Last week’s NCUA board meeting had only one topic: the financial state of NCUSIF.
The interest rate context for this briefing was described by a CNBC commentator as follows:
“What we’ve seen in the last few years was a cost of money that was 0. Throughout history, that’s very rare. Now we have a cost of money that is high and going to keep going higher.”
The implications of this context were absent in the initial presentation.
A Puzzling Omission
The CFO’s presentation of the September 30 NCUSIF financial position was the routine reciting of numbers on slides, until the questions started.
Vice Chair Hauptman referenced the fund’s cooperative nature and the importance of transparency. He pivoted to making a pitch for CLF legislation to enhance liquidity for 3,600 small credit unions and “for the NCUSIF.” His first question was , what is an appropriate liquidity level for the NCUSIF? The September overnight number was $362 million.
That’s when the bombshell was dropped. CFO Shied said that the NCUSIF now held $1.7 billion in overnights. This is almost four times the amount initially presented. This increase was partly the result of $650-$700 million in additional 1% deposits. Partly because the fund was “pausing on long term investments.”
This $1.7 billion yields almost 4% or three times the year to date yield of 1.31%. For over a year the fund’s declining NEV showed that the robotic laddering over 7+ years was locking in significant NCUSIF underperformance for years in the future.
Why this dramatic balance sheet change was not part of the initial update is puzzling. It marks a change in the year-long investment explanation that changing the ladder approach in the face of the rise in rates would just be “timing the market.”
No one asked the obvious question. Is this a change of investment tactics to a managed WAM approach? Or just a temporary pause?
It was Board member Hood who brought out the impact of the underperformance of the fund. His three questions follow.
Q. Given how interest rates have increased, every security we have currently is underwater, correct?
Answer: That is correct Board Member Hood. The continued and sizable increases in interest rates mean that the entire portfolio other than the overnights is underwater at this time.
Currently the NCUSIF’s portfolio has lost over $2.0 billion in market value(NEV). The agency continued NCUSIF’s auto investment policies even when rates were at “historical lows.”
Now every security in the $22 billion portfolio is underwater. Even long term securities purchased this year in the rising rate environment.
The result will lock in below market portfolio yields for a long term (up to the WAM of 3.7 years). This underperformance means credit unions are on the hook should the fund’s operating expenses (liabilities) exceed its annual income.
Q. At a previous board meetings on the status of the Share Insurance Fund, we discussed the outside accounting firm we hired to look at the true-up issue and how this impacts the equity ratio. For the record, at one of the last share insurance board updates, we discussed that the true-up memo by the outside accounting firm states that the timeliness and accuracy of the data is required in the Federal Credit Union Act so this provision in the law, and I quote, “May provide some latitude from a strict interpretation, that the equity ratio must be calculated based on the financial statements amounts, particularly given the knowledge of the timing effect on the calculation of the equity ratio. Accordingly, it may be permissible to use the pro forma calculation of the contributed capital amount when calculating the actual equity ratio.” In a previous board meeting, I noted that the letter pointed out the current practice understates the equity ratio by several basis points and that there were several options for correcting this understatement. Can you please provide an update on next steps?
CFO Schied said a committee was studying this issue. The memo in question was presented a year earlier. One would hope that this considerable delay would result in a more accurate NOL calculation. For as Hood noted the present calculation understates the actual yearend ratio by 2-3 bases points.
Q. I see several sizable institutions changed in their CAMELS score. Is there any takeaway from these data? Do we think any of this has to do with the new “S” component–or any individual scoring component?
Answer: This does include elevated interest rate risk, but examiners also noted increased liquidity and compliance risk in these institutions. The downgrade in CAMELS ratings also reflects a lack of governance or poor risk management practices.
Not a Liquidity Issue but Risk Management
Other board members spoke to the importance of liquidity. This has become more pressing as any sale of a security from the portfolio would result in a realized loss to the fund.
With an NCUSIF portfolio nearing $22 billion and regular predictable cash flow, the last concern should be liquidity.
Credit union owners should receive more than a perfunctory reading of data on slides when an NCUSIF update is presented. The critical issues of investment performance, NEV risk management and detailed explanations of allowance expenses should be the routine.
Anyone can read numbers on a slide. What they mean should be the substance of every update. It should not require board questions to discover that the data presented was not timely, relevant or representative of current conditions.
Hood’s questions show the need for better risk management in the NCUSIF. They also demonstrate the need for a more professional and current briefing by staff.