Time For Real Credit Union Disruption: Seek Change From The NCUA!

Credit unions are inevitably polite; part of their service persona. But there comes a time when the pretense of public civility no longer pertains. The NCUA’s hoarding of billions in credit union member’s funds via the merger of the Temporary Corporate Credit Union Stability Fund (TCCUSF) into the National Credit Union Share Insurance Fund (SIF) is that tipping point for me.

Now Is The Time To Act

Are you:

• Willing to sign a letter of appeal of the NCUA board’s actions?
• Willing to share that letter with your congressman and state how you would use the funds?
• Willing to ask members to sign a common petition requesting that their funds be returned?

Let me know at chip@callahan.com.

Here’s why. Since 2011, 97% to 98% of SIF expenses have been reimbursement for the NCUA’s operating budget. In 2016 this transfer covered 73% of the agency’s total spending. This transfer of $203 million took more than 90% of the SIF’s total income in 2016. By keeping the vast majority of the initial TCCUSF $2.4 billion distribution, the NCUA is creating a larger SIF primarily to pay for the regulator’s ever-increasing operating expenses.

This self-interest was not disclosed or discussed with the credit union member-owners. Rather this motivation was disguised with novel modeling and undocumented assertions of higher risk conveniently discovered as the TCCUSF is being closed.

Much more is at stake than money. On the line here is nothing less than the independent future of the most successful cooperative financial service system in the world ? the American credit union movement.

I’ll lay out the situation in detail below but to summarize what’s just happened:

• On Sept. 14, the House of Representatives, following extensive credit union lobbying, voted to leave the NCUA out of the congressional appropriations process, something that would have subjected NCUA financial decisions to congressional oversight, and potentially to Congress asking why the SIF should not be merged with the FDIC.
• On Sept. 28, the NCUA board then voted to merge the TCCUSF into the SIF. The regulator is keeping about $2 billion for itself. The remaining balance after NCUA takes its portion off the top would return about $600 million to credit unions and their members. These are the people who funded the entire corporate credit union losses in the first place. The board also approved raising its Normal Operating Level (NOL) from 1.30% to 1.39%. This increase enables the NCUA to continue to transfer its operating expenses to the SIF without raising the overhead transfer rate (OTR).
• On Oct. 6, the NCUA released its proposed 2018 operating budget, giving itself a $6.1 million raise. For the past eight years the NCUA has transferred virtually all increases in annual costs to the SIF, resulting in a compound annual growth rate over 11%.

Easy work if you can get it. No need to be either efficient or effective.

The credit union movement’s reward for rallying to the side of the NCUA keeping its independence? It was taken advantage of once again by a regulator now building a long track record of self-service over serving the more than 110 million members of America’s natural person credit unions.

In addition to withholding rightful funds from credit unions, the regulator’s reasoning about its decisions adds more fodder for bankers and lawmakers who argue that credit unions are no different from banks and should be treated as such.

In the name of all things cooperative, it’s time to act. Read more here.

What Just Happened?

The industry was surprised, some even dumbfounded, when the NCUA’s formal merger proposal came out in July and the regulator said it would retain up to 75% of the estimated $2.4 billion surplus initially available. After all, it was the credit unions themselves that had absorbed more than $10 billion in combined premiums for the TCCUSF and SIF plus write-offs of capital accounts at corporates.

They rightly assumed their monies would be refunded if the projected losses proved to be much less. The losses were much less, but the agency chose to keep the money to feed itself.

Further, the two-person board ignored the fact that more than 98% of the 663 commenters, in the short, 45-day comment period provided, opposed the NCUA’s actions in whole or in part. The NCUA itself stated that only 12 credit unions supported in full, or appeared to support, the agency’s plan to keep most of the money. ContentMiddleAd

The board asked for comments, then changed nothing in its original plan. The views of the industry were entirely ignored.

More Background. More Context.

• Credit Unions Rally To NCUA’s Side. For What?

• Pre-Funding Hypothetical Losses

New Leadership Yields Same Old, Same Old

When former GOP TARP oversight staffer and law school professor Mark McWatters became NCUA chairman, his welcoming personality, industry outreach, and erudite speeches and objections as a minority board member suggested new leadership that could re-energize the cooperative system after the burdens of the Great Recession.

That hope reached a peak after his 2016 GAC speech in which he called for regulatory reform and mentioned merging the two funds.

The TCCUSF merger shows that those hopes were misplaced. McWatters is following the same path as his predecessors. Nothing changes. They preach safety and soundness instead of presenting facts, offer opaque reasoning or just plain stonewalling instead of transparency, and have twisted the cooperative enabling charge of the NCUA.

The self-funded insurance pool is now being managed as though it’s taxpayer money at risk and to protect the Treasury from credit union losses and wrongdoing. It’s not. It’s self-funded and intended to support credit unions when needed. Worse yet, the NCUA board has converted the SIF from its insurance role to a cash cow for funding agency operations, not for its primary duty of problem resolution.

Credit union critics have long circled the movement, looking for reasons to revoke the tax exemption. The false equivalency of putting credit union’s risk in the same category as the for-profit, self-interested banks who helped cause the Great Recession can only grease the skids that would eviscerate the movement. After all, why have two insurance funds that do the same thing of protecting the taxpayer? From there, why have credit unions?

Putting credit unions in the same category as the for-profit, self-interested banks who helped cause the Great Recession can only grease the skids that would drown the movement. After all, why have two insurance funds that do the same thing? From there, why have credit unions?

A Decade Under The NCUA’s Boot

Since 2009, the NCUA has unilaterally imposed its unchecked authority on the industry by seizing and liquidating five corporate credit unions and then assessing all credit unions, up front, for the billions that action cost.

NCUA board chairs initially promised stability if only credit unions would continue their support by leaving their funds in the corporates, supported with NCUA guarantees. In return agency chairs promised to work with the industry on cooperative solutions.

At no point were credit unions consulted about the NCUA’s subsequent actions. To the contrary, the seized corporate boards and CEOs thought the NCUA supported their workout efforts. No corporate was given a chance to make their case versus seizure. The NCUA’s mind was made up. Options were not wanted even though several of the country’s largest natural person credit unions volunteered assistance by taking the legacy exposure.

Instead, the NCUA went to Wall Street advisors for the agency’s government-backed NCUA Guaranteed Notes (NGNs), replaced credit union funding with much more costly Wall Street capital, and spent billions in added expenses to oversee the paydown of legacy assets ? an event well underway on the corporates’ balance sheets.

The NCUA Steals the Fruits of Credit Union Labor

That leads us to today, when the NCUA now has decided that the results of credit union labors are really the NCUA’s fruits. The agency is withholding up to 75% of the $2.4 billion in initial recoveries that are immediately available by closing the TCCUSF. This is just a continuation of unilateral, we know better than you, boot-on-the-neck decisions, the NCUA began in 2009.

Four facts from the stabilization fund should be kept in mind.

1. The corporate credit unions had fully reserved, by writing down their legacy investments, for all potential credit losses using models as far as 10 to 15 years in the future. For the five liquidated corporates these OTTI expenses totaled $11.63 billion, of which only $1.13 billion losses had been realized. More than 90% of the reserves were unused in 2010. Even today the NCUA estimates total legacy asset losses at $8.1 billion, leaving a surplus of $2.5 billion to $4.0 billion from the investments collateralizing the NGN offerings.
2. The NCUA’s liquidation actions added $3.5 billion to $5.0 billion in costs via the stabilization-liquidation plan. These costs include the auditor’s addition of $1.4 billion to the TCCUSF loss estimate when five corporates were put in liquidation, over $1.0 billion in administrative expenses, and another billion from losses due to the agency’s sale of non-legacy investments.
3. The NCUA’s TCCUSF premium assessments of $4.8 billion were not for corporates’ credit losses on investments. Rather, the agency needed these funds to cover cash flow shortfalls from NGN funding to repay corporate debt, redeem insured credit union shareholders, reduce Treasury advances, and to cover the added out-of-pocket, liquidation-imposed costs prior to receiving sufficient cash flows from the legacy assets.
4. The surplus funds now available are due to the lower losses (surpluses) of $2.5 billion to $4.0 billion on legacy assets versus the OTTI amounts expensed. Added to that is the positive spread income of approximately $1.0 billion from these same assets after subtracting NGN financing costs and the NCUA’s fee of .35 basis points.

It was credit union premiums that funded the TCCUSF fund’s operations; material legal recoveries did not occur until three or four years later and, as yet, do not fully cover the NCUA’s additional expenses imposed by the stabilization-liquidation plan.(In no small part because the agency spent $1 billion on outside attorneys, something in itself that drew some congressional attention.)

Flouting the Federal Credit Union Act

Credit unions’ TCCUSF assessments were to fund the stabilization plan not the SIF. The board has diverted the recoveries from their legally authorized use to an entirely new role.

This diversion from credit unions’ use is substantial. The average credit union’s asset size is $244 million at midyear. That $2.4 billion in estimated surplus converts to 22 basis points per $1,000 of insured savings. The refund due the average credit union would be more than $500,000. These amounts are significant for every credit union, no matter their size.

For credit unions trying to help members whose homes were damaged or destroyed by hurricanes or lost to the California fires, this injection of capital would accelerate special relief efforts beyond what normal budgets would allow. From other credit unions’ comment letters, these funds would support financial wellness programs, data analytics innovation, and improve member returns.

Instead of helping credit unions better serve members, the bulk of these recoveries will now sit idle in overnight accounts at the U.S. Treasury, waiting only to be spent by the NCUA on itself.

Instead of helping credit unions better serve members, the bulk of these recoveries will now sit idle in overnight accounts at the U.S. Treasury, waiting only to be spent by the NCUA on itself.

What’s Normal About This Operating Level?

The NCUA’s reasons for increasing the Normal Operating Level of the SIF through this diversion are not only unsubstantiated; this precedent also opens a Pandora’s box for future boards to set the level wherever and whenever they alone determine is appropriate.

1. The NCUA says its models show the need for a 1.33% NOL. On Oct. 12, I contacted the NCUA directly and via FOIA asked for the estimates and assumptions that affect model output used for this decision. I also pointed out this should be readily available since the models had just been run for the board meeting. Their response: Your request necessitates additional time to consult among multiple NCUA components with a substantial subject matter interest consequently our anticipated response time is by Nov. 27, 2017. So much for transparency. The NCUA wants credit unions to accept the output, but not see the input which drives the decision.
2. The NCUA’s action in raising the Normal Operating Level of the SIF via retaining credit union premiums assessed under a different authority is contrary to the express requirements of the share insurance fund’s enabling statute. The increase of the NOL above 1.3% by premiums is prohibited by law. The increase above 1.3% can only be done through retaining the earnings of the fund itself.

The NCUA is seizing these rebates because it does not want to assess credit unions directly a premium which is permissible at the fund’s current level of 1.26%.

The board does not want to make the case nor acknowledge the plain fact that any concerns about the fund’s financial trends are not due to credit union losses, but rather the ever-increasing transfer of the NCUA’s operating expenses to the fund via the overhead transfer process.

Today more than 90% of the fund’s income is used to pay the NCUA’s operating expenses before any loss reserves or addition to retained earnings. The eight-year compounded expense growth of over 11% was primarily due to the agency’s raising the Overhead Transfer Rate (OTR) from 52% in 2008 to 73.1% in 2016, thus eroding the financial resources in the fund for its primary purpose of resolving problems at credit unions.

The NCUA wants to withhold another $400 million from credit union members for a contingency that auditors state has not existed for years, and even the NCUA’s own models say could not occur.

The NCUA says its modeling shows a new fund cap of 1.33% is necessary after fully considering the experiences of the last crisis. Three basis points on top of the existing cap of 1.30% is a 2% change to a new maximum NOL capital level. How can a 2% increase be meaningful in any severely adverse crisis let alone justify seizing members’ funds, circumvention of the law, and the board’s inability to control its own budgets?

The additional basis points that the board wants to add on top of this new NOL cap of 1.33% are similarly unfounded.

The hold-back of 4 basis points to cover the SIF’s guarantee is refuted by both the TCCUSF’s most recent audits and the NCUA’s own modeling.

In the 2016 audit, footnote 8 states: The TCCUSF recorded no contingent liabilities on the TCCUSF’s balance sheet as of Dec. 31, 2016 and 2015. In other words, there’s no probable losses from the guaranteed notes, and thus no reason to retain credit unions’ money over it.

The NCUA’s own modeling of the contingent liability reported on page 19 of the July board action memorandum aso shows that even in the severely adverse (or worst-case) scenario there would be a $500 million positive cash flow from the securities. Yet the NCUA wants to withhold another $400 million from credit union members for a contingency that has not existed for years, and even the NCUA’s own models say could not occur! This $400 million holdback is a flawed if not fraudulent rationale.

The NCUA wants to withhold another $400 million from credit union members for a contingency that has not existed for years, and even the NCUA’s own models say could not occur! This $400 million holdback is a flawed if not fraudulent rationale.

A Rainy-Day Fund That’s Turned To Slush

This latest diversion of the funds and the manipulation of hypothetical and unverifiable models repeats patterns of behavior that have become common during the corporate credit union crisis.

This new NOL manipulation is contrary to statute and it follows the clear pattern of the board’s exploitation of the Overhead Transfer Rate process to cover the agency’s ever-increasing budgets to avoid going to federal credit unions to raise the operating fee.

The OTR increase from 52% in 2008 to 73.1% (2016) resulted in the annual operating expenses paid by the SIF growing from $79.4 million to $203 million. This increase equaled the growth in the agency’s annual expenditures between 2008 and 2016.

The cavalier way the NOL is now being raised to retain as much of the TCCUSF credit union rebates as possible, opens a new opportunity for the agency to keep future funds rightly due credit unions. Instead of dividends to the fund’s owners when times are good, and fund equity above 1.3%, the agency will just promulgate a new NOL requirement because we have to put aside more money for the inevitable rainy day.

These future NOL adjustments will have precedent, but not verifiability. It will be just another arbitrary board decision without objective documentation. There will be no way to audit a process or validate outcomes absent the underlying assumptions and estimates.

This hoarding of more credit union funds reflects a complete misunderstanding of the financial options, the flexibility, and the unique design of the National Credit Union Share Insurance Fund.

This hoarding of more credit union funds reflects a complete misunderstanding of the financial options, the flexibility, and the unique design of the National Credit Union Share Insurance Fund. The fund’s structure was developed with credit unions, using both credit union experiences and the cooperative financial model. The banks’ premium-based model hadn’t worked for co-ops, so the industry created a solution that fit credit unions.

These unique features included the credit union commitment to increase the fund’s size commensurate with increased risk with the 1% deposit structure. The deposit always covers 80% of the growth of insured risk (1.00/1.25). Therefore, fund earnings on the total asset base need cover only 20% of the increase of insured risk; the balance of income could be used for resolving problem situations. This process contrasts with the premium-based FDIC in which premiums plus earnings must cover 100% of the growth in insured risk to maintain an acceptable fund ratio.

The resolution options for the credit unions, without private ownership, are much broader than with FDIC-insured, for-profit banking firms. Credit union insurance resolution options include injecting capital into troubled institutions, authorizing guarantee accounts, the ability to borrow from a liquidity fund, or guaranteeing direct borrowings by credit unions.

In return for this open-ended commitment to regularly funding the 1% deposit, credit unions requested safeguards due to concerns that sending money to the government would just result in its being spent.

The setting of the NOL with a range of 1.2% to 1.3% (versus a single target ratio) was one of those guardrails, as was the legal requirement to increase the NOL above 1.3% only through retained earnings. The 10-basis point (1.2-1.3) range in NOL today amounts to almost $1 billion in capital flexibility. This amount grows as insured risk increases, thus providing proportionate funding for economic downturns, even before the necessity of premiums.

The 1% deposit is important in one other critical way beyond its financing role. Without this deposit structure, or if the 1% would cease to be an asset on the books of credit unions, there would be no logic preventing a merger of the SIF with the FDIC. The insurance coverages are identical, and it would be reasonable for Congress to ask why there are two separate pools doing the same job. This was how the FSLIC was merged after the savings and loan crisis of the 1980s.

Board chair Mark McWatters and board member Rick Metsger said credit unions really didn’t understand the issues, when in fact, credit unions see clearly their funds have been taken away, again.

A Leadership Default

What we’ve seen from the NCUA board is a failure to thoroughly consider the self-interested staff proposals. In subsequent press comments both board members have been defensive, even condescending to the experiences and logic credit unions presented in their comments. Board chair Mark McWatters and board member Rick Metsger also said credit unions really didn’t understand the issues, when in fact, credit unions see clearly their funds have been taken away, again.

Hoarding $2 billion of credit union rebates in the SIF was not due to some future risk that only prescient models contracted by NCUA could predict. Rather the real risk was having to follow the requirements of the law to take credit union funds. That would entail presenting a case for a premium in a public meeting, documenting the case for a higher NOL, and then managing the fund to grow its reserves to this new level just as credit unions grow their reserves today.

Rather than follow this statutorily prescribed path, especially the requirement to raise the NOL above 1.3% via retained earnings, the board seized credit union monies assessed for one purpose and diverted it to a separate NCUA purpose.

This circumvention to hold back credit union money is a fundamental failure of leadership. The board took the easy way out, creating a foundation for future decisions built on sand not the bedrock of passion and commitment to a unique cooperative system. In the words of one commenter, the board’s action was too clever by half.

The NCUA has now sequestered enough money that tough decisions about future staffing levels and program effectiveness will not have to be made. There will be no need to reassess $25 million data system projects. No need to worry about examiner or supervisory performance. No need for special premiums because the finances are in hand to spend their way out of any trouble spots. Most importantly, no need to reduce budgets even after closing 40% of the regional offices.

The staff understands the political realities that drove the board’s decision. The NCUA has now sequestered enough money that tough decisions about future staffing levels and program effectiveness will not have to be made. There will be no need to reassess $25 million data system projects. No need to worry about examiner or supervisory performance. No need for special premiums because the finances are in hand to spend their way out of any trouble spots. Most importantly, no need to reduce budgets even after closing 40% of the regional offices.

Credit unions have succeeded because they have leaders who believe that purpose is about more than financial performance. It means putting member-owner interest’s first. The potential of cooperative design can be contagious and empowering. Or it can be perverted when those in charge put their interests ahead of member-owners.

In previous decades the NCUA provided collaborative solutions that strengthened the system and added options for all to use in the event of economic downturns. It will be heartening when NCUA leadership can once again affirm this cooperative capability and work for common purpose, not institutional self-interest. It looks like that day is still to come.