Category: NCUA

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NCUA’s General Counsel On Directors’ Number One Responsibility

Fiduciary Duties “Are Properly Owed to People, and Not to Entities”

Credit union leaders often state priorities for their financial institution’s future but not how members will benefit. The following is NCUA’s view of directors’ principal fiduciary duty.

This analysis was in response to a state league CEO’s concerns about a proposed rule on directors’ responsibilities. NCUA General Counsel Bob Fenner wrote on March 15, 2011 as follows:

At the very beginning of your letter, you do not state that you are writing to NCUA on behalf of credit unions. Instead, you and your fellow authors state that “[a]s associations representing 18,280,456 members in nine states . . . we want to call your attention to several key issues.

. . . .” I presume that by “members” you mean the people who are members of the credit unions in your states, and I commend you for attempting to look beyond credit unions as entities and through to the people that credit unions were structured to serve. As our rulemakings make clear, the directors of federal credit unions must also represent the interests of the members of their credit unions.

The “Interests of Members”

I do not believe that a rulemaking clarifying that FCU directors owe their fiduciary duties to the membership of the FCU is a difficult concept or one that should surprise or concern directors. Section 701.4 is intended to make clear that the law with regard to federal credit unions is in direct alignment with the credit union philosophy; that is, that credit unions exist to serve their members; that credit unions are about people, not profits; and that the members own their credit unions. As the NCUA Board stated back in 2006 . . . when making important decisions affecting the FCU, directors should ask themselves the following questions:

What financial services do my members need and want? How do I know this? [And] [w]ill my decision today help the credit union provide these member services in a quality manner and at low cost to the members?

Fiduciary Duties Are Owed to Members

Your letter, however, states that “[i]t is our position that the director’s duty should be to the credit union as an organization, and not to the members of the credit union.” I disagree. As the NCUA Board has discussed at length in rulemaking preambles going back to 2006, for federal credit unions the law (as determined by the FCU Act) and philosophy align: the directors’ duties flow primarily to the membership. Id. at 77154-55.

As a practical matter, however, we believe that in the vast majority of situations what is good for the credit union will also be good for the members. See 75 Fed. Reg. 15574, 15575 (fn. 5)(March 29, 2010). . .

 . . .we also believe that fiduciary duties are properly owed to people, and not to entities. FCU directors must understand the people who are affected by the directors’ decisions and identify which people the directors are serving.

The danger is that, if the directors are allowed to focus only on the credit union when making a decision – without regard to how the members are affected – the directors can justify making self- serving decisions, or decisions that serve primarily the FCU’s insiders, under the guise that the directors are simply doing what is best for the credit union.

Ed. (emphasis added)

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How This Story Ends May Show the Future of a Unique Coop System

Oscar Abello, economic editor at the non-profit reporting site Next City, finds instances where credit unions provide “solutions for liberated cities.”  In his latest coverage, the event is a six plus years effort to charter a new credit union for North Minneapolis.

However the end of the story is not clear.   Will there be a new community financial institution, or will the process be stillborn?

Abello poses this fundamental question:  The travails of Arise Community Credit Union, set to be Minnesota’s first Black led-credit union, raise the question: How hard should it be for communities to have their own financial institutions?

The link to his analysis posted on July 11th can be read here.  While recent events are promising, the charter has yet to be granted.

I have three takeaways from his description of this new chartering effort.

Three Lessons

  1. New charters require people with passion and commitment, that is entrepreneurs who believe in their cause. His article profiles Daniel Johnson the CEO-designate who left a successful financial career to serve a clear community need where businesses have been “disinvesting” for years.

Johnson’s motive for leaving his career security: “The community said,(after George Floyd’s death) ‘We don’t want another park. We don’t want another place just to throw flowers. We want something more tangible, something that we can have as an institution that will be around long after we’re gone.’”

  1. In addition to the community’s decline, the market timing was right as Minnesota had just capped payday lenders at 50% APR: One fact: “The average borrower took out nine payday loans, at an average loan amount of $365, and was charged an average of 197% interest per loan.”

The process is not easy as Abello describes:  But chartering a new credit union today is like traversing a long-lost trail through the woods, one that used to be well-traveled but is now overgrown or littered with fallen trees or other obstacles no one has had to navigate previously.

Prior to 1970, there were 500 to 600 new credit unions chartered across the country every year. After a steep decline to near zero, the numbers have never recovered. Over the past ten years, fewer than 30 new credit unions have been chartered across the country.

Changes of leadership, loss of local funding from foundations, the challenges from Covid have led to stops and restarts.   The  Minnesota Credit Union Network and AAUC have stepped up to help.  Credit unions have contributed to a $1.0 capital fund and pledged deposits of several million when up and running.

NCUA is apparently requiring $3.0 million in committed capital based on the credit union’s projections to be $10 million in assets in three years-or a 30% net worth ratio.  This capital base would equate to 50% of the first year’s asset goal of a $6 million balance sheet.  This is an amount not required by law, regulation, or common sense.

In addition to this enormous fundraising barrier, the requirement distorts the fundamental dynamics of self-help for a new charter.   Raising capital encourages investments in fixed assets and operational capabilities that may not be required for years.  It discourages the boot-strapping and learning that must occur when a new  charter reaches out to find the best ways to serve their community.

  1. The chartering process is failing the communities which most need credit union support. Abello points out that “out of 4,700 credit unions across the country, only 500 are self-designated minority credit unions.”

The executive director of the Minnesota Credit union foundation has a new goal from this effort: “One thing that we’re working on right now is coming up with a playbook because the chartering process is quite complex, and really trying to take the learnings that that we’ve had working with Arise and trying to come up with a resource that’s going to be helpful for additional groups going forward.”

Abello tentatively answers the question he posted at the beginning with this observation:

“If a community wants it, if it can prove there is a market for such services that no one else is meeting, and if it can marshall the necessary financial, professional, technological and other resources necessary to pass regulators’ muster, then for now, any community has the right to try and answer the question for itself.”

The obvious answer is few would want to navigate this obstacle course before even entering the market’s fray.

Why did CEO-designate Johnson decide to join a startup in this context of financial consolidation, established competitors and bureaucratic barriers:  “It’s important for people to be able to see that an institution has planted a flag that really represents them and isn’t driven by stockholders.”

In other words:  You own it.  But will that motive be enough to overcome a process that discourages new coop charters?

How this story ends may be a harbinger for the future of the unique credit union financial system.

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The Source for Credit Unions’ Greatest Peril

When concerns are raised about risks to credit unions’ future, the most common threats  are perceived to be “out there.”   The potential for recession,  a continuing rise in rates, cyber threats, technology innovations, or other external marketplace disruptions.

However the greatest challenges may not be external, but closer to home.   In a speech to a major credit union conference, a former NCUA Chairman described his five greatest concerns as:

  1. The combining of the deposit insurance funds;
  2. The possibility of merging the federal regulatory agencies;
  3. Doing away with credit union’s tax exemption;
  4. Abolishing the CLF and having credit unions go into the Federal Reserve bank;
  5. The FFIEC requiring expanding its regulatory disclosures for credit unions comparable to banks.

The concerns are from a speech by Chairman Ed Callahan to the 49th Annual Meeting of CUNA in 1983.  (Source Credit Union Magazine, June 1983, pg 10)

Two lessons.   What Ed describes is exactly the sequence of events that led to the demise of the S&L industry as an independent  financial system.  While the tax exemption was ended in the early 1950’s, the later changes occurred in just ten years beginning in the mid 1980’s due to the system’s inability to transform when facing deregulation.

Secondly,  the five  concerns were being considered  by  entities in Washington D.C.   These included commissions on governmental efficiency and reform,  congressional proposals following deregulation, and both Treasury and opponent’s questioning cooperative’s tax exemption.

These winds are still blowing in DC.   They blow harder every time  terms such as “level playing field” and “parity” are used.

Credit unions can continue to excel in members’ eyes. However, they could  lose in the  political marketplace if their primary goal is to have the same regulatory options as their banking competitors.

Why some in Washington will ask, do we need a separate agency to oversee the same activities?

 

 

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Two NCUA Chairmen Report to Congress on the State of the Credit Union Industry

Following are excerpts from two NCUA chairmen on the state of the credit union system.

Both presentations came following severe economic disruption.  In one case the events included double digit inflation and unemployment levels, plus the highest short term Fed Funds rate ever-in the mid teens.

In the second,  the economy had emerged from a post covid shut down with inflation rising to 9% and a Fed once again tightening.

The two updates were in May before Congressional banking committees, but 40 years apart: 1983 and 2023.

One statement expressed confidence in credit unions, with sufficient agency capabilities and a pragmatic approach for the future.  The primary concern was including credit unions in any potential banking regulation.

The second statement suggests inevitable failures, insufficient agency resources and the desire for “parity” with any  changes to banking oversight.

The question for readers:   Two assessments 40 years apart: Which understanding of NCUA’s relationship with credit unions is most likely to enhance the movement’s future?

We know the answer to the first approach.  What will be the outcome of the second?

From May, 1983: Chairman Callahan’s testimony before the Senate Banking Committee:

The overall condition of FCU’s is “quite good” thanks to the grassroots strength of the CU movement and to the freedom CUs have been given to adjust to local market conditions, NCUA Board Chairman told the Senate Banking Committee.

The committee which is conducting oversight hearings into the conditions of the financial system was told by Callahan that “few if any changes should be made in the existing  CU operational and regulatory environment.”

Reporting on 1982 financial performance Callahan said that savings at FCUs grew by 17.2% and assets rose by 16%.  As a result, CUs increased their share of the overall consumer savings market from 4.25% to 4.5%.

“I’m pleased to report that deregulation really works,” Callahan said.  “It’s time to leave the credit union system as it is for a while and observe the results.”

The committee is considering  potential changes in the financial industry and Callahan warned against the tendency to apply these changes to CUs.   “CUs, he said, “come from a different mold.  The biggest threat to the movement is not competition, but homogenization to the financial services industry.”

(Source:  Credit Union Magazine,  June 1983, pgs 19-20)

Excerpts From: Chairman Harper’s Written Statement to the House Banking Committee, May 16, 2023:

Legislative Requests

The recent failures of Silicon Valley, Signature, and First Republic banks are a reminder of the dangers of concentration risk and the need for effective risk-management policies and practices to manage capital, interest rate risk, and liquidity risk. These fundamentals have remained true throughout all economic and regulatory cycles and have recently been areas of supervisory focus for the NCUA. Credit unions that fail to manage these core issues can and will continue to fail. . .

Accordingly, to better manage such liquidations in the future, the NCUA requests amendments to the Federal Credit Union Act to provide more flexibility to the NCUA Board to manage the Share Insurance Fund, bringing the fund’s operations more in line with those of the Deposit Insurance Fund administered by the Federal Deposit Insurance Corporation (FDIC). Likewise, as Congress considers amending federal deposit insurance requirements, the NCUA supports maintaining parity between the Share Insurance Fund and the Deposit Insurance Fund. . .

Specifically, the NCUA requests amending the Federal Credit Union Act to remove the 1.50-percent ceiling from the current statutory definition of “normal operating level,” which limits the ability of the Board to establish a higher normal operating level for the Share Insurance Fund. Congress should also remove the limitations on assessing Share Insurance Fund premiums when the equity ratio of the Share Insurance Fund is greater than 1.30 percent and if the premium charged exceeds the amount necessary to restore the equity ratio to 1.30 percent.

 

 

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How a Black Barber in Little Rock, AR Started a Credit Union

The first new charter in Arkansas in over a quarter of a century is the focus of a new podcast.

Arlo Washington is a barber, a self-made man who turned his entrepreneurial instincts into helping his community.

The story of People Trust Community FCU, chartered in September 2022 is told in this 30 minute podcast by the reporter Oscar Abello from Next City and Arlo Washington the credit union’s founder.

Hearing the story in their own voices, brings to life the challenges and promise of a new credit union.

The context matters.  Payday lenders were shut down by Arkansas in 2010.  Arlo had started a barber college and by necessity and local tradition became a lender to his customers.

The reporter states there have been just 25 new charters in the last ten years. He points out in the 1970’s there were hundreds of new charters  granted per year.

Today Arlo describes the chartering effort as “intimidating, scary and tedious.”  The endgame was to have “local ownership in the banking system.”

“If we’re ever going to close the racial wealth gap, we need financial institutions that understand neighborhoods and can meet their community members where they are in the process of building their financial well-being,” says Washington.

This example of a small lending enterprise adding a credit union is a model that could be replicated many times in other underserved communities across the country.

 Seeds of Hope at the Grassroots

Planting seeds  whether in a garden or in our communities’ choices is the practice of hope.   Seeds that will grow and flourish to make lives more colorful and abundant.

There are more Arlo Washingtons throughout America who want to become gardeners for their community.  How do we reach out to them?  And grow our grassroots?

 

 

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Why an Oath for Credit Union Directors and Officers is Desirable

Boy Scouts have a pledge.  Couples exchange wedding vows.  Deacons, elders and lay ministers all affirm belief before the laying on of hands and becoming church officers. Naturalized American citizens take an oath-even agreeing to bear arms.

These ceremonies signify individual commitment in a public setting for the people they serve or community they join.  There are responsibilities in an oath, whether occasioned by election, by appointment or by personal choice.

Faithfully Discharge the Duties:NCUA’s Oath for Employees

All NCUA employees are required to take an oath upon accepting their positions.

This oath is administered by an NCUA employee, usually in the HR division, during new employee orientation on an employee’s first official day. Here is the text:

I, [state your name] do solemnly swear (or affirm) that I will support and defend the Constitution of the United States against all enemies, foreign and domestic; that I will bear true faith and allegiance to the same;  that I take this obligation freely, without any mental reservation or purpose of evasion; and that I will well and faithfully discharge the duties of the office on which I am about to enter. So help me God.  (emphasis added)

Duties, faithfully carried out.  Faithful performance is itself one aspect of the standard liability bond for credit union coverage.

A State Example:  OATH OF A CREDIT UNION DIRECTOR

Pursuant to Revised Code 1733.10, I, the undersigned director of NAME Credit Union, located in City, Ohio, do solemnly swear/affirm that I will diligently and honestly administer the duties of the office of director and that I will not knowingly violate, or permit to be violated, any law applicable to the Credit Union.

As a director, I have a legal responsibility and a fiduciary duty to credit union members to administer the Credit Union’s affairs faithfully and to oversee its management.  In carrying out my duties and responsibilities, I shall exercise reasonable care and place the interests of the Credit Union before my own interests.  I shall fulfill my duties of loyalty and care to the above named Credit Union.

I shall ensure that I learn of changes in statutes, regulations and policies of the Division of Financial Institutions and other applicable regulatory agencies affecting the Credit Union which affect my duties, responsibilities or obligations as a director and regulated person of the Credit Union.

I understand it is my responsibility to attend meetings of the Board of Directors and participate fully on all committees of the Board to which I am appointed.  I understand it is my responsibility to review the examination reports of the supervisory authorities at the next succeeding board meeting after the receipt of the reports.

Signed and notarized by each director.

The Current Status of an FCU Oath

The following was the response when I asked NCUA if FCU directors were required to have an oath:

The answer is no. There isn’t a required oath of office for federal credit union boards of directors in the Federal Credit Union Act or Federal Credit Union Bylaws.

Our legal team reviewed the current bylaws, the previous version (Timeframe of the mid to late 1990s, with amendments), and even earlier versions of the Bylaws from the 1930s to 1940s. None of these documents require an oath of office.

Also, an oath of office is not something we track in regulatory reporting like the Call Report or Profiles. As such, I don’t have any information on which federal credit unions, if any, administer an oath of office.

While we don’t have specific rules on this topic, the NCUA has received and considered the question of an oath of office before. The attached 1985 NCUA legal opinion says an oath of office is allowed because it would not conflict with the Federal Credit Union Act or Bylaws for a federal credit union to require directors to take an oath of office. 

Why An Oath is Desirable

Leadership of a credit union is a responsibility to  members, the community and those who in generations past created the cooperative as an enduring organization to pass forward its legacy of wealth and service.

Sometimes the concept of a “volunteer” has connotations of a position that can be taken or left at will.   Duty is voluntary.  Anyone can step up.  The responsibility is institutional and collective, not individual.   Except for a number of state charters, directors are not paid, which is sometimes interpreted as an absence of individual accountability.

Cooperative board leadership now involves oversight of trillions of dollars member-owned assets.  The directors’ roles are becoming more consequential for members and communities.

Moreover there are unique aspects in cooperative leadership:

  • Awareness and implementation of cooperative principles;
  • Recognition and respect for democratic member governance;
  • Adherence to bylaws and numerous regulations specific to credit unions;
  • The absence of any federal tax liability.

Moreover, the traditional director duties also still pertain including the standards of loyalty, care and the fiduciary obligation to act in good faith.

An Oath as Promise

An oath ideally in public at the annual meeting would be an act of honor and commitment.  It signifies both responsibility and accountability even as volunteers.

Credit unions are a part of a society that at times has differences about the priorities of their leaders.   Oaths remind all of our common obligations.

An oath is a promise.  In the NCUA’s example it comes with a sacred commitment-so help me God.  It would elevate the moral and communal character of cooperatives.

A person when taking an oath acknowledges the responsibility, not merely the public honor,  of their role.  The commitment is elevated beyond the routine director tasks of attendance and oversight.

All oaths remind us of who we are and what we want to be.

They show a solemn undertaking with commitments to the past and future, not just today’s agenda.  It is another way to show how the cooperative model stands apart from for-profits.

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Two Trends Deserving Debate

At the NCUA’s May board meeting, one trend jumped out at me.  Not new, but accelerating and read without comment.

In the first 90 days of 2023 there were 59 NCUSIF charter cancellations.  That is a rate of almost 5 per week, one every business day.  Without exception these charters are decades old, some surviving and most thriving.   Why?

These charters are the handiwork of generations of volunteers, whose current leadership have decided to give up.  It is a morale and ethical problem.   For it undercuts the coop premise that pays forward the members’ collective legacy for which the present leaders are  now the steward.

Many will suggest that the credit unions members are in better hands.  However these hands are not the leaders they know or elected, nor the organization that created their collective reserves.  Every charter cancellation eliminates an example of economic self help, self finance and self governance.

In most cases these are locally focused institutions which created unique relationships with their communities.   Financial services may continue, but not from the same roots.   Another civic organization so essential to a vibrant democratic political economy is no more.

What Can Be Done

Regulators should put the same time and effort into requests to cancel charters that  they extend to new charters.  If a merger is the strategy, show us the plan.  If the volunteer leadership is giving up, ask members for new volunteers.  If the sponsor has moved away, then seek a new group for re-energizing the charter.

Today the regulators have endorsed an exit strategy that benefits only the senior leaders who leave the membership in the lurch.  And retiring CEO’s especially, are taking advantage by transferring their legacy to another credit union, often for just a few more silver coins.

When quitting a business or long standing effort is easier than getting in, the movement will continue to close future growth options, create higher concentrations of risk, and remove financial services away from their local connections and knowledge.

No charter should be cancelled without an effort to find others who are willing to pick up the opportunity.

A Second Trend to Be Re-energized

No brand, business or opportunity can continue without the support of the next generation of consumers.

Student run and led credit unions have been part of the educational and financial services of cooperatives from the beginning.

Yesterday I learned about a scholarship program to identify young persons often from disadvantaged backgrounds (poverty, refugees, disabled) who are given the opportunity to become part of a special education effort.

The premise is that brilliance is equally distributed in persons,  but opportunity is not.  The focus is on 15-17 years old.  This is an age when  “ideation,” the willingness to consider new ideas and become doers is formed.

This educational support is for four years.   The time frame for measuring success is in decades.  It may take ten years or more to see if those chosen in the program will become leaders in their chosen professions.

The program called Rise recognizes that leadership will be manifested in many different ways but over time.  But the investment in this generation must be made now.

The cooperative model is designed to attract this kind of self starter.  But today again, the regulatory community discourages new charters.  The application has become a compliance drill, not support for people with passion to serve a community.  The next student chartered credit union will be the first since the 1980’s.

In the meantime these young change makers are engaging their start up  fervor elsewhere sometimes in other innovative finance-related endeavors.

The Common Thread

Credit union leaders, regulators and professional staffs, have become captured by the short term focus that drives most performance reporting.   What are the latest quarterly numbers?  How will we expand the market reach of our FOM?   What Fintech partner will give us short erm lead on innovation?

All these efforts while necessary overlook the longer term outcomes.   Without  this awareness, the movement will become just another increasingly concentrated, and limited,  financial service option in ten years.  The number of active charters will be halved.

Tomorrow’s  innovative financial models will have been created by the high school and college generation outside the movement. Credit unions will be seen as  old fashioned “banking” firms just tending to their own, stand alone, self interests.

Both of these trends today are shaping what the movement will be a decade from now. There will be other cooperative solutions designed to serve consumers’ financial needs; however they may not be called credit unions.

 

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The More Things Change, the More Things Stay the Same

The NCUA’s May board meeting’s most important item was the NCUSIF update.  One slide  highlights why many credit unions are skeptical of the agency’s ability to evaluate its actions as circumstances change.

This  slide states that the Agency’s investment policy will go back to the same 10-year ladder in effect before the current banking and liquidity crises.

Since the March 2022 Federal Reserve  rate increases to counter inflation. many portfolio managers reported large declines in  the market value of  longer term investments.

In most cases, credit unions can  choose to “wait out the cycle” rather than sell and realize an investment loss.  This is because credit unions have multiple balance sheet options to ameliorate the impact on net interest income from holding assets with below market earnings.

However, over this last 18 months of rate increases, many portfolio managers have reviewed their policy assumptions that led to this illiquid situation. When cash flows again generate excess investable funds, I know of no one going back to what they were doing before this cycle began. Lessons are being learned.

This latest interest rate cycle has overturned many market assumptions drawn from the historically low rates in the post 2008-9 financial and then covid crises.  One expected outcome is a higher “normal”yield curve than experienced over the past decade.

The More Things Change  . . .

In the May NCUSIF update, the data show that the NCUSIF’s portfolio has a market loss in each  tranche of its investment ladder. This includes even the very short term amounts under one year.

Yet, as stated in the policy above, the intent is never to have to borrow or sell at a loss.   A difficult goal with ten year investments, a period which will likely experience several interest rate cycles.

The Fund’s  yield for the March quarter is 1.75% or approximately 3% below the overnight rates in the same quarter.

Every 1% below market yield results in an annual revenue loss to the fund of $200 million. NCUA’s only change in its portfolio ladder strategy was announced last fall.  It  paused term investments until the overnights reached $4 billion.  How this amount was determined was not explained.  Nor its impact on overall return or weighted average life.

Below Market Returns Lasting Years

In the May meeting, no board member commented on the Fund’s below market returns and unrealized losses. Board member Hood asked how long it would take for the portfolio to return to par value if the current rate structure became the new normal.  The response was three years, which is the portfolio’s current weighted average life.

Whatever the time frame for a new normal to settle in,  the NCUSIF and its credit union owners are facing below market returns for many more months, if not years.  The portfolio yield is the Fund’s principal, and in most years, only revenue source. The portfolio’s positioning hurts both fund performance and credit union potential dividends.

The only IRR/ALM analysis the NCUSIF provides in its monthly updates is the total portfolio gain or loss versus the current market.  Since December 2021, this indicator has been negative reaching a peak of  $1.8 billion in 2022.  At March 2023 the valuation loss was still $1.4 billion.  Why this very  obvious trend did not cause an assessment of the strategy before the pause in late 2022, is not clear.

The More Things Stay the Same

So what is the staff and board changing as a result of this eighteen months of  NCUSIF’s declines in portfolio value and below market yield returns?

The answer in the Slide is clear: “Once overnight target ($4.0 billion) is met, plan to return to slow buildout of (ten-yer) ladder.”   No board member questioned this approach.  By remaining silent, the board members consented to going back to the same practice that is leading to years of underperformance.

The Distressing Part of NCUSIF Oversight

The dilemma is more than hundreds of millions of lost annual revenue  from a below par portfolio. Those numbers are large and do matter to the Fund’s soundness.

But there is  a much larger challenge: no one is accountable for NCUSIF performance.

Even though CFO Schied presents the numbers he  references other offices when giving specific responses:  the economist for share growth estimates; E&I for the loss expense numbers using an undisclosed model; and legal for lack of clarity for true up options, etc.

The NCUA board  speaks with different views on the fund’s situation.  The Chair says he learned in school that when interest rates rise, bond prices fall. Therefore the Fund’s decline is just what we should expect.  That remark overlooks the whole IRR  risk management responsibility.

Vice Chair Hauptman characterizes any change to the ladder strategy as “trying to time the market.”  Hood’s questions are more targeted, but their import often seems lost on staff.  Example: why the true up mattes.

The distressing aspect is that any real changes to this extended underperformance seem to be fading off into the sunset. In contrast,  the entire industry is actively evaluating its ALM investment assumptions and policies.

Within NCUA committees are formed, policies reviewed, expert and even sometimes cu opinion sought, but there is no person sitting where the buck stops. It’s how bureaucracy functions.  When staff doesn’t know what to do, or the Board can’t agree, nothing changes.

If May’s NCUSIF update is  the best NCUA can do, credit unions should worry about the future of their Fund.

A Past Lesson

After the recapitalization in 1984 there was one practice that may resolve the current status quo approach. One person was responsible for the monthly update and explaining all expenses, reserves and future outlooks.  That person was not the CFO or the head of E&I, but Mike Riley,  He had total performance accountability even when it involved recognizing losses from problem cases.

Today the ideal solution would be for the Executive Director to provide the NCUSIF update. Regardless of how inputs are gathered the process needs a single point of responsibility.

Now no one is accountable.   By dividing NCSIF inputs  into multiple reporting sources, the CFO update  is merely a reporting role.  There is no  responsibility assumed even for accounting issues.

Appointing a single person for Fund accountability is the most critical change the Board could make.  Then the numbers might have real coherence.

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A Disturbing Slide in May’s NCUA Board Meeting

If the CFO came to your May board  with a forecast that the credit union’s retained earnings margin would fall by 50% in the first six months of this year, it would get your attention.

That is what CFO Schied presented in the slide below showing a decline in the NOL from December’s 1.3% to 1.25% by the end of this June.  That would be halfway to the 1.20 NOL floor at which the NCUA must come up with a restoration plan.

As summarized in my earlier report, all of the actual credit union CAMELS data, the NCUSIF financial position and other accompanying information was good news.  Especially in the context of the first quarter banking failures and the continuing risk in interest rates.

Board members acknowledged the actual resilience of the cooperative system but then picked up the forecasted alarm.

Chairman Harper suggested the actual data was just “the calm before the storm.”

Vice Chair Hauptman opened his comments stating his objective was to protect “the taxpayers” from NCUSIF failure.

Only board member Hood attempted to get behind the numbers.  He asked how the $12 million  loss reserves expense was determined and the status of proper presentation of the 1% true up.  The answers were a polite stonewall.

Similar to a credit union’s net worth, the NCUSIF’s reserve ratio is an easy shorthand for its financial position.  The calculation is straight forward.   The ratio is simply retained earnings divided by the insured shares at the same date.

This ratio was 29.1 basis points or .291% of insured shares at December 2022.  As of March 2023 the ratio was 28.8 basis points. This .3 of one basis point minimal decline in the first 90 days is a far cry from the 5 basis points projected above.

The projected ratio in slide 8 is a made-up number. Its relevance depends on the assumptions used.  The estimated growth of insured shares to $1.75 trillion is a 7.2% twelve month increase from 2022.  The actual rate of increase as of March 2023 from the year earlier was 2.2%.

The addition to retained earnings for the quarter ending June is just $6 million versus a net income of $41.7 million in the NCUSIF’s just reported March quarter.

The final number in the numerator is the 1% deposit.  The calculation above reverts back to the six-month-old December 31, 2022 total deposits. By using this out-of-date number this invented ratio understates the actual 1% deposit total due from credit unions.  Including this six-month-old deposit liability misstates  the actual ratio and cash due.

The slide’s 1.25%  manufactured outcome became the lead in several press reports. It misinforms about the trend in the NCUSIF’s financial position. The ratio’s assumptions were not explained even though they were significantly different from actual trends through March.

Monitoring an accurate Fund equity ratio matters.

Per stature, the actual NOL is calculated at yearend to determine whether a dividend must be paid should the fund’s reserves exceed the NOL cap. The number is also the floor from which a potential premium could be assessed to increase the NOL to a maximum of 1.3% of insured shares.  Getting this NOL right is vital for every credit union.

More critically the use of a number from an earlier accounting period to compare with a current period’s insured risk total does not align with standard GAAP accounting practice.

Two Accounting Examples

There are direct accounting precedents with GAAP for how the 1% true up should be reported.  They show that the concurrent presentation of insured risk and the legally required true up of the capital deposit base is standard industry practice.

The first example is Deloitt & Touche’s audit of  ASI’s required deposit an identical structure to the NCUSIF.  From the December 2022 ASI audited financials:

In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the Company as of

December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.   Deloitte & Touche, LLP April 11, 2023

And regarding the deposit requirement:

Participants’ capital contributions that are receivable or payable as of December 31, 2022 and 2021, are presented on a gross basis in the accompanying consolidated financial statements. Included in participants’ equity at December 31, 2022, is a receivable for capital contributions of Primary-insureds of $2,530,000 (no payable). The receivable and payable balances result from annual growth or shrinkage in participating credit union shares and the receivables were substantially collected subsequent to December 31, 2022.

Included in participants’ equity at December31, 2021, is a receivable for net capital contributions of Primary-insureds of $25,200,000. The receivable and payable balances result from annual growth or shrinkage in participating credit union shares and the receivables were substantially collected subsequent to December 31, 2021.  (page 13, Notes to the Consolidated Financial Statements)

The second example is the recognition in the NCUA’s Operating Fund of an “account receivable,” on the balance sheet and the income statement in its monthly statements postings.

From the January 30, 2023 NCUA Operating Funds monthly financial statements:

The cash position is considered sufficient to cover current and future budgetary obligations of the Fund through April 2023, at which time the Fund will collect the 2023 operating fees from its credit union members. . . Operating fee revenue reflects one twelfth of the 2023 Operating Fees.

A longer explanation of this accounting presentation for the expense receivable in the January 2022 statement:

Other accounts receivable, net had a month-end balance of approximately $10.5 million. Its balance increased by approximately $10.2 million from prior month primarily due to the unbilled receivable for the 2022 Operating Fee. The Operating Fee will be invoiced in March and collected in April.

In other words the Operating Fund recognizes a net receivable and records one twelfth of the total operating fee as income each month even though the fee is not invoiced till March and collected in April.

In these instances the amounts legally due are presented as receivables in ASI and NCUA’s    respective audited financial statements and monthly financial presentations.

The 1% True Up Topic Raised Again

Board member Hood asked again about the status of the external assessment of accounting options the NCUA board requested in 2021. CFO’s Schied characterized this external memo saying:  “Each option was “non-optimal.”  An unusual accounting conclusion.

NCUA has refused to publicly release this expert review under FOIA.  What options were reviewed, what data or precedents referenced, and how were the pros and cons presented?

The current practice leads users of the information astray. It potentially shortchanges credit unions’ dividends. NCUA self-interest is keeping the status quo.  The memo should be published for all to evaluate.

The credibility of NCA’s oversight of the insurance fund is a function of the legitimacy of the numbers and explanations it provides. If NCUA is not able to present the Fund’s position accurately, at a minimum it leads to misleading conversations.

How an Inaccurate Number Distorts Discussion

The fabricated 1.25 NOL ratio forecast as of the end of next month led to several illusory discussions and unfortunate public headlines.

One board member commented how the Fund’s “margin was narrowing” before “taxpayers will have to pay.”  That unfortunate characterization shows the importance of knowing real numbers.  In the first 90 days of 2023 the ratio had changed by just .03 of one basis point.

Moreover the only “taxpayers” who are legally bound to support the NCUSIF are members of credit unions. Each sends 1 cent of every savings dollar in their credit union’s 1% deposit in the Fund.

The board member’s observation that “there is not a lot of room between 1.2 to 1.3 equity” unfortunately mischaracterizes the fund’s actual operating performance since 1984.  The long term insured loss rate for the fund is just over 1 basis point.   Even in the 2008-2010 the net cash losses from natural person credit unions were 3.5, 2.0 and 3.0 basis points of insured shares.  The highest cash losses in the three years was $228 million, nowhere close to the “billions” response in the meeting.

In the most recent four years (2019- 2022) which includes the Covid crisis, the economy’s total shutdown and a rising rate cycle, the highest loss from “old school failures” was .3 of one basis point.  In 2021 the Fund reported actual net cash recoveries.

An accurate presentation of past and current NCUSIF performance is important in understanding the unique design and resilience of the NCUSIF.  Because of this collaborative resource, the credit union cooperative system is much more stable than FDIC insured bank premiums.

The Fund’s relative size to insured risks remains stable in all circumstances.   The 10 basis point guardrails (the 1.20-1.30 operating ratio range) today equates to almost $1.8 billion. For comparison, the NCUSIF’s entire total insured losses from 2008 through 2022 were $1.9 billion.   The operating expenses in this same period were over $2.4 billion.

The legislative guardrails were put in for a reason.  Credit unions feared that open ended funding would just lead to unchecked spending by NCUA.  This is what has occurred through increasing the Overhead Transfer Rate allocation to shore up the agency’s ever increasing budgets.

Constantly rising expenses, not insured losses, are the Fund’s largest drain on reserves.

Everyone Can Project NCUSIF Yearend Outcome

Forecasting the NCUSIF’s yearend NOL ratio is simple.  Here is the link to a spreadsheet anyone can use. If any difficulty using, please email.

The inputs are portfolio yield, share growth, NCUSIF net income, insured loss and whatever assumptions a user believes are consistent with present trends.  The current numbers include the latest actual NCUSIF updates through March 2023. It projects a yearend NOL of 1.2917.

Tomorrow I will review one other slide that is vital to understanding the Fund’s management.

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A Commentary on  NCUA’s May Public Board Meeting

Even though NCUA’s public board meeting yesterday had a minimal agenda of two items, comments completely scripted, and outcomes pre-determined by design, there is still much to be learned from the live session.

As one NCUA Board member stated, all who are subject to the board’s authority can see if  it is carrying out its  “fiduciary duties” in a thoughtful manner.

Were the presentations documented with relevant and timely information? Were key issues raised? How knowledgeable were staff and board with the subjects?

While reports of the prepared remarks or occasional comment are helpful, there can be much more to be seen from the public “performance.”

The Context for the Meeting

The two agenda items were the quarterly NCUSIF update and a proposed change to the charitable deduction accounts (CDA’s).

However the external context was especially relevant. In addition to the continuing economic and financial uncertainty there is the current government debt ceiling political impasse.  Would the many  government employee focused credit unions  be affected by a temporary halt of payments?  This topic was not raised.

The Good News

Despite political and financial uncertainties, NCUA’s field  examiners reported the lowest percentage of code 4 and 5 rated credit unions in decades: just .29% of insured shares.

How did this happen? Are credit union leaders just better managers than their competitors? NCUA a more effective regulator? Or credit unions just lucky at this moment?  What one board member cryptically called the “calm before the storm.”

Only Hood provided an analysis for the current state of the system:

 Our public financial postings and disclosures and credit union performance highlight the unique character of the cooperative system—a system that was the basis for rejecting the FDIC premium models in years past and still in use today and designing a uniquely cooperative approach. The credit union system is a unique financial system, and our regulatory and Share Insurance Fund framework should reflect this.

Certainly the data summarized is great news in the current context. But end of story?  No.  A number of explanations and  data points offered were unexamined.  Questions would have demonstrated a better grasp of several critical areas of NCUA board oversight.

Issues Left open and Questions Not Asked

 

CFO Schied’s fund NCUSIF update was a literal reading of numbers from ten slides with no accompanying analysis.

He did point out that the number of NCUSIF insured had declined by 59 in the quarter.  In contrast the board complimented staff on granting a new charter.

However no board member spoke to  the critical question.  Is this rate of  annual decline of over 200 credit union charters acceptable?  For any industry opening 1-3 new locations a year while shutting down 200 which existed for decades, raises the question: is the system sustainable?

Some would respond that this trend is OK because these are mostly smaller mergers and total credit union members keep growing.

However from the member-owners’ perspective, these are 200 charter failures. Suggesting a chairman’s award for a new charter or two would seem a miss-focus compared to the oversight of 200 charter closures.  Reducing charter cancellations would seem to be the first priority; getting a new one is a multiyear ordeal.

The CLF and Credit Union Liquidity

 

All three members mentioned the need for  Congress to again restore the CLF’s temporary Covid era authority.  This has been supported by the assertion that over 3,000 credit unions under $250 million now lack CLF access.  A status only Congress can fix.

I believe this constant tossing the ball to Congress’ lap for CLF coverage overlooks NCUA’s primary responsibility for the situation:

  • For four decades all credit unions were CLF members under existing legislation that is still in place. It was NCUA’s actions that closed down this solution.
  • There has been no credit union borrowing from the CLF since 2009. That borrowing was via the NCUSIF for US Central and WesCorp.
  • Today smaller natural person credit unions rely on two primary sources: the corporate system and FHLB.  Even when the recent banking liquidity crisis occurred, there was no CLF effort to match the Fed’s Bank Term Funding Program (BTFP) which offered all comers loans up to one year in length.

The CLF has been missing in action for two decades. The NCUA has not  collaborated with corporates or credit unions to design a CLF  that credit unions would see as vital and relevant. The FHLB system, a cooperative model, has done this well. The CLF’s liquidity design is not a Congressional legislative issue.  It is an NCUA leadership and management  responsibility.

The NCUSIF’s Performance

The single most critical aspect of NCUSIF performance is the management of its investment portfolio, its primary revenue source.

For the first quarter revenue grew by 49% versus the year earlier.   However the YTD yield was only 1.75% or roughly 3% below the first quarter’s overnight rate.  In November 2022 NCUA staff announced it was pausing its ladder strategy until overnight funds reached $4 billion.  There was little information how this amount was determined and why?

The critical topic is what has NCUA learned during this ongoing rate cycle that would affect how it approaches future activity. When asked about this, CFO Shied said the fund followed a SLY investment policy.  After the $4 billion level is reached it would then go back to the 10-year ladder.

When asked how long it would take the fund to achieve par value in the current rate environment, he replied three years. He listed the required cash flows of $400 million, $700 million and $1.0 billion in that period. That corresponds to the current wighted average life (WAL) of 3.0 years.

Should the current rate situation become a new normal, then  NCUSIF revenue will have recorded below market returns for over four years since the Fed began raising rates in March 2022.

Every 1% of below market yields costs credit unions $200 million annually on the NCUSIF’s $21 billion portfolio.  The current 3% under market yield results in a $500-600 million annual revenue shortfall that will continue until rates normalize and the portfolio reprices.

This revenue gap is twice NCUA’s total annual budget.  It is a performance shortcoming keeping credit unions from reaping the returns from their fund 1% underwriting.  This revenue shortfall is a safety and soundness concern that affects the system’s overall stability. It is not a design flaw, but a management responsibility.

Managing IRR risk, and related fund revenue, is the NCUSIF’s top responsibility.  It should be guided by two questions:

  1. How soon will I need the money? Ans. There is no way to know this, which means there should be a bias toward more, not less liquidity, whatever the interest rate outlook.
  2. What is the earning’s goal for the portfolio? Ans. We know from the fund’s loss history, long term rate of share growth and budgeted operating expenses, that a yield of 2.5-3.0% would  maintain a 1.3% NOL in virtually all scenarios.

Moreover in years of low losses the Fund should pay a dividend. That was the mutual commitment for credit unions to support the NCUSIF’s perpetual underwriting with a 1% deposit.

The essential NCUSIF management skill is IRR monitoring.  Compared with a  credit union’s ALM challenge of managing the two sides of a balance sheet and forecasting net interest income or the economic value of equity, the NCUSIF responsibility is a straight forward.  How should the WAL be adjusted given the two questions above and rate outlook?

The Fed’s rise in rates was announced in advance.  The speed and amount may have caught many portfolio managers flat footed, but the take away should be to enhance IRR, not revert back to a rote formula that is costing credit unions hundreds of millions in lost revenue.

To not address this critical aspect of NCUSIF performance and just accept the intent to go back to the old ways of doing things once the $4 billion goal is reached, is an oversight failure.

The CDA Proposal’s Data Omission

 

The second board item was one page long.  It was a proposal to add more eligible organizations for CDA donations beyond 501 C 3’s.  The specific suggestion was 501 C 19,  nonprofit groups serving veterans.

The proposal would seem reasonable.   However the discussion was made in a vacuum. There was no information provided about this ten year old incidental power to know the scope of the policy decision.   How many credit unions have this account?  How much do they contribute?  What data indicate this authority is actually working as intended?

The 5300 quarterly report has some data. At March 2023 there were 278 credit unions holding  $1.4 billion in CDA accounts.  Seventy-four credit unions had added this account during the past year, and thirteen had dropped it.  Total balances had increased by $85 million or 6.5%

When asking for public comment, it is important to provide  data relevant to the issue at hand. How is this authority benefitting members?

One board member stated the rule’s intent was to provide higher returns by allowing investments not authorized for the credit unions to use in their own portfolios.  The theory was that the expected higher return would allow credit unions to make donations without impacting their net income.  Is that what is happening?

In making policy recommendations there should be a data context, especially when information is easily available, so that commenters can know the impact of what is being discussed.

Next week I will return to the most important discussion that didn’t happen with the NCUSIF.