Category: Cooperative Design

In last Thursday’s Board meeting the NCUA  members twice failed in their fiduciary role as directors.

The first shortcoming is specific.  It was their collective unexamined and unquestioned acceptance of  the continuation of the current NOL for 2024 and the failure to vote on the upper limit one way or the other.

The NOL sets the fund’s cap for retained earnings each year.   Any net income above that amount must be distributed back to credit unions as a dividend.

This was a fundamental part of credit unions agreeing to an open-ended 1% funding of insured shares to provide a stable NCUSIF revenue base.  So essential was this understanding that it was put into the revised 1984 Title II statute at 1.3%-only to be modified by CUMAA in 1997.

This design is the cooperative alternative  to the failed premium models the other federally managed funds used—and still use today.  This yearend 1.3%  had been the traditional limit until 2017 when the board raised it to accommodate the merger of the TCCUSF’s surplus.

When credit union performance and fund net income do well, then credit unions share in the success.  When there are unexpected crises, then credit unions can be assessed a premium.

As reported, 2023 was one of the best years in the fund’s history.   Actual credit union losses were just over $1.0 million in a year the FDIC had spent over $761 billion in “receiverships costs” through just the first nine months.   The NCUSIF’s yearend NOL was 1.3%, or 3 basis points higher than staff had projected only three months earlier-a significant miss.

(note:  for credit unions’ concerns about this change, see NCUA’s summary of comments on the 2017 change at the end of this post)

Staff’s Failure to Document a Higher NOL

Every year since 2017 the staff has provided the board their internal modeling assessment following a policy laid out at that time.   But not this year.   At a time when all of the objective data shows the fund more than well capitalized for any contingency, the board did not even raise a question about the missing documentation and why the actual 2023 yearend outcome should not be more than sufficient going forward.

Staff’s dereliction was pushed aside by CFO Shied saying that there was a need for more analysis.  However when one revisits the model’s disclosed  inputs for the previous two prior years’ NOL (2022 and 2023), those numbers do not support the presentation that the NCUSIF floor of 1.2% would have been reached in an adverse scenario,  These models, fully run, provide no support for a 1.33% NOL cap in those years.  And certainly not in  2024.

If their models had showed otherwise, staff would have presented it along with the assumptions used. Here for comparison is the official Board position on risk modeling in December 2021 when setting the NOL:

The unprecedented share growth related to the pandemic resulted in an equity ratio of 1.26 percent as of December 31, 2020, and an equity ratio of 1.23 percent as of June 30, 2021.

The Board does not agree with arbitrarily setting the NOL. The NOL represents the level of equity the Share Insurance Fund should have to meet the policy objectives based on a robust modeling of risk. 

A $525 Million “Premium Tax” On Insured Credit Unions for 2024

The failure to lower the NOL to its long time, proven upper limit set by all previous boards until 2017 will likely cost the credit unions a dividend in 2024.   Each 1 basis point above 1.3% in 2024 will equal at least $175 million.  By not lowering the cap, the NCUSIF will hold onto $525 million or more that should have been paid to credit unions.

The most disappointing response was by Vice Chairman Hauptman.   He had been a board member for each of the three prior NOL settings in December 2020, 2021 and 2022.  He had no problem approving the staff’s recommendation even when a fellow board member in 2022 suggested a lower limit of 1.3% was adequate.  This year he feigned ignorance  of his prior votes, saying he didn’t know what the right number should be  !.34 or 1.35 or 1.36!

Hauptman compounded his recently acquired amnesia with a total misunderstanding of the fund’s financial model.   The model does not require a specific level.  Under GAAP, a loss allowance for both specific and general insurance losses has already been expensed from retained earnings-a level that auditors review.  But in addition there is a ten basis point range of .2 to .3 of equity plus the current year’s earnings to cover any additional losses. That 10 basis point now totals $1.75 billion of capital. The NOL is only the upper  CAP on this wide range of equity.

Chairman Harper and newcomer Otsuka each  voiced similar themes.

Since joining the NCUA board Harper has made no secret of his intent to remove all current statutory limits on NCUA’s oversight.  He has repeatedly cited the FDIC’s options as ones he would like to have for the NCUSIF.  This year as the FDIC again struggles, he did not repeat his admiration for the FDIC’s premium model.

Harper’s basic regulatory philosophy can be summed in one word, MORE–more resources, more rules, more personnel and more of whatever anybody else does or has, and NCUA does not.

His longstanding dour forecasts suggests  a lusting for real industry problems to be able to justify NCUA’s existence-and his role.  This behavior began even before he became chairman.  Here are some early comments of his outlook for the credit union’s system:

At June 2019 board meeting:   With the recent inversion of the yield curve, we know that a recession is coming, we just don’t know exactly when and how severe.

December 2019 OpEd in CuToday:

We know that a recession is coming. . . That’s why we should fix the roof before it rains by implementing this rule (RBC) at the start of 2020. 

February 2021 speech to the DCUC after becoming chair:

As the COVID-19 pandemic rages on, we must smartly, pragmatically, and expeditiously address the economic fallout within the credit union system. To that end, when I first became Chairman, I issued my Commander’s Call to the agency.”

August 2021 DCUC speech:

But, I must caution everyone that we are not out of the woods just yet. Credit union performance will continue to be shaped by the fallout from the pandemic and its financial and economic disruptions.

With pandemic-relief efforts like supplemental unemployment benefits, foreclosure prevention programs, and eviction moratoriums coming to an end, many households could face financial stress in the coming weeks and months. This could lead to higher delinquency and charge-off rates and potential losses for credit unions — and even failures.

September 2021 Board meeting:  But, nevertheless, we ultimately should expect delinquencies and charge-offs to rise in the months ahead, and all credit unions should pay careful attention to their capital, asset quality, earnings, and liquidity. To protect the Share Insurance Fund — and, ultimately, taxpayers — against losses, the NCUA needs to stay on top of these emerging risks and problems in the credit union system.

Harper’s modus operandi (MO)when presenting the state of the credit union’s system is to focus on risk, uncertainty and fear.

And he was true to form this in this meeting. After acknowledging all of the  Fund and credit union strengths, his traditional downbeat forecast about how things can only get worse from here followed:

“While we should recognize those positive things, today’s presentation also illustrates why we cannot become complacent in the supervision of federally insured credit unions, In recent quarters, the NCUA has seen growing signs of financial strain on credit union balance sheets and consumer financial stress. And, we continue to see that financial stress manifest itself in the number of credit unions and the percentage of assets held by composite CAMELS code 3, 4, and 5 credit unions.”  Etc

Board member Otsuka took her cues from the chairman, apparently oblivious to the lack of any staff documentation for the NOL and the 40-year history of the fund’s  1.3% cap proving more than sufficient in all economic environments and CAMELS distributions.  She said:

“The percentage of shares held by CAMELS 3 credit unions has more than tripled in the last two years and more than doubled this last year. . . . I understand we had few credit union failures this year and that the necessary reserves decreased in part due to greater economic stability forecasted in the macroeconomy, but this is a concerning trend that I will be focused on as the year progresses.

This may be one of the moments where it is good to be prepared and think about the “what ifs.” While there are several positive factors to be encouraged about, there are some worrying signs as well. “

In these comments, the members fail to note that it is the Agency’s supervision and examination activity that is the primary means of for managing individual credit union risk taking-not the NCUSIF.  The Fund comes into play only when this most critical activity fails in its oversight role.

Board Members Fail the NCUSIF’s IRR Oversight

CFO Schied repeatedly cited liquidity and interest rate risk (IRR) as the dominate factors in CAMELS downgrades.

But none of the board members noted that the NCUSIF portfolio has been underwater since December 2021-which means its own interest rate risk management has been at best poor, at worst nonexistent.

Two directors commented, without even a note of irony, that going back into a ladder strategy that resulted in the Fund’s illiquidity and years long below market performance, was the right thing to do.

Interest rate risk management is the number one responsibility of the fund.   It determines both NCUSIF liquidity and adequate levels of income.

No one mentioned the one year shortening of the Fund’s weighted average duration which is the vital component of IRR.  And a major factor in the gain in interest revenue in 2023.

This silence continued as staff announced its next investment will put the fund back on the same ladder pattern that has resulted in 2 ½ years of underperformance  in this current rate cycle.

The Second Failure: Board Governance

In 1977 one of CUNA’s primary legislative initiatives was to replace the Bureau of Credit Unions single administrator ovesight with an independent agency and a three person board.   There was concern that a single administrator, even with an industry advisory board, might not be responsive to the growing industry’s needs.  In other words an unchecked supervisor.

The public governance process in a Board meeting is a critical demonstration of the effectiveness of the individual member’s and their collective capability.   Reading from prepared scripts with questions already written out, is neither transparent nor a model for board conduct.

Why can’t members just have a normal conversation with the staff most responsible for the areas under review versus a designated spokesperson reading responses for which he has no direct accountability (eg. CAMELS scores)?

How Democratic Design Falters

This President’s day weekend we honor the political example of two American leaders for very different reasons.

From essayist  Gleaves Whitney:  George Washington earned the respect even of his former enemy, King George III, by doing something exceedingly rare in history: When he had the chance to increase personal power, he decreased it — not once, not twice, but repeatedly.

During the American Revolution, Washington put service before self. His personal example was his greatest gift to the nation. It has often been said that the “Father of our country” was less eloquent than Jefferson; less educated than Madison; less experienced than Franklin; less talented than Hamilton. Yet all these leaders looked to Washington to lead them because they trusted him with power. He didn’t need power.

In all of the history of the NCUA board, I know of but one, who voluntarily left their position before their term ended.   Power, prestige and position are addictive.  What’s missing is performance.

From Abraham Lincoln in January 1838 to the Lyceum club in Springfield, Ill on “The Perpetuation of Our Political Institutions”  as summarized by Heather Cox Richardson:   “The destruction of the United States, he warned, could come only from within. “If destruction be our lot,” he said, “we must ourselves be its author and finisher. As a nation of freemen, we must live through all time, or die by suicide.” . . .

“He warned that the very success of the American republic threatened its continuation. “[M]en of ambition and talents” could no longer make their name by building the nation—that glory had already been won. Their ambition could not be served simply by preserving what those before them had created, so they would achieve distinction through destruction.”

Contrary to the statements of the  three board members, their primary fiduciary duty is not to the NCUSIF.  It is to the member-owners of credit unions.  The Fund is only one of many tools and roles the NCUA has for creating “a system of cooperative credit” for the United States.

The Fund was not even formed until almost 40 years after the Federal credit Union act was passed. It was put on a sound financial basis 50 years after the Act.  And it is arguably the least important resource as more than 90+% of all credit unions are safe and sound, not due to insurance, but from supervisory examinations.

The  Board’s failure to formally review the NOL was by design.  It violated a fundamental agency commitment when the legislation creating the new structure was implemented.  Informed governance  oversight is missing. Paraphrasing Lincoln, The greatest threat to the NCUSIF is not from external threats to credit union solvency but from internal NCUA mismanagement by intent or simple inexperience. 

And that is how freedom is lost, one small step at a time.  This time it is NOL review.  And next?

Harper has made no secret of his intent to reshape the NCUSIF in with the FDIC’s premium options.  Hauptman can no longer claim ignorance of previous precedent and practice.  Otsuka must decide if she wants to  be merely an echo for the Chair or really dig in and learn about the history and uniqueness of cooperative design.  Then truly express her own independent judgment.

The NCUA board was set up with democratic intent, to be a check and balance on agency or individual interest overriding that of credit union members.   The design does not guarantee this will happen.  Rather it is the conduct of those in their chosen positions of authority that will ensure this structure truly protects members best interests.  That is the governance model every credit union is expected to follow.

Additional References

Credit Unions Comment on NCUA’s Raising the NOL in 2017 from NCUA staff summary:

Federal Register Notice October 4th, 2017

Around 55 percent of all commenters expressly opposed any increase to the normal operating level. However, around 90 additional commenters urged a ‘‘full rebate’’ of Stabilization Fund equity, implying they also opposed any increase to the normal operating level that would decrease a distribution in 2018 or beyond. Many of these commenters contended no increase could be justified because a normal operating level of 1.30 percent had been sufficient to withstand the financial crisis. A large number of these commenters (as well as some that supported an increase) were concerned the Board would never again decrease the normal operating level if it increased it in 2017. Many commenters that opposed any increase to the normal operating level urged that, if the Board did increase it, the increase should sunset after one year and the Board should then substantiate any extension of a normal operating level above 1.30 percent. Some of these commenters suggested increasing the normal operating level would erode the NCUA’s motivations to control its operating expenses and that the NCUA’s operating budget and the overhead transfer rate had consumed most Insurance Fund investment returns in recent years. A common thread in the comments was that failure to return all Stabilization Fund equity would be contrary to prior assurances and promises from the Agency.

Some commenters contended an increase to the normal operating level would be akin to credit unions over reserving for loan losses, a practice NCUA examiners generally advise against. They noted the strength of the credit union industry, the recent strengthening of the NCUA’s regulations related to capital, and more stringent supervisory tests as additional firewalls that reduced the need for an increase to the normal operating level. These commenters often pointed to loss estimates related to the Legacy Assets as a basis to doubt the NCUA’s projections of the Insurance Fund’s performance.

Staff response for those citing the Corporate Crisis as a reason for increasing today’s NOL:

Other than the $1 billion capital note issued to U.S. Central Federal Credit Union, no material expenses related to the conserved and liquidated corporate credit unions were paid from the Insurance Fund. Immediately after Congress established the Stabilization Fund, the Board transferred the $1 billion capital note receivable to the Stabilization Fund, at which time the Insurance Fund received full payment on the capital note from the Stabilization Fund.

A Member-Centric Approach to Overdraft fees: The Unicorn Theory

Fees are now front and center as a political and hence regulatory topic, not just a business decision.  Chairman Harper has said he intends to shed some light on the practice in credit unions by collecting data.

AT SECU (NC) the credit union developed an approach to this money management issue that was designed to help the member, not create a borrowing dependency.

Here is Jim Blaine’s description of the program which I assume is still in place.  If  you read his following day’s blog, he describes SECU’s $5.0  billion draw of the Federal Reserve’s Bank Term Lending Program (BTLP).   The analysis  includes the other top five credit unions by assets and their use/nonuse of this option.

The NCUA Board’s NCUSIF Discussion

Yesterday’s board meeting had one primary topic, the state of the NCUSIF and the related responsibility of setting the NOL.

Unfortunately the live stream broadcast cut out during Harper’s initial comments and then permanently as board member Otsuka began her comments.

The NCUSIF had its best year in a very long time.  Record net income,  no insurance losses, rising income and an NOL at 1.3%.   All that was missing was a dividend for the owners.

There were two disappointing aspects.  CFO Schied said the increase of credit unions in CAMELS 3 category was due to “liquidity, interest rate risk and risk management.”  He  then announced that the latest portfolio maturity of $700 million would be invested in two tranches-50% in overnights and the rest in the traditional ladder out to 7 or 10 years.

Since December 2021 the NCSIF’s portfolio has been underwater. The earnings of the NCUSIF have suffered greatly from this robotic IRR approach to portfolio management.

But no one apparently has learned anything from this ongoing underperformance, now in its third year.  The board members just nodded in tandem as this decision would produce a “good source of future  income.”  The board’s inability to even address their IRR  oversight was a failing to take proper care at best; or at worst irresponsible.

The second shortcoming was the failure to review and reset the fund’s Normal Operating Level(NOL).  This has been the standard bpard process every December.  The board would review staff’s five-year model with  its various scenarios and then approve a cap for the next year.

Not this year.  Schied who presented the modeling in year’s past, made an excuse about staff needed to do “more analysis.”  Harper who controls the agenda, obviously did not want the NOL to be reviewed as all the data would show the traditional 1.3% cap was more than sufficient.  If reset this historical limit would likely provide a dividend for credit unions in 2024 given the much higher earrings from the  fund.

Hauptman in the December 2022 board meeting in responding to Hood’s suggestion that the level should be 1.3% said it wouldn’t make any difference. He implied the fund could not possibly reach or exceed that level, so it didn’t matter whether it was 1.3 or 1.33.

This year his approach was even more cavalier.  He failed to note for the record that the staff had did not present their standard analysis of the NOL, the first time since 2017.  Then in a series of flippant remarks said in effect “I don’t know what the right number should be.  Is it 1.34? of 1.35 or 1.36?”

Since 1984 NCUA board members have had no difficulty setting a limit, a decision well understood and documented for forty years. This cap limit really matters to credit unions now.  Each basis point above 1.3% equals $175 million that could potentially be paid in dividend to credit unions.

Hauptman did not call out the chair’s failure to put the item on the agenda and just let the current cap slide through.   His dismissal of the staff process which he supported in prior years suggests either a lack of conviction or courage, or both.

In the end it probably doesn’t matter that the livestream went out.  There wasn’t any real engagement on matters of substance before the lights went out.

Callahan’s Trend  Watch Update for 2023

Yesterday’s 2023 yearend industry analysis by Callahans was a very useful summary of the sound state of the industry.  There were the standard summary slides showing macro trends.  These reflected a  slower growing system.

The presentation included a new effort to show  how larger credit union’s dominance of averages can be better understood by including the mean outcome for every ratio.

Finally there were several slides with a 20-year time horizon that demonstrated the inherit cyclicality of performance such as delinquency or share growth.

The full set of slides and the recording can be downloaded here.    https://go.callahan.com/rs/866-SES086/images/2023_Trendwatch_SlideDeck.pdf?version=0

The recording: https://creditunions.com/webinars/trendwatch-4q23/

The centerpiece of today’s NCUA’s board agenda is a review of the NCUSIF’s 2023 performance.  Three areas are most important:

1. Loss management and the reserving allowance estimate.
2. Investment performance oversight.
3. Trends in operating expenses.

The  2023 insured share growth was published in the audit preamble, so the NOL cap for yearend 2024 is the outstanding board determination.

This annual NOL review was a commitment by Chairman McWatters when the two-person board first raised the historic 1.3% cap in the NCUSIF in 2017. This change was to retain the inflow of funds from the merger of the TCCUSF. Credit unions uniformly questioned this process and urged a return to the 1.3% as soon as possible.  It has been seven years.

The Insured Losses Rate and Allowance Level

The 2023 net cash losses in the NCUSIF were minuscule, just $1.0 million.  In comparison the banking system has paid the FDIC $761 billion in premiums  for “receivership costs” through September 2023.  

CFO Schied stated in his board update last fall: Since the last taxi failure on October 2018, actual SIF losses are a total of $53.8 million or .0031% (.31 bps) of insured shares as of June 30, 2023.  

With the full 2023 results now in, this annual loss rate is less than .10 basis point per year.  A remarkable record during five years of economic ups and downs. 

The NCUSIF’s yearend $209 allowance account is 1.2 basis points of insured savings or 12 times this  annual loss rate.  Or five times the total for all dollar losses in the past five years.  

CFO Schied told the board that this reserve amount is determined  using a macroeconomic  model.  Will the numbers, assumptions and calculations in this model be available so users of the statements know how it works and its factual validity?

NCUSIF’s  Investment Portfolio Management

The $22.4 billion (book value) in total NCUSIF investments is the only revenue source for the fund, unless the Board chooses to assess a premium.  This has occurred only four times in the past forty years.

Since December 2021 the portfolio’s market value has been less than book.

This means the portfolio is not earning current market rates.  At yearend 2023 the NCUSIF’s term portfolio had a yield of just 1.4%;  the $5.2 billion in overnight funds earned 5.4%.  The combined yield for all 2023 was just over 2.0%.

During 2023 the buildup of portfolio cash  reduced the Fund’s weighted average yield by a full year, from 3.33 years to 2.30 years. This change reduces interest rate risk.    This number is the approximate time it would take the portfolio’s reinvestments from maturing securities to reprice  if rates normalized at their current level.

In last fall’s presentations to the NCUA board, the CFO indicated that the Fund’s investment policy had not changed.  And that having achieved the initial cash target ($4.0 billion), the committee would begin considering extending out the curve—even though the interest rate curve continues to be inverted.

Interest rate risk is the primary  threat to be managed consistent with optimizing earnings.  This is what I believe an NCUA examiner would write about the current Board oversight.  The wording is borrowed from a CAMELS code 3 exam of a multibillion dollar credit union:

Risk:  Strategic    Degree of Risk:  High

CAMELS Effect:  Management, ALM, Earnings, Capital

Reason for rating:  A capital planning discipline is not in place to manage the interest rate risk (IRR) that is commensurate with the size and complexity of (credit union). . . and the exposure presented to the NCUSIF.

The Credit union’s ALM (investment) policy establishes guidelines related to capital, net income, and net economic value of equity, but does not contain specific, established interest rate risk limits. 

Examination Requirements:  Matters requiring Board attention.

The board should further develop, document, and implement a policy to measure and monitor interest rate risk. The revised policy and plan should include the following actions at a minimum:

1. Establish and implement maximum policy limits for the interest rate risk metrices used in the ALM/investment analysis.
2. Evaluate and provide interest rate compliance and trending reports/charts based on the existing balance sheet under current rate forecasts monthly.
3. Update projected yearend capital ratios on a monthly basis.

I could not have suggested a better approach for the Board’s attention.

Operating Expenses

Since 2008, 93% of the operating expenses of the fund are from NCUA’s overhead allocation of its expenses via the Overhead Transfer rate.   The OTR ranged from a low of 52% (2008) to 73.1% (2016).  For 2023, NCUSIF’s operating expenses increased 12.6% using an OTR of 62.4%.

From 1979 through 1984, the percent of NCUA’s expenses paid by the NCUSIF, were never higher than 26% (pg 39 NCUSIF 84 Annual Report).  Until 2001, the transfer rate had been fixed at 50%.

The current expense level equals approximately 1.3 basis points of insured shares.  In terms of yield on the entire portfolio, this requires the fund to earn 1%.  Operating expenses are a fixed cost, right off the top of revenue. If not controlled they take resources away from the Fund’s primary insurance resources.

Calculating the Normal Operating Level

With the audit numbers and the total of insured shares from December call reports in hand, the equity to insured shares ratio can be computed at yearend.  NCUA says the NOL number is 1.3%.

This ratio determines the prospect for a dividend when the fund’s net income raises retained earnings above the NOL upper cap.   This cap is set by board action each December.

The 2022 board meeting kept the 2023 upper limit   at 1.33 even though one member expressed the view that it should revert to the historical 1.3% which had existed until from 1984 through 2017.

When will the board make this determination for 2024?

The meeting starts at 10:00 AM.  For a full review of credit union’s financial performance, Callahan & Associates presents their quarterly Trend Watch analysis at 2:00.

Late yesterday NCUA released the independent CPA audits of the four credit union funds it manages.

The one that matters most for credit unions is the NCUSIF’s performance.  Plumbing through the opaque federal accounting presentation reveals much good news.

Bear in mind  when reviewing the highlights below that the FDIC is struggling to increase its insurance ratio.  It has assessed increased premiums  to pay for the hundreds of millions of bank failures in 2023.

Some NCUSIF 2023 Highlights

• Net income increased to $210 million. This is the best operating result ever and almost double the $119 million recorded 2022.
• Net insured losses (cash payments less recoveries) were just $1.0 million. Nonetheless he allowance account was increased to $209 million, the largest total since the taxi medallion inflated reserve in 2017.
• Insured share growth was flat ending at $1.7 trillion. The aggregate net worth ratio for all insured credit union increased to 10.95% from 10.78% at yearend 2022.
• The Fund’s normal operating level (NOL) grew to over 1.30% at yearend. Each basis point equals $170 million.  Adding the allowance account raises total reserves to over 1.31% or a potential $1.9 billion cushion above the NCUSIF’s lower NOL limit of 1.20%.  Since 2008, the total losses for all the NCUSIF’s preceding 15 years equal $1.877 billion.
• There is opportunity for even greater returns in 2024. The NCUSIF’s yield on its $22.4 billion investment portfolio was just over 2% in 2023.  Overnight rates are projected to remain above 5% for the first half of 2024.   Adding the current overnights of $5.2 billion plus the $1.4 billion maturing in the first five months, gives a cash portfolio of $6.6 billion yielding 5% or higher, until the Fed begins reducing rates.

The One Missing Number

In the December’s 2022 board meeting, NCUA set an NOL upper cap of 1.33% for the NCUSIF.  Board member Hood had urged that the historical .3% upper limit be restored.

This upper cap matters. All income above this limit in a year must be distributed as a dividend to the Fund’s owners, the credit unions.  This is the fundamental promise in return for credit union’s open-ended 1% deposit underwriting.

To date I have seen no upper cap set for 2024.  Hopefully this means the long term, historically validated limit will be in place for this year.

Restoring this 1.3% cap would make this the perfect Valentine for the credit union system’s uniquely successful  cooperative Fund.  Isn’t it time NCUA shared a little love with credit unions?

This week NCUA will report on the 2023 financial audit of the NCUSIF in two days.  This will be the 42^th external, independent certified audit of the fund.

The Good News: A Ratio Showing the Fund’s Stability

Multiple financial events have presented numerous stress tests for the NCUSIF since 2008.  These include  2008/9 Great Recession followed by quantitative easing and a period of abnormally low rates. Then came the COVID national economic shutdown. The current inflation has been countered by the Federal Reserve’s rate increases, the most rapid in 40 years.

Through all these scenarios, one trend line demonstrates the Fund’s resilience. The chart below is the ratio of retained earnings to insured shares for this 14-year period.

The blue line shows the Fund’s equity at or above the historical .3% upper cap.  The orange line adds the allowance account balance, which are additional reserves already expensed from equity.

The uniqueness of the fund is more than a steady  earnings base growing in tandem with insured risk.

This cooperative funding model aligns with the values, culture and balance sheet structure of the credit union system.  Every member contributes 1 cent of every $1 share for this collective insurance. In turn it is a resource available to assist any credit union that needs cash or other 208 assistance if facing insurmountable challenges.

The unique NCUSIF design works; however the history may not be known to current board members or to some credit union leaders.   Credit unions need to remind all of this important story and what this stability has meant for their members.

The NCUSIF’s Founding-Getting the Correct Numbers

Outside audits were not the practice from the NCUSIF’s founding in 1971 through 1981.  GAO had performed an audit every two years; the report came six months or more after the audit date. The 1982 NCUSIF Annual Report described this change from GAO to a private independent firm implementing GAAP accounting standards:

“To ensure the Fund’s statements are examined in the most timely manner and to seek an assessment of accounting procedure, the NCUA contracted for the first independent audit ever conducted of the Fund’s balance sheet by an outside accounting firm. 

In the years prior to fiscal 1982, the Fund recorded losses from financially troubled credit unions at the time these credit unions were ultimately merged or liquidated.  Additionally, losses on asset guarantees . . . were recorded at the time that payments were made under guarantee agreements. 

Beginning in 1982 the Fund began the process of conforming its accounting for losses from credit unions to GAAP.   (These) principles require that the fund record losses at an earlier point in time than had previously been the Fund’s practice.   In this respect the Fund recorded estimated losses under the cash assistance program of $14.1 million and of $15.6 million on outstanding asset and merger guarantees. 

In addition, GAAP generally required that the Fund record estimated potential loss accruals for credit unions identified as experiencing financial difficulties but not receiving cash assistance. . . The Fund did not attempt to estimate these additional losses for fiscal 1982 because it was not practicable to accumulate the information needed to make the estimates.

Equally as important as the change in accounting methods were the improvements to the fund’s records.  Ernst & Whinney worked with the Fund’s accounting staff identifying areas that were not properly recorded . . . As a result the Fund is now publishing monthly statements which will help all interested parties monitor the financial results.”  (pages 7-8 NCUSIF 1982 Annual Report)

The Report’s remaining 20 pages gave details of cash assistance, guarantees and merger costs along with an overview of all insurance programs and credit union trends.  Transparency in every respect was essential for confidence in the Fund’s management.

Chairman Callahan’s view was that, “We believe our “full and fair” disclosure should be no less than what we expect insured credit unions to give their members.”

A Radical Change in Accounting Accuracy, Timeliness and Transparency

In the 1984 audit, Ernst & Whinney gave the Fund its first ever clean opinion “in conformity with generally accepted accounting principles applied on a consistent basis.”

Without this three-year effort (1982-1984) to improve the timeliness (monthly board reports), accuracy (GAAP accounting) and transparency,  the credit union system  might not have supported the radical redesign of the NCUSIF. This new approach  required  perpetual 1% deposit underwriting.

This cooperative model was passed by Congress in 1984 with full credit union support. To implement the 1% underwriting, 15,303 federally insured credit unions deposited $845 million into  the fund by January 1985.

The Last Shall Be First

The result was that the NCUSIF instantly became the strongest and, through time,  the most stable of the then three federal deposit insurance funds.

The NCUSIF never looked back or across the aisle.  The FSLIC merged with the FDIC.   The FDIC has reported negative net worth and periods of ever increasing premiums, such as now, to try to meet its minimum ratio level.

NCUA’s graph of this change in the standing of the three funds from page 37, NCUSIF’s 1985 Annual Report.

Vigilance-The Price for Performance

In a speech to credit union managers and the press following the 1984 recapitalization, Chairman Callahan gave the following “pitch”(his word):

“Don’t set it up and forget about it.  It’s unique. It’s a better way.  But just as important, it’s yours to monitor—it’s your responsibility to keep it working—because if you don’t it’ll go just like everything else the government touches.  When government gets more money, it wants to spend more.  Our goal is to spend less (on insurance). You’ll have to hold us to that promise.”

Then in 2010 there came a change in how the NCUSIF’s financials were presented.

The Change In Accounting Standards for the NCUSIF

The NCUSIF’s GAAP presentation was a financial format that all credit unions knew and followed. This GAAP audit is the only format used in NCUA’s Operating Fund and the CLF since they were both audited by independent accounting firms beginning in 1982.

On June 23, 2010 Credit Union Times printed a story with the headline, Auditors Fault NCUA’s Accounting.  The article in part:

“KPMG gave the NCUA an unqualified audit but found material weaknesses in the reporting and documentation methods.  . . NCUA Chairman Debbie Matz said the 2008 and 2009 audits (released on June 14, 2010) had been delayed because of the problems facing the corporate credit unions. . . According to the KPMG report, the NCUSIF does not have sufficiently comprehensive policies and procedures that document control activities and monitoring functions that should be embedded and/or performed within the financial and reporting process.”

In a June 17, 2010 Agency bulletin, the NCUA board announced it had adopted Federal GAAP accounting for the newly authorized TCCUSF.  The same bulletin had this statement:

The National Credit Union Share Insurance Fund (NCUSIF) is required by the Federal Credit Union Act to follow U.S. generally accepted accounting principles (GAAP). The General Counsel’s opinion concluded that “section 105 of the GCC Act, as interpreted by the General Accounting Office, does not preclude NCUSIF from using an alternative set of accounting rules such as FASAB in preparing the NCUSIF’s financial statements.”

Shortly thereafter there was a change as reported in this footnote in  the NCUSIF’s 2010 yearend audit: Basis of Presentation  The NCUSIF historically prepared its financial statement in accordance with generally accepted accounting principles (GAAP) based on standards issued by FASB, the private sector standards setting body. On September 16, 2010, the NCUA board authorized the NCUSIF to adopt the FASAB standards for financial reporting, effective from January 1, 2010.   Accordingly, this is the first year of the presentation of the NCUSIF financial statements in accordance with FASAB.

A Misleading Accounting Presentation

However, FASAB’s  form and content are very different from private GAAP. The account titles, presentation and interpretation are intended for reporting entries that rely on governmental funding.  The NCUSIF is totally dependent on credit union funding.  The FASAB format is completely alien to the accounting presentations familiar to and used by credit unions and CUSO’s.

A Strange Set of Federal Accounts

Some of the NCUSIF’s balance sheet accounts that are completely novel under federal GAAP include:

Balance Sheet headings and account categories: Intergovernmental.  With the public; Insurance and guarantee program liabilities;(Loss reserve); Net Position, and its cumulative results of operations (not the same as retained earnings)

The traditional Income Statement is replaced with two other presentations. The first is, “Statements of Net Cost”.  This includes Gross Costs followed by Less Exchange Revenues and concludes with a bottom line Net cost of Operations (which is not net income).

The second Statement is Changes in Net Position.  This includes net unrealized loss or gain on investments, and interest income, the primary revenue source for the NCUSIF.

In standard GAAP, Statements of Cash Flows is replaced with the governmental “appropriations terminology”: Statement of Budgetary Resources.  This includes subtotals for Total Budgetary Resources, Status of Budgetary Resources and Outlays Net.

These accounting concepts are far removed from any of NCUSIF’s actual operations.  When staff gives the board’s NCUSIF quarterly update, it converts the income and balance sheet statement to the traditional GAAP format.  However the monthly postings are not converted. They remain in the idiosyncratic federal GAAP Accounting format.

Understanding Critical Accounting and Finance Decisions

The NCUSIF’s federal presentation is misleading in its factual representation of transactions which suggests that the NCUSIF is a governmental appropriated fund.

Certain critical  concepts and terms are absent. The most important is “retained earnings.”  One looks in vain for the number which is used to compute the NCUSIF’s normal operating level.  Another concept is “fiduciary assets” which means AMC assets are not fully recognized on the NCUSIF balance sheet.

The NCUA Board’s Opportunity:  Enhance Transparency for the Fund’s Users

Eternal vigilance is hard when numbers are presented in a federal disguise. At a minimum, the NCUA board should request the auditor also represent the yearend audit numbers in private GAAP format.  Staff should also present the monthly updates in this standard.

Then users of the statements can easily understand the trends. More importantly they can fulfill the challenge from a previous NCUA chair for credit unions:  it’s yours to monitor—it’s your responsibility to keep it working. 

Restoring easily understood transparency to  the NCUSIF’s financial presentation would be an important step forward for the NCUA Board in its upcoming annual review.