Important New Data from NCUA’s Recent Board Meeting

In anticipation of the NCUSIF update at last week’s board meeting I described several topics of vital importance. These included the fund’s operating stability, the investment lag from market rates, the loss reserving level and the reliability of projections of future performance.

In answering Board member Hood’s questions, there was important new data from staff.

The Fund’s Normal Operating Level is Stable and Growing

As in any enterprise with a bottom line, NCUA’s outcome is to optimize the fund’s retained earnings. Adding the 1% required credit union deposits, these two factors sustain a stable Normal Operating level.  CFO Schied responded that the actual level of the NOL ratio at June 2023 would be 1.29% if the retained earnings and required 1% trueup were recorded in the same accounting period.

Staff’s NOL projection in May had been for a 1.25% at June. This 4 basis point projection materially understated the Fund’s trends and financial stability.

Moreover, we learned that using a six month old data point to calculate the 1% trueup, overstated the reported December 2022 actual ratio.  There had been a $5 billion decline in total savings in the last half of 2022.  That resulted in  $72 million net returns of the 1% deposits from June’s 2022 total. Using this six-month old 1% datapoint resulted in a higher NOL number than if all three ratio factors were from the same accounting period.

The Fund’s Loss Reserve Equals Four Times Its Recent Loss Rate

CFO Schied reported net cash losses in the fund since the taxi medallion write offs, were just .31 basis points of insured shares.   The current loss provision ($204 million) is 3.8 times this recent experience and equals 1.2% of insured savings.

The actual net cash loss for the first six months of 2023 is only $1 million. However,  over $20 million has been added to the provision expense.  When asked why this difference, Schied replied:  “The general reserve is derived using an internal econometric model that applies estimated probability of failure and loss rates.” 

No details of this model were provided to evaluate  assumptions and whether they were validated by actual experience. This is critical detail for users to have confidence in the financial estimates provided.

The loss provision expense comes directly from retained earnings.  The current level reduces the reported NOL level  by over 1 basis point of insured savings.

The NCUSIF’s Below Market Valuation

Current short-term rates under two years are yielding over 5%.   The NCUSIF’s portfolio has a YTD yield of 1.79%.  This was due to the Fund’s continual investing out to seven years when rates were near zero.  The result was a weighted average maturity for the portfolio of almost three years.  That is the time it will take to bring the portfolio back to par once rates normalize.

The market value of the portfolio went negative in December 2021 and was $1.5 billion below book at June, 2023.   This results in revenue far below current yields.   Investment revenue is the primary driver of retained earnings.  This is the most critical management responsibility in the NCUSIF’s financial performance.

When asked about the status of the investment committee’s  policy review begun early in 2022 Schied’s response: The investment policy has not been updated.  The investment committee has identified a few modest updates and clarification, and is still considering one item.  So again, at this point the policy that is on our website remains the current investment policy.

Is there a more important priority for the board than to understand the reasons for the recent underperformance?  And then to update the NCUSIF’s interest rate risk management policy/practice to avoid this outcome in the future?

The Accuracy of Staff Projections

The June forecast for the NCUSIF’s NOL was 1.25% provided to the  board in late May.  The actual outcome was 4 basis points higher at 1.29%.

The staff gave an updated NOL projection for this December of 1.27%.   Projecting the Fund’s actual numbers at June, this would be a gain of $70 million in net income, or lower than the first six month’s bottom line.  The 12-month growth in insured shares was forecast at 4.2%.   The real growth for the first half of the year was 1.8% from the previous June.  In 2022 last two quarters there was a net outflow of $5 billion.

There was no information to support these assumptions and the NOL of 1.27.   If  share growth is zero from June, and the same net income estimate, the retained earnings ratio would rise to .2948 at yearend. This would be an increase from the actual .2922 at December ‘22.

As with the econometric model used in the loss provision expense, this NOL forecast cannot be evaluated without the underlying assumptions being transparent.

The Board Meeting Process

The board members’ comments, their Q & A with staff and staff’s responses were all scripted.  Board members read their statements, there was no effort at dialogue, there was no learning from the supposedly differing points of view represented.

Only Hood engaged the staff on what the NCUSIF numbers mean.  Chair Harper followed his ever present “MO” of hyping future risks after acknowledging the fund’s sound condition.  Hauptman talked about how interest rates are set by buyers and sellers of money, but did not apply his observation to the current outlook for rates.  And how this might affect future decisions.

Hood’s questions brought out some very important aspects of the NCUSIF’s management.  New information from Schied included a positive  forecast of $12 million in further recoveries from US Central’s AME.

The Q&A highlighted the shortcoming of current accounting presentations and  investment practices.  These can mislead users of the financials statement.

The Fund’s below market investment performance will cause lower revenue for the fund and its credit union owners by hundreds of millions of dollars.

Moreover the investment position compromises the two primary goals stated for the investment committee’s performance.  These are liquidity (never borrowing to meet the fund’s obligations) and meeting all operating expenses, plus dividend.  These two outcomes should be a walk in the park in current conditions.

If the fund were earning 5% on its portfolio, total revenue would be over $1 billion, a result that would pay real dividends to credit unions for their underwriting commitment.

There is great potential for the cooperative structure of the NCUSIF to be a positive contributor to the credit union system.  It will be up to the board to ensure this outcome is indeed realized.

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