Category: NCUA

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GAO’s NCUSIF Study Omits the Most Important Data Point

The GAO  released a report in October analyzing the causes of credit union failures from 2010-2020.   The news stories and report lead with two facts:  145 credit unions caused $1.55 billion in losses to the NCUSIF in these eleven years.

The full report  took 16 months to complete and contains appendices full  of math correlations and sophisticated looking analysis.

However it omits the most important fact about these losses.  That is the NCUSIF’s 1.30 Normal Operating Level (NOL) is 93 times larger than the rate of insured losses for this period.  That is a critical actuarial finding.

The GAO failed to put its analysis in any context or perspective.  Any loss is too much.  All credit unions operate in a competitive market.  As noted by Ed Callahan when Chair of NCUA discussing deregulation, “Some credit unions will do better than others.”

The most important issue is the financial impact of losses on the NCUSIF and credit unions.   Using the GAO’s $1.55 bn total, this results in a loss rate on insured savings in this eleven-year period of 1.4 basis points.

The loss  trend is also declining as noted in the study.  Of this total, the report (page 13) says $831.7 million was from the failure of three taxi medallion credit unions in 2018.   That means the 142 remaining credit unions lost $718 million for a loss rate of only .65 of 1 basis point.

In the context of a $20 billion insured fund with total capital equal to 1.3% of insured savings, the fund is 200 times larger than the insured losses if the disruptive event of the taxi medallions is not included.  If counted, the fund as noted, is 93 times larger than the eleven-year  insured loss rate.

Reasons for Failures

Figure 7 on page 19 is a table labelled: Top Material Loss Review Causes or Contributors to Failure by Number of Times Mentioned.

This is the list of the six causes from most to less frequently cited:

  1. Credit Union Board or Committee Oversight
  2. Failure by NCUA examiners
  3. Weak or missing NCUA Guidance
  4. Fraud
  5. Management integrity
  6. Lack of timely and aggressive NCUA action

All of these six areas are why there is an examination of every insured credit union.  These “causes of failure” should be covered in every exam.

The report does not cite economic circumstances or external disruptive events, as in the taxi medallion credit unions, as reasons for losses.  The report began after the Great Recession with losses in 2010 when the economic recovery was well underway.

What the report makes clear is that NCUA’s exam program has much room for improvement.

At yesterday’s November board meeting, the CFO commented that the positive NCUSIF AME recoveries from prior loss estimates has continued into November.   So the net loss reserving expense for 2021 is, in effect, negative.   This means the two most recent NCUSIF loss ratios cited above should be even lower when this year’s results are added to this study’s total.

 

 

 

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Leading with Competence, Not Position or Authority

On January 7, 1984, NCUA Chairman Ed Callahan spoke to the Hawaii Credit Union League’s Political Action Conference.  This was the predecessor to today’s governmental affairs conference.

He opened by discussing deregulation a term he described as “overused and misunderstood.”  “I was not the inventor, but I gave it a good push.”

He then addressed why credit unions had been so uneasy, even fearful with this radical change that would apply to entire financial industry.  The fear was whether cooperatives could compete.  For on December 14, 1982, in a first step, all rates for all institution’s  money market accounts were removed.

He then presented the evidence. Growth in savings showed credit unions, whose liabilities (shares) had been totally deregulated in May 1982, had increased by double digits for three consecutive years, far ahead of the banking industry’s outcome.

The most important benefit of the change was that credit unions would make their own business decisions not government bureaucrats.  There was no more “follow the leader” putting all our “eggs in one basket.”  He also recognized “some will succeed more than others.”

The Rest of the Story

He then explained the additional changes necessary for this result to succeed.

The agency had approved a “more realistic common bond” which he believed would have the most lasting “real impact in the long run.”

He talked about the agency’s decentralization, putting resources into the field where they were most needed in order to conduct an annual exam program.   “We threw out the old cookbook and created a new exam process so we could be “problem solvers” if required.”

The agency needed to be “more efficient” using the resources provided by credit unions.  One example was “resource sharing” where the agency would compensate credit unions who would lend their personnel and knowhow to assist other credit unions experiencing difficulties.

Finishing the Job

He closed asking support for a new design for the NCUSIF.  The Fund was “not competitive” relying on double premiums to try to meet the 1% of shares objective set in the Act.

The new design would be “less costly, puts control of funds in your hands, and makes the fund all yours when you put up the money.”  This change would “complete the system.”

Leadership Change that Lasts

Ed took questions at the end of the talk replying to attendees’ concerns about “overlapping FOM’s, competition for members,” and the threat of taxation.

He closed with the thought that he did not want to be remembered for what he had done as NCUA chair but rather for “being part of the future.”

His ending rouser challenged credit unions: “You’ve been a model for your members; now become an even better one.”

What Sets a Leader Apart-“Feeling Safe”

Ed did not lead change by preaching fear.  Instead in this speech and many others he directly addressed the “fears” that credit union leaders shared.   Fear of the unknown future, competition from without and within the industry, or the lack of expertise and navigating an economic recovery with members.

Hearing him speak, credit unions “felt safe” with his proposals for the future.   They had confidence not just in current results, but in the way the agency presented the context for change-the transparency, the joint efforts, and the shared belief in the unique value of the cooperative system.

In 1984 credit unions supported Congress’ change of the NCUSIF to a 1% deposit-based system, bringing all the benefits described in the plan.   This was critical for credit unions to have a sound, unique and competitive future in the newly deregulated financial markets.

Ultimately the trust in any organization depends on those who interact with it, “feeling safe” with its leaders.   That belief is real; it is earned not granted by position; and it is the fundamental confidence required for any system’s success.

One of Ed’s gifts was instilling confidence in others and their ability to succeed.  Every coach knows this reality if there is to be a winning team.  An example that is  much needed today in DC.

 

 

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When Words Matter Most

On November 5th, Pomona Postal FCU, founded in 1964, became NCUA’s  fifth conservatorship of 2021.

The Credit Union Times story contained this standard explanation:

The NCUA issued a media release and other information, showing the agency took possession and control of the insured credit union to conserve its assets, protect the National Credit Union Share Insurance Fund, and resolve operational problems that could affect the credit union’s safety and soundness.

At September 30,  this $4.2 million credit union reported a net worth of 6.86%–down .01bps from a year earlier; an ROA of .48, delinquency of $33,184 covered by an allowance of $41,000.

The Critical Question

This action raises again the ultimate question, Why?  The $20 billion NCUSIF had to be “protected” from the deprecations of this $4.4 million monster disguised in tiny sheep’s clothing?

Or, as typical of other small credit union seizures, will we learn from court records (years from now) that there has been a long, on-going pattern of misdeeds in this two-employee firm, overlooked in multiple past annual NCUA exams?

Or, perhaps it is just examiner and regional office frustration that their supervision has been unable to stabilize a slowly declining financial picture?

Both options are troubling. The failure of NCUA to be transparent in the use of its most absolute authority is itself a symptom of the real issue.

If NCUA is unable to supervise this credit union speck in the $2.2 trillion system, how can anyone have confidence in their oversight of a $40 or $400 million, let alone a $4.0 billion entity.

The irony of NCUA’s explanation is stunning.  For if true that this $4.4 million was taken over to protect the insurance fund, the greatest danger to the system is not from credit union malfeasance or failures; rather it is NCUA’s incompetence.

It is time for the agency to drop the bureaucratic doublespeak and start giving straight talk about its actions. For the issue is not what happened at Pomona Postal but why the agency feels so compelled to cover up its most important responsibility.

 

 

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Two CEO’s Experiences with  NCUA

From a retired 30-year CEO commenting on NCUA’s oversight of loans to credit union executives and directors- (2021).

“I hope NCUA has improved their guidance for loans to Management and the Board of Directors.  We merged with a credit union that had a policy that Board members, management and their families could borrow $100,000 each unsecured.  When we merged with them we found the Manager, his wife and two sons each borrowed $100,000 as well as the Asst Manager and two directors.

Each went bankrupt and the loans were never paid. When I challenged NCUA, CUMIS and our lawyers, they all said since they went bankrupt, we could not collect from them as long as the Board approved the policy allowing them to borrow up to $100,000 each unsecured.  NCUA should have a policy that officials cannot have special terms that the members do not have. “

Changing Role of the Regulator: A  Relationship That Should Be Based on Mutual Respect (1984)

“. . . it seemed as though we would never escape the attitude that the regulator knows best. . . A dramatic change has taken place in the last few years.  We now have a federal regulatory agency which openly concedes that credit union people know more about running credit unions than the agency does. . .

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. . .

The nature of the federal bureaucracy being what it is. . .there will be a great amount of inertia to cause it to revert a less creative and less cooperative approach to regulating credit unions. 

I would not like to see that happen.”

Frank Wielga, CEO Pennsylvania State Employees credit Union. Source: NCUA 1984 Annual Report

 

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Missing Voices

 

          NCUA’s New Logo

“I wish I had kept the phone numbers and emails of CEOs that are now gone from view.  Ex-CEOs that could tell me what they had wished they had done when they faced downward curves on the way to the end.

I worry that lessons lost and archived outside our industry are what is needed now.

What did we miss when we justified the NCUA or regulators’ actions to end an organization?  What did we miss when no owners really dug into a vote to end a charter?  What did we miss when the life-cycles of leaders and volunteers were more important than CUs needing young blood?

What did we miss when we followed models based on scale that left local communities and individuals on the sidelines?  What did we miss that are the keys to turning a losing streak back towards winning?

Some might say we missed nothing, we witnessed progress and the natural march towards an industry’s maturation.  But that sounds to me like short term winners talking.” (Randy Karnes, 2018)

Tens of Thousands  Fewer Voices

NCUA was converted to an independent agency with a three-person board in 1977.

The results include 12,000 fewer charters and the elimination of  12,000 CEO’s and volunteer board’s leadership platforms.   Their employees  lost independent career opportunities as these organizations were shuttered. 

The movement’s human capital–enthusiasm, insights and entrepreneurial spirit–has been lessened.   

Communities have fewer options.  As charters are pulled up by their roots, the movement becomes less diverse, less democratic, more concentrated and remote.

Credit unions are being depleted.   No movement can sustain itself built on subtraction rather than addition and multiplication.

In the end there will be no need for an NCUA or logo.

 

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NCUA’s Is Falling Down on its #1 Actvity

In Illinois, the initial state credit union act prohibited officers and directors from borrowing from their own credit union.   The act authorized chapter credit unions  to meet those official’s needs as well as serve members of any groups too small to form their own credit union.

When I became Illinois credit union supervisor in 1977, this restriction had been removed.  However the concept that persons managing money should be subject to special scrutiny remained.   As one colleague noted, one aspect of our job was to keep honest people honest.

Examiner Norman Glazer

Illinois conducted an annual exam of its 1,000 plus charters.   An important part of the onsite visit was reviewing all official family loans, their relatives and the travel and other expenses they charged the credit union.

Examiner Normal Glazer looked like a bookkeeper.  He wore wire rimmed glasses, was slight of stature, talked in subdued tones and was a long-time state employee.   He was  a very thorough examiner, who knew accounting and more importantly, the many ways that humans might conceal wrongdoing.

I asked him how he reviewed the loan and savings verifications looking for fictitious accounts.  It was simple-he selected a sample of each, and then looked up the names in the phone book.  If there was no name, he dug further.

Among Norman’s discoveries was a $1.0 million embezzlement from the Scott Foresman Credit Union where the manager kept a double set of books and accounting ledger cards.  When Norman’s tape of the individual ledger cards did not match the GL total, he sensed something was wrong. He refused to accept the “missing cards” explanation and found a completely separate set of ledgers with which he documented the full amount of the loss.  CUMIS paid the claim he substantiated.

Human Nature Has Not Changed

I cite this Illinois examination practice in support of Board member McWatters and others who have publicly observed that fraud is the most common cause of NCUSIF’s losses.

The historical concern about senior managers and directors engaging in self-dealing has a 5300 call report “echo.”   Account codes 995 and 996 show the number of loans and total dollar amount to this leadership group.   The table below lists the top 20 credit unions by highest average loan balance with total loan numbers and balances as one way of reviewing the data.

This table shows wide variations in this activity even among these 20.  The list by itself might prompt some obvious questions; however, the point is NCUA still believes this is an activity for ongoing monitoring—or is it?

Job # 1

NCUA’s largest budgeted amounts and the majority of its workforce are dedicated to  on-site exams. One assumes all loans, family related transactions and the expenditures charged by senior staff and directors to the credit union would be reviewed as normal exam protocol.

Reporter Peter Strozniak of the Credit Union Times regularly follows NCUA’s legal filings and court documents. From these records he describes the details of these internal thefts and other employee/director wrongdoing, unfortunately years after the credit unions’ failure.  These detailed accounts show that examiners have overlooked extended periods of self-dealing.

A recent example is from the Time’s report of NCUA’s suing CUMIS for recoveries from Melrose Credit Union’s CEO.  His October 15, 2021 story described one NCUA claim:

Prior to his 1998 retirement, Herb Kaufman, Kaufman’s father, was Melrose CEO and served as the board’s treasurer. In May of that year, Herb Kaufman became an independent consultant to Melrose under the terms of what the NCUA described as an unusual three-page agreement, which was signed by only one member of the board who turned out to be a life-long and close friend of Herb Kaufman.

The agreement contained a one-year renewable term that paid Herb Kaufman $5,600 a month for his services.

“Despite his obvious conflict of interest, Kaufman aggregated solely to himself the over site within the Melrose Consulting Agreement with his father,” the NCUA lawsuit reads. “Thereafter for more than 18 years, Kaufman covertly caused the renewal of his father’s Consulting Agreement without ever informing the Melrose board or otherwise bringing its continued existence to the attention of the Board.”

According to the NCUA, Herb Kaufman was paid $1,239,795 over 18 years and failed to generate any business for Melrose or provide any meaningful consulting services to the credit union. What’s more, Melrose also paid Herb Kaufman’s travel expenses of more than $26,000 even though his consulting agreement stipulated the travel expenses were to be paid by Herb Kaufman.

The facts offered by NCUA say the Melrose President paid his father (the retired CEO) for 18 years without a fully approved contract.

Assuming an annual NCUA and state exam, this arrangement went un-noted for almost two decades.  How could this be?  Same last name, monthly checks, a written agreement-it raises the question of what do examiners look at?   And NCUA is asking CUMIS to pay up because the bond company should have detected this?

This is not the first time NCUA has sued CUMIS for credit union failures.

On April 23, 2010 NCUA placed the East Lake, Ohio-based St. Paul Croatian FCU in conservatorship  with an estimated loss of $170 million, or almost the entire amount of insured shares balance. Loan fraud was among the primary reason for the CU’s collapse.

The IG significant loss report stated:

At St. Paul Croatian FCU, examiners didn’t assess the weakness of the credit union’s internal controls and failed to ensure that the credit union took corrective action on document of resolution issues.

How does NCUA atone for its exam failures?  The CU Times report:  The NCUA filed a proof of loss claim with CUMIS for nearly $72.5 million (St Paul Croatian FCU). However, because CUMIS’ fidelity bond has a $5 million coverage limit, the amount of money in dispute would be less than 7% of that figure, said Phil Tschudy, a CUNA Mutual Group spokesman.

Between this 2010 St. Paul failure and the October 2021 CUMIS suit for Melrose recovery, there have been repeated cases of significant examination failures over multiple exam cycles.   Three of these are described in this post.    The information, all from court proceedings, documents CEO embezzlements lasting years.  In the CBS Employees FCU case, the CEO fraud extended for two decades resulting in an estimated $40 million loss to the members.

NCUA’s Two-foldProblem

These recurring, costly examples, suggest that NCUA is not doing well its number one job of examination.  Examiners should be given a whole new process  and trained on reviewing self-dealing activity.

But it is hard for NCUA to fix a problem that is hidden from public scrutiny until years after the fact.

A second challenge is NCUA’s lack of transparency.  It provides no information on its supervisory actions.  The agency has said nothing about its current conservatorships, one of which is over $4billion in assets. But then years later court proceedings show how extensive and elongated the pattern of misconduct and coincident examination shortcomings were.

Generalized IG critiques of exam failures provide no details of the examiner oversights or  any mention of accountability.   The response to IG findings is by the same people responsible for the entire process in the first place.

Accomplishing Job # 1

With all the recent public remarks by NCUA leadership about cyber ransomware, cryptocurrency, DEI, climate change and other current “risk” topics, the agency seems unable to perform its most important, historically necessary, oversight function effectively.

Examinations produce pages of financial statements, ratios and trends, and checked boxes for policy adequacy.  Almost 97% of credit union assets are held by Code 1 and 2 rated credit unions.  The biggest risks are internal, not on the balance sheet.

Examiners should be training for conversations about all forms of self-dealing to see who approved what, when and why.  These discussions should be part of the exam record.  The topics should be raised and documented in the board exit conference.  Without putting these activities in the light of day during exams, everyone presumes it’s OK to keep questionable activities in the dark, and out of the record.

Where is Norman Glazer when credit unions need his sixth sense, or rather common sense?  For example he might look at the table above and ponder why are real estate loans to senior credit union personnel so much larger in the lower priced Midwestern states than in any of the more expensive big city coastal markets?

I know he would have challenged a $35 million dollar sinecure committed to a newly organized non-profit by two merging credit unions to support the “advocacy” activities of the CEO who arranged the merger.

The fiduciary concepts of care and loyalty would appear to have been erased from NCUA’s examination and supervision process a long time ago.

Credit union members pay the costs of these failures. However in the long run its is the public reputation of NCUA and the system that is at risk when examinations miss the obvious.

 

 

 

 

 

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NCUSIF Investment Decisions Are Hurting Credit Unions

Several days ago, NCUA posted the August financial results for the NCUSIF.

The good news is that the fund continues to show positive net income.  For the first 8 months the year-to-date net is $122.2 million versus $45.4 for 2020.

However, only 13% of the fund’s $19.2 billion portfolio matures in less than one year.

In contrast, at June 30 credit unions reported 53% of their total investments were under one year.  Of that amount over half, or 38% of all investments were in cash and overnights.

Both credit unions and NCUA have access to the same economic forecasts.   Why is there such a dramatic difference in how investments are being positioned in this part of the rate cycle?

At the September board meeting CFO Schied promised to publish the NCUSIF’s investment policy in response to a question from a board member.   The $1.2 billion reported in new August investments shows why this transparency is so urgent.

The most important monthly  decisions by the fund are selecting investment maturities.   The board and credit unions should know  the assumptions committee members used when making these decisions.

The NCUSIF’s August Investments

As listed in the NCUSIF financial report:

8/16/21 T – Note 600,000,000 $ 8/15/2028 1.01%

8/26/21 T – Note 100,000,000 $ 8/15/2026 0.84%

8/26/21 T – Note 100,000,000 $ 8/15/2027 0.97%

8/26/21 T – Note 100,000,000 $ 8/15/2028 1.11%

8/26/21 T – Note 100,000,000 $ 8/15/2025 0.66%

8/26/21 T – Note 100,000,000 $ 8/15/2023 0.22%

8/26/21 T – Note 100,000,000 $ 8/15/2024 0.45%

I calculate an average weighted life of 5.7 years and a portfolio yield at .943% for these seven investments.

The critical question is what were the committee’s assumptions that caused them to lock up $1.2 billion for 5.7 years at a yield under 1%.  These actions also reduced the overnight account of over $1.0 billion in June to just $230 million in August.   It lengthened the portfolio’s average maturity by over 100 days.

The decisions show a seeming absence of any market awareness. Two investments have the same seven-year final maturity.  However between the August 16, $600 million first note purchase, and the August 26 $100 million second note at exactly the same maturity, the yield rose 10 basis points!

This 10 basis point lower yield on the first $600 million will cost the fund and credit unions $600,000 per year for seven years, or a total of $4.2 million over the life of the note.  How did the committee make such an obviously untimely decision?  Why has the committee continued to invest further out the yield curve when the consensus of most economists is that rates will be rising?

Shouldn’t the fund instead be rolling over these  notes in 13 week, 6 month or one year Treasury bills yielding .05% to .15% in order to reinvest these funds as the markets move? For example the two year treasury bill has more than doubled in yield from the .22% return NCUA received in August.

I know of no credit union that would have made these investments with this average maturity and this yield with member funds.   But that is what the committee did.

At the markets close today, the seven-year treasury note yielded 1.414% and has traded as high as 1.5%.

If the $600 million had yielded 50 basis points higher, this would generate $21.0 million over next seven years for the NCUSIF.

Going Forward

For the quarter the major topic on the economy has been inflation.   Is it transient due to temporary structural issues or shooting way beyond the Fed’s 2% target?

The economy’s continued supply shortages are now estimated to extend into mid 2022.  Today  the Fed will release its interest rate and monetary policy steps going forward.   The tapering of bond purchases is expected and many forecasters foresee a Fed rate increase sometime in 2022.

Unfortunately recent NCUSIF investments will be a drag on its revenue for years to come.   Continuing to invest in a period of historically low interest rates using the same ladder approach as in years of more normal rates makes no sense.  These unusual investment decisions hurt credit unions and their members by causing revenue shortfalls for the fund.

The NCUSIF’s incremental investments should instead be rolled over in very short maturities and then re-invested as rates move into ranges consistent with the yield requirements for the NCUSIF’s operations.

The investment committee is presumably the same senior NCUA officials who oversee examination and supervision priorities.  What would their response be to a credit union making these investment decisions?

Timely and transparent presentations of the cooperatively-owned NCUSIF financials is a commitment made by the agency when the 1% underwriting deposit was implemented.   Fund results should be posted as soon as they are ready.

There needs to be a discussion in the published report of the investment actions, or none, made during the month.  That is one critical way to build confidence in the management of this unique credit union resource.   And to insure decisions are made in credit union members’ best interests.

 

 

 

 

 

 

 

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NCUA’s 2021 Year End Forecast for Credit Unions

At the September Board meeting, CFO Eugene Schied presented the forecast for the NCUSIF’s year end NOL.   The ratio he gave was 1.28%.    The slide showed the outcome  and the formula, but not the numbers used to calculate the ratio.

NCUA’s public affairs officer Joseph Adamoli has provided that data.

Large Slowdown in Share Growth Last Six months of 2021

NCUA staff projected yearend insured shares totaling  $ 1.597 trillion.  This would be an 8.8% growth from 2020’s yearend total of $1.468 trillion.

Since we know the midyear insured shares were $1.580 trillion, this indicates NCUA believes credit unions will add just $17 billion more in the second half of the year.

The 2020 yearend share growth was 20.9%;  the 12-month growth at June 30, 2921 was 15.4%.    Therefor NCUA foresees a significant decline in new deposits from these actual double digit  trends.

Net Income for the NCUSIF

The yearend retained earnings are estimated to be  $ 4.701 billion which would be a decline from the NCUSIF’s  July report of $4.739 billion.   In other words, NCUA projects an operating loss for the final five months of approximately $38 million versus a positive net income through July of $118 million.

There was no information to explain the decline in net income. Since monthly investment income more than covers all operating expenses, the agency must be projecting an increase in  the insurance loss expense.

2021 NCUSIF Equity Ratio

NCUA’s two yearend forecasts of $4.7 billion of retained earnings and insured shares of $1.597 trillion, results in the fund’s equity ratio of .294%, or almost at the 1.3% historical NOL level.

This forecast shows the importance of the NOL cap.  For if retained earnings exceed the NOL, then any overage must be paid in dividends to credit unions.

If instead of negative net income for the final five months, the NCUSIF were to report a gain of just $52.8 million, the equity ratio would be right at .3%.   Even that result would be less than half the net reported in the first seven months.

Transparency and Responsibility

No matter how close NCUA’s estimates prove to be, the first conclusion is that this will be a good year for the NCUSIF, even if share growth ends up higher than the forecasted 8.8%.

The estimates also demonstrate the importance of resetting the NOL based on actual historical performance versus hypothetical scenarios with no objective validation.

We don’t know if there will be an NCUSIF update during today’s Board meeting.   If there is, the credit union owners have the data necessary to track performance which is one of credit union’s most important responsibilities.

For if the owners and contributors of the 1% perpetual underwriting show little interest in the NCUSIF’s performance, the prospect of a dividend or effective use of the fund’s investments, then the  accountability for oversight built into this unique  co-op model will break down.

The transparency from NCUA is helpful, but only if credit unions use it to monitor the fund and provide comments  to the board.   For the next big NCUSIF decision will be setting a new NOL level (currently 1.38) at one of the two monthly board meetings remaining this year.

 

 

 

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Harper’s NCUA Priorities: “Fiddling While Rome Burns”

Chairman Harper’s Senate hearing for a second term confirmed his intentions for NCUA.  In his opening statement and when answering questions, he reiterated his regulatory to-do list.  Along with prior speeches and proposals these include:

  • Establishing a separate consumer examination force (he stated NCUA is working on a white paper to validate this need).
  • Eliminate all current legislative constraints on NCUSIF funding and premium assessments.
  • Seek authority for examining and supervising third party vendors serving credit unions.
  • Climate change risk must be included when evaluating safety and soundness.
  • And the need for multiple agency investments to “continue prioritizing capital and liquidity, cybersecurity, consumer financial protection, and diversity, equity, and inclusion.”

His opening Senate statement reflects his experiences as entirely within the “legislative, regulatory and policy” arena.  He sees the scope and purpose of his role as running a government agency, not facilitating the relevance, role and reach, i.e. the sustainability of the cooperative system.

Since the late 1990s, I have worked as an advisor, manager, and executive on banking, insurance, and securities legislation and regulation. These jobs have given me broad knowledge of financial services policy and a deep understanding of the many issues facing our nation’s $2 trillion credit union system. 

One Vote Short to Enact Harper’s Agenda

Sooner or later all of Harper’s desires to expand NCUA’s authority and resources will receive a second board vote.  Either by convincing a current member that “bipartisan compromise” is the correct leadership response, or due to the expiration of one of the other board member’s term.

Harper’s positions are not driven by facts, data analysis, or even trends.  He has been advocating for risk-based capital (now linked with CCULR) since 2014 despite all the factual evidence that it is both unneeded and does not work.  He persists in immediately imposing this 400+ page rule even in the face of statements such as this by former board Member McWatters at a June 2019 board meeting:

Board Member McWatters: Okay, so there’s work to be done on the rule. And I should also note that when this rule was proposed and finalized, I dissented from it. And I dissented from the rule because in my view, as a lawyer for over 37 years, the rule violates the Federal Credit Union Act. I said that twice in written dissents in some detail in some legal analysis.

Now, I understand that reasonable minds may differ. Other people, other people in this room have a different view. I respect those views, but I also think that if this delay passes, we should look at that. We should go through that analysis again. I don’t want a rule on the books that in my view as a lawyer dealing with issues like this for a long, long time simply does not comply with what Congress told us to do. So I hope that, I hope that we can do that.

The Danger of a Misguided Regulator

We all see what we want to see.

Harper has spent most of his professional life working on legislative and regulatory policy. His goal is to enhance government’s role, not sustain the cooperative movement that created the agency in the first place.

His position on issues is to promote a regulation- heavy outcome.

His lack of credit union experience, knowledge and operations is a serious blind spot.

Today the credit union movement faces growing challenges. They have nothing to do with Harper’s understanding of safety and soundness, forecasting the next recession or even competitors overwhelming the movement through innovation or scale.

There are two wildfires burning uncontrolled throughout the cooperative environment. Both were started internally, and each is continuously fed by NCUA’s actions.

Not “Mergers” but “Collective Euthanasia”

The first wildfire is the increasing use of self-interested mergers, allegedly for economies of scale by managers of sound, stable and long-standing credit unions to become part of a larger one.  The increasingly brazen appropriation of credit union members’ common wealth is exemplified by a CEO’s arranging $35 million in funding for the non-profit organization he will run after his $650 million credit union is merged.

These acts of the CEO and senior leadership cashing out via merger are not new.  But they are increasingly promoted by third parties who draw up “change of control” clauses for CEO contracts.  Then the same CEO’s go out and negotiate their own change to collect the bonus.

NCUA routinely signs off on these self-serving charter cancellations.  The problem is more than self-enrichment.  Every merger of these long serving credit unions rips out roots feeding the cooperative model. Members’ accounts, loyalty and common resources are transferred to a third party which has little to no relationship to the community which loses their decades old local financial institution.

These mergers destroy the credit union system at its roots.  Members leave and the entire basis of the credit union’s soundness, the member relationship, withers and dies.

The continuing credit union may seem strong, but that is a temporary illusion.  Loyalty, trust and confidence cannot be bought.  They are earned via long standing service relationships.

The common bond which first brought the credit union to life is now transformed into an act of  cooperative euthanasia in these merger manipulations.

The rot then shows up in the continuing credit union even when it tries to regain former member’s allegiance. The roots have been severed.  As a result  the solution is sometimes to ask its own members to approve this collective merger death ritual by the continuing credit union— the story of Xceed CU.

Using Member Reserves to Buy Banks

The second challenge is credit unions using members’ accumulated reserves to buy banks.  Often these are outside the credit union’s existing network and market influence.  The reasons are to grow faster than might otherwise occur, especially in new markets.

However, paying $1.50 to $2.00 for each $1.00 of book assets sooner or later will lead to a financial dead end.  Unlike mergers, these purchases are for cash.  There will have to be a return over years to support the premiums being paid for these assets.  The results of each purchase will not be known for some time.  Meanwhile, credit unions will have to convert new employees, customers and  products and services in a process different from the credit union’s traditional member-chosen relationships.

The jury is out as to whether these financial investments will ever payout.  But one trend is apparent.  Bank purchases to pursue growth becomes a narcotic.  It is like an opioid that a CEO and board become addicted to when their own efforts at internal expansion no longer seem enticing. Some credit unions have completed more than one bank purchase.  It is not unusual to see a credit union undertake two transactions back-to-back or in a current case, two at once.

The Common Source for these Growing Cooperative Wildfires

Both of these activities are failings of fiduciary duties.  The common characteristic in both is  credit unions have lost touch with their own members.  Their leaders believe the credit union is their personal fiefdom to do as they like, even when the decision is to ask members to commit cooperative suicide by giving up their generations-old charter.

As institutional growth and performance is prioritized over member well-being, the credit union model becomes more and more like the competitors’ it was meant to replace.

In both activities members are kept in the dark- told nothing about bank purchases. Or in mergers, members are given  a series of assertions about better products and services that omit significant information or misrepresent the entire situation—and given less than 45 days to act before voting.  Few vote, rightly sensing the system is rigged against them, which is often the case.

The solution to these two failings is as straight forward as the cause—empower members to be truly informed and engaged about their credit union’s activities.  Transparency is critical whenever members’ collective wealth is used outside the normal business model.

In mergers members are given nothing more than PR cliches.  Should ending a successful, sound charter be so much easier than what is required for a new charter in the first place?

Harper sees “consumer protection” as crossing every “T” and dotting every “I”.  That approach is  fiddling while the cooperative industry burns down.  In the meantime, members’ collective legacies are stripped away by their boards and managers.

Sound, well run credit unions are losing their cooperative roots and purpose.  No one is willing to address the situation for what it is and stop these extermination.  Unfortunately, we know how this movie ends.  The original version was called the S & L industry.

 

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A $35 Million Example of an “Emperor with No Clothes”

Hans Christian Andersen’s story about the emperor who had no clothes is familiar to most. You can read the parable here to refresh your memory. Two swindling weavers convinced the entire court and the emperor that their invisible new uniforms were perfect. They pocketed the gold and silver threads for the garments stealing them for their own use.

I have always wondered why it took a small boy in the crowd watching the king’s parade of “new” clothes to shout out, “But he hasn’t got anything on.”  What was the reason for everyone else’s silence?

  • Fear of authority when challenging the emperor’s actions?
  • Loss of a senior position if a trusted advisor should speak up?
  • Who am I to argue with the emperor’s wisest, most senior advisors?
  • Onlookers: not my problem if the emperor wants to go out naked
  • Too isolating to be a person stating an inconvenient truth?
  • Situation so far-fetched that no one believes the facts before their eyes?
  • Perhaps an example of: “you can fool all the people some of the time”

Whatever the explanation, the story raises the issue of people avoiding uncomfortable realities that no one else wants to acknowledge. In the merger situation below, a single thoughtful and brave member decided to call out what no one else would, even though the facts were presented in plain sight.

The Merger of Financial Center and Valley Strong Credit Unions

On May 31, 2021, Michael Duffy, CEO of the $643 million, 65-year old Financial Center Credit Union(FCCU) announced the intent to merge with the $ 2.4  billion Valley Strong:

The phrase ‘Growing Together,’ is a perfect adage, as this merger represents a strategic partnership between two financially healthy, future focused credit unions committed to providing unparalleled branch access, digital access, and amazing service for the Members and the communities they serve,” says Michael P. Duffy, president/CEO of Financial Center. “In a financial services sector that is constantly evolving, this merger is a true embodiment of the credit union industry’s cooperative mind-set. At its core our partnership with Valley Strong represents us selecting the best credit union partner to help us achieve our goals faster than we could duplicate on our own.

“As the CEO of Financial Center Credit Union for the past 21 years, my perspective on mergers has evolved just as much as our industry has in that same time period,” Duffy continued. “As credit unions built by select employee groups (SEGs) increasingly partner with community credit unions, I have marveled at what credit unions of today’s scale can accomplish when they join forces with their Member-owners and communities chiefly in mind.”

The 86% member approval in the merger vote was announced in a September 27 Valley Strong press release which included this statement by CEO Duffy explaining the rationale:

“In a financial services sector that is constantly evolving, this merger is a true embodiment of the credit union industry’s cooperative mindset. At its core, this is about a collective mindset that allows us to achieve our goals faster than we could duplicate on our own.”

When asked what it means to Members to achieve these goals faster, Duffy added, “We recognize merger critics may point to our healthy capital and ask why we didn’t just opt to go it alone. That was of course the first consideration. But the reality is, we do the same things for the same reasons so why not eliminate redundancy and grow faster and better together. On our own, it would take years to develop and implement while still having the challenges scale, so why not give members more and build the organization for the next decade at the same time.” Duffy continued, “We took our national search for a partner seriously. Together with Valley Strong, it’s a win-win, because members are the focus, and we will be able to serve even more people throughout San Joaquin and the state of California.”

The Member-Owners’ Notice of the Merger

As required by NCUA rule, FCCU provided members the reasons for the merger. These general descriptions included “consolidation of energy and resources, to better serve members through competitive pricing and services, additional products, enhanced convenience and account access and continued employee and volunteer representation.”

The member Notice then listed seven categories of benefit with a little more detail.  For example, Duffy will become Chief Advocacy Officer for Valley Strong and be “actively involved in the day-to-day operations.”  In addition, the Notice described two contributions to a non-profit charitable foundation FCCU2.  More on this community outreach initiative later.

Share Adjustments and Golden Handshakes

At midyear 2021, FCCU had net worth of 16% totaling $107 million or twice the ratio of Valley Strong. The Notice included a special dividend distribution of almost $15 million based on two factors.

  1. Each member will receive $100 for every five years of membership to be capped at $1,000 for members who joined in the oldest tier 1946-1976.
  2. A dividend of .869% on the 12-month average balance for “Base” shares with a $500,000 ceiling on the maximum shares included.

Each member’s pro rata share of the net worth at the merger vote is $3,620.  However, the credit union will pay only an average of $505  per member just 14% of their common wealth.  To equalize FCCU’s with Valley Strong’s per member net worth, each member should have received an average of $1,800.

The four golden handshakes, that is additional compensation over and above what employees would have earned without the merger, will be paid to:

  • Nora Stroh EVP for $150,000 if she stays with the new credit union for 30 days following the merger;
  • Steve Leiga, VP Finance of $150,000 for staying 30 days after merger completion;
  • Amanda Verstl, VP HR $257,352  for retention, severance opportunity, accrued sick and leave payout;
  • David Rainwater VP Information for $244,000 for staying through the system conversion.

These special payments are similar to other merger transactions although the special dividend structure is unusual and recognizes the generations of member loyalty.

Two questions arise from these disclosures in the Notice:

  1. Why would a $643 million credit union with over 16% net worth and $521 million in investments believe it is unable to provide competitive member services and pricing into the future?
  2. And why did CEO Duffy not receive any merger payment? The Notice further notes that he and the VP finance would not receive anything from the one-time bonus dividend.

Some Context

Michael Duffy joined the credit union in October 1993 and has been President for over two decades.   The EVP and COO, Norah Stroh, has been with the credit union for almost 32 years. She joined as HR, benefits and personnel manager in February of 1990.  In January 2001, she was promoted to her current number two role.

Michael and Norah are brother and sister.

Steve Leiga, VP Finance, joined the credit union in January 2002.  Amanda Verstl’s employment at FCCU exceeds 13 years.  David Rainwater’s connection began as a summer intern in 2011.

For an experienced team to suddenly decide merger is the best course for members after three decades seems somewhat unusual no matter the rationale. Why are the senior leaders of this credit taking their severance bonuses and closing up shop? Where is the succession planning, or was merger a predetermined strategy?

One FCCU trend seems especially puzzling. Why is there no Lending VP? Who had this responsibility for this most critical role in every credit union?   The loan to asset ratio has declined in the last five years from 39% to 16.9% at June 2021. The $107 million in reserves equals the net amount in outstanding loans, for a risk based net worth ratio of 100%.  All the $521 million investments are in cash or government and GSE securities.

When reviewing the two last available 990 IRS filings for the credit union, a dramatic change occurs.

In 2017, the three most senior employees were paid a total of $1.4 million or 21% of total salaries and benefits.  In 2018 the three were paid $3.1 million, or 46.5% of total salaries. The 121% increase is in just one year.  In both years the CEO is a member of the five-person board which approved these compensation packages.

No IRS 990’s are yet available for 2019 and 2020 to know if this trend continues.  It would certainly be useful for the credit union to post public copies of these required filings in light of the merger decision.

A Million Dollar Public Contribution-Conflating Personal and Professional Roles

 

As the credit union’s lending portfolio continued to decline and member numbers fell from a peak of 32,382 in 2017 to 29,101 today, the credit union made a very public contribution to the city of Stockton.

In April, 2020 Michael Duffy presented a $1.0 million check to a COVID relief effort, the 209 Stockton Strong fund. The  subsequent  press release described the effort as follows: “This donation represents a continued commitment from the entire FCCU team. They are donating, together, out of the care and concern for others in their local community. . . Duffy presented this opportunity to the FCCU team as a way to help their community and received immediate support with a resounding yes.”

Even though the announcement states the $1 million donation is from “the entire FCCU” team and the Michael Duffy Family Fund, there is no information of how much came from each source.   The only public reference to the Duffy Family Fund is as one of several donor advised funds managed by the Community Foundation of San Joaquin.

The mayor’s office prepared for Facebook an 11 minute video of this donation featuring Duffy and a six foot enlarged check with the credit union’s name. And here is this brief excerpt on the KRCA evening news.

Philanthropy can certainly be positive.  Donor advised funds are an easy way for individuals to manage the timing of their contributions.  But it can also be self-interested.  This $1.0 million single “gift” is one of the highest donations I can recall associated with a credit union during this time of COVID, or any other time.

The credit union or Duffy could certainly have donated the money to the identified charities directly.  Why Duffy would combine his personal philanthropy with whatever the employees donated for this appeal is unclear.

One might suggest this conflation of professional and personal activity is a PR effort to promote the credit union, not just Duffy.

However, the IRS 990’s  show credit union funds given to a wide number of political campaigns.  There were 17 donations totaling $60,250 in 2018, including a second $10,000 contribution to the current CA governor, and donations to Stockton’s mayor.  Is this credit union money to political campaigns in the members’ best interests, or to promote the public influence of Duffy?

Why the Merger?  Why did the CEO do this?

FCCU has been a closely-run, family operation for almost three decades.   The CEO is a member of the five-person board. The credit union is more than financially sound, with its very liquid balance sheet and net worth two and a half times the well capitalized 7% standard and twice Valley Strong’s ratio of 8.7%.

Why would the entire leadership of the credit union give up their 66-year history of relationships at the peak of financial capability?  Motivations can be hard to discern.  But on August 26, 2021, a member posted his analysis for opposing the merger on NCUA’s website for comments:

Vote NO on the proposed merger until the provision to transfer $10 million of member assets to a non-profit foundation for “Community Outreach” is eliminated from the proposal. Member financial assets of any amount, especially $10 million, should not be given away for any purpose. If Financial Center Credit Union is so flush with cash that it wants to give away $10 million, then that amount should be distributed to members. I’ve written to FCCU twice asking for the rationale for giving away $10 million. They have failed to answer me, obviously because there is no rational reason for giving away $10 million from its member-owners.

Given that FCCU’s current CEO Patrick Duffy is being given the unexplained job of “Chief Advocacy Officer” in the Continuing Credit Union, it’s easy to guess that Duffy’s only job duties will be running the new foundation doling out the $10 million to his favorite groups and his own large compensation. The so-called “FCCU 2 Foundation” was created less than two months ago for setting up Duffy in his new give-away-our-assets role. In any case, FCCU’s failure to explain to members any rationale for GIVING AWAY $10 MILLION OF MEMBER ASSETS is insulting and outrageous. Vote NO on the merger until the $10 million giveaway of our assets is eliminated from the merger proposal.

The FCCU2 Foundation was set up on June 25, 2021.  The two persons listed with the registration are Manuel Lopez, the credit union’s chair, as the Foundation’s CEO; Michael Duffy is the agent for service.  The organization is described only as a domestic non-profit.  Its address is the same as the credit union’s main office in Stockton.  As stated in one other public notice: The company has one principal on record: The principal is Michael P Duffy from Stockton CA.

The member merger Notice states the total funding committed for this new foundation is $35 million.  There is the initial grant of $10 million from the members’ reserves at FCCU. The Valley Strong members are committed to donate $2.5 million per year of their  funds for the next ten years for the remaining $25 million.

The purpose of the non-profit in the merger Notice is:  “community outreach-charitable and educational activities to benefit the greater Stockton area.”  No further rationale is provided why this entirely new organization created and run by Duffy should be given $35 million of members’ money.

A lone member, Frederick Butterworth who in August posted on NCUA’s comments page makes the obvious point: this emperor has no clothes.

The Duty of Care and the Duty of Loyalty

But the situation is more serious than the action of establishing a $35 million fund as a personal sinecure for CEO Duffy as he transfers leadership of the credit union to another board.

In a widely publicized court sentencing hearing last week of a former credit union CEO the following statements were made in court:

U.S. Attorney Audrey Strauss: The (CEO) shirked his duty to act in the best interests of the credit union and its account holders, exploiting his position for personal gain.

Federal prosecutors said the CEO viewed the credit union as his personal fiefdom, repeatedly betraying his fiduciary duties to the institution and its members.

“This was a family-run business,” Judge Kaplan said of the credit union. . . “If you ran a delicatessen you could do what you want. But this was a federally insured credit union and you were oblivious to that fact.”

The fiduciary duty of directors and managers is more than avoiding criminal conduct.    NCUA’s legal suits against selected corporate directors and management were based on violations of their fiduciary duties of Care and of Loyalty.

Were the boards and managers following these standards when committing $35 million of member money to the FCCU2 Foundation to fund the work of the Chief Advocacy Officer Duffy?   Is this two-month-old foundation just a means of providing future compensation to the former CEO? Was this ten-year funding commitment from Valley Strong a requirement of the merger?

Whatever word one uses to describe this setup -a bonus, a buy-out, or a quid pro quo/kickback-it appears to be a betrayal of fiduciary duty to the members of both credit union by their respective CEO’s and directors.

In March NCUA conserved the $ 106  million Edinburg Teachers Credit Union with a 22% net worth ratio and a loan to share of 14.6%.   The only public information suggested by the  media for the action, given the strong financials,  was the average compensation of $189,000 per employee and the CEO’s compensation in excess of $8.7 million over the past eleven years.   The Texas Commissioner explained the conservatorship as “to ensure the businesses in these industries. . .are entitled to the public’s confidence.”

All NCUA participants from the field examiner to the highest levels in DC admired the clothes this emperor said he was wearing.  NCUA’s RD and assistant RD, the supervisory examiner, CURE which posted the Notice and member comment, and the California Department of Financial Institutions, liked what they saw.

All were bystanders to this event without asking why a 66-year-old credit union, overly-liquid and over-capitalized with a declining loan portfolio and inbred leadership could not continue to be run as an independent credit union for the benefit of its member-owners.  But perhaps that has not been the case for years. The CEO just took the logical next step.

The Hans Christian Andersen parable above ends as follows:

“Did you ever hear such innocent prattle?” said its father. And one person whispered to another what the child had said, “He hasn’t anything on. A child says he hasn’t anything on.”

“But he hasn’t got anything on!” the whole town cried out at last.

The Emperor shivered, for he suspected they were right. But he thought, “This procession has got to go on.” So he walked more proudly than ever, as his noblemen held high the train that wasn’t there at all.

Is NCUA playing the emperor in this modern version and just walking on by? Are other credit unions the crowd? Might the “whole town” be today’s public press and Congress?

One vigilant and thoughtful credit union member proclaimed the truth about this situation.  He gave a shout out to everyone.  Is anyone listening? Or do we continue to live in a fantasy land complying with regulations that don’t protect the members who credit unions were designed to serve?