Karl Hoyle and His Powerful Cooperative Talent

Last week Karl Hoyle (1943-2021), a  credit union advocate, was interred in Arlington Cemetery.

There are 450,000 other graves, an honor earned, not bought.

The ceremony starts with a brief service in the Old Post Chapel.  The Honor Guard brings in the urn. The Chaplain reads the 23rd Psalm; the attendees say the Lord’s Prayer.  The organ plays America the Beautiful and On the Wings of Eagles.

Following the service the congregation goes with the honor guard to the gravesite.  The American flag is meticulously folded in a triangle.

There is the seven gun salute, the bugle playing taps and the sacred moment when the flag is presented to Kathy Hoyle, Karl’s wife, by an officer on bended knee.

Afterwards, roses are placed on the grave next to the urn where the only identifier on the wooden box is Karl’s military medals.

The Air Medal and Purple Heart

I learned during the reception that Karl had been awarded the Air Medal.  This  Medal recognizes military and civilian personnel for single acts of heroism while participating in aerial flight in actual combat.  It is the equivalent of the bronze star.

Karl was deployed to Vietnam as part of the 9th Infantry Division.   At the support base, a call came for helicopters to  medivac the wounded from a platoon still in the midst of battle.    He volunteered, got on the chopper and went straight into the firefight to evacuate his fellow soldiers.

As his military colleague stated: “Karl was the guy you wanted on your team.”

His life subsequently expanded to be much more than that moment of choice marked by courage and duty.

Joining the Cooperative Team

Jim Barr and Karl were the top lobbyists in CUNA’s Washington Office when Ed Callahan, Bucky Sebastian and I arrived at NCUA at the end of 1981.  Both had worked together in the late 70’s at the newly organized NAFCU.

Karl would sometimes remark that his profession’s reputation was not always the highest.  His favorite line was, “If you run into my mother, tell her I am just the piano player in a whorehouse.”

However when mentoring many others on the Hill, he counseled that :  “To be a professional with integrity, know that everything you say will be remembered.”

Three Personal Contacts

Of the many occasions Karl and I spoke, three stand out.

  1. Karl learned that I had moved to Bethesda, MD in 1982 to be near NIH because my wife was being treated for breast cancer. We hoped to get accepted in one of their special cancer studies, but had no idea how to begin. Karl offered to call and see what might be possible.  Shortly he informed us that because Mary Ann had already been on several chemo therapies, she was not eligible for their new protocols.  The studies were limited to patients with no previous treatments.
  2. In 1984 NCUA and the entire credit union system endeavored to find a Congressional bill in which to insert wording to redesign the NCUSIF in the Federal Credit Union Act. Democrat Bill Bradley was a key player on the Senate Banking Committee.  Karl was aware that Bill and I had played basketball together.

He brought me up to the Hill and sent a messenger into a banking hearing saying Chip Filson wanted to talk to the Senator.  Bill came out, motioned me into an elevator with him.  Lobbying Congress was not something I did for a living.  I don’t remember what was said, although I suspect Karl gave me the points to make.

Later that year Congress passed the Deficit Reduction Act, with bipartisan support, creating the NCUSIF’s new cooperative financial structure based on credit union’s 1% deposit perpetual underwriting.

  1. In May 1985, Ed, Bucky and I left NCUA to set up Callahan & Associates with a first office in the Triangle Towers building in Bethesda. Initial capital, $1,000. The location allowed me to be close to home, since I was a single parent with two teenage girls.

Shortly after, Karl called and asked if we needed any furniture.  CUNA was moving offices and had several old desks and chairs which we could have if we moved them ourselves.   We did.

He also asked if we needed any staff.  All three of us had worked in state or federal government for the past decade and were used to having support.  We said yes.   He said his wife Kathy, a superb office manager, was looking for a new opportunity.   She became Callahan’s first hire.

Karl’s Essential Cooperative Skill-Connecting

Karl’s special talent was facilitating the power that results from connecting people for common purpose.  Connections are what tie us together in community or when confronting personal circumstances.

Bucky said Karl’s success  was the result of his building relationships with  the staff in Congressional offices.

A former hill staffer at the reception knew Karl.  Her husband had been killed in the Air Florida crash in the winter of 1982 when the Potomac had frozen over.  She said Karl’s way of helping was: “Don’t call. Just show up.”

Tawana James, Karl’s deputy when he was Executive Director at NCUA, said “he cared about people.”

Credit unions’ competitive advantage is at its strongest when leaders collaborate.  Karl’s talent for connection came naturally, it was not an artifice.

Staying Connected

Two examples of his talent are in the pictures below.  One was a note to Bucky when Karl was in Madison at CUNA’s headquarters.  The second, a photo with the coach of the credit union team at the time, on which Karl was such a vital player.

Kathy like Karl has filled many roles  within the credit union system.  This year she will retire after working  more than a decade at InFirst Federal Credit Union.

Kathy and Karl: A relationship  bound by common purpose and service.

People Say the Darndest Things

With an important agenda of public meetings including the  Federal Reserve, I think it is helpful to start the week with a little humor.

Quotes from a court reporter’s favorite testimonies.

ATTORNEY: She had three children , right?
WITNESS: Yes.
ATTORNEY: How many were boys?
WITNESS: None.
ATTORNEY: Were there any girls?
WITNESS: Your Honor, I think I need a different attorney. Can I get a new attorney?

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

ATTORNEY: Is your appearance here this morning pursuant to a deposition notice which I sent to your attorney?
WITNESS: No, this is how I dress when I go to work.

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

ATTORNEY: ALL your responses MUST be oral, OK? What school did you go to?
WITNESS: Oral…

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

ATTORNEY: Now doctor, isn’t it true that when a person dies in his sleep, he doesn’t know about it until the next morning?
WITNESS: Did you actually pass the bar exam?

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

ATTORNEY: What is your date of birth?
WITNESS: July 18th.
ATTORNEY: What year?
WITNESS: Every year.

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ATTORNEY: The youngest son, the 20-year-old, how old is he?
WITNESS: He’s 20, much like your IQ.

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Outside The Box Thinking…

( a Jim Blaine classic post)

In the beginning ( no I was not there!); credit unions were created as cooperatives, which were to be owned and controlled by the members and managed in their best interests.

One member / one vote; a democratically elected Board; a common goal, a common purpose – the common good !

“We’re all in this together…”

But today, some Boards and CEOs have become “more creative” in how they view their relationship with and their responsibilities to those member-owners.

Kind of an “outside the box” sorta view….
See the problem? 
The members have become “outsiders”…. 
and therein lies our greatest challenge for the future!
A complete
box set!


Don’t box yourself in, 
don’t box your members out!

The NCUSIF Look Back: Its Vulnerabilities after 40 Years

The radical, cooperative redesign of the NCUSIF was approved by the NCUA board in October 1984.

In this board meeting video excerpt, Chairman Callahan thanked all who had worked to put this new “safety net” in place.  He called it a “great victory that is truly unique and sets the credit union system apart from all other financial institutions.”

Board member PA Mack stated his support of the new plan:  “I think this is an outstanding product as a partnership among government and credit unions. “

Chairman Callahan closed with these words about what it would take for this redesign to succeed:  “The real challenge now goes to the people at NCUA. The system can work beautifully for credit unions in the future. . . the real secret now is the operations.” 

This look back suggests the wisdom of Ed’s insight.  For the unique structure is only as effective as the people responsible for its implementation.

Immediate Success Brings Temptations

In NCUA’s  1985 NCUSIF’s Annual Report, the board  led by Chairman Roger Jepsen reported that in the first year the restructuring had “returned over $275 million in tangible benefits” to credit unions.  (Page 5)

The major initial concern was whether the agency’s multiple supervision efforts to resolve problem situations could reduce the losses charged to the fund.    The 1985 Report reported five-year trends that documented losses for all liquidations at only 1.5 basis points of all credit union insured savings.  Net losses in closed credit unions were $3.1 million, the lowest in the previous five years. The fund’s $29 million dividend at yearend was a payout ratio of 46% of  net income.  The Fund still maintained its 1.3% equity ratio.

But the fund’s fourfold increase in size, revenue, earnings and financial success also resulted in changing the long-standing practice of how the agency’s operating costs were allocated to the NCUSIF. From 1981 through 1985,  this allocation had ranged from a low of 30.5% to 34%.  This ratio aligned with the percentage of state charted credit unions insured by the NCUSIF.

At yearend 1986, state charters were just 33.3% of all NCUSIF insured institutions.   However the NCUA board increased the indirect expense to 50%.   As stated in that year’s Annual Report “The cost of these services which totaled $16,821,936 and $8,069,244 for the years ended September 30, 1986 and 1985, respectively, are reflected as a reduction of the corresponding (operating) expenses in the accompanying financial statements.”

The NCUA’s operating expenses charged to FCU’s “declined” from $21.5 million in 1985 to $17 million in 1986. This 100% increase in the NCUSIF’s expenses reduced the operating fee paid by federal charters. There was no change in the proportion of state chartered credit unions covered by the NCUSIF. This was an easier political option than raising the fee charged FCU’s.

This 50% increase in the expense allocation highlighted the most frequent concern expressed by credit unions about the new plan.  Here are some questions asked at a Q & A open meeting about the plan as reported in NCUA’s 1984 Annual Report:

Questioner:

What if the fund doesn’t operate on the interest earned?  If you don’t pay a dividend?  What happens if the agency is poorly run?  (pages 18, 19)

The concern was specific.  If the agency was given more money, wouldn’t it just be tempted to spend more?   Could the agency change the guardrails at its sole discretion?

This 50% increase in the Overhead Transfer Rate (OTR) was just the beginning of efforts to use the increased resources, not for insurance costs, but to underwrite the ever expanding agency budget.

“Building Out” The Agency

Soon after the 1986 OTR adjustment, the NCUSIF became the funding source for the NCUA’s building aspirations.  In 1988 the Operating Fund “entered into a $2,161,000 thirty-year unsecured note with the NCUSIF for the purchase of a building. . .In 1992, the Fund entered into a commitment to borrow up to $41,975,000 in a thirty-year secured term with the NCUSIF.  The monies were drawn as needed to fund the costs of constructing a building in 1993.”  (NCUA 2003 Annual Report pg 52.)

The variable rate on both notes was equal to the NCUSIF’s prior month yield on investments.  The interest was paid by the Operating Fund, 50% of whose expenses were then charged back to the NCUSIF.  The NCUSIF loaned the money and then paid half the interest on the loan!

It should be noted that during this construction and move to a new building in Alexandria , VA financed by the $42 million loan, the NCUSIF still paid a dividend  every year from 1995 through 2000, as the fund’s yearend equity ratio was above the 1.3% cap.

A Double Whammy in 2001

The Fund’s financial management which had produced six consecutive annual dividends was altered in two significant steps in 2001  by the NCUA Board.

The first was to increase the percentage of the fund’s OTR from 50% to 66.6%.   This resulted in a 37.3% growth NCUSIF’s operating expense while the operating fund reported a 31% decline in expenses in just the first year of this change.

The operating assessment for FCU’s fell by 20.4%.  The NCUA board was able to lower this fee on all FCU’s by shifting the expenses internally to the NCUSIF funded by all credit unions.

Each year since 2001, NCUA has calculated a different OTR’s based on “a study of staff time spent on insurance-related duties versus supervision-related duties.”   This ever fluctuating OTR peaked at 73.1% in 2016 under Chairman Matz.

During the past two decades of variable OTR, the percentage of state chartered credit unions in the NCUIF has remained more or less constant.    At June 30,2022 the 1,811 stare charters were only 37.3% of all FISCU’s.

The second administrative action was more consequential, because it modified how the normal operating level (NOL) was calculated and thus when the dividend is required. In a footnote 5 to the NCUSIF’s 2001 audited financials the following change was announced:

The NCUA board has determined that the normal operation level is 1.30 %  at  December 31, 2001 and 2000.   The calculated equity ratio at December 31 was 1.25%. The equity ratio at December 2000 was 1.33% which considered an estimated $31.9 million in deposit adjustments billed to insured credit unions in 2001 based upon total insured shares as of December 31, 2000.  Subsequently, such deposit adjustments were excluded and the calculated equity ratio at December 31,2000 was revised to 1.3%.

The Fund reversed its year earlier NOL determination. But even with this retroactive adjustment to the December 2000 equity ratio, the footnote continued:  Dividends of $99,490,000 which were associated with insured shares as of December 31, 2000 were declared and paid in 2001. 

Since the 1% deposit redesign in 1985, this annual adjustment has always been collected  in the following year.   And until this 2001 modification, the retained earnings/equity ratio was based on yearend insured savings.  A dividend was paid if retained earnings exceeded the .3% cap.

By not counting the 1% true up until the amount was billed results in an understatement of the actual NOL. It eliminated a dividend in years when the ratio would have exceeded the .3% cap under the prior practice, starting in 2001.

The Ultimate Guardrail Change

Since 1985, the NCUSIF normal operating level (NOL) had always been set at 1.3%.  In many years the cap was not reached, but the resulting ratio was considered adequate even if under the cap.  During and after the Great recession, the Board did not change the 1.3% cap even though they had been authorized to do so in the 1998 CUMAA.

Then in 2017 the board voted to merge the surplus from the TCCUSF into the NCUSIF.  But this surplus would have raised he NOL to greater than 1.5%.  To retain this amount above the traditional 1.3% cap, the board took two actions.  It raised the cap to 1.39%, the first time this change had ever happened.

The agency also immediately expensed and added to loss reserves $750 million from the TCCUSF surplus to pay for potential losses in natural person credit unions.   This action directly contradicted the congressional language establishing the TCCUSF that the fund “was not to be used for natural person credit union losses.”  But it did reduce the NOL to 1.39% even after setting aside a dividend for credit unions from a portion of the surplus.

This was the first time that the cap had been raised above the longstanding 1.3 level.  No verifiable details were provided about how this new level was determined except for summary data unsupported with actual calculations.

NCUSIF Success Raises Temptations

Credit unions’ concerns about supporting a perpetual 1% underwriting were well founded.  Their worry was “If we send more money to the NCUA, won’t they just be tempted to spend it because that is what government does.“

Subsequent NCUA boards have converted the “partnership” understandings referred to by Board member PA Mack into a perverse interpretation:  that to “protect the fund” the agency has to spend more and more on its operations to accomplish that objective.

From 2008 through 2021, the NCUSIF spent $2.2 billion on operating expenses and only $1.88 billion on actual cash losses.

NCUA has converted the fund into the agency’s cash cow. It has transferred much of its annual budget increases to the NCUSIF.   For example in 2012 the operating fund expense was $90.6  million; six years later in 2017 the expenses were still only  $90.3 million   All of the annual increases in the agency’s operating budget and more, in this six years, were paid by the insurance fund.

Federal credit unions became “free riders” as the operating fee paid an increasingly smaller share of the agency’s expenses.

The NCUA Board’s Responsibility: A Legacy Being Squandered

While staff proposes, the board disposes of their recommendations.  NCUA and its budget are literally exempt from any outside approval.  The agency is independent.  This absence of oversight raises responsibility of political appointees.

The annual OTR transfer have lost any connection to insured risk.  Instead they remind one of a person declaring their waistline to be 32″; but then, when you gain weight, redefining 32″ as whatever your waistline happens to be.  Insurance activity is whatever we want it to be.

The shortcomings have been bipartisan.   Republicans and democratic appointees have repeatedly affirmed transparency and actions to protect the fund.  But in practice the agency has declined to release the accounting options provided by its own outside CPA firm Cotton, the details in setting its annual NOL limit above 1.3, or the investment options and risk analysis used in managing the fund’s portfolio.

Every NCUA board member inherits a unique cooperative legacy in the NCUSIF that requires both knowledge and diligence if the fund is to be sustained.  This responsibility takes work and continual vigilance.

When the critical guardrails of the fund are modified one by one, the initial signposts of success are forgotten, and critical facts routinely omitted, then the prospect of a sound NCUSIF future is undermined.

The most important success factor in the Fund’s special public-private partnership is the ability to ask hard questions.  When this is not possible for board members to do and to followup, then it is up to credit unions or Congress.

A Lookback: The NCUSIF Four Decades after Redesign (1985-2022)

Knowing the past is essential to understanding the present and charting the future. This is true for individuals, institutions and society.

History provides us with a sense of identity. People, social movements  and institutions require a sense of their collective past that contributes to  what we are today.

This knowledge should include facts about our prior behavior, thinking and judgement.  Such information is critical in shaping our present and future.

The NCUSIF’s Transition Story

 

The NCUSIF legislation was passed by Congress in October 1970 authorizing  a premium based financial model imitating the FDIC’s and FSLIC’s  approach begun four decades earlier. This multi-decade head start was how those funds achieved their 1% required statutory minimum fund balance. This reserve growth occurred  during the post-war years of steady economic growth with only modest cycles of recession.

Then the economic disruption with double digit inflation and unemployment of the late 70’s and 80’s led to the complete deregulation of the financial system established during the depression.

Ten years after insuring its first credit unions, the NCUSIF’s financial position at fiscal yearend September 30, 1981, was:

Total Fund Assets:   $227 million

Total Fund Equity:    $175 million

Insured CU assets:    $57 Billion

Total Insured CU’s:    17,000

Fund equity/Insured shares:   .30%

CUNA president Jim William told NCUA Chairman Ed Callahan before his GAC speech in 1982, the dominant concern of credit unions was survival.

Because the fund equity ratio was so far short of its 1% legally mandated goal,  NCUA  implemented the only available option  to increase the ratio.   Double premiums were assessed in 1983 and 1984 totaling 16 basis points of insured savings for every insured credit union.

However, the ratio continued to decline primarily due to increased losses from the country’s macro-economic challenges. These trends and the prospect of double premiums caused  credit unions to ask if there were a better way.

The history of the analysis of the fund’s first dozen years leading up to these changes is in this seven minute video from the NCUA Video Network.

In April 1984, NCUA delivered a congressionally mandated report on the history  and current state of the NCUSIF.  It included the development of private, cooperative share insurance options and league stabilization funds.  It presented four recommendations to restructure the NCUSIF from a premium revenue model, to a cooperative, self-help, self-funding one.

Today’s NCUSIF after 40 Years

The four decades of NCUSIF performance since 1985 have proven the wisdom of the redesign and generated enormous financial savings for credit unions versus annual premiums.

Today the NCUSIF is $21.2 billion in total equity giving a fund insured share ratio of approximately 1.29%.   This size represents a 12.7% CAGR since 1981 when the fund’s equity was  just $175 million.

The critical success factor  of the 1% cooperative funding model is that it tracks the growth of total risk with earning assets, whatever the external economic environment.

This was and is not the fate of the premium based funds. The FSLIC failed and was merged into the FDIC in 1994.  The FDIC has assessed an annual premium(s) on total assets every year since the 1980’s.

The FDIC’s ratio of fund equity to insured shares at March 31, 2022 was 1.23%, down from its peak of 1.41% in December 2019.   On a number of occasions, the FDIC fund has reported negative equity during financial crisis.

NCUSIF Twice the Coverage Size of FDIC

It should also be noted that FDIC insured savings are only $10 trillion (41%) of the $24.1 trillion total assets in  FDIC insured institutions at the end of the March 2022.  The FDIC  is only .51% of all banking assets.

For credit unions insured shares are 78% of total assets.  Today, the NCUSIF’s total assets are  1% of all credit union assets, a ratio two times the size  of the FDIC’s.

Five Decades of Reliable, Sound Coverage

Throughout the redesigned NCUSIF’s history, a premium has been assessed to augment the fund four times: 1991 and 1992; and 2009 and 2010.   In both situations the premiums were levied based on reserve losses expensed but then subsequently reversed in later years.

In 1985, the fund’s first full year of the redesign, NCUA reported “for the first time ever, the NCUSIF paid a dividend.”   The NCUSIF Annual Report further stated that “credit unions were returned $275 million in tangible benefits.” (page 5).  This from a fund that just four years earlier reported $175 million in total equity.

The fund continued to pay dividends including six consecutive years from 1995 through 2000, and again in 2008 when the equity ratio was above 1.3%.

These results were achieved because of a collaborative partnership between NCUA and credit unions.  The changes were based on an analysis of prior events.  Options were evaluated and based on open dialogue at every stage.  Ultimately this consensus for change was critical in obtaining congressional support for this unique cooperative solution.

The redesign included commitments by credit unions to guarantee the fund’s solvency no matter the circumstances. But it also mandated guardrails on agency options and required transparency in reporting and managing the fund’s assets.

The NCUSIF four decades of performance has also provided a valuable record for reviewing credit union loss experience in multiple economic circumstances and events.   It provides an audited account of actual losses during the many years when there are none and credit unions received a dividend.

But it also documents the actual cash losses in the four or five short recessions or economic upheavals such as the aftermath from the 9/11 attacks, the Great Recession and the most recent COVID economic shutdown.

The NCUSIF’s record is sound.  It is proven. The facts are known.   So what could possibly go wrong?

Tomorrow I will review the temptations awakened by the NCUSIF’s successful track record.

 

 

 

 

Queen Elizabeth’s Wisdom on How Credit Unions Succeed

The world is now in the middle of a ten-day state funeral planned long ago with the name London Bridge.  The British government’s royal pageantry is in full bloom honoring Queen Elizabeth’s life and reign.

In her Christmas Day broadcast years ago, there is wisdom that describes I believe,  the motivation for the cooperative model.  Credit unions were not the example for her commonwealth listening audience; rather she singles out the human capital that every coop needs to succeed.

These are a two excerpts from this annual holiday address (with English spellings).

I often draw strength from meeting ordinary people doing extraordinary things: volunteers, carers, community organisers and good neighbours; unsung heroes whose quiet dedication makes them special. They are an inspiration to those who know them, and their lives frequently embody a truth expressed by Mother Teresa, from this year, Saint Teresa of Calcutta. She once said: “Not all of us can do great things. But we can do small things with great love.”

The following observation is key for the cooperative mission.

But even with the inspiration of others, it’s understandable that we sometimes think the world’s problems are so big that we can do little to help. On our own, we cannot end wars or wipe out injustice, but the cumulative impact of thousands of small acts of goodness can be bigger than we imagine.

Change Starts Small

 These words echo the idea of subsidiarity —the belief that individuals, families, local communities, non-profits and churches (faiths) can change society for the better and that large organizations tend to make big problems even bigger.

Her words suggest that when change is needed, it can start locally, at the grassroots level, by individuals passionate about improving  their communities.

Sounds like a credit union idea to me.

 

Credit Union’s Status at June 30, 2022

Last week a reader responded to my analysis of credit unions investments at June 2022. His comment was so insightful and comprehensive, I asked Mike Higgins to convert his response to a post, which follows.

Musings On the State of Credit Unions June  2022

Another quarter has passed, and the economy is behaving like a moody teenager – one day up, the next day down.  Wall Street has a slightly optimistic outlook, but the Federal Reserve has different plans.  A lot of mixed messages. This leads me to a handful of musings and situations to consider based upon second quarter credit union call report data.

  • Net interest margin finally improved this quarter (up 16 bps to 2.73%). It was driven by two items:
    1. Rising loan to asset ratio (more assets earning higher loan yield vs. lower surplus funds yield).
    2. Higher surplus funds yield (up 34 bps).

I count cash as surplus funds because I am ruthless about sloppy funds management, so if you see a slightly different number somewhere else, you will understand why.

  • Those credit unions with short weighted average maturities (WAM) in surplus funds will see immediate benefit from continued (signaled) rate hikes.
  • Loan yield barely budged this quarter.  It increased 1 bp to 4.29%.  Why?  Let’s look at where the massive amount of loan growth came from this quarter:
    1. 40% from real estate lending (1st mortgage held and commercial real estate).
    2. 35% from vehicle lending.

Those tend to be fixed rate.  So huge loan growth, mostly fixed rate, adds little movement in loan yield.  When rates go up, the incentive to pre-pay is reduced, so duration will extend here.

  • On the funding side, we normally see price inelasticity as rates on core checking and savings are “sticky” tending to lag markets. However:
    1. The Federal Reserve is starting quantitative tightening.  Bank deposits declined this quarter, which rarely happens — the supply of funds is shrinking.
    2. Credit union deposits were basically flat this quarter.
    3. Credit union borrowings and non-member deposits increased by 36% this quarter.
    4. Deposits are becoming valuable again!  The spread between cost of funds and the yield on surplus funds is producing a high rate of return after being low for so long.

Banking Like It Used to Be

So, the tendency is greater demand for funds going forward.  Banking like it used to be  with deposit and loan spreads near equilibrium (deposit spread = surplus funds yield minus deposit cost; loan spread = loan yield minus surplus funds yield).

  • Unrealized losses on available for sale (AFS) securities now represent 12.6% of credit union net worth.  This will only grow larger with each rate hike.  I realize there is no loss on any security held to maturity, so it’s just a paper loss, but it reflects the following:
    1. Credit unions will be reluctant (or unable) to stomach losses, so they will hold the securities until maturity.
    2. This effectively converts the securities to fixed rate loans for interest rate risk purposes.
    3. Fixed rate loans held to maturity reduce liquidity, thus increasing demand for funds to support continued loan growth.  Fortunately, there is still room left in the loan to asset ratio. However AFS securities should really be viewed as a loan for ALM analysis, because they are going to model the same behavior.

Navigating to a New Normal Interest Rate Curve

How would you characterize your balance sheet today?  What concerns do you have and how do you plan to address them?

Every credit union will be in a different position, but here are four general situations I am seeing right now:

  • Nothing Changes.  Credit unions that are good at lending don’t have to worry about surplus funds management — because they don’t have lots of surplus funds to begin with.  Assuming they are following sound ALM practices, they should be just fine. Suggestion:  Stay the course.
  • Happy Days Are Here Again.  For credit unions who are not so good at lending, and as a result, have excess amounts of surplus funds, but did not chase yield in the investment portfolio, their ROA is in for a big boost from rapidly rising rates. A reasonable deposit spread has finally returned after a long drought. Suggestion: Closely monitor any outflows of deposits and increase rates on shares to avoid runoff–which should also make members happy.
  • Can You Say Liability Sensitive? For credit unions good at lending but chasing growth using price/terms as a differentiator (low yield, fixed rate), you will experience increasing liability sensitivity.  The funding side of the balance sheet will see faster increases in costs than the asset side can absorb. Decreasing net margin may cause ROA to wane.  If you have a large enough net interest margin, you should be able to ride things out; however, run some net income simulations to get a better read on P&L exposure.
  • A Forecast That May Incur Pain. Those credit unions not so good at lending, and with excess amounts of surplus funds which chased yield hard, are facing a net margin squeeze. Rapid rate increases are not a friend.  Increased unrealized losses will come with each rate hike.  Suggestion: Re-evaluate your liquidity. Your securities are like fixed-rate loans in ALM analysis.  To grow, you may need new funds since much of your liquidity is “underwater.”

Asset liability management is changing quickly now after a two plus years of historically low rates and a flat yield curve.  The current market consensus forecasts an overnight rate in the 3.50-4.00% range before the Fed pauses to let things get sorted out.

Those of you who remember banking before the Great Recession can draw upon your experience.  Those who were not in the industry at that time may want to do a little research of the interest rate cycle post 9/11 and the return to “normal.”

 

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Mike Higgins is a consultant helping credit unions and community banks improve their competitive position through performance-based compensation.  He sees financial statements for just over 100 financial institutions every month.  He was also a founding investor in a 2006 community bank startup.

 

Credit Union Investments at June 2022 and the “Wisdom of the Crowd”

Wisdom of the crowd is a theory that assumes large crowds are collectively smarter than individual experts. It believes that the collective knowledge and opinions of a group are better at decision-making, problem-solving, and innovating than an individual or single organization.

The collective judgment of a diverse group  compensates for the bias of a small group.

On September 2, Credit Union Times published an analysis by Callahan’s Jay Johnson of credit union investment trends at June 2022.  How did the industry respond to 2022’s rise in market rates?

Investments 30.5% of Total Assets

Total investments held by credit unions, including cash balances, fell 9.5%, or $68.6 billion.  But the June total $655.5 billion was still 30.5% of the balance sheet.

As reported in the article, credit union investments boomed in the past two years, growing from $389.3 billion in December 2019 to a high of $724.0 billion in March 2022, mostly by  Covid relief payments held as cash. Even after this quarter’s decline, total investments are well above where they stood at the start of the pandemic.

 Credit Unions Favor the Front of the Curve

Johnson’s analysis reported the  trends in market rates at quarter end as follows:

“The yield curve flattened after the Fed raised rates 75 bps in both June and July. Short-term Treasuries, which are most sensitive to Fed action, priced in expectations for additional rate hikes. The two-year yield increased 40 basis points in June after some dramatic intra-month swings. It settled at 2.95% at month end after reaching as high as 3.45%.

“The market struggled to price in both recession risk and more Fed rate increases at the same time, as the two forces counteract each other. The 2-year/10-year spread finished the month at 6 basis points, threatening inversion.

“Portfolio allocators took advantage of the increase in shorter-term yields and reinvested funds into securities of more near-term maturity. The one-to-three-year maturity category took in $4.2 billion from credit union investors since March, good for a 3.6% increase and enough to become the largest non-cash category.

“Investments in securities are spread relatively evenly across each of the maturity categories within the one-to-10-year range, understandable given recent changes to the yield curve. Cash comprises 28.3% of total investments.”

Portfolio Yield up 21 Basis Points

“The average yield on investments increased 21 basis points quarter-over-quarter, up to 1.12% through June. While this marked the fifth straight quarterly increase, it was the most significant change in yield since the first quarter of 2019.

“Of course, with rising yields come unrealized losses on available-for-sale securities, and these, perhaps temporary, losses now total $28.3 billion throughout the industry.”

A Crowd Sourced Benchmark for WAM and Investment’s NEV Risk

As shown below 42.6% of credit union investments are cash or under one year maturity.  Obviously it is difficult to reposition longer maturities as rates rise, without incurring a loss.   This short-term liquidity build up allows credit unions to “ride the yield curve up” as rates are taken to a new normal by the Fed in its inflation fight.

The overall weighted average investment maturity for all credit unions is 2.83 years.  Every institution’s balance sheet, cash flow and business priorities are different.

The 2.83 years is the risk profile of the total credit union portfolio.  It is based on 4,900 independent decisions about managing risk as measured by WAM at the end of June.

Individual credit union investments may have a longer or shorter WAM.  But this is the “collective wisdom” at this point in the upward rate cycle as the Fed tries to rein in the highest inflation in four decades.

Total Balance Sheet Analysis

Investments are one component of overall balance sheet risk management.  In addition to NEV calculations, credit unions use net interest income (NII) simulations to project possible outcomes for net income in changing rate scenarios.

NII is a comprehensive look at the repricing of assets and cost of funds.   The June data showed that the industry’s net interest margin  improved in the latest quarter.

Rising market rates will lead to increased cost of funds. The ALM challenge is to manage this adjustment in tandem with the repricing of both investments and loan assets.  So far, so good.

While market “narratives” about future rate hikes can vary daily, the overwhelming consensus  about future  Fed moves is “higher for longer.”

Investments are just one aspect of interest rate risk management. For this component, how would your portfolio’s risk profile and  recent decisions compare with the industry’s collective wisdom?

 

 

 

Notes from the Field

The notes below are from  three CEO’s monthly staff updates to all employees.  All report excellent financial results with above plan loan growth and strong earnings. The  comments illustrate these credit union leader’s efforts to reinforce their distinctive cultures.

Taking Care of Employees: Stimulus Checks and Health Care at WPCU

Thank you to all the people who expressed their gratitude with an email, a handwritten note or a thank you in the hallway. The management team was thrilled to do this for all our Partner-employees and the myCU experts. Though I want to make sure I remind you that every dollar we paid out in the stimulus check (and every other dollar WPCU spends) comes from the members – and that is why it’s so essential to take better care of members than anyone else does.

CREDIT UNION RECOGNITION: I am excited to share that WPCU has once again been named one of the healthiest employers in Ohio by Healthiest Employers®. Since 2009, Healthiest Employers has been the leading recognition program for employer wellness. Healthiest Employers has over 10,000 employers from all 50 states, including 72% of the Fortune 100.

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A Credit Union Member Story from WEOKIE

Ms. Member came into the credit union to speak with a mortgage loan officer about how she could consolidate her debt to make ends meet each month. Ms. Member stated that she is 79 years old and still has 23 years left on her mortgage. Due to the economy, she is unable to make ends meet each month. She got very emotional and told me there are times when she eats very little to make sure all bills are paid. I told her I would take good care of her and look at all her options.

She told me she wanted to consolidate all debts, if possible, into one monthly payment. We added up all debt payments totaling $1879. She only receives $3000 total a month between social Security and retirement. After reviewing all the products Ms. Member settled on the low-cost 15yr fixed. I was able to shave eight years off her mortgage and put $970 back into her pocket each month. Not to mention we closed her loan the last day of the month therefore, she was able to skip September. So that’s an additional $909 (the new mortgage) in her pocket. I told her to go enjoy a steak dinner with her grandson, who she talked about every time we met.

Partnering with local nonprofits.

The WEOKIE Foundation is proud to be partnering with two new local nonprofit organizations. One organization called NorthCare works with the community to recover from mental illness, substance use, and trauma. They have 400 awesome employees in multiple facilities and have asked our team to assist their employees with their finances by providing education, tools, and 1:1 counseling. We kicked off the program the last week of August with a presentation to their staff and have many other future events planned.

Another group that we are working with is ReMerge, a local nonprofit offering a second chance to women battling trauma, poverty, and incarceration. We’ll be working to assist these women as they rebuild their lives in regards to their finances.

We have many exciting things planned for both nonprofit groups and look forward to helping our community with some practical tools to improve their financial lives. Both of these nonprofits are doing amazing work in our community. The Foundation is honored to be assisting with more than just monetary donations.

Connecting with a 90Year Old Former NCUA Mentor.

Kim and I were able to travel to Palm Springs last week to celebrate the 90th Birthday of a long-time mentor and friend Hap Blaisdell. Hap was an early mentor to me and is recognized as the “father” of the Student Credit Union movement while serving as Executive Assistant to then NCUA Vice Chair Elizabeth Burkhart. Hap eventually became my “first hire” as the Executive Director of the Campus Credit Union Council (CCUC) when I served as its chair. Hap has been “uncle Hap” to thousands of young credit union leaders over the years. The occasion also facilitated a new friendship for Kim and I with Georgetown Student Credit Union Alumni Peter and his wife Agnes.

See Harry Blaisdell’s role 1986 in this blog on student-run credit unions in a New York Times story.

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Employee Appreciation Event

It was a little hot Sunday but there were clear skies as about half the Day Air team and their families came out to Day Air Ballpark for the Associate Appreciation event.  The Credit Union is once again having a “best year ever” so there’s a lot to recognize and appreciate.  A good time was had by all, especially by the little ones.  Thank you to everyone on the team for living the mission and making a difference in the lives of our members each and every day.

Member Feedback on the Net Promoter scores of 1 through 10.

  1. Ten is for everything I have ever needed help with was taken care of. Things were taken care of quickly and done right. Also day air saved my family; my car didn’t work anymore. I was in a bad time in life and needed a new car like an emergency. I went in to get a loan with not very good credit. Day air helped and gave me a loan and changed my life forever. I will forever be greatful.
  2. Many times you have helped me during a financial crisis

A Member note.

“When i came in to open my personal and business accounts I had a problem with my tax# and Palisha Boyd was great she was patient with me and she navigated me through the process to get my tax# straight. I was so grateful that’s what I would tell anyone who I refer to dayair. Something else I love about dayair is that you have a relationship with re-entry people trying to get their lives back after incarceration.”

Keeping in touch with state legislators.

I met with State Rep Andrea White last week. She left very impressed with all that Day Air is doing in the areas of home ownership affordability, financial literacy, and supporting the local economy.  She was receptive to and will likely support several bills endorsed by credit unions, including county recorder modernization and residential PACE loans.  She was interested in the history behind the public funds issue (credit unions are prohibited from accepting public funds in Ohio) and requested information that led other states to move in favor, which will be provided to her.

Supply Chain Issues.

The HVAC system in the suite level of Day Air Ballpark is operating at 50% capacity and replacement units aren’t available for 30 weeks due to supply chain issues.

 

A Valuable Case Study of a Ransomware Attack on a Credit Union

This morning’s news started with the report of a ransomware attack on the country’s second largest school system in Los Angeles.

The warnings or reports of cyber security threats occur daily.   However, until reading the article below I had not seen an actual account of responding when this happens in a credit union.

The case study appeared  in CUSO Magazine.  It was written by Matt Sawtell, VP of Managed Technology Sales at CU*Answers who had first-hand experience with the event.

Facts are given and lessons learned.  I would urge anyone in this area of responsibility to read this account.

The Anatomy of a Ransomware Incident (And What We Learned)

Following a trend that has been developing over the last ten years, cybersecurity is a topic that is no longer reserved for the dimly lit, garden-level, IT-dwelling teams to consider. It is a topic that is on the minds of those in the boardroom.

As events have garnered ever more concerning headlines, from the Colonial Pipeline incident, which was settled for around $5M in Bitcoin, to the various Microsoft incidents, to the cypto.com hack which saw thieves lift approximately $33M from over 500 user wallets back in January, it’s hard to imagine that no credit union has been affected by an incident in the last few years.

The target that financial institutions have on them is especially large. The attackers believe FIs have the dollars to pay and they possess sensitive member information, which has its own value and adds leverage to a potential payout.

In the last year, we have had the experience of participating in the response to one of these attacks on a credit union. The experience reaffirmed the importance of solid cybersecurity plans and operations as essential, and we gathered some takeaways for others as we worked through the event.

The event unfolds

Friday afternoon, nearly the close of business, our support team received a call from a credit union asking some questions about why their access to data on the network wasn’t working. We followed our normal troubleshooting and escalation protocols. Shortly after digging into this troubleshooting, the bad actor reached out to the credit union to say they had exfiltrated member information out of the credit union and communicated the ransom. Our team escalated this to management, who then advised the credit union to shut down systems and to contact their cybersecurity insurer to begin assisting with the incident.

Cybersecurity insurance is crucial

You have cybersecurity insurance, right? Believe it or not, we have run into organizations recently that do not. We view this as very important coverage, not just because of the financial aspects but also the incident response and forensic and legal resources these insurers can bring to bear in order to minimize the impact of an incident like this.

In this instance the response was swift—a forensic team and case manager were assigned from a firm that specializes in that work. They would quarterback the incident from here through the end. The lead had extensive experience working for a federal agency responding to just these kinds of incidents.

Be diligent, there is a pattern of timing with these events. If you look at the recent rash of events, it seems like the news often breaks on a Friday afternoon, weekend overnight, or before a major holiday. The bad guys know they may have a better go of it when we may have relaxed our guard a bit.

The mitigation work begins

From the initial contact Friday, the case manager was working with multiple parties and coordinating that work on daily (sometimes multiple) calls with all involved. The groups included the forensic team, legal team, negotiator, cybersecurity firm, our CUSO, and the credit union.

We were tasked with a few things at the start, such as determining if we had good backup copies offsite and getting the credit union an alternative way to do some of the daily processing and member work that was needed while the network was shut down. Thankfully, the online and mobile banking systems and audio response were unaffected by this outage so members could still do many of the transactions they needed.

The forensic team was digging in and looking for indicators of compromise (IOCs) as well as any information that might point to a known group of bad actors that pulled off the attack. They used tools, requested hard drives be pulled out of equipment and sent for inspection, and on a daily basis made progress in unraveling the who, when, and how details.

The negotiator was busy interacting with the bad actor and working to negotiate down the initial $5M ransom request. This if nothing else would buy time to decide what the options were over the coming days. The updates from this individual made the whole event seem like a spy movie as much as a cyber incident.

The cybersecurity company utilized tools to start monitoring behavior on the network, process and traffic analysis, and ingress and egress.

The credit union had closed itself to the membership for over a week following the start that Friday. They were present for every call and update, and ultimately made decisions on how all parties would proceed with the work they were doing. In the meantime, they also needed to figure out how to communicate with their members, regulators, law enforcement, and other stakeholders.

Do not overlook a communication strategy

Communication is key. When you have an incident, it is a stressful time. We have all witnessed companies that do a good job of communication and manage the incident well and we have also seen those who… leave room for improvement.

Take for instance the Colonial Pipeline incident. If you lived in the DC/Maryland/Virginia area during this incident, you witnessed panic fuel buying almost overnight. Communication between the pipeline company and the government was not forthcoming where it could have been to calm and inform the public.

On the other side of that are incidents like the Kaseya zero-day from 2021, where the CEO was out in front with regular updates, clients were informed and given IOCs before they were in the news, and the credit union provided transparency and clarity about what to do next.

As a financial institution, one thing to consider is having your incident response strategy and even sample messaging ready to go in advance. Have it cleared through your legal team, management team, and board; keep them in the know on the details and approach. Most importantly, understand that in some cases sharing too little, too much, or speculating publicly can do more harm than good.

You can take this a step further even by conducting tabletop exercises where your team will role-play out various scenarios in order to prepare. Finding someone with experience is a great way to guide the conversation and get the most out of one of these exercises.

Backups and the ensuing recovery

The forensic team started to make headway with their analysis. IOCs were found and pointed back to a foreign group that specialized in gaining access to business networks in the west. They could not tell when that original compromise had happened, but the method they used was sophisticated and had been found at other companies that had similar intrusions.

One of the most interesting things they found was that the state-sponsored group had likely sold access to the credit union network to another, likely an organized crime group that specialized in ransomware. This approach we are told is more common these days as the groups then specialize in their respective areas.

In the meantime, we had validated that offsite backups were not contaminated and could be used to help rebuild the credit union network. The cybersecurity firm had a standard process to create a new, separate, air-gapped network and slowly move machines from the dirty network to the clean one after they had been sanitized. This was painstaking work and took many days to complete. We worked very closely with them and at their direction to ensure the details were followed for each system.

While this was happening, the negotiator continued to haggle with the bad actors over the dollar amount requested. The bad actors had also given proof that they were able to exfiltrate member information, including an AIRES file, from the credit union and were prepared to sell that information on the dark web if their demands were not met. This is a newer tactic to add leverage in the hope of getting a payout.

The credit union was closed for this week while all tech was sanitized. Given they had good backups, and there was no guarantee the bad actors would return the exfiltrated member data, they decided not to pay the ransom, which at this point had been negotiated down to approximately $2.5M. The members who wanted to do in-branch transactions were starting to get frustrated, so re-opening as soon as was safely possible was the highest priority.

A more common and costly occurrence 

Ransomware events of several years ago were not nearly as sophisticated or as costly as they had become. Ransomware events were often slow to propagate the network, easy to detect if they had already been in the wild by traditional endpoint security software and the ransoms were in the tens of thousands, not millions of dollars.

The involvement of both states sponsored and organized criminal groups point to how effective a revenue generator this has become for groups that are sheltered in countries that either directly support or turn a blind eye to their activities. Think about the number of companies you have read about that publicly disclose this because they must…then think about the many multiples more that do not.

The end of an incident

Thankfully, this incident had as good an outcome as could be expected. The following week the credit union reopened its doors to members. The credit union retained most of their members, for whom they were providing credit monitoring for the next year. They opted to retain the cybersecurity firm to supplement their efforts after the incident concluded. The remediation and recovery was an effort that required over 1,000 hours of work from multiple teams. Our Network Security team had over 400 hours in the recovery alone.

What are the key takeaways for your institution?

  • Have a solid plan. It is best to prepare in advance and avoid trying to come up with a response in the stress of the moment. Prepare communications, understand and have contact information for the key players on your incident response team, and make sure everyone knows their roles and responsibilities.
  • Understand the technology and security you have. It is difficult to assess cybersecurity risks and gaps if you do not understand both what your team is doing, what your third parties and partners are doing, and what they are not doing. Make sure you have gone through a detailed assessment of this and that you are comfortable with the residual risk based on your approach.
  • Align with the right partners. Consider seeking out specialized partners for things like 24×7 monitoring through a security operations center or a managed detection and response service. Make sure your insurance coverage is appropriate for your organization.
  • Test, prepare, and practice. People are key in cybersecurity effectiveness and incident response. Make sure you’re training your team on the threats out there, how to use tech safely within the organization and to report suspected incidents as soon as possible. Conduct tabletop incident response scenarios to practice what an event might look like with your team.