On July 27, 2010, more than 66 leaders of California's Inland Empire sent NCUA a letter about Arrowhead’s conservatorship. NCUA responded on August 10 with a letter reiterating previous explanations about its actions. (Click links to read the letters.)
Part 1: An Extraordinary Action
The request from community representatives and Arrowhead members for a clear commitment from NCUA to return the credit union to the members was extraordinary for two reasons.
The signers were from a remarkable cross section of community leaders, representing institutions essential to the well-being of any city: Company presidents, hospital CEOs, university presidents, attorneys, CPAs, MBAs, local council members, pastors and the mayors of three communities (Ontario, San Bernardino, and Rancho Cucamonga).
In more than 30 years of working with credit unions, including eight years as a regulator, I have never seen a document with such a diverse and widespread public statement of support for a credit union — especially one in difficulty. These are persons who have their own community responsibilities to consider and are putting their reputation on the line in this situation.
Just as important, the letter reminds us the true source of safety and soundness in any credit union cooperative is first and foremost its membership. Their loyalty, not merely their resources, is the foundation on which credit is granted and long-term common wealth created. Working together for the common good or in the face of common threat is fundamental to every credit union’s success.
It is on this foundation that every credit union is built. There is no start-up capital from investors, only sweat equity from members.
In this way, credit unions turn upside-down conventional prescriptions for business success. Their purpose is to address problems and needs traditional financial providers either could not or would not on terms in the members' interest. In other words, they become even more essential in times of economic downturns.
This incredible public demonstration of support is a testament to Arrowhead Credit Union’s fundamental soundness — a fact that cannot be learned from numbers or exam reports.
The Common Purpose
Credit unions exist for members. There is not another separate insurance fund interest or financial model ideal that says one institution is serving members and another not. For the first 75 years of credit union history, for both federal and state charters, there was no common insurance fund. The NCUSIF and other cooperative insurers were a late addition to the cooperative system’s evolution. They are the collective resources assembled to assist individual institutions when circumstances beyond their control or resources create financial difficulties.
Credit union insurance is structured with a 1% deposit not a premium system as exists in banking. These common resources are always on hand to renew and carry forward credit union capability when problems occur. Credit union regulation is unique in that all of these regenerative capabilities (chartering, supervision, liquidity, and insurance) are contained within one structure, the NCUA, which is responsible for managing the only source of the system’s collective capital, the $10 billion insurance fund.
This supportive regulatory purpose is vital to a cooperative system. With no external capital, even the Federal Credit Union Act provides a minimum period of 10 years for a new charter before traditional financial sustainability goals are required. The law recognizes only time can create capital and resolve problems.
Historically, the Agency would recognize its own examiners who started the largest number of credit unions and those credit unions that grew with outstanding savings programs. This renewing role is even more vital today when the efforts of generations of members are threatened by economic conditions.
The letter from the leaders of Arrowhead’s community have one request: Tell us how we get our credit union back. But that is the fundamental purpose of conservatorship, rather than being a halfway house to merger or liquidation.
Numbers Matter: But Common Purpose Determines Relevance
In its August 10 letter to Arrowhead’s community leaders, NCUA repeated previous general assertions with selective data to support its actions. Numbers are important for they are critical in making good judgments about appropriate actions. As shown in the notes below, there are compelling facts and data NCUA omitted, or in several instances created, to fit the circumstances.
But this is not about numbers. It’s about members and their best interests. Arrowhead is being downsized, experienced and capable staff are being removed and laid off, and loan programs are being discontinued. Instead of playing a proactive role in the Inland Empire’s economic recovery, with a long-term view to the community’s future, Arrowhead is being stripped of its ability to serve the members who founded it. The NCUA overseers and their local contractors do not live in the communities served by the credit union and will not be there to see the effects of their handiwork.
When will the NCUA give the community back its credit union back so it can be responsible for its future? That is all these writers were asking for and what NCUA did not respond to.
Part 2: Notes on Arrowhead’s Data and Financial Condition as Cited in NCUA Chairman Matz’s Letter
NCUA’s letter gives a new set of explanations for the conservatorship — no longer citing Arrowhead’s “declining financial condition” but rather “to improve operational weaknesses, correct financial misstatements, and maintain normal operations.” NCUA has not listed any operational weaknesses prior to this. Arrowhead’s management and board were certainly maintaining normal operations. This is the NCUA's fourth different rationale given since the initial action.
California's Department of Finance has not stated publically what its position was; however, members of Arrowhead’s leadership team believe DFI was closely monitoring the credit union but did not participate in the planning and execution of the conservatorship.
Arrowhead’s financial condition was stable and getting stronger monthly. Total capital is more than $70.5 million or 8.7% of assets using NCUA’s June 30 numbers. The allowance for loan losses at the same date was 280% of total delinquent loans, a percentage that is three times the national average and two-and-a-half times the California credit union average. The credit union had contracted for a CPA, an experienced auditor who has trained NCUA staff on this process, to validate its numbers. This effort was stopped. By any objective criteria, the credit union is over-reserved and will soon be able to reverse a portion of this allowance account back to the net worth component of capital.
The credit union had not only submitted but also met all of the primary goals of its net worth restoration plans. The Board and management believed prudent downsizing rather than reductions in branches, assets, staffing, and other operations was critical to maintaining the credit union’s capability to serve members and the community. NCUA disagreed with that approach and is now imposing a radical reduction in the credit union’s overall operations.
The NCUA implies that because the former management and board did not contest the conservatorship in the 10-day appeal period, they had implicitly agreed with the action or did not believe they had a strong case. It should be noted the June 25 meeting with NCUA was only with the Board and not management. The Board was told they could contest the conservatorship, and they would have to personally pay all the legal costs and NCUA had never lost one of these suits. Senior management had been put on administrative leave with no access to the credit union, records, or phones. They were kept on the payroll during this period and told, as employees, they were not to have any contact with former Board members. Once the 10-day period was over, the four senior managers’ administrative leave was cancelled, and they were terminated. The so-called appeal option is in name only; there is no due process in principal or practice.
NCUA now maintainsthe timing was to prevent Arrowhead from selling its “highest performing loans to an out-of-state institution at a steep discount that would not have represented the true value of the portfolio." This assertion completely mischaracterizes the transaction and contradicts the examination valuation estimates given by NCUA examiners to the credit union just 90 days earlier.
The so called out-of-state-institution was Alaska USA FCU, which had merged with two southern California credit unions more than a year earlier with NCUA’s blessing.
The complete transaction was to purchase four Arrowhead branches with a gain of more than $1.0 million for Arrowhead along with $75 million of various loans to support the deposit and branch operations.
Both credit unions had agreed to the loan pricing of approximately $0.96 ½ per dollar, a modest discount from the face value.
NCUA completed the branch sale as scheduled but stopped the loan sale saying that Alaska was paying too much and there should have been a lower price closer to an 8% discount.
These loans were representative of Arrowhead’s entire portfolio including kind of loan, delinquency, and FICO scores. The sale of this $75 million would have reduced Arrowhead’s loan risk pool by more than 15% — and again create an excess of capital in the allowance account.
In NCUA’s own exam report given to the credit union in March using estimates from the Agency’s Asset Management Center, the Agency’s estimate of the value of RV loans at 50% of book and MBL loans at 80% of book value. Moreover, it indicated it was unable to value the second liens. All of these loans were part of the sale portfolio NCUA now describes as Arrowhead’s “highest performing loans.” In fact, Arrowhead was getting a steep premium from the examiner’s recent estimates. Obviously, neither Alaska USA nor Arrowhead believed either of these valuation extremes were sound judgments.
The NCUA letter is correct that Arrowhead had not been making member business loans for a year, but the credit union was able to do these loans for less than $50,000 under its SBA program. Those loans have now been stopped. The other critical issue is what will happen to current lines of credit that mature. Will they be renewed?