Many NCUA management actions have limited direct impact on credit unions. But when mistakes are made in a critical system component, the NCUSIF, they can cost credit unions dearly.
The NCUSIF’s sole source of revenue is the earnings on its $20.5 billion investment portfolio of government securities.
The objectives of the NCUSIF’s current investment policy are clear:
The investment objectives of the NCUSIF are:
- To meet liquidity needs resulting from the operations of the Fund; and
- To invest, on a daily basis, any excess cash in authorized Treasury investments seeking to maximize yield.
The Investment Committee has fallen increasingly short of these objectives for at least the past 15 months. Results have been contrary to these clearly stated goals.
The Numbers: $10 billion in New Investments in Two Years
At December 2019, the NCUSIF’s portfolio size was $16.02 billion of which $5 billion matured in two years or less. At February 2022, the portfolio had increased to $20.5 billion.
Since interest rates declined to historic lows in March 2020 at the start of the national economic shutdown, the NCUSIF has invested more than $10 billion ( 50% of its current portfolio) following a robotic 7-year ladder.
Today these $10 billion investments are worth less than par. They cannot be sold without incurring market losses constraining the NCUSIF’s liquidity options as stated in objective 1.
At February 2022, the portfolio reports a total unrealized market loss of $343 million, a decline in value of over $ 800 million since December 2020. The current unrealized loss will increase as rates rise. These declines since December 2020, easy to see from the monthly market value disclosure. They also indicate that the portfolio’s yield is increasingly falling behind market rates.
A $45 Million Dollar Mistake and Still Growing
The most recent investment of $650 million on February 15, 2022 for seven years at a fixed yield of 2.01% continues this mismanagement in the face of unanimous market indicators and Fed statements pointing to rising rates.
Today the seven year T-Note is near 3% yield. Not only is this investment from just 60 days earlier worth less than par, the loss of income over the seven-year term is currently over $45 million. That is 1% (or higher yield pickup) times $650 million times seven years.
Credit unions and their members will pay the cost for these and other misjudgments that have resulted in at least half of the NCUSIF’s portfolio below market. With a 3.5 year effective price duration, the portfolio will continue to decline in value by 3.5% for every 1% increase in the yield curve going forward.
The NCUSIF Investment Committee
The Board’s Policy delegates the implementation of the its two policy objectives to four of the agency’s most senior staff including:
Director of Office of Examination and Insurance, Chair
Chief Financial Officer
Director, Division of Capital and Credit Markets
Chief Economist
One would have hoped given the first quarter’s “Rout in the Bond Market” (WSJ headline), the continued inflation projections, the Federal Reserve’s frequent announcements of policy change, that someone would have called a timeout on this robotic investing ladder. The declines in market value are in plain sight; but more critical are increasing constraints on future income possibilities, objective 2.
What Can Credit Unions Do?
The reason for monthly NCUSIF financial disclosures is so the fund’s owners who rely on NCUA management, can see the results and raise concerns with the board.
Credit union’s first responsibility is to speak up. Directly communicate your views of this performance failure. For your members will pay the cost of these misjudgments ($45 million and higher) potentially for years.
The reported results fall way short of policy. What will the board do? The committee seems unable to follow market trends, its own NEV data or internal IRR analysis (if any), or even to be aware of different portfolio options.
In public board meetings, staff is dismissive of change calling alternatives “market timing” when in fact the real issue is simply “investment management.” This is a responsibility every credit union is expected to perform in all phases of the interest rate cycle.
Assuming the board is incapable of monitoring and implementing its stated policy, then Congress is the next recourse.
The Damage to NCUA and the System’s Reputation
When NCUA and senior employees are oblivious to market trends, the situation raises questions about competency in many other areas of operational assessments and regulatory approvals.
Supervision requires judgments. Policies nor rules can prescribe detailed actions. Ratio calculations can be written down but determining the correct numbers entails seasoned analysis.
The economy is in an inflationary period which some say has not been experienced for 40 years. The Federal reserve’s balance sheet and its increase in money supply has never been larger. Short term overnight rates are priced in forward markets as high as 3% in a year’s time.
There will be significant adjustments as credit unions transition their balance sheets to the new environment and as member’s see rising rate options.
There will be lots of hyperbolic forecasts and many forebodings in forthcoming months. After all, “preaching negativity makes you an expert” as one colleague used to say.
But credit union’s track record in the most extreme crises has been one of patient, experienced adjustments even when markets seemed to have lost all logic.
As NCUA’s enters this new cycle of interest rates, will its ability to make reasoned adjustments match credit union’s own track record? This initial response in the comparatively simple management of a treasury portfolio, with just two clear policy goals, is not encouraging.
Can the agency learn from its own misjudgments?