Category: NCUSIF

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One More Time: How Does $13.6 Million Vanish without a Trace?

The Creighton FCU insolvency resulted from the sudden discovery of a $13.6 million hole in this reportedly $67 million asset credit union.  The failure, NCUA’s largest in 2024, is apparently an unsolvable mystery.  One in which the only suspect has  died.  As I first posted, NCUA has provided not a single fact about where any of the money went.  Just speculation.

More incredible is the IG suggestion that there is no money missing, just a bunch of accounting errors. Moreover, no one seems very curious about finding out where money went. In the IG response to the Congressional inquiry he opens with the statement:  “my office was not required to perform a material loss review. Additionally, NCUA informed us that the agency was not required to conduct a post-mortem review.”  In other words, don’t look for any answers from us.

The one IG explanation is that the CFO, who died in April 2024 leading to the shortfall’s discovery. was covering up actual operating losses for up to 26 years. We’ll examine this idea later.  In the IG’s summary review, no one within the credit union or NCUA  examiners and external  CPA auditors apparently saw any indications of irregularity during  three decades.

The IG further assures Congress that an over “20 year review” of the CFO’s family records reveals no unusual credit union cash diversions. Yet this is still the person who carried out this cover up apparently alone, fooling every check and balance and division of duties for such an extended scheme.

Blaming a person no longer around, and who apparently took no funds, feels too convenient.  Let’s look at the plausibility of the IG’s theory and facts we do know.

The Cash Came In

We know the members deposited the cash and the funds which went missing.   When the $13.6 million shortfall was discovered, this hole was covered by underreporting shares by an almost equal amount.  Shares balances in the March 30, 2024 call report were $61 million.  Ninety days later the total reported by NCUA in their exam and the June call report  was $74 million.  This is the exact total change in net worth. And the same order of magnitude ($74 million) for Creighton members’ share liability when merged with Cobalt.

But where did the cash go?   Here is the IG’s “official explanation” after reviewing all the information he reviewed:

NCUA officials believe the credit union failed due to bad accounting and financial statement fraud. The large deficit was hidden by the former CFO who exploited Creighton’s weak accounting system that allowed back posting, forward posting, deleting transactions, and hiding general ledger accounts when generating reports. Because no money was found to have left the credit union through this, NCUA officials believe the former CFO committed the fraud not for personal financial gain, but to make the credit union appear to be thriving in the eyes of its Board and membership.  

The IG’s “Thriving by Hiding” CFO Motivation

Reread what the IG just asserted.  Although we know the $13 million member deposits came in, “no money was found to have left the credit union.”   This CFO was cooking the books just to hide operating losses for 26 years.  This is what the IG wants us to believe?

Cash shortfalls creating a cumulative deficit can only occur if the credit union pays out that cash in some form (hidden operating expenses, fraudulent loans, fake withdrawals, phoney investments etc) What were those payouts? Some entity or person received these cash diversions hidden by accounting coverups for decades.

A brief IG reference is made to the management of the credit union’s 150 ATM’s for which the accounting was difficult to reconcile.  This should have prompted questions such as, what accounts were used to fund the ATM operations?  Who managed the cash deliveries and cash drawer balancing when machines were serviced?  Was there an external servicing contract or were cu personnel responsible? The IG letter states:  Fraud auditors reviewed ATM and lease payment accounting transactions. The regional director stated that the ATM accounting was extremely complicated due to Creighton having over 150 ATMs and the multiple ways in which income and expenses could be divided.”    

The IG statement is an NCUA and auditor admission they could not figure out what was going on. Managing 150 cash receiving and paying ATM’s is similar to having to reconcile 150 teller cash drawers periodically.  Cash comes from deposits and checks, and cash is with withdrawn by members from their share accounts.

NCUA’s Regional Director is reported to find that “ATM accounting was extremely complicated.”   This is what should be expected from covering up a missing $13 million.  But not a single instance of imbalance or shortfall is cited.   Or even a reference to how the machines were managed.

And the closest we get to the smell of a smoking gun is not from NCUA or outside auditors, but from Cobalt which is quoted in the IG report:

“NCUA officials advised (note the passive voice) that in early October 2024, they learned from Cobalt that after the merger, Cobalt determined that the former CFO understated expenses related to the ATM network to artificially boost Creighton’s income statement to appear to achieve a steady net income.  The IG continues:

“Cobalt surmised that the former CFO was either not booking the monthly ATM expenses at all or was severely understating the expenses. Cobalt indicated the ATM costs alone should have been $255,000 each quarter. They determined the CFO booked around $120,000 per quarter to the office Operations account. Cobalt officials explained to NCUA officials that this would account for an approximate $500,000 to $550,000 reduction in net income per year if no other expenses were booked to the Office Operations account. 

Cobalt officials explained that over more than 26 years, such an understatement would easily account for the $12.5 million deficit.”

One can only say Wow! to this explanation from Cobalt.  NCUA did not make this finding. ATM expenses are for cash outlays for withdrawals and network operations.  The bottom line is that someone or some entity was paid the money.  Who wrote and signed the checks for these underreported expenses? The IG report makes it appear it was all just confusing bookkeeping.

Putting the Blame on a Fall Guy

Cash from members shares came in and $13 million cash ended up missing.  For 26 years it was all the “fault” of a person no longer living.   Which means that all of those who were simultaneously responsible for the safe and sound operation are let off the hook.

Among these listed in the IG letter are the CEO of 32 years, a senior accountant, the board, the supervisory committee, the outside auditor, special auditors and multiple NCUA officials from the supervisory examiner, problem case officers up to the RD’s office.

These were not just persons called in to observe a financial autopsy. They were directly responsible for this institution’s safe and sound operation  in their various  capacities in the many years before this failure came to light.   Yet we read not a word about their roles including the person who oversaw the CFO and his senior accountant staff this entire time.

The Reported and Reconstructed Net Income

Here is what we know from the most recent eleven yearend call reports prior to June 2024.

Creighton FCU’s Reported Financial Performance

OK performance, but certainly not world beating.  If one believes the IG’s theory, then the real result in this most recent eleven years was an operating loss of $5.5 million from ATM “expenses” plus false net income of $2.0 million. A $7.5 million difference somehow  hidden by creative accounting.

However if one presumes a steady cash diversion as the problem, then adding back the estimated $500,000 or more per year means the credit union actually made $7.5 million—most of which was “expensed away.”  This earnings  would equate to an average ROA of 1.2% or four times the net in the call report.  And a reasonable possibility.

The cash from member share growth came in. The cash went out the door as an “operating expense” somehow, somewhere.

A diversion of this magnitude for this long would seem to require several participants.  Presumably the ATM’s were not deployed all at once.  A system of diverting cash was initially set up and expanded as the network grew. Was some entity or person(s) servicing the machines somehow involved?  Other credit union employees had to balance the ATM total cash receipts and disbursements to the general ledger.  There had to be a system for quickly producing expense and suspense entries to cover up the missing cash for exams and auditors.  No one person could fill all these roles.

Since the share shortfall was quickly found suggesting a second set of books, there is probably a similar recurring system for diverting cash to sustain this activity for decades.

All the people listed in the IG reports were in the room when this happened.  But none of them was apparently asked for an explanation of how this could have occurred on their watch. For example how could the CFO have “managed” the expected net income without first talking to the CEO about the results?

After reviewing 20 years of the deceased CEO’s family records, and finding  “no improper transfer of credit union funds”, the IG’s simple explanation is that “that the CFO hid this $12 million deficit by exploiting the credit union’s weak accounting system.”   But how long had this “weak accounting system” been in place?

The lack of any IG mention of NCUA exam and CPA  responsibility for “weak accounting” suggests a reluctance to learn who is accountable for what in this failure.  Instead put the blame on the person no longer available, and who took nothing.

Questions the IG should have asked include: What were the examiners’ CAMEL ratings in the most recent years?   What did the supervisory committee do?   How did examiners record the problems of” back posting, forward posting, deleting transactions, and hiding general ledger accounts”  now offered to explain the inability to find the shortfall?  Did the CPA firm give a clean audit opinion?

The NCUA and IG’s failure to look at the standard processes for oversight and accountability reflects a flaw in the agency’s own structure. Handing problems over to another credit union to cover up NCUA’s supervisory failures, will only lead to more such failures.

Throwing a Credit Union Under the Bus

Cobalt FCU and their members are taking the hit for Creighton’s financial and supervisory failures. The immediate results of the Creighton merger in the September 2024 quarter include a share inflow of over $73 million; a reduction in undivided earnings of almost $7.0 million (from $115.6  to $106.5–( i.e. Creighton’s negative net worth); and an increase of 6,700 members versus declines in the immediate prior quarters.

Additionally, Cobalt’s net income from ongoing operations reported a $400,000 third quarter loss. The year to date net income is a negative $2.2 million. These combined changes resulted in Cobalt’s net worth falling to 8.1% from 9.2% at the September 2023 quarter end.

A Case Study of Failure-at All Levels

In the IG’s reply to Congress, he states one of the objectives was to report on:

the effectiveness of the National Credit Union Administration’s (NCUA) examination and oversight processes in detecting and preventing financial irregularities, and the role and performance of external auditors in this case.  The letter covers none of these issues. 

At this time no one yet knows where the missing cash has gone.  NCUA has not worked very hard to get critical information on the event. The IG mentions a possible explanation suggesting there is no missing money-just accounting confusion.   But the $13 million of member funds is gone.

NCUA seems to have distanced themselves from any further explanations, even citing Cobalt for the latest accounting examples.  Yet overseeing the safe and sound operations of credit unions is NCUA’s number one priority.   NCUA failed totally and quickly moved on  in this case.  They have literally closed the books, fended off queries and  said there is nothing more to see here.

If this sudden $13 million failure is not a wakeup call, when will the senior leaders of the agency step up to the mike and take responsibility?  The NCUA board is responsible for governing the agency, not staff.

The Board’s silence and turning over responses to the IG for a Congressional inquiry for its largest cu failure in 2024 is a leadership failing.  The agency’s no comment and the IG’s second and third hand reporting,  undermines pubic trust and confidence in NCUA’s administration.  Congress, credit unions  and the public want to hear from their leaders in a crisis, not the bureaucracy.

Perhaps it is time for a real change at the NCUA board.

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Congress Queries NCUA On the Largest Credit Union Failure of 2024

During the January 6 WOWT’s First Alert news program, the station presented  a report titled Watchdogs Say $13.6 million is missing from recently-absorbed Omaha-based credit union.   The TV Reporter, Michael McKnight, had contacted me for comments on the case.

The TV story told of the $13.6 million dollar loss at Creighton FCU leading to its subsequent merger with Cobalt FCU in August 2024.  Cobalt said this was the result of the “CEO’s retirement.”  Both Peter Strozniak’s Credit Union Times article and I had written about this forced merger and the loss in its final June 2024 quarter of operations.

The merger was caused by an enormous deficit equal to 20% of assets uncovered following the CFO’s death in April.  NCUA gave no explanation of what happened, where the money went or who was responsible for the follow-up.  NCUA and Cobalt refused to answer any questions about the event.  Problem resolved, no questions please. 

But the TV news triggered immediate additional facts that NCUA has refused to provide the press and public about its actions. The TV reporter received a letter NCUA’s Inspector General (IG) sent to Omaha Congressman Mike Flood responding to his inquiry about the circumstances of the loss in November.

The IG response is linked here.  The letter opens with an unusual disclaimer of direct responsibility as the IG and NCUA are not required to investigate this situation any further:

Because there was no loss to the Share Insurance Fund, my office was not required to perform a material loss review. Additionally, NCUA informed us that the agency was not required to conduct a post-mortem review for the same reason.

But the IG then proceeds to state facts from the public 5300 call report and details of all the external resources and NCUA officials who became involved when the CFO died in April. Those listed include a local CPA firm, the NCUA’s supervisory examiner, the regional director, associate regional director, the director of special actions and a problem case officer.   NCUA requested the credit union hire a bond attorney, fraud auditor and an interim CFO to work with its problem case officer.  On May 3 the case was transferred to the Western Region’s Special Case office on May 3.

The only NCUA offices not listed are those ultimately responsible for the oversight of NCUA’s federal credit unions:  the Executive Director, the Director of Examination and Insurance and the NCUA board.  By omitting any mention of their role, they are apparently excused from any accountability.

In October 2024 Cobalt reported to NCUA that the “former CFO understated expenses related to the ATM network to artificially boost Creighton’s income statement to appear to achieve a steady net income.” The IG’s explanation also includes this assertion of agency’s due diligence:

When reviewing the deceased CFO’s family financial records and computers that:The regional director also said the fraud auditors looked for all ways cash could have left the credit union and found no instances of cash removal.

The IG’s concluding paragraph provide NCUA’s theory of the case:

In summary, NCUA officials believe the credit union failed due to bad accounting and financial statement fraud. The large deficit was hidden by the former CFO who exploited Creighton’s weak accounting system that allowed back posting, forward posting, deleting transactions, and hiding general ledger accounts when generating reports. Because no money was found to have left the credit union through this, NCUA officials believe the former CFO committed the fraud not for personal financial gain, but to make the credit union appear to be thriving in the eyes of its Board and membership. 

The IG’s Theory of the Case

Several observations from the IG’s summary.  First all the information is second and third hand.  The IG did not complete any direct review, but solely reported what others have said and done.

If this preliminary description is accurate, one has to believe this accounting coverup occurred over at least 26 years with an average operating shortfall of $500,000 per year between reported and actual net income.

To accomplish this alleged coverup, the CFO would have to keep two complete sets of books. As the deficits were recorded from share balances this would require hundreds of individual entries each quarter to balance out the shortfall but keep member statements accurate.  Then these two sets of books would need to be updated quickly whenever external NCUA examiners and auditors arrived on site.  Or whenever there was any external loan and share verifications.

A person capable of this legerdemain bookkeeping effort for over 26 years was however not capable of managing the credit union’s financial performance with positive net income?

There is no explanation of how such a consequential scheme could have gone undetected from annual CPA audits, NCUA examinations. supervisory committee share and loan verifications and traditional separation of duties in the accounting shop.  It was not discovered until the CFO’s death in April.  New people quickly found the out of balance situation and the $13 million shortfall. The fact that the share shortfalls were recovered so rapidly and then transferred in full to Cobalt, suggests these two sets were readily available.  An internal defalcation involving member share balances over three decades would normally be an auditing and forensic nightmare to reconstruct.  But in this case resolved quickly.

Just Country Bumkins Fooling Experts

Finally, it strains credulity to believe there was no shortfall of funds. The cash had been received from the incoming share deposits.  But the IG’s letter presents the assumption that the CFO just used “suspense accounts” to cover unrecorded continuing operating losses—that would average at least $500,000 per year.   Why would a person go to this much trouble to just cover operating losses for which he was not directly responsible?  If in fact it was failure to balance out ATM deposits and withdrawals—one suggestion—how could such a continuing imbalance go unnoticed for over three decades?

The IG report describes the accounting coverup: Specifically, the CFO had understated expenses related to the credit union’s ATM network to artificially boost Creighton’s income statement.  And, The regional director stated that the ATM accounting was extremely complicated due to Creighton having over 150 ATMs and the multiple ways in which income and expenses could be divided.   

A credit union of this asset and member size managing a 150 ATM network seems highly unusual.  What happened to this system after the merger?  Why were examiners and auditors unable to balance out this system for decades?

Assuming the CFO’s only rationale was to hide a continuing operating loss and that he received no benefit from his actions, one must ask who also might benefit from such a coverup?  Who supervised the CFO?  Is this just a situation of two country bumkins fooling all exam and auditing experts for decades?

NCUA’s Silence on This Failure

Until the IG’s December response to Congressman Flood’s inquiry, all responsible parties have said nothing about the situation.  Press queries are referred to call reports and  to Cobalt’s press release saying the merger was due to the CEO’s retirement, a completely false account.  Why would the NCUA and Cobalt put out such a blatantly false and easily contradicted explanation?   Was it to avoid addressing the $7 million or greater shortfall that Cobalt members will now cover?

One fact is clear, everyone, including the IG is distancing themselves from any responsibility for getting to the bottom of this $13 million loss.  The IG presents second hand information and lists multiple NCUA involvements with everyone handing off the ball to someone else-either internally or externally.  Cobalt does the cleanup.  The IG quotes Cobalt’s theory of the loss from October, not NCUA findings, for the missing funds. The IG washes his hand because no “material loss” review is required, but he will consider adding a review to his 2025 “to-do” list.

When people in positions of responsibility have nothing to hide, they will speak up with their understanding of events and what more needs to be done.  In this case there is silence for all parties, but most especially the highest levels of NCUA. The initial explanation of multiple decades of accounting coverups  creating a  $13 million shortfall seems unlikely and inconsistent with some of the data reported.  It feels like there must be more to the story.

The True Shortcomings

NCUA’s lack of public candor is the real problem. No one at NCUA wants to take responsibility for the agency’s  most fundamental  role of overseeing a credit union’s safe and sound operation.  Noticeably absent from IG’s account is the role of the three-member board, the information they received and the actions they did, or did not, take.

Did the Board approve the forced merger without member vote?  If so, what was in the Board Action Memorandum about the situation and alternatives?   Why was Cobalt FCU willing to absorb this accounting and operational mess with a $7.0 million loss which their members must now cover?  Where is their upside, if any?

Why weren’t the previous NCUA annual (?) exam papers reviewed for how so-called unrecorded expenses could be disguised in other accounts (suspense and office expenses)?  The three quarterly call reports clearly show the credit union reporting positive net income, but no increase in net worth until the yearend.  Don’t examiners first review the accuracy of call reports as one of their first verifications?  Etc. etc.

The Largest Credit Union Failure in 2024

The Creighton case is an example of institutional failures.  The most serious is not the $13 million unexplained loss shutting down a federal credit union. But the total lack of responsiveness to the members and the public by NCUA’s leadership. In a crisis, leadership should come from the NCUA board members, not the professional staff.  They are merely foot soldiers.  The leaders are missing in action.

Is the best explanation NCUA can provide Congress and the public an IG summary of second-hand agency actions, a listing of all the professional resources sent and offering a third party’s partial explanations of what may have happened?

The buck should stop at the Board’s three desks.  The board members are nowhere to be found or heard on the most significant failure in 2024.  A long standing, apparently successful federal credit union collapses overnight and costs its members their institution and $13 million in combined resources.

More Precious than Dollars: Trust and Confidence

The NCUA board member’s inaction and silence when facing real problems in an open, prompt and responsible manner is a failure of leadership.  Hiding from issues and accountability leads to internal coverups.  It creates a lack of public confidence in the agency’s oversight.  The perception that board members are not up to the agency’s most basic responsibility raises  questions about their competency supervising other areas of credit union activity in which members good faith and trust (e.g.merger payouts)  are routinely compromised.

After the TV investigation was reported on Monday, I received the following from a former Creighton member.  It read :

Hi Chip – I ran across your coverage (in November) of Creighton Federal’s large shortfall. I am a customer there and had followed their directives to switch to Cobalt. Now I’m wondering if my money is safe at Cobalt! I liked some of Cobalt’s products (a money market savings account with high interest, for instance) and have been happy with their service so far. Still, your coverage of the slap-dash management at Creighton Federal, and its rescue by Cobalt has me wondering if I should move my money to another credit union in town that doesn’t have any problems (that I know of). Thanks!

Hopefully this case is at its beginning and the three members of Congress on the IG’s response will continue to press for actual facts, updated numbers and direct explanations for what happened.  NCUA seems incapable of self-assessments.   Credit unions should not expect perfection from their regulator, but they should have honest accountability.

Editorial update at 5:00 PM January 8.

Yesterday the WOWT station published this follow up report incorporating some of the IG’s December letters comments to Representative Hood.

Follow on January 7 report here.  

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NCUSIF 3Q Public Update:  How to Enhance the Board’s Stewardship (Part 2 of 2)

My earlier analysis, part 1,  of the NCUSIF’s financial performance in 2024’s first three quarters, highlighted the fund’s soundness.  It concluded with Board member Otsuka’s statement about the board’s role to be good “stewards” of the fund.  This post shows how that oversight role could be improved.

The Benefit of Public Board Meetings

The board’s quarterly discussion of the fund’s performance is an important responsibility.  It demonstrates each board member’s “grasp” of the subject matter, their preparation and their reasoning for any conclusions.  Just like a credit union board’s role, their judgment is critical in overseeing staff’s recommendation.

It is in the board’s particular roles in this quarterly review, that the public learns each member’s understanding of general policy, especially the role of America’s cooperative financial alternative.

Additionally, NCUA’s monthly publication of the NCUSIF’s performance provides the fund’s cooperative owners the opportunity to monitor how their 1% deposits are managed by following critical financial indicators.  This monthly update was a condition for the open-ended funding model of the 1% deposit by credit unions.  If the trends are in the wrong direction, then credit unions have the facts to speak up.

Critical NCUSIF Financial Issues

The fund’s finances have one primary revenue driver, the yield on the investment portfolio.  This was by design.  It was a dramatic change from the premium based approach of the FSLIC and the FDIC which was also followed for the first 15 years of the NCUSIF’s operations.  That premium model proved fundamentally flawed. That history is described at the end of this post.

The NCUSIF’s Investment Underperformance

Slides from the September financials in November meeting clearly demonstrates the agency’s continuing shortcomings  in managing the Fund’s interest rate risk.

The first tracks how the fund’s yield (blue line) began trailing its market indicators as of mid-2021.

The next shows that the NCUSIF portfolio has been “underwater,” that is below market in value and return, since December 2021.

The first consequence of this portfolio strategy is that the fund’s primary revenue source is  shortchanging the fund and credit unions. The second is that the majority of the fund’s investments are not readily liquid in the event needed without either borrowing or selling investments at a loss.

Below is the latest investment report provided to the board in the quarterly review.

It shows an overnight yield of 4.79% on 24% of the portfolio; 1.74% on the remaining 76%; and a weighted average YTD yield of only 2.48%.  This below market return is  due to the fixed rate bonds purchased following a robotic investment ladder out to over seven years independent of any ongoing IRR assessments.

At September 2024, every investment maturity bucket except overnights, and recent investments for seven years, are below market value.

This update shows one investment action during the third quarter: $1.1 billion of bonds purchased on August 15, 2024  at “various” yields of 3.5% to 3.85%.  Following are the other yield-investment  options that same day from the Department of the Treasury.

Date 8/15/2024
1 Mo 5.53
2 Mo 5.4
3 Mo 5.34
4 Mo 5.22
6 Mo 5.04
1 Yr 4.52
2 Yr 4.08
3 Yr 3.9
5 Yr 3.79
7 Yr 3.83
10 Yr 3.92
20 Yr 4.28
30 Yr 4.18

This August investment decision  yields less than all other Treasury options with maturities less than three years-shown in blue.  It extends the interest rate risk as measured by the fund’s weighted average life (WAL). It follows the same pattern of activity that resulted in the fund’s past three plus years of underperformance. 

With the portfolio’s current WAL, this revenue-yield shortfall could extend for another 2.5 years.  Have no lessons been learned from this latest interest rate cycle?

Since 2008, the fund’s data shows that a portfolio return between 2.5% and 3.0%  is more than sufficient to maintain an NOL of 1.3%.  Returns above that breakeven range would give credit unions a dividend to recognize their open-ended underwriting commitment. More importantly, it rewards their collective risk management.

The Fund does not need more assets relative to risk, as some board members have stated.  It needs more effective management of the portfolio investments it already receives.

The Chairman of the investment committee and two of its four members were at November board table responding to questions.   This would have been the perfect time for a dialogue about whether alternative investment options were considered.  This one day’s investments in August increased IRR risk, reduced liquidity  and returned a lower yield than multiple other options.

Instead of explaining this decision, the board continues to put its head in the sand.  It glosses over performance charts that would not get past questioning by the newest examiner should a credit union report this outcome and unexamined policy.

In the meantime, credit unions are on the hook for NCUA’s mismanagement of the fund’s return, not just the industry’s potential insurance risks.

The Lack of Transparency

There are a several calculations used in the final numbers that are vital to understanding their reliability.  At times in the past these assumptions and data are shown in detail at briefings. This time only a final number is given so that it is impossible to validate the results presented.

The classic example of a lack of transparency was that until February of 2024, the staff had provided its calculation of the modeling data used for recommending the normal operating level (NOL) for the fund’s coming year. This cap determines when a dividend must be paid from net income.   In February however, the board continued the 1.33% with no underlying data or assumptions presented to justify a cap higher than the long time, traditional 1.30%.

That 1.30 was exactly the actual NOL reported for December 2023.  The financial model was working exactly as designed, yet the staff and board just rolled over the old higher level with no factual justification.  The fund’s own performance belied the need for an NOL above the historic cap.

In the prior two years of staff’s 1.33% NOL recommendation, the underlying data were provided.  But when modeled out this information did not support their recommendation.  Rather it showed that the historic 1.3% cap would have covered all the forecasted model’s contingencies in the next five years.  Is that why no details were given for 2024’s NOL setting?

One board member commented in the Q&A for 2024’s NOL that he did not know what the right number should be.  Moreover he didn’t think it would make a difference for credit unions whether the cap was 1.3% of 1.33%.  As of September 30, the fund’s equity ratio was .303% and headed higher by year end.  Should the December 2024 exceed 1.3% that decision will matter greatly, causing credit unions to forego tens of millions in NCUSIF dividends.

The question is not, what is the right cap on the NOL;  rather, it is what is the appropriate range for the fund’s equity so that credit unions can share in the success when all goes well.  That judgment is no different from managing a credit union’s capital ratio, a decision and responsibility familiar to every credit union board member and CEO.

Other Missing Details

Another disclosure shortcoming was the  investment report.  Instead of listing the individual investment purchases as in past reports,  “various” maturities and a range of yields  (3.8 to 3.85%) were given.  This suggests the individual securities were for at least 7 years.  This investment choice was at a time when the yield curve offered multiple higher returns on all options with maturities less than three years.

These shorter investments would reduce liquidity risk, improve yield immediately and enhance portfolio flexibility—but no board member questioned these August 15 investment decisions.

Undocumented Projections

The 2024 year end NOL projection by staff was given in a footnote as 1.28% in the last slide.  In  previous  December year end forecasts, the staff has presented a full NOL calculation in a single slide. The data included projected retained earnings,  insured share totals  and the resulting NOL outcome.

Insured shares grew only .46%  in  the third quarter.  If that growth pattern continues in Q4, then the NOL could be much higher than the 1.303 at September. Why present such an important forecast result (1.28%), which is below the current actual level with no substantiating numbers or assumptions?

Yet no board member commented on this lack of disclosure—and its implications for credit unions.

An Increase in Allowance Account and No Losses

Another critical number is the loss expense which is used to increase, or sometimes lower, the total dollars in the reserve account.   For the quarter the additional expanse was $21.7 million raising the total allowance to $232 million or 1.32 basis points of September 2024 insured shares.  So far in 2024 the total actual insured losses are near zero.

Th allowance ratio is greater than the NCUSIF’s average annual loss experience since 2008. In the most recent five years there have been no major losses.  Yet the reserve continues to grow in both dollars and relative to insured risk.

The formula being used for this reserving should be disclosed.  This expense comes right out of retained earnings and thus reduces the NOL number. Just as when presenting an NOL forecast, the underlying assumptions and data should be open for board, public, and credit union scrutiny.

The State of the Board’s Stewardship

As for Otsuka’s call out of the board’s stewardship of the NCUSIF, the examples above are some of the specific opportunities to enhance this responsibility. And we haven’t even gotten to the backward looking calculation of the NOL, but that issue is for another day.

Endnote: Brief History of NCUSIF Redesign

The new NCUSIF financial design in 1984 was based on a study of insurance alternatives and the fund’s initial 15 year trends.  The traditional premium approach in the first years of the 1980’s required double premiums assessed by NCUA.  But even then, the fund made no headway toward the statutory goal of 1% of insured shares.

There were two major reports of this in-depth reassessment.   One was a 100 page study sent to Congress on April 15, 1983 by Chairman Callahan.   The report addressed specific congressional questions, provided a history of cooperative stabilization and share insurance funds, and gave recommendations for change.  It also included extensive comments from credit union leaders.

When the new design, A Better Way, was established by Congress in 1984 the background analysis for a new model was explained in the video below.  It was sent to all credit unions outlining this unique collaborative effort and its benefits for credit unions. For without the credit union support, there would have been no congressional action to authorize this unique cooperative approach to NCUA’s share insurance model.

(https://www.youtube.com/watch?v=IlqxLeFkuLY)

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Great Third Quarter NCUSIF Report! (part 1 of 2)

I missed the November 21 NCUA board’s NCUSIF update so went back and listened to the 30 minute discussion via video.  The report was incredibly positive.  About both the financial performance of the fund and credit union industry trends.

There were several data “blanks” and areas that were not covered that I will discuss tomorrow.

The slides used to update the NCUSIF can be found here.  YTD net is over $226 million which raised the Fund’s total retained earnings to $5.4 billion.  This is .3033% of total insured shares ($1.767 trillion) at September 30, thus exceeding the .30% historical NOL cap.

Total insured losses for the year are negative, that is, recoveries of $2.0 million on prior losses have offset current writedowns of just $1.1 million.  Nonetheless, NCUA has increased the loss allowance reserve to $232 million, or 1.3 basis points of insured shares in addition to the .3033 in retained earnings.

Since 2014 the NCUSIF has recorded actual net cash losses that exceeded 1 basis point of insured shares in only one year, 2018.  That year the Fund wrote down the value of its portfolio of taxi medallion loans.  In 2020 it sold this portfolio  to a New York distressed asset fund manager (Marblegate) which benefitted from the full recovery in portfolio value as credit unions took all the write downs via the NCUSIF.

The CAMEL Trends

Even the CAMEL trends are positive.  Kelly Lay Director of Examination  and Supervision was at the table.  The % of credit union assets classified as Code 4 & 5 declined from the June quarter.   When asked about the change, Lay said it was because of improvements in specific credit union’s liquidity positions-a trend validated in Callahan’s third quarter TrendWatch analysis presented on November 12, 2024, nine days prior to the board meeting.

These two slides from that presentation show these changes in system liquidity:

She further stated that any large credit union that is downgraded in rating or with a 4/5 CAMEL ratings is examined at least annually.   When pressed by a board member about potential exposure in commercial real estate loans, she replied that “there was nothing very concerning.”

External Third Quarter Data Analysis Positive

Several times board members referred to second quarter data, one citing an increase in delinquency and lower ROA at June 2024.

However both the macro-analysis in Callahan’s 3Q Trend Watch Video and the large, individual credit union performance comparisons by Jim DuPlessis of Credit Union Times all show marked improvement in the third quarter.

Two excellent data analysis by Jim DuPlessis include graphs that do not support this observation from older data:

Analysis of five most recent quarters through Q3 ’24 of industry loan production, published on November 4.

Top Ten Credit Union’s Earnings Still Improving on November 1,  using the most recent five quarters through Q 3, 2024.

Two of TrendWatch slides:

And if the macro trends  in credit unions was not convincing by itself, the final TrendWatch slide showed this perfpr,amce comparison with competitors thru June as later data is not yet released:

Stewards of the NCUSIF

In her opening statement board member Otsuka commented:  Being stewards of the National Credit Union Share Insurance Fund is one of NCUA’s primary jobs—a critical component of our duty to protect members’ shares at credit unions. Thus, I continue to be encouraged by the strong performance of the Share Insurance Fund.

Tomorrow I will cover areas where the data was lacking compared to prior updates and the one primary performance topic that the board failed to address.

In future updates, the presentations could be improved if more timely data were used, so the board members have the benefit of the latest information when asking questions or making comments.  Or even when testifying before Congressional committees.

 

 

 

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Celebrating a Year of Extraordinary Credit Union Accomplishment

There have been pivotal years in credit union history, none more so than 1984.

NCUA and credit unions celebrated unprecedented market place, legislative and industry financial success.  NCUA issued over 100 press releases over the 12 months.  These announcements covered credit union performance, agency initiatives, and multiple press and political comments on the cooperative system.  Here is a very small sample, in date order, of these Agency communications:

Jan  4:   American Banker reports credit unions grow faster.

Jan 11:  CLF pays quarterly dividend of 9.0%.

Jan 16:   NCUA Acts to recover Penn Square losses

Feb 15:  Credit Union Stamp Released in Massachusetts

Feb 29:  Symposium on College Student Credit Unions

Mar  6:   Financial Performance Reports a Hit

Mar  9:   NCUA Board to Meet in Tucson

Mar 14:  Credit Unions Fastest Growing Financial Institutions

Mar 21:  Callahan Testifies Before Senate Banking Committee on Insurance Fund Capital

Mar 24:  NCUA to hold First Conference of Federal and State Examiners

Apr   4:   Banking Committee Approves Capitalization Bill

Aor  18:  NCUA Names Koppin Supervisory Examiner of the Year

Apr  30:  Credit union Statistics for March

May 15:  NCUA Central and Regional Office Realignment

May 24:  NCUA Investment Hotline Unveiled

May 30: Credit Union chartered for Cannon Hills Employees

June 19:  50th Anniversary Celebration

June 22:  President Issues FCU Week Proclamation

July 18:  President signs Bill to Strengthen Insurance Fund

July 26:  NCUA 1985 Budget down 4.9%

Aug 21:  FCU Growth Surges at Midyear

Aug 31:  Two Per Credit Union Limit Placed on Las Vegas Conference

Oct  9:   Board Adopts Capitalization Rule

Oct 12:  Credit Union Membership tops 50 Million

Oct  22:  Credit Unions Most Popular Financial Institutions

Nov 15:   Board Slashed Operating Fee Scale 24%

Nov  23:  Seger, Breeden, Connell, Pratt Announced as Speakers at Las Vegas Conference

Dec 18:  American Banker Reports CU’s Growing Faster than Thrifts

Over 70 additional releases about key Agency and credit union events were issued.

All of these releases were amplified in the monthly NCUA News sent to all credit unions as shown in the samples below.

Additionally, NCUA created a Video Network in which the Agency communicated significant changes and events both internally and with credit unions.  Here is the brief opening segment of an hour long video introducing the recapitalized  NCUSIF.

 

(https://www.youtube.com/watch?v=Wsq74FkMrPQ)

Forty Years On and Context for Today

In 1984 there were over 16,000 active credit unions.  All FCU’s were examined annually overseen by six regional offices and a staff of just over 600.  The brief excerpts above of the Agency’s wide-ranging activities and reports are a tiny sample of the interactions and communications with the credit union system, Congress, the White House and the public press.

These events occurred in the third year of Ed Callahan’s chairmanship which began in October 1981. The NCUA board, Bucky Sebastian, Executive Director, and the Senior staff believed that public service is a public responsibility.  Senior employees were available, willing and eager to engage with all constituents.   And most importantly. accountable to those who entrusted their funds and members’ futures to the regulator for oversight.

A highpoint of this interaction was the December 1984 National Credit Union Conference organized and led by NCUA with the support of the credit union system.  It was a first for NCUA, and the largest conference ever held at that point in credit union history.  The event was a coming together to celebrate the cooperative system’s growing relevance and success.  And to share views about the future of the movement by all those who were dedicating their lives to their members’ well-being.

In 1984 as this year, there was a Presidential election.  Everyone remembers the outcome. NCUA’s leadership and its results in 1984 are a reminder that good government is also good politics.  An example especially relevant now, four decades later.

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Where Did Creighton FCU’s Members $13 Million Go?

On August 7 Credit Union Times reported the story of the merger, without a member vote, of the $66.9 million Creighton FCU with the $1.2 billion Cobalt FCU.   The source was not from NCUA, but rather a joint announcement by Cobalt of the NCUA approved combination.

In the twelve months ending June 2024, Creighton’s networth fell from a positive $6.3 million to a negative $7.3 million.  A total loss of $13.6 million, all of which was recorded in the June 2024 quarter’s call report.

What happened to cause this loss of over 20% of credit union members’ total assets in just 90 days?

Until this quarter, Creighton FCU had been doing business as usual.  Tom Kjar the President for 32 years had just announced his retirement. The credit union’s chair had posted a Credit Union President open position on LinkedIn with a salary range of $114-$152K.

On April 3, 2024 the credit union’s Vice President of Operations and Finance, Vorace Packer, died.  There was no public announcement of the circumstances in his obituary.  The credit union provided  no followup successor.

What the Data Shows

For a sudden financial loss this large that is not connected to asset write offs, all of the indicators point to an internal defalcation.

In the 5300 call report numbers NCUA posted at March ’24, Creighton’s shares total $61 million.  Just 90 days later that total is $74 million. The difference is almost equal to the the total loss of $13.6 million.  Of this sudden share increase, $12 million is in regular shares.

These numbers show shares were under reported a pattern often used to cover irregular transfers of funds.   Because the total amount is so large,  a single diversion of $500,000 or $1.0 million would cause attention or a cash flow problem.  It seems likely this diversion has probably taken place over many years.   For example at $1.0 million per year the cash outflow would be only $250,000 per quarter.

To accomplish this cash diversion and reducing reported member share balances, there would have to be two sets of books—the incorrect numbers for the auditors and examiners, and then the actual records so members would not see shortfalls in their account statements.  The fact that the under reported balances were totalled so quickly, suggests this second set was readily discovered.

There are other patterns in the data going back over ten years that should have raised questions.  For example the credit union would report positive net income for each quarter, but the total net worth did not change until the final call report filing for December.  The pattern of reporting “reserves” was changed in March of 2022,

Why Did the Members Lose their Credit Union?

NCUA has said nothing about its actions in this event.  Cobalt is the source of the merger announcement.  It is that credit union’s members who will cover the $7.6 million hole in Creighton’s balance sheet, subject to any valuation adjustments.

Cobalt reported, before this event, a $1.8 million loss for the first six months of 2024 along with negative loan and share growth.  NCUA said that there will be no impact on the NCUSIF from this event, so Cobalt members will be the rescuers.

Will there be bond recoveries for this loss?   What is the prospect of recoveries from where the funds were sent?  Who will pursue these and other recovery options?

The Most Important Questions Remain Unanswered

How did this apparent long-standing diversion occur?   Where did the $13 million of member funds go?

As a federal charter, when was the last NCUA exam prior to the finding of the defalcation? Was there an annual exam?  If so, were normal exam procedures followed?

The credit union reports employing the same auditor, Wipfli LLP, for at least the last five years.   Were their external CPA audits clean?  Did they or the supervisory committee do an annual  sample test verification of member share balances?   Were large disbursements of funds to third parties by the credit union reviewed?

Outside audits, supervisory committee verifications and NCUA exams are all intended to keep honest people honest.   How could these required processes have failed so hugely and over such an extended time period?

What was the CEO’s role—was there no division of duties, that is different persons authorizing transfers from those  initiating specific transactions?

NCUA’s Silence is Deafening

NCUA made no announcement of this event.   We have no idea if the board approved a conservatorship or the forced merger.   What options were presented, if any, to the board?  What was their role? Or, did they just delegate this action to staff elsewhere in the organization?

Why has there been no official explanation of NCUA’s role two months after the June 30 facts have been posted?

NCUA’s primary purpose is to prevent the loss of member funds. In this case there is a $13 million dollar shortfall between the $73 million in total shares and the purported net worth and assets to cover them.

What happened to the multiple supervisory oversight roles supposedly in place?   Until these apparent failures are understood and addressed, a much bigger problem remains.  Can the supervisory system charged with the responsibility and resources to oversee the industry’s soundness perform its basic functions?

Until there is transparency and full answers about this situation, the potential for greater difficulties is possible.  The NCUA’s silence about the members’ $13 million financial and charter loss at Creighton is a greater problem than this financial failure.

The critical question is whether the regulatory system’s processes are performing as intended?Who is willing to represent the NCUA in this episode to discuss what happened, why and any necessary changes from this event’s analysis?

 

 

 

 

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Former Oracles of Alexandria Offer a New Prophecy

(Note: This is an updated post to reflect an error in my initial post where Vice Chair Hauptman’s name was mistakenly used instead of Chairman Harper’s) 

On May 11, 2024  four former NCUA chairs sent a cosigned letter to the majority and minority leaders of the House Financial Services Committee.

In this unique, unprecedented and “bipartisan” communication they urged that NCUA be given new power and expanded authority to examine/supervise  “third parties” who do business with credit unions.

The four signers with their dates as chair were Mike Fryzel (2008-2009), Debbie Matz (2009-2016), Rick Metzger (2016-2017)  and Mark McWatters (2017-2019).

These former chairs presided over situations involving the largest projected losses ever recorded by the NCUA in its oversight of credit unions.  Their joint prophecy of future catastrophe if the federal credit union act is not changed, would therefore appear to merit some consideration.

Their Records at Predictions as Chairs

The first of the two largest losses ever recorded by the credit unions was the forced liquidation of five corporates in 2010 with combined projected write offs and additional premiums of up $16.2 billion all paid by credit unions.

The second largest was the loss of approximately $750 million recorded in the sale of taxi medallion loan portfolios  to a New York City “vulture fund” Marblegate Asset Management LLC in 2020.

In both cases these future loss estimates proved highly inaccurate.  Instead of collective writedowns and assessments in the billions, credit unions and the NCUSIF have recorded recoveries and payouts to corporate shareholders in the billions of dollars.

In the taxi medallion resolution, the fund that purchased the medallions has seen a four-to-five-fold increase in guaranteed value to $250,000 for New York medallions.  NCUA refused multiple  FOIA requests about sale details,  but public estimates were these medallion-secured loans were sold by NCUA for under $50,000 in this liquidation.  Credit unions took the entire loss and a third party got the windfall.

Moreover, in their traditional oversight of natural person credit unions in the 2009-2010 financial crisis, the NCUSIF expensed estimated loss provisions of $1.362 billion. Actual net cash losses in the same two years were only $373 million or 27% of the amount projected.

Two observations from the tenures of these four former NCUA chairpersons when estimating future losses from their time on the job are:

  1. The estimates they provided for both natural person losses (or projected recoveries) and corporates 2009-2020 were wildly inaccurate. In the case of the taxi medallions the cash liquidation sale provided all the upside recovery to a third party, not to the credit unions’ borrowers or the NCUSIF.
  2. In none of the problem cases were third party vendor difficulties ever cited as a factor in these largest cases of potential or realized losses.

New Oracles about the Future

So what is the basis for these four former oracles now calling for greater NCUA regulatory powers given their track records.   They refer to none of their prior events as Chair as a basis for their position.   They cite no reference to any studies, factual analysis or actual examples from any regulatory experience.  There is no insight from their post chairman responsibilities or even reference to recent bank failures.

Without actual evidence, their plea  presents a dystopian prediction about how future bad actors could harm the credit union system.

“Many credit unions have large concentrations of members that could be of high value to our nation’s foreign adversaries.  These fields of membership are tied to military installations, the state department, agencies of the United States Intelligence Community, Congressional staff and others.

“A cyber incident could create devastating consequences for these very sensitive populations.

“It is not hyperbolic to say that the safety and soundness of the credit union system is at risk due to the potential for operational failures, cybersecurity breaches and compliance violations by third party vendors.

“Credit unions in many cases unknowingly expose themselves to financial losses, reputational damage and regulatory enforcement actions because of vendors who fail to meet regulatory requirements or adequately manage risks.

It is all hyperbole however, a verbal waving of the bloody flag to create fear and uncertainty absent any factual evidence.   And in the ultimate logical flip flop to support this open-ended expansion of authority, they claim it will actually be a form of regulatory relief:

“Additionally, this statutory authority would translate to significant regulatory relief for many small and mid-size credit  unions who, in many cases, do not have the requisite experience, or resources to conduct due diligence on vendors who are vital to their survival.”

The Four Horseman of the Apocalypse

The content of this letter is an embarrassment to credit unions and the signers’ reputations as knowledgeable about cooperative financial services and the credit union system.

Their own track records is one of misleading catastrophic future predictions of losses around the core business they should be most expert.  The NCUA had examiners on site full time at WesCorp and US Central before their conservatorships on March 20, 2009.  Every month’s financial results and investment actions were sent to NCUA’s head office for review.

Similarly, the taxi medallion problems had been in NCUA’s crosshairs for decades.  The agency actually stopped credit unions from issuing new loans years before the conservatorship of $1.3 billion Melrose in February 2017.

Despite these records of oversight failures, the four authors proclaim that “Without proper (NCUA) oversight of these service providers, credit unions may be exposed to greater chances of operational disruptions, financial losses, etc,etc” 

The core problem from past failures is not NCUA authority, but the Agency’s effectiveness in problem resolution.   Individual downturns and occasional failure are inevitable  in a market economy.   Rules and regs do not prevent bad decisions by credit unions just as good policy does not guarantee NCUA performance.

Credit unions survive and thrive not because they are better at conquering fear and danger, but rather because they embrace the human spirit of hope and betterment.   That spirit has sustained them for over 100 years as the country and cooperative institutions have gone through  periods of change and challenge.

What caused these chairs to sign on to this political act, obliviously designed by NCUA’s current chair Harper (correction to original post which mistakenly used Vice Chair Hauptman’s name), is  unknown.  They create a caricature of informed and experienced regulatory wisdom.  Their desperate reasoning makes them appear like the four horsemen of the apocalypse, the biblical figures in the Book of Revelation that represent the end of times. Instead of the challenges of conquest, war, famine, and death their prophecy is about the end of the cooperative system.

Their collective letter reminds one of the first rule of leadership by Richard Feynman: “The first principle is that you must not fool yourself — and you are the easiest person to fool.”

Let’s not let these four prophets of doom fool credit unions or Congress.

 

 

 

 

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NCUSIF Investments: Repeating the Practice that Caused the Current Underperformance

I’m afraid I must rant again about NCUA’s management of the NCUSIF investment portfolio.

From the most recent posted financials as of February 2024, the Investment Committee appears to have learned nothing from the past two years of Fed Reserve short term rate increases.

The Committee bought a $650 million Treasury bond yielding 4.26% with a final maturity of 6 years and three months on February 15.

The investment extended the NCUSIF’s duration, increased the portfolio’s interest rate (IRR) risk, and reduced short term  liquidity. The term portfolio (75% of the $22.5 billion total) is underwater by $1.3 billion and yields just 1.44%.  the Fund’s overnight position in contrast earned an average yield of 5.41% in February.

This new term investment reduces income versus rates available at the short end of the curve by at least 1% or $6.5 million per year until the Fed decides to change course.  Here are the Treasury rates as of Wednesday April 3, 2024 from CNBC  Pro, Stocks at Night:

Bond Yields Above 5%

  • The U.S. 1-month Treasury bill is now yielding 5.36%.
  • The U.S. 2-month T-bill is also now at 5.36%.
  • The U.S. 3-month T-bill is at 5.35%.
  • The U.S. 6-month T-bill is at 5.31%.
  • The U.S. 1-year T-bill yield is now back above 5%, hitting 5.044%.
  • The U.S. 2-year Treasury note is yielding 4.67%.

Ignoring Investment Fundamentals

This decision ignores the IRR lessons from the more than two years of Fed rate increases. The negative consequences of this investment pattern on the earnings and liquidity of the portfolio during this time have been enormous.  Moreover, in recent Board updates, staff said they made no change in their investment policy.

Those policy assumptions fail to adjust to not only  events of the past two and one half years creating this ongoing underperformance; it is oblivious to the history of the Federal Funds rate.

Here is  an analyst’s review of this rate experience in a recent update by a longtime observer and consultant to financial service firms:

Since the inception of the Fed Funds Overnight rate in 1954, the average and median have been in the 4-4.5% range. (https://fred.stlouisfed.org/series/fedfunds)

If you entered the industry after 2009 then you probably didn’t know this.  Your “normal” was a Fed Funds rate in the 0-2% range and you probably think the sky is falling with the current rate at 5.33%.   

The implication of a low Fed Funds rate since 2009 was that you could only survive by making loans because there was very little spread to be had between deposit cost and investment yields.

The Need for Leadership

As NCUA staff repeats its past misjudgments, one would hope the board had the abiity to ask relevant questions and more importantly, documented policy plans and goals.   This is what any examiner would require of a credit union with this continuing record of a $17 billion investment portfolio yielding 1.44%.

The current practice/policy increases the portfolio’s interest rate risk,  provides  no weighted duration goal based on the earnings requirements of the fund, and shortchanges the credit unions who should be receiving dividends from their performance during these last five years of minimal insurance losses.

Reviewing the NCUSIF history since 2009 shows that a portfolio yield of 2.5-3.00% would provide a stable NOL after all costs and growth assumptions.  Returns above that would give credit unions a return on their collective investment—a public commitment when the NCUSIF was redesigned with industry support.

Here for example, is the published forecast from the August 1985 NCUA News (page 3) the year following the Fund redesign:

An estimated 6.8% dividend has been projected for the federally insured credit union deposits  in the NCUSIF based on the Fund’s performance as of June.

The estimated dividend is part of an overall program of reporting to the NCUA Board and to credit unions on the Fund’s activities.  The dividend forecast is updated each month.  Office of Program Director D. Michael Riley noted that he expects the fiscal year dividend to be in the 6.5% to 7% range.

No Muscle or Memory

The core problem is that the board and staff have lost all the “muscle-memory” demonstrated by prior Agency leadership when projecting dividends.   The dividend was and is the key success factor that separates the NCUSIF from all other federally managed deposit funds.

A 5%  portfolio yield would result in total NCUSIF revenue of over $1.0 billion and a substantial return for credit unions.   Current NCUSIF investment policy and practice shortchanges credit unions and mismanages the most important asset under NCUA’s administration.

The only advantage of this six year and three month investment is for the three board members, Their terms will all have expired.  So they won’t have to explain how making the same oversight error increased NCUSIF’s portfolio risk while reducing its earnings for credit unions.   In short, this NCUA board has no memory let alone muscle when it comes to overseeing the NCUSIF.  Perhaps that’s why there was no Board meeting in March.

 

 

 

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Charter Conversions: What Is the State of Credit Union’s  Dual Chartering System?

One of the extraordinary advantages of a credit union charter is the choice of either a state or federal license.   This choice has been a critical aspect in credit union’s expanding role in the economy and responding to changing market conditions.

So when I recently received a letter from the CEO of Harvard University Employees Credit Union (HUECU) announcing a members’ special meeting to approve a conversion to a federal charter, I was very interested in why the change.

Was this a one-off situation or an indicator of an imbalance in charter choice in Massachusetts?

A Current Study

HUECU reported $1.2 billion in assets and loans of almost $1.1 billion, serving 55,000 members at December 2023.   Most operating ratios are in a stable to strong range:  Net worth 8.5% Delinquency .65%, ROA .28 and operating expenses of 2.74% of average assets.

The loan portfolio continues its healthy growth in three distinct components:  an alumni credit card with $44 million in balances, a $252 million student loan portfolio and $721 million real estate loans.

The CEO’s cover letter included five pages summarizing the pros and cons for the action:

Advantages:

  • Reduces multiple credit union exam and compliance requirements;
  • Potential flexibility with various initiatives, especially branching and CUSO investments;
  • MSIC insurance for all deposits above $250,000 will be continued, but is no longer required;
  • Easier to open branches outside the state;
  • A redefined and broader field of membership with a multiple FCU common bond to seek growth outside Massachusetts:
  • No state sales tax, lower supervisory fees, and elimination of state CRA compliance.

Disadvantages:

  • The costs of conversion including signage, changes in legal documents, and consultant’s fees totaling as much as $600,000;
  • Loss of local regulator accessibility and responsiveness;
  • Limited ability to influence national regulation and issues;
  • State law offers greater interest rate loan flexibility and longer maturities on other loans.

The special meeting requires a quorum of 18 members and a majority of votes by ballot or in person in favor to approve the conversion.

The CEO’s cover letter states the members will see no operational differences after the conversion.

In addition to my membership in the credit union, the CEO Craig Leonard encouraged members to call in with questions.   I was given his email, and we talked for an hour this past Monday.

He outlined three priorities which he hoped to accelerate with this step.

  • Faster growth,  beyond the Harvard community into other New England states and perhaps Florida;
  • Immediately draw in more savings especially as loan demand has always been plentiful—with an initial focus on the small business market;
  • Retain the Harvard name (Harvard Federal Credit Union), its strong brand and the relationship of its employees to the University and its benefit plans.

Craig said this topic had been raised several times as he perceived a lack of a “level playing field between state and federal” charters in Massachusetts.

The state is home to approximately 135 credit unions that rank it as the 12th largest in total credit union assets.   Of this total, 50 are state charters.

Both regulators have approved the credit union’s business plan forecast.   It is now up to the members.  Craig holds periodic town hall meetings with members because he believes “I work for you.”   This Special  meeting is March 26 at the Harvard Faculty Club.

While this may be a unique event, the balance and perceptions of charter advantages are an important metric on the soundness of the credit union system.

Whenever state or federal regulations become less responsive to their credit unions, charter change is a real option for many. It is one means of keeping regulatory accountability.  It is also a spur to keep the multiple state regulatory systems, individually  much smaller than NCUA. responsive to their local charters.

The State of Dual Chartering

The ability to convert from a state to a federal charter and vice versa remains a uniquely cooperative option.

In 2023 there were twelve charter conversions.  Nine state credit unions (from seven different states) converted to FCU’s, two federal charters went to state and one state chose ASI insurance versus the NCSIF.   The longest serving state charter was Mississippi’s Mutual Credit Union, founded in 1931. Two other Mississippi credit unions also converted to federal.

A choice of share insurance is also permitted in ten states which allow their charters to choose between ASI cooperative insurance or the NCUSIF.  This option remains central to a real choice as well as validating the underlying the 1% deposit design of the NCUSIF.

Dual chartering option creates a check and balance, even positive competition, among regulators.  It provides an opportunity for a credit union program as some states still do not have a charter option. However,  the state system can often change more quickly to meet new market and member needs when response by NCUA may take years or in some situations, never happen.

The dual system is a critical aspect of credit union history. The first credit union charter was in 1909 for St. Mary’s Bank.   Until the federal credit union act was passed in 1934, only state charters were available, and then limited to about two thirds of the states.

These state “startups” created multiple charter variations and operating authority.  As there was no single example, charter details and oversight were sometimes drawn from already operating financial examples.  For example, proxy voting is authorized by nine states, drawn from mutual S&L practice, but not an option for federal charters.

The Turning Point in Dual Chartering: The creation of the NCUSIF

The choice of either a fed or state charter from 1934 onward led to a 30-year period of rapid chartering across America.   The states were often the laboratories for change, innovation and system leadership with local leagues and chapters forming potent political state-wide organizations.  CUNA itself was an organization of state leagues, not individual credit unions.

The introduction of the NCUSIF in 1970 was led by a group of federal charters in the newly formed direct-member organization NAFCU in the late 1960’s. CUNA opposed this mandatory insurance requirement and supported multiple state-chartered alternatives to the federal program.

CUNA’s fundamental concern was that mandating federal  insurance would inevitably create a single regulatory system for all charters.  The diversity and choice created by dual chartering would be negated, if not lost all together.

The NCUSIF Override of State Options

This concern that the insurer could become a single regulator had a very quick example.  Bob Bianchini, who was simultaneously President of the Rhode Island League and a member of the state legislature, encountered  such an issue in the mid 1970’s.

NCUA refused to insure the NOW/checking accounts authorized for Rhode Island state charters.  In response, the credit unions formed their own state chartered deposit insurance corporation.  In Bob’s words:

The NCUA’s decision refusing to insure Rhode Island credit unions that offered checking account services to its members led to the creation of the private insurer RISDIC .. Seems to me there was never any specific law that would have led to that decision, but rather simply pandering to the commercial banking industry which claimed checking accounts fell strictly under their purview .. 

RISDIC would have never gotten off the ground if Rhode Island credit unions that provided checking accounts to its members, could have obtained NCUA insurance. 

The other RISDIC insured institutions were Loan & Investment companies. privately owned for profit financial institutions and it was one of those organization’s demise that led to RISDIC’s failure.

NCUA’s insurance power has led to other differences in regulatory interpretations. The insuring requirement has also been a major hurdle for groups seeking new charters.

Ultimately the major advantages of state charters continue to be their more accessible local regulatory oversight and the capacity to respond faster to changing market conditions.

The Final Word

The S&L crisis in the mid 1980’s resulted in that system’s failure of its state sponsored insurance options.  It led some credit union leaders to back away from the credit unions’ insurance choice.

In a 1986 speech to the credit union league xecutives (ACULE), former NCUA Chair  Ed Callahan, now  CEO of Callahan and Associates spoke to the group.  He described the importance of choice  saying that “the insurer is the regulator.”  His words are just as true today.  Scroll down to the video.

“The Best Damned System in the Country”

 

 

 

 

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The NCUA’s  Double Failure of Fiduciary Responsibility

In last Thursday’s Board meeting the NCUA  members twice failed in their fiduciary role as directors.

The first shortcoming is specific.  It was their collective unexamined and unquestioned acceptance of  the continuation of the current NOL for 2024 and the failure to vote on the upper limit one way or the other.

The NOL sets the fund’s cap for retained earnings each year.   Any net income above that amount must be distributed back to credit unions as a dividend.

This was a fundamental part of credit unions agreeing to an open-ended 1% funding of insured shares to provide a stable NCUSIF revenue base.  So essential was this understanding that it was put into the revised 1984 Title II statute at 1.3%-only to be modified by CUMAA in 1997.

This design is the cooperative alternative  to the failed premium models the other federally managed funds used—and still use today.  This yearend 1.3%  had been the traditional limit until 2017 when the board raised it to accommodate the merger of the TCCUSF’s surplus.

When credit union performance and fund net income do well, then credit unions share in the success.  When there are unexpected crises, then credit unions can be assessed a premium.

As reported, 2023 was one of the best years in the fund’s history.   Actual credit union losses were just over $1.0 million in a year the FDIC had spent over $761 billion in “receiverships costs” through just the first nine months.   The NCUSIF’s yearend NOL was 1.3%, or 3 basis points higher than staff had projected only three months earlier-a significant miss.

(note:  for credit unions’ concerns about this change, see NCUA’s summary of comments on the 2017 change at the end of this post)

Staff’s Failure to Document a Higher NOL

Every year since 2017 the staff has provided the board their internal modeling assessment following a policy laid out at that time.   But not this year.   At a time when all of the objective data shows the fund more than well capitalized for any contingency, the board did not even raise a question about the missing documentation and why the actual 2023 yearend outcome should not be more than sufficient going forward.

Staff’s dereliction was pushed aside by CFO Shied saying that there was a need for more analysis.  However when one revisits the model’s disclosed  inputs for the previous two prior years’ NOL (2022 and 2023), those numbers do not support the presentation that the NCUSIF floor of 1.2% would have been reached in an adverse scenario,  These models, fully run, provide no support for a 1.33% NOL cap in those years.  And certainly not in  2024.

If their models had showed otherwise, staff would have presented it along with the assumptions used. Here for comparison is the official Board position on risk modeling in December 2021 when setting the NOL:

The unprecedented share growth related to the pandemic resulted in an equity ratio of 1.26 percent as of December 31, 2020, and an equity ratio of 1.23 percent as of June 30, 2021.

The Board does not agree with arbitrarily setting the NOL. The NOL represents the level of equity the Share Insurance Fund should have to meet the policy objectives based on a robust modeling of risk. 

A $525 Million “Premium Tax” On Insured Credit Unions for 2024

The failure to lower the NOL to its long time, proven upper limit set by all previous boards until 2017 will likely cost the credit unions a dividend in 2024.   Each 1 basis point above 1.3% in 2024 will equal at least $175 million.  By not lowering the cap, the NCUSIF will hold onto $525 million or more that should have been paid to credit unions.

The most disappointing response was by Vice Chairman Hauptman.   He had been a board member for each of the three prior NOL settings in December 2020, 2021 and 2022.  He had no problem approving the staff’s recommendation even when a fellow board member in 2022 suggested a lower limit of 1.3% was adequate.  This year he feigned ignorance  of his prior votes, saying he didn’t know what the right number should be  !.34 or 1.35 or 1.36!

Hauptman compounded his recently acquired amnesia with a total misunderstanding of the fund’s financial model.   The model does not require a specific level.  Under GAAP, a loss allowance for both specific and general insurance losses has already been expensed from retained earnings-a level that auditors review.  But in addition there is a ten basis point range of .2 to .3 of equity plus the current year’s earnings to cover any additional losses. That 10 basis point now totals $1.75 billion of capital. The NOL is only the upper  CAP on this wide range of equity.

Chairman Harper and newcomer Otsuka each  voiced similar themes.

Since joining the NCUA board Harper has made no secret of his intent to remove all current statutory limits on NCUA’s oversight.  He has repeatedly cited the FDIC’s options as ones he would like to have for the NCUSIF.  This year as the FDIC again struggles, he did not repeat his admiration for the FDIC’s premium model.

Harper’s basic regulatory philosophy can be summed in one word, MORE–more resources, more rules, more personnel and more of whatever anybody else does or has, and NCUA does not.

His longstanding dour forecasts suggests  a lusting for real industry problems to be able to justify NCUA’s existence-and his role.  This behavior began even before he became chairman.  Here are some early comments of his outlook for the credit union’s system:

At June 2019 board meeting:   With the recent inversion of the yield curve, we know that a recession is coming, we just don’t know exactly when and how severe.

December 2019 OpEd in CuToday:

We know that a recession is coming. . . That’s why we should fix the roof before it rains by implementing this rule (RBC) at the start of 2020. 

February 2021 speech to the DCUC after becoming chair:

As the COVID-19 pandemic rages on, we must smartly, pragmatically, and expeditiously address the economic fallout within the credit union system. To that end, when I first became Chairman, I issued my Commander’s Call to the agency.”

August 2021 DCUC speech:

But, I must caution everyone that we are not out of the woods just yet. Credit union performance will continue to be shaped by the fallout from the pandemic and its financial and economic disruptions.

With pandemic-relief efforts like supplemental unemployment benefits, foreclosure prevention programs, and eviction moratoriums coming to an end, many households could face financial stress in the coming weeks and months. This could lead to higher delinquency and charge-off rates and potential losses for credit unions — and even failures.

September 2021 Board meeting:  But, nevertheless, we ultimately should expect delinquencies and charge-offs to rise in the months ahead, and all credit unions should pay careful attention to their capital, asset quality, earnings, and liquidity. To protect the Share Insurance Fund — and, ultimately, taxpayers — against losses, the NCUA needs to stay on top of these emerging risks and problems in the credit union system.

Harper’s modus operandi (MO)when presenting the state of the credit union’s system is to focus on risk, uncertainty and fear.

And he was true to form this in this meeting. After acknowledging all of the  Fund and credit union strengths, his traditional downbeat forecast about how things can only get worse from here followed:

“While we should recognize those positive things, today’s presentation also illustrates why we cannot become complacent in the supervision of federally insured credit unions, In recent quarters, the NCUA has seen growing signs of financial strain on credit union balance sheets and consumer financial stress. And, we continue to see that financial stress manifest itself in the number of credit unions and the percentage of assets held by composite CAMELS code 3, 4, and 5 credit unions.”  Etc

Board member Otsuka took her cues from the chairman, apparently oblivious to the lack of any staff documentation for the NOL and the 40-year history of the fund’s  1.3% cap proving more than sufficient in all economic environments and CAMELS distributions.  She said:

“The percentage of shares held by CAMELS 3 credit unions has more than tripled in the last two years and more than doubled this last year. . . . I understand we had few credit union failures this year and that the necessary reserves decreased in part due to greater economic stability forecasted in the macroeconomy, but this is a concerning trend that I will be focused on as the year progresses.

This may be one of the moments where it is good to be prepared and think about the “what ifs.” While there are several positive factors to be encouraged about, there are some worrying signs as well. “

In these comments, the members fail to note that it is the Agency’s supervision and examination activity that is the primary means of for managing individual credit union risk taking-not the NCUSIF.  The Fund comes into play only when this most critical activity fails in its oversight role.

Board Members Fail the NCUSIF’s IRR Oversight

CFO Schied repeatedly cited liquidity and interest rate risk (IRR) as the dominate factors in CAMELS downgrades.

But none of the board members noted that the NCUSIF portfolio has been underwater since December 2021-which means its own interest rate risk management has been at best poor, at worst nonexistent.

Two directors commented, without even a note of irony, that going back into a ladder strategy that resulted in the Fund’s illiquidity and years long below market performance, was the right thing to do.

Interest rate risk management is the number one responsibility of the fund.   It determines both NCUSIF liquidity and adequate levels of income.

No one mentioned the one year shortening of the Fund’s weighted average duration which is the vital component of IRR.  And a major factor in the gain in interest revenue in 2023.

This silence continued as staff announced its next investment will put the fund back on the same ladder pattern that has resulted in 2 ½ years of underperformance  in this current rate cycle.

The Second Failure: Board Governance

In 1977 one of CUNA’s primary legislative initiatives was to replace the Bureau of Credit Unions single administrator ovesight with an independent agency and a three person board.   There was concern that a single administrator, even with an industry advisory board, might not be responsive to the growing industry’s needs.  In other words an unchecked supervisor.

The public governance process in a Board meeting is a critical demonstration of the effectiveness of the individual member’s and their collective capability.   Reading from prepared scripts with questions already written out, is neither transparent nor a model for board conduct.

Why can’t members just have a normal conversation with the staff most responsible for the areas under review versus a designated spokesperson reading responses for which he has no direct accountability (eg. CAMELS scores)?

How Democratic Design Falters

This President’s day weekend we honor the political example of two American leaders for very different reasons.

From essayist  Gleaves Whitney:  George Washington earned the respect even of his former enemy, King George III, by doing something exceedingly rare in history: When he had the chance to increase personal power, he decreased it — not once, not twice, but repeatedly.

During the American Revolution, Washington put service before self. His personal example was his greatest gift to the nation. It has often been said that the “Father of our country” was less eloquent than Jefferson; less educated than Madison; less experienced than Franklin; less talented than Hamilton. Yet all these leaders looked to Washington to lead them because they trusted him with power. He didn’t need power.

In all of the history of the NCUA board, I know of but one, who voluntarily left their position before their term ended.   Power, prestige and position are addictive.  What’s missing is performance.

From Abraham Lincoln in January 1838 to the Lyceum club in Springfield, Ill on “The Perpetuation of Our Political Institutions”  as summarized by Heather Cox Richardson:   “The destruction of the United States, he warned, could come only from within. “If destruction be our lot,” he said, “we must ourselves be its author and finisher. As a nation of freemen, we must live through all time, or die by suicide.” . . .

“He warned that the very success of the American republic threatened its continuation. “[M]en of ambition and talents” could no longer make their name by building the nation—that glory had already been won. Their ambition could not be served simply by preserving what those before them had created, so they would achieve distinction through destruction.”

Contrary to the statements of the  three board members, their primary fiduciary duty is not to the NCUSIF.  It is to the member-owners of credit unions.  The Fund is only one of many tools and roles the NCUA has for creating “a system of cooperative credit” for the United States.

The Fund was not even formed until almost 40 years after the Federal credit Union act was passed. It was put on a sound financial basis 50 years after the Act.  And it is arguably the least important resource as more than 90+% of all credit unions are safe and sound, not due to insurance, but from supervisory examinations.

The  Board’s failure to formally review the NOL was by design.  It violated a fundamental agency commitment when the legislation creating the new structure was implemented.  Informed governance  oversight is missing. Paraphrasing Lincoln, The greatest threat to the NCUSIF is not from external threats to credit union solvency but from internal NCUA mismanagement by intent or simple inexperience. 

And that is how freedom is lost, one small step at a time.  This time it is NOL review.  And next?

Harper has made no secret of his intent to reshape the NCUSIF in with the FDIC’s premium options.  Hauptman can no longer claim ignorance of previous precedent and practice.  Otsuka must decide if she wants to  be merely an echo for the Chair or really dig in and learn about the history and uniqueness of cooperative design.  Then truly express her own independent judgment.

The NCUA board was set up with democratic intent, to be a check and balance on agency or individual interest overriding that of credit union members.   The design does not guarantee this will happen.  Rather it is the conduct of those in their chosen positions of authority that will ensure this structure truly protects members best interests.  That is the governance model every credit union is expected to follow.

Additional References

Credit Unions Comment on NCUA’s Raising the NOL in 2017 from NCUA staff summary:

Federal Register Notice October 4th, 2017

Around 55 percent of all commenters expressly opposed any increase to the normal operating level. However, around 90 additional commenters urged a ‘‘full rebate’’ of Stabilization Fund equity, implying they also opposed any increase to the normal operating level that would decrease a distribution in 2018 or beyond. Many of these commenters contended no increase could be justified because a normal operating level of 1.30 percent had been sufficient to withstand the financial crisis. A large number of these commenters (as well as some that supported an increase) were concerned the Board would never again decrease the normal operating level if it increased it in 2017. Many commenters that opposed any increase to the normal operating level urged that, if the Board did increase it, the increase should sunset after one year and the Board should then substantiate any extension of a normal operating level above 1.30 percent. Some of these commenters suggested increasing the normal operating level would erode the NCUA’s motivations to control its operating expenses and that the NCUA’s operating budget and the overhead transfer rate had consumed most Insurance Fund investment returns in recent years. A common thread in the comments was that failure to return all Stabilization Fund equity would be contrary to prior assurances and promises from the Agency.

Some commenters contended an increase to the normal operating level would be akin to credit unions over reserving for loan losses, a practice NCUA examiners generally advise against. They noted the strength of the credit union industry, the recent strengthening of the NCUA’s regulations related to capital, and more stringent supervisory tests as additional firewalls that reduced the need for an increase to the normal operating level. These commenters often pointed to loss estimates related to the Legacy Assets as a basis to doubt the NCUA’s projections of the Insurance Fund’s performance.

Staff response for those citing the Corporate Crisis as a reason for increasing today’s NOL:

Other than the $1 billion capital note issued to U.S. Central Federal Credit Union, no material expenses related to the conserved and liquidated corporate credit unions were paid from the Insurance Fund. Immediately after Congress established the Stabilization Fund, the Board transferred the $1 billion capital note receivable to the Stabilization Fund, at which time the Insurance Fund received full payment on the capital note from the Stabilization Fund.