Category: NCUSIF

Ed Callahan as both Director of the DFI in Illinois and as Chair of NCUA, had a post-Thanksgiving practice to recognize the December holiday spirit.  He would find a local radio station that  played holiday music as its full time programming through Christmas.  In  Washington the classical FM stations used to follow this practice.

He kept the volume low, but still  enough to acknowledge the special spirit and joy this time of year can bring.

But work does not go away.   December is the month that the NCUA board will make very consequential decisions on the amount of credit union funds it proposes to spend.

The budget agenda includes how much is spent, the normal operating level (NOL) for the insurance fund, the Overhead Transfer Rate (OTR) taken from the NCUSIF,  and how the full year financials for  three credit union funded operations were managed.

December’s posts will imitate Ed’s practice by presenting music of the season.   At the same time, I will preview some of the data and issues for NCUA’s upcoming budget approvals, along with other observations.

This is a season of joy and beauty, sometimes beyond our understanding.  But amid these moments of glory the real world events  of power used and misused continue.

Angels We Have Heard on High

This French Christmas hymn was translated by James Chadwick and is performed by a traditional choir.

(https://www.youtube.com/watch?v=7RlMuRYvndU)

NCUA’s Budget Creep: Growing from a Specialist to an 8-Person Office

On February 10, 2020 NCUA ‘s IG published an investigation  titled Misuse of Official Time, Illegal Drug Use, Time and Attendance Fraud.

In a March 9, 2020 post, I wrote of the personal indiscretions by Michael McKenna, NCUA General Counsel (July 2011 to November 2019) and his Deputy General Counsel Lara Daly-Sims.

The IG report detailed strip club visits and drinking while on the job from February 2017 through the beginning of the investigation in November 2019.  The General Counsel is the Agency’s senior legal officer providing interpretations and support directly to the NCUA Board and Chair.

Besides replacing the Agency’s two top lawyers, what else did the Board do about this high level leadership failure?   On April 22, 2020 NCUA announced that in a March closed meeting the Board decided to hire a “chief ethics counsel.”

Supervised by the chairman, the press release stated: “The Office of Ethics Counsel will certify the agency’s compliance with relevant federal ethics laws and regulations, promote accountability and ethical conduct, and help ensure the success of the NCUA’s ethics programs.” This responsibility had been under the General Counsel’s office.

This personnel performance failure was resolved by expanding staff, a classic bureaucratic response to a problem. This new position was necessary to inform three board members, their personal policy advisors, senior staff including the executive director and deputy, the general counsel and deputy, and the human resources office the difference between right and wrong behavior!

The real problem was actually a failure of administrative oversight, not understanding morality.  The hiring was a political act to divert responsibility from all the senior staff who worked closely with these people during the episodes described in the IG’s investigation.

But is there any downside for another pair of eyes reviewing the agency’s personnel actions.  There is. It quickly became much more than one pair of eyes.

The 2024 NCUA budget increases the Office of Ethics Counsel to 8 full time staff with an average salary of $293,000 each.  This 15.2%  increase pushes the total 2024  expenditures to $2.449 million.

Some believe that problems are solved by government  spending more.  In this episode of personal indiscretions, the solution has grown from a “chief ethics counsel” to a separate, new legal department of  8 full time employees.

This is the pattern across NCUA’s ever expanding budgets for 20 separate “Offices” and three regions.

Harper and Hood both approved this solution (McWaters was replaced by Hauptman).   Is now the time to assess this ever-growing cost to determine whether there are more efficient ways to address the Agency’s ethical climate?

If safety and soundness is the Agency’s primary purpose how does an 8-person Ethics Office contribute?  These positions are in addition to the 44- person legal department and 47 employed in human resources.  Are ethics of the NCUA staff really that big a problem?

The initial Thanksgiving story celebrates abundance.  The timing still coincides with the regular rhythms of bountiful harvests which have filled farmer’s storage elevators to capacity.

Times are good. The American economy grew the fastest of any major country in the third quarter.  Unemployment remains at historical lows and inflation is sinking.  Job openings still exceed available workers.

This harvest holiday combines services of Thanksgiving with opportunities to share  with those in need in our communities.  Locally, families who may participate in an early morning turkey trot race can then go to a food kitchen to serve others  in the afternoon.

It is important for our future together as Americans to see our society from a perspective of abundance, rather than an economy of scarcity.  Even when our consumer driven culture constantly tells  us we need more.

Perspective Matters

Abundance does not mean prosperity is equally or equitably shared.  But without a sense of our own well being, serving others easily becomes secondary.

Recently Callahans Trend Watch presented a 60+ set of data slides with commentary on the state of credit unions as of the third quarter.

The message repeated throughout was that the industry is sound and that trends are normalizing from the exaggerated levels due to COVID.

However not all listeners had the same interpretation.  The headline in one credit union report about the call was Callahan Shows Sharp Drop in Q3 Earnings for Credit Unions.   This news story of the one hour briefing included multiple use of the words down, fell or fell sharply, far below and lower.  The overall tone was one of angst:

Credit union’s loan balances grew. . . but the growth rate was down. . . One way credit unions have coped with tighter liquidity is through borrowing, which has tripled in the past two years. It still accounts for a small portion of assets, but that portion is growing.

This was  the opposite interpretation the presenters gave.  Here are some of the headlines from the data slides:

The loan to share ratio is returning to prepandemic highs

Credit union market share is growing in key areas

Share draft account penetration climbs steadily

Quarterly loan originations are on a par with previous levels

Repricing drives record increasing total revenue

Capital ratios improve from slower asset growth

Operational efficiency improves. . . etc.

“Never Enough”

There is a belief created by America’s market driven, consumer led economy that one can never have enough.  Consumerism in its extreme forms becomes an addiction where spending becomes a way to cope with all of life’s shortcomings.

It unfortunately  appears to be the logic of NCUA as it prepares its budgets for its role with credit unions.  In the NCUSIF board  update dialogue last week, the fact that the actual losses are less than $1.0 million, fund reserves at a level of four to five times the last five years actual total losses, made no difference.   Board members observed the CAMELS trends are negative and Black Swan events could be just around the corner.

The NCUA’s budget for the next two years shows increases of double digit spending.  It is driven by the belief that there are never enough resources even with a declining number of charters.  Spending, like consumerism, becomes an addiction not a response to reality.

A Story of Gratitude

How does one respond in a society whose marketplace messages are constant efforts to make one dissatisfied with their current situation, whether personal or with an organization’s future outcomes?

In February 1982 my family and I moved to Bethesda, MD from Illinois to serve at NCUA alongside Bucky Sebastian and Ed Callahan.

At that time one of Bethesda’s local residents was called the “bag lady.”  She walked pushing her shopping cart filled with plastic grocery bags, cardboard and  personal possessions throughout the downtown area.

When the weather was cold, raining or she just need to stay indoors for a night, she would somehow find a way into a church, right next to her downtown journeys.

Our family could walk to this local Bethesda Presbyterian church, where I sang in the choir on Sundays.  The bag lady’s frequent overnight visits were a topic of conversation about the church’s security.  The questions was, how did she always find another way to get in?  Weren’t we locking all the doors?

One Sunday morning as I came early for choir rehearsal, the minister was in the sanctuary placing the offering plates on the alter for the service.  I noticed as he put the top plate to one side of the cross he took something out and put it in his suit coat pocket.  I asked. “Oh did somebody forget to take the offering?”

I will never forget his response:  “No, that’s just the bag lady.  Every time she stays here she puts something in the offering plate. She has left hairpins, political campaign pins and even clothing buttons.”

This lady had little to none of the world’s possessions. However she still had one of the greatest gifts anyone can ever receive: gratitude.

When we celebrate the varied and numerous  blessings which we all enjoy, may we experience the gratefulness this person knew and shared.

In a Marketplace analysis yesterday, the daily financial update reported how the Federal Reserve’s management of its multi-trillion dollar portfolio can reduce or increase the government’s overall operating deficit.

As reported, for the last 15 years the Fed’s been making about $100 billion a year a profit sent right to the Treasury which, as revenue, reduces the federal deficit.

The “profit” comes from the net spread between what the Fed earns on the trillions of  bonds and mortgage-backed securities that it began purchasing during the financial crisis of 2008 under the policy of “quantitative easing.”

This macro economic policy continued and expanded during the Covid shutdown.   The cost to carry these interest earning assets in the Covid era was near zero.  The majority of funding was from the excess reserves banks kept with the Fed which was paying less than 1%.

Today that spread is upside down as the cost of funds has risen to nearly 5.5% on overnights.  Rates on the portfolio are mostly fixed and at much lower yields as securities were purchased in a much different part of the interest rate cycle. Interest expense is now greater than interest income with the result that “the Fed has lost on the order of $100 billion since last fall,”

Here are the Fed’s total balance sheet holdings as of October 18, 2023 showing almost $8 trillion in total assets.  Tables show that the majority of assets have maturities beyond ten years.

When the Fed has a loss, it files the loss away until it can pay it back once it’s making a profit again. This year’s “loss” will equal about 5% of the total government deficit.  So instead of lowering the shortfall as in prior years, it adds to it.

The NCUSIF Analogy

The largest asset managed by the NCUA is the NCUSIF’s $22 billion investment portfolio.  As of August 30, $4 billion was invested overnight with a yield of 5.4%.  The remaining $18 billion was invested in maturities as long as seven years with a combined yield of 1.4%.

At month end the portfolio’s market value was $1.5 billion less than book.  As short term investments become a greater portion of the total, the duration has declined slightly to 2.64 years.  This is the approximate time that it would take the cash flows from the maturing investments to be at  market–should the current yield environment become the new “normal.”

If the NCUSIF’s portfolio yield were 5% or greater, the fund’s total revenue would exceed $1 billion. This would result in dividends to the fund’s credit union owners. When the portfolio is below market for an extended period this shortfall comes out of credit unions’ pockets.

Time for Credit Unions to Be Alert

It will be critical for credit unions to monitor the monthly updates of the fund. The Agency’s upcoming investment decisions are critical. Its interest rate risk management and duration will  have a critical impact on the Fund’s future.  This includes total revenue, its financial soundness and credit unions’ bottom lines.

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

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

The Fund’s Normal Operating Level is Stable and Growing

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

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

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

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

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

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

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

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

The NCUSIF’s Below Market Valuation

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

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

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

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

The Accuracy of Staff Projections

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

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

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

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

The Board Meeting Process

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

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

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

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

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

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

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

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

Following are excerpts from two NCUA chairmen on the state of the credit union system.

Both presentations came following severe economic disruption.  In one case the events included double digit inflation and unemployment levels, plus the highest short term Fed Funds rate ever-in the mid teens.

In the second,  the economy had emerged from a post covid shut down with inflation rising to 9% and a Fed once again tightening.

The two updates were in May before Congressional banking committees, but 40 years apart: 1983 and 2023.

One statement expressed confidence in credit unions, with sufficient agency capabilities and a pragmatic approach for the future.  The primary concern was including credit unions in any potential banking regulation.

The second statement suggests inevitable failures, insufficient agency resources and the desire for “parity” with any  changes to banking oversight.

The question for readers:   Two assessments 40 years apart: Which understanding of NCUA’s relationship with credit unions is most likely to enhance the movement’s future?

We know the answer to the first approach.  What will be the outcome of the second?

From May, 1983: Chairman Callahan’s testimony before the Senate Banking Committee:

The overall condition of FCU’s is “quite good” thanks to the grassroots strength of the CU movement and to the freedom CUs have been given to adjust to local market conditions, NCUA Board Chairman told the Senate Banking Committee.

The committee which is conducting oversight hearings into the conditions of the financial system was told by Callahan that “few if any changes should be made in the existing  CU operational and regulatory environment.”

Reporting on 1982 financial performance Callahan said that savings at FCUs grew by 17.2% and assets rose by 16%.  As a result, CUs increased their share of the overall consumer savings market from 4.25% to 4.5%.

“I’m pleased to report that deregulation really works,” Callahan said.  “It’s time to leave the credit union system as it is for a while and observe the results.”

The committee is considering  potential changes in the financial industry and Callahan warned against the tendency to apply these changes to CUs.   “CUs, he said, “come from a different mold.  The biggest threat to the movement is not competition, but homogenization to the financial services industry.”

(Source:  Credit Union Magazine,  June 1983, pgs 19-20)

Excerpts From: Chairman Harper’s Written Statement to the House Banking Committee, May 16, 2023:

Legislative Requests

The recent failures of Silicon Valley, Signature, and First Republic banks are a reminder of the dangers of concentration risk and the need for effective risk-management policies and practices to manage capital, interest rate risk, and liquidity risk. These fundamentals have remained true throughout all economic and regulatory cycles and have recently been areas of supervisory focus for the NCUA. Credit unions that fail to manage these core issues can and will continue to fail. . .

Accordingly, to better manage such liquidations in the future, the NCUA requests amendments to the Federal Credit Union Act to provide more flexibility to the NCUA Board to manage the Share Insurance Fund, bringing the fund’s operations more in line with those of the Deposit Insurance Fund administered by the Federal Deposit Insurance Corporation (FDIC). Likewise, as Congress considers amending federal deposit insurance requirements, the NCUA supports maintaining parity between the Share Insurance Fund and the Deposit Insurance Fund. . .

Specifically, the NCUA requests amending the Federal Credit Union Act to remove the 1.50-percent ceiling from the current statutory definition of “normal operating level,” which limits the ability of the Board to establish a higher normal operating level for the Share Insurance Fund. Congress should also remove the limitations on assessing Share Insurance Fund premiums when the equity ratio of the Share Insurance Fund is greater than 1.30 percent and if the premium charged exceeds the amount necessary to restore the equity ratio to 1.30 percent.