversions have temporary problems. Rather it is VyStar’s strategy that credit union membership is a one-way street. Members just transact and are viewed as customers, not owners. There is no respect for members’ “faith” which is the primary foundation for any credit union’s long-term success.
A two-way street means the owner’s role is understood, honored and continually enhanced. The primary means is seeking to expand the multiple ways value is created for members, especially those who have the least or know the least.
The credit union model is foremost an advocate for members’ well-being. That was the original intent.
The vibe at VyStar is all about the institution and its size. This is a sentence from an April 2022 merger announcement before the digital debacle: VyStar, which has more than 800,000 members and over $12 billion in assets, will remain the 14th-largest credit union in the country by asset size.
When the member relationship is always front and center, the owners return much more than transactions. They give their loyalty, patience when necessary, and word of mouth endorsements with friends and family.
That was how the credit union movement achieved their current $2.3 trillion position while serving the fourth or fifth generation of members. Members’ contributions are paid forward to benefit future members.
For the founding members’ spirit of purpose to prevail, it must be constantly renewed in the words and actions of those leading cooperative charters now.
While NCUA’s $350 million annual budget is the primary Board item, that is not the most important financial issue. For there is unfinished business stretching back over a decade. The agency owes credit unions an amount that is 250% greater than the budget it will be discussing.
Here’s the details.
In March 2009 NCUA Board member Rodney Hood along with Chair Michael Fryzel and member Gigi Hyland voted to conserve US Central Credit Union and WesCorp, the two largest corporate credit unions.
My hunch is that board member Hood never expected to be overseeing the continued distribution of US Central’s almost $2.0 billion surplus thirteen years later during a second term on the Board.
As of the March 2022 AME financial reports for the five liquidated corporates, NCUA projects over $846 million is remaining to be paid. The majority, $556 million, is from US Central’s estate.
When completed total AME payments to credit union member shareholders will exceed $3.2 billion. As a comparison, the total capital of the eleven active corporates at December 2021 was only $2.5 billion.
Put bluntly, the collective funds returned by the four liquidated corporates is 132% great than all the equity in corporates active today. Closing these solvent corporates was a catastrophic error in judgment!
The March 2022 AME financials presents the total forecasted payments to the four corporate’s members and the remaining amounts due.
US Central: $1.832 billion with $ 556 million due
Mbrs United: $ 622 million with $130 million due
Southwest: $ 613 million with $127 million due
Constitution: $ 48 million with $ 32 million due
There are no payments for the $1.1 billion of credit union member capital at WesCorp. NCUA projects a WesCorp deficit after all recoveries at $2.1 billion. This is the only loss to the NCUSIF from the five corporate liquidations. (from line B4-Due to Government March 2022 AME financials)
The above amounts do not include the $2.563 billion added to the NCUSIF when the TCCUSF surplus was merged on October 1, 2017. Adding this amount brings total recoveries to almost $5.8 billion.
This surplus continues to point the need for an objective review of the entire corporate resolution effort.
When US Central was seized in March of 2009 NCUA Chair Fryzel was quoted in a Wall Street Journal March 21 article: “With us in control, we’d get honest numbers.”
If subsequent events have shown anything, it is that “honest” numbers in an environment of uncertainty depends on who does the accounting. Especially when the underlying process relies on valuation models that claim to project the economic climate and related cash flows years or even a decade into the future.
The problem is not the models or their incorrect assumptions, both of which were wrong. The error is that predictions should not be the primary basis for resolution strategy. All models are wrong; some are useful.
The required response is managing the daily dynamics as markets change. Trying to predict the future as the basis for today’s tactics led to disastrous decisions in NCUA’s assessment of the corporate assets.
With NCUA’s ALM/NEV supervisory tests becoming more prominent in today’s rising rate environment, the limitations of financial modeling is a much needed lesson to bear in mind.
But a look back is important for another reason. Still today NCUA Chair Harper and senior staff use the apocalyptic estimates and conjectures thrown out in 2009 as NCUA projected future events. The hyperbolic forecasts were incorrect then; it is double injury to repeat them today when the actual facts are known.
In the same WSJ article above, Chairman Fryzel was quoted: “regulators aren’t concerned about the health of any other wholesale credit unions besides the two brought into conservatorship.” Yet just a year later when no longer chair, member Fryzel supported the liquidation of three more corporates, a decision that was devastating for the system and individual corporates. Both Southwest and Members United are paying liquidating dividends on top of returning all their members’ capital shares.
By forecasting disaster, NCUA took unilateral action without any industry involvement except paying the bills. There was no check and balance, no transparency and no alternative solutions developed.
Unfortunately, that unilateral regulatory mindset continues today. It undercuts the unique cooperative advantage of collaboration represented in the common credit union funded resources in the NCUSIF and CLF for individual turnarounds.
The most important takeaway from the corporate debacle is not estimation failures or the value of patience when resolving problems. Rather it is NCUA’s failure to understand the unique cooperative capabilities when developing regulatory work out plans.
That lesson should include respect for the institutions in difficulty and a willingness to work together for solutions versus liquidating problems to make them go away.
The one board member who is best positioned to state the importance of this learning opportunity is Rodney Hood. He was there at the Alpha and now hopefully, the Omega.
His counsel should be heard. And credit unions should get their funds back ASAP. Enough delays!
PS: I hope a board member will ask what the additional $10 million in liquidation expenses paid (outside the NCUA budget) in the first quarter from the AME recoveries was used for.
This coming Thursday the NCUA board will review the agency’s midyear budget. To do so thoughtfully, it is useful to put the operating budget’s long term and recent trends in perspective.
Below is a summary of the growth rate of NCUA’s operating fund budget from 1999-2001. The first column shows the compound annual growth (CAGR) for the entire period; the second column for the most recent five years. Note the annual growth rate is per year.
Annual Growth of NCUA’s Operating Fund Expenses (1999-2021)
| Account | CAGR’99-’21 | CAGR ’16-’21 |
| Beginning Cash Balance $MN | 11.47% | 22.43% |
| Operating Fee Receipts $MN | 4.27% | 8.97% |
| Operating Expenses $MN | 3.66% | 9.48% |
| Net Fund Bal at Yearend $MN | 16.92% | 26.01% |
| Ending Cash Balance $MN | 12.32% | 21.33% |
During these 22 years, NCUA has transferred ever higher amounts of its operating expenses to the insurance fund. This is via the Overhead Transfer Rate (OTR) process. That rate of expense allocation has been as low as 52% in 2008 and as high as 73.1% in 2016. Currently it is 62.7% an increase from 2021.
This overhead transfer has exceeded 50% even though state charters have always had fewer than 50% of total insured shares this entire time. NCUA is subsidizing its regulation of federal charters by shifting costs onto state credit unions.
Following this arbitrary, open-ended expense transfer however, operating expenses still increased 3.66% annually or faster than inflation for the entire period. Most recently in the five years 2016-2021 this annual growth accelerated to 9.84 % or three times faster than the overall 22 year average.
NCUA invented inflation five years before the rest of the economy could catch up.
After this OTR allocation, the Operating Fee charged to FCU’s exceeded actual operating expenses by an average of 104.5% for this entire period– some years more than 100% and others less. Since 2015 however, the NCUA’s the operating fee collected has exceeded actual expenses every year.
The result of these excess fees is that yearend cash on hand has grown from $13 million to $129.6 million (or ten times-1000% ) in this 22 year period. During these same years, while annual expenses grew by just 3.6%, NCUA grew cash balances at 12.3%, or four times as fast.
The 2021 year end cash balance of $129 million was 110% more than that year’s total expenses, and double the 46% average for the entire period.
NCUA held cash balances for the first 16 years of this analysis between 30-40% of the actual expenditures. Since 2016 NCUA has retained more and more credit union funds. Yet there has been no change in either the agency’s ability to assess its fee or in its operations to require this ever growing cash and fund balance.
As of end of May, cash balances are $191.8 million slightly higher than 12 months earlier. Operating expenses for the first five months are $48.3 million exactly the same as the prior year.
The net fund balance (equity) is at an all-time high of $141.3 million for this time of year. In 1999 the net fund balance was just $6 million. The numbers and trends suggest that $75 million or more of this excess cash could be returned to credit unions and NCUA still have more than enough to cover all operating expense.
American author Edward Abbey observed: “Growth for the sake of growth is the ideology of the cancer cell.”
This Thursday if expenses lag budget, the NCUA’s habit is to repurpose unspent funds and/or approve new positions not in the original budget.
Normal business practice would be to reduce the budget, not find new ways to spend a surplus.
How will the board view this ever-growing cash hoard? The traditional government mindset is to spend all the money on hand, whether that is necessary or effective. Staff is always fearful that if money is left over, it will justify reducing the budget request for the following year.
Chairman Harper has been very public in of his ambition to grow staff, the NCUSIF and the budget at every opportunity.
Will the rest of the board go along with this six-year pattern of uncontrolled operating expenses and buildup of excess cash? Or will they stop the spread of NCUA’s operating fund cancer?
After all this is the members’ money.
NCUA’s open board meeting In May had only one agenda item, the quarterly staff update on the NCUSIF.
This was an opportunity to focus on many topics that have swirled around the management of the Fund over the past year. These include:
The NCUSIF’s $22 billion is its largest asset . The fund’s unique cooperative design means credit unions have a direct financial stake in its performance. Credit unions should receive a dividend in years of strong performance and pay a premium in the event of mismanagement or a catastrophic loss.
As noted by Vice Chair Hauptman in the meeting: it’s a mutual asset of the credit union movement and NCUA. . . it’s worth reminding everybody that every dollar of that one percent contribution belongs to credit union members and no other. NCUA has the obligation to credit unions and their members to manage that fund prudently and effectively.
Board member Hood reiterated: The 1% capital deposit which comprises most of the Share Insurance Fund’s equity is also an asset of the credit union. We should never forget this.
I would add that the unique coop design intended the 1% deposit be an earning asset for credit unions.
As reported by CNBS: Minutes from the Fed’s June meeting, which were released Wednesday, revealed that the central bank is prepared to use even more restrictive measures to tame surging inflation. They indicated that July’s meeting would bring another rate hike of up to 75 basis points, and acknowledged that the economy could suffer a slowdown.
“Participants concurred that the economic outlook warranted moving to a restrictive stance of policy, and they recognized the possibility that an even more restrictive stance could be appropriate if elevated inflation pressures were to persist,” the minutes said. Treasury yields, meanwhile, continued to rise.”
This is not new news. Since October 2021 the Fed has indicated that it would change its accommodative monetary policy in response to signs of growing inflation. That intent became explicit in December with forecasts of interest rate hikes from the historically low levels engineered in 2020 to respond to the Covid economic shutdown.
The market’s response was swift. Through this year’s second quarter, bond fund valuations have fallen almost 20% in market value. The NCUSIF has gone from a market gain of over $500 million in 2020 to a market valuation loss of $1.1 billion as of the April 2022 NCUSIF report.
The staff’s response to this dramatic change in rates was provided in May’s presentation: Extend the investment portfolio further by going from a maximum term of 7 years to 10 years. Rick Mayfield, capital market specialist. stated this strategy would place approximately 10% of the portfolio in annual buckets over the 10 year range in a one to two year time frame.
The result would raise the average weighted duration from 3.5 years to almost 6 years—at a time when the overwhelming consensus and Fed intent is that rates will continue to rise.
The continuing decline in the NCUSIF’s market value in the past 18 months shows how far the portfolio is falling short of current rates. This below market return is lost revenue in the tens of millions of dollars. The continuing decline is a specific indicator of the portfolio’s performance gap from current market rates.
To mechanically continue investing in equal “buckets” over ten years is a failure of management.
This investment extension aligns with neither the current policy nor experienced investment judgment. No objective data or analysis was offered to support this extension to a 5-6 year duration.
Extending a portfolio does not automatically bring higher rates. Yield curves do not always slope upward.
As an example, when yield curves invert, that is the two year bond pays more than the 10 year, how does purchasing the lower return 10 year bond “maximize yield” per fund policy?
Managing the portfolio’s duration is the most critical function to match the liabilities for which the fund is responsible. These include paying operating expenses, growing retained earnings in line with insured shares, and if necessary, covering insurance losses. Those expense liabilities can be easily quantified and monitored monthly to align with investment earnings (yield) decisions.
For example, a 2% fund yield would generate $400+ million in revenue easily meeting the operating expense and projected equity growth goals. A 3% earnings rate should result in a dividend to the owners if insurance losses are at, or below, long term trends.
This is the integrated ALM/IRR management NCUA expects all credit unions to practice. This management responsibility is not a fixed formula followed routinely whatever the market conditions or future outlooks. Rather modeling tools, forecasts and judgment are used to align asset returns and the cost of liabilities as market events change.
Even more disappointing was the assertion by CFO Schied that the portfolio’s new extension to ten years would be initiated this quarter-despite the explicit forecast of further raises from the Federal Reserve.
“ . . .with respect to the investment portfolio and consistent with the existing board approved investment policy. the investment committee has decided last month to begin to extend the portfolio ladder out to 10 years. This is not reflected in today’s quarter one presentation because the decision to do so does not show up until quarter two which will be evident in my quarter two presentation as well as our monthly reporting that we post on the website going forward.”
Naively extending investments to “chase yield” is a common examiner criticism of poorly documented credit union investing. Such extensions may produce a short term income jolt but at significantly increased ALM/IRR risk.
Vice Chair Hauptman remarked: I can say as somebody who worked in fixed income markets for years you know there is no free lunch. We can get more income by taking more risk and in no other fashion.
There was no data presented to justify a decision to extend from 7 to 10 years in a rising rate environment, an action contradictory to traditional sound portfolio practice. This extension was also taken in the face of increasing market losses. This mechanical approach underperforms in the current interest rate environment.
Making a fixed rate 10-year investment in the face of inflation and other economic uncertainties, is extremely speculative. It severely limits management options for responding to market events and any changes in credit union insurance needs. It results in a fixed revenue cap for an even longer period than the current practice.
The result is that NCUA’s hands are tied responding to events during this extended average life of almost 6 years. The Fund becomes dependent on other sources for liquidity or revenue, a contradiction in the fund’s fundamental financial role.
This extension announcement doubles down even after the mounting evidence of NCUSIF investment management shortcomings. The investment policy referenced has not been updated since 2013. But most concerning is that there appears to be no ability to objectively evaluate investment practice.
In addition to presenting the current investment approach, CFO Schied’s projected the NCUSIF’s NOL to June 30, providing two interesting data disclosures.
The first is that he projects an operating loss of $68 million for the NCUSIF in the second (June) quarter versus a net income of $54.4 million in the March quarter. That is a $122 million reversal in operating results.
Since investment revenue more than offsets operating expenses, the only possible reason for such a reversal is insurance loss reserves. Yet all the CAMEL results are positive. There was no indication of any major unaddressed issues. So why this dismal forecast?
Secondly Schied also gave the agency’s 12-month insured share growth forecasts for 2022. Actual share growth was 9.3% for the March quarter. The projections are 7% growth at June 30, year over year; and only 4.3% for the full calendar 2022. A significant slowdown from the past two years.
The Agency’s mechanical NCUSIF investing in the face of dramatic rate changes and increasing portfolio devaluations was a disappointment. Extending the investment duration to almost six years (versus current 3.5 years), will only reduce the Fund’s flexibility responding to changing rates and future industry risk events.
Both Chair Harper and CFO Schied downplayed or even denied there was any real risk to extending the portfolio. Here is the Chairman’s summary observation:
The changes in the value of these(investment) assets were expected. That is because as interest rates go up the value of these bonds go down. I learned that in my finance 301 class back in college.
These unrealized losses fortunately do not impact the equity ratio and do not increase the likelihood of a premium just as unrealized gains do not increase the equity ratio. What the unrealized losses signal is a change in the interest rate environment. We are moving forward to address this issue. The NCUA is adjusting its investment strategy from a seven year ladder to a ten-year ladder. . .
This observation is incorrect in two respects:
The staff continues to present financial information following Federal GAAP that both confuses and misinforms readers about the actual state of the NCUSIF.
The federal presentation of the balance sheet shows that both the assets and Fund equity have fallen this year from yearend. That is because the decline in market value is is subtracted from both investment assets and the cumulative results of operations (equity) on both sides of the balance sheet. This understatement is $1.1 billion as of April 30 and increasing each month as portfolio valuations decline further.
To the user of this information, the NCUSIF appears to be reducing in size and value.
The accounting category, year to date retained earnings, is not reported under Federal GAAP. Calculating the Fund’s NOL trends requires this number. However it is not presented in the financial statements, but must be derived from the information presented.
Finally the issue of how the NOL is being calculated using numbers from two different accounting periods was again raised by Board Member Hood. He referenced the Cotton accounting firm’s review from 2021 and its reported description of several ways the 1% true up could be presented in the Fund’s yearend financial statements.
CFO Schied’s response to Hood’s query was:
We are reviewing and doing the due diligence over alternative approaches including that pro forma idea that you’ve mentioned in order to have a complete picture of the relative costs and benefits and to understand any potential hidden implications of any alternatives.
Because I’m not sure back then that they realized that the change was going to lead to the timing gap that we have today. I would look forward to updating you on these findings over the summer.
Credit unions will certainly be looking for this review!
Overall this single-topic open board meeting identified, but failed to resolve, these ongoing issues of NCUSIF investment management, fund financial presentation and more accurate NOL calculation.
(Editor’s note: Later updates corrected earlier spelling error of Vice Chair Hauptman’s name)
The new RBC/CCULR net worth rule is the most comprehensive, intrusive and costly regulation ever passed by NCUA.
The agency’s staff’s initial estimate of the funds now restricted from increasing member value is over $24 billion. From their December 2021 board presentation:
Under the CCULR, if all 473 credit unions opted into the CCULR and held the minimum nine percent net worth ratio required to be well capitalized, the total minimum net worth required is estimated at $111.8 billion, an increased capital requirement of $24.3 billion over the minimum required under the 2015 Final Rule.
This is a minimum 30% increase of capital, restricting its use for members, and imposed just nine days after the rule’s printing in the Federal register.
RBC/CCULR is both procedurally and substantively deeply flawed. Instead of implementing the legislative intent that PCA be applied to a limited number of “complex” credit unions, the regulation passed covers 85% of all credit union assets.
But what can be done especially as the NCUA board composed of different philosophies approved the rule 3-0?
The recent Supreme Court 6-3 ruling in the West Virginia v. EPA case suggests there is another opportunity to withdraw the rule or to challenge its validity.
The EPA case is about much more than regulating pollution. The 89 page opinion is here.
As summarized in a New York times article:
It . . . signals that the court’s newly expanded conservative majority is deeply skeptical of the power of administrative agencies to address major issues facing the nation and the planet.
Chief Justice Roberts, employing the phrase for the first time in a majority opinion, said it applied in cases of unusual significance and was meant to address “a particular and recurring problem: agencies asserting highly consequential power beyond what Congress could reasonably be understood to have granted.”
Another account of the decision in The Hill explains the broader significance of the Court’s reasoning:
In reaching its conclusion, the court relied on the controversial “major questions doctrine.” The major questions doctrine is a relatively new interpretative maxim that directs courts to presume that Congress does not intend to vest agencies with policymaking authority over questions of great economic and political significance.
Only Congress’s “clear statement” that it did intend to confer the claimed authority can overcome this presumption. When a court employs this maxim, it reads statutes narrowly, stripping the agency of the power to address the major question that the statute, on its face, gives the agency the authority to address.
Unsurprisingly, the main focus of the media, scholars and the public is on the consequences of the court’s move for the size and contours of the federal administrative state. . .
The impact of the court’s ruling on federal agency authority and power cannot be overstated.
A lawyer friend when asked, opined: “what I’ve read about it suggests the Court is going to take a very restrictive view when assessing agency claims of regulatory authority (effectively dispensing with Chevron deference). When the authority to regulate is clear, I have no idea how much discretion the agencies will be afforded when exercising that authority. I’m not sure what category the RBC rules fall into.”
The RBC/CCULR rule’s flaws include the following;
Credit unions can sue the agency for the substantive violations noted. But that takes years and the harm done members will just continue in the meantime.
The most feasible course of action will be for a more informed NCUA board, responsive to the needs of credit union members, to use this Supreme Court precedent to withdraw the rule entirely.
That will require leadership, courage and insight from current or future board members. The first test is to ask the sitting members their views on this deregulation opportunity.
What would Hood, Harper and Hauptmann say in response to this Supreme Court interpretation?
In December 2021 the NCUA Board passed a completely new regulation of over 500 pages to imposing a new RBC/CCULR net worth requirement. The rule took full effect on January 1, 2022, or just 9 days after posting in the Federal Register.
It instantly raised the minimum net worth ratio to be considered “well-capitalized” by 29% that is, from 7% to 9%.
All credit unions over $500 million in total assets were immediately placed under this new capital standard. As of March 31, 2022 these 701 credit unions manage 85% of the industry’s total assets, or $1.809 trillion.
Those subject credit unions with less than a 9% net worth ratio must comply with the Risk Based Capital (RBC) computation. It takes five pages of call report data to calculate this one ratio.
As of March 31, there were 193 credit unions with $345 billion in assets that reported less than 9% net worth. For them there is no CCULR off-ramp.
They are thrown into a financial, accounting and classification “wonder-land” of arbitrary ratios, regulatory accounting decisions and almost 100 distinct asset classifications.
Following the RBC requirements is a complicated mess.
For example, individual credit unions have at least four options for calculating the net worth ratio. They can use average daily assets for the quarter, or the average of the three-month end quarter balances, or the average of the current and preceding three quarter end balances, or the quarter end total.
NCUA doesn’t even try to present the industry’s total net worth in this multiple manner, just asserting that the 10.22% is the industry average even though many other calculations are authorized.
Depending on which denominator a credit union chooses to determine the ratio, the outcome may or may not be a net worth over 9%. Net worth comparisons become much less informative for members and the public without full disclosure of the methodology used.
Changes in the ratio, higher or lower, may reflect nothing more than different calculations, not actual soundness.
RBC’s Reach Goes Beyond the $500 million level. Another 123 credit unions with total assets between $400-$500 million are within range of the $500 million RBC/CCULR tripwire. 46 of these have net worth below 9% and hold 37% of this segment’s total assets of $55 billion.
(Data update: 324 CUs completed the RBC ratio, and reported a value on the 5300. 324 minus the 193 under 9% is a difference of 131. These completed the RBC ratio despite qualifying for CCULR, or they may have failed one of the tests.
This suggests credit unions want to know their requirements under either net worth option to make the optimum decisions about which to follow.)
The increase in regulatory net worth is a tax on asset growth. It requires resources be directed to reserves held idle on the balance sheet, instead of being used for investment in credit union products and services or higher returns on savings and lower fees.
Credit unions must choose to slow deposit and asset growth to build their net worth or increase their ROA by paying less or charging more. Whatever financial choice is made, the members will pay the cost for this additional capital.
This burden occurs at a time when members are coping with a rate of inflation not experienced in 40 years. Instead of serving members’ needs, credit unions must first serve the regulator which provided no factual basis for the rule.
The passage of the RBC/CCULR capital regulation met no objective safety and soundness need and contradicted the express language imposing PCA on credit unions under the Credit Union Membership Access Act in 1998.
When presenting the rule, NCUA staff stated their analysis of credit union failures for the past decade showed that this new requirement would have established a higher capital threshold for just one problem credit union over $500 million.
The last minute addition of the so called CCULR off ramp in 2021 was defended as a way to reduce the acknowledged new and enormous burden of RBC. Congress passed legislation permitting banking regulators this CCULR exception. That statue did not include NCUA or credit unions.
The fact that credit union CCULR has no Congressional authorization is just one of many improper steps NCUA took when imposing this regulatory monstrosity affecting every asset decision made by a credit union.
The regulation is the Fruit of a Poisonous Tree failing at least five explicit requirements of the PCA legislation and the Administrative Procedures Act.
So why didn’t credit unions sue? Why did two board members go along with this deeply flawed regulation and process to make the passage unanimous?
What options are now possible to overturn a regulation that injects the federal insurer into literally every specific balance sheet and asset decision made by credit unions?
Tomorrow a new approach to eliminate this rule, take away the burden, and return responsibility for the management of the credit unions to the members and their board and managers now appears possible.
Note: Additional details of this flawed regulation can be found in these articles.
https://chipfilson.com/2022/02/cculr-rbc-unconstrained-by-statute-an-arbitrary-regulatory-act/
https://chipfilson.com/2021/12/why-the-rbc-cculr-should-be-abandoned/
https://chipfilson.com/2022/02/cculr-rbc-unconstrained-by-statute-an-arbitrary-regulatory-act/
Net promoter scores. Five star yelp ratings. Uber driver feedback. Multiple processes measure customer satisfaction. Especially where consumers have a choice of service.
But there are few examples tracking the interactions between those exercising authority and the public subject to it. A most critical area for this need is law enforcement policing.
Warrenton Virginia is a small, traditional rural community of 10,000 residents, most of whom are republican. The community is conservative, wary of government and proud of its long local history.
It is one of the least likely towns to implement an innovative feedback process to manage the relations between the police and citizens. But since the George Floyd murder in 2020 every community has sought out methods to incentivize fair and ethical law enforcement.
Warrenton’s police department of 29 officers and three civilian employees is one of three early adopters of the Guardian Score system of monitoring policy and community interactions.
After every significant encounter with residents, officers are required to hand out their business card on the back of which is a QR code which asks for feedback on the interaction. The questions use a star-based system to rate officers on their communication, listening skills and fairness.
The feedback is anonymous. It can be given any time after the event. It provides the department another tool to evaluate performance beyond data on arrests, fines or other required interventions. It is similar to an Uber driver rating, yet the power dynamics are much different.
There have been 179 reviews so far in 2022. Guardian provides a score dashboard visible to the Chief. The officers’ overall rating is 4.94 out of five stars.
The Guardian Score effort is in the pilot phase. But the one-sided relationship between those in authority and citizens is not limited to policing. The credit union system and its regulators have experienced this imbalance which has been the subject of several recent articles.
As one writer summarized: Yes, (NCUA) has become an entity that has lost its way in helping small credit unions succeed. Or, They are Coming to Bayonet the Wounded.
NCUA Board member Hauptman has encouraged credit unions to record their meetings with examiners as one way to encourage open and honest interactions.
The Texas Credit Union Depart has conducted an annual “customer satisfaction survey” of its state charters for the past twenty five years. The department publishes the complete results and comparisons with earlier years. The latest report can be found here.
Neither approach enables the comprehensive and timely monitoring possible from the Guardian process.
There are times when NCUA and credit unions act as if they are not mutually dependent on each other’s success. The cooperative model is not the banking model in which shareholders try to maximize their independent ownership returns.
The coop system’s interdependence relies upon collaborative solutions among credit unions and with the regulator, especially when the relationship is working productively.
However there is no ongoing monitoring of the quality of examiner and regulatory interactions with credit unions. Public speeches and anecdotal news stories are insufficient and irregular.
The Guardian Score process is dynamic, easy to implement and can be tracked daily at both the regional and main office level. It is ready to go. It is inexpensive. The cost for Warrenton is $4,500 per year.
This feedback option would promote a better balance between examiners and credit unions under their oversight. It measures quickly the quality of the interactions that take place: listening, explaining and helpfulness.
Moreover it could be easily extended to other areas of regulatory interactions to monitor the responsiveness of agency personnel.
In Warrenton the initial worry was that negative reviews would affect performance evaluations. Of the 170 submissions, all have been positive. The program is even used to celebrate thoughtful interactions reported in the surveys.
Where to start? This initiative is an ideal one for NASCUS as an element in its state accreditation program. It would provide specific, continuous data on examiner effectiveness-a traditional advantage for state charters.
Innovation at the state level has been a hallmark of the dual chartering system. This is an opportunity to respond to a growing worry openly expressed by credit unions. It is a process to raise the quality of cooperative oversight and community trust.
Which state regulator will be the first to step up?