The Jan. 1 merger of Progressive Credit Union ($382.8M, New York, NY) into Pentagon Federal Credit Union ($24.1B, McLean, VA) was billed as an emergency takeover caused by capital and concentration risk problems at the troubled taxi cab medallion lender, the last of its kind.

But the merger also underscored the NCUA’s overarching willingness to wash its hands of that segment of lending after three decades of increasingly strident attacks. In fact, it was the third such action in just a few months, following the liquidations in October of LOMTO Federal Credit Union ($156.2M, Woodside, NY) and in September of Melrose Credit Union ($1.1B, Briarwood, NY).

Press reports repeated the press release explanations that these troubled taxi lenders needed to vanish because of the risk they posed and for the good of their members. Elsewhere, the Pentagon takeover of Progressive sparked banker outcry against PenFed’s open charter, citing concerns about unlimited credit union membership.

But there is more to be learned from this event than the predictable positions of the participants and observers. I believe there are at least three takeaways that anyone concerned about the future of the cooperative model should consider.

Every credit union will have to confront the NCUA’s taxi medallion solution at some point. Waiting without action until the moment arrives only ensures there will be a time when the bell will ring for thee.

Takeaway 1: Diversify Or Die. Myth Or Fact?

Progressive’s balance sheet was heavily concentrated (75% or more) in taxi medallion lending. The loans were conservatively underwritten with loan-to-value ratios that averaged 50-60%. This was supported by a peak net worth ratio in excess of 40% and ROA that hovered between 2-3%. Medallion loans were disbursed among different cities and regulatory environments including Boston, Chicago, and Philadelphia.

But New York City was home to the majority of Progressive’s loans. NCUA board member Rick Metsger in a December 2017 speech cited NCUA letters in 2010 and 2014 warning of concentration risk.

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We have known about this risk for some time and … unfortunately a lot of credit unions will have to pay for losses incurred by a small number of credit unions that gambled on a market that was disrupted and a bubble that burst, he said, adding that the regulator might need to increase loss reserves as taxi medallions continue to decline in value.

But the NCUA’s taxi medallion letter of 2014 made no mention of any potential disruptive event (see page 4, What Affects the Value of Taxi Medallions?). Rather, it stressed broadened underwriting requirements that NCUA examiners presumably oversaw for the next three years before the steep decline in medallion values in 2017.

Predicting the future of the taxi medallion business versus ride-sharing companies is now commonplace. Numerous firms are making business decisions based on their assessments. One hedge fund has bought more than 300 New York medallions at foreclosure sales because, at its core, the medallion is a license to run a business and create revenue. Many forms of secured lending such as first home mortgages and auto lending do not result in a revenue opportunity if the collateral is taken. In these cases, resale is the only option.

Takeaway 2: Niche Versus Concentration

Is concentration risk really the root of the problem? Almost every credit union has created a business niche that could be labeled a concentration. Sometimes this is a product emphasis such as medallion lending, first mortgage lending, indirect auto lending, or credit cards.

Almost every credit union has created a business niche that could be labeled a concentration. Sometimes this is a product emphasis such as medallion lending, first mortgage lending, indirect auto lending, or credit cards.

For example, for the top 100 credit unions in first mortgage dependency, the average first mortgage loan concentration is 82%; for auto lending, the top 100 average concentration is 92%. Niches are a common business strategy.

Almost all credit unions started with an employer or association niche that constitutes member concentration. Three decades ago, more than 20 credit unions focused on IBM work sites (IBM had never laid off an employee) and International Harvester had 27 credit unions serving its plants, offices, and subsidiaries such as Wisconsin Steel. Today there are no purely IBM credit unions and International Harvester no long exists.

Geographic or multi-common bond expansions replaced the concentration of a single employer or industry. However, few credit unions are now so diverse that they are not at times impacted by regional economic or other catastrophic events. Hurricanes, floods, and fires are the obvious examples.

The current government shutdown shows the disruption possible for what is generally viewed as one of the most stable sources of employment and members in the U.S. economy.

Other forms of business concentration include large credit unions that deploy few or no manned branches to credit unions that invest in branch footprints as their primary form of market presence, even in a digital era.

Invoking concentration risk as the cause of failure is a sop. Virtually every credit union depends on some market, product or business niche, or even prior investment decisions as the way it competes for member loyalty.

No credit union can escape the cycles of economic change, technology and product disruption, geographic favorability (Rust Belt versus Sun Belt), the ever-changing configuration of competitors, and even politically driven events.

The problem is not about concentration; it’s about how an organization responds to changes in opportunities and challenges to its members and in its immediate market. These transitions take time, patience, and capable leaders who can build on still-relevant strengths while resolving specific value disruptions from whatever source.

As one commentator observed: We are corrupted by the impatience that drives our pursuit of safety and success. We don’t just want these outcomes. We want them immediately.

Cooperative patience, because of the absence of market pressure on stock price, should be a fundamental advantage when credit unions are faced with the need for financial transformation.

Takeaway 3: Liquidity, Capital, And Regulatory Abdication

Announcements from both Progressive and Pentagon singled out Pentagon as the leading choice to provide Progressive the liquidity and capital needed to provide stability and support to its members.

These two factors are present in any problem financial institution. That’s why credit unions designed a cooperative liquidity solution in the Central Liquidity Fund with explicit authority to assist its members in changing economic circumstances. The National Credit Union Share Insurance Fund, by both statute and decades of practice, has provided capital for credit unions to resolve difficult financial and economic challenges.

But if there is no will or ability to use these system capabilities, then either failure or outsourcing to a credit union via merger to oversee the financial turnaround becomes standard operating procedure.

Further, liquidation as a regulatory solution will always bring fire sale prices to asset values. Mergers, especially with larger firms, can result in a loss of market reputation (goodwill) and experience that enabled the creation of competitive value in the first place.

This abdication of the NCUA’s problem-resolution resources is an especially critical lesson. The cooperative system mobilized options so it need not be indifferent to the failure of any institution because in the end, it is members, not the institution, that suffers.

Rather than work through the challenges and problems of a troubled credit union, NCUA’s standard procedure is to run from them.

On April 16, 2018 Progressive’s CEO, Robert Familant, published an opinion article in theCredit Union Journaltitled Taxi Medallion Exec: Don’t Rule Cabs Or Us Out Yet. Nine months later, Progressive chose to merge when it still reported more than 11% net worth ($40 million) and total capital of more than 50% for its $300 million medallion portfolio.

Each member’s pro rata share of net worth was more than $13,000 of common wealth created over 100 years and 172 days. It is now lost to their control.

The effectiveness of NCUA oversight should be a major concern for every credit union because it is credit union members that pay all the bills. In 2018, resolution expenses totaled more than $1.5 billion on top of the NCUA’s $300 million operating budget. Rather than work through the challenges and problems of a troubled credit union, NCUA’s standard procedure is to run from them. The NCUA’s approach has been promotional and/or defensive instead of effective in the creative use of cooperative resources.

Not My Problem? It Is Your Problem!

A CEO might ask, Why should I care?

After all, on the face, how the NCUA handles problems, particularly regional ones, costs members only a few basis points of capital or income.

But how cooperatives resolve institutional problems via the regulator tells them who they are and who they will become. Cooperative leaders unwittingly give creditability to regulatory actions when they keep quiet.

It’s easy to copy the competition. It’s easy to copy the regulatory models of oversight that were created for the for-profit sector. But the cooperative system should be where leaders push one other to be better, to raise both member and collective outcomes, and to encourage new designs for cooperative success.

There have been instances when the public-private regulatory partnerships of credit unions, enabled by legislation and then successfully implemented, helped position the cooperative model to new levels of success.

But that’s not the practice today. The liquidation of credit unions serving the taxi medallion business perpetuates a myth that the system will prosper by just doing away with a few bad eggs. Every credit union will have to confront the NCUA’s taxi medallion solution at some point. Waiting without action until the moment arrives only ensures there will be a time when the bell will ring for thee.

Progressive’s Former Treasurer/CEO Responds

In a letter to CreditUnions.com, Progressive’s former treasurer/CEO Robert Familant offers his side of the merger story.