Just a Member

A vital leadership skill for persons and organizations is the ability to learn from mistakes. Ignoring failures can lead to coverups and ultimately the loss of personal integrity and institutional purpose.

At the March NCUA board meeting, all three members, including Chairman Harper, publicly supported a “look back” to understand the Corporate crisis and lessons that might be gained. This could be an invaluable effort if truly open, independent and expert.

Last week NCUA conserved Edinburg Teachers CU with a net worth over 20%, without explanation. If the problems are not quantitative (financial) but qualitative (internal fraud, governance failures) is this a situation examiners should have discovered?

Self-examination is difficult in the best of circumstances. In some respects, it is contrary to the ethos of a regulatory enterprise which itself is charged with ensuring proper conduct. To admit its own processes and judgments may be less than satisfactory, could harm the agency’s reputation. Better to stonewall and let bygones be gone.

Look Backs at An Agency

The FDIC’s success in assuring the public that insured deposits are indeed safe does not rest on its fund balance. The FDIC resources are far less than 1% of the banking assets it insures. Rather it depends on public confidence in the FDIC’s ability to resolve problems-whether caused by circumstances within insured banks or from its own supervisory shortcomings.

One key to this continuous improvement process is FDIC’s public analysis of failed banks.

The most recent was posted on Friday, March 26, the Failed Bank Review, Almena State Bank, Almena, Kansas.

The 5-page report on the October 2020 closure of Almena State bank shows a loss of $18 million or 27% of the bank’s $69 million total assets.

The IG’s review is to determine “whether the subject bank failure warrants an In-Depth Review.”

This initial assessment analyzes “key documents related to the bank’s failure, including the Division of Risk Management Supervision’s (RMS) Supervisory History, the Division of Resolutions and Receiverships’ (DRR) Failing Bank Case, and examination and visitation reports dated 2016, 2017, 2018, 2019 and 2020.4”

The Analysis

Report sections include Causes of Failure and listings of all FDIC supervisory contacts. The review process includes multiple considerations:

“The OIG considers four factors to determine whether unusual circumstances warrant further review. These include: (1) the magnitude and significance of the loss to the DIF in relation to the total assets of the failed institution; (2) the extent to which the FDIC’s supervision identified and effectively addressed the issues that led to the bank’s failure or the loss to the DIF; (3) indicators of fraudulent activity that significantly contributed to the loss to the DIF; and (4) other relevant conditions or circumstances that significantly contributed to the bank’s failure or the loss to the DIF.”

The factor most relevant for credit unions is (2), cases where “the OIG identifies significant programmatic weaknesses in the FDIC’s supervision, to determine if there is a need for follow-up work and the appropriate course of action.”

In the Almena case “we found that the FDIC’s supervision identified and effectively addressed the issues that led to the bank’s failure and the loss to the DIF.”

What NCUA Can Learn

As valuable as an analysis of the corporate resolution efforts will be, there are more immediate lessons NCUA might draw from FDIC’s ongoing “after-action reports.” Improvements include:

1. Publish full details in all reports, including exam contacts. If critical facts are kept from the public, it is the same as if no assessment was done.
2. Set up an independent process. NCUA’s OIG is dependent on the agency and personnel whose actions it is supposed to review.
3. Include exam and supervision findings in the report (factor 2 above)- what went right and what mistakes occurred?  For example, NCUA’s IG review of Chairman McWatters’ travel expenses and his verbal explanations had more facts than the agency provided in its loss review of CBS Employees FCU. That loss exceeded $40 million, according to one newspaper article, and extended over decades of NCUA examinations.
4. Evaluate how reviews and audits are done. NCUA OIG contracts much of its work to outside auditors. This process, while seemingly objective, is rarely expert and relies on the cooperation of those whose responsibilities are being assessed.
5. Be timely in reporting. Late, after the fact analysis, may not change  current performance. Conservatorships often do not return control to members but are quietly ended in private sales. Meantime all members and the public are in the dark.

Maintaining public confidence requires leaders who acknowledge mistakes. Credit unions pay the bills for regulatory short comings. Today it is too easy to expense away failures and avoid public questions. In the end, this will only lead to further errors, misjudgments and greater losses.

Board leadership is required if  NCUA self-assessment is to be an agency priority. This can also be a chance to identify staff with the capability for this institutional self-examination.

NCUA’s email announcement came at 6:30 PM Friday evening, 3/26/21, after the credit union press had gone home.  And weekend events might produce a different headline for Monday’s news cycle.

The Texas Credit Union Department had “taken possession of” the $106 million Edinburg Teachers Credit Union and appointed NCUA conservator.

Edinburg thus joins the $6.6 million Indianapolis Newspaper FCU conserved on January 15, 2021 for “unsafe and unsound practices” and CO FCU, at $4.6 million, taken over on January 6, 2021, without further explanation.

These credit unions are “locked up” with fellow inmates confined in 2020 and 2019: the $46 million Southern Pine, taken in June 2020, and the $3.9 billion Municipal Credit Union in New York, seized in May 2019.

Members Behind NCUA Bars

There are now over 608,000 credit union members behind NCUA regulatory bars in these five conservatorships.  These member-owners have no say in their credit union and are given no plans for the future.

What makes Edinburg Teachers somewhat surprising is that the December 2020 call report shows net worth of 22%, ROA of .68% and share growth of 11.4%.  Two numbers are outliers, however. The loan-to-assets ratio was only 14.6%, or 3.5% lower than one year earlier.

Average salary and benefits for 9 FTE’s was $223,372, a figure that would place the credit union in the upper 1% of all salaries.

But neither of those facts is new. A 2016 article on creditunions.com ranked the average salary of Edinburg as the 4^th highest of all credit unions as of December 2015.

NCUA Prison

Some imprisoned credit unions are accused of committing unsafe and unsound acts. No such accusation in Edinburg’s incarceration.

As regulatory prisoners, the credit unions are prohibited from speaking to the public. NCUA refuses to provide any updates on their condition or priorities while under their control.

The only information that filters out is the quarterly report of financial health signs. These reports are often spare.  Extraordinary increases are reported in provision expense or other miscellaneous category without explanation. For example, Southern Pine CU recorded an additional $10 million in operating expenses after being “saved” by NCUA in 2020.

Over 600,000 members now reside in this regulatory purgatory. They are told nothing about the institution they created with their loyalty. Their only solace is that the federal government promises to return up to $250,000 in shares, but not their credit union.

A Pattern of Silence Inconsistent with Public Duty

NCUA routinely covers its assumption of control using an “unsafe and unsound” blanket, or sometimes with no story at all.  The agency policy as stated by its office of external and public affairs: Please note that notwithstanding key personnel announcements, we do not comment on our efforts or conditions related to conserved credit unions.

The moment the regulator exercises its most extreme authority, seizing the members’ institution, is when their conduct should be the most accountable. Both to assure the public and so that all credit unions can learn from whatever caused such a severe situation in the first place.

But instead, silence.  One factor contributing to this regulatory “omerta” is that the problems that resulted in these takeovers are often long-standing and reflect deficiencies in the regulator’s examination and supervision process.

This is not a hypothesis. Four days before this latest conservatorship, an analysis gave examples in which NCUA’s examiners have been unable to see wrong doing happening before their eyes, for years, even decades.  NCUA’s Most Important Function Needs Transparent ReassessmentWill Texas Set a Responsible Model for Regulatory Candor?

One potentially important difference in the Edinburg event is that the Texas Credit Union Commissioner had primary jurisdiction for this state charter. Texas credit unions are overseen by an independent board described as follows:

The nine-member Credit Union Commission is responsible for overseeing the activities of the Credit Union Department and serves as the primary point of accountability for ensuring that state credit unions function as a system. 

The Commission is a board of private citizens appointed by and responsible to the Governor of Texas. Four members of the Commission must be individuals who serve as a director, officer or committee member of a Texas state credit union or a federal credit union with a principal office in Texas. The remaining five members of the Commission are representatives from the general public.

Commissioner John J. Kolhoff, an experienced state regulator and previously Michigan’s credit union supervisor, provided the following comment on Edinburg’s takeover:  The Texas Credit Union Department remains focused on continuing our efforts to provide appropriate regulatory oversight of state-chartered credit unions. We work to ensure that the businesses within these industries are safe, sound, and entitled to the public’s confidence.

As the primary regulator, Commissioner Kolhoff can earn the public’s confidence with a frank account of what went wrong in this apparently strong credit union’s failure. Were there supervisory mistakes? Was there no board or governance oversight?

NCUA’s practice is to bury its examination failures or to hand the problem over to someone else to resolve.  In contrast, the Texas Commission publishes on its website a Compact with Texans detailing is responsibilities and service standards.

Will the Texas Commission stand tall and fulfill its duty to the public and state credit union system?  Or hide inside NCUA’s credit union lockup?  This is not to assign blame but to improve professional leadership and accountability. And provide system awareness.

Most importantly, it is to show answerability to the members who have lost control of their cooperatively owned institution.

Tomorrow:  How another regulator publicly evaluates its regulatory and exam oversight when problems occur.

NCUA has developed a bad habit as a public agency.  It fails to report any details of its most vital activities when engaged with problem credit unions. This covers conservatorships, liquidations and other important supervisory activities. Total silence on these critical functions raises the question of what is NCUA trying to hide?

The Latest Example

Last week the credit union press reported the details from court hearings of IBEW Local 712 FCU, a 56-year old charter with $7.6 million in assets when closed in May 2020. Key facts from the Credit Union Times account:

• The CEO’s embezzlement began May 2017, five months into the position, and lasted until March 2020.
• The fraud was primarily from cash advances on credit cards (presumably from the credit union) of $589,222 in 2018 and $1,085,549 in 2019.
• Total theft $2,099,437.
• Credit union was $7.6 million with 3,000 members when “merged-assumed” in May 2020.
• Court documents did not reveal how the embezzlement was uncovered, how it was concealed or what was done with the money.
• IBEW Local 712 FCU’s March 2020 Call report shows a loss of $2,099,437 presumably from the NCUA examiner’s review of the situation.

Under current practice, NCUA had no comment last May when assigning the credit union’s remnants to West Penn P&P FCU just down the road.  In offloading  the responsibility for this failure to West Penn, the transaction increased West Penn’s assets from $14.2 to $23.4 million and immediately reduced its net worth ratio from 16.1% to 10.2%.

Not the First Time  

From a July 10,2014, NCUA press release on another IBEW FCU liquidation: “The National Credit Union Administration today liquidated IBEW Local 816 Federal Credit Union of Paducah, Kentucky. . .

“NCUA made the decision to liquidate IBEW Local 816 Federal Credit Union and discontinue its operations after determining the credit union was insolvent and had no prospect for restoring viable operations. . .

“IBEW Local 816 Federal Credit Union served 929 members and had assets of approximately $6.3 million. Chartered in 1954, IBEW Local 816 Federal Credit Union served members, employees and their families of the International Brotherhood of Electrical Workers, AFL-CIO, in Paducah.”

In September 2015, a year later, the facts are reported in a CUToday story, again from court documents and not NCUA, the regulator:

• Debra C. Pyfrom, the former manager of the IBEW Local 816 Federal Credit Union, pleaded guilty in a to a single charge of bank fraud.
• Restitution promised by Pyfrom: $600,520.
• Pyfrom admitted to issuing loans to herself and to her daughter and posting false payments to conceal the fraud and make payments appear current on IBEW’s books.

What Is the Real Problem?

NCUA’s most important function is examinations. This responsibility consumes the majority of the agency’s employees and budget. Its effectiveness is augmented by quarterly call reports and numerous other supervisory and administrative interactions.  When examinations are only fill-in-the-blank financial analysis or completing check lists of required activities, the entire basis for the exam is compromised.

The most critical aspect of any well-done exam is judgment: what to look at beyond numbers and how far to follow up areas of uncertainty. Then the skill in presenting reasoned judgments to the credit union’s leadership team, if changes are necessary, even when no apparent issue of safety and soundness is evident.

Using Fraud as an Excuse

The most devastating example to date of this “fraud” cover for examination shortcomings is the case of the $40 million CBS Employees FCU in 2018.  The fraud began in 2000 and according to the LA Times account: “was first exposed on March 6, (2019) when a credit union employee discovered a $35,000 check made payable to the manager. The employee then conducted an audit and discovered $3.775 million in checks made payable to CEO Rostohar between January 2018 and March (2019). Those checks included the forged signature of another employee, who did not give consent.”

The $40 million figure in the story is the $25 million taken plus interest lost on the stolen funds.    The CEO had been managing insured share accounts and paying interest for members that were 150% greater, over time, than the amounts on the books examiners reviewed for decades.  Common sense should have alerted a casual reviewer that the transaction activity did not square with the reported balances.

IBEW Local 712 FCU’s demise in last week’s CU Times is just the most recent example suggesting the examinations basics are not sufficient.  In this case, 2017, 2018, 2019, 2020: four exams.  CEO takings amounted to over 25% of the credit unions assets in this period.

Reviewing the accounts of the CEO, senior managers and Board members is a standard, essential examiner responsibility.  So obvious is self-dealing in money management that for the first half century of credit union charters, many state laws prohibited officers and directors from borrowing from their own institution-they had to borrow from Central credit unions established just for this purpose.

Were these reviews not done?  How were the cash advances on credit cards hidden? Was the examiner properly trained? Where was the supervisory examiner’s review? How often has this occurred in the Region?

Instead of confronting these examples of agency shortcomings, NCUA conceals its mistakes by perfunctorily assuring all accounts are insured up to $250,000.  The agency charges off the losses from their institutional failures to the NCUSIF-that is all other credit unions.  Only later, sometimes years afterwards, are the myriad details released demonstrating the scope and length of the misdeeds and multiple examination misses.

Why An Annual Exam Contact is Essential

Some trade groups, credit unions and even NCUA board members have suggested extending exam frequency up to as much as 18 months,  as a cost savings measure or as a reward for a prior top exam rating.

I believe an annual exam contact is essential for two reasons.  A “contact” proportionate to the circumstances of each credit union reminds all concerned that the regulator is watching.  As one CEO commented, it keeps honest people honest.

But more importantly, when over 95% of credit unions are rated camel codes 1 and 2, this is an opportunity for both sides to learn what is going on in real time, not 30-90 days later from call reports. This learning can be as mundane as following a credit union’s PPP loan activity, its assimilation of a merger or future plans to change a major technology provider or engage a new partner venture.

The key skill of judgment is developed from the experience of seeing multiple examples of how institutions respond to both universal and individual circumstances. Observing proactive examples, or passive responses, to common challenges makes the examiner more competent when providing an informed external point of view.

The board must reverse the agency practice of hiding or covering up problem resolutions. Let the light in. If NCUA continues to bury problem credit unions out of sight, sooner or later it will run out of space to place the remains, or out of bodies to bury.

The Wall Street Journal headline and subtitle suggested something very bad was going on in the credit union system:

Credit Unions Ramp Up Risk

Lenders Loosen Lending Standards, Increase Exposure to Longer-Term Assets  By Ryan Tracy June 5, 2014

The following lead paragraphs cites NCUA as the primary source:

“Credit unions in search of higher returns are loosening lending standards and piling into longer-term assets, exposing the firms to potentially significant losses if interest rates rise and worrying regulators in the process.

Such moves are raising concerns at the National Credit Union Administration, the sector’s regulator, which said a rise in interest rates could make loans and investments unprofitable. Some analysts also said credit unions likely are unaware of the risk they are taking on because they largely avoided the housing downturn. That has raised worries that lax underwriting standards could fuel another bubble.

“I am concerned that the message [about rates] is either not getting through, or it’s getting through and they are just choosing not to do anything about it,” said Debbie Matz, chairman of the NCUA, who has long sounded the alarm about the industry’s exposure to interest-rate risk.

“Credit unions’ net holdings of long-term assets, a measure of exposure to rising interest rates, rose to an all-time high at the end of 2013 to 35.85% of total assets, according to the NCUA. The increase comes as some credit unions are adopting lax standards for mortgage and home-equity loans and lines of credit reminiscent of those leading up to the financial crisis, according to interviews. Credit unions also are extending the duration on investments like mortgage bonds, regulatory data show.”

The Backstory

In response to the regulator’s alarming and authoritative outlook, Jim Blaine printed an internal NCUA document in which senior staff celebrated, in an email high-five, this external PR coup.  The full blog can be found here under the ironic title, NCUA Ramps Up Risk.  A brief excerpt follows.  Reader comments to the post provide even more context for this PR exercise:

“Story’s up!…”

Seems that “a bunch of the boys” over at the Agency were breathless with excitement, waiting for the WSJ article to appear!

An interesting little group spending their Thursday evening [6/5/2014 – the day before publication!] playing with matches, waiting to read this little firestorm-creating, napalm piece.

NCUA Misleads the Public

Further down the Journal article is a calming quote from a Callahan executive:

“Jay Johnson, executive vice president at Callahan & Associates, a firm that advises the sector, said credit unions are prepared for a rise in interest rates because they have to hold capital against potential losses, and they also are holding short-term assets that could provide cash in a pinch, including more than 40% of investments in short-term holdings that mature in less than one year. “For the most part, I would say that [credit unions] are extremely ultraconservative,” he said.”

Contrast this NCUA created assessment in the Journal with the official portrayal  of the real state of credit unions by Chairman Matz in her opening paragraph in the agency’s 2014 Annual Report:

“In 2014, the U.S. credit union system also had one of its strongest years in recent memory. Membership continued to rise, reaching 99.3 million members. Delinquencies and charge-offs continued to fall, and the overall credit union system had its best year-over-year loan growth in nearly a decade at 10.4 percent. Federally insured credit unions also had aggregate net income of $8.8 billion, the best performance ever. As a result, our country’s federally insured credit unions ended 2014 with a healthy net worth ratio of 10.97 percent and more than $1.1 trillion in assets.”

Banging the Drums of Fear

This PR misinformation effort occurred at the same time NCUA had to withdraw and rethink its first risk-based capital RBC rule proposal.  Over 2,050 comment letters (the most ever on a rule) were submitted, all with substantive criticism.

As a result, the agency backed off and said it would make significant changes in what became the RBC-2 proposal.

Forecasting a future of doom and gloom or hyping a present crisis is unfortunately an all-too-frequent regulatory temptation. Predicting negativity creates an aura of expertise.   It elevates the power of the regulator.  Crises enable overreach of authority.

There is no downside to predictions of future problems especially by regulators.  If nothing happens, then the warning worked,  everyone feels OK and no-harm-no foul for an erroneous judgment.  If there is a downtrend, then one can claim prescience and proven expertise about the future.

An example of this crisis-hyperbole was trotted out  in the March 2020 NCUA board meeting.  The staff provided “background context” to the 2008-2009  corporate crisis.  They opened by stating there was a $50 billion difference between the book and market value of corporate investments at some point in the Great Recession. They proclaimed that if the agency had let those corporates fail, then this “loss” would have caused thousands of credit unions to also liquidate.

That possibility was never an option, but a wonderful story to justify any and all subsequent actions. In fact the agency’s auditor presented the collective corporate TCCUSF potential deficit at yearend 2009 as $6.9 Bn in the firm’s opinion released in early 2010.  By dramatically exaggerating risks in an event, NCUA avoids addressing its mutual responsibility for the state of affairs.

Banging the rhetorical drums is a political tactic unfortunately tempting in a democracy.   When those in authority say things are bad and can get worse, it legitimizes the exercise of unbounded and unexamined power. Due process is not an option.  For the ‘house is on fire” echoing Blaine’s metaphorical critique.

The person with the responsibility for Congressional and Public Affairs when this article placement occurred was Todd Harper, current NCUA Chair.

I will next look at a continuing policy priority he has championed, the immediate implementation of the final RBC rule on credit unions.  NCUA cited FDIC as the precedent for this rule in 2014.  Yet the FDIC completely eliminated this standard of capital adequacy for banks under $10 billion three years ago stating it was so ineffective to that even collecting the data was no longer necessary.