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…

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The $530 Million Gift of a Credit Union’s Legacy

The 2019 financial year of Schools Financial CU’s (Sacramento, CA) operating performance is impressive. Loan growth of 10.4% to $1.6 billion with delinquency of only 0.26% and an allowance account of more than double all past due loans. ROA of 1.55% building net worth to 12.3% . Member growth of over 4% adding up to a year-end total of 160,00 member-owners.

As of January 1, 2020, Schools Financial CU, chartered in 1933, no longer exists. Its total assets of $2,150,075,670 including net worth of $264 million were transferred via merger to the control of the Board and executives of SchoolsFirst FCU ($16.8B) in Santa Ana, CA.

The Gift That Doubles in Value

The total gain for SchoolsFirst FCU however is $530 million in this generosity from the members of Schools Financial CU.

The $265 million in reserves will be transferred intact as “equity acquired in merger” to SchoolsFirst’s balance sheet. And following the accounting requirements for business combinations, the assets and liabilities of Schools Financial CU will be marked to market, creating an excess of assets over liabilities of a similar amount. This second gain will be called “negative goodwill” and recognized as income on the books of SchoolsFirst FCU for a total gain of $530 million.

The Immediate Benefits of the Merger for Members of Schools Financial

As described in the Schools Financial Chairman’s letter to members recommending they approve the merger, the two largest financial “benefits” disclosed as part of this transaction were:

  1. A one-time special year-end $4.0 million dividend (an average of $26 per member) , if they approved the merger, to be paid from Schools Financials’ 2019 results above;
  2. The opportunity for Schools Financial CEO, who arranged this merger, to increase his existing compensation by over $8.0 million

The details of this event and possible consequences have been described in three prior blog posts.

How Can This Merger Be in the Members’ Best Interest?

Part I: The Half-Billion Dollar Wealth Transfer in the SchoolsFirst FCU Merger

Part II: The Half-Billion Dollar Wealth Transfer in the SchoolsFirst FCU Merger

The only question remaining: Is this example what the credit union cooperative system was intended for?

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A Picture Worth a Thousand Words

A Call to Action and a Test of Who Credit Unions Are

This photo is shared with permission from the January 23, 2020 NCUA board meeting courtesy of the New York Taxi Workers Alliance.

What are these members telling us? Why has no one listened to them before? More crucially, why did these borrowers show up at an NCUA board meeting?

Member frustration and hope are on display. Throughout the taxi medallion disruption NCUA from top to bottom has turned a deaf ear to the needs of the member-borrowers.

This neglect has been pointed out time and again in letters to the NCUA Board, in articles in the New York Times, and in the stories from members to the press. Now there is a last opportunity to do the right thing. And to demonstrate the credit union difference.

A Thousand Words

A Feb 5, 2019, an article on described NCUA’s ineffectiveness in its oversight of the taxi medallion disruption. The article asked: The Taxi Medallion “Resolution” Works In Whose Interest? Following are excerpts from one year ago:

. . . .The critical question is not what the normalized the value of the medallion asset might be, but how does a credit union manage through a business disruption to sustain operations? The NCUA’s response was to eliminate the impacted credit unions through liquidation, purchase and assumptions, and forced merger. And in the end, to charge credit unions $744 million for “washing its hands” for oversight.. . .

This raises two questions: Did the NCUA act in members’ best interest? And is the $744 million liquidation expense the wisest use of credit union money?

Who Is The NCUA Really Helping?

The traditional approach of share insurance is to ensure the safety of member savings for all amounts less than $250,000. But in a credit union, the interests of the borrowers should also be considered and treated with the same or even greater respect as those of savers.

Credit unions were not designed primarily as savers clubs. Consumers have multiple options for safely saving money, insured and uninsured.

Credit unions were formed to address borrowers’ needs. Taxi medallion financing was not only a community service but also an ideal example of cooperative finance. A lot of people — many of them immigrants making their way in a new country — financed their American dream through taxi driving and then medallion ownership.

When the security that underwrites a loan is devalued, both the borrower and the institution suffer. When the security is an income-producing asset, such as a taxi medallion, the impact on both is even greater. Both income prospects and accumulated value are hurt. 

Whatever the security for a loan, a lender’s successful transition through a crisis depends on its willingness to rewrite terms, lower payments, and recognize the borrowers’ efforts to find other income and/or to persevere in current circumstances. This is what credit unions did repeatedly for home and auto borrowers during the recent Great Recession. Cooperative design makes this patient, member-focused adjustment process possible.

The Broken Bonds Costing $500 Million

Conservatorship is an important regulatory option for sustaining the institutional framework as a credit union works through problem assets (loans or investments) whose future value is uncertain. But if regulatory problem-solving becomes merely a “fire sale” to dispose of problem loans, then the bond between the borrowing member and the credit union is broken. The future for both becomes problematic and the options for positive, mutual solutions much reduced.

The NCUA conserved Melrose and LOMTO credit unions in February 2017 and liquidated them 18 months later. When these conservatorships were terminated, the opportunity to preserve value, and assist members, was destroyed..

LOMTO and Melrose reported their June 30, 2018, financial condition under NCUA management as a combined deficit capital position of $155 million. When liquidated within months of that filing, NCUA recorded a $744 million expense. This $500 million difference shows the cost of giving up all future value from working with members. Resolution becomes “cutting and running” away from members’ problems rather than using cooperative design advantages to resolve them.

A Request to the NCUA Chair

NCUA’s ineffective oversight undermined the relationship between the credit unions and borrowers so much that the president of the Committee for Taxi Safety wrote NCUA chair McWatters on May 12, 2017, about the agency’s shortcomings: 

“For the most part medallion owners are not seeking to walk away from their loans. They are not seeking to walk away from personal liability. Recognizing this, lenders have stepped up to meet this challenge and work with medallion owners. … The only lender that is refusing to work with medallion lenders is Melrose, under the control of NCUA. Regardless of each owner’s outstanding debt, the NCUA has taken a hard-line, one-size-fits-all approach that demands massive up-front principal pay downs of several hundred thousands of dollars and/or mortgages on residences to renew loans. 

“Even if the borrower complies, the NCUA then seeks to substantially increase the interest rate on the loans. Melrose has taken borrowers who want to pay and placed them in a position in which they know they will be put in default, thereby forcing them to face financial ruin. …

“The NCUA’s position is so extreme that it has told borrowers who are current on their loans and still making all payments, that if a medallion is in storage for any reason, temporarily or long term, that it will immediately commence foreclosure proceedings. … 

“All we are asking is for the NCUA to act reasonably and allow struggling medallion owners some flexibility in paying off loans. … The NCUA’s behavior has been that of a bully. … It is time for the NCUA to end this assault on our industry and show leadership and human decency.”

Transferring Loans to an Outside Servicer

The best estimates implied by call report data are that all credit unions now hold more than 8,000 member loans secured by taxi medallions. The average outstanding loan is between $250,000 and $350,000. Many of these borrowers will be financially challenged as self-employed driver/ debtors. Like others working in the so-called gig economy, their future is not certain. Will credit unions work with these borrowers as members, or will the regulator and its agents try to rid themselves of any responsibility for these member-owners?

The NCUA transferred Melrose’s medallion loans to an outside servicer. . . The borrowers now have three options: pay, go delinquent, or walk away via bankruptcy. Without an interested lending partner holding the loan, rewrites or other refinancing accommodations are lost. There is no prospect of a future relationship. The credit union promise to member-owners is non-existent. Selling problem loans is how banks, not coops, routinely solve their problem credits.

Although written one year ago, the article shows why the borrowers came to the NCUA, not the FDIC’s board meeting last week.

Where We Are Now: NCUA Largest Holder of Taxi Medallion Loans

Newspapers reported NCUA’s intent to sell in the open market its portfolio of loans acquired from its liquidations. Last week a New York city councilman announced a multi-pronged effort to stabilize the taxi industry including creating a mission driven, nonprofit entity to purchase the loans at a discount and then pass the lowered obligation through to borrowers CUNA and three leagues wrote NCUA on January 22 requesting that NCUA delay a liquidation sale due to harm it would cause borrowers, even those who are current in payments, and to credit unions still holding loans but whose collateral would be devalued in a fire sale.

NCUA working in collaboration with credit unions, leagues, CUSOs and New York taxi regulators, has the chance to create a cooperative solution that would help thousands of member-borrowers and set break from its past neglect. One NCUA board member called the drivers’ attendance “democracy in action.” But democracy only works if those in positions of authority respect their constituents by supporting collaborative solutions, versus selling out to financial bargain hunters seeking to maximize profits out of the misfortunes of others.

A Message: Who Does the Credit Union System Serve?

Read more:

CU Times: Amid Urgent Calls for Help, NYC Taxi Medallion Task Force to Meet With NCUA Officials

NY Times: New York Is Urged to Consider Surge Pricing for Taxis

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.

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.

The Cooperative Advantage in Mutual Funds

The fastest growing mutual fund family over the past decade has been the Vanguard funds. Their products feature no load, low cost index funds. The underlying philosophy is that investors cannot beat the market. Paying fees to investment managers that claim superior returns not only locks in higher costs, but also the claim to beat market averages is rarely achieved.

But there is one other critical advantage that allows Vanguard to offer this approach to investing contrary to the market positioning of virtually all other major mutual fund advisors. The funds are owned by their investors.

As described in a recent LA Times article“the investment group is swelling at a dramatic pace, thanks to one crucial advantage over its rivals: It is owned by its own funds, allowing it to use profits after covering costs and business investments to lower its fees, rather than reward outside shareholders with dividends and buybacks.

In other words, the more it grows, the cheaper its funds can become, in turn generating more growth — a virtuous cycle that has helped Vanguard more than triple in size since 2011. It is particularly dominant in the U.S., where last year it took in more money than its two biggest rivals, BlackRock and Fidelity, combined, according to Morningstar.

Vanguard today accounts for over a quarter of the entire U.S. mutual-fund market — a market share almost as big as Fidelity, BlackRock and Capital Group put together — and it is one of the biggest shareholders in virtually every major listed U.S. company.”

A Harbinger for Credit Unions?

NCUA Chairman Ed Callahan (1981-1985) frequently described credit unions as America’s best kept secret or a “sleeping giant.”

Vanguard is a powerful example for cooperative design where the user-owners are the sole focus of management’s priorities. Could Vanguard’s success become an example for credit union’s future contribution to the American economy?

From the Field: Concerns About Leadership for CU America

The following email recently landed. The writer lists multiple concerns which reflect a lack of vision for the system. My experience is that his concerns are widely shared. Following used with permission:

I find myself squirming about another CU Times article pushing mergers.

  • A month or so ago I was talking with an Ohio CU CEO who shocked me with the tale that the NCUA was pushing them toward dropping their State charter because the CU was informed they would never be a candidate to acquire a CU in a merger if they did not fall back into the Federal ranks.
  • A few months before that I was contacted that my credit union was “ripe” and a good candidate for merger and wanted to know if I was interested further.
  • A year before that we were pulled from consideration from a perfect merger candidate when the NCUA put a rep in their shop to “facilitate” and pushed it toward a fed charter CU.
  • All of these things have been like an itch I can’t scratch. Here are my thoughts on lack of vision and these pressures:
    • I thought it was about member choice? – doesn’t the Boards know that they are the representatives and should stand up for their base’s wishes?
    • If CU Times and NCUA are going to champion mergers, why do they need MORE operating budget?
    • Why are well capitalized smaller, even the tiniest, cu’s “ripe” for anything?
    • What happened to the unique circumstance that brought them in to existence? – why is that not relevant now?
    • Why do CU leaders not recognize the risk to loss of tax status if we just keep consolidating, homogenizing, embracing banking attitudes and strategies, not evangelizing currently recognizable differences.
    • Why does the national leadership groups keep beating this drum? – what is the agenda and long-term vision for CU America?
    • Is CUNA Management school really focused on creating opportunities for CU rising stars in an environment that is saying less and less opportunities will be available?
    • When did CU leaders agree not to be cooperative and eat our own?
    • Can we get efficient with process and products and investments and keep our uniqueness out front?
    • NCUA approved 50 mergers in the 3rd quarter 2019 (138 Q3 2018) – what was the value gained for the industry?
    • Growth and value are not the same thing
  • These may seem like rantings with no clear meaning/point/resolutions. I may not be able to articulate the concern but my hackles are up and the lack of national CU leadership recognition and the media that pander to it are making me feel like I put on that thick scratchy wool sweater that you have to wear to a relative’s house because they gave it to you.