Just a Member

(Source for quotes below: the December 16, 2021 NCUA board video:  https://www.youtube.com/watch?v=zstCJgfdYTM)

In two prior blogs I outlined several problematic aspects of the new CCULR/RBC rules:

• The instant implementation, nine days after posting, raising the “well capitalized” standard by 29% on January 1, 2022
• The immediate imposition of three capital tests replacing one, long-standing, easy to understand 7% leverage ratio. The RBC tools are not yet available for credit unions to know where they stand.
• The inane rationale justifying CCULR as a regulatory “off ramp” from the admitted draconian compliance burden of RBC
• Imposing additional capital requirements in the $ billions on credit unions below the new 9% standard
• Restricting credit unions’ use of their  reserve buffers, created over decades, above 7%. If every CCULR eligible credit union elects this 9% well capitalized minimum, they must sequester over  $26.8 billion in spending for member benefit.  To regain control, they must submit to RBC.
• The abrupt disruption of long approved credit union plans by these new financial constraints
• The financial downgrade of hundreds of credit unions from their previous “well capitalized” net worth standing

Combining RBC/CCULR in one package is the ultimate regulatory hubris.  NCUA’s  new higher capital requirement, was  to mitigate the extraordinary burden of the RBC.  Both remain. As Board member Hood commented:  The RBC rule is so tragic, that yes, it needs an off ramp.

Only a myopic, closed bureaucracy, completely indifferent to its impact on credit unions, could create such a convoluted compliance outcome.

Never in the history of NCUA has so great a regulatory burden been imposed on so many credit union members with such groundless reasoning and data.

The Absence of Substantive Objective Data

When implementing a statutory requirement as NCUA claims to do with these intertwined deformities, the federal administrative procedure process requires there be substantial objective data to support the action.

The legal principle is simple: if the government is going to restrict the choices people are making under their own agency, then the regulation must document the harm either taking place or to be prevented. In this case ,the issue is the credit union system’s safety and soundness.  One board member stated the regulatory requirement in December this way:

Rodney E Hood:  The framing of the issue today is really about capital adequacy and if credit unions have shown through history that they have sufficient capital to serve member-owners while facing various risks.

Have the financial outcomes of credit unions failed to meet NCUA’s safety and soundness standards  prior to this?

NCUA presented neither past failures nor current inadequacy to support these increased capital changes.  Credit unions’ track record since the implementation of PCA in 1998, following the RBNW (risk-based net worth) rule, is one of increasing safety and soundness even during the peak of the Great Recession.

Unnecessary, Unjustified and Unneeded

For 110 years credit unions’ reserving results, in good years and bad,  have proven prudent, adequate and responsive to changing market risks.

In the traumatic GDP drop during 2020’s first quarter’s national economic shutdown (the largest fall on record) and the subsequent multiple economic uncertainties due to COVID, the NCUSIF recorded zero net cash losses in both 2020 and 2021.

Credit unions achieved record two-year share growth, increasing levels of capital, and even stronger performing loan portfolios during this unprecedented crisis.

Throughout the last two decades credit unions have maintained a reserve buffer of over 300 basis points above the required well capitalized 7% standard, as pointed out by Vice Chairman Hauptman in his comments about the rule.  The following chart shows the capital levels during these two decades, including the years of the Great Recession.

Only One Credit Union Failure in the Last Ten Years Would Have Come Under RBC

The most critical fact about why the rule is unnecessary was given by staff in response to a question by board member Hood.

Rodney E. Hood: . . . what have been the largest five losses to the Share Insurance Fund over the last ten years, and what were those losses to be specific?

Kathryn Metzker (staff): When reviewing credit union losses of natural person credit unions in the last — I actually looked back about ten years . . .The risk-based capital framework would only apply to one of the (five) failed institutions as mentioned earlier, one credit union over $500 million as the remaining four have assets less than the complexity thresholds.

Earlier in the dialogue, she identified the additional capital requirement shortfall under RBC in this one case as $77 million.

Hood’s other comments on the rules are illuminating and cogent:

After serious study and consideration, my preference is to consider repealing the RBC rule outright and fine tuning our existing risk based net worth rule.

The reality is that RBC should be a tool and not a rule, and if it is effective in identifying risk, then it should be put in the examiner’s toolbox.

But the last thing I think the NCUA should do is impose it on credit unions as an operating model. The juice isn’t worth the squeeze for risk-based capital, because this is a regulatory burden with what I believe is limited benefit.

 I think risk is something that you manage each and every day.  It’s not a formula you can run on your balance sheet.

Chairman Harper’s Defense of CCULR

Chairman Harper is the author of this action. He asserts that RBC/CCULR is required under his interpretation of the PCA statute.  To defend his support of a 9% CCULR minimum versus his original 10% proposal, he cites Goldilocks and the Three Bears’ logic.

Harper: Our biggest decision in finalizing this rule was at what level to set the CCULR. In reaching a consensus, we looked at the lessons of the famous children’s story. Some wanted the leverage ratio to be 8%. I view that as too soft. I wanted the final CCULR level to rise over time and reach 10%, a level that others considered too hard, so we compromised and permanently set the CCULR at 9%. That ratio turned out to be just right. While lowering a credit union’s capital risk‑based compliance requirements, CCULR actually increases the system’s capital buffer.

The RBC complex burden was so clear even to NCUA that it proposed the CCULR “off ramp.” The 9% “just right” number was selected because the Board did not want to make it too easy “to move between the two capital options” or what it called “the potential for regulatory arbitrage between the two frameworks.”

From both a macro and a micro data perspective, there are no facts to support raising the credit union system’s capital requirements. The RBNW approach with the long standing 7% minimum required by PCA and has proven sufficient time and again.

The absence of objective data is important for future corrective action.  Once this rule becomes embedded in NCUA and credit union  actions, there could be reluctance to give up this expanded financial comfort cushion, no matter how damaging to members it might be in the meantime.

A Fast-Burning Fuse of 500+ pages of rules

Both in substance and process these rules are an extraordinary and unprecedented immediate regulatory burden.

The rules were approved with a short burning fuse of just 9 days.  If the 10% standard in the proposal had been adopted, it would have been with a two-year phase in.  But 1% lower, no phase-in needed.

There was no recognition that the only source of credit union capital is retained earnings which are only built up over time. There was no crisis or need for immediacy.  RBC was first proposed in 2014, seven years earlier.

RBC/CCULR is a failure of regulatory discretion and judgment.  NCUA’s RBNW rule had been in effect for over 20 years. It embraced limited certainties from observed experience.

The new rules present unlimited certainties about every asset’s potential risk.  These risk weightings are projected into the indefinite and unknowable future.  It did so ignoring all “substantive objective evidence” of the cooperative system’s capital adequacy and sound performance under the existing RBNW.

The direct immediate impact of the new CCULR/RBC rule requires credit unions to hold between $30 to $40 billion more in reserves.  These funds cannot be used for daily operations such as expenses to increase member value or lower fee income or loan rates.

A major portion of these newly restricted funds is in credit unions that follow the 9% CCULR minimum required reserves versus the RBC option. The $24.3 billion CCULR “off ramp”  means these funds are unavailable for operations but required to stay in reserves.

This is from the December 16, 2021 Board Action Memo:

Of the total 680 complex credit unions as of June 30, 2021, 473 have a net worth ratio greater than nine percent and would be well capitalized under a nine percent CCULR standard. Of those 473 credit unions, the Board estimates that all of them meet the qualifying criteria, and are thus eligible to opt into the CCULR framework.

Under the CCULR, if all 473 credit unions opted into the CCULR and held the minimum nine percent net worth ratio required to be well capitalized, the total minimum net worth required is estimated at $111.8 billion, an increased capital requirement of $24.3 billion over the minimum required under the 2015 Final Rule. This additional capital would strengthen the system’s ability to absorb any future financial losses and economic shocks.

(Note: the 493 credit unions over $500 million and 9% net worth or greater, held $1.340 trillion in assets at yearend 2021. Therefore, when NCUA raised their net worth well capitalized requirement from 7 to 9%, the rule placed a total of $26.8 billion in restricted retained earnings. These extra funds are no longer available for credit unions to use as they choose-or else lose their CCULR option.)

The Disruptive Spread of the New Red Line

The new rule in theory applies only to the 83% of credit union assets with over $500 million. However, this 29% higher CCULR option will not be available to approximately 210 credit unions with $386 billion in assets. Before this rule they were considered “well capitalized.” And only three of the 210 would have been below the 7% well capitalized level.

All now fail the  revised “well capitalized” ratio.  The immediate regulatory sanction is to subject them to RBC, an entirely different  more complicated process under the never implemented rule.

All these,  24% by assets (30% by number), of this  $500 million class are in an RBC never-never land of capital measurement.  However the immediate impact is much broader than these 210 below the new 9% red line.

RBC’s  Shadow Extends Beyond 9%

Every credit union over the 9% threshold is now on notice that any short term run-up in assets  could result in their ratio falling below this new minimum.

As an example, there were 70 credit unions between 9 and 9.35% net worth at yearend.  Any time their asset growth exceeds the capital growth, the ratio will fall.

Historically, the highest amount of share growth occurs in the first two quarters.  If a credit union has 9.3% at the beginning of a month and grows 3% in assets, the net worth ratio falls to 9.0% by month end.

Since capital increases only through retained earnings, at an average of 1% of assets per year,  every credit union between 9 and 10% faces a dilemma: either  limit growth or increase ROA by amounts above traditional returns.

There are 173 credit unions in the 9-10% net worth range that will be in a state of unending compliance uncertainty as their ratio moves up and down in monthly variations.

 CCULR’s Shadow Hovers Over Those Below $500 Million

Many credit unions below $500 million must now closely monitor their growth and capital because when they cross this size threshold, the old 7% well capitalized rating no longer applies.

An example: At 2021 yearend there were 119 credit unions in the $400-500 million asset segment. They managed $52.7 billion in assets. Forty-five of these,  with $20 billion in assets, reported net worth below 9% and would not be CCULR eligible when passing $500 million.

Assuming this entire segment grows by the industry’s long-term average of 7%, then 13 credit unions with $465 million assets (or higher) at January 1 this year will be over the $500 million threshold by yearend.  They must monitor and calculate three capital measures simultaneously: the current 7%, the new 9% CCULR minimum, and failing that, the arcane rabbit hole of RBC.

An estimate of the total number of these three groups of credit unions that must immediately put net worth at the top of their business priorities is over 502, holding approximately 35 to40% of total industry assets.

This sudden new financial priority will turn upside down established business plans, pricing initiatives, and investments in new service capabilities.

Credit unions are being forced to turn away from serving their members to complying with NCUA’s  needs.

To this point in time, the industry’s average 2021 yearend capital ratio of 10.6% would be evidence of prudent capital management. That ratio is 360 basis points (3.6%) above the long standing well capitalized 7% benchmark. (see buffering discussion below) Financial uncertainty now permeates every business decision where there was none before.

The Tens of Billions Taken Away from Member Value

It is the members who will pay the cost.

To comply with this new capital standard, credit unions have two broad options.  First, closely limit all growth.  NCUA’s habitual approach to capital restoration plans is to require “downsizing” of assets to fit the available capital.

The second option is to ask members to pay more: no more over draft or other fee reductions, higher loan rates, or accept lower savings than would be the possible under the long standing 7% standard.

If the choice is downsizing, fewer members will be served with fewer loans and services.  If the choice is to require members to pay more, the direct additional costs are easy to calculate.

The 210 credit unions not in compliance with the 9% CCULR minimum, are collectively $2.7 billion short of capital under the new standard. That shortfall assumes no growth in assets.  Before the 7% benchmark was eliminated, these credit unions collectively maintained a margin of 1.31% above that old standard.

For these 210 with the $2.7 billion shortfall, setting a net worth goal just 1% above the 9%, would require another $3.9 billion.  This $6.6 billion total for more capital just repositions them relative to where they were under the old standard.

How easy is this to accomplish? In 2021 the entire movement grew total capital by 6.7% to $221 billion. The $6.6 billion more to exempt these 210 credit unions from  RBC requires an increase of 21% in their current net worth.  This is roughly three times the growth rate of capital in the industry.  And that assumes these 210 have no asset growth while they are building this new capital level.

Total Business and Financial Disruption Costing Members Tens of Billions

The other 292 credit unions above $500 million  in the 9-10% net worth range, and the 119 credit unions in the $400-$500 million below the new red line, will face similar challenges to their business model.  For example, in the $400 million plus segment, 45 are below 9% now by a total of amount of $195 million.

All these 502 credit unions face the same urgency of modifying previously approved business plans. Now they must either limit growth or charge members more.   Either choice is done at the members’ expense.

Before this apocalyptic rule took effect, at yearend 2021 only six credit unions in the $400 million and above category were below the 7% well capitalized standard. And five were considered “adequately capitalized.”

By changing the rules of the game overnight, NCUA has created a perception of financial weakness. At the same time the regulator has prevented credit unions from using literally tens of billions in existing reserves in the manner boards think best to compete in the market.  These funds were prudently set aside for the proverbial rainy day.  But now are restricted from use.

The cooperative system has been called to a financial halt by NCUA.  It reputation has been  turned upside down in member and public perception in a mistaken effort to make credit unions appear safer.

The outcome will be just the opposite.  The rule’s complexity and RBC uncertainty will just cause more sound, long serving credit unions to throw in the towel.

Capital is not and has never been the critical component of credit union success.  It is the resilience of leaders.  It was the founders’ passion that began these enterprises with no capital.

This newly imposed costly regulatory burden will lead current volunteers and professionals to feel they can no longer make the critical business decisions about how to best serve their members.

The government-NCUA-has now asserted by rule, that they know more than credit union’s leaders about how to manage  business decisions.

Appendix:  The Buffering Mentality Will Raise the Member Costs Further

The $30-40 billion cost estimate in new capital requirements does not include the credit unions “normal” buffering behavior.  Here is how Vice Chairman Hauptman raised the issue at the December board meeting.

Kyle S Hauptman: And we do know that . . .they keep a buffer of 3% right now, a little over 3%. Do you have any reason to believe they will not continue to keep a buffer of around 3% in the future? 

Tom Fay(staff): I don’t think I could estimate that, Vice Chair. 

Kyle S Hauptman: Okay, well, we can agree they do, now, have a ratio. All I’m trying to say is, when we say oh, no, this isn’t going to affect somebody because most of them, you know, if you already have 9.5%, you’re in the clear, but we already know that they like to have a buffer.

So, I think we just need to acknowledge that based on the way the credit unions operate, that being just above 9% does not mean you’re in the clear to meet our 9% CCULR because we know that they want to have a buffer for the reasons you just eloquently said. . .

. .  we shouldn’t be doing this without acknowledging that we are making credit unions hold substantially more capital because they’re going to have a buffer.

You think it’s good to have a buffer; so do I. We are raising the standards for credit unions. I just think we need to be clear about that. We shouldn’t be disingenuous to say, oh, no, look how many of them have over 9%. They should be fine with CCULR.

Well, we already know they have a buffer, so there’s no reason to think the operations of the credit unions will suddenly change; and we are raising capital for the vast majority of these because they will have — that number of 10.2%, at least for those subject to RBC and CCULR.  I’m happy to bet you that that number will go up because of what we are doing today.

In early January the latest AME financial updates were posted on NCUA’s website.  Shareholders of the four solvent corporates are projected to receive total payments from their respective liquidation estates of over $3.185 billion.

Of this total 54% had been distributed as of September 30, 2021.  The remaining $1.470 billion will be sent to shareholders later this year.

Southwest and Members United members will receive a liquidating dividend on top of the return of all their ownership shares.  Only WesCorp members will see no payment.   NCUA expects to have  a deficit on its insured savings liability of $2.1 billion.

That amount appears  to be final actual loss to the NCUSIF for the combined corporate resolution.

Adding these direct shareholder payments to the $2.563 billion TCCUSF net worth when merged   into the NCUSIF (September 2017) brings the total cash surplus to $5.7 billion.   All credit unions were paid two dividends totaling $895.8 million from these merged funds.  The result is that credit unions and the corporate members, will directly receive 72% of the AME’s growing surpluses.  The balance was kept in the NCUSIF.

A $12.9 Billion Total Turnaround

When the five corporates were liquidated in the fall of 2010 the auditor’s estimate of the combined deficit for the TCCUSF was reported by  KMPG as follows:

At the time of liquidation in 2010, the AMEs had an aggregate deficit of approximately $7.2 billion, which represented the difference between the value of the AMEs’ assets and the contractual or settlement amount of the claims and member shares recognized by the NCUA Board as the liquidating agent.

Adding the current $5.7 AME surpluses, the total variance from this initial loss estimate is $12.9 billion.

As recently as the September 30, 2017 final TCCUSF audit, the estimate in the footnotes was that the combined estates would still have a total deficit.

Total Fiduciary Net Assets/(Liabilities) $ (110,863) millions, at September 30,2017

The Schedule of Fiduciary Net Assets reflects the expected recovery value of the AMEs’ assets, including the Legacy Assets collateralizing the NGNs issued through the NGN Trusts, and the settlement value of valid claims against the AMEs outstanding at September 30, 2017

93% of Legal Recoveries Pay NCUA’s Liquidation Expenses

All of this $12.9 billion recovery is from the interest payments and principal pay downs on the legacy assets.  The longer the assets were held, the more valuable they became.  The initial estimates of the credit losses over the life of these securities have proved to be in error by over $12.9  billion.

Some assert that NCUA’s net legal recoveries of $3.85 billion were a critical part of this turnaround.  That is not the case. The net recoveries were important for another reason however.

NCUA’s liquidation expenses, not including payments to the lawyers, total $3.569 billion.  So 93% of  the net legal settlements went directly for NCUA’s operating expenses managing the AME’s and NGN trusts.

Moreover, NCUA’s costs were much greater than just those directly recorded.  In  one of its first actions in 2010 after seizing the five corporates, NCUA sold approximately $10 billion of sound performing corporate assets at a loss from book value of over $1.0 billion.   This  added an actual loss on these fully current securities whose value was temporarily impacted by “market dislocations.”

There were also additional charges paid from the AME’s assets including NCUA’s 35 basis point guarantee fee on the outstanding NGN monthly balances as reported in the audits:

The guarantee fee amount due to the NCUA, at each monthly payment date, is equal to 35 basis points per year on the outstanding NGN balance prior to the distribution of principal on the payment date,

Learning the Lessons of a Crisis

As credit unions receive these final payments, it will be tempting to close the books, move on and let bygones be gone.  The crisis was over 12 years ago.  But it is still referenced today by NCUA as a reason for challenging the adequacy of the NCUSIF’s design, setting the NOL, or even when imposing the new CCULR/RBC capital requirements.

Leaving these events open to these “urban myths” kinds of recall would be a critical error.  There is much to learn when both auditor and NCUA’s initial total projected losses  to credit unions were  $13.5 to $16.5 billion versus the actual outcome of a $6.0 billion in surplus.

Why were the accounting estimates so far in error?   Were the corporates more than adequately reserved even at these extreme loss estimates?  What options for resolution were considered?   What happened to the plan presented by the corporate network?

Why did NCUA refinance the assets via Wall Street at extremely high, above market rates, when credit unions had demonstrated the ability and willingness to continue funding all corporates at much lower costs?

What can be learned from a patient, long term view of problem resolution especially one caused by cyclical fluctuations in asset or collateral values?

The immediate public diagnosis and blame placed on corporate boards and management is a typical reaction when any firm is in difficulty.  However is that criticism still useful as the legal recoveries show that fraud played a role in the design of these investments  all of which were NCUA authorized?  Will the corporate system ever  play a leadership role again, or are they to remain permanently muzzled due to a crisis assessment that has proved wrong in so many ways?

Past problems may seem to offer little for current events.   But not learning from them means the mistakes  of panic judgments, placing blame, misplaced expertise and  failing to respect mutual efforts are easy to repeat.

One of the great strengths of the cooperative system has been its ability to fix things and make necessary changes.   Both at the credit union and the system’s institutional levels.

Cooperative design can check the ambition of  self-interest by the power of collaboration and common purpose.   A through public study of all the circumstances around the corporate events would restore credit union confidence in the ability of the regulator and industry to work together when future crisis occur.

An earlier  analysis of why this look back is so vital can be found here.