Tell Me Why I'm Wrong

In the preamble to Randy’s recent post The NCUA’s role has become writing a check and giving the bad news, he challenged me about how the insurance fund got its start:

Chip, did you, Bucky, and Ed build this system to simply sell our members to someone else when the going got tough? Was the insurance fund designed to punish credit unions, and reward non-CU problem solvers? Was the point of our investment to hire consultants to broker our problems away? Was the point of insurance not to keep us better off, but whole. Somehow, feeling whole and true to the game is not something I associate with the managers of our fund today. Are they insurance people, or just money managers and political fixers?

When all of this was set up, we saw the need to see it as a system and not an aggregation of independently funded and operating institutions. As to the insurance fund we had to start somewhere. The bottom line is we could not prove with numbers that the 1% plan was a better way, because there were no audited numbers and therefore no accurate loss reserves. Just a cash basis kind of accounting. And 10-15 years of successful state operations. We now have the numbers and almost 30 years of experience. The critical factor is there is so much money that NCUA can use it as a slush fund, not just insurance; and they can claim they are doing their duty just by liquidations—which was not the intent. They seem to be opportuning the system instead of managing or running the fund the way it should work.

In Randy’s blog, he makes the case that he sees the NCUA’s practice of liquidating versus solving credit union problems as just that; mismanagement, a departure from the design, and ratifying their actions by a misinterpretation of the design in the best light, and a clear perversion of the design in the worst light. The $1.62 billion cash outlay to close Melrose and Lompto is just an extreme case of NCUA’s inability to effectively resolve problems, whether they be temporary, such as leadership performance or a CEO transition, or longer term with overvalued assets. NCUA has outsourced its responsibilities to third party, for-profit firms such as Barclays and Black Rock in the case of the corporates. More routinely today, examiners strongly “encourage” credit unions that are having organizational shortcomings to seek a merger rather than working with the credit union to sustain operations.

One study by a CDFI group calculates the age of the average founding date of all active credit union charters today as 1954. Many are older. All have lived through the 70s oil crisis, the recession and double-digit inflation and unemployment of the 1980s, deregulation, multiple banking crises including the shuttering of the S&L industry, the Internet revolution and even the Great Recession. So why would someone quit the charter now having survived a history of economic perils that have caused so many other industries to fail? I believe people give up when they are told repeatedly that the unique capabilities possessed within their credit union charter no longer matter. Members can get the same or better deal elsewhere.

The unique co-op design was not just at the member-owner level. The regulatory system followed the same principles. Whereas the banking industry had three separate institutions responsible for chartering (OCC), liquidity (the Fed) and insurance (FDIC); credit unions created a unified regulatory structure with all three oversight functions under a single board. This approach reflected both the fact that co-ops were a unique financial system outside traditional clearing house and liquidity options. More importantly the structure of the CLF and NCUSIF copied the member-owner design of the credit union model. Consolidated oversight allowed different funds for different needs, good coordination and greater efficiency in sharing information and data. But the cost was the checks and balances of three different institutions in the banking sector.

And credit unions’ combined regulatory capabilities were extremely effective in responding to the economic, political and financial upheavals that occurred. From the 1980s onward.

The structure of the NCUSIF with the 1% deposit and a retained earnings range of 20-30 basis points on top proved to be an ingenious solution. When the NCUSIF was launched in 1971 it had no ability to build retained earnings as did the FDIC and FSLIC both created in the 1930s. The fund’s equity ratio never exceeded .30 basis points of insured shares. The premium-only system did not work. A better way was found by copying the structure and successful experiences of the 16-state chartered private insurance funds.

But the solution was more than design: it also changed the role of the fund from a purely “insurance-pay out the loss and move on model” to a co-op venture capital fund that could be used to stabilize, and recapitalize if necessary to support credit unions affected by internal or external events. Because credit unions had no access to outside capital, the NCUSIF became the capital provider “of last resort”. No institution experiencing a financial downturn will have access to normal capital markets. Title II of the FCU Act created a special section for providing fund assistance (section 208) to provide financial help for credit unions to right themselves when falling short of required capital standards. Capital assistance was an integral part of the NCUSIF design. Credit unions have no other capital options which is why the role of the NCUSIF is so vital.

These early NCUSIF workouts succeeded and saved the NCUSIF and credit unions hundreds of millions of dollars during the 1980s recession and challenges from the transition to deregulation. More importantly, this was the commitment NCUA made to credit unions who were concerned that sending more money all at once to Washington (versus an annual premium) which they feared would just increase the temptation to spend it.

Most importantly the fund’s design worked as intended:

• From 1971-1984 when the NCUSIF could rely only on premiums (1/12^th of 1% or 8 basis points) the fund’s annual insurance loss rate was 4.16 basis points or half of the annual premium.
• From 1985 through 2007 the fund’s annual loss rate was only 1.6 basis points. Moreover, the fund required an outside audit according to private company standards so that the loss reserving expense and allowance accounts remained objectively verifiable. In seven years there was not even an insurance loss. In other words, a yield of only 1.6% interest per year on the 1% deposit would be sufficient to cover the annual loss, before adding interest on retained earnings.
• The fund’s normal operating level of 1.2-1.3% of insured shares was 81 times more than the rate of the annual insurance loss. And the 10 basis point retained earnings range in the NOL would have covered a catastrophic loss six times the average with no need for a premium. Today that 10 basis point range is almost $1.2 billion.
• The design worked because of the accountability that was part of the fund’s reporting structure plus the ability and willingness of examiners to assist with problem resolution.

From 2008 through 2018 the loss rate jumped to 1.9 basis points due to NCUA’s practice of liquidating problems versus solving them, which began with the corporate resolution which was moved off the NCUSIF’s balance sheet and onto a separate fund of the TCCUSF. This liquidation pattern carried over into the shutdown of all lenders affected by the taxi medallion disruption. But a second factor was the NCUA’s transferring an increasing percentage of its every growing operating budget to the NCUSIF through the overhead transfer rate. Thus, over 90% of the NCUSIF operating expenses were not from managing the insurance fund, but rather paying for NCUA’s overall operations.

NCUA has changed both the practice and the cooperatively designed approach to use the NCUSIF to liquidate rather than rehabilitate credit union downturns. Instead of using cooperatively provided resources to support turnarounds, NCUA used them to make the problems go away: merge them for someone else to worry about or liquidate. Instead of being a source for system support, it became an off ramp for credit union charters.

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About Chip Filson

A nationally recognized leader in the credit union industry, Filson is an astute author, frequent speaker, and consultant for the credit union movement. He has more than 40 years of experience in government, financial institutions, and business. Filson’s breadth of experience makes him an authority on a range of topics, including analysis of credit union trends, credit union public and market-facing opportunities, and strategies for enhancing member value. His contributions to the cooperative movement have been demonstrated with his analysis and advocacy for the corporate credit union system, NCUA’s Corporate Stabilization role, and the need for regulatory reform.

Chip co-founded Callahan & Associates. Filson has held concurrent positions at the National Credit Union Administration (NCUA) as president of the Central Liquidity Facility (CLF) and Director of the Office of Programs, which includes the NCUSIF and the examination process. He holds a magna cum laude undergraduate degree in government from Harvard University. After being awarded a Rhodes Scholarship, he earned a master’s degree in politics, philosophy, and economics from Oxford University in England. He also holds an MBA in management from Northwestern University’s Kellogg School in Chicago.

On 3/28 Chip Filson pushed this to our marketplace. Did you read it? Did you yawn, and then delete it? Or did you think about it and act on it? I can think of a few things to do with this posting:

• Send it to my board and declare that the future based on these new board members will probably be a lot more of the same – they are cut from known cloth with known track records, and with no new things in sight.
• I would then send it to everyone I know that might have some influence over this process and say I hope McWatters’ replacement is at least a small if not major course adjustment.
• I would drop every contribution to the political side of our industry—there are no lobbies that really are as upset as our members are with these leaders—until they decided to do something about the way we assign NCUA board members. I would follow that up by pushing for future administrations to actually have a plan or project for these seat warmers to lead on, if they can lead. Board members are supposed to push for something other than bureaucratic constants.
• I would then study board members that get appointed to the agencies that lead our competitors and consider the fact that we do not get the same draft picks for our hopes and dreams. Another thing to point out as we think about our political contributions and support lent to others. Have you read the writings or speeches made by Chairman Jelena McWilliams? Wow.
• And finally, I would send all politicians a message: My Organization Has Left the Building – savings its money to survive the political system’s wake washing up my strategies and hope I have enough saved to avoid being washed away by their actions. Because based on the history that Chip lays out here, there are no players coming to the NCUA that are worth the money to stay engaged.

You might say, Randy hold on here, we can’t change anything by quitting, we need to influence the game. To that I say we have to REVOLT against the current game, and since so many of us just do not know how to really get our politicians’ attention that might be a sucker’s bet. I have no kingdom to offer in exchange for a solution here, just my hope. Chip gets me thinking…..

What Does the Changing of the Guard at NCUA Mean?

NCUA Board Member Richard Metsger, whose term expired in August 2017, leaves shortly. Two board members, Harper and Hood, will fill the Metsger “democratic” seat and the vacancy that has existed since Debra Matz resigned in 2016.

NCUA’s role is unique and consequential. No other organization in the cooperative system has the influence and resources to affect the direction of the entire credit union enterprise as does the regulator.

This three-person turnover in the Agency’s leadership is an opportunity to assess the past and to consider what the new board members may need to address. This new leadership configuration should be at the front and center of everyone’s attention who believes a course change is necessary.

Metsger’s Tenure

Metsger’s nearly six-year tenure is important because for that time he was effectively “in the majority.” He was the automatic second vote for Chairman Matz until her departure in early 2016; he served as chair from May 2016 to January 2017. And as the only other board member with Chair McWatters, he was effectively co-chair for any decisions requiring Board approval, for his veto would mean nothing gets passed.

While facts do not always tell their own story, they are an important place to start when evaluating a person’s leadership contribution. Some of the outcomes during Metsger’s term include:

• A 33% increase in NCUA’s budget from $251.4 million in 2013 to $334.8 million for 2020, the second year of the most recent two-year approval process.
• A reduction in NCUA staffing from 1,261.5 FTEs to 1,173 and closure of two regional offices.
• A total of 935 federal credit union charter cancellations since 2013. The total decline in NCUSIF insured state and federal credit unions was 1,443, or 21% of the industry numbers at the end of 2012, the year prior to his arrival.
• Granting 4 de novo federal charters in the same six years.
• Reporting the first ever loss in the history of the NCUSIF in 2017 of $229.1 million.
• Recording the single largest cash payout by the NCUSIF for natural person credit union resolution in 2018 of $1.165 billion. The previous highest cash payout was $349 million in 2012.
• Approving the “merger” of over $3.1 billion of TCCUSF surplus into the NCUSIF in 2017 despite the Congressional language accompanying the enabling legislation which stated: “These provisions are intended to ensure that the activities of the Fund are restricted to resolving problems in the corporate credit union system and not used for other purposes, such as for dealing with natural person credit union problems.”
• Raising the NOL of the NCUSIF for the first time since the fund was restructured with the 1% deposit in 1984, despite comments from credit unions in which only 12 of 663 (1.4%) respondents were in favor. As pointed out in credit union comments, the numbers presented by staff were fictional, not related to any real data or historical validation, and contradicted by auditors’ own comments about contingent liabilities.
• By raising the NOL to 1.39 and “merging” the TCCUSF surplus, Metsger admitted in a December 8, 2017 speech that staff analysis “reinforces why we needed to increase the fund’s normal operating level this year, to account for any significant losses that otherwise might have required a sudden and significant premium charge to credit unions.” The statement confirms the intent to circumvent the FCU Act’s premium restrictions when the NOL was above 1.3% of insured shares and use the TCCUSF for natural person losses.
• Passage of the 400-page risk-based capital rule despite overwhelming evidence that that the approach was intellectually flawed and legally dubious. This was the most burdensome, lengthy and intrusive rule ever imposed on insured credit unions. This action continues even though the FDIC’s own experience as stated repeatedly by Vice Chairman Tom Hoenig’s is that “a more dependable measure of capital strength is the tangible leverage ratio” or in credit union terms, the net worth ratio.

Even Metsger’s description of the $160 million NCUSIF 2019 “dividend” as the second highest in fund history is a misstatement. NCUSIF retained the entire $3.1 billion TCCUSF surplus, the ongoing earnings on that amount plus NGN fees—all intended by Congress to go back to credit unions. NCUA still owes the industry $2.2 billion before any return could accurately be called a “dividend.”

One might counter the above summary with the industry’s continued growth in assets and members despite the decline in charters and increasing NCUA burdens. I believe a more accurate assessment would be that credit unions have succeeded in spite of NCUA, not because of their oversight.

Two Steps Back?

If Metsger’s departure is a step forward, what about the two NCUA returnees in Harper and Hood as board members? Will they just rely on previous experience to continue past practice or will they see a need for change, and if so where and how? How would they interpret the trends above?

One point of commonality among all three is that the terms cooperative system and cooperative design are almost never used or referred to. The term “cooperative association” is in the first paragraph of the FCU Act. It is the most important factor distinguishing credit unions from other financial firms. It characterizes credit unions’ singular responsibility to the member-owner.

Cooperative design also creates a different regulatory agenda from banks where there is an ongoing challenge of balancing shareholder interests, with fair consumer treatment and with the public’s backstop of insurance and liquidity safety nets. Instead of regulators trying to align private wealth with public purpose, credit unions create common wealth that can be “paid forward” to benefit future members and communities.

Expectations of a Board

The Federal Credit Union Act is clear on the Board’s role in that it uses the term “manage” the agency. That word can have a lot of different interpretations. But there can be no doubt that this is where the buck stops, not matter how responsibilities are assigned by the Chair.

Unfortunately, in their board role, members most often present themselves as performers at public meetings, reading scripts, and never discussing real policy or “management” options. The role of the board to ask thoughtful questions and/or to challenge prepared positions and data never occurs. Staff’s assessments and conclusions are accepted without meaningful dialogue.

Instead of leading, the board merely endorses the staff’s interpretations and in-house views. No outside perspective from the members, policy perspective or even board expertise is provided. Board members become merely voyeurs going through pre-staged motions of accountability.

Can either Hood or Harper learn from versus repeat these past experiences?

McWatters’ Conundrum

So, will McWatters stay the course charted with Metsger? Or has he been biding his time to make real change until he has a second vote?

McWatters’ initial participation in 2014 as a minority board member was very encouraging for credit unions. He was bright, willing to listen, unfailingly polite and responsive to issues brought to his attention. His dissents around NCUA budget processes and substance, the risk-based capital rule and other interpretations of authority (think corporate capital rule) were positive contributions on critical topics. He openly challenged the “regulatory aggression” practiced by the agency on credit unions after the Great Recession including the then Chairman’s very public feud with State Employees Credit Union in North Carolina. Or even the agency’s self-justifying so-called appeals process.

McWatters repeatedly showed, while in the minority on the board, the competence to challenge the regulatory status quo. His long essay style, legal briefs of dissents were a level of effort and insight never seen at the board level.

But somehow those positions dissolved once he became Chair. Was this because he felt checkmated by having only one other board member? Or that it was not his role, but staff’s, to initiate change? Was his assessment that personal circumstances did not allow him to “manage” the agency, so he must revert to a role that credit unions refer to as a “knife and fork” director?

One role of a Chair is to help define the contribution expected of other board members in their collective capacity to lead the NCUA. Can he recover from a period of passive leadership where bipartisanship seems the only justification for action? Can he break the cycle of hyperbolic spending through the NCUSIF’s manipulation of numbers to underwrite off budget expenses? Can he rise above the Orwellian use of “safety and soundness” to justify any and every regulatory event? Will he articulate the unique value of cooperatives in the American financial system and re-energize the entrepreneurial spirit that animated almost 50,000 charter creations in the 20th century but almost none in the 21st?

I don’t know what the answers to these questions will be. But what I believe is that credit unions are running out of runway to correct the trends that Metsger inherited and then dramatically extended. If these trends continue, the endgame is becoming clear. An independent cooperative financial choice for the next generation will just be an episode for economic history texts, much like the S&L system which expired in the last century.

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About Chip Filson

A nationally recognized leader in the credit union industry, Filson is an astute author, frequent speaker, and consultant for the credit union movement. He has more than 40 years of experience in government, financial institutions, and business. Filson’s breadth of experience makes him an authority on a range of topics, including analysis of credit union trends, credit union public and market-facing opportunities, and strategies for enhancing member value. His contributions to the cooperative movement have been demonstrated with his analysis and advocacy for the corporate credit union system, NCUA’s Corporate Stabilization role, and the need for regulatory reform.

Chip co-founded Callahan & Associates. Filson has held concurrent positions at the National Credit Union Administration (NCUA) as president of the Central Liquidity Facility (CLF) and Director of the Office of Programs, which includes the NCUSIF and the examination process. He holds a magna cum laude undergraduate degree in government from Harvard University. After being awarded a Rhodes Scholarship, he earned a master’s degree in politics, philosophy, and economics from Oxford University in England. He also holds an MBA in management from Northwestern University’s Kellogg School in Chicago.