In the January Callahan Report, Maurice Smith, a lawyer and CEO of Local Government Federal Credit Union ($1.08B, Raleigh, NC), responds to NCUA’s new rule that imposes a financial literacy test on credit union volunteers. He presents the case that NCUA’s requirement is contrary to the Federal Credit Union Act and violates the U.S. Constitution’s First Amendment on freedom of expression.
Being financially literate is one of many important attributes for a director. A more important question is whether the industry should also expect this capability from NCUA’s leadership?
Should Financial Literacy Begin at Home?
The Chairman’s Corner of NCUA’s January Report contains the following: “We completed 2010 with 28 consumer credit union failures … The costs of those credit union failures amounted to less than $300 million [presumably this includes the $170 million loss at St. Paul Croatian Credit Union, which means the combined losses of the remaining credit union failures would amount to $130 million]. However, the National Credit Union Share Insurance Fund had budgeted for losses of $750 million....”
Three paragraphs later, this statement appears: “It is important to note that NCUA does not charge credit unions for the dollars budgeted in the Insurance Fund … Credit unions are only charged for the dollars spent.”
In fact, credit unions expensed an insurance premium totaling $929.5 million and sent those funds to NCUA. These funds came out of members’ pockets and are recorded as an insurance expense on the 5300 Call Report. NCUA charged the NCUSIF a loss provision expense of $ 750 million in 2010, not the $300 million actual losses cited above.
The NCUSIF’s loss reserves at December 31, 2010 are more than $1.26 billion — four times the $300 million cash losses incurred in 2010. The NCUSIF’s loss provision is over reserved. Today, NCUA could raise every credit union with a net worth less than 7% to a well-capitalized standard from the loss provision alone, and there would still be several hundred million dollars left in the reserve.
Refusing to Disclose the Reserve Calculation
Because the funds are in the reserve versus retained earnings, they do not count in computing the 1.3% operating expense ratio cap. As a result, NCUA retains funds in excess of the operating cap by overstating the loss provision and total reserve.
Moreover, the NCUA Board made a conscious decision not to disclose the basis for its NCUSIF reserve calculation. General Counsel Robert Fenner stated as much in a Board Action Memorandum from October 2009.
“Two commentators requested the final rule include a requirement for NCUA to provide detailed information about the causes, type and amount of any NCUSIF’s expenses in connection with any assessments,” Fenner wrote. “The Board has not adopted such a requirement.”
The Biggest Misstatement of All
For a moment, let’s accept Chairman Matz’s point that credit unions should be focusing on actual losses as the critical indicator of regulatory expenses even while credit unions are expensing much larger amounts.
When NCUA shut down the existing corporate system on September 24, 2010, by taking over three more corporates and imposing a new business model via a rule on all others, the actual OTTI losses incurred by all the corporates since the financial crisis began in 2008 were $1.154 billion. The unused reserve for future losses, already expensed against corporate retained earnings, capital, and special insurance premiums for the TCGGF, was an additional $10.6 billion. Just 10% of the OTTI losses had been incurred after more than three years of these so-called toxic investments’ performance.
Even in the case of the highest estimate of losses, which resulted in WesCorp’s presentation of a 24% negative equity, the actual cash defaults had not exceeded the credit union’s prior reported retained earnings when liquidation began. WesCorp’s economic value was much greater than its accounting estimates.
If it’s actual losses that are critical, and not models projecting years into the future, then why haven’t actual losses guided NCUA decisions? Why have credit unions been expensing insurance premiums and sending cash to Washington DC when actual losses are less than 25% of existing reserves? Why was the corporate network shutdown, which forced all 7,500 credit unions to evaluate new settlements and lines of options when only 10% of actual losses had been incurred and $10.6 billion was still sitting unused in reserves?
When will NCUA return the excess NCUSIF contributions to credit unions?
These are fundamental questions about the NCUA Board’s financial literacy that affect every credit union’s 2011 budget and planning. Shouldn’t the Board be held to the same standard that NCUA’s rule imposed on unpaid volunteers, to: “have at least a working familiarity with basic finance and accounting practices, including the ability to read and understand the FCU’s balance sheet and income statement and to ask, as appropriate, substantive questions of management and the internal and external auditors ….”
What Should Credit Unions Do?
The financial literacy rule is the latest in a series of actions that show the lack of accountability in NCUA’s role as regulator. The corporate shutdown and the requirement that credit unions recapitalize a system on its way to recovery are discussed in a special Callahan Report. The Report concludes that these actions are the result of a governance failure caused by a structure that overrides all traditional checks and balances on regulatory action.
In a webinar on Wednesday, February 2, 2011, Callahan & Associates will present steps to help credit unions address these issues and explore reforms. “Expanding Credit Unions’ Role in the American Economy: Reforms to Enhance Credit Unions’ Ability to Create Shared Value,” will take place at 2 p.m. Eastern. The presentation is free to Callahan Report subscribers; for all others, the $165 fee includes the special 52-page Callahan Report on the corporate shutdown, the January edition containing Maurice Smith’s analysis of the new financial literacy rule, and a year-long subscription to the Callahan Report.