Uncertainty in Washington-What are the Options?

When I was a member of Ed Callahan’s team, he would offer two thoughts when evaluating uncertain situations: The first was “Never say never,” when talking about future possibilities. The second was “What are the options” when working through a challenge.

Each day brings more Washington rumors, supposed plans, new faces and real events that have led to increased uncertainty for NCUA and credit unions under the Trump overhaul of the federal government.

Those who see changes as a threat to the independent co-op system are urging credit unions to prepare for battle, increase lobbying efforts and deploy new member engagement tools. Others will go with the flow assuming they will be OK if they stay invisible as part of a herd of 4,500 institutions.

If a never-say-never event unfolds, how does one prepare for it? Are there options that should be ready to go beyond the standard lobbying or “fight back” efforts?

A Short Credit Union History

The most important means of acting as a check to an overreach or an unresponsive federal regulatory environment is the dual chartering system.

Credit unions were birthed and spread first in the state legislatures. From 1909 until the Federal Credit Union Act passed in 1934, over 25 states authorized local and varied credit union charters. These multiple state examples were the “proof of concept” that gave Congress the example to extend this unique member-owned design to all states via a federal chartering option.

But state innovation did not end with this beginning. Senator Proxmire in a 1984 hearing stated he received his first real estate loan in the 1940’s from a credit union. FCU’s did not have real estate lending power until 1978. State systems pioneered the introduction of NOW (checking accounts) in Rhode Island and share drafts in other states before this transaction authority was given all financial institutions in the Monetary Control Act of 1980.

State charters led the way in deregulating rates and terms on savings years ahead of the DIDC and NCUA action in 1982. State options have had much more flexible fields of membership, CUSO investments and other varied business options.

State credit unions lead federals in transparency with their required annual IRS 990 reports. These filings disclose director and senior executive compensation as well as listing all 501 C3 contributions and political donations, if any.

Dual chartering has been a source of diversity, change and responsiveness to local conditions. The NCUSIF’s regulations, including the risk based capital requirement, impose a one size fits all accounting and capital model on a very diverse industry.

The Critical State Advantage

However, there is one option that keeps the independent role of the state system intact. That is the opportunity, currently in ten states, for their credit unions to choose private versus NCUSIF deposit insurance.

At yearend ASI, the Ohio based deposit insurance company, covered the shares of approximately 100 credit unions with $23.4 billion in assets serving 1.4 million members. Six of these insured firms have over $1 billion in assets; seven have less than $1.0 million. The average asset size is $240 million.

Expanding CU Choice Across the System

Recently ASI presented a webinar as part of a campaign called CUChoice. The focus was on Michigan credit unions to encourage their support for a legislative change to give state charters a choice in their insurance coverage.

The full recording of the webinar is here.

(https://www.youtube.com/watch?v=hP-QN8HazKA)

The slides present the advantages of ASI vs NCUSIF. Points covered include credit union ownership, a member-elected board of directors, and the specific role of an insurer that is not a regulator. ASI’s focus is on being a business partner with its credit unions in which interests are aligned.

Slides 13-29 are a presentation by CUNA’s long time chief economist Bill Hampel, now retired. In his talk he discusses the advantage of a Michigan state charter and compares the performance history of NCUSIF and ASI from 2007 though 2013. He directly answers the vital question referred to as the tall tree issue by showing how the two insurers compare in size to their single largest credit union. (slide 22)

Slide 29 is a detailed comparison of ASI’s equity to insured coverage ratio of 1.75%. to the NCUSIF’s 1.31%

More Than a State Charter Option

The choice of deposit insurance has benefits far beyond state charters. The option enhances the vitality of the entire dual chartering cooperative model. In those states with an option, Hampel presents data suggesting those states have stronger performance.

Having an option prevents NCUA from being a total monopoly and provides real time performance comparisons. For example, ASI financial audits and reports follow private GAAP accounting, whereas the NCUSIF in 2010 adopted federal GAAP. This federal standard mischaracterizes the NCUSIF’s operations and distorts the NCUSIF’s year end financial position. Also ASI must comply with reserving requirements under both GAAP and state insurance regulations.

ASI’s most critical difference is You Do Own It. The credit union elects the board and there is an appointed advisory group. The users have a direct say and responsibility for the management of their collaborative fund.

ASI has a performance track record as long as the NCUSIF. That history had a direct impact when the NCUSIF’s financial model was redesigned by Congressional legislation in 1984. The 1% deposit model, which provides the earnings and equity foundation for the fund’s financial stability, was a direct borrowing from ASI’s structure and experience.

By offering choice, ASI provides all credit unions a check and balance on the unilateral power of a monopoly insurer/regulator. The choice follows the unique constitutional system of state and federal powers. It rests on the cooperative values of self-help and collaboration.

No one knows what the future of federal regulatory and insurance systems will be under Trump’s administration. Credit unions should further enhance their options now building on their unique dual chartering roots.

In all other areas of Americans’ insurance coverage-life, auto, health and many more, the licensing and regulation responsibility rests solely at the state level. There is no federal option-except for deposit insurance. ASI is an example of this responsibility and choice that makes the credit union system more resilient and viable than any other model yet created.

Uncertain about outcomes at the federal level? Act now because no one knows today what you might need tomorrow.

October 7, 2024October 7, 2024

Join or Die: Credit Unions, Social Capital and Democracy

A 2023 documentary film’s message puts credit unions right at the center of our current political angst.

The film is Join or Die. ( this is the 3 minute trailer) It is based on the work of social scientist Robert Putman who in 2000 published a book called Bowling Alone. It documented the decline of local organizations that create the connections on which individuals built their trust in and sense of community.

The author calls this foundation of mutual confidence and relationships “Social Capital.” In his analysis, these organizational connections have real value.

The film updates this decades long continuing trend of increasing social isolation. He believes the loss of local networks has contributed to the decline of confidence in American democracy. For it is in our connections with multiple organization that we develop awareness of mutual obligations and the common good.

The Credit Union Example

The cooperative movement, and especially credit unions, were founded with social capital. Unlike other profit making firms, only minimal shares were pledged by organizers to receive a credit union charter. The Field of Membership was the existing external network that provided the connections giving a new charter its mutual support and market focus.

The net worth or financial capital requirement was a flow concept. Either 10% or 5% of revenue had to be set aside into reserves until a certain ratio of net worth to risk assets was attained.

In the 1998 Credit Union Membership Act this “flow” concept of capital adequacy was replaced with a “stock” measure–that is the ratio of net worth to assets. This financial point in time definition was expanded by the 2022 imposition of a risk-based capital. This raised the well capitalized ratio from 7% to 9%.

The founding cooperative bond of social capital was replaced with financial ratios. This transformation was accelerated as credit unions evolved their fields of membership into new groups, areas or criteria with little connection to each other. Instead of established connections, credit unions began relying on new brand creations and marketing to establish a their presence in the markets they sought to serve.

A Second Factor

As credit unions moved further and further from points of connection with relationships of trust, a second decline was in member-owner governance. The annual meetings no longer featured contested board elections; rather the board nominated the same number of internally selected candidates as vacancies. No member votes were cast; the positions were filled by acclamation.

This resulted in the erosion of any pretense of democratic governance. Increasingly self-appointed boards grew further and further away from their members. Credit unions were not alone. Putman’s work suggests that over half of America’s social/civic infrastructure has disappeared since he first wrote.

As these foundational experiences of local connection are lost, individuals become more isolated. And with that feeling, so does confidence in the governmental process, both locally and nationally.

One can debate whether credit unions contributed to, or are just another example of, institutions caught up in a fundamental transition of community relationships. It is certainly possible to find longstanding successful credit unions still serving their core markets. One indicator is a credit union’s name such as Wright-Patt Credit Union. The counter evidence would be examples where the institution has repositioned itself with growth efforts based on leveraging of members’ financial capital with mergers or bank purchases.

The film highlights Putman’s analysis of what makes American democracy work.

It explains why our traditional political process of compromise is much more difficult.

Finally he suggests what can be done about it.

While the film documents the loss of social infrastructure, there is good news. As the trends are laid out, the film closes with the message, “You can decide to change history.” The “financialization” of credit unions with their loss of a social capital bonding can be recovered. But how to start?

Re-establishing Credit Union’s Social Capital Advantage

A recent communication from the Texas Credit Union Commission’s monthly newsletter provides a place to reaffirm this core cooperative asset. Change comes from the top. Here is an excerpt from their Newsletter that I believe directly speaks to Putnam’s concerns.

The Importance of Board Meeting Attendance in a Time of Rapid Technological Change

Critical to the long-term success of a credit union is an active, involved board that provides proper oversight of operations and a sound strategic direction for the future of the credit union. One of the keys to ensuring that a board is successful is regular, participatory attendance.

This is particularly true given the rapid pace of technological change and the need for partnerships with financial technology companies (“Fintechs”) to provide services wanted by your members. . . Management and the board must ensure that . . .the Fintechs chosen are a good fit for the credit union and the membership.

Board involvement is important in Fintech selection and other important strategic decisions affecting your credit union. The issue of board attendance is a tricky one. Board members are volunteers with their own jobs, families, and busy lives to balance in addition to the voluntary obligations of serving on a credit union board. However, missed meetings seriously diminish the effectiveness of the entire board, and a director’s irregular or inconsistent meeting attendance could result in removal from the board. . .

It is important for board meeting minutes to reflect if a director’s absence is excused or unexcused. The lack of a record of an affirmative vote by the board is construed as an unexcused absence. . . Once a director misses . . . the prescribed number of meetings . . .there is nothing the board can do except to fill the vacancy with a new person within sixty days. . .

This Texas regulator’s message is a clear reminder of every board’s guiding role and responsibility, from NCUA’s three directors to the system’s smallest of credit unions,

This is an important leadership statement from one component of the credit union’s unique dual chartering system. Board members should actively Join in their roles, or credit unions could Die.

April 12, 2024April 12, 2024

The Good, the Bad, & the Beautiful for the Week of April 7, 2024

The Good: 125% Risk Based Capital Ratio for a $6.6 Billion Credit Union

If you were ever curious about the difference between a state and federal credit union regulatory environment, the open public meeting of the North Carolina Credit Union Commission the past Tuesday, April 9, is an eye-opener. (It was online).

In 90 minutes a listener received comprehensive, transparent. and timely information from multiple presenters. The topics covered state and national legislative priorities by a League representative and a thorough state-of-the industry review for all 29 state charters (ratios with and without SECU) by the Commissioner. There were updates on the status of the state system: sixteen credit unions have the low income designation and one pending merger.

Administrative briefings on the Commissioner’s office including an examination update (one done, six in process, and 22 to go), examiner training and staff openings.

At the agenda’s completion, the chair solicited comments from the attendees. Credit union members presented concerns about the Administrator’s oversight of SECU bylaw changes. One questioned the Administrator’ support for House Bill 410 to change the operating authority for North Carolina state charters.

The meeting showed the accessibility and transparency of the state’s regulatory environment. All were welcome. It was an open town hall with democratic participation and citizen oversight.

An Up-to-the-Minute Market Update

One of the most interesting reports for me was by Fred Eisel, CEO of Vizo Financial Corporate which serves the Carolina market and credit unions in 40 other states. His information was timely, positive, and specific. Several of his points: liquidity is growing in credit unions with corporate shares up and borrowing by members down. Vizo’s financial results are strong enabling increasing returns for members. Credit union operations are stable.

However, the number that struck me was Vizo’s Risk Based Capital Ratio at March end of 125%–that is not a typo.

Vizo financials through February are posted on their website. It has extensive disclosures of balance sheet and income statement details, shows total available liquidity of $6.5 billion, and includes nine measures of capital adequacy.

Fred sent me the March 2024 numbers showing the 125% RBC ratio.

Vizo’s Multiple Capital Calculations

The NCUA’s RBC requirement for well-capitalized corporates is 10%. Vizo’s ratio is twelve times that standard. Moreover, the corporate’s total capital exceeds 10% of assets.

Vizo CEO’s presentation of March’s final data just seven working days after month end, is extraordinary. It is a disclosure practice documented with web posting, that every credit union might model for their members. The timeliness is a tribute to the credit union’s management. It is also a standard NCUA should emulate in its reporting of the three funds it manages for credit unions.

The Bad:

Coffee hit a 30-month high today. The commodity is up 16% so far this year. One of the reasons is a heat wave in Vietnam.

Cocoa has been soaring due to weather problems in Africa. Cocoa is up 150% so far in 2024. (source: stocks at Night by CNBC Pro April 11, 2024)

The Beautiful: Eclipse Pictures

From my driveway by Luis Escalante who was repaneling my workroom in Bethesda, MD. Luis used my eclipse glasses to cover his camera lens.

From the shores of Lake Ontario by Scott Patterson, CEO Credit Union Student Choice.

His commentary on being in the moment: Clouds didn’t cooperate to see the sun much, but we did get total darkness for a few minutes. Very eerie. The expansive lake view let us watch the darkness line approaching across the water and then see the full daylight on land in the far distance. A thrilling experience.

March 17, 2023March 17, 2023

THE Credit Union Lesson from SVB and Regulation

In a news conference following the failed Bay of Pigs invasion of Cuba, President Kennedy remarked: “Victory has a thousand fathers, but defeat is an orphan. “

The SVB’s failure proves this adage untrue. The press and numerous pundits have already assigned multiple parentage: the CEO and management, the Fed’s rapid rate increases, regulatory and examination shortcomings, the external auditor’s clean opinion, the Silicon Valley customers $40 billion twitter run, Trump’s deregulation in 2018 and the Biden administration DEI policy objectives.

When everyone and everything is to blame, then no one is accountable. Just another “black swan” event. With more investigations/hearings to come, each new revelation will just add to the piles of condemnations. No lessons taken away. More regulations of course, for this is the default response whenever the barn door is left open.

A Spotlight on One Factor

From all these commentaries, I want to highlight one aspect that contributed to overlooking this risky situation. This factor has just become a part of the credit union regulatory eco-system.

In responding to my analysis earlier this week, Doug Fecher, the retired CEO of Wright-Patt Credit Union in Ohio, commented:

This situation makes me wonder if NCUA’s new “RBC” standards would have flagged the risks to SVB’s balance sheet. From what I can tell, much (most) of SVB’s investments were in “risk-free” treasury bonds and high quality agency securities, which in NCUA’s RBC formula would have earned some of the lowest risk multipliers.

To me it is another example of the folly of RBC-style risk management regimes … and why NCUA was wrongheaded in its pursuit of RBC.

This point of view is not limited to Doug’s observation.

During his time as Vice Chair of the FDIC, Thomas Hoenig challenged the agency’s reliance on risk-based capital requirements. He questioned both the theory and practice, pointing to the lending distortions which contributed to banking losses during the Great Recession.

He wrote about the SVB failure in this commentary:

The regulator apparently relied on the bank’s risk-weighted capital standard for judging SVB’s balance sheet strength. Under the risk weighted system government and government guaranteed securities are not counted as part of the balance sheet for calculating capital to “risk-weighted” assets.

This allowed the bank to report a ratio of around 16%, giving the appearance of strongly capitalized bank. However, this calculation failed to account for interest rate risk in its securities portfolio or the risk of having a highly concentrated balance sheet. It misled the public, and apparently the regulators.

In contrast, if the regulator had focused on SVB’s ratio of equity capital-to-total assets, including government securities, the ratio falls to near 8 percent; and if they had calculated the ratio as tangible capital-to-assets (removing intangibles and certain unbooked loses from capital) the ratio would have fallen to near 5%.

What this would have disclosed to the world is that the bank’s assets could not lose 16% of their value before insolvency but only 5%, a stark contrast.

Had the regulator not relied on the misleading risk-weighted capital measure, it might have take actions sooner. A simple capital-to-asset ratio, tells the regulator and public in simple, realistic terms how much a money a bank can lose before becoming insolvent. The regulatory authorities need to stop pretending that their complex and confusing capital models work; they don’t.

RBC and Credit Unions: A First Birthday

RBC became the surrogate capital ratio for all credit unions with assets greater than $500 million one year ago on January 1, 2022.

Before this in a September of 2021 analysis, Why Risk Based Capital is Far Too Risky. Hoenig is quoted:

“A risk-based system inflates the role of regulators and denigrates the role of bank managers.

We may have inadvertently created a system that discourages the very loan growth we seek, and instead turned our financial system into one that rewards itself more than it supports economic activity.”

RBC and Asset Bubbles

Shortly after the critique of regulatory incentives induced by risk weighted assets, in Asset Bubbles and Credit Unions (JANUARY 10, 2022) the consequences from potential Fed tightening were noted:

When funding looks inexpensive and asset values stable or rising, what could go wrong?

The short answer is that the Fed’s inflation response will disrupt all asset valuations and their expected returns.

The distorted results caused by RBC was presented in Credit Unions & Risk Based Capital (RBC): A Preliminary Analysis in February of this year. Among the findings:

The 304 credit unions who adopted RBC, manage $822.7 billion in assets. But the risk weighted assets total only $479 billion. That 58% ratio is the NCUA’s discounting of total assets total by assigning relative risk weights. and,

One credit union with assets between five and ten billion dollars, reports standard net worth of 12.5% and an RBC ratio of 48.3%.

This February analysis using June 2022 data of RBC credit unions showed that:

250 of these 308 credit unions reported unrealized declines in the market value of investments that exceeded 25% of net worth. Four credit unions reported a decline greater than 50% of capital. This was before the five additional Federal Reserve’s rate increases through the end of the year.

RBC’s primary focus is credit risk, the loss of value from principal losses from loans or other assets. Balance sheet duration mismatch is not captured as are other common management errors: concentration in either product or market focus, limited or no diversification of product or market, or just simple operational mismanagement.

These common challenges become amplified by insufficiently considered non-organic growth forays such as third party loan purchases or originations. Whole bank acquisitions are an example of such risks often accompanied (disguised?} by growing amounts of the balance sheet’s intangible asset, goodwill.

The RBC proxy indicator for safety and soundness creates a distorted impression of real institutional risks. Managers learn to game the system so that boards, members, and regulators fail to understand the institution’s total financial situation.

And when along comes a change in underlying assumptions, like the Fed’s rate increases, the previously unrecognized vulnerabilities quickly appear.

RBC creates for some institutions a theoretical capital ratio that is nothing more than a “regulatory house of cards.” SVB will not be the last example.

As Doug Fecher recommended in his 2016 comment letter on the proposed rule, “RBC should be a tool, not a rule.”

To his credit, Kennedy learned from the Bay of Pigs misjudgments when the Cuban missile crisis occurred in 1962.

September 6, 2022September 6, 2022

“The Public Purpose” of the Credit Union Cooperative System

In every new administration and most assuredly following economic or other national crisis (Covid, natural disasters), the need to review governmental and agency responsiveness is raised. Are changes needed?

Whether prompted by political priorities or performance shortcomings, this is how existing policies are reassessed.

Another motivator is when market competition carries over to the political arena . Firms call out their rival’s more favorable regulatory or tax status in their lobbying messaging.

In last week’s posts listed below, I noted the current absence of a policy framework at NCUA for the cooperative system. I believe this leaves the system vulnerable to priorities set by others or to purely personal agendas.

The Reviews Begin

Last week the Director of the Federal Housing Finance Agency (FHFA) announced a review of the FHLB system. FHFA, created in 2008, is the successor to the five person FHLB board. This single administrator oversees the eleven FHLB’s and the conserved Fannie Mae and Freddie Mac.

The assessment of the 90-year old FHLB’s $ 1 trillion assets is to determine if its modern day activities fully match its original mission of supporting mortgage lending.

FHFA Director Thompson’s purpose is to ensure the banks “remain positioned to meet the needs of today and tomorrow.” One outside observer noted: “The home-loan banks lack a well-articulated contemporary purpose.”

Similar to credit unions, the FHLB cooperatives are exempt from corporate federal, state, and local taxation, except for local real estate tax. For individuals, all FHLB bonds are also exempt from state and local taxes.

Credit Union’s Tax Exemption On the Agenda

A month earlier on July 27, columnist David Bauman wrote how the GAO was urging the OMB to study tax expenditures, a budget category that includes the credit union tax exemption. Are numerous tax exempt organizations still fulfilling their mission?

Bauman points out the Treasury Department estimated the credit union tax immunity will cost the federal government $25.3 billion between 2022 and 2031. This issue he wrote is “part of an ongoing battle between the banking and credit union industries.”

Scrutiny Not a New Process

From 1981 through 1985, the credit union system was part of four national studies directed by the Regan administration. These were in response to record high inflation, unprecedented interest rates, disintermediation, financial innovation and growing concerns with institutional solvency. For example, the Penn Square Bank’s 1982 failure was the largest FDIC liquidation post WW II.

In addition to the normal inter-agency or industry councils such as the FFIEC, NASCUS and multiple studies such as CUNA’s CapitalizationCommission, NCUA’s Chair was directly assigned to these four government-wide assessments.

The Depository Institutions Deregulation Committee (DIDC) was a six-member committee established in 1980 by Depository Institutions Deregulation and Monetary Control Act passed on March 31, 1980. DIDC’s primary purpose was phasing out interest rate ceilings on deposit accounts by 1986.

NCUA Chairman Callahan was one of five federal depository regulators. Chaired by Treasury Secretary Regan, all banks and S&L’s were given until June 1987 to end all federal controls on deposits.

NCUA chose not to follow the banking group’s timetable, eliminating all regulations in one new rule in May 1982. The decision effectively gave credit unions a five-year head start in the new market-facing era for financial intermediaries.

The Garn-St Germain Depository Institutions Act of 1982, known as the “Deposit Insurance Flexibility Act” mandated that the three regulatory agencies study their insurance funds and make any recommendations for future changes.

On April 15, 1983, NCUA forwarded its 71-page, five-chapter study containing four policy recommendations. This study became the foundation for the NCUSIF’s financial redesign approved by Congress in The Deficit Reduction Act signed by the President on July 18, 1984,

In Chairman Callahan’s forwarding letter to the study he noted: “For credit unions there are very clear answers to the issues raised by Congress. This is because credit unions . . .have actual experience with the options and alternatives suggested. . .Our responses are based on historical facts and current operational realities rather than academic theories or untried options. The credit union experience with insurance has been substantially different from the other agencies and our recommendations accordingly reflect this unique heritage.”

The Private Sector Survey on Cost Control(PSSCC), commonly referred to as The Grace Commission, was an investigation requested by President Ronald Reagan, authorized in Executive Order 12369 on June 30, 1982.

The focus was waste and inefficiency in the US Federal government. Its head, businessman J. Peter Grace, asked the members of that commission to “Be bold and work like tireless bloodhounds, don’t leave any stone unturned in your search to root out inefficiency.”

The Grace Commission Report was presented to Congress in January 1984. The Report included this observation: “NCUA Chairman Callahan is a role model for government agency executives. In one year NCUA reduced Agency staff 15% and its budget, 2.5%, while maintaining their commitment to preserving the safety and soundness of the credit union industry.” (NCUA 1983 Annual Report, page 3).

The Vice President’s Task Group on the Regulation of Financial Services was formed in late 1982. Treasury Secretary Regan, the five financial regulators, the Attorney General, Directors of OMB, chairs of the SEC and FTC and state regulators raised the total principals to thirteen. The Group was given one-year to make recommendations to address the challenges of the emerging financial markets after deregulation and the potential repeal the Glass Steagall Act.

A final report was issued in November 1984. The Group’s recommendations were summarized by John Shad, Chairman of the SEC, in a later speech. He closed saying:

The lines of demarcation between the financial service industries have eroded. These activities should be regulated, and permitted to compete, according to their functions, rather than outmoded industry classifications.

NCUA and the independent cooperative system were not mentioned in the Group’s regulatory recommendations.

NCUA and credit unions thrived in this transformative period of rapid financial change and increased scrutiny by completing the institutional, regulatory and policy foundations for a separate, unique and sound cooperative system.

Why a Cooperative Policy Framework is Essential

Without a clearly stated understanding of credit union’s role, every government study above could have drawn credit unions into their macro policy recommendations.

Instead NCUA demonstrated its ability to develop, document and implement how the deregulated cooperative system was successfully meeting its public purpose role serving members.

The cooperative system’s soundness was based of the values of self-help, self funding, and democratic volunteer leadership. The “moral hazard” concern from FDIC/FSLIC insurance of private financial ownership was absent in cooperative’s creation of “common wealth.”

Today the ability to articulate this purpose is missing. Regulations, especially the recently imposed RBC/CCULR were defended as being virtually identical to bank capital requirements. New charters are rarely issued raising the question of credit union relevance today. Whole bank purchases are routinely approved by NCUA even though this use of member savings would seem contrary to why a cooperative system was created.

Absent an awareness of cooperative history and precedents, policy pronouncements or priorities of board members may just seem like comfortable generalities.

In Harper’ July 2022 investiture address, he reflected on his year and half tenure as Chairman:

In achieving each of these things (regulatory activities), we have followed a philosophy that should guide all financial services regulators. Specifically, we were fair and forward looking; innovative, inclusive, and independent; risk focused and ready to act when needed; and engaged appropriately with stakeholders to develop effective regulation and efficient supervision. This philosophy will continue to drive our actions in the years ahead.

Is this the regulatory understanding that credit union cooperatives are seeking?

Sooner or later credit union’s special identity will be challenged by some governmental or political process.

The cooperative system navigated the multiple reviews from 1981-1985 because NCUA and credit unions earned a reputation for trust, expertise, mutual respect, shared purpose and performance. This achievement was recognized by the industry and throughout the executive and legislative branches of both state and federal government.

NCUA Chairman Callahan in the Agency’s 1984 Annual Report observed: The only threat to credit unions is the bureaucratic tendency to treat them, for convenience sake, the same as banks and savings and loans. This is a mistake, for they are made of a different fabric. It is a fabric woven tightly by thousands of volunteers, sponsoring companies, credit union organizations and NCUA-all working together. (page 3)

Should the movement aspire for anything less in this time?

August 9, 2022August 9, 2022

Risk Based Capital: A Timeless Analysis

This Jim Blaine classic post is an analysis of the distortion of the Federal Credit Union Act by NCUA when imposing Risk Based Capital on credit unions. Board Member McWatters voted against the proposed and final rule stating NCUA lacked the authority for the regulation.

These critiques are even more relevant as NCUA continues to expand its interpretation by adding a CCULR capital option to RBC in December 2021. The lack of legislative authority to do so was detailed in this analysis.

These critiques are important if future corrections are to be undertaken to credit union’s RBC/CCULR regulatory morass. The following is Blaine’s original critique.

***************************

Risk-Based Capital: Commenting on Your Future -OVERRIDING CONGRESS!

BLAST FROM THE PAST!

(originally published 3/26/2014 and again July 15, 2016)

… in which NCUA moves from rule making to lawmaking!

Really can’t believe this !

Little different tack today in terms of reviewing NCUA’s member-punitive and professionally embarrassing proposed, risk-based capital (RBC) regulation.

We have taken a look at how NCUA’s “we-know-better-than-everybody-else-despite-our-track-record” approach to RBC will 1) deter member mortgage lending, 2) damage MBL lending, and 3) severely limit safe CU investments, forcing unnecessarily lower savings returns on CU members. All proposed with utter disregard for the new, lower RBC standards now already in place for all other federally insured depository institutions.

Today let’s look at how NCUA has decided to independently override the U.S. Congress and federal law with the new RBC proposal. Have always noted how proud NCUA was of being “an independent agency of the Federal government”, but it had never occurred to me that NCUA believes it is independent of Congress – and above the law.

Congress is such a bother to
an independent federal Agency!

Here’s how NCUA intends to override Congress. In Section 216 of the 1998 Credit Union Membership Act (“HB 1151”), Congress specifically and purposefully wrote into the Federal Credit Union Act (FCUA) a series of mandatory “net worth” categories and prompt corrective action (PCA) requirements. Congress defined statutorily that a credit union was “well capitalized” if its net worth was >7%, “adequately capitalized” if its net worth was >6% but <7%, etc – five categories in all. Congress wrote into the FCUA statute a very, very clear definition of “net worth” – nothing accidental nor haphazard about what Congress meant by “net worth”, nor how it was to be used to determine CU capital levels.

NCUA through a sleight-of-hand (which they hope you won’t notice!) has rewritten the Congressional definition of “well-capitalized” for CUs.

Let’s take a look at the proposed RBC reg:

NCUA is becoming
thoroughly Pinnochioan …

“The proposal would change the title of Sect. 702.102 from “Statutory net worth categories” to “Capital classifications”. NCUA believes that replacing the term “net worth” with the general term “capital categories” better describes the combined “net worth ratio” and “risk-based net worth” measurements that make up the five categories listed in the statute. Moreover, the term “capital” is generally more inclusive of all accounts available to pay losses than the term “net worth” and is more commonly used in the financial services industry. No substantive changes to the requirements of Sect. 216(c) are intended by these changes in terminology.”

“[Several sections of 216] of the

“It’s growing…!!

Federal Credit Union Act (FCUA) use the term “risk-based net worth” requirement, NCUA believes that replacing the term “risk based net worth” with the functionally equivalent term “risk-based capital” in the proposed rule would better describe the equity and assets the requirement would measure. No changes to the requirements of the statute are intended by the alternative term…”

NCUA’s RBC comes with
strings already attached…

Now I’m sure that didn’t make any sense at all to most of you, because you’re nice, reasonable straight-forward kind of folks – unlike the folks who wrote this proposed regulation. So, let’s break it down…

Under current law: Credit unions with net worth > 7% are “well capitalized”. Under the current risk-based net worth (RBNW) formula, if a credit union is determined to be “complex”, it may be required to hold additional capital (none of even the 25 largest CUs are required to hold capital above their statutory net worth and most are not complex under current RBNW standards).

Under the proposed reg: NCUA unilaterally has 1) decreed that all CUs with assets > $50 million are complex! No test, no evaluation – as now required by the FCUA – to determine if a CU is simple or complex. NCUA simply changes a Congressionally approved law to make you complex regardless of your balance sheet risk; and then since you are complex(!), NCUA imposes its new RBC regime requirements on your CU.

Weaseling Congress !
(… robustly !!)

Here’s the weasel, NCUA is attempting to change the Congressionally legislated definition of “well capitalized” to:

“To be well-capitalized a credit union must maintain a net worth ratio of 7% or greater and, if a complex credit union, (which NCUA has defined as all CU with assets >$50 million) must have a risk based capital ratio of 10.5% or greater…”

NCUA’s proposed RBC reg flies in the face of express Congressional intent under the FCUA. You can always spot a weasel when you read phrases like:

1. “… replacing the term “net worth” with the term “capital categories” better describes…” – That’s a Weasel!
2. “… no substantial changes … are intended…” – That’s a weasel!
3. “… replacing the term “risk-based net worth” with the functionally equivalent term “risk-based capital”… – That’s a weasel!
4. “… the term “capital” is generally more inclusive… and is more commonly used in the financial services industry …” – That’s a weasel!
5. Changing “if you are complex” to “you are complex”… – That’s a weasel!
6. “… no changes to the requirements of the statute are intended…” – That’s a weasel!

Shouldn’t we – on behalf of our 100+ million member-owners – demand that Congress make changes, if necessary, to credit union statutes, …

… and not have to deal with these weasels?

July 7, 2022July 7, 2022

The Supreme Court, The Administrative State and NCUA’s RBC/CCULR Rule

The new RBC/CCULR net worth rule is the most comprehensive, intrusive and costly regulation ever passed by NCUA.

The agency’s staff’s initial estimate of the funds now restricted from increasing member value is over $24 billion. From their December 2021 board presentation:

Under the CCULR, if all 473 credit unions opted into the CCULR and held the minimum nine percent net worth ratio required to be well capitalized, the total minimum net worth required is estimated at $111.8 billion, an increased capital requirement of $24.3 billion over the minimum required under the 2015 Final Rule.

This is a minimum 30% increase of capital, restricting its use for members, and imposed just nine days after the rule’s printing in the Federal register.

RBC/CCULR is both procedurally and substantively deeply flawed. Instead of implementing the legislative intent that PCA be applied to a limited number of “complex” credit unions, the regulation passed covers 85% of all credit union assets.

But what can be done especially as the NCUA board composed of different philosophies approved the rule 3-0?

A Future Opening

The recent Supreme Court 6-3 ruling in the West Virginia v. EPA case suggests there is another opportunity to withdraw the rule or to challenge its validity.

The EPA case is about much more than regulating pollution. The 89 page opinion is here.

As summarized in a New York times article:

It . . . signals that the court’s newly expanded conservative majority is deeply skeptical of the power of administrative agencies to address major issues facing the nation and the planet.

Chief Justice Roberts, employing the phrase for the first time in a majority opinion, said it applied in cases of unusual significance and was meant to address “a particular and recurring problem: agencies asserting highly consequential power beyond what Congress could reasonably be understood to have granted.”

Another account of the decision in The Hill explains the broader significance of the Court’s reasoning:

In reaching its conclusion, the court relied on the controversial “major questions doctrine.” The major questions doctrine is a relatively new interpretative maxim that directs courts to presume that Congress does not intend to vest agencies with policymaking authority over questions of great economic and political significance.

Only Congress’s “clear statement” that it did intend to confer the claimed authority can overcome this presumption. When a court employs this maxim, it reads statutes narrowly, stripping the agency of the power to address the major question that the statute, on its face, gives the agency the authority to address.

Unsurprisingly, the main focus of the media, scholars and the public is on the consequences of the court’s move for the size and contours of the federal administrative state. . .

The impact of the court’s ruling on federal agency authority and power cannot be overstated.

A lawyer friend when asked, opined: “what I’ve read about it suggests the Court is going to take a very restrictive view when assessing agency claims of regulatory authority (effectively dispensing with Chevron deference). When the authority to regulate is clear, I have no idea how much discretion the agencies will be afforded when exercising that authority. I’m not sure what category the RBC rules fall into.”

The RBC/CCULR rule’s flaws include the following;

The agency provided no “substantial objective evidence” that the system’s capital levels were inadequate under the existing RBNW rule. Staff admitted that only one troubled credit union in the past ten years would have been subject to RBC’s higher net worth ratio.
The agency wrongly applied the “comparable” standard to implement a clone of bank regulations. This approach clearly contradicted the statutory intent that RBNW cover only an identified small number of “complex” credit unions that presented unusual risks. As staff confirmed in its board action memo: A special note that most, if not all, of the components of the CCULR are similar to the federal banking agencies’ CBLR.
There was no statutory authority for a CCULR option which Congress, in legislation, authorized only for banking regulators.
Nine days for implantation violates the “reasonable period of time” statutory requirement for a change in PCA capital levels.
The rule imposes significant financial harm to members by reducing the value they receive, beginning with the $24 billion staff estimate. That is just the initial number. It will grow every year.
The compliance burden is unreasonable. It mandates a one-size-fits-all mathematical capital formula for every credit union independent of hundreds of individual risk circumstances.

A Way Out of the RBC/CCULR Morass

Credit unions can sue the agency for the substantive violations noted. But that takes years and the harm done members will just continue in the meantime.

The most feasible course of action will be for a more informed NCUA board, responsive to the needs of credit union members, to use this Supreme Court precedent to withdraw the rule entirely.

That will require leadership, courage and insight from current or future board members. The first test is to ask the sitting members their views on this deregulation opportunity.

What would Hood, Harper and Hauptmann say in response to this Supreme Court interpretation?

July 6, 2022July 6, 2022

85% of Credit Union Assets Subject to RBC/CCULR at March 31, 2022

In December 2021 the NCUA Board passed a completely new regulation of over 500 pages to imposing a new RBC/CCULR net worth requirement. The rule took full effect on January 1, 2022, or just 9 days after posting in the Federal Register.

It instantly raised the minimum net worth ratio to be considered “well-capitalized” by 29% that is, from 7% to 9%.

All credit unions over $500 million in total assets were immediately placed under this new capital standard. As of March 31, 2022 these 701 credit unions manage 85% of the industry’s total assets, or $1.809 trillion.

No CCULR “Off-Ramp” for 193 Credit Unions

Those subject credit unions with less than a 9% net worth ratio must comply with the Risk Based Capital (RBC) computation. It takes five pages of call report data to calculate this one ratio.

As of March 31, there were 193 credit unions with $345 billion in assets that reported less than 9% net worth. For them there is no CCULR off-ramp.

They are thrown into a financial, accounting and classification “wonder-land” of arbitrary ratios, regulatory accounting decisions and almost 100 distinct asset classifications.

Following the RBC requirements is a complicated mess.

For example, individual credit unions have at least four options for calculating the net worth ratio. They can use average daily assets for the quarter, or the average of the three-month end quarter balances, or the average of the current and preceding three quarter end balances, or the quarter end total.

NCUA doesn’t even try to present the industry’s total net worth in this multiple manner, just asserting that the 10.22% is the industry average even though many other calculations are authorized.

Depending on which denominator a credit union chooses to determine the ratio, the outcome may or may not be a net worth over 9%. Net worth comparisons become much less informative for members and the public without full disclosure of the methodology used.

Changes in the ratio, higher or lower, may reflect nothing more than different calculations, not actual soundness.

RBC’s Reach Goes Beyond the $500 million level. Another 123 credit unions with total assets between $400-$500 million are within range of the $500 million RBC/CCULR tripwire. 46 of these have net worth below 9% and hold 37% of this segment’s total assets of $55 billion.

(Data update: 324 CUs completed the RBC ratio, and reported a value on the 5300. 324 minus the 193 under 9% is a difference of 131. These completed the RBC ratio despite qualifying for CCULR, or they may have failed one of the tests.

This suggests credit unions want to know their requirements under either net worth option to make the optimum decisions about which to follow.)

The Members Will Pay

The increase in regulatory net worth is a tax on asset growth. It requires resources be directed to reserves held idle on the balance sheet, instead of being used for investment in credit union products and services or higher returns on savings and lower fees.

Credit unions must choose to slow deposit and asset growth to build their net worth or increase their ROA by paying less or charging more. Whatever financial choice is made, the members will pay the cost for this additional capital.

This burden occurs at a time when members are coping with a rate of inflation not experienced in 40 years. Instead of serving members’ needs, credit unions must first serve the regulator which provided no factual basis for the rule.

A Unnecessary Rule Not Authorized by Congress

The passage of the RBC/CCULR capital regulation met no objective safety and soundness need and contradicted the express language imposing PCA on credit unions under the Credit Union Membership Access Act in 1998.

When presenting the rule, NCUA staff stated their analysis of credit union failures for the past decade showed that this new requirement would have established a higher capital threshold for just one problem credit union over $500 million.

The last minute addition of the so called CCULR off ramp in 2021 was defended as a way to reduce the acknowledged new and enormous burden of RBC. Congress passed legislation permitting banking regulators this CCULR exception. That statue did not include NCUA or credit unions.

The fact that credit union CCULR has no Congressional authorization is just one of many improper steps NCUA took when imposing this regulatory monstrosity affecting every asset decision made by a credit union.

The regulation is the Fruit of a Poisonous Tree failing at least five explicit requirements of the PCA legislation and the Administrative Procedures Act.

So why didn’t credit unions sue? Why did two board members go along with this deeply flawed regulation and process to make the passage unanimous?

What options are now possible to overturn a regulation that injects the federal insurer into literally every specific balance sheet and asset decision made by credit unions?

Tomorrow a new approach to eliminate this rule, take away the burden, and return responsibility for the management of the credit unions to the members and their board and managers now appears possible.

Note: Additional details of this flawed regulation can be found in these articles.

https://chipfilson.com/2022/02/cculr-rbc-unconstrained-by-statute-an-arbitrary-regulatory-act/

https://chipfilson.com/2022/02/thedisruptive-costly-reach-of-cculr-rbc-30-40-billion-for-initial-compliance-no-longer-available-for-members/

https://chipfilson.com/2021/12/why-the-rbc-cculr-should-be-abandoned/

https://chipfilson.com/2022/02/cculr-rbc-unconstrained-by-statute-an-arbitrary-regulatory-act/

March 29, 2022March 30, 2022

Subdebt: The Fastest Growing Balance Sheet Account for Credit Unions

Outstanding subdebt (subordinated debt) for credit unions grew 51% in 2020 to total $452.1 million. In 2021 the increase was 109% and with credit unions reporting $938.9 million.

The number of credit unions using this financial option grew from 64 in 2019 to 104 credit unions at December 2021. The total assets of these credit unions was $96 billion or about 5% of the industry’s yearend total.

A Product with Many Facets

This financial instrument has many characterizations. Subdebt is reported as a liability, that is a borrowing, on the credit union’s books. But because of the structure of the debt, NCUA considers it to be capital when calculating net worth for RBC-CCULR and all low-income credit unions.

Subdebt can be sold to other credit unions as well as outside investors. Purchasers perceive it to be an investment, but technically it is a loan to the credit union which makes it as an eligible “investment” for credit unions to hold.

“A Watershed Moment”

Earlier this month Olden capital announced the largest placement yet: a $200 million borrowing sold to 41 investors including credit unions, banks, insurance companies and asset managers.

The process as described in the release required: The coordination of a team that included leaders from the credit union, investment bankers, lawyers, other consultants and service providers. . . Olden labelled it “a watershed moment, notable for its size and breadth.”

Certainly considering size that is an accurate statement. This one placement exceeds 40% of the total of all 2021 debt issuance. Credit union demand is certainly picking up and more intermediaries are getting into the business to arrange transactions.

Olden did not name its client, although the purchasers were aware that it was Vystar Credit Union.

Why the Rapid Subdebt Growth?

This borrowing is a form of “Buy Now, Pay Later” capital for credit unions. The terms of the debt are generally ten years with no repayment the first five, and level amortization of 20% each in the remaining years.

The interest paid is based on several factors including market rates and the credit union’s overall financial position.

Traditional credit union capital comes only from retained earnings. Maintaining well capitalized net worth means that comes only from earnings means the process places a “growth governor” on a credit union’s balance sheet.

By raising subdebt this organic “growth governor” is removed in the short term. Some credit unions have been bold to say that their intent is to use the newly created capital for acquisitions. Both VyStar and GreenState ($60 million in subdebt) have been active buyers of whole banks.

The overnight increase in the well capitalized net worth category from 7% to 9% by NCUA on January 1, 2022 is also causing credit unions to look at ways to comply with this higher requirement.

Others believe it will help them accelerate investments that might otherwise be spread over several years.

Getting into the Leverage Business

Because subdebt has a price, unlike free retained earnings, and its function as capital is time-limited, its use requires increased asset growth to be cost effective.

It refocuses credit union financial priorities from creating member value to enhancing financial performance through leverage. This leverage requires both increased funding and matching earning assets to achieve a spread over the costs of these increased funding. Buying whole banks is an obvious strategy to accomplish both growth goals at once.

The Unintended Consequences

The use of subdebt as a source of capital was provided as a sop to help credit unions meet NCUA’s new higher and much opposed RBC capital standards.

The irony is that its use will entail a more intense focus on balance sheet growth to pay the cost of this new source of net worth. Unlike retained earnings, the benefit is only for a limited period.

The event will impose a new set of financial constraints or goals that have no direct connection with member well being. It converts a credit union’s strategy from “member-centric” to maximizing balance sheet financial performance.

In later blogs I will explore some financial model options for subdebt, the transaction costs and other factors in its use.

One of the most important needs at the moment is for greater transparency for individual transactions.

These are ten-year commitments that may exceed the tenure of the managers and boards approving the borrowings. The financial benefits and impact on members will not be known for years. This is especially true when the primary purpose is to acquire capital as a “hunting license” to purchase other institutions.

This rapid and expanded use will have many consequences for the credit union system, some well-meant, others unintended. It is a seemingly easy financial option to execute that the cooperative system will need to monitor.

March 16, 2022March 16, 2022

RBC Update: 257 Credit Unions in NCUA’s “Hotpot”

In two weeks, credit unions will be able to calculate their newly imposed capital ratios. Three different calculation requirements are now in effect.

Using yearend 2021 data, there are 212 credit unions over $500 million that will likely have to use RBC (risk based capital) because they had net worth below 9% at December 31. Another 45 credit unions between $400 and $500 million reported net worth below 9%. They will be subject to RBC when their total assets exceed $500 million.

This total of 257 credit unions is probably the minimum number as credit union share growth is usually seasonal, concentrated in the first four months of the year. That is, assets will increase faster than capital can be earned at the same pace.

RBC’s Impact

RBC has still not hit home for some. These credit unions are telling members they are well capitalized because they exceed the 7% net worth level. Those so doing often fall short of the new 9% minimum.

The impact of RBC is best described with the boiling frog analogy. A frog put in boiling water will immediately jump out. But put the frog in a pot of cold water, slowly raise the temperature and the frog will hot-pot to death.

Many large credit unions view RBC similar to a pond Kermit. As the RBC multiplex calculations slowly engulf quarter by quarter many will find themselves in unfathomable amounts of creeping normality.

Some will immediately jump to the seeming sub debt life preserver to stay above the 9% threshold. Soon they will realize that option itself requires more leverage just to breakeven. Sub debt just made the water deeper and harder to jump out of the pan.

RBC and NCUA’s Record of Risk Analysis

In an April 30, 2010 speech to the Illinois Credit Union League 80^th Annual Convention Chairman Matz offered these remarks on the corporate crisis:

“Let me start by assuring that I fully recognize the legitimate anger many of your feel. The anger has come through loud and clear. . .I have heard directly about the pain you have felt. I know that many of you blame NCUA: After all, two examiners were on-site at US Central and WesCorp. NCUA definitely shares some of the blame (and then comes the big qualifier) but there is plenty of blame to go around.”

What she forgot is that the regulator’s role is because crises are to be expected. And when they occur, to be managed prudently.

The Irony of the RBC rule which is supposed to “protect the insurance fund” is that NCUA is often the source of the problem. As one veteran CEO observed:

“All the losses -excluding a relatively low level of cu management fraud – that NCUA has incurred is the result of errors in risk analysis by NCUA. They don’t like to acknowledge that fact, but the logic is inescapable.

By decreeing that most assets are now in complex credit unions, the industry is far more subject to the whims of a less than stellar team of NCUA executives who are increasingly enthralled by the “predictive” accuracy of astrologically and phrenologically based statistical models.”

The most catastrophic error in risk analysis is the Corporate crisis referred to by Chairman Matz. NCUA is now projecting a minimum of $5.7 billion in recoveries from the corporate AME’s. Over $1.2 billion is still due shareholders of the four corporates.

This is the exact opposite result projected for years after the conservatorship when total costs of $13.5 to $16 billion were estimated by NCUA. The agency never revealed their analysis always referencing the results of their “engaged securities expert, Black Rock.”

Learned Helplessness and the Actions of Others

With RBC it is easy to slip into a state of “learned helplessness.” That is behavior exhibited when a person is repeatedly exposed to negative stimuli beyond their control. Think regulatory burden.

The term describes experiments in which humans subject to loud noises, did nothing. seemingly helpless to change.

Not all the human participants responded the same way. Many blamed themselves for “failing,” but others blamed the way the experiment was framed. They knew it set them up for failure. In other words, not everyone is equally susceptible to learned helplessness.

Those who do not become passive when confronted with apparently uncontrollable situations are because they see others act with courage, overcoming difficult odds. These leaders actions inspire others not to give up.

There is an initial segment of 257 credit unions who will be subject to the sophistry and real burden of RBC. Some will throw in the towel, some will try to comply, and others will look for an “out” such as RBC or shrinking the balance sheet.

The hope is that most will have the courage and resilience to persevere until wiser heads prevail in Alexandria.