Category: NCUA

An easy but critical first step for a new NCUA board for insight into the agency would be to change the current auditor, KPMG, of its three credit union financed funds. This is normal good business practice as NCUA documents in its examination recommendations cited below.

It would bring a fresh set of eyes and objective rigor to a series of events such as the ambiguities in managing the corporate AME assets and the inexplicable annual accounting for loss reserves in the NCUSIF.

It would also bring much needed review for how the Inspector General’s office performs both its internal and external audit oversight.

Finally, it would replace a firm whose professional integrity and competence have been publicly and repeatedly called to account in the past three years by both regulators and the financial press.

KPMG’s Recent Press Reports

For several years the business press has reported on the professional and ethical failures at KPMG. The following are a few of the public stories about events from 2016 through this year.

1. The KPMG cheating scandal was much more widespread than originally thought

Jun 18, 2019 — A $50 million fine against KPMG LLP for its use of stolen regulatory information to cheat on audit inspections wasn’t a surprise: The Wall Street Journal warned last week that the Securities and Exchange Commission was ready to impose such a move, and the scandal had been known about for more than a year.

https://www.marketwatch.com/story/the-kpmg-cheating-scandal-was-much-more-widespread-than-originally-thought-2019-06-18

2. KPMG reveals eight audit clients collapsed

Updated Feb 18, 2020 

KPMG has revealed it failed to flag problems with the financial statements of two of the eight collapsed listed companies it audited over the last 10 years.

https://www.afr.com/companies/professional-services/kpmg-reveals-that-eight-audit-clients-collapsed-20200203-p53x6l

3. Accounting Watchdog Finds Ongoing Problems at KPMG

The Public Company Accounting Oversight Board (PCAOB) said half of the 52 audits it inspected from top accounting firm KPMG were seriously deficient and KPMG was not as committed to quality as the accountancy claimed.

“In 26 audits, certain of these deficiencies were of such significance that it appeared to the inspection team that the firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence to support its opinion,” the PCAOB said in its report.

The accounting watchdog also released a revised inspection report for 2016 that found deficiencies in 22 of 51 engagements.

Some of the most common deficiencies occurred in the area of revenue and included failures to sufficiently test the design or effectiveness of controls.

https://www.cfo.com/auditing/2019/01/accounting-watchdog-finds-ongoing-problems-at-kpmg/

4. SEC Charges Three Former KPMG Audit Partners for Exam Sharing Misconduct

Washington D.C., May 18, 2020 

The Securities and Exchange Commission today announced settled charges against three former KPMG LLP audit partners for improperly sharing answers to internal training exams and for subsequent wrongdoing during an investigation of exam sharing misconduct at the firm. The SEC previously charged KPMG with violations concerning the exam sharing misconduct, as well as for altering past audit work after receiving stolen information about inspections that would be conducted by the PCAOB.

An NCUA Examination Comment On External Auditing

Following is an excerpt of standard wording NCUA provided one  credit union’s supervisory committee about managing their external audit process: (emphasis added)

Examiner’s Observation: As standard exam procedure, we conducted a meeting with the supervisory committee chair during this year’s examination. We inquired about the process of soliciting bids from audit firms prior to the end of the engagement period, to select the audit firm for the next engagement period. Our discussions with the supervisory committee and review of policies and procedures noted that there is no documented bidding process and that the audit committee has not solicited bids since 2010.

It also appears that the audit committee had no defined timeline as to when they would solicit bids in the future. While specific limits are not required, recent accounting and auditing scandals highlight the importance of rotating audit firms periodically. Otherwise, auditors and clients could loose independence and overlook areas of concern.

Prudent and standard business practices recommend the development of written processes and procedures, outlining the steps the supervisory committee needs to follow when engaging an audit firm to complete the annual audit. The supervisory committee needs to follow the guidelines when soliciting and reviewing bids from audit firms.

We recommend the supervisory committee develop, approve, and implement written procedures for reviewing proposals for the annual audit. Furthermore, the audit committee must understand and implement the procedures as intended, as this is among the most important functions of the committee. It is imperative the supervisory committee maintain documentation to support their review and selection of the audit firm. Furthermore, we recommend that management and the board consider periodically rotating audit firms. It is important to note we are not taking exception to or criticizing the quality of the annual audit report or the audit firm.

An Example of a Board Policy Statement of a Co-op’s Audit Process

Effective audit controls include review as to whether internal and external audits are effective.

• • The Board of Directors and Executive Management of XYZ expect to be apprised of the condition of the organization, including the system of internal controls.
  • On an annual basis the Board of Directors is asked to approve the Risk Based Audit Plan. The Audit Plan describes the internal and external audits designed to prove the adequacy and effectiveness of internal controls and policy, as directed by the Board of Directors and Executive Management of XYZ.

Board Action Required

This brief policy statement should be the starting point for a new NCUA Board to better monitor and understand the effectiveness of the Agency’s management. It is what the agency expects of credit unions. Should it not hold itself to the same standard?

At the November NCUA board meeting, two members responding to the NCUSIF update made “the sky is falling” projections about whether the fund will have adequate resources in 2021.

One board member confidently predicted that the assessment of a premium is not a question of if, but when.

Neither forecast was supported by factual analysis.

Relevant Facts

Before offering a simple, immediate solution to these future seers’ concerns it is important to affirm basic facts about the NCUSIF’s financial strength and record.

• As reported by Chairman Hood to Congress the fund’s NOL is 1.32, which is above the legal cap of 1.3%. Anytime the fund exceeds this cap, a premium cannot be charged.
• The current NOL is 12 basis points above the 1.20 floor below which a restoration plan must be prepared. This is a financial margin of almost $2 billion.
• In the last 12 years of operations, the total insurance losses for the entire period Is $1.887 BN or less than the current NOL “surplus” margin.
• NCUA’s transfer of its fixed operating expenses to the NCUSIF via the overhead transfer rate (OTR) in this same 12 years is $1.968 BN or more than the total insurance losses.
• NCUSIF’s operating expenses have grown at a CAGR of 8.06% versus the growth of insured shares of only 5.6% in this time span. It is this fixed operating expense, not insurance losses, that eat up the fund’s revenue.
• The fund’s average insurance 12-year loss is 1.727 of insured savings. This includes the entire years of the Great Recession. The current 12 basis point NOL margin is seven times (700%) this average annual rate of loss.
• The September 2020 NCUSIF financials show an allowance reserve already funded for both general and specific losses. Moreover, the total assets of all code 4 and 5 credit unions is only .64% of the industry’s assets, that is less than 1%. This is the lowest level in the past decade.

Full details of the NCUSIF’s operations can be found on this spread sheet.

2019 NCUSIF Performance Spreadsheet_AJ1

 

The NCUSIF 1% semi-annual deposit “true up” underwriting means the NCUSIF is entirely countercyclical in its structure. The NOL range of 10 basis points(1.20 to 1.30) provides flexibility no matter the uncertainties that might occur. It is the ever-increasing fixed expense charged the NCUSIF in the OTR, not the variable insurance losses, that take the majority of NCUSIF income.

The fund’s financial architecture has proven its resilience since 1984 a period of time in which the FDIC has gone negative three times. The FSLIC failed and was merged into the FDIC in the 1990’s. In spite of these failures, the FDIC is still based on the same premium financial model that has led to its repeated failure.

A Ready, Easy Source of Additional Revenue-Not Premiums

As of September 30, the market value of the NCUSIF investment portfolio exceeded its book value by $586 million. This is due to the precipitous fall in interest rates engineered by the Federal Reserve at the beginning of March responding to the pandemic and economic shut down.

By selling these securities and staying short, the fund would book immediate revenue in the hundreds of millions, become more liquid and be better positioned for the inevitable rise in rates from present historic lows.

This market premium disappears if the securities are held to maturity. The time to realize this gain is now. It will add immediately to equity if the board truly believes the NCUSIF must sustain an NOL above 1.3. A premium cannot be levied if the NOL is above 1.3%

But what about the future revenue possibly foregone when the bonds are sold and reinvested at today’s lower rates? That is a contingency easily modeled, but ultimately relies on the assumptions made about how long the current rate environment is likely to continue.

The NCUSIF reported the following fixed rate investments by the NCUSIF in September:

Term   Rate
4 yrs    .20%
5 yrs    .27%
6 yrs    .36%
7 yrs     .45%

Is there any CFO or CEO who would make investments for their credit union at these terms and fixed rates into the future? While no one knows the future, the preponderance of experience suggests that it will take only one move by the Fed from its current 0-25 bps overnight range, to a first step raising it to 25-50 bps, for all of these investments to be underwater, that is less than book value.

Yes, there is a risk of some foregone revenue next year, but a reasonable forecast suggests that a strong recovery will bring with it higher rates. And if the opposite happens and economic disaster occurs, then the liquidity would be readily available.

The Action Needed and the Precedent

If the NCUA board decides to keep the NOL above the 1.3% current cap, then sell some of its investments, take the gains and recognize the revenue now. When rates rise, the market premium goes away. This is an opportunity that will decline if not disappear in the not-too-distant future.

The precedent is 2008 when the NCUSIF sold longer term securities to prepare for the potential contingencies brought by the Great Recession. This boosted income so that no premium was necessary with the fund reporting net income of $24 million and an NOL of 1.26.

In an October 6, 2015 CU Times op ed, then new board member McWatters presented his approach to credit union regulation. He resigned his board seat last Friday. Below are selected verbatim excerpts of his original policy priorities that I believe should stand the test of time and party.

Credit unions are best served by having a regulator that understands the not-for-profit, cooperative business model. . .

Rick Based Capital Rule

Last week, by a bipartisan margin of 50-9, the House Financial Services Committee sent an undeniable message to the NCUA: Take more time to review the law, assess the need for additional regulation, evaluate alternatives and consider the real impact now and into the future before moving ahead with the Risk-Based Capital 2 final rule.

This is a message I welcomed and championed in my written dissent (available on the agency’s website) to the issuance by the agency of its proposed RBC2 rule last January as contrary to a plain reading of the Federal Credit Union Act.

Regulatory Burden

I think the agency would do well to heed this message for other major regulatory issues as well, most notably how the agency deals with the growing regulatory burden confronting credit unions, particularly small credit unions. The increasing number, scope and costs associated with regulatory requirements, not just from the NCUA but from all agencies, that credit unions must manage is a concern that the NCUA must take more seriously and devote more resources toward addressing in a meaningful way. , ,

Fraud Losses Cost to NCUSIF

We should also more rigorously address the dramatic losses, year in and year out, to the National Credit Union Share Insurance Fund caused by fraudulent activity committed by a limited number of bad actors within the credit union community. . .

Editorial note: All these issues are still live in the industry today.

To ensure a safe Thanksgiving, my wife and I lined up Friday night for our Covid tests at the county recreation center. The test was free. The line took about an hour. Everyone stood six feet apart as the temperature got cooler as night came.

We were given clipboards to complete our registration—name, email, age, race. One of the staff helping with sign ins came by to ask the obligatory questions. Have you had any Covid symptoms? Been around anyone who has tested positive?

It was the last question that was memorable, however. She qualified it by saying “I think I know the answer, but I have to ask anyway. Are you pregnant?”

An NCUA Exam Risk Rating

The predictable routine of bureaucracy is an important factor in performance. We rely on formulaic responses especially by those in authority. But it can also result in actions that contradict common sense.

In a conversation with a CEO about how to respond to his most recent exam, this same anomaly was present.

The credit union has been a CAMEL 1 for almost two decades. It has navigated the pandemic with improving performance. Liquidity is 500% the policy minimum, delinquency is down and most loans in forbearance are back making payments. ROA and net worth are way above peer averages. A consistent track record of exceptional performance in the present and the past, through thick and thin.

So, I asked given these documented facts why the risk rating for “credit” and “liquidity” were judged “moderate” versus the “low” ranking on every other factor. The CEO’s observation was “It feels like we are being punished for what could happen in the future.”

The Culture of Bureaucracy

This is the difficulty with bureaucratic culture. When facts don’t fit a program’s priorities, the instinct is to assert future scenarios that do. This tendency is not limited to examiners. Listening to last week’s NCUA board meeting, two members confidently predicted the future financial downturn of credit unions in 2021 and with it, the necessity of collecting more money for the NCUSIF. This was after the staff updated the distribution of CAMEL ratings that showed the continuing reduction in code 4 and 5 classifications in both total assets and number of credit unions.

Facts will not deter the inevitable government instinct to always seek more money. This prediction of future NCUSIF premiums reflects a bureaucratic mindset similar to asking all males if they are pregnant.

After getting our Covid tests, we walked out by the admin line and everyone wished me a safe pregnancy. For I had answered yes to the question. We all enjoyed the humor of this bureaucratic incongruity.

Common sense, humor and a negative test. Good ingredients for a safe 2020 Thanksgiving. For it is my hunch that 2021 could be the best year credit unions and their members have ever enjoyed.

This week there were two different, but distinctly connected public presentations.

The first was Callahan’s quarterly Trend Watch call which analyzed September 30 data for the credit union system. One takeaway from the slides http://bit.ly/3Q-2020) is the ongoing rise of credit union liquidity to $552 billion, a 45% increase over the past 12 months. This was driven by the historically high 18% pandemic-induced annual share growth. Most of this new liquidity is in cash and short-term investments. Credit unions are awash in liquidity.

Across town NCUA Chair Hood submitted Congressional testimony to the Senate Banking Committee.

His statement included a Central Liquidity Facility (CLF) update. He reported that the number of natural person regular CLF members was 340, up from 283 members in April when the CARES Act changes were passed. All eleven corporate credit unions became agent members in May. As a result 4,145 credit unions, or 80 percent of all federally insured credit unions, now have access to the CLF.

These new members increased subscribed capital stock to $989.8 million. The facility’s borrowing authority increased to $32.2 billion from $21.7 billion as a result of the Cares Act changes.

In his statement he had one legislative request. It was that the statutory changes providing the CLF greater flexibility from CARES Act be “extended for the length of the pandemic.” These four changes were the increase in the borrowing multiple from 12 to 16 times capital, relaxed agent membership requirements, a broader definition of liquidity needs, and greater discretion in lending authority.

What Was Left Out of Hood’s Testimony

What Hood did not mention was that there has been zero demand for CLF loans. The co-op system has record amounts of liquidity. Also credit union asset quality has remained stable with readily available market values, unlike the situation in the 2009/2010 Great Recession.

Even though 80% of credit unions may be members, the amount of subscribed capital stock (1/4 of 1%), suggests that they represent only 25% of the industry’s $1.547 trillion total shares as of September 30. In other words, most of the largest credit unions with three quarters of the movement’s total assets have chosen not to join.

What are the reasons the largest credit unions see the CLF as irrelevant? If there is zero loan demand now, and the most probable scenario going forward, why extend temporary “reforms” that have no practical purpose? Why should $1 billion of credit union funds be tied up in an NCUA-managed entity that is not providing value for credit unions?

The CLF’s Future: A Time for Transformation

The CLF enabling legislation was passed in 1977 when credit unions were outside the established financial system. They had no access to the Federal Reserve clearing system nor could they join the FHLB’s. The CLF was intended to be the third leg of the regulatory structure for an independent cooperative financial system when added to NCUA’s chartering/supervision and insurance responsibilities.

Since founding, the primary use of the CLF is to fund NCUA’s insurance regulatory needs, not credit union liquidity. In the aftermath of the corporate crisis and the liquidation of US Central, the partnership which covered 100% of the industry was ended and nothing replaced it.

The current “temporary” CARES Act changes are merely a deformed offspring of a partnership effort which NCUA terminated.

With the availability of FHLB funding and access to the Fed, the question is: does the credit union system need the CLF?

Hood described the CLF’s role in his Senate statement:

“The CLF is a mixed-ownership government corporation that provides the credit union system with a contingent source of funds to assist credit unions experiencing unusual or unexpected liquidity shortfalls during individual or system-wide liquidity events. The CLF also serves as an additional liquidity source for the Share Insurance Fund, which helps to ensure the credit union system and the fund remain strong. Member credit unions own the CLF, which is managed by the NCUA. Joining the facility is voluntary.”

How might this public-private voluntary partnership become more relevant for its owners and credit union members? What would real reform look like?

The Rare Opportunity for National Credit Union Legislation

Historically, significant federal credit union legislation happens only once per decade. The CLF/NCUA restructure in 1977; the NCUSIF redesign in 1984; passage of CUMAA in 1988; the TCCUSF in 2009; and today.

The only occasion when the impetus was not a national economic crisis was the Membership Access Act in 1998 following the Supreme Court’s decision to narrowly define FCU’s field of membership.

The current prospect of more pandemic legislative is another of these infrequent occasions. But the legislation needed is not a temporary extension “to the end of the pandemic,” but a rethinking of the role of the CLF in the cooperative system.

Such a reform would focus on the system’s total liquidity needs, not mere firefighting in a crisis. It would involve three areas of change:

1. Broaden the purpose and scope of the CLF. The fund would be charged with improving access for credit union liquidity in both normal and extraordinary circumstances.
2. Its operations would become a cooperative conduit to the secondary market much like Fannie and Freddie, not just an emergency source of cash.
3. Its governance would be similar to the FHLB where the member owners would vote for a board of directors representing the membership. The board in turn would contract with NCUA and corporates on the management of the fund’s short term and extended lending authorities.

Such a CUSO-like redesign would incorporate cooperative principles and focus solely on credit unions to provide members better options in good and difficult times.

The time to do this is now. The 45-year-old legislative assumptions and structure of the CLF are no longer relevant to the operations of today’s credit union system.

To make this happen, current credit union and corporate owners should provide their transformative design and request NCUA support for the legislation to bring it about.

Working together a new CLF could truly become a Cooperative Liquidity Facility and help underwrite a new era of credit union safe and sound practice Real reform would make this legislative effort truly innovative and consequential, versus temporary and irrelevant.

Several probable NCUA board openings mean there will be new leadership at NCUA during the next year. In the past decade the appointments have been without any apparent industry influence. In several instances the board member had no credit union or regulatory background.

To bring knowledgeable and capable candidates to the new administration’s attention, the effort should begin now, be public and stress the importance of credit unions’ role in serving America’s consumers.

Biden Transition Teams In Place

The incoming administration recently announced over twenty transition teams to advise on every major government department and activity. The teams total over 530 people and were formed during the campaign. The complete listing is here:

https://buildbackbetter.com/the-transition/agency-review-teams/

Their role is described as: “Agency review teams are responsible for understanding the operations of each agency, ensuring a smooth transfer of power, and preparing for President-elect Biden and Vice President-elect Harris and their cabinet to hit the ground running on Day One. These teams are composed of highly experienced and talented professionals with deep backgrounds in crucial policy areas across the federal government. The teams have been crafted to ensure they not only reflect the values and priorities of the incoming administration, but also reflect the diversity of perspectives crucial for addressing America’s most urgent and complex challenges.”

One Credit Union Leader as a Member

The most recent employment column shows appointees from law firms, universities, consulting businesses, Visa, banking, think tanks and the ubiquitous “self-employed.” Scanning the listings, I could find only one current credit union leader in the group under the CFPB team.

Consumer Financial Protection Bureau

Bill Bynum Hope Enterprise Corporation Volunteer

Credit Unions know Bill as the CEO of the $352 million Hope FCU in Jackson, MS.

The transition team charged with overseeing federal regulatory agencies is listed below. I do not know if any of these have cooperative or credit union experience or are even credit union members.

However, at least four of the institutional employers of these members have credit unions serving their community. It would seem useful if the CEO’s of these credit unions would make contact and ask if it would be appropriate to bring credit union needs to the committee’s purview.

Federal Reserve, Banking and Securities Regulators

The Federal Reserve, Banking and Securities Regulators group includes the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Federal Reserve, the National Credit Union Administration, and the Securities and Exchange Commission.

Name	Most Recent Employment	Source of Funding
Gary Gensler, Team Lead	Massachusetts Institute of Technology	Volunteer
Reena Aggarwal	Georgetown University	Volunteer
Mehrsa Baradaran	University of California, Irvine School of Law	Volunteer
Lisa Cook	Michigan State University	Volunteer
Amanda Fischer	Washington Center for Equitable Growth	Volunteer
Andy Green	Center for American Progress	Volunteer
Campbell Haynes	Virginia Coordinated Campaign	Transition — PT Fund, Inc.
Simon Johnson	Massachusetts Institute of Technology	Volunteer
Dennis Kelleher	Better Markets, Inc.	Volunteer
Satyam Khanna	New York University, School of Law, Institute for Corporate Governance and Finance	Volunteer
Renaye Manley	Service Employees International Union	Volunteer
Lev Menand	Columbia University	Volunteer
Damon Silvers	AFL-CIO	Volunteer
Victoria Suarez-Palomo	Orrick, Herrington & Sutcliffe, LLP	Volunteer

It’s About Relationships

Credit unions’ competitive advantage depends on the relationship with its member-owners. Politics depends on relationships built on loyalty. Now is the time to reinvigorate existing relationships or establish new ones. Maybe we could start by asking Bill Bynum for counsel?

From an early age, one learns that actions speak louder than words. This observation applies to institutional behavior as well as individuals.

NCUA Recognizing Credit Union Growth

A regulatory example supporting cooperative expansion is from the NCUA’s 1978 Annual Report (pgs. 26-27) under the Chartering heading:

“During 1978 , 348 new federal charters were issued. The combined potential membership of newly chartered FCU’s in 1978 was 1,081,953 persons. Most (225) new Federal charters were issued to credit unions serving occupational fields of membership . . .approximately 47% of the new charters were issued to groups in five state—Pennsylvania for 46; New York, 45; New Jersey 30; California, 22; and Texas 22. “

Propelling These New Chartering Successes (pg. 27)

“Under the Administrator’s Organizer’s Recognition Program, the Administrator (NCUA Chair) recognized the efforts of volunteers, trade association representatives and NCUA staff members for organizing new Federal credit unions. During the year 117 awards were issued under the provision of this program. Twenty-three certificates of were issued for fifth charters, 10 certificates were issued for tenth charters, and two special certificates for 25^th charters. The remainder of awards (82) were given for first charters.”

Honoring Credit Unions Serving Family Members (pg. 27)

“In mid 1977 A Family Service Award Program was established to recognize those Federal credit unions that actively seek to provide financial services to all eligible family members. A total of 107 Federal credit unions received the Family Service Award in 1978.”

Supporting Cooperative Outcomes

Leading by example is harder than issuing new rules or pronouncements about expected performance. Leadership by example requires transparency and provides public accountability.

Imagine how those NCUA, League, and credit union employees must have felt about their personal recognition. And how others might aspire for the same. The awards confirmed the priority and value of these individual and institutional efforts. They celebrated important progress in the cooperative model’s expansion.

The question from these examples: How is NCUA recognizing cooperative achievements today?

At the September 17^th NCUA board meeting, the three members responded with misleading statements, false comparisons, and dire warnings about the June 30, 2020 financial update of the NCUSIF. Their dialogue materially misrepresented the state of the NCUSIF currently and in the future.

All three implied the fund will need more money and new, FDIC-like flexibility in assessing potential premiums. Mark McWatters even suggested that the 1% NCUSIF deposit was double counting this credit union asset, unlike the FDIC which has no deposit base.

Before addressing the mischaracterizations, it is important to recall how the current NCUSIF, redesigned in 1984, still depends upon a most important innovation–the cooperative movement’s democratic foundation.

“It Is Your Fund”

As NCUA Chairman Ed Callahan stated in NCUA’s 1984 Annual Report (pg. 18) describing the NCUSIF’s restructuring: “We’ve said all along that it’s a better way, but it is also unique. . .It is unique because really it is your Fund.”

While much comment is properly focused on the radically changed financial structure of the NCUSIF from a premium to a deposit-based fund, often overlooked is the fact that the NCUSIF is a credit-union-owned fund. The redesign was built on cooperative principles. The fund is not “owned” by the NCUA or even the federal government. Rather, members send 1 cent of every deposit for its capital base, just as member shares are the basic capital of every credit union.

This democratization of the NCUSIF also entailed responsibilities that any member-owned institution requires. In the same 1984 article, Chairman Callahan laid out these duties: “It means you have an investment in your fund. . .Can you forget about it? Well do you ignore your other investments, or do you monitor them?”

He listed the safeguards created to monitor NCUA’s management of the fund. These included the withdrawable option of the deposit; the 1.3% cap above which a dividend must be paid; the monthly report by the NCUA board to track expenses and losses; and the annual external audit, as just some of the new guard rails.

He closed: “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 is your responsibility to keep it working—because if you don’t, it’ll go just like anything else the government touches. When government gets more money, it wants to spend more. Our goal is to spend less. You have to hold us to that promise.” His message is timelier than ever: that a democratically formed fund requires ongoing engagement, not passive acquiesce.

The industry supported legislative changes made in 1984 are still in place. NCUA’s commitments of self-restraint, transparency and responsive oversight that made this common effort possible are also still binding.

Before this congressionally approved redesign, the statutory NOL was 1%. NCUA had only premiums as its primary income. These premiums were not subject to credit union review or even consent. The new cooperative restructuring created checks and balances and institutional commitments so that NCUA would be accountable to the fund’s owners and the common good of the credit union system.

The NCUSIF Is Not the FDIC

The insured savings coverage of the FDIC and NCUSIF are the same. But that is where the similarity ends.

The two funds serve very different financial segments. The NCUSIF is for not-for-profit member-owned cooperatives based on self-help; the FDIC, profit making institutions. FDIC is a stand-alone insurance provider; NCUSIF is one aspect of a tripart regulatory structure. Reflecting the different purposes and “capital” options of the organizations served, the two funds have unique financial structures and constraints.

Finally, their histories and roles have evolved from very contrasting circumstances. The FDIC was created in 1933 in the middle of Great Depression and a national banking crisis; the NCUSIF in 1971 as a recognition of a vital economic role that warranted an option for a federally managed fund alongside the banks and S&L’s.

The Sept. 17^th NCUSIF update mischaracterized the fund’s financial situation in emphasizing the decline in the operating level from 1.35% to 1.22% at June 30, an apparent fall of 13 basis points. This reduction appears close to the 1.2 lower limit, below which the Board is required to develop an eight year “restoration plan.”

This ratio calculation recognized all insured shares as of June 30 but does not include the required capitalization deposit contribution from credit unions’ net increase of shares as of the same date. This accounting receivable is only recognized “when invoiced” thereby creating an artificial lag in presenting the fund’s actual financial position.

As stated by staff when questioned, when invoices are sent in October the fund’s ratio will be 1.33% due to the added $1.5 billion in required capitalization deposits. The ratio is nowhere near the 1.2% floor. The headline portrayal of a precipitate decline in the ratio is significantly misleading. Moreover, staff forecasted that even before considering this accounting lag, the fund will be around 1.32% at year end.

Faulty Analysis and Comparisons

The NCUA’s board oversees the three legs of regulatory responsibility: chartering/supervision, liquidity, and insurance. FDIC is only an insurer. OCC (or state regulators) and the Fed have the other roles. The combined regulatory functions in NCUA should increase efficiency of operations. Instead, as shown on the enclosed spread sheet, NCUA has increasingly used insurance fund income to pay its agency-wide fixed costs of operations.

The FDIC and NCUSIF have totally different financial structures. FDIC is a premium-based fund. Its reserves come from charging banks an expense, plus the minimal revenue it earns on investments, to build its capital base.

This premium-based revenue stream has repeatedly been insufficient to align the fund’s base with fluctuations in insured deposits, unexpected loss events or even changes in interest rates. This was the same result for NCUSIF’s early “premium-based” years and why “a better way” was implemented in 1984.

The NCUSIF is a deposit-based fund which aligns its growth with credit union insured savings. This 1%, which is 80% of the 1.25 of the normal operating level’s midrange (NOL), increases the fund’s size automatically, every six months.

The FDIC reliance on premiums to keep pace with deposit growth means that

at an average annual fee of .08% of assets, approximately ten years would be needed to increase the FDIC’s balance to maintain its NOL ratio. By contrast, the NCUSIF’s structure accomplishes this increase in fund balances semi-annually with the 1% capital deposit adjustment.

The stability of the NCUSIF’s asset base means that both earnings and liquidity are more dependable than the premium-revenue model of the FDIC. Because its revenue is fee dependent, the FDIC requires a much longer time period to increase its core assets (unless fees are raised). This fact underscores the urgency for FDIC ‘s restoration plan when it falls below the Congressionally mandated 1.35%.

For the NCUSIF, the normal operating level is a range between the floor of 1.2 and cap of 1.3%, or 10 basis points of insured shares. The NCUA, using flawed logic, “temporarily” raised the NOL to 1.39% in 2017 when merging the TCCUSF. The board then failed, despite Chairman McWatters’ promise, to review these “temporary” justifications as the NOL came up for review in the following two years–most recently in December 2019.

We’ve Been Here Before

Board Member Harper asked staff if there was a precedent for the extraordinary share growth during COVID. He called it a “black swan event which we haven’t seen before or even thought about.” That assertion is dead wrong. For the three years following the 1% deposit restructuring in 1984, credit unions experienced double digit share growth. Not only did the fund stay in the 1.2-1.3% NOL range, there were no premiums.

The advantage of a range with a floor and a cap as the normal operating level means there is a surplus always available, apart from current income, to meet any extraordinary needs.

Today that 10 basis point range totals over $1.4 billion and grows proportional with the credit union insured base. There has never been an insurance loss that comes close to this NOL range. The NCUSIF’s historical loss rate for the past 12 years is just 1.727 basis points off for each $1 of insured shares or over 5 times this 10-basis point variation.

• 2019 NCUSIF Performance Spreadsheet_AJ1 (PDF)

• 2019 NCUSIF Performance Spreadsheet_AJ1 (Excel)

This 12-year analysis shows insured share growth of 5.6% CAGR. To maintain the NCUSIF’s NOL at 1.25% of insured shares with this long-term growth rate and also cover the average known loss rate (1.727 basis points), the fund must earn 1.14% on its investments. Today the NCUSIF’s yield in 2020 is 1.63% with an average weighted life of investments exceeding three years. There is over $620 million in unrealized gains on these investments. Given the Federal Reserve’s low interest rate policy, these gains should remain for years to come if needed to generate additional current income.

The Real Issue–Uncontrolled Spending

The misleading discussion of the NCUSIF’s resilience and the suggestion that legislative adjustments are needed should alarm credit union owners.

When asked to support the fund’s restructure in 1984, credit unions’ most worrisome concern was their open-ended 1% capital base funding obligation. How do we know NCUA won’t just spend the money, they asked again and again? There were built-in protections to ensure that members’ money was prudently managed. In addition to those listed in NCUA’s 1984 Annual Report, these included:

• The elimination of special premiums;
• An annual premium could not be charged to raise the fund above 1.3; rather an increase in the ratio can only come from retained surplus.
• Monthly board reports on the NCUSIF’s condition;
• Control of operating expenses, and especially the overhead transfer rate used to partially pay for NCUA’s operations

It is not insured losses that use up the NCUSIF’s revenue. In the last 12 years, NCUA has charged the NCUSIF $1.968 billion in operating expenses, while incurring cash insurance losses of only $1.888 billion. (see spread sheet) To increase these charges, the overhead transfer charges were raised from 33% in 1984 to 61% in the most recent calendar year.

So far in 2020, the NCUSIF has spent $94.1 million on operations and $34.5 million on loss reserve expenses. The core concern of credit unions addressed by Chairman Callahan decades ago has occurred. Absent management and supervisory effectiveness, the natural impulse of government is to implement oversight by just spending more.

In the September 17^th NCUA insurance presentation, staff showed that the total amount of code 3, 4, and 5 CAMEL rated credit unions had declined. The one liquidation year-to-date was largely due to “fraud” and resulted in a minimal loss. This is the best measure for supervision responsiveness and creativity, not the amount of NCUSIF’s reserves.

Board members uniformly congratulated themselves for increasing the fund’s NOL to 1.38, a figure that has never been factually explained. All expressed apprehension about probable future losses. Each suggested a “restoration plan” needs to be anticipated, even though this has never been a close event in the fund’s almost 40 years since financial restructure.

Board members failed to mention that the fund might help credit unions transition through this downturn by providing temporary capital assistance. The NCUSIF is more than a fund to cover loss. More critically it is a source of supplemental capital, an historical activity inherent in its cooperative structure. In credit unions, unlike banks, no private owners’ investment is being saved, nor is “moral hazard” risk present. Both of these severely limit FDIC’s open bank assistance efforts.

Not a Money Issue, But a Time for Leadership

As shown in the spread sheet attached, the resources of the NCUSIF have always been more than adequate. It is disheartening to hear board member McWatters congratulate himself for creating a “sizeable safety net of reserves” when raising the NOL to 1.39% on erroneous data. He then opined that FDIC gets to count 1% as its own funds and that the 1% credit union deposit is double counting. He appears to have no knowledge of either fund’s accounting basis or an understanding of how the NCUSIF structure aligns with the cooperative self-help credit union funding model.

As evidenced in recent, unprecedented insured losses, the board also seems to think that problem resolution means holding fire sales to for-profit firms of member loans as fulfilling the agency’s obligation to member-borrowers.

Board Member Harper referenced the FDIC and its multiple options that he would like to incorporate in the NCUSIF’s oversight. These changes would require Congressional legislation. If adopted, they would destroy the remaining checks and balances credit unions relied upon when they agreed to an open-ended, perpetual capital funding commitment of the NCUSIF.

Harper’s view that we are in the “calm before the storm” and “we” should initiate legislation to put the fund on a “counter-cyclical” footing, is a misunderstanding of the NCUSIF’s fundamental financial structure. The semi-annual 1% deposit is an inherently counter-cyclical self-funding model. Unlike a premium system, it ensures resources are readily available at all times to assist credit unions.

The NCUA board referred the FDIC’s recent decision to initiate a restoration plan to restore its required 1.35% level (now 1.3%) after seeing the same double-digit run up in bank insured deposits. What each board member failed to note is that the FDIC board, based on an analysis of the environment and its staff’s recommendation, made no changes in its current assessments. As stated by the Chair Jelena McWilliams at the September FDIC board meeting:

In establishing a restoration plan, we explored a range of reasonable estimates of future insured deposit growth and future potential DIF losses. Based on these estimates, we project the reserve ratio would return to a level above 1.35 percent without any increase in the deposit insurance assessment rate schedule.

Mobilizing Cooperative Democratic Engagement

Hopefully, Chairman Hood will show the same confidence in the NCUSIF’s resilience (and NCUA’s supervisory capabilities) as the FDIC board demonstrated in assessing its fund’s outlook in the current environment.

Given the NCUA Board’s public dialogue, credit unions must mobilize their cooperative courage and assert their concern to keep the financial integrity and institutional commitments Congress and NCUA made in 1984. With the Board’s track record of unrestrained spending and alarmist projections, the necessity for credit unions to monitor their common investment in the NCUSIF could not be more urgent. That involvement, just as in 1984, is the key to this unique democratic fund’s survival.

Comments on Spread Sheet attached
Source: NCUSIF Audited Financial Statements 2008-2019

• 2019 NCUSIF Performance Spreadsheet_AJ1 (PDF)

• 2019 NCUSIF Performance Spreadsheet_AJ1 (Excel)

1. Compound Annual Growth Rate (CAGR) insured savings: 5.6%
   CAGR: NCUSIF Operating expenses: 8.06%

2. Cumulative NCUSIF Insurance loss rate per each dollar of insured savings:
   12-year average: 1.727 basis points
   One-year High: 6.95 basis points (2018)
   One year Low:  .127 basis points (2016)

3. December Year End NOL level: Fund equity to insured shares
   Low 1.23 (2009)
   High 1.39 (2018)

4. Overhead Transfer (OTR) as % of total NCUSIF Operating expenses: 92.5% twelve-year average
   OTR low rate: 52% (2008)
   OTR High rate: 73.1% (2016)
   Twelve-year numerical average OTR 62.01%

5. Fiscal Year End allowance Loss as a % of following year’s actual cash loss
   Low year 117% (2017
   High year 1,349% (2014)

Numerical average of year end allowance divided by following year’s actual cash losses: 570% or the loss account expense is funded at a level almost six times the following year’s actual cash losses.