In North Carolina-Daffodils
In Bethesda, Maryland-Scottish Heather
War Stories or How Creative Leaders Save Credit Unions: Part 2
“History is not the past. History is the present. We carry our history with us.” -James Baldwin
Part I ended with the investment manager who engineered the workout at Eglin having to find a new job. (link to Part I)
I am skipping his next workout story to go to the biggest, most difficult challenge: saving a large troubled, insolvent credit union when economic times were relatively stable.
The Challenge: In his Own Words
In early 1990, John Ruffin and Henry Garcia came back into my life by requesting me to interview for the CEO position of San Antonio FCU. John was the NCUA Austin Regional Director and Henry was his Senior Special Actions Officer. This time I asked for three years of Annual Statements of condition and yearly income and expense.
Those financials did not show the TRUE numbers for SAFCU. However, my EGO was tempted to take on another work-out if the rewards were worth it. But I loved living in Chattanooga and my family also loved it. The only concern I had was the private school cost to educate my three children and the future cost of sending them to college.
I turned down Henry G. at least two times and then he told me John Ruffin was in three days going to drive from Atlanta, where he was visiting family, to Chattanooga to interview me. My prep work was to find out what large CU’s CEOs were on average being paid and I found that the top 10% average was $200,000 a year.
So, when John arrived and made his pitch, I was prepared to ask for three things.
- First, If I accepted John and the Regional Office staff would become my and my team’s partners in this SAFCU turnaround.
- Second, in this high-risk challenge I wanted to be paid equal to the top 10% CU CEO’s average annual compensation of $200,000.
- Third, I wanted some “bonus” opportunities if I was successful. I asked if negative equity was improved to zero or positive, I would want a bonus of 1 year’s compensation. If total Capital equaled 4% of risk assets, I wanted a bonus of 1 year’s compensation. Finally, when total capital equaled 6% of total assets, I wanted a bonus of 1 year’s compensation.
John agreed to my requests and I reported to duty July 25th, 1990. It took my first 90 days to identify how bad the pain and the problem really was.
I found $110 million of commercial loans, the worst of the worst, after NCUA’s ALMC purchased at par $75 million. Then we began getting appraisals and to the best of our ability to establish what the allowance for loan losses (ALL) funding should really be. After the completion of this process we determined that SAFCU was $36 million insolvent after funding of the ALL.
The commercial portfolio was the disaster, but I found a jewel in beginnings of a robust indirect lending program that would allow me and my team to grow quality earning assets with short durations.
Working with the Austin Region we began crafting a letter of understanding and agreement (LUA) that included the ability to earn out (retain) $25 million in NCUA capital notes. I can’t recall the thresholds to fund the capital notes but within 18 months we were fully funded and had removed the negative equity.
I noted that in a workout the CU staff always expects the worst to happen. In fact, six months before I was hired, the previous CEO had eliminated and fired over 100 SAFCU staff members. It would take time for the economy, Texas oil prices, and local real estate values to recover for SAFCU to liquidate at a reasonable price the commercial loans and the collateral we had repossessed securing them.
My workout tactic was to take the CU’s financial statements and income and expense and create a Good Cu and a Bad CU financial statements. By doing this I could show progress to my CU staff as well as NCUA Regional and Washington Staffs.
I then challenged my Indirect Lending staffs to increase loan production by an annual 20% increase for the first year and 30% year two and finally by year three, doubling our annual indirect vehicle loan production.
The tactic I used for working out the commercial loans and repossessed real estate was managed by this guidance: “Reduce the commercial loans and repossessed collateral as fast as possible with the least loss.”
I said “No” to sales where the price was extremely low, and I waited for an improving market. Likewise, we saw appraisals per square foot costs were lower than the costs of new construction were per square foot. Simply said, someone wanting office space could buy it cheaper than building it new.
The preceding were the core tactics to encourage the turn around. Add to them hiring freezes, cooperative ventures to share costs, zero based budgeting and extreme cost cutting while not cutting service to members.
His Appraisal
Did it work? Well I earned my first capital improvement bonus in 1993; the second capital Improvement bonus in 1994 and the third and final bonus in 1996.
When I retired at the end of 2011, SAFCU’s Capital was $254 million and the total assets $2.9 Billion.
The financial turn arounds success, while great for me, also impacted others. The continuance of the financial health of these credit union meant that their members could be served and provided fair priced and valued financial services If the three credit unions had been liquidated during the time that S&L’s were being closed, I estimate that the losses to the NCUA Share Insurance fund would have been close to $250 million.
My greatest career satisfaction was mentoring nine future credit union CEO’s. Two or three of them after a stint in dealing with Board members switched to other career paths. Also, as of the as of December 2019, four of my mentees have retired, and three are active Credit Union CEO’s.
Footnote: Today San Antonio FCU is renamed Credit Human. It serves 233,110 members with 787 full time equivalent employees, in 20 branches and managing $3.2 billion in assets. The net worth ratio is 11.1%
War Stories or How Creative Leaders Save Credit Unions: Part 1
“History is not the past. History is the present. We carry our history with us.” -James Baldwin
From 1978 through 1982, the US economy went through a financial wringer.
The precipitating event was the rise in oil prices that threw all 20th century assumptions about financial markets into doubt.
Double digit inflation and interest rates arrived at the end of the decade. They were the components of Reagan’s misery index which he used in the 1980 campaign to characterize the incumbent President Jimmy Carter’s economic results.
The Impact on Credit Unions
Credit unions were struggling mightily in this unprecedented interest rate environment. Most states and federal credit unions had a 12% usury loan ceiling in the law. Likewise, FCUs and most state charters were limited by regulation as to the rates they could pay on savings. These limits were based on long standing market assumptions that were being upended.
The balance sheet management problems were acute. Member savings were flowing out the door to money market mutual funds which passed to consumers the rising market rates. As rates soared to double digits, mutual funds and other securities such as Treasuries which paid these unprecedented rates, were draining {disintermediating} the accounts of insured depository institutions.
The cooperative systems liquidity safety net, the CLF had just been passed by congress but was still in formation. Credit unions were not eligible to join either the Fed or the FHLB systems. The Corporate network was still coming together and did not yet have a strong point of focus subsequently brought by US Central.
Moreover, both loans and savings accounts at credit unions were much simpler than several decades later. Savings were in a regular (passbook) account or short-term CDs. No share drafts. Most loans were short term unsecured personal or auto borrowings.
But the most pressing problem was that a number of large credit union balance sheets were loaded down with long term, fixed rate securities, primarily GNMA 8’s. These were mortgage backed investments offered at 8%, a yield no one ever expected rates on short term savings to exceed. The spread seemed locked in. Yet in the late 1970s overnight rates were in double digits. All fixed income securities market values were under water, and there seemed to be no way out of the interest rate (income) squeeze and the liquidity challenge, except failure.
Into this economic maelstrom stepped a 32-year-old, former First Lt in the US Army who left in 1970. His first civilian experience was managing an investment portfolio and retail branch for an S&L during this time of rising rates from 1973-1978.
His First Turnaround of the 5th largest FCU-In his words
In December 1978, a lawyer friend asked me if I would apply and interview for Eglin FCU’s (EFCU) Investment Director. At the time EFCU was the largest financial institution in Fort Walton Beach.
What closed the deal is when FCU’s GM offered me $24,000 a year which was $2,000 more than I was making. However, I did not do any due diligence on the financials and or problems that led to the firing of the former CEO. Further, three years earlier they had built a four-story office tower, 100,000 sq. ft., with inland waterway access and a view of the Gulf of Mexico. Finally, in my former job as a banker we had to compete with EFCU’s 6% annual share dividend.
When I got to EFCU (age 32) I found that the $150 million asset CU, had $40 million borrowing as reverse repo using $50 million of Federal Agency MBS investments as collateral. $90 million of total loans and under $5 million of daily liquidity. The real liquidity kicker was EFCU had $100 million of unfunded future forward contracts to purchase GNMA’s or FNMA’s MBS.
As of January 1979, the market loss on the funded portfolio was approximately $10 million and the loss on the forward contracts were an additional $20 million. Note the mark to market pricing in January averaged 20% principal loss but by July 1979 this had increased to 35% of the par value.
July 1979 NCUA comes in and removes the General Manager and tells the Assistant General Manager that he had until year end to find another job. One month later, EFCU with the agreement of the Atlanta Regional Director hires an Alabama League Staffer, Jim Appleton. He and I then begin the back and forth with the Special Actions Examiner called John Ruffin (who later became an NCUA Regional Director).
In those days it was common that step one was to lower the share dividend, step two was to liquidate the “bad/underwater” assets. However, NCUA did not have any experience in dealing with liquidating long-term assets which had declined in value in a rising interest rate scenario.
The GM and I went to Washington and we pitched a unique Letter of Understanding and Agreement. Instead of selling out at the moment with the losses locked in, I crafted a workout plan. We would take the total of MBS on EFCU’s books plus the total of unfunded forward MBS and divided it by 30 months. That amount was the “required’ MBS sales per month. If market values declined 1% or more, we were required to sell 1.5 times the required sell. If market values rose 1% or more, we were allowed to sell ½ of the required sales.
With luck and favorable markets, I was able to liquidate all of the on-book investments plus the forward MBS contract and pay off the debt of the reverse repos by November 1980. Note we took capital losses but EFCU never went insolvent. Given the EFCU was the 5th largest FCU and one of the worst financially troubled NCUA insured CU; I had solved their investment and borrowing problem.
The Reward
Then I had an unexpected surprise, the General Manager told me since we no longer had any investments, he no longer needed my services but there was a Credit Union in Tennessee that was looking for a new GM.
But that is for another blog.
Footnote: At December 31, 2019 Eglin FCU served 121,309 members with 347 “full time equivalent” employees, $2.05 billion in assets and a net worth ratio of 12.3%.
“I Won’t Die of Old Age”
These words are hand written on placards at a public demonstration. They are carried by children concerned about the future of the planet. Children crying out for our attention to confront the growing environmental crisis.
When our first child was born, I promised my wife that I would share the nighttime feeding duties. Every morning I would wake up and she would ask, didn’t you hear Lara crying? I had slept soundly; it was her mother who responded to the crying and got up. An event I seemed incapable of hearing.
Today children are crying out to the adults in the room about the most urgent crisis they perceive in their young lives. They are not encumbered by comfort and fruits of success. They bring a future perspective not clouded by present accomplishments.
They have become the salt of the earth and a light for many adults “in the room” but will we hear their call?
P.s. Have you ever wondered what your “carbon footprint” is?
Two Past Regulatory Reforms That Are Foundational Today
In 1905 President Teddy Roosevelt met at the White House with a future President, Woodrow Wilson. At the time Wilson was President of Princeton University and had yet to embark on his political career.
But there was a serious national problem: that year 19 football players had died as a result of injuries. The game was brutal and filled with unsportsmanlike conduct (see excerpt included below). Roosevelt was a graduate of Harvard. Princeton and Harvard were two of the most powerful Eastern football programs at the time. Influential alumni and members of the faculty and administration of colleges were calling for the sport to be banned.
The two men met along with other college officials who wanted to see change. Roosevelt, ever the pragmatic reformist, worked quietly to form a new group to oversee a revision to the game’s rules and the sport’s conduct. The body created to do this was the Intercollegiate College Athletic Associating, known today as the NCAA.
Reforms took time, but football’s future was saved in a mutual effort by all parties, some of which held very divergent views. They collectively agreed to take a new regulatory approach outside of government, yet accountable and independent of any one college’s control.
This model of bipartisan, pragmatic progressive change was part of an era of governmental reforms.. These included regulations on interstate commerce, establishment of national forests, direct election of US senators to name a few. And there would be no Super Bowl without college football.
Fast Forward: Reform and Government in 1982 Led by a Former Football Coach
When newly appointed NCUA Chairman Ed Callahan spoke to the CUNA’s Governmental Affairs Conference in February 1982, the President of CUNA, Jim Williams, said there was only one topic on credit union attendees’ minds: survival.
Double digit unemployment and inflation had led to the election of Ronald Reagan. Short term interest rates were in double digits. One of Reagan’s core political goals was deregulation, reducing government’s role in many areas of the economy.
All insured depository institutions were suffering from disintermediation of their deposits by money market mutual funds which passed through market rates that greatly exceeded what credit unions, banks and S&L’s were allowed to pay by government regulation. Industry growth was at a standstill. NCUA was still trying to establish itself as an independent agency, with a three-person board, instead of a bureau within Treasury run by a single administrator.
In that maiden speech, Callahan, who had been the Illinois Director of the Department of Financial Institutions the prior five years, gave the audience a vision for the future. Business decisions about who to serve and the rates and services offered would now be in the hands of the boards and managers, not the government. Deregulation meant putting the responsibility for operations and success, or otherwise, with those who knew their members and communities best;
Just as importantly, Callahan knew there had to be institutional reform at the NCUA to properly oversee this newly, deregulated market-driven industry. The former football coach created a new “game plan” for the system.
The two most important institutional changes were solutions designed with, and capitalized cooperatively by, credit unions. First the Central Liquidity Facility (CLF) was fully funded in partnership with the corporate network. All credit unions had access to a liquidity lender that would be a source of “unfailing reliability” in a crisis. This self-financed, joint partnership expanded to a backup line in excess of $40 billion with Treasury during the 2008/9 Great Recession.
The second reform was to redesign NCUA’s insurance fund. The old FDIC/FSLIC premium based model was transformed into a cooperative structure in which credit unions would maintain 1% of deposits as the financial core. Earnings from the deposits and reserves should create sufficient income so there would be no more premiums as the primary revenue source. Credit unions should even expect a dividend in normal times.
But more importantly the redesign created an ever expanding source of cooperative capital. The NCUSIF became a credit union “sovereign wealth fund” financed solely from the industry whose members would be the beneficiaries of this collective resource. The NCUSIF was repositioned as a vital industry partner for a credit union system that has no access to external capital.
Reforms From Mutual Understanding and Interests
What ties these two reform examples together is that they occurred through teamwork. All interested parties saw a need for change and agreed on immediate steps to make it happen. The institutional changes were voluntary and embraced by all the participants.
The problem of a game that had gotten dangerously out of hand, or an industry faced with unprecedented financial pressures, could have led to total failure for either.
Fortunately, these events had leaders in place who were knowledgeable , could think clearly and give direction and hope to all by identifying a path forward. Both crises were overcome by these decisive actors, determined to work through them by collaborating with those who had most at stake in the outcome.
These leadership examples provide a reminder of the effectiveness of team work when affected parties are empowered to resolve the problems confronting them. These solutions endure and indeed may be more relevant than ever for today’s cooperative industry.
Excerpt from “Political Football: Theodore Roosevelt, Woodrow Wilson and the Gridiron Reform Movement“:
Since the 1890s, the term “put out of business” had referred, in a football context, to intentional injuries of key players. Needham gave the example of a black player for Dartmouth who suffered a broken collarbone early in a game against Princeton. When the guilty Princeton player was confronted by a friend on the Dartmouth team, he denied that the injury had anything to do with race. “We didn’t put him out because he is a black man,” he replied. “We’re coached to pick out the most dangerous man on the opposing side and put him out in the first five minutes of play.
In September 1905, Roosevelt received a plea from, his friend Endicott Peabody, the headmaster of Groton School. On behalf of a group of eastern private schools, Peabody asked the president to intervene. The headmasters were concerned that the behavior on the college gridiron was corrupting their own athletes. The plea to a chief executive who had graduated from Harvard and took an interest in college athletics might not have been unusual. That the president who had just resolved Russo-Japanese War and had earlier intervened in the far more crucial coal strike in 1903 would commit himself to football reform was unprecedented.
Yet Roosevelt may have had reasons that went beyond the public criticisms of college athletics…
From the Field: Are Online Members Twice As Valuable as Regular Ones
In response to my blog “What is the Value of a Member Account“, one reader sent:
“Thought you might be interested . . . this is a bank purchase a few years ago; $1200 per customer!”
From the Field: “Takes Away Choice” – One Member’s Comment on Proposed Chesterfield FCU Merger
The Board wrote in part to justify the merger:
Your Chesterfield FCU Board of Directors . . .has approved and is seeking a merger . . .It is the role of the board to look ahead and make decisions that we believe place our credit union in the best position to serve you. As we look to the future, we recognize the potential for economic challenges ahead. The last recession was very difficult for our credit union and we are not confident that we could remain well-capitalized through another economic downturn. We believe the time to take this step is now while our credit union remains financially strong.
The member responds:
I have been a member of Chesterfield F.C.U. for over 17 years. I do not support this merger and ask that all members vote against it. I have looked at the Financials for Chesterfield F.C.U. and in my opinion, the credit union is stable and is meeting its financial commitments.
It is well known that large majority of the members of Chesterfield F.C.U. can already qualify for membership at VACU due to being part of the Virginia Retirement System. This merger only takes away a choice from the current Chesterfield F.C.U. membership and future employees of Chesterfield County government and the Chesterfield County Public Schools. Less consumer choice is not a good thing. For this reason, I ask that the NCUA not approve this merger.
An Observation from the Field
The Stickiness of a Checking Relationship
In the January 2020 monthly AARP magazine, there is an article, Why You Should Search for a Different Bank.
There are four generic options listed: a national bank, a community bank, a credit union and a virtual/online firm.
The article provides brief pros and cons for each choice along with average rates from last October for two loan and two deposit options. But what struck me as important was the opening facts. Checking accounts are very stable relationships.
The Longevity of the Primary Checking Account
One 2019 survey cited that 40% of Americans have never switched banks.
A 2017 survey by Money magazine stated that the average primary checking account stays at the same financial institution for 16 years. People over the age of 65 have held their primary checking for 26 years.
No wonder banks are willing to pay as much as a $600 bonus to acquire new checking accounts.
The Business Analyst’s Challenge
The data suggests an interesting metric to track–the length of a member’s checking relationship, by age cohort. Obviously older members should have longer relationships.
Some questions that might be asked: How does the credit union’s checking loyalty compare with national averages? Are online competitors eroding the relationships of younger members versus persons in middle age?
More strategically, how might one predict that a member is likely to close their primary checking account in the next six months (or any forward time period) based on closed account statistics and related activity data?
PS: In 1985-1986 AARP received a FCU charter from NCUA to serve its nation wide members. The CEO hired of the de novo startup was P.A. Mack, the former NCUA board member. The charter was given up after approximately one year’s effort. Might such a charter make even more sense today?
Clayton Christensen (1952-2020): A Case Study for Life
The Harvard Business School professor and author of thinking disruptively was not unfamiliar to credit unions.
A number of years ago, I heard him at a reunion panel describe why he thought education, especially post high school, was ripe for disruptive innovation. After all, most knowledge is digital, improved real time virtual interactions were feasible, and the scalability of online reach is limitless.
At the close he said he would be putting his analysis into action by launching an online offering for the Harvard Business School called HBX (now rebranded as HBSO). The focus would be applying disruptive thinking to any organization coping with change.
I caught up afterwards and told him that Callahan would be very interested in seeing if his new course might be open to credit unions. He gave me his business card and turned it over to show me his assistant whom we should contact.
Several months later the Callahan team visited Cambridge and the founders of HBX in their temporary offices to seek ways we might tailor the course for credit unions. This was done. The first course was launched in 2014 called Disruptive Strategy with Clayton Christensen. A second offering is now available: Sustainable Business Strategy with Rebecca Hendersen.
Success in Life is More than Course Work
But what I remember most about Clayton’s thinking were his periodic comments on the personal qualities of leadership. A most readable example is How will you measure your life?
The paragraph that struck me is:
On the last day of class, I ask my students to turn those theoretical lenses on themselves, to find cogent answers to three questions: First, how can I be sure that I’ll be happy in my career? Second, how can I be sure that my relationships with my spouse and my family become an enduring source of happiness? Third, how can I be sure I’ll stay out of jail? Though the last question sounds lighthearted, it’s not. Two of the 32 people in my Rhodes scholar class spent time in jail. Jeff Skilling of Enron fame was a classmate of mine at HBS. These were good guys—but something in their lives sent them off in the wrong direction.
That is Not the Brand We Stand For
A personal story that captured this unique combination of moral and professional leadership is what he reminded his children when one of them had been accused of pushing another student.
He told them that is not who we are: “The brand that the Christensens are known for is kindness.”
And that is why I received his business card that summer afternoon.