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When Less Is More: NCUA Board’s Mid-Year Operating Budget Review

This coming Thursday the NCUA board will review the agency’s midyear budget.  To do so thoughtfully, it is useful to put the operating budget’s long term and recent trends in perspective.

Below is a summary of the growth rate of NCUA’s operating fund budget from 1999-2001.  The first column shows the compound annual growth (CAGR) for the entire period; the second column for the most recent five years.   Note the annual growth rate is per year.

  Annual Growth of NCUA’s Operating Fund Expenses (1999-2021)

 

Account CAGR’99-’21 CAGR ’16-’21
Beginning Cash Balance $MN 11.47% 22.43%
Operating Fee Receipts $MN 4.27% 8.97%
Operating Expenses $MN 3.66% 9.48%
Net Fund Bal at Yearend $MN 16.92% 26.01%
Ending Cash Balance $MN 12.32% 21.33%

What the Recent Numbers Mean: Expenses Out of Control

During these 22 years, NCUA has transferred ever higher amounts of its operating expenses to the insurance fund.    This is via the Overhead Transfer Rate (OTR) process. That rate of expense allocation has been as low as 52% in 2008 and as high as 73.1% in 2016.   Currently it is 62.7% an increase from 2021.

This overhead transfer has exceeded 50% even though state charters have always had fewer than 50% of total insured shares this entire time.  NCUA is subsidizing its regulation of federal charters by shifting costs  onto state credit unions.

Following this arbitrary, open-ended expense transfer however, operating expenses still increased 3.66% annually or faster than inflation for the entire period.  Most recently in the five years 2016-2021 this annual growth accelerated to 9.84 % or three times faster than the overall 22 year average.

NCUA invented inflation five years before the rest of the economy could catch up.

After this OTR allocation, the Operating Fee charged to FCU’s exceeded actual operating expenses by an average of 104.5% for this entire period– some years more than 100% and others less. Since 2015 however, the NCUA’s the operating fee collected has exceeded actual expenses every year.

Building NCUA Cash  from Credit Union Funds

The result of these excess fees is that yearend cash on hand has grown from $13 million to $129.6 million (or ten times-1000% ) in this 22 year period.   During these same years, while  annual expenses grew by just 3.6%, NCUA grew cash balances at 12.3%, or four times as fast.

The 2021 year end cash balance of $129 million was 110%  more than that year’s total expenses, and  double the 46% average for the entire period.

NCUA held cash balances for the first 16 years of this analysis  between 30-40% of the actual expenditures.  Since 2016 NCUA has retained  more and more credit union funds.  Yet there has been no change in either the agency’s ability to assess its fee or in its operations to require this ever growing cash and fund balance.

The Latest Numbers: May 2022

As of end of May, cash balances are $191.8 million slightly higher than 12 months earlier.   Operating expenses for the first five months are $48.3 million exactly the same as the prior year.

The net fund balance (equity) is at an all-time high of $141.3 million for this time of year.  In 1999 the net fund balance was just $6 million.   The numbers and trends suggest that  $75 million or more of this excess cash could be returned to credit unions and NCUA still have more than enough to cover all operating expense.

The Board’s Budget Review

American author Edward Abbey observed:  “Growth for the sake of growth is the ideology of the cancer cell.”

This Thursday if expenses lag budget, the NCUA’s habit is to repurpose unspent funds  and/or approve new positions not in the original budget.

Normal business practice would be to reduce the budget, not find new ways to spend a surplus.

How will the board view this ever-growing cash hoard? The traditional government mindset is to spend all the money on hand, whether that is necessary or effective.  Staff is always fearful that if money is left over, it will justify reducing the budget request for the following year.

Chairman Harper has been very public in of his ambition to grow staff, the NCUSIF and the budget at every opportunity.

Will the rest of the board go along with this six-year pattern of uncontrolled operating expenses and buildup of excess cash? Or will they stop the spread of NCUA’s operating fund cancer?

After all this is the members’ money.

 

 

 

 

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Lincoln’s Insights for Today: # 4

Lincoln’s meditation on Divine Will September 2, 1861.

The Civil War was not going well.  There had been a second Union defeat at the battle of Bull Run.  He became depressed.   These are thoughts written to himself found in John Hay’s papers.

The will of God prevails.  In great contests each party claims to act in accordance with the will of God.  Both may be, and one must be wrong.  God cannot be for, and against the same thing at the same time. 

In the present civil war it is quite possible that God’s purpose is something different from the purpose of either party—and yet the human instrumentalities, working just as they do, are of the best adaptation to effect his purpose  I am almost ready to say this is probably true—that God wills this contest, and wills that it shall not end yet.  By his mere quiet power, on the minds of the now contestants.

He could have either saved or destroyed he Union without a human contest.  And having begun, He could give final victory either side any day.  Yet the contest proceeds. 

Editor’s comment:

This excerpt is  from a lecture by Dr. Ronald C. White (BA, UCLA; PhD Princeton University) an independent scholar and authority on Abraham Lincoln. He is the author of Lincoln in Private: What His Most Personal Reflections Tell Us about Our Greatest President.

His book is based on 111 private notes Lincoln wrote to himself which provide insights  into his personal, religious and  intellectual journey as a politician and statesmen. 

Lincoln’s words are timeless, especially as we face  our political divisions today.  They were transformative when first prepared.  They feel even more relevant today.

Ronald White’s complete lecture can be heard here.

 

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Lincoln’s Insights for Today: # 3

Lincoln’s note to himself on Slavery, July 1, 1854

Lincoln served one term in Congress from 1847-1849.   He was defeated for reelection in part due to his questioning of president Polk ‘s war on Mexico– which Lincoln’s constituents did support.  This brief note shows how he develops his political positions by first presenting his opponent’s point of view.  And then rebutting it.

If A. can prove, however conclusively, that he may, of right, enslave B.—why may not B. snatch the same argument, and prove equally, that he may enslave A.?  You say A. is white, and B. is black.  It is color, then; the lighter, having the the right to enslave the darker? Take care.  By this rule, you are to be a slave to the first man you  meet, with a fairer skin than your own.

You do not mean color exactly?–You mean whites are intellectually the superiors to blacks, and therefore have the right to enslave them?  Take care again.  By this rule, you are to be slave to the first man you meet, with an intellect superior to your own.

But say you, it is a question of interest; and if you can make it your interest, you the right to enslave another.  Very well. And if he can make it his interest, he has the right to enslave you. 

Editor’s comment:

This note is  from a lecture by Dr. Ronald C. White (BA, UCLA; PhD Princeton University) an independent scholar and authority on Abraham Lincoln. He is the author of Lincoln in Private: What His Most Personal Reflections Tell Us about Our Greatest President.

His book is based on 111 private notes Lincoln wrote to himself which provide insights  into his personal, religious and  intellectual journey as a politician and statesmen. 

Lincoln’s words are timeless.  They were transformative when first prepared.  The logic is  still profound today.

Ronald White’s complete lecture can be heard here.

 

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Lincoln’s Insights for Today: # 2

From Lincoln’s address Before the Young Men’s Lyceum, Springfield, January 27, 1838

On November 7, 1837, Elijah Parish Lovejoy, a Presbyterian minister, journalist, newspaper editor, and abolitionist, was killed by a pro-slavery mob while defending the site of his anti-slavery newspaper the St Louis Observer.  Lincoln was deeply concerned by the event and the lynching of a freedman in 1836.  This speech was from the time he served in the Illinois state legislature in Springfield ( 1834-1842 )where he shaped his skill as a public debater.

The Lyceum  talk was titled:  “The Perpetuation of Our Political Institutions”.[1][2] In this speech, Lincoln warned that mobs or people who disrespected U.S. laws and courts could destroy the United States. He went on to say the Constitution and rule of law in the United States are “the political religion of our nation.”

How then, shall we perform it?  At what point shall we expect the approach of danger? . . .Shall we expect some transatlantic military giant, to step the Ocean, and crush us at a blow?  Never! All the armies of Europe, Asia and Africa combined, with the treasure of the earth (our own excepted) in their military chest;  with a Bonaparte for commander, could not by force, take a drink from the Ohio, or make a track on the Blue Ridge in a trial of a thousand years.

At what point then is the approach of danger to be expected?  I answer, if it ever reach us, it must spring up amongst us.   It cannot come from abroad.   If destruction be out lot, we must ourselves be its author and finisher.  As a nation of freemen, we must live through all time, or die by suicide.

Editor’s comment:

This excerpt is from a lecture by Dr. Ronald C. White (BA, UCLA; PhD Princeton University) an independent scholar and authority on Abraham Lincoln. He is the author of Lincoln in Private: What His Most Personal Reflections Tell Us about Our Greatest President.

His book is based on 111 private notes Lincoln wrote to himself which provide insights  into his personal, religious and  intellectual journey as a politician and statesmen. 

Lincoln’s words are timeless, especially as we face  our political divisions today.  They were transformative when first prepared.  They feel even more profound today.

Ronald White’s complete lecture can be heard here.

 

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Lincoln’s Insights for Today: # 1

This is the first of five examples of Lincoln’s thoughts and insights from a lecture described at the end of this post.

When Lincoln first announced as a Candidate for Political Office, March 15, 1832 at the age of 23, the custom was to announce one’s candidacy in the newspaper  which would then be followed by letters of recommendation.

This first public declaration shows Lincoln’s character.  It also is an example of  how each of us might consider our own ambition.

Every man is said to have his peculiar ambition.  Whether it be true or not, I can say for one that I have no other so great as that of being truly esteemed of my fellow men, by rendering myself worthy of their esteem. 

How far I shall succeed in gratifying this ambition is yet to be developed.  I am young and unknown to many of you.  I was born and have ever remained in the most humble walks of life.  I have no wealth or popular relations to recommend.

This excerpt is  from a lecture by Dr. Ronald C. White (BA, UCLA; PhD Princeton University) an independent scholar and authority on Abraham Lincoln. He is the author of Lincoln in Private: What His Most Personal Reflections Tell Us about Our Greatest President.

His book is based on 111 private notes Lincoln wrote to himself which provide insights  into his personal, religious and  intellectual journey as a person, politician and statesmen. 

Lincoln’s words are timeless, especially as we face  our political divisions today.  They were transformative when first prepared.  They feel even more profound today.

Ronald White’s complete lecture can be heard here.

 

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Lincoln’s Insight for today: How January 6, 2021 Occurred

There is a temptation for current generations, with their additional perspective, to feel morally superior to prior ones.

For example in June of this year, Cornell University removed a bust of Abraham Lincoln and a plague of the Gettysburg Address from the University library “when someone complained.” Cornell even holds one of the five original copies of the Address in Lincoln’s own writing.

It is true that continual efforts are necessary for achieving America’s aspirational goals of greater equity and freedom for all its citizens.

However previous generations  had  timeless insights about America’s political experiment that are still vital today.

As the January 6th House Committee holds another hearing this afternoon,  I want to share an analysis  that is profoundly prescient of the actions of President Trump.

Lincoln was an Illinois state legislator in 1838 when he gave a speech to The Young Men’s Lyceum titled titled “The Perpetuation of Our Political Institutions”.[1][2]

He warned of the dangers  of a tyrant taking over the US political system from within. This excerpt  could easily define what happened on January 6th, 2021.

It is to deny what the history of the world tells us is true, to suppose that men of ambition and talents will not continue to spring up amongst us. And when they do, they will as naturally seek the gratification of their ruling passion as others have done before them.

The question then is, can that gratification be found in supporting and maintaining an edifice that has been erected by others? Most certainly it cannot. Many great and good men, sufficiently qualified for any task they should undertake, may ever be found whose ambition would aspire to nothing beyond a seat in Congress, a gubernatorial or a presidential chair; but such belong not to the family of the lion or the tribe of the eagle.

What! think you these places would satisfy an Alexander, a Caesar, or a Napoleon? Never! Towering genius disdains a beaten path. It seeks regions hitherto unexplored. It sees no distinction in adding story to story upon the monuments of fame erected to the memory of others. It denies that it is glory enough to serve under any chief. It scorns to tread in the footsteps of any predecessor, however illustrious. It thirsts and burns for distinction; and if possible, it will have it, whether at the expense of emancipating slaves or enslaving freemen.

Is it unreasonable, then, to expect that some man possessed of the loftiest genius, coupled with ambition sufficient to push it to its utmost stretch, will at some time spring up among us? And when such a one does, it will require the people to be united with each other, attached to the government and laws, and generally intelligent, to successfully frustrate his designs.

Distinction will be his paramount object, and although he would as willingly, perhaps more so, acquire it by doing good as harm, yet, that opportunity being past, and nothing left to be done in the way of building up, he would set boldly to the task of pulling down.

To counter this internal threat, Lincoln concluded that there was a need to cultivate a “political religion” that emphasizes “reverence for the laws” and puts reliance on “reason—cold, calculating, unimpassioned reason.”

This is how the House Committee’s hearings on the January 6th insurrection is fulfilling Lincoln’s call to action 184 years earlier.

 

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Ralph Swoboda

(by Jim Blaine)

Annually, the National Credit Union Foundation (NCUF) recognizes an exceptional credit union leader with the Herb Wegner Individual Achievement Award. Can’t think of anything less challenging than being asked to write a nomination letter on behalf of Ralph Swoboda for this honor.

What a waste of time! Really, the selection is just too obvious, a real no-brainer, an eyes-closed slam dunk. And, in a moment, I’ll tell you why that’s so. But first, a bit about Ralph for those who don’t know…

Won’t bore you with the details of Ralph Swoboda’s  credit union career. You can get off of your Tik-Tok for a moment and Google-up Ralph’s remarkable record. Ralph’s reach was international; but of most importance, Ralph Swoboda was to American credit unions what Winston Churchill was to England during the Second World War. Ralph Swoboda led CUNA – and credit unions – through two crucial, turning points, when nothing was certain, the odds were long, and everything was at risk.

You see, Herb Wegner, the charismatic, visionary leader of CUNA in the late 1970’s – for whom the Award is named, understood the future power and potential of credit unions – what they could become. But, that future required great change – new standards, new laws, new systems, greater accountability.

Mom and pop credit unions were on the verge of moving from being post office/factory floor “cigar box cooperatives” to Main Street, USA. Not all credit unions were prepared for this change, not a few were unhappy with the prospect!

Herb Wegner needed someone he could trust without reservation to advise him along this difficult path – to make sure his vision became a reality. Ralph Swoboda was the man Herb Wegner put his trust in when he hired Ralph as his General Counsel at CUNA.

And, after Herb Wegner’s untimely death, Ralph – in several executive roles and eventually as CUNA CEO – did guide credit unions skillfully across that dangerous, inflection point and into the future. Much of what credit unions are today rests on foundation stones and bridges engineered by Ralph Swoboda.

But, like Churchill in England after WW II, in 1994 CUNA sent Ralph packing! Change again was at hand and Swoboda was not as certain of the long-range impact of this next evolution.

The sea-change was in CUNA moving from being a hardscrabble, smoke-filled backroom, vibrantly passionate, states-rights democracy toward a highly centralized, DC-based, political monocracy. Ralph had won the big war, but had lost the last battle! Perhaps Ralph had become too old fashioned, too quixotic, too stubbornly Ukrainian…? Time will tell.

Lastly just for the record, Ralph Swoboda was also a man of great personal charm and presence, but not of the classical sort. Ralph was not exactly a person of well-coifed, smooth-skinned, impeccably dressed and manicured good looks. He was more into the all-natural, slightly rumpled, “came as I got up” style.

He always sported a riotous shock of vigorously unruly hair, flopping around a pair of oversized glasses – the kind the smartest kid in the class always wore. His grin was impish, frequently verging on the devilish. Ralph liked to laugh and it was a full-throated, rough-edged kind of laugh, aged by years of multi-pack-a-day Marlboros. Ralph was a bit Irish at the bar, with good endurance and always fun to be around.

But what Ralph liked best was to talk…and talk…and talk…in encyclopedic depth…especially about credit unions. As a great storyteller, Ralph told the cooperative story from the heart, he made it real, as if he meant it…which all knew he did!

So, what about that Selection Committee decision? Well folks, who did Herb Wegner trust more than anyone else? That person was Ralph Swoboda, who Wegner hired as his chief advisor, his general counsel, his “don’t let me fail in this effort” friend. Ralph Swoboda proved worthy of Herb Wegner’s trust.

Herb Wegner saw the light, Ralph Swoboda made it shine.

What’s to decide? You’re going to question Herb Wegner’s judgment?

Nah… I’m sure you’ll do the right thing!

(Editor’s note:  A history of Ralph’s contributions at CUNA is at: The Cooperative Leadership of Ralph Swoboda (1948-2021)

 

 

 

 

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A Review of the NCUA Board’s Oversight of the NCUSIF

NCUA’s open board meeting In May had only one agenda item, the quarterly staff update on the NCUSIF.

This was an opportunity to focus on many topics that have swirled around the management of the Fund over the past year.   These include:

  • The fund’s investment strategy especially in the rising rate environment;
  • The accounting confusions using  Federal not private GAAP presentation;
  • Projections for the fund’s operating outcomes later in the year;
  • Options to more accurately present the Normal Operating Level (NOL). The ratio now uses two separate accounting period’s data;
  • The prospect of lowering the NOL to its historic range of 1.2 to 1.3% from 1.33%.

The NCUSIF’s $22 billion  is its largest asset . The fund’s unique cooperative design means credit unions have a direct financial stake in its performance.  Credit unions  should receive a dividend in years of strong performance and pay a premium in the event of mismanagement or a catastrophic loss.

As noted by Vice Chair Hauptman in the meeting:  it’s a mutual asset of the credit union movement and NCUA. . . it’s worth reminding everybody that every dollar of that one percent contribution belongs to credit union members and no other.  NCUA has the obligation to credit unions and their members to manage that fund prudently and effectively.

Board member Hood reiterated:   The 1% capital deposit which comprises most of the Share Insurance Fund’s equity is also an asset of the credit union.  We should never forget this.

I would add that the unique coop design intended the 1% deposit be an earning asset for credit unions.

The Fed’s Response to the Current Economy

As reported by CNBS:  Minutes from the Fed’s June meeting, which were released Wednesday, revealed that the central bank is prepared to use even more restrictive measures to tame surging inflation. They indicated that July’s meeting would bring another rate hike of up to 75 basis points, and acknowledged that the economy could suffer a slowdown.

“Participants concurred that the economic outlook warranted moving to a restrictive stance of policy, and they recognized the possibility that an even more restrictive stance could be appropriate if elevated inflation pressures were to persist,” the minutes said. Treasury yields, meanwhile, continued to rise.”

This is not new news.   Since October 2021 the Fed has indicated that it would change its accommodative monetary policy in response to signs of growing inflation.   That intent became explicit in December with forecasts of interest rate hikes from the historically low levels engineered in 2020 to respond to the Covid economic shutdown.

The market’s response was swift.   Through this year’s second quarter,  bond  fund valuations have fallen almost 20% in market value. The NCUSIF has gone from a market gain of over $500 million in 2020 to a market valuation loss of $1.1 billion as of the April 2022 NCUSIF report.

The NCUSIF Staff”s Response to Rising Rates

The staff’s response to this dramatic change in rates was provided in May’s presentation:  Extend the investment portfolio further by going from a maximum term of 7 years to 10 years.   Rick Mayfield, capital market specialist. stated  this strategy would place approximately 10% of the portfolio in annual buckets over the 10 year range in a one to two year time frame.

The result would raise the average weighted duration from 3.5 years to almost 6 years—at a time when the overwhelming consensus and Fed intent is that rates will continue to rise.

The continuing decline in the NCUSIF’s market value in the past 18 months shows how far the portfolio is falling short of current rates.  This below market return is lost revenue in the tens of millions of dollars.  The continuing decline is a specific indicator of the portfolio’s performance gap from current market rates.

To mechanically continue  investing in equal “buckets” over ten years is a failure of  management.

This investment extension aligns with neither the current policy nor experienced investment judgment.   No objective data or analysis was offered to support this extension to a 5-6 year duration.

Extending a portfolio does not automatically bring higher rates.  Yield curves do not always slope upward.

As an example, when yield curves invert, that is the two year bond pays more than the 10 year,  how does purchasing the lower return 10 year bond “maximize yield” per fund policy?

Managing the portfolio’s duration is the most critical function to match the liabilities for which the fund is responsible.  These include  paying operating expenses, growing retained earnings in line with insured shares, and if necessary, covering insurance losses.   Those expense liabilities can be easily quantified and monitored monthly to align with investment earnings (yield) decisions.

For example, a 2% fund yield would generate $400+ million in revenue easily meeting the operating expense and projected equity growth goals.  A 3% earnings rate should result in a dividend to the owners if insurance losses are at, or below, long term trends.

This is the integrated ALM/IRR management NCUA expects all credit unions to practice.   This management responsibility is not a fixed formula followed routinely whatever the market conditions or future outlooks.  Rather modeling tools, forecasts and judgment are used to align asset returns and the cost of  liabilities as market events change.

No Free Lunch

Even more disappointing was the assertion by CFO Schied that the portfolio’s new extension to ten years would be initiated this quarter-despite the explicit forecast of further raises from the Federal Reserve.

“ . . .with respect to the investment portfolio and consistent with the existing board approved investment policy. the investment committee has decided last month to begin to extend the portfolio ladder out to 10 years.  This is not reflected in today’s quarter one presentation because the decision to do so does not show up until quarter two which will be evident in my quarter two presentation as well as our monthly reporting that we post on the website going forward.”

Naively extending investments to “chase yield” is a common examiner criticism of poorly documented credit union investing.  Such extensions  may produce a short term income jolt but at significantly increased ALM/IRR risk.

Vice Chair Hauptman remarked:   I can say as somebody who worked in fixed income markets for years you know there is no free lunch.  We can get more income by taking more risk and in no other fashion.

There was no data presented to justify a decision to extend from 7 to 10 years in a rising rate environment, an action contradictory to traditional sound portfolio practice.  This extension was also taken in the face of increasing market losses.  This mechanical approach underperforms in the current interest rate environment.

Making a fixed rate 10-year investment  in the face of inflation and other economic uncertainties, is extremely speculative.  It severely limits management options for responding to market events and any changes in credit union insurance needs. It results in  a fixed revenue cap for an even longer period than the current practice.

The result is that NCUA’s hands are tied responding to events during this extended average life of almost 6 years. The Fund becomes dependent on other sources for liquidity or revenue, a contradiction in the fund’s fundamental financial role.

This extension announcement doubles down even after the mounting evidence of NCUSIF investment management shortcomings.  The investment policy referenced has not been updated since 2013.   But most concerning is that there appears to be no ability to objectively evaluate investment practice.

Projecting the Equity ratio And Slowing Share Growth

In addition to presenting the current investment approach, CFO Schied’s projected the NCUSIF’s NOL to June 30, providing two interesting data disclosures.

The first is that he projects an operating loss of $68 million for the NCUSIF  in the second (June) quarter versus a net income of $54.4 million in the March quarter.  That is a $122 million reversal in operating results.

Since investment revenue more than offsets operating expenses, the only possible reason for such a reversal is insurance loss reserves.  Yet all the CAMEL results are positive.  There was no indication of any major unaddressed issues.  So why this dismal forecast?

Secondly Schied also gave the agency’s 12-month insured share growth forecasts for 2022.  Actual share growth was 9.3% for the March quarter.  The projections are  7% growth at June 30, year over year; and only 4.3% for the full calendar 2022.  A significant slowdown from the past two years.

A Board Meeting with Mixed Outcomes

 

The Agency’s mechanical NCUSIF investing in the face of dramatic rate changes and increasing portfolio devaluations was a disappointment.  Extending the investment duration to almost six years (versus current 3.5 years), will only reduce the Fund’s flexibility responding to changing rates and future industry risk events.

Both Chair Harper and CFO Schied downplayed or even denied there was any real risk to extending the portfolio. Here is the Chairman’s summary observation:

The changes in the value of these(investment) assets were expected. That is because as interest rates go up the value of these bonds go down. I learned that in my finance 301 class back in college.

These unrealized losses fortunately do not impact the equity ratio and do not increase the likelihood of a premium just as unrealized gains do not increase the equity ratio. What the unrealized losses signal is a change in the interest rate environment. We are moving forward to address this issue.   The NCUA is adjusting its investment strategy from a seven year ladder to a ten-year ladder. . .

This observation is incorrect in two respects:

  1. Extending the ladder increases the portfolio’s risks, especially as it relates to meeting its matching  liability/expense requirements.
  2. As the portfolio continues to carry underwater investments, that is returns below market, then the fund’s revenue is short changed. It is credit unions that may have to pay a premium for NCUA’s mismanagement due to potential  revenue shortfalls.

Confusing Financial Presentations

The staff continues to present financial information following Federal GAAP that both confuses and misinforms readers about the actual state of the NCUSIF.

The federal presentation of the balance sheet shows that both the assets and Fund equity  have fallen this year from yearend.  That is because the decline in market value is is subtracted from both investment assets and the cumulative results of operations (equity) on both sides  of the balance sheet.  This understatement is $1.1 billion as of April 30 and increasing each month as portfolio valuations decline further.

To the user of this information, the NCUSIF appears to be reducing in size and value.

The accounting category, year to date retained earnings, is not reported under Federal GAAP.  Calculating  the Fund’s NOL trends requires this number.  However it  is not  presented in the financial statements, but must be derived from the information presented.

Finally the issue of how the NOL is being calculated using numbers from two different accounting periods was again raised by Board Member Hood. He referenced the Cotton accounting firm’s review from  2021 and its reported description of several ways the 1% true up could be presented in the  Fund’s yearend financial statements.

CFO Schied’s response to Hood’s query was:

We are reviewing and doing the due diligence over alternative approaches including that pro forma idea that you’ve mentioned in order to have a complete picture of the relative costs and benefits and to understand any potential hidden implications of any alternatives. 

Because I’m not sure back then that they realized that the change was going to lead to the timing gap that we have today.  I would look forward to updating you on these findings over the summer.

Credit unions will certainly be looking for this review!

Overall  this single-topic open board meeting identified, but failed to resolve, these ongoing  issues of NCUSIF investment management, fund financial presentation and more accurate NOL calculation.

(Editor’s note:  Later updates corrected earlier spelling error of Vice Chair Hauptman’s name)

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The Supreme Court,  The Administrative State and NCUA’s RBC/CCULR Rule

The new RBC/CCULR net worth rule is the most comprehensive, intrusive and costly regulation ever passed by NCUA.

The agency’s staff’s initial estimate of the funds now restricted from increasing member value is over $24 billion. From  their December 2021 board presentation:

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 is a minimum 30% increase of capital, restricting its use for members, and imposed just nine days after the rule’s printing in the Federal register.

RBC/CCULR is both procedurally and substantively deeply flawed. Instead of implementing the  legislative intent that PCA be applied to a limited number of “complex” credit unions, the regulation passed covers 85% of all credit union assets.

But what can be done especially as the NCUA board composed of different philosophies approved the rule 3-0?

A Future Opening

The recent Supreme Court 6-3 ruling in the West Virginia v. EPA case suggests there is another opportunity to withdraw the rule or to challenge its validity.

The EPA case is about much more than regulating pollution.  The 89 page opinion is here.

As summarized in a New York times article:

It . . . signals that the court’s newly expanded conservative majority is deeply skeptical of the power of administrative agencies to address major issues facing the nation and the planet.

Chief Justice Roberts, employing the phrase for the first time in a majority opinion, said it applied in cases of unusual significance and was meant to address “a particular and recurring problem: agencies asserting highly consequential power beyond what Congress could reasonably be understood to have granted.”

Another account of the decision in The Hill explains the broader significance of the Court’s reasoning:

In reaching its conclusion, the court relied on the controversial “major questions doctrine.” The major questions doctrine is a relatively new interpretative maxim that directs courts to presume that Congress does not intend to vest agencies with policymaking authority over questions of great economic and political significance.

Only Congress’s “clear statement” that it did intend to confer the claimed authority can overcome this presumption. When a court employs this maxim, it reads statutes narrowly, stripping the agency of the power to address the major question that the statute, on its face, gives the agency the authority to address.

Unsurprisingly, the main focus of the media, scholars and the public is on the consequences of the court’s move for the size and contours of the federal administrative state.  . . 

The impact of the court’s ruling on federal agency authority and power cannot be overstated.

A lawyer friend when asked,  opined: “what I’ve read about it suggests the Court is going to take a very restrictive view when assessing agency claims of regulatory authority (effectively dispensing with Chevron deference).  When the authority to regulate is clear, I have no idea how much discretion the agencies will be afforded when exercising that authority.  I’m not sure what category the RBC rules fall into.”

The  RBC/CCULR rule’s flaws include the following;

  • The agency provided no “substantial objective evidence” that the system’s capital levels were inadequate under the existing RBNW rule. Staff admitted that only one troubled credit union in the past ten years would have been subject to RBC’s higher net worth ratio.
  • The agency wrongly applied the “comparable” standard to implement a clone of bank regulations. This approach clearly contradicted the statutory intent that RBNW cover only an identified small number of “complex” credit unions that presented unusual risks. As staff confirmed in its board action memo: A special note that most, if not all, of the components of the CCULR are similar to the federal banking agencies’ CBLR.
  • There was no statutory authority for a CCULR option which Congress, in legislation, authorized only for banking regulators.
  • Nine days for implantation violates the “reasonable period of time” statutory requirement for a change in PCA capital levels.
  • The rule imposes significant financial harm to members by reducing the value they receive,  beginning with the $24 billion staff estimate. That is just the initial number. It will grow every year.
  • The compliance burden is unreasonable. It mandates a one-size-fits-all mathematical capital formula for every credit union independent of hundreds of individual risk circumstances.

A Way Out of the RBC/CCULR Morass

Credit unions can sue the agency for the substantive violations noted.  But that takes years and the harm done members will just continue in the meantime.

The most feasible course of action will be for a more informed NCUA board, responsive to the needs of credit union members, to use this Supreme Court precedent to withdraw the rule entirely.

That will require leadership, courage  and insight from current or future board members.   The first test is to ask the sitting members their views on this deregulation opportunity.

What would Hood, Harper and Hauptmann say in response to this Supreme Court interpretation?

Posted on

85% of Credit Union Assets Subject to RBC/CCULR at March 31, 2022

In December 2021 the NCUA Board passed a completely new regulation of over 500 pages to imposing a new RBC/CCULR net worth requirement.  The rule took full effect on January 1, 2022, or just 9 days after posting in the Federal Register.

It instantly raised the minimum net worth ratio to be considered “well-capitalized” by 29% that is, from 7% to 9%.

All credit unions over $500 million in total assets were immediately placed under this new capital standard.   As of March 31, 2022 these 701 credit unions manage 85% of the industry’s total assets, or $1.809 trillion.

No CCULR “Off-Ramp” for 193 Credit Unions

Those subject credit unions with less than a 9% net worth ratio must comply with the Risk Based Capital (RBC) computation.  It takes five pages of call report data to calculate this one ratio.

As of March 31, there were 193 credit unions with $345 billion in assets that reported less than 9% net worth.   For them there is no CCULR off-ramp.

They are thrown into a financial, accounting and classification “wonder-land” of arbitrary ratios, regulatory accounting decisions and almost 100 distinct asset classifications.

Following the RBC requirements is a complicated mess.

For example, individual credit unions have at least four options for calculating the net worth ratio. They can use average daily assets for the quarter, or the average of the three-month end quarter balances, or the average of the current and preceding three quarter end balances, or the quarter end total.

NCUA doesn’t even try to present the industry’s total net worth in this multiple manner, just asserting that the 10.22% is the industry average even though many other calculations are authorized.

Depending on which denominator a credit union chooses to determine the ratio, the outcome may or may not be a net worth over 9%.   Net worth comparisons become much less informative for members and the public without full disclosure of the methodology used.

Changes in the ratio, higher or lower,  may reflect nothing more than different calculations, not actual soundness.

RBC’s Reach Goes Beyond the $500 million level. Another 123 credit unions with total assets between $400-$500 million are within range of the $500 million RBC/CCULR tripwire.  46 of these have net worth below 9% and hold 37% of this segment’s total assets of $55 billion.

(Data update:  324 CUs completed the RBC ratio, and reported a value on the 5300.  324 minus the 193 under 9% is a difference of 131.  These completed the RBC ratio despite qualifying  for CCULR, or they may have failed one of the tests.

This suggests credit unions want to know their requirements under either net worth option to make the optimum decisions about which to follow.)

The Members Will Pay

The increase in regulatory net worth is a tax on asset growth. It requires resources be directed to reserves held idle on the balance sheet, instead of being used for investment in credit union products and services or higher returns on savings and lower fees.

Credit unions must choose to slow deposit and asset growth to build their net worth or increase their ROA by paying less or charging more.  Whatever financial choice is made, the members will pay the cost for this additional capital.

This burden occurs at a time when members are coping with a rate of inflation not experienced in 40 years.  Instead of serving members’ needs, credit unions must first serve the regulator which provided no factual basis for the rule.

A Unnecessary Rule Not Authorized by Congress

The passage of the RBC/CCULR capital regulation met no objective safety and soundness need and contradicted the express language imposing PCA on credit unions under the Credit Union Membership Access Act in 1998.

When presenting the rule, NCUA staff stated  their analysis of credit union failures for the past decade showed that this new requirement would have established a higher capital threshold for just  one problem credit union over $500 million.

The last minute addition of the so called CCULR off ramp in 2021 was defended as a way to reduce the acknowledged new and enormous burden of RBC.   Congress passed legislation permitting banking regulators this CCULR exception.  That statue did not include NCUA or credit unions.

The fact that credit union CCULR has no Congressional authorization is just one of many improper steps NCUA took when imposing this regulatory monstrosity affecting every asset decision made by a credit union.

The regulation  is the Fruit of a Poisonous Tree failing at least five explicit requirements of the PCA legislation and the Administrative Procedures Act.

So why didn’t credit unions sue?  Why did two board members go along with this deeply flawed regulation and process to make the passage unanimous?

What options are now possible to overturn a regulation  that injects the federal insurer into literally every specific balance sheet and asset decision made by credit unions?

Tomorrow a new approach to eliminate this rule, take away the burden, and return responsibility for the management of the credit unions to the members and their board and managers now appears possible.

Note:  Additional details of this flawed regulation can be found in these articles.

https://chipfilson.com/2022/02/cculr-rbc-unconstrained-by-statute-an-arbitrary-regulatory-act/

https://chipfilson.com/2022/02/thedisruptive-costly-reach-of-cculr-rbc-30-40-billion-for-initial-compliance-no-longer-available-for-members/

https://chipfilson.com/2021/12/why-the-rbc-cculr-should-be-abandoned/

https://chipfilson.com/2022/02/cculr-rbc-unconstrained-by-statute-an-arbitrary-regulatory-act/