Chip Filson
The Nova Scotia Co-operative Council in celebration of their 70th anniversary have teamed up with presenting sponsor Atlantic Credit Unions and a grouping of other sponsors to host “A conversation with Barack Obama” in Halifax at the Scotiabank Centre in Halifax.
Wednesday November 13, 2019 6:30pm
$115 – $325
The web site reports the 9,000 seat auditorium was sold out almost immediately. Now that’s an eye-opening brand impact!
Corporate credit unions have labored under a very detailed risk based capital rule (RBC) for almost eight years. At the end is a footnote from a corporate’s audit showing the reporting required by the rule which demonstrates four very different outcomes:
As of December 2018 these ratios range from 6.26% (leverage) to 44.07% (total risk based). These single numbers actually simplify the multiple ways the ratios can be presented by using different ways to calculate the average asset denominator.
Two other columns show the regulatory minimum ratios to be considered “adequately capitalized” or “well capitalized” under the rule..
There are a total of 12 numbers for a reader to compare to evaluate a corporate’s capital status at a point in time—before undertaking any trend analysis.
With a range of outcomes from 6.26% to over 44% as indicators capital sufficiency, one must ask if the numbers have any meaning at all.
The Delay in Risk Based Capital for Natural Person Credit Unions
In June the NCUA board approved a two-year delay in RBC rules for credit unions. Among reasons given was consideration of yet another leverage rule for complex credit unions in addition to PCA. That would make the rule more complicated, not less.
As shown by the bank regulatory agencies and even more clearly by the corporate RBC rule, the outcomes are so complicated that the data fails to clarify any dimension of capital adequacy; for example does this corporate have too much or too little capital?
It is a tool that confuses, adds burdens and ultimately locks credit unions into a legally-mandated assessment of relative risk among all asset categories.
Natural person credit union balance sheets are many times more complex than corporates whose balance sheets are almost all investment securities. These all have relatively easy market based values for referencing.
Risk based approaches are not only confusing, they can also tilt credit union decisions to increase exposure to whatever the regulatory “safest” relative risk of the day might be.
The simple leverage ratio has served the industry well for over one hundred years including more than 50 since deregulation. RBC might be useful as a tool; but it could potentially drive credit unions off a cliff if it were to be a rule.
CORPORATE FOOTNOTE 11 – REGULATORY CAPITAL
The Credit Union is subject to various regulatory capital requirements administered by the NCUA. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Credit Union’s financial statements. Failure to meet minimum capital requirements would require the Credit Union to submit a plan of action to correct the shortfall. Additionally, NCUA could require an increase in capital to specific levels, reduction of interest, and ceasing or limiting the Credit Union’s ability to accept deposits.
The Credit Union’s actual and required ratios for December 31, 2018 and 2017 are as follows:
In an 18-page complaint filed August 7, Victor Webb filed suit against the board and supervisory committee of the failed CBS Employees FCU seeking over $40 million in recoveries for members.
According to press reports the loss was first discovered on March 6, by an employee who raised questions about a $35,000 check the CEO, Rostohar, had made out to himself.
NCUA’s audit as of February 28, 2019 said the loss could be as high as $40.5 million for an embezzlement scheme that Rostohar admitted carrying out over two decades. In the credit union’s last call report as of December 31, 2018, it reported $21 million in assets, $2.6 million in capital and 2,798 members.
The federal credit union was chartered in 1961 to serve CBS employees and related companies. In the complaint Webb stated he joined the credit union in 1970 while a CBS employee. He remained a member until the credit union was liquidated in March, although he retired from CBS in 2014.
His suit names the board and supervisory committee members at the time of liquidation and prior members who served in similar capacities during the two decades of defalcations.
As a class action, Webb seeks damages of $40 million on behalf of all members, by stating that the benefits of membership were devalued by this amount which should have been available so members could benefit from lower fees and loan rates or higher dividends—that is the lost benefits of credit union ownership.
The core argument for suing the Board and supervisory committee members is summarized as follows:
“By reason of Individual Defendants’ positions with CBS Employees (FCU) as members of the Board of Directors, they are or were, at all times herein relevant, in a fiduciary relationship with Plaintiff and other CBS Employees (FCU) members and owe them a duty of highest good faith, fair dealing, loyalty, as well as a duty to maximize member value.” (Page 3)
The fiduciary responsibility of directors and committee members is well documented in NCUA regulations and letters, but rarely is their conduct formally challenged by a member. But this is a case of extraordinary loss equal to almost 10% of the last reported assets, or $2 million per year, for over two decades. Both the amount and length suggest a complete breakdown in both internal and external, regulatory oversight.
This suit focusing on the fiduciary duties of the Board and Supervisory committee could be a very important milestone in cooperative governance and oversight.
How NCUA’s reported audited shortfall of $40.5 million in a $21.3 million asset size credit union could occur is hard to fathom.
The credit union’s December 2018 call report shows $18.4 million in shares for 2,798 members, resulting in an average share balance of $6,576. The credit union’s assets consisted of $14.7 million of investments and $6.1 million in loans with a reported delinquency of only 0.33%.
The credit union’s $18.4 million in member shares would seem to be more than adequately covered by the $21.2 million (with $2.6 million net worth) in easily verifiable assets if a liquidation were ever necessary.
Internal processes to monitor the credit union’s management are mandated in both bylaws and by rule and reg.
Every federal credit union is required to complete an annual audit under the auspices of its Supervisory Committee. Such an audit, whether internally conducted or outsourced, would entail a verification of member accounts, selected confirmations of investments and loans, and a review of internal controls. The results are reported to the Board.
Additionally, NCUA has conducted annual audits of every FCU since the 2008-09 financial crisis. This review would review the credit union’s own supervisory committee’s audits, including member confirmations, plus a complete examination of investments and loans. In addition, the examiner would review all settlement accounts against the latest bank statements to ensure up to date postings and that the credit union’s general ledger is in agreement with external financial confirmations.
If the assets reported by the credit union are correctly reported, then that would mean the total loss caused by the CEO’s fraudulent activities would be the $40.5 million shortfall plus the $2.6 million in net worth for a total of $43.1 million.
NCUA’s obligation to member shareholders is to pay up to the $250,000 per account insured limit. A $43.1 million payment on top of the $18 million in reported shares would mean that over 6,500 more accounts (using the average share balance from reported members) would have been kept in a second set of off-the-book records.
There are only two explanations for NCUA’s reporting a $40.5 million loss after its February 28,2019 audit:
If the second option is the explanation, this suggests the CEO was running a shadow credit union with almost three times the number of members and shares as the reporting credit union. How could this activity be hidden from employees, the directors or supervisory committee, since these members must have received statements and conducted business transactions regularly with the credit union?
If the reported assets are phony, which would account for half of the loss, the only question is what type of annual exam had NCUA conducted over the two decades that this theft occurred?
I salute member Webb for standing up and asking that responsible parties be held to account. This is more than sending the former CEO to jail and then covering the tens of millions shortfall out of NCUA’s “rainy day insurance fund.”
All the public evidence suggests that the problems are much more extensive than a corrupt CEO and a hoodwinked and a deleterious board and supervisory committee. The regulatory oversight that is supposed to assure the industry’s safety and soundness through onsite examinations would appear to have been negligent as well.
When a member takes a stand against ineptness, self-serving conduct and dereliction of duty, the whole democratic movement will benefit. Cooperative governance requires that fiduciary duty have real meaning, not just good intentions. Hopefully this suit will bring out the full story and create a much-needed precedent along with a correction of examination shortfalls.
I salute Victor Webb and say with him, “Enough is Enough.” Stop paying out losses, let’s correct the problems letting these occur.
Over the past twelve months the credit union community is on the hook or paid the bills for the following situations:
In each situation there has been no objective, public discussion of what happened. No lessons have been taken away from these extraordinary losses and how they might be eliminated or mitigated in the future.
Specifically:
When a loss occurs, there is a rush to judgment. What went wrong? Who screwed up? Why did this happen, again?
The natural response is to point fingers, blame someone for the problem. Then punish or banish wrongdoers from ever working at a credit union. And resolve the loss by paying for the shortfall out of the NCUSIF—and move on.
While indicting possible malfeasance may be necessary, it can miss entirely the lessons to be learned. The result is that there is no return on the money expended. Credit union monies are swallowed up in a regulatory “black hole.”
For informed judgement is about discernment, understanding the circumstances of what happened and identifying the possibly numerous opportunities to have done something about the situation much earlier.
Judgement is much more than holding people accountable. In the cooperative community, all members pay for the individual losses via the NCUSIF. Therefore the most important benefit should be corrective actions or processes that can prevent similar circumstances from getting “out of hand” in the future.
For example, NCUA says correctly that it sent a letter about potential problems in the taxi medallion industry to all examiners in 2014. The letter did not identify the possible disruption of the entire industry by Uber and Lyft, but it did reinforce proper underwriting including the ability of borrowers to service the debt.
But somehow the problem grew and grew and no one knew how to manage through a cyclical decline in asset values. This is not a new situation for credit unions. Loans secured by real estate, autos and leases, and/or commercial properties and farm land will all have changes in the value of security during the term of the loan.
But somehow these inevitable fluctuations in value cause reactions as if the problem has never occurred. Before. This panic often exacerbates the situation, freezing new responses and resulting in irreversible financial decisions at the lowest point of value for the security.
Cooperatives are interdependent on each other for market success. The most consequential connection is via the shared capital pool created in the NCUSIF. While the temptation may be to approach difficult situations with an eye to eliminating the problem, that not only may be the least desirable outcome for members of the credit union, but more importantly, it may not be the positive example needed by the whole cooperative community.
Credit unions were created to solve problems especially for members and in circumstances when normal market options were unavailable or too expensive. When problems are just done away with and all circumstances swept under the rug because of sufficient resources to do so, everyone loses. Other credit unions facing similar loan challenges as the taxi medallion example, those with concerns about the adequacy of their internal and external audits; or credit unions with underfunded pension or other liabilities could all benefit from a thorough knowledge of the above cases.
Every credit union board and CEO any CPA or auditing firm and every DP, bonding and any vendor connected to the credit unions above, has an interest in knowing what happened. That knowledge is necessary if there is to be a common commitment to do better in the future. NCUA has to lead by example. The three circumstances above would be excellent places to start with full public reviews. Credit unions have received nothing for the $1.25 billion spent so far. The buck has to stop somewhere before credit unions run out of bucks.
From the new credit union’s announcement:
On Wednesday, August 14, the National Credit Union Administration (NCUA) approved charter number 24915 for Maine Harvest Federal Credit Union. This approval was announced publicly in an NCUA press release:
https://www.ncua.gov/newsroom/press-release/2019/ncua-charters-maine-harvest-federal-credit-union
Maine Harvest FCU become the first regulated, deposit-taking financial institution with a mission to promote a local food system by lending to small farms and food producers. At Maine Harvest FCU, we hope to see the impact of our mission in stronger rural economy, a cleaner environment, increased soil fertility and improved public health.
Maine Harvest FCU becomes the first new credit union in Maine in 30 years and only the second credit union chartered nationally in 2019.
The process took eight years and required $2.5 million in donated, startup capital.
Since starting the chartering process with NCUA’s required survey (seen below), there have been eight crop harvests. How many small farms and start up efforts were frustrated in the interim?
Which is harder: being a small farmer or a credit union organizer?
Potential Member Survey (2012)
The potential member survey was fielded at MOFGA’s Common Ground Fair in 2012. This two-page survey was based on a template from the National Credit Union Administration and is an important part of the credit union chartering process. The goal of the survey was to gauge the level of interest in the proposed credit union and to get an idea of potential deposits from prospective members. 258 responses were received and consistently indicated a high level of interest in joining the CU and with substantial potential deposits. (Source Maine Harvest web site)
In a recent podcast interview by Robert McGarvey, CEO Randy Karnes summarizes CU*Answers’ approach to strategy. On more than a dozen business issues from culture to market analysis, his concise insights are extraordinary.
At a time when supplemental capital for credit unions is a topic of regulatory review and wide industry interest, his comments on the CUSO’s approach to financial soundness, especially capital planning, are especially relevant.
As he explains, for his CUSO patronage by the owners is more valuable than dollars of capital. The reason is that patronage is “belief, persistence and cash flow.” Capital dollars have to be paid back. Patronage sustains and grows.
All of the proposed approaches to supplemental capital will need to be paid back. The real “capital” that has been the source for all credit union’s soundness from day one is the member relationship. Member loyalty, use and trust are the patronage that sustains viability even if net worth ratios fall below well-capitalized.
The reason for 208 assistance in the FCU Act is to allow members to “recapitalize” their credit union over time through their patronage. When PCA or other supervisory actions prevent members and management from recovering from setbacks, the fundamental strength of the cooperative model is compromised.
Almost all credit unions active today, were founded without financial capital. Their financial success is created over years or even decades of member participation.
When the success or status of a credit union is measured by only financial yardsticks, sooner or later, that framework will be found wanting. It overlooks the fundamental difference between a member-owner cooperative and a for-profit financial alternative.
The message for credit unions from this CUSO’s 50-year history may be that all financial capital is supplemental. Longevity requires relationships. That is the cooperative difference and unmatchable advantage.
To listen to Randy’s 34 minute interview by Robert McGarvey’s CU 2.0 Podcast , Episode 47, visit: https://www.buzzsprout.com/268738/1513849-cu-2-0-podcast-episode-47-randy-karnes-cu-answers-for-small-credit-unions
A Labor Day reflection:
In my present position I could scarcely be justified were I to omit raising a warning voice against this approach of returning despotism.
It is not needed nor fitting here that a general argument should be made in favor of popular institutions, but there is one point, with its connections, not so hackneyed as most others, to which I ask a brief attention. It is the effort to place capital on an equal footing with, if not above, labor in the structure of government. It is assumed that labor is available only in connection with capital; that nobody labors unless somebody else, owning capital, somehow by the use of it induces him to labor. This assumed, it is next considered whether it is best that capital shall hire laborers, and thus induce them to work by their own consent, or buy them and drive them to it without their consent. Having proceeded so far, it is naturally concluded that all laborers are either hired laborers or what we call slaves. And further, it is assumed that whoever is once a hired laborer is fixed in that condition for life.
Now there is no such relation between capital and labor as assumed, nor is there any such thing as a free man being fixed for life in the condition of a hired laborer. Both these assumptions are false, and all inferences from them are groundless.
Labor is prior to and independent of capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration. . .
Source: State of the Union Address: Abraham Lincoln (December 3, 1861)
A common assumption by many working in credit unions is that scale, that is increasing a credit union’s balance sheet size, is critical to competitiveness, and therefore survival. As one CEO wrote: “Given our market and community field of membership, we believe scale is more important than ever.”
This belief in “scale economies” is often supported by citing average financial performance by peer group size. These averages do show that larger credit unions tend to grow both members and assets faster than smaller ones. Also, they generally operate with lower expense ratios, larger dividend payouts, and generally higher ROA’s and loan to share ratios.
However even within the same peer group (over $1 billion in assets) there is a wide variation in these ratios. Becoming larger does not automatically create these outcomes.
The logic that data confirms the necessity for scale, does not hold true across all situations. Facts alone may not reveal underlying truths about successful cooperative performance.
Moreover, the facts used may rely on an assumption or mindset, that itself is debatable.
Scale matters in a competitive market, some argue, because it can lead to larger market share and therefore greater economic power.
Scale is achieved by growth, that often means out running competitors. This can be done organically or more recently, by some credit unions soliciting mergers or buying out bank competitors.
Growth thus becomes the primary objective, if not the mission of the credit union. It is driven by an assumption of limited resources (or members) and that an institution must get their “share” before someone else takes it away.
I call this the “scarcity mindset” myth. Credit unions think of strategy as a struggle to get more and more, and can never slow down, because ultimate scale is always unreachable. The end point keeps growing from $100 million, to $1 billion to $10 billion in assets. No asset size is ever enough.
Credit union were founded on belief in the power and resources of community. That by working together we can mobilize savers (those with more) to help borrowers (those with less).
By institutionalizing this process, members become empowered and the well-being of all is improved. It is not the amount of resources that matter, but rather how they are managed for the common welfare.
This approach created by self-help and collaboration rests on the assumption of abundance. Credit unions are motivated by relationships and mission. This focus creates trust that underwrites the inevitable cycles of economic fortune that will occur either individually or organizationally.
Instead of a scarcity mindset that focuses on getting whatever one can to grow an institution, credit union design rests on a belief in commerce organized around neighborliness and community. In my individual capacity, I may not have what I need; but in my collective contributions, there is enough for all.
The vast majority of credit unions have never had a major merger. Most credit unions do not seek to buy out their financial competitors.
However, there is a commercial motivation promulgated by self-interested brokers, consultants and growth-oriented CEO’s and boards that assert survival depends on outmaneuvering the competition through size. This market driven ideology of institutional success subverts the cooperative focus on purpose.
The cooperative model was created to give member-owners the opportunity to create and manage their own financial options in a market dominated by firms that make a profit from relationships.
The cooperative goal is to transform individual options and bring the resources of like-minded persons to build an institution using the resources available, that is a belief in an “economy of abundance.”
The credit union approach is sustained by a community of shared values, not just more plentiful resources.
As boards consider strategy, it may be helpful to ask the following:
As I look across the multiple examples of success among all credit union asset groups, I note that those who possess less are less possessed by motives for scale. And instead of intending to be sustained by their savings from scale, they rely instead on the member’s trust and loyalty.
According to the US Census Bureau’s population clock, the estimated 2018 United States population (February 2018) is 327.16 million.
This is a bit lower than the 329.06 million estimated by the United Nations.
As reported in Pentagon FCU’s June 30, 2019 quarterly call report, every one in the US is eligible to become a member. The data submitted by the credit union is as follows:
| MISCELLANEOUS INFORMATION | NUMBER | ACCT |
|---|---|---|
| 2. Number of current members (not number of accounts) | 1,788,610 | 083 |
| 3. Number of potential members | 329,152,485 | 084 |