What should credit unions do when the regulator who makes the rules, does not follow its own rules?
Yesterday the consumer price increase for calendar 2021 was reported as 7%, the highest in 40 years. This was not a surprise. Concern about increasing inflation and the Fed’s response had been growing since the summer of 2021.
Interest rate risk is not a new topic. NCUA first proposed adding an S for sensitivity to the CAMEL rating in 2016. In October 2021, the board approved a rule adding this “S” with Chairman Harper saying:
The NCUA’s adoption of the CAMELS system is good public policy and long overdue. Separating the liquidity and market sensitivity components will allow the NCUA to better monitor these risks within the credit union system, better communicate specific concerns to individual credit unions, and better allocate resources.
The agency’s description of interest rate risk was straight forward:
The sensitivity to market risk reflects the exposure of a credit union’s current and prospective earnings level and economic capital position arising from changes in market prices and the general level of interest rates. Effective risk management programs include comprehensive interest rate risk policies, appropriate and identifiable risk limits, clearly defined risk mitigation strategies, and a suitable governance framework.
Ignoring its Own Rules
However Just six days prior to this, those responsible for managing the NCUSIF’s portfolio invested $1.0 billion (5% of the portfolio) at an average weighted life of 5.95 years and yield of 1.19%.
These investments actually extended the portfolio’s overall maturity from the month before.
This was a continuation of the robotic process the NCUSIF investment committee had followed since market rates had fallen to near zero in 2020.
In December 2020 question were raised about these investment decisions: What Is NCUSIF’s IRR Investment Policy? Is this a Gap in NCUA Board Oversight? The article pointed out NCUSIF’s most recent investments included a 7-year fixed rate yielding only .45%. Would any reasonable person make this investment at this point in the cycle of historically low rates?
In August 2021, the NCUSIF continued its market tone-deaf investing by placing $1.2 billion at an average weighted yield of .943% and life of 5.7 years. The analysis pointed out that these decisions were hurting credit unions. One immediate decision that month cost credit unions $4.2 million in foregone revenue over the next 7 years before it matures.
At the same time, credit unions in contrast, reported keeping 53% of their record level of investments in overnight funds.
Who Makes These Decisions?
The NCUSIF has an investment committee of four people including the Chief Financial Officer, the Director of E &I, the chief economist and the head of the Capital and Credit Markets division.
NCUA preaches interest rate management, but does not practice it. One doesn’t have to run a stress test to see the devastating results of these recent decisions. The NCUSIF’s monthly data documents the decline in portfolio value as rates began rising over the past 12 months.
In September 2020, the $17 billion NCUSIF reported a market gain of $586 million. In October 2021, the latest report available, this had fallen by 97%, to just $16.2 million on a portfolio $20.3 billion. Large portions of the most recent investments are now worth less than their purchase price. These low yields will hurt the NCUSIF’s performance for years to come.
Who Is Responsible for this Performance Failure?
The NCUA board receives a monthly report on the NCUSIF and a quarterly in-person update.
In questions about investments as recently as December’s meeting, staff’s response is they are just following Board policy. In the September’s 2021 board meeting the CFO agreed to make public this investment policy. It didn’t happen. Several meetings later, he explained the policy was under review and would not be released until that was completed-at some indefinite time in the future.
The Board unanimously approved the new interest rate sensitivity rule in October 2021, which was first published in March. It receives the monthly report showing the robotic investment activity and steadily falling portfolio values. The board’s words and deeds are far apart when it comes to IRR.
The Costs to Credit Unions and NCUA
When the agency’s highest professionals show an inability to manage the agency’s largest asset, the $20 billion NCUSIF, in accordance with its own rules on interest rate sensitivity, fundamental questions are raised.
Are senior staff competent for this task? Are these investments what the Board really intends with policy? Is no one in the agency, staff or board, able to see the damage this causes to the fund’s revenue and its financial soundness?
Good judgement comes from experience. And experience? That comes from bad judgement. How many more bad judgements does the board need?
More than the NCUSIF’s future is at stake, as important as that is. This year-long example of failure to respond to the changing economic conditions in managing the funds, begs the question: Is the agency capable of overseeing this issue in credit unions? The IRR monitoring of the NCUSIF is simple. In most credit unions the issues are much more complex.
Both the NCUA board and senior staff are letting credit unions down. Sooner or later the bill for this failure will come due. A simple portfolio yield of just 2% on $21 billion is sufficient to cover the normal financial expenses in the fund. When these investment decisions lock in rates of 1% or less for 5 or 6 years, a premium may be required to pay for the damage caused by poor management.
If this failure is the outcome for the simple management of the NCUSIF’s IRR, the bigger issue is whether the agency has the grasp to properly monitor the industry through the coming rise in the interest rate cycle.
The first test will be what the leadership does about their responsibility for the NCUSIF. Will the board and senior staff continue to kick the can down the road, blind to the consequences of inaction, or make a difference now?