In three prior commentaries I have described NCUA’s conservatorship of Municipal Credit Union.

• https://chipfilson.com/2019/12/where-is-the-transparency-for-ncuas-actions-at-municipal-credit-union/
• https://chipfilson.com/2020/02/municipal-credit-union-nyc-reports-30-million-net-income-gain-in-4th-quarter/
• https://chipfilson.com/2020/08/what-do-municipal-credit-union-and-the-u-s-postal-service-have-in-common/

Because of this credit union’s 104-year history and its vital role in the city, I contacted the credit union to update its recovery following the release of the September call report.

NCUA’s director of external affairs sent the following to my request:

November 30, 2020 at 10:49 AM

Hello, Chip. We received the inquiry that you sent to Municipal Credit Union requesting to speak to someone on the credit union’s progress. Please note that notwithstanding key personnel announcements, we do not comment on our efforts or conditions related to conserved credit unions.

Regards,
Joseph B. Adamoli
Office of External Affairs and Communications

My reply:

December 1, 2020

I understand your email responds to the inquiry I sent MCU to update their progress in conservatorship.

I am surprised your office would miss an opportunity to demonstrate NCUA’s leadership by ducking simple questions about running such a large and important $3.7 billion credit union serving New York and its 600, 000 members.

For example, the members and credit union system would be interested in:

• • • • Why has the Agency chosen four different chief executives in the last two years, Kyle Markland being the most recent? Who makes these decisions? What marching orders are they given?
      • Under agency control, why has the credit union reported such wildly fluctuating results, for example a loss of over $120 million in one quarter and an extraordinary ROA in the following two quarters? (https://chipfilson.com/2020/02/municipal-credit-union-nyc-reports-30-million-net-income-gain-in-4th-quarter/)
      • Why have the financial concerns of the 600,000 members not merited a statement about the forward conditions they will have to deal with or better yet, some announcement of confidence about the future?

The credit union’s quarterly call reports are public. Its financial performance is open for anyone to review and comment on. Are the numbers a good sign for members or not?

Given NCUA’s track record for conservatorships, does the turnover of executive leadership signal a lack of momentum for the institution, staff, and its financial plan?

Your policy seems positioned to give the NCUA a blackout period to simply keep the institution out of the members’ sightlines in hope the NCUA can package the credit union in a back-room handoff to a convenient suitor versus working to hand the credit union back to its community.

I urge you to manage this differently. Transparency creates trust. Silence undermines member and public confidence just when regulatory leadership is most needed.

Chip Filson

Why MCU’s Situation Matters

MCU’s September 30, 2020 call report numbers are in many respects very positive.

The credit union grew shares by 27% to $3.5 billion in the past year while adding 27,000 members to total 600,000. Its ROA is 1.18% and a net worth of 4.66%. Delinquency remains very stable with the allowance account funded over 200% of total delinquencies. Its balance sheet holds over $1.7 billion in investments including $800 million in cash.

Chartered in 1916, the cooperative has served five generations of New Yorkers through thick and thin. It is a vital part of the city and state’s credit union system.

Importantly, it is a highly visible example of the broader narrative of the cooperative role for members in times of crisis. Local response to circumstances is the hallmark of a credit union relationship.

NCUA Puts Itself In Charge

When NCUA manages a credit union via conservatorship, it has a heightened responsibility to all the member-owners. To keep the confidence of the credit union system, open communication is necessary.

All NCUA employees are public servants. They are paid entirely from credit union funds. Board members and their politically appointed advisors have a singular responsibility for the wise use of authority and industry resources.

This is especially true in difficult times. For if government is not effective when its role is primary, then the entire industry suffers.

Transparency Essential for Trust

Public dialogue is how trust is created in NCUA oversight. Kyle Markland’s appointment will be the MCU’s fourth chief executive in the past two years, all selected by regulators. In previous commentaries, I described the importance of this selection as follows:

The key success factor (in a conservatorship) is finding and supporting the right turnaround leader. The challenge is simple: Any jackass can kick down a barn, but it takes a carpenter to build one.

Will NCUA appoint a jackass or a carpenter? Someone to play caretaker until the agency elects a merger partner to resolve a leadership transition? Certainly, there will be vultures a plenty looking to take the “problem” off NCUA’s hands.

The financial numbers reported in conservatorship have fluctuated widely. A loss in one quarter of over $120 million to an extraordinary ROA two quarters later. Members have been kept in the dark about the credit union’s plans.

Decisions with long term consequences are being done in a vacuum. It is not clear who is calling the shots and who is willing to take responsibility.

Where is the Problem?

The Agency’s professional competence is on the line in its takeover of MCU. Many ask how this situation could have occurred if NCUA and state regulators had conducted adequate oversight to begin with.

Is the real problem the credit union or a multi-year failure of examination and supervision?

NCUA’s record in large conservatorships is not encouraging. In the takeover and liquidation of five corporate credit unions in 2010, the Agency’s forecasted costs to credit unions were in error by over $20 billion. In these forced liquidations there is a $6 billion surplus even after NCUA spent almost $4 billion additional expenses overseeing the closures.

Moreover, without timely information, it is hard for the credit union system, vendor partners and employer sponsors to provide support to MCU.

The Need for Leadership

Who at NCUA is willing to take responsibility for informing the credit union community about this critically important situation? It is a time for leadership. One leader stepping up could inspire others to contribute to MCU’s return to its member-owners.

My earlier blog today about Fellowship Credit Union (now BECU) contains an even more powerful message than acorns becoming tall oaks.

It is the example of people willing to put limited resources to the aid of their fellow human beings in difficult circumstances. That is, the many giving others the opportunity at a better life—during the hard times of the depression.

Another Reality: Disposable Members

Last year when walking in downtown Chicago, the following message on the side of a public trash unit caught my eye.

This is unfortunately one of the consequences of NCUA’s current practice in problem credit union resolution. Members with savings receive all their money back at full value. Borrowing members are sold off to the highest bidder. For savers this would be the same as NCUA transferring members’ insured balances to Wells Fargo or a finance company. Sell savings accounts for the best price and then let members work out their future relationship on their own.

Borrowers are the primary reason for a credit union. They provide the most important source of revenue. But in problem situations, the borrowing members’ fate is not NCUA’s concern. Loans are only an asset to be rid of.

This practice was most dramatically illustrated in the NCUA’s February sale of over 4,500 member taxi medallion loans to a hedge fund seeking to build a dominant share of the NYC taxi medallion market.

How This Topic Came Up Last Week

At NCUA’s Wednesday 2021/22 budget hearing, this issue was raised when one of the presenters gratuitously congratulated his organization and the Agency on this action, according to the CU Times.

The reported statements were:

“As NAFCU’s SIF Committee pointed out prior to the sale the unusually large taxi medallion portfolio would strain agency resources and pose a risk to the credit union community so long as it remained under management by the Asset Management and Assistance Center.

“While NAFCU did not anticipate a global pandemic at the time we offered this advice, we believed that retaining the portfolio in the hopes of extracting a higher sales price presented unnecessary risks, and recommended that the agency divest the portfolio at the earliest opportunity so long as it received a fair price.”

No facts were offered to support this position. The idea that the portfolio would “strain agency resources” in a $19 billion dollar fund is nonsensical. The agency two years earlier had expensed all the estimated loss–at a magnitude 4 times ($750 million) the last reported deficits ($150 million) in conservatorship.

The return on this additional cash in the NCUSIF is under 10 basis points.

Why this superfluous statement was made in a budget hearing is unclear–a crude attempt at sucking up to the Agency or poking a sharp stick in the eye of a group that challenged the sale. Whatever the reason, it not only undercuts the credibility of the presenter, but more critically it supports the unfortunate Agency practice that member borrowers are not NCUA’s responsibility, just savers.

Hiding the Truth on the Taxi Medallions

NCUA has repeatedly refused to present any details that would support its sale as in the best interests of the members. Or even the best financial outcome for the NCUSIF.

At least three organizations requested FOIA information on the sale; all denied. Some of the sale details were already published in a Feb. 20, 2020 WSJ story on the hedge fund’s purchase.

The Journal reported the price of $350 million for a portfolio of 3,000 New York medallions, 900 Chicago medallions, 500 Philadelphia medallions and 100 from other cities.

This is an average loan value of $77,800 each, all secured by medallions. An estimate of the average book value of these loans is the purchase price of $350 million plus the loss NCUA says it has taken on the portfolio of $760 million. These numbers combined total $11 billion and suggest an average book value of $245 thousand per loan. The cash received would be a payment of 31 cents per loan dollar.

What’s Wrong with Cashing Out?

The challenges of the New York taxi medallion market continue to be tracked. One example is the 2015-2020 chart below which shows the rider volumes as the uber/lyft new entrants disrupted the taxi industry. So, wasn’t 31 cents better than holding on? That is the question which NCUA and the presenter have failed to offer any factual information.

For some the chart may be a sufficient justification forgetting the fundamental rule of markets, what goes up must come down and vice versa. Cashing out at the bottom is generally the highest cost strategy—just remember the five corporate liquidations, all supposedly insolvent, whose estates have generated a surplus of over $6 billion so far.

Better options for members are what the Taxi association, CUNA and others offered to present to NCUA which refused to consider all offers. Medallion drivers, one of the most diverse group of credit union members, include many individual entrepreneurs. They were denied any ability to negotiate their own future. The sweat equity that they hoped to build was turned over to a firm that specialize in profiting from others in financial difficulty.

One Easy Solution for a Win-Win

Instead of turning its back on members striving to realize the American dream through their own labor, what if the agency had offered to discount the members’ loans to the same level that the hedge fund bought them? Furthermore, these rewrites could include a contingency that if the borrower was able to sell the medallion for more in the future, the gain could be split between the borrower and the fund.

More proposals for assistance continue to be drawn up today by the alliance and New York city leaders. Some taxi owners were able to receive help from financial programs in the CARES act. But NCUA washed its hands and walked away from the members in trouble as others attempted to find solutions.

NCUA’s lack of transparency suggests there is much to hide in its failed supervision of the taxi medallion situation and sale. The agency used money due credit unions from the TCCUSF surplus to expense $750 million to cover up their inability to carry out basic responsibilities for problem supervision and resolution.

The most unfortunate aspect of the taxi medallion sale was that it proved again that NCUA views credit union borrowers as disposable. This is exactly the opposite of the founding spirit of the Fellowship CU and the purpose for which all credit unions were formed.

December 7^th is also a day that no one will forget because it brought America into WWII. A basic code of honor in the US military is that no one gets left behind whether as POWs or MIAs. Decades, even generations later, the US government sends teams to recover the remains of missing from Korea to Vietnam and other places of combat. No one is forgotten, whatever the circumstances.

That is the heart of the American democratic commitment to each other. It’s the motivation for Fellowship Credit Union, begun this day four generations ago.

Isn’t it time NCUA followed this same principle when performing its responsibilities?

An easy but critical first step for a new NCUA board for insight into the agency would be to change the current auditor, KPMG, of its three credit union financed funds. This is normal good business practice as NCUA documents in its examination recommendations cited below.

It would bring a fresh set of eyes and objective rigor to a series of events such as the ambiguities in managing the corporate AME assets and the inexplicable annual accounting for loss reserves in the NCUSIF.

It would also bring much needed review for how the Inspector General’s office performs both its internal and external audit oversight.

Finally, it would replace a firm whose professional integrity and competence have been publicly and repeatedly called to account in the past three years by both regulators and the financial press.

KPMG’s Recent Press Reports

For several years the business press has reported on the professional and ethical failures at KPMG. The following are a few of the public stories about events from 2016 through this year.

1. The KPMG cheating scandal was much more widespread than originally thought

Jun 18, 2019 — A $50 million fine against KPMG LLP for its use of stolen regulatory information to cheat on audit inspections wasn’t a surprise: The Wall Street Journal warned last week that the Securities and Exchange Commission was ready to impose such a move, and the scandal had been known about for more than a year.

https://www.marketwatch.com/story/the-kpmg-cheating-scandal-was-much-more-widespread-than-originally-thought-2019-06-18

2. KPMG reveals eight audit clients collapsed

Updated Feb 18, 2020 

KPMG has revealed it failed to flag problems with the financial statements of two of the eight collapsed listed companies it audited over the last 10 years.

https://www.afr.com/companies/professional-services/kpmg-reveals-that-eight-audit-clients-collapsed-20200203-p53x6l

3. Accounting Watchdog Finds Ongoing Problems at KPMG

The Public Company Accounting Oversight Board (PCAOB) said half of the 52 audits it inspected from top accounting firm KPMG were seriously deficient and KPMG was not as committed to quality as the accountancy claimed.

“In 26 audits, certain of these deficiencies were of such significance that it appeared to the inspection team that the firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion,” the PCAOB said in its report.

The accounting watchdog also released a revised inspection report for 2016 that found deficiencies in 22 of 51 engagements.

Some of the most common deficiencies occurred in the area of revenue and included failures to sufficiently test the design or effectiveness of controls.

https://www.cfo.com/auditing/2019/01/accounting-watchdog-finds-ongoing-problems-at-kpmg/

4. SEC Charges Three Former KPMG Audit Partners for Exam Sharing Misconduct

Washington D.C., May 18, 2020 

The Securities and Exchange Commission today announced settled charges against three former KPMG LLP audit partners for improperly sharing answers to internal training exams and for subsequent wrongdoing during an investigation of exam sharing misconduct at the firm. The SEC previously charged KPMG with violations concerning the exam sharing misconduct, as well as for altering past audit work after receiving stolen information about inspections that would be conducted by the PCAOB.

An NCUA Examination Comment On External Auditing

Following is an excerpt of standard wording NCUA provided one  credit union’s supervisory committee about managing their external audit process: (emphasis added)

Examiner’s Observation: As standard exam procedure, we conducted a meeting with the supervisory committee chair during this year’s examination. We inquired about the process of soliciting bids from audit firms prior to the end of the engagement period, to select the audit firm for the next engagement period. Our discussions with the supervisory committee and review of policies and procedures noted that there is no documented bidding process and that the audit committee has not solicited bids since 2010.

It also appears that the audit committee had no defined timeline as to when they would solicit bids in the future. While specific limits are not required, recent accounting and auditing scandals highlight the importance of rotating audit firms periodically. Otherwise, auditors and clients could loose independence and overlook areas of concern.

Prudent and standard business practices recommend the development of written processes and procedures, outlining the steps the supervisory committee needs to follow when engaging an audit firm to complete the annual audit. The supervisory committee needs to follow the guidelines when soliciting and reviewing bids from audit firms.

We recommend the supervisory committee develop, approve, and implement written procedures for reviewing proposals for the annual audit. Furthermore, the audit committee must understand and implement the procedures as intended, as this is among the most important functions of the committee. It is imperative the supervisory committee maintain documentation to support their review and selection of the audit firm. Furthermore, we recommend that management and the board consider periodically rotating audit firms. It is important to note we are not taking exception to or criticizing the quality of the annual audit report or the audit firm.

An Example of a Board Policy Statement of a Co-op’s Audit Process

Effective audit controls include review as to whether internal and external audits are effective.

• • The Board of Directors and Executive Management of XYZ expect to be apprised of the condition of the organization, including the system of internal controls.
  • On an annual basis the Board of Directors is asked to approve the Risk Based Audit Plan. The Audit Plan describes the internal and external audits designed to prove the adequacy and effectiveness of internal controls and policy, as directed by the Board of Directors and Executive Management of XYZ.

Board Action Required

This brief policy statement should be the starting point for a new NCUA Board to better monitor and understand the effectiveness of the Agency’s management. It is what the agency expects of credit unions. Should it not hold itself to the same standard?

At the November NCUA board meeting, two members responding to the NCUSIF update made “the sky is falling” projections about whether the fund will have adequate resources in 2021.

One board member confidently predicted that the assessment of a premium is not a question of if, but when.

Neither forecast was supported by factual analysis.

Relevant Facts

Before offering a simple, immediate solution to these future seers’ concerns it is important to affirm basic facts about the NCUSIF’s financial strength and record.

• As reported by Chairman Hood to Congress the fund’s NOL is 1.32, which is above the legal cap of 1.3%. Anytime the fund exceeds this cap, a premium cannot be charged.
• The current NOL is 12 basis points above the 1.20 floor below which a restoration plan must be prepared. This is a financial margin of almost $2 billion.
• In the last 12 years of operations, the total insurance losses for the entire period Is $1.887 BN or less than the current NOL “surplus” margin.
• NCUA’s transfer of its fixed operating expenses to the NCUSIF via the overhead transfer rate (OTR) in this same 12 years is $1.968 BN or more than the total insurance losses.
• NCUSIF’s operating expenses have grown at a CAGR of 8.06% versus the growth of insured shares of only 5.6% in this time span. It is this fixed operating expense, not insurance losses, that eat up the fund’s revenue.
• The fund’s average insurance 12-year loss is 1.727 of insured savings. This includes the entire years of the Great Recession. The current 12 basis point NOL margin is seven times (700%) this average annual rate of loss.
• The September 2020 NCUSIF financials show an allowance reserve already funded for both general and specific losses. Moreover, the total assets of all code 4 and 5 credit unions is only .64% of the industry’s assets, that is less than 1%. This is the lowest level in the past decade.

Full details of the NCUSIF’s operations can be found on this spread sheet.

2019 NCUSIF Performance Spreadsheet_AJ1

The NCUSIF 1% semi-annual deposit “true up” underwriting means the NCUSIF is entirely countercyclical in its structure. The NOL range of 10 basis points(1.20 to 1.30) provides flexibility no matter the uncertainties that might occur. It is the ever-increasing fixed expense charged the NCUSIF in the OTR, not the variable insurance losses, that take the majority of NCUSIF income.

The fund’s financial architecture has proven its resilience since 1984 a period of time in which the FDIC has gone negative three times. The FSLIC failed and was merged into the FDIC in the 1990’s. In spite of these failures, the FDIC is still based on the same premium financial model that has led to its repeated failure.

A Ready, Easy Source of Additional Revenue-Not Premiums

As of September 30, the market value of the NCUSIF investment portfolio exceeded its book value by $586 million. This is due to the precipitous fall in interest rates engineered by the Federal Reserve at the beginning of March responding to the pandemic and economic shut down.

By selling these securities and staying short, the fund would book immediate revenue in the hundreds of millions, become more liquid and be better positioned for the inevitable rise in rates from present historic lows.

This market premium disappears if the securities are held to maturity. The time to realize this gain is now. It will add immediately to equity if the board truly believes the NCUSIF must sustain an NOL above 1.3. A premium cannot be levied if the NOL is above 1.3%

But what about the future revenue possibly foregone when the bonds are sold and reinvested at today’s lower rates? That is a contingency easily modeled, but ultimately relies on the assumptions made about how long the current rate environment is likely to continue.

The NCUSIF reported the following fixed rate investments by the NCUSIF in September:

Term   Rate
4 yrs    .20%
5 yrs    .27%
6 yrs    .36%
7 yrs     .45%

Is there any CFO or CEO who would make investments for their credit union at these terms and fixed rates into the future? While no one knows the future, the preponderance of experience suggests that it will take only one move by the Fed from its current 0-25 bps overnight range, to a first step raising it to 25-50 bps, for all of these investments to be underwater, that is less than book value.

Yes, there is a risk of some foregone revenue next year, but a reasonable forecast suggests that a strong recovery will bring with it higher rates. And if the opposite happens and economic disaster occurs, then the liquidity would be readily available.

The Action Needed and the Precedent

If the NCUA board decides to keep the NOL above the 1.3% current cap, then sell some of its investments, take the gains and recognize the revenue now. When rates rise, the market premium goes away. This is an opportunity that will decline if not disappear in the not-too-distant future.

The precedent is 2008 when the NCUSIF sold longer term securities to prepare for the potential contingencies brought by the Great Recession. This boosted income so that no premium was necessary with the fund reporting net income of $24 million and an NOL of 1.26.