ACTIVE DAY AT THE NCUA BOARD – BANKS SELLING TO CREDIT UNIONS, SUBORDINATED DEBT AND CHANGES IN EXECUTIVE LEADERSHIP

Quite often the NCUA Board meetings are viewed as somewhat perfunctory in the eyes of credit unions and many credit union leaders are of the mindset that “the less action they take – the better off credit unions are.”  However, yesterday’s NCUA Board meeting was anything but routine. And it was certainly not lacking in issues of significance to credit unions.

Several very far-reaching actions were taken and, following the public board meeting, some key agency executive leadership changes were announced that could impact just how seriously NCUA is moving to implement some of the actions they took at this meeting and a number of other positive actions they have taken in recent months.  

Let’s look at the two most substantive actions taken in the public session.  And then we’ll go a bit into the changes announced in the executive ranks of the agency.

 

BANK SALES OF ASSETS AND DEPOSITS TO CREDIT UNIONS

As our Client Update earlier this week indicated, what has become classified in the media (driven by the banking association lobbyists in hopes on scoring points against the credit union tax exemption) as “credit unions buying banks” is actually banks electing to sell some or all of their assets and/or deposits to a credit union if that is the best deal for them when the bank board of directors decides it is time to sell.

All three NCUA Board members reiterated that distinction very clearly in their remarks.  They made it clear that they did not intend to take any action that was designed to close this option for credit unions as long as all laws, rules and regulations are followed and the result is a safe and sound credit union.

In particular, Chairman Hood and Board Member McWatters were quite strong in their defense of the free market principles at stake in this issue.  Even Board Member Harper, normally more of a pro-regulation rulemaker than a vocal defender of the free market, forcefully made the point that the banks have the right to sell to the buyer of their choice as long as it is done in compliance with law and the principles of safety and soundness.    

Board Member Harper, as did Chairman Hood, took a pro-consumer stand on the issue as well.  Both emphasized that a community bank selling to another community based institution such as a credit union could very likely result in continued service to residents in many communities that might otherwise be underserved if the bank simply shuts down or sells to a huge mega-bank without an interest in remaining in the community.

For those who feared that the NCUA Board might have succumbed to recent questioning from banker-driven congressmen at a series of recent hearings and begin to pull back on their heretofore balanced approach that followed what the law allows and did not try to pick winners and losers, this meeting was a refreshing bit of good news.  

There was nothing in their proposed rule on purchasing bank assets by credit unions that gave an indication of a sea change in the NCUA approach to these transactions.

They held firm and, essentially, just codified their current processes that they follow when a bank sells its assets and/or deposits to a credit union.  

They reaffirmed the field of membership requirements that are always a factor in these transactions.  They made clear that the difference in deposit insurance requirements had to be met to allow any deposits to transfer from FDIC to NCUSIF insurance.

Frankly, the proposed rule is a very good capsulation of the process involved in a purchase of bank assets and/or deposits by a credit union.

There was very little new added other than a prohibition against credit union directors making any profit from the purchase of the bank’s assets – hardly a problem in almost any conceivable bank deal, but still a provision worth having in the rule.

A link to the proposed rule regarding purchase of bank assets and assumption of bank liabilities is provided below.  The proposed rule is out for a sixty-day comment period.  

Most credit unions will probably never seriously consider purchasing assets or deposits from a bank.  It is not a fit for all or even most credit unions.

However, because there are so many inherent restrictions of credit union growth (restricted FOMs, capital restraints, MBL limitations, usury caps) in the current law and regulations, it is not good for credit unions to lose any growth and diversification options that are now in place.

NCUA needs to hear from credit unions supporting their approach to the ability to purchase bank assets and/or deposits.  The comment letter instructions are included in the link.  

https://www.ncua.gov/files/agenda-items/AG20200123Item3b.pdf

 

SUBORDINATED DEBT, OR SUPPLEMENTAL CAPITAL, IS FORMALIZED INTO A PROPOSED RULE

For ten years I have given a presentation at conferences and planning sessions called “2020 Vision – Where Credit Unions Will Be in 2020.”

While I missed on a few predictions (such as the banking lobbyists becoming less driven by fighting credit unions as the number of community banks fell and the influence of the larger mega-banks began to drive the bank trade associations), I have been citing my belief that by 2020 credit unions would have access to supplemental capital with a NCUA approved set of guidelines of how to do so.

Well, even though it may not become a final rule and implemented until 2021, the NCUA Board yesterday approved a comprehensive proposal that would allow over half of all credit unions to enter the capital markets through offering subordinated debt instruments that can count as either Tier 1 (PCA capital) net worth or Tier 2 (regulatory capital counting towards the Risk-Based Capital or RBC requirements) capital. 

For low-income designated credit unions regardless of their size, they are authorized to issue subordinated debt or supplemental capital instruments and can count them as net worth to qualify as well-capitalized under the Prompt Corrective Action (PCA) statute and regulation.  This is generally referred to in most financial service industry standards as Tier 1 capital (retained earnings).

There are over 2600 low-income designated credit unions currently.  These are credit unions that have been validated to have over 50% of their membership residing in low-income census tracts or otherwise qualified as low-income.  

For complex credit unions (which is defined as credit unions with over $500 million in assets and therefore subject to the RBC requirements of over 10% capital versus risk-weighted assets), they are authorized to issue subordinated debt or supplemental capital instruments and can count them as regulatory capital toward their RBC requirements.  This is generally referred to in most financial service industry standards as Tier 2 capital.  

There are approximately 280 complex credit unions that are not already qualified for subordinated debt as being low-income designated.  

So, this proposed rule will allow between 2800 and 2900 of the total 5200 credit unions to have access to the option of supplemental capital through subordinated debt.

Allowing credit unions access to the capital markets is huge.  It could be a game changer for credit unions having access to the capital needed to stimulate and maintain growth, enhance lending, expand services, invest in technology – all of the things needed to better compete in today’s marketplace.

And, because of its potential positive impact for credit unions, the bankers will come after it with everything they have in their arsenal.

I have a new 2020 prediction.  The ABA and ICBA will begin to shift their obsession about credit unions away from field of membership where they keep losing after spending millions in fruitless legal battles and more toward fighting to keep credit unions out of the capital markets.

Their opposition to supplemental capital, subordinated debt, or secondary capital (whatever its supporters and opponents choose to call it) will be fierce and unrelenting.

They know this is a game changer if credit unions are able to go into the capital markets to raise the funds for investment in enhanced service without having to directly hit their retained earnings and risk falling below the 7% net worth requirement prescribed in the law.

Prepare for a major battle.  And it will begin with the comment period which, for this important rule, has been extended from the normal 60 days to 120 days.  All credit unions should be heard on the issue, even if you do not foresee the possibility of issuing subordinated debt.

Again, credit unions need to have all the options for growth that the law allows.  And the law allows for credit unions to borrow from multiple source – including their members and non-members.

Subordinated debt is a borrowing.  Credit unions are authorized to borrow from any source.  Therefore, subordinated debt is legal.

Yes, it will have to meet GAAP requirements.  It will have an extended term (5 to 20 years in the proposed rule).  It will be uninsured (which must be clearly and fully disclosed).  

It will be subordinated to all other debts of the credit union in the event of the institution’s failure (the potential for loss of the entire principal is there).  

It will have strict notice requirements specified in the instrument itself that will specify how much in advance an investor must give the credit union before cashing it in and any penalties for doing so.  

There will be specified requirements for when the credit union can buy out the obligation.  And the instruments will not be automatically renewable.  

It will have limitations on who can borrow (members, non-members, institutional investors and accredited personal investors).  

And, yes, because of those factors it will be costly for credit unions to issue.

Strategic plans and extensive applications will be required to gain advance NCUA approval before subordinated debt can be issued.

Without question, it will be a major undertaking for credit unions who want to enter the capital markets.  But it is an option that growing credit unions in need of investment dollars, within the bounds of their own strategic plans and safety and soundness position, will want to at least have available to consider – if not now, certainly in the future.

We strongly encourage all credit unions, particularly low-income credit unions and complex credit unions (over $500 million in assets) to read this lengthy proposed rule.  

Prepare some talking points and write a comment letter.  The link below takes you to the rule in its entirety and provides the addresses for comments.  

As always, if we can assist you in the comment process, please don’t hesitate to let us know.

https://www.ncua.gov/files/agenda-items/AG20200123Item4b.pdf

 

EXECUTIVE CHANGES ANNOUNCED AT NCUA INDICATE MAJOR CHANGES IN AGENCY LEADERSHIP AND PERHAPS DIRECTION

Now, for a little perspective on the making of policy and the implementation of policy at a federal agency.

From my experience at NCUA, it matters as much what approach the staff takes in implementing (or failing to implement them fully) a rule passed by the NCUA Board as it does what is in the rule.

We can give numerous examples of board enacted alternatives in the field of membership arena that, when a credit union applies to take advantage of, NCUA has determined that the alternative was not clear enough to apply in that particular case.

And any credit union that has applied for supplemental capital under the current NCUA process that is being fleshed out more completely in this proposed rule knows that the right to submit an application does not mean that the odds are good for approval.  Our guess would be that 90% of the supplemental capital plans that have been submitted to NCUA over the past five years by low-income designated credit unions have been denied or deferred to the point of effective denial.  

If this subordinated debt rule is not followed by solid guidance to the executive leadership at NCUA that the Board wants to see it implemented effectively and efficiently, this new rule will be a major disappointment.

So, knowing this, it is key to the implementation of any rule passed by the NCUA Board that NCUA staff make its availability to credit unions – without unnecessary burden and hurdles – a priority.  And the most influential leaders impacting the NCUA staff and those that set the direction of the examiners, analysts and implementation staff are the senior career executives at the agency.

The executive director, general counsel, director of examination and insurance, director of credit union resources/expansion and the three regional directors are the folks who make things happen – or not – at NCUA.

Yes, the NCUA Board sets policy.  But the Board does not implement policy.  They select the executives that do. And, frankly, many of those have been at NCUA for ten, twenty and sometimes thirty years watching NCUA Boards come and go.

They know how to work around the policies and slow walk decisions on implementing the policies they cannot get around.  They are truly the NCUA as far as credit unions are concerned.

The NCUA Board, and particularly the NCUA Chairman who is charged in the delegation of authority with the responsibility to supervise the executive staff on behalf of the Board, can have impact on the approach these senior career executives take on a day-to-day basis as they implement the rules, regulations, interpretations and policies of the agency.  

But the NCUA Chairman as designated supervisor over the senior staff must choose to exert that influence and have that impact.  It requires constant and vigilant oversight, monitoring and accountability of the senior leadership team at NCUA to ensure that the Board is directing the agency’s approach – rather than the staff supplanting the Board’s approach with their own.

With that background in mind, perhaps the most potentially significant action taken at NCUA yesterday was not the two very far-reaching proposed rules that we covered earlier in this Client Update.

Those two rules, if and when they become final regulations subject to implementation, will be nothing but window dressing if the executive leadership at NCUA does not show a willingness to implement them as passed.

It matters not if there is a rule allowing the purchase of bank assets and/or deposits by a credit union if the regional directors, general counsel and the office of examination and insurance begin slow walking the approvals of banks selling to credit unions due to paralysis analysis, constant requests for additional data and a predisposition to find a way to prevent the purchase – rather than to facilitate it as the law and regulation allow.  A few months delay in implementation can make the difference in a successful purchase or one that is lost to another bidder.

And certainly the most thorough and best documented subordinated debt or supplemental capital application submitted by a credit union for NCUA approval is little more than wasted work if the regional office or the office of examination and insurance constantly find it lacking just a few more figures and needing answers to a handful of additional questions.  After months and months of non-decision making, any capital market quotes will be outdated, and the entire application must be resubmitted.

In other words, the permanent executive team at NCUA will make or break these new regulations just as they do the field of membership rules, the member business lending rules and the merger rules.  

It is essential that the implementation of NCUA rules is handled by an executive team that follows the rules and does not lower standards – yet they put forth an approach throughout the agency that emphasizes trying to find a way to get to “yes” (rather than immediately falling back to finding an excuse to go to “no”) when a credit union applies for anything under the rules and consistent with safety and soundness.

Therefore, the announcement of a new executive director, a new deputy executive director, a new regional director and a extending the term of the new acting general counsel could be the most significant action to come from NCUA recently.

Rather than spend time giving our assessment of the new executives, I prefer to call your attention to this as one of the most wide-ranging replacements and shifting of NCUA executive personnel in recent history.

And since two of those replaced executives were definitely a part of the older regime at NCUA and were replaced by individuals from the newer generation of NCUA officials, this has the potential to be a watershed moment in determining the direction of the agency in the next few years.

See the link below for an overview, from the agency’s announcement, of these new executives at NCUA.

https://www.ncua.gov/newsroom/press-release/2020/fazio-named-new-executive-director-others-named-key-positions

Larry Fazio, the new executive director, is unquestionably one of the brighter minds and more open-minded executives at NCUA.  He will be of a different generational mindset from his predecessor, Mark Treichel, a great guy who was once one of the younger, more open minds to new approaches at NCUA.  However, over time, Mark evolved into an institutionalized leader in recent years that the entire agency considers part of the “old guard” going back to a more regulatory activist era at NCUA.

John Kutchey, who I do not know as well as Larry Fazio as he came to the agency after my departure, is certainly considered by many observers to be of a new school of thought when it comes to agency approach.  Although he has been Treichel’s deputy for a number of years, there are those who believe he will bring a much more open approach to the eastern regional director position than thirty-year NCUA veteran Jane Walters did.  

Frank Kressman, the new acting general counsel, replaces Mike McKenna who was incredibly innovative back in our day but in recent years had become very banker lawsuit fearful in his interpretations and approach to the legal issues involved in regulation – particularly on field of membership.

Although Frank served under Mike, he certainly has the legal ability to expand his thinking beyond banker fear and timidity over concerns about lawsuits that might be filed.  This has resulted in very tight interpretations on a number of issues that have not even been a subject of banker lawsuits. But, if they can win by making the general counsel at NCUA so afraid of a lawsuit that he restricts credit unions rather than having to defend a more flexible approach to regulatory interpretation, the bankers often win without ever having to go to court.

Hopefully, Frank will show that he can be a strong general counsel in his own right and return to some of the earlier innovative promise that McKenna showed in his early years with the agency and in the position.

In all three of these key positions, there is definitely an opportunity for a new and more balanced approach.  A great chance exists to create a culture of finding a way to get to “yes” rather than the tendency to a default “no” or, more likely, a submission to the non-decision making answer of deferral, delay and demand for more data before an answer can be given.

I am optimistic that Fazio, Kutchey and Kressman can bring that renewed vigor into the professional leadership ranks at NCUA.  If so, we may see the very positive regulatory actions of the past year (appraisal rule, RBC re-write, non-member deposits, subordinated debt, banks selling assets to credit unions) and the even more positive court rulings on field of membership implemented into something meaningful and long lasting for credit unions.

Of course, the tendency of initial enthusiasm turning into inertia and inaction over the months and years of new office holders is very real.  

It will require this NCUA Chairman and future NCUA Chairs, supported by their Board Member colleagues, to consistently direct these executives with their expectations for policy implementation.  There will have to be constant oversight and ceaseless accountability required by the Chairman to ensure that these policies to which the board has acted favorably and with much fanfare are implemented just as fully as it was promised they would be when enacted by the Board.

If not, the deserved accolades that Chairman Hood has received for the Board actions he has ably led the three-member NCUA Board to take over the past year will fade into credit unions being disappointed that the “message from the top is just not getting down to where the rubber meets the road for credit unions.”

While it requires effort and intentionality, I know that this level of direction, oversight and accountability of NCUA executive staff can take place effectively.  We did it during my tenure and NCUA. Credit unions will tell you that the Dollar approach was not visible just at the Board level, but that it permeated the agency from analyst to examiner.  

We wish Chairman Hood the best in so establishing that level of implementation success in his NCUA.  It will determine the long-term success of his administration which, to date, has been incredibly impressive from a policy point of view.

He has accomplished more from a policy perspective in his first year than, frankly, I feel that even we did in our first year as chairman.  

But the real test is whether the policy making arm of NCUA is able to drive the policy implementing arm of the agency as it should.

Our rules changes and RegFlex approach permeated the agency.  And we held the agency leadership accountable to ensuring that it did.

Sometimes we had to bring them along kicking and screaming.  But they came along.

These newly designated executives give the chairman a great new opportunity to implement the policies he has espoused effectively with his own team leading the implementation.  But the natural tendency of regulators is to regulate, not to provide regulatory flexibility as some of the Hood initiatives have provided. He will have to manage it carefully to avoid the “we can wait him out and still do things our way” approach at a federal agency like NCUA.  

It will be interesting to watch how much friction there is when the “rubber meets the road.”

Until next time.