Chip Filson
Recently the White House posted a video of NCUA Chairman Hood praising President Trump’s economic program for benefiting African-Americans.
The video link and some of the subsequent twitter comments were reported by CUToday.
The decades long trend toward more political polarization in both voter’s views and in Congressional debate and actions (or inactions) is not new. This approach to politics is a key factor of President Trump’s leadership style.
So it was not surprising that democratic Senator Sherrod Brown should question Hood’s video message in a letter seeking more information about the event.
The letter raises the issue of the wisdom of the Chair of an independent regulatory agency making such an overt political statement. No banking regulators, the FDIC chair, the OCC or the Chair of the Federal Reserve have made such endorsements. In fact Fed Chairman Powell, has repeatedly stressed the Fed’s and his independence. President Trump has responded by attacking the Chair’s policy priorities.
In the book It’s Even Worse Than It Looks, the authors Mann and Ornstein provide the history of the collision of American Constitutional practice and what they call the NEW political extremism. In Chapter 2, titled “The Seeds of Dysfunction”, the authors chronicle the impact of Newt Gingrich’s role on the political culture of Congress.
The following is an example of Gingrich and his team’s use of CSpan media to communicate their view of the “fat and pork laden” House:
A group of Gingrich allies calling themselves the “Gang of Seven” seized on the (House) bank scandal to take Gingrich’s confrontational tactics to new levels. Its ring leaders were Rick Santorum of Pennsylvania; John Boehner of Ohio, then only in his second year as a member; and Jim Nussle of Iowa. Their most memorable moment came when Nussle put a brown paper bag over his head while on the house floor, proclaiming that he was ashamed to be a member of Congress. . . Gingrich’s goal of causing voters to feel enough disgust at the entire Congress that they would throw out the majority was within reach; he attained it a little more than two years later.
Today Jim Nussle is President of CUNA. So partisan tactics can be effective, or do they generate a counterforce that defeats its practitioner’s goals?
Credit unions have tried to forge a bipartisan appeal in Washington, even as prior Chairs have been politicians or supporters from one party or the other. The issue is not one of party affiliation. Rather how does the leader of an independent agency best represent the interests of credit unions in Washington? Will becoming an overt partisan help or undermine support for the cooperative financial option in Congress and with credit unions throughout the country? Is Nussel’s past behavior and current responsibility a positive or a cautionary example for how credit unions should navigate the ever increasing turbulent political currents of our time?
We’ve already seen that the risk based approach does not work. It’s obvious that neither man nor model can adequately assess a given asset’s risk under all circumstances before the fact. It doesn’t make sense to spend a lot of time trying. It does make sense to have a minimum leverage ratio but it should be the same for banks of all sizes.”
(Thomas Brown, A Loss of liquidity, not inadequate capital, is what often dooms banks. Bankstocks.com, April 22, 2014)
The leverage, net worth ratio, is the current credit union capital model. Risk based capital formulae should be tools, not a rule.
The immediate vulnerability for the credit union system at this time is the absence of the CLF-Corporate liquidity safety net. Liquidity allows fluctuations in asset values to recover rather than selling during market disruptions and taking losses that reduce capital.
On September 17, the FDIC board eliminated risk based capital (RBC) requirements for community banks with assets of less than $10 billion.
It replaced the international banking BASEL-inspired approach with a simple leverage ratio. A community bank will be considered well-capitalized under required prompt corrective action (PCA) regulations if the tier 1 leverage ratio is 9%.
Banks will not be required to report or to calculate a risk-based capital according to the FDIC’s press release.
The FDIC Chairman Jelena Williams said the new rule ensures that the regulatory framework is commensurate with the operational reality of these institutions.
“The final rule. . .supports the goals of reducing regulatory burden for as many community banks as possible. . .and will allow community banks to significantly reduce the regulatory reporting associated with capital adequacy on the call report.”
The rule was also supported by all the other banking regulators, the comptroller of the currency and the Federal Reserve.
The final RBC rule passed by the NCUA board was over 400 pages and requires all of the regulatory and reporting burdens cited by the FDIC as the reason for eliminating this requirement.
Surely the NCUA can learn from this experience! There is no better time or precedent to cancel this ineffectual, burdensome and deeply flawed approach to capital measurement. For if such a rule had been effective, it would have stayed. The FDIC’s experience shows RBC doesn’t work in practice.
The simple to understand leverage ratio, now in effect, has served credit unions well since deregulation and the imposition of PCA in 2008.
Don’t be misled by the 9% well-capitalized FDIC level versus the credit union’s 7% well-capitalized PCA standards into thinking cooperatives need to raise their capital. All of the capital reserves in credit unions are “free.” More than half of bank capital is in equity shares, whose owners are expecting a return on their investment. Free cooperative reserves do not have this performance expectation and cost.
There is no better time for NCUA board to withdraw this misguided rule. Will the board show the leadership demonstrated by the FDIC?
All credit unions would give a great sigh of relief to have this burden removed from the horizon.
At a time when many credit union leaders see NCUA board members announcing new regulatory agendas in virtually every speech, it is helpful to remember this counsel from a former NCUA Chairman:
“The only threat to credit unions is the bureaucratic threat to treat them for convenience sake, the same as banks and savings and loans. This is a mistake, for they are made of a different fabric. It is a fabric woven tightly by thousands of volunteers, sponsoring companies, credit union organizations and NCUA-all working together.”
Source: Chairman’s letter: NCUA 1984 Annual Report
In an 18-page complaint filed August 7, Victor Webb filed suit against the board and supervisory committee of the failed CBS Employees FCU seeking over $40 million in recoveries for members.
According to press reports the loss was first discovered on March 6, by an employee who raised questions about a $35,000 check the CEO, Rostohar, had made out to himself.
NCUA’s audit as of February 28, 2019 said the loss could be as high as $40.5 million for an embezzlement scheme that Rostohar admitted carrying out over two decades. In the credit union’s last call report as of December 31, 2018, it reported $21 million in assets, $2.6 million in capital and 2,798 members.
The federal credit union was chartered in 1961 to serve CBS employees and related companies. In the complaint Webb stated he joined the credit union in 1970 while a CBS employee. He remained a member until the credit union was liquidated in March, although he retired from CBS in 2014.
His suit names the board and supervisory committee members at the time of liquidation and prior members who served in similar capacities during the two decades of defalcations.
As a class action, Webb seeks damages of $40 million on behalf of all members, by stating that the benefits of membership were devalued by this amount which should have been available so members could benefit from lower fees and loan rates or higher dividends—that is the lost benefits of credit union ownership.
The core argument for suing the Board and supervisory committee members is summarized as follows:
“By reason of Individual Defendants’ positions with CBS Employees (FCU) as members of the Board of Directors, they are or were, at all times herein relevant, in a fiduciary relationship with Plaintiff and other CBS Employees (FCU) members and owe them a duty of highest good faith, fair dealing, loyalty, as well as a duty to maximize member value.” (Page 3)
The fiduciary responsibility of directors and committee members is well documented in NCUA regulations and letters, but rarely is their conduct formally challenged by a member. But this is a case of extraordinary loss equal to almost 10% of the last reported assets, or $2 million per year, for over two decades. Both the amount and length suggest a complete breakdown in both internal and external, regulatory oversight.
This suit focusing on the fiduciary duties of the Board and Supervisory committee could be a very important milestone in cooperative governance and oversight.
How NCUA’s reported audited shortfall of $40.5 million in a $21.3 million asset size credit union could occur is hard to fathom.
The credit union’s December 2018 call report shows $18.4 million in shares for 2,798 members, resulting in an average share balance of $6,576. The credit union’s assets consisted of $14.7 million of investments and $6.1 million in loans with a reported delinquency of only 0.33%.
The credit union’s $18.4 million in member shares would seem to be more than adequately covered by the $21.2 million (with $2.6 million net worth) in easily verifiable assets if a liquidation were ever necessary.
Internal processes to monitor the credit union’s management are mandated in both bylaws and by rule and reg.
Every federal credit union is required to complete an annual audit under the auspices of its Supervisory Committee. Such an audit, whether internally conducted or outsourced, would entail a verification of member accounts, selected confirmations of investments and loans, and a review of internal controls. The results are reported to the Board.
Additionally, NCUA has conducted annual audits of every FCU since the 2008-09 financial crisis. This review would review the credit union’s own supervisory committee’s audits, including member confirmations, plus a complete examination of investments and loans. In addition, the examiner would review all settlement accounts against the latest bank statements to ensure up to date postings and that the credit union’s general ledger is in agreement with external financial confirmations.
If the assets reported by the credit union are correctly reported, then that would mean the total loss caused by the CEO’s fraudulent activities would be the $40.5 million shortfall plus the $2.6 million in net worth for a total of $43.1 million.
NCUA’s obligation to member shareholders is to pay up to the $250,000 per account insured limit. A $43.1 million payment on top of the $18 million in reported shares would mean that over 6,500 more accounts (using the average share balance from reported members) would have been kept in a second set of off-the-book records.
There are only two explanations for NCUA’s reporting a $40.5 million loss after its February 28,2019 audit:
If the second option is the explanation, this suggests the CEO was running a shadow credit union with almost three times the number of members and shares as the reporting credit union. How could this activity be hidden from employees, the directors or supervisory committee, since these members must have received statements and conducted business transactions regularly with the credit union?
If the reported assets are phony, which would account for half of the loss, the only question is what type of annual exam had NCUA conducted over the two decades that this theft occurred?
I salute member Webb for standing up and asking that responsible parties be held to account. This is more than sending the former CEO to jail and then covering the tens of millions shortfall out of NCUA’s “rainy day insurance fund.”
All the public evidence suggests that the problems are much more extensive than a corrupt CEO and a hoodwinked and a deleterious board and supervisory committee. The regulatory oversight that is supposed to assure the industry’s safety and soundness through onsite examinations would appear to have been negligent as well.
When a member takes a stand against ineptness, self-serving conduct and dereliction of duty, the whole democratic movement will benefit. Cooperative governance requires that fiduciary duty have real meaning, not just good intentions. Hopefully this suit will bring out the full story and create a much-needed precedent along with a correction of examination shortfalls.
I salute Victor Webb and say with him, “Enough is Enough.” Stop paying out losses, let’s correct the problems letting these occur.
Over the past twelve months the credit union community is on the hook or paid the bills for the following situations:
In each situation there has been no objective, public discussion of what happened. No lessons have been taken away from these extraordinary losses and how they might be eliminated or mitigated in the future.
Specifically:
When a loss occurs, there is a rush to judgment. What went wrong? Who screwed up? Why did this happen, again?
The natural response is to point fingers, blame someone for the problem. Then punish or banish wrongdoers from ever working at a credit union. And resolve the loss by paying for the shortfall out of the NCUSIF—and move on.
While indicting possible malfeasance may be necessary, it can miss entirely the lessons to be learned. The result is that there is no return on the money expended. Credit union monies are swallowed up in a regulatory “black hole.”
For informed judgement is about discernment, understanding the circumstances of what happened and identifying the possibly numerous opportunities to have done something about the situation much earlier.
Judgement is much more than holding people accountable. In the cooperative community, all members pay for the individual losses via the NCUSIF. Therefore the most important benefit should be corrective actions or processes that can prevent similar circumstances from getting “out of hand” in the future.
For example, NCUA says correctly that it sent a letter about potential problems in the taxi medallion industry to all examiners in 2014. The letter did not identify the possible disruption of the entire industry by Uber and Lyft, but it did reinforce proper underwriting including the ability of borrowers to service the debt.
But somehow the problem grew and grew and no one knew how to manage through a cyclical decline in asset values. This is not a new situation for credit unions. Loans secured by real estate, autos and leases, and/or commercial properties and farm land will all have changes in the value of security during the term of the loan.
But somehow these inevitable fluctuations in value cause reactions as if the problem has never occurred. Before. This panic often exacerbates the situation, freezing new responses and resulting in irreversible financial decisions at the lowest point of value for the security.
Cooperatives are interdependent on each other for market success. The most consequential connection is via the shared capital pool created in the NCUSIF. While the temptation may be to approach difficult situations with an eye to eliminating the problem, that not only may be the least desirable outcome for members of the credit union, but more importantly, it may not be the positive example needed by the whole cooperative community.
Credit unions were created to solve problems especially for members and in circumstances when normal market options were unavailable or too expensive. When problems are just done away with and all circumstances swept under the rug because of sufficient resources to do so, everyone loses. Other credit unions facing similar loan challenges as the taxi medallion example, those with concerns about the adequacy of their internal and external audits; or credit unions with underfunded pension or other liabilities could all benefit from a thorough knowledge of the above cases.
Every credit union board and CEO any CPA or auditing firm and every DP, bonding and any vendor connected to the credit unions above, has an interest in knowing what happened. That knowledge is necessary if there is to be a common commitment to do better in the future. NCUA has to lead by example. The three circumstances above would be excellent places to start with full public reviews. Credit unions have received nothing for the $1.25 billion spent so far. The buck has to stop somewhere before credit unions run out of bucks.
According to the US Census Bureau’s population clock, the estimated 2018 United States population (February 2018) is 327.16 million.
This is a bit lower than the 329.06 million estimated by the United Nations.
As reported in Pentagon FCU’s June 30, 2019 quarterly call report, every one in the US is eligible to become a member. The data submitted by the credit union is as follows:
| MISCELLANEOUS INFORMATION | NUMBER | ACCT |
|---|---|---|
| 2. Number of current members (not number of accounts) | 1,788,610 | 083 |
| 3. Number of potential members | 329,152,485 | 084 |
On June 12 I described NCUA’s May 17, 2019 conservatorship of Municipal Credit Union in New York City. The critical point was who will be the conservator? What will be the plan? Will NCUA’s chosen leader knock the place down or build it up? We now have an answer.
In less than two months on the job, the conservator recorded a June 30, second quarter loss of $125 million. This results in a reduction of net worth from 7.60% (well-capitalized) at March 30 to 3.41% (under-capitalized) at June 30.
The conservatorship was initiated by New York regulators in June 2018 by removing the full board and appointing an administrator, who was then let go earlier this year. New York then appointed NCUA conservator.
In late June several “unnamed sources” placed a leak in a CUToday story saying the credit union had a large underfunded defined benefit plan in an amount of over $100 million. NCUA declined to comment on the story, continuing a pattern of silent neglect throughout the entire conservatorship.
But the loss was a lot more than a benefit funding issue for a credit union which had reported a $3 million net income in the 2019 first quarter. The conservator’s total expenses in the quarter of $168.6 million were more than three times the first quarter total of $49 million. Of this increase, $130 was added to personal expenses, $19.1 quarterly increase in office operations, $8.9 million spent on professional services and $9.3 million in loan loss provision. This loss provision increased the coverage ratio from 147% to 177% even though there was no increase of delinquency at .76% of loans.
The clear answer is nobody. For any so called expert to come in and wipe out half of a credit union’s net worth in less than 45 days on the job shows an inability to look at options, identify alternatives and develop a plan to sustain operations. An underfunded pension obligation is not a new situation for both public or private organizations. Defined benefits are paid out in decades to come and funding plans similarly are long term. Multiple options are available to manage underfunding which is why actuarial assessments are a normal part of a plan’s annual review. The only time cash in full is required is if the plan is to be terminated immediately which can result in every plan member being 100% vested in full whatever the plan’s actuarial cash requirements might be.
The lack of any explanation, public discussion or consideration of alternatives plus the abruptness of the action, suggests kick-the-barn-down strategy to justify a merger of this $3.0 billion credit union chartered in 1916. For cashing out the plan, if that is the reason for the expense, would leave any subsequent leader with no options and with having to develop a new retirement benefit for employees.
Silence and quiet leaks to the press are not patterns of accountability. NCUA board members may make speeches about all sorts of future risks and opportunities but fail to speak to the immediate needs of 588,000 members who have seen a complete breakdown of regulatory responsibility and accountability.
Every year NCUA and the state have examined the credit union. The credit union must have a CPA annual audit which would include an actuarial assessment of the benefit plan. And yet no action was taken until the CEO was found to have embezzled money. Compounding the failure to address the defined benefit funding (if it was an exam issue) is choosing a conservator with no ability to develop a plan for sustainability. Conservatorship becomes nothing more than preparation for a fire sale.
The members have no voice, they have been denied any role in their CU’s future. The credit union has a 22 branch network and a sound and diverse $2.0 billion loan portfolio and over $660 million in cash. Shares are up 6% and loans over 8% from June 2018, during a full year of conservatorship. And the reward for their loyalty and patronage is to be tossed aside as the regulators attempt to cover with silence their repeated failures to address issues that were clearly disclosed previously.
Two factors provide credit unions a major advantage when problems occur. The first is the member relationship, loyalty and trust. The second, derived from the first, is patience when resolving problems.
There is no public pressure on stock price to divest of problems and move to new markets. With the right leadership in place credit unions have survived the most severe crises.
In the June 12 article of NCUA’s actions, a line from Hamilton states, “you have no control, who lives, who dies, who tells your story?” There are only two sources for help—can the members mobilize to assert their rightful role? Will credit unions demand accountability from a regulator whose absence from the fray is a stunning dereliction of duty?