Category: NCUA

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.

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?

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.

The official word from NCUA: