In response to Frank Diekmann’s column in the July 21 issue, the new sheriff, Michael Fryzel, needs to clean up Dodge City and, as Mr. Diekmann implied, his own deputies. The NCUA became complacent and turned its focus away from safety and soundness to a myriad of other things, including The Office of Small Credit Union Initiatives, Access Across America and the Bank Secrecy Act. In the meantime the examination process failed to detect and prevent credit union failures, prompt corrective action failed and the problem resolution process turned problem credit unions into disasters.
Credit unions need to change as well. Boards of directors failed to hold management accountable. Boards have allowed management to add dangerous levels of risk to the balance sheet or failed to assure the credit union was meeting member needs. I suggest that Mr. Fryzel address the following areas, beginning with NCUA.
The Regulator Issues
1) The examination process is flawed and needs to be changed. NCUA requires that credit unions follow Generally Accepted Accounting Standards (GAAP) to assure that the financial statements and call reports are fairly stated, consistent with prior years and accurately represent the financial condition of the credit union.
NCUA needs to follow generally accepted auditing standards to determine whether the credit union has an adequate and functioning system of internal controls to assure that the financial statements and call report data are accurate and that the credit union can control the risks it has assumed. The examination process is not based on sound auditing principles and in most cases is not adequate to assess the internal control system. The CPA firms have all realized that internal control evaluation is the key to their opinion audits and they have in the last two years changed their audit standards. NCUA must do the same.
2) The problem-resolution process is flawed. When NCUA does determine a credit union has problems, there does not seem to be an organized process that assures that prompt corrective action is taken to preserve the remaining capital, to remove the failed leadership and to place the credit union under competent conservatorship. I define prompt corrective action as a process that leads to conservatorship when a credit union is either insolvent or will likely become insolvent within the next 12 months. NCUA does not appear to have a process for determining whether a credit union is likely to become insolvent.
I have been involved in a number of problem credit union cases and have never seen any evidence that NCUA has any reasonable means of determining future insolvency. NCUA disposes of problems by directing the credit to seek a merger within a specified period of time. In many cases the CU is so severely impaired that merger partners are difficult to find. The due-diligence process used by nearly every prospective merger partner determines whether or not the credit union is or will be insolvent and forms the basis for making a merger decision. NCUA could develop a similar process.
3) When NCUA does take over a credit union it often makes the situation worse because the agency does not appear to have experts that are qualified to manage a credit union. At Cal State 9 the credit union funded its second mortgage program with high-rate CDs. After NCUA took over the credit union because of the huge losses caused by the second mortgage program, they continued issuing high rate CDs. Those CDs in my opinion, increased the level of risk in the CU.
4) The bidding process for failed CUs raises the costs to the insurance fund. NCUA often limits the number of bidders for a failed credit union. The NCUA appears to exclude willing bidders. Banks need not apply. In the case of Nolarco, the NCUA excluded a large, well-run Texas credit union from bidding. In the case of Sterlent CU, the NCUA assigned the credit union to Patelco without any bids that I am aware of. It is a basic tenet of economics that when you restrict the number of bidders you lower the price for failed credit unions and increase the loss to the insurance fund. A closed bidding process also conveniently distracts attention from credit union failures and any faults in the regulatory process.
The Credit Union Issues
1) Credit Union governance is not working as it should. All of the credit union failures in our area (Sterlent, Cal State 9, Kaiperm, Capital Power) and many of those that have yet to happen have a history of mismanagement and not meeting member needs. In the banking world management is held accountable by stockholders who have an ownership interest in the corporation. The price of the company stock is a barometer of management performance and is influenced by how well the company is performing financially which is ultimately a reflection of how well it is serving its customers.
2) Credit union members don’t have an ownership interest and therefore are not holding management or the board accountable for the credit union’s performance. Members today vote with their feet and close their account and move to another institution. Most board members are appointed by the nominating committee and, being unopposed, are seated without a vote of the members. Boards and management have a vested interest in perpetuating the status quo. Thousands of credit unions should be consolidating. The only impetus for consolidation in credit unions is regulatory fiat or financial distress. The Continental/Wings merger proposal raised a hue and cry about protecting member ownership of the credit union.
Members don’t own the credit union; they have no right to the capital unless the credit union liquidates. We rarely see liquidations except at the time of financial failure when there is no capital left. The Continental/Wings credit union flap said more about protecting the board and management than it did about protecting the members. By most accounts Continental Credit Union failed to provide its members competitive services for years. What is needed is a way to create member ownership of credit unions and give members an incentive to hold their boards and management accountable.
3) Credit union cooperation is big multiplier of credit union effectiveness and the ability to serve members. Consolidation through mergers won’t solve our problems. Credit Unions need to gain economies of scale and mergers will give us scale. But the lesson of the Savings and Loan industry is that mergers are as likely to produce WaMu’s as they are to produce Wells Fargos. Credit unions should have clear authority to develop franchises similar to the ACE hardware model. Credit Unions could then develop a common brand like ACE Hardware and centralize and share support functions like data processing, marketing, purchasing, facilities, call centers and others.
I wish the new sheriff all the luck. His future is our future. Good regulation is a key ingredient to credit union success. The failure of IndyMac has increased our member’s awareness of safety and soundness and the importance of share insurance. If NCUA is weak, then credit unions will have a difficult time gaining market share in an era when safety and soundness is of such importance to the member.
Henry Wirz, CEO
SAFE Credit Union, North Highlands, Calif. (c) 2008 The Credit Union Journal and SourceMedia, Inc. All Rights Reserved. http://www.cujournal.com http://www.sourcemedia.com