Written by Anthony Demangone
I can't remember when I stumbled upon "The Big Picture." Â But this blog has been a joy to read for the past few years. Â Written by Barry Ritzholtz, the blog shares things that would be on a Wall Street money manager's mind. Â If you are interested in Wall Street or the U.S. economy, I recommend that you add it to your reading list.
Barry recently wrote about Five Things That Surprised Him About a Career on Wall Street.Â Â It is a nice read, but I'll draw attention to "Thing No. 4."
"Get Rich Slowly: Few people have the patience to get rich slowly Ã¢ÂÂ everyone on Wall Street who ever got into trouble was impatient, and couldnÃ¢ÂÂt wait the requisite 10-20 years it took to become a millionaire. They ended up in jail or as mortgage brokers. Patience is virtue."
That really resonated with me. Â If any of you have pored over NCUA's Material Loss Reviews, you'll see that Mr. Ritzholt's advice would have been useful for those credit unions that were discussed by NCUA's Office of Inspector General. Here are some examples.
The following text comes from page 5 of NCUA's Material Loss review of U.S. Central.Â
Since 2001, U.S. Central had modest growth and a generally conservative investment strategy. However, in 2006, U.S. CentralÃ¢ÂÂs business strategy shifted towards more aggressive growth that was focused on increasing or maintaining market share of the retail corporate credit union balances by offering competitive investment products and rates. U.S. CentralÃ¢ÂÂs assets grew to $44.7 billion by December 31, 2007, an increase of 22 percent from December 31, 2005. U.S. CentralÃ¢ÂÂs growth was achieved by offering highly competitive rates to its retail corporate credit union members, encouraging these members to invest their liquid funds with U.S. Central.
U.S. CentralÃ¢ÂÂs aggressive growth strategy placed increased pressure on the credit union to produce higher levels of revenue in order to increase or maintain sufficient capital. In an effort to maintain or increase net income and continue to grow its retained earnings, U.S. Central management increased its offerings of higher yielding investments for its members to invest in, such as mortgage-backed securities. U.S. Central, in turn, significantly expanded its investments in higher yielding, higher risk subprime mortgage-backed securities, to support this growth strategy. In addition, this growth strategy negatively impacted U.S. CentralÃ¢ÂÂs defined goal of obtaining a retained earnings to Daily Average Net Assets of 2 percent due to significant losses on previously highly-rated securities. Furthermore, we believe this growth strategy and accompanying investment decisions to purchase higher yielding securities to such extraordinary levels was contradictory to U.S. CentralÃ¢ÂÂs fundamental purpose as a wholesale corporate credit union, which was serving as a secure investment option and a source of liquidity for retail corporate credit unions, and support for the not for profit credit union structure.
I'm speaking for myself now. Â I have long held the view that U.S. Central's demise was partially due to a desire to grow. Â And grow quickly. Â (Like any organizational failure, U.S. Central's demise is a complicated issue. Â Much more than I'm describing here.) Â But that "growth" decision did lead to the need for higher returns. Â Where do you get those returns? Â You know the rest of that story.
But this isn't just a U.S. Central issue.
1. Â From NCUA's Material Loss Review on Nolarco.
Examiners determined, and we agree, that as a result of Norlarco management's failure to develop policies and parameters to manage risk in pursuing loan growth, as well as the lack of an adequate strategic plan, Norlarco had escalating levels of liquidity, strategic, and credit risk that required corrective action and monitoring.
2. Â From Cal State 9.
Cal State 9 managementÃ¢ÂÂs poor strategic decisions, aggressive appetite for asset growth, and excessive concentrations of sub-prime loans, combined with the declining California real estate market, and lax internal controls, created a financial situation where institutional failure was all but assured.
Because our review found that Ensign management did not understand appropriate risk management practices or the underlying risks inherent in their growth strategies, we believe NCUA management should consider establishing a renewed emphasis on evaluating managementÃ¢ÂÂs due diligence over new or fast growing programs, as well as other areas of emphasis, with particular attention to the risk the program or area may pose to the credit unionÃ¢ÂÂs safety and soundness.
ClearstarÃ¢ÂÂs Board and management focused on growing the loan portfolio without an apparent understanding of credit and concentration risk in that portfolio. In order to accelerate growth, liberal credit policies, minimum underwriting standards, and excessive loan modifications were approved and implemented. This resulted in the Credit UnionÃ¢ÂÂs loan portfolio becoming increasingly more risky as higher risk loans were originated. A large portion of the loans originated between 2004 and 2008 were through an indirect loan program in partnership with new and used automobile and recreational vehicle (RV) dealers. The underwriting standards employed by the Credit Union allowed high loan to values (LTV) and attractive loan rates for borrowers with low Fair Isaac Corporation (FICO) scores.12 The high risk nature of the loan portfolio was generally not understood, as evident in the 2008 exam, which noted that indirect auto loans had grown to $52 million and included approximately $11 million of subprime loans.Â
As organizations, including credit unions and trade associations, go about their business, different opportunities will present themselves. Â Those opportunities could involve growth, revenue, or both. ThereÃ¢ÂÂs nothing wrong with growth strategies, per se. Â But they must be managed properly. AndÂ I'll try to recall Barry's advice when I encounter those opportunities. Â As he so wisely stated...
There's no free lunch. Â And patience is a virtue.