The NCUA’s May board meeting’s most important item was the NCUSIF update. One slide highlights why many credit unions are skeptical of the agency’s ability to evaluate its actions as circumstances change.
This slide states that the Agency’s investment policy will go back to the same 10-year ladder in effect before the current banking and liquidity crises.
Since the March 2022 Federal Reserve rate increases to counter inflation. many portfolio managers reported large declines in the market value of longer term investments.
In most cases, credit unions can choose to “wait out the cycle” rather than sell and realize an investment loss. This is because credit unions have multiple balance sheet options to ameliorate the impact on net interest income from holding assets with below market earnings.
However, over this last 18 months of rate increases, many portfolio managers have reviewed their policy assumptions that led to this illiquid situation. When cash flows again generate excess investable funds, I know of no one going back to what they were doing before this cycle began. Lessons are being learned.
This latest interest rate cycle has overturned many market assumptions drawn from the historically low rates in the post 2008-9 financial and then covid crises. One expected outcome is a higher “normal”yield curve than experienced over the past decade.
The More Things Change . . .
In the May NCUSIF update, the data show that the NCUSIF’s portfolio has a market loss in each tranche of its investment ladder. This includes even the very short term amounts under one year.
Yet, as stated in the policy above, the intent is never to have to borrow or sell at a loss. A difficult goal with ten year investments, a period which will likely experience several interest rate cycles.
The Fund’s yield for the March quarter is 1.75% or approximately 3% below the overnight rates in the same quarter.
Every 1% below market yield results in an annual revenue loss to the fund of $200 million. NCUA’s only change in its portfolio ladder strategy was announced last fall. It paused term investments until the overnights reached $4 billion. How this amount was determined was not explained. Nor its impact on overall return or weighted average life.
Below Market Returns Lasting Years
In the May meeting, no board member commented on the Fund’s below market returns and unrealized losses. Board member Hood asked how long it would take for the portfolio to return to par value if the current rate structure became the new normal. The response was three years, which is the portfolio’s current weighted average life.
Whatever the time frame for a new normal to settle in, the NCUSIF and its credit union owners are facing below market returns for many more months, if not years. The portfolio yield is the Fund’s principal, and in most years, only revenue source. The portfolio’s positioning hurts both fund performance and credit union potential dividends.
The only IRR/ALM analysis the NCUSIF provides in its monthly updates is the total portfolio gain or loss versus the current market. Since December 2021, this indicator has been negative reaching a peak of $1.8 billion in 2022. At March 2023 the valuation loss was still $1.4 billion. Why this very obvious trend did not cause an assessment of the strategy before the pause in late 2022, is not clear.
The More Things Stay the Same
So what is the staff and board changing as a result of this eighteen months of NCUSIF’s declines in portfolio value and below market yield returns?
The answer in the Slide is clear: “Once overnight target ($4.0 billion) is met, plan to return to slow buildout of (ten-yer) ladder.” No board member questioned this approach. By remaining silent, the board members consented to going back to the same practice that is leading to years of underperformance.
The Distressing Part of NCUSIF Oversight
The dilemma is more than hundreds of millions of lost annual revenue from a below par portfolio. Those numbers are large and do matter to the Fund’s soundness.
But there is a much larger challenge: no one is accountable for NCUSIF performance.
Even though CFO Schied presents the numbers he references other offices when giving specific responses: the economist for share growth estimates; E&I for the loss expense numbers using an undisclosed model; and legal for lack of clarity for true up options, etc.
The NCUA board speaks with different views on the fund’s situation. The Chair says he learned in school that when interest rates rise, bond prices fall. Therefore the Fund’s decline is just what we should expect. That remark overlooks the whole IRR risk management responsibility.
Vice Chair Hauptman characterizes any change to the ladder strategy as “trying to time the market.” Hood’s questions are more targeted, but their import often seems lost on staff. Example: why the true up mattes.
The distressing aspect is that any real changes to this extended underperformance seem to be fading off into the sunset. In contrast, the entire industry is actively evaluating its ALM investment assumptions and policies.
Within NCUA committees are formed, policies reviewed, expert and even sometimes cu opinion sought, but there is no person sitting where the buck stops. It’s how bureaucracy functions. When staff doesn’t know what to do, or the Board can’t agree, nothing changes.
If May’s NCUSIF update is the best NCUA can do, credit unions should worry about the future of their Fund.
A Past Lesson
After the recapitalization in 1984 there was one practice that may resolve the current status quo approach. One person was responsible for the monthly update and explaining all expenses, reserves and future outlooks. That person was not the CFO or the head of E&I, but Mike Riley, He had total performance accountability even when it involved recognizing losses from problem cases.
Today the ideal solution would be for the Executive Director to provide the NCUSIF update. Regardless of how inputs are gathered the process needs a single point of responsibility.
Now no one is accountable. By dividing NCSIF inputs into multiple reporting sources, the CFO update is merely a reporting role. There is no responsibility assumed even for accounting issues.
Appointing a single person for Fund accountability is the most critical change the Board could make. Then the numbers might have real coherence.