Category: NCUSIF

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“Protecting the Insurance Fund”

From NCUA board members’s statements in Senate confirmation hearings  to the examiner on the street, the most frequently stated goal stated by NCUA staff is  to “protect the insurance fund.”

This goal is repeated even though the NCUSIF is a means and not an end in itself.  The ultimate purpose of NCUSIF is to safeguard member assets.

The primary venue in which Board members demonstrate their responsibility to “protect the fund” is the quarterly statistical report  provided by staff and discussed in an open meeting.

The NCUSIF’s status was the principal topic of May’s board meeting.   I was unable to listen to the live broadcast.  All I have is the  slide deck from the agenda and posted board statements, not the actual live exchanges  that took place.

Questions on the NCUSIF’s  from the March Update

Here are some  initial questions from the  information presented.  I would hope that some or many of these would be  part of the dialogue in the Board’s duty “to protect the fund.”

  1. Since December 2021, total NCUSIF assets have declined by $130 million even after recording $578 million in new capital deposits receivable. The cumulative results of operations (equity) shows a decline of $727 million in the first quarter.  How did these declines occur?  How should users of this data understand Fund performance?
  2. The March report shows that the market value of the portfolio has fallen $806 million below cost or book value. What does this decline indicate about the management of the Fund’s interest rate risk?
  3. The Fund’s yield year to date is only 1.22% What is the required breakeven yield to cover the Fund’s operating expenses?  How large is the revenue loss in the next 12 months as indicated by the current and  continued decline in market value?
  4. How did the Fund’s investment committee modify their approach after  the rise in rates initially forecast last October/November  by Chairman Powell?
  5. How will the investment committee deploy the approximately $4.0 billion in funds arriving in the next 12 months from maturities, new capitalization deposits and interest payments?
  6. The Fund reported net income of $54.4 million in the 1st However Slide 13 shows estimated retained earnings of $4.792 billion, or an anticipated loss of $68 million in the current quarter.  That would represent a $122 million net operating decline for the June quarter.  How was this projected?  What is causing this loss?
  7. Insured savings growth is estimated at 7.1% at June 30, 2022, down from 14.2% at the June 2021 quarter. Actual twelve month share growth was 9.3% as of March 31, 2022. How much additional growth  slowdown is projected for this year?
  8. In Slide 13, the numerator and denominator use data from two different time periods to calculate the NCUSIF’s equity ratio (NOL).  If the same June 30 data were used for both parts of the ratio,  the resulting NOL would be 1.283 % versus 1.25 %.   This three basis point difference is over $500 million at the current level of insured shares.   Shouldn’t this more timely ratio be used in reporting the Fund’s actual financial position?

Fund Performance and Investment Policy

The NCUA’s immediate and ongoing opportunity  to “protect the fund” arises from its  management of its current $22 billion and  ever growing asset base.

The questions above are vital to understanding how NCUA staff implements the Board’s twin NCUSIF investment policy objectives  “To meet liquidity needs” and “To invest. . .seeking to maximize yield.”

The March financial statistics raise critical question of how the NCUSIF responded to the changed interest rate outlook over the past 12 months.  And, more importantly how it will respond going forward.

I will report on Board member’s interactions and assessments to NCUSIF’s   March information  when the May meeting video/ transcript is available.   That dialogue will be a useful example to learn how NCUA board members see their role  “ to protect the fund.”

 

 

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Today’s NCUA Board Meeting: an Opportunity for Insight into the NCUSIF

With only one agenda item, the NCUSIF’s March quarterly update, today’s NCUA board meeting presents an in-depth learning opportunity about the fund’s management.

With almost $22 billion in assets, the NCUSIF is the largest investment under NCUA’s control.

Because NCUA publishes monthly updates on its three major funds, credit unions are able to monitor how their members’ funds are being used.

The public board discussion is a vital part of this process for credit unions and board oversight.

What I Am Listening For

  1. There is much confusion caused by the NCUSIF’s use of Federal GAAP versus private GAAP accounting, the standard credit unions must follow. The Federal accounting terms, presentation and practice are different from private GAAP.

This is because Federal GAAP was intended for use by entities which rely on government appropriations.

Some examples.  Cumulative results of operations: Following SFFAS No 7 the NCUSIF recognizes interest on investments as “non-exchange revenue” which in turn means unrealized holding gains and losses are reported as part of revenue.

In contrast, credit union “available for sale” securities are reported at book value with unrealized gains or losses recorded in a valuation account, not as an income or expense.  This  account is not included when computing the net worth ratio.

Credit unions report retained earnings.  Federal accounting has no comparable account. This and other differences mean that NCUA staff transform NCUSIF Federal presentation into a private format, but then do not follow private accounting practice.

For example the 1% deposit true up (or refund) is treated as revenue in the NCUSIF; however credit unions record this adjustment as an investment asset on their books.

Will this confusion be addressed?   How will this affect the calculation of the 1% true up when presenting the NOL ratio for the fund?  Private GAAP recognizes the true up as a receivable or payable on the insurer’s books when the insured risk is reported triggering the required deposit adjustments.

  1. How has the NCUSIF investment committee responded to the rising interest rate environment? The market value of the NCUSIF’s investments may have fallen by as much as $1.5 billion from the peak in 2021.   What changes have been made in response?  How will the below market income stream from the fixed rate, lower earning. long-term bonds, affect the income of the fund and projections of the NOL in 2022?
  2. Credit union’s first quarter results have been summarized in Callahan’s Trendwatch. How does the first quarter’s 9.3% actual share growth compare with NCUA’s projections for the year? What impact, if any, will the rise in interest rates have on CAMELS ratings?
  3. What changes in NCUSIF investment policy and accounting presentation/practice is staff proposing? Or will be requested by the board?

Over the past 16 months, I have written several blogs about NCUSIF investing and accounting anomalies.   Here are selected observations and additional background for the questions that may be raised in today’s meeting:

I’ll follow up next week on the board’s dialogue.  Hopefully this will be a fresh start for improving the fund’s financial practices.

 

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Tantrums and a $10 Million Credit Union Loss

As interest rates continue their upward cycle to reduce inflation, credit unions will manage this year-long transition process with multiple tactics and product adjustments.

There is no one operational formula to be universally applied because every credit union’s balance sheet and market standing is different.

But a simple model was the core of NCUA’s response in 2013 and 2014 when Fed Chairman Ben Bernanke announced a policy change to reduce support for the recovery after the Great Recession.   The reaction to his June 2013 announcement was an abrupt rise in rates, referred by some writers as  a “market tantrum.”

The following  is one credit union’s experience as NCUA  pursued its own regulatory tantrum as recalled by the current CEO.

A Case Study from a Prior Period of Increasing Rates

Today’s rapidly increasing interest rate environment is very reminiscent of the 2013-2014  period when Federal Reserve Chair Ben Bernanke’s “Taper Tantrum” led to a great deal of market volatility.  While Bernanke’s comments in May of 2013 touched off the increase in rates, it really took until the next year for the full effect to be felt.

NCUA’s response to this period of rising rates was nothing short of a panic.  Any credit union holding bonds whose value declined due to the increase in market yields was heavily criticized for having too much interest rate risk.  This critique was despite the fact that most natural person credit union had more than adequate liquidity to hold the bonds. 

The use of static stress tests, which showed dire results from up 300, 400 or 500 basis points, was used as a reason to force credit unions to sell some of their holdings turning unrealized losses, with no operational reason to act, into realized ones.  These forced sales unnecessarily depleted capital, the very thing that an insurer/regulator should be trying to preserve.

Things got so heated at our credit union that the Regional Director called a special meeting. Only our Board of Directors could attend; management was forbidden to be there. NCUA lectured them about the evils of excessive interest rate risk.  This sent many of them and our CEO into a full-scale panic. 

We sought advice from outside experts but finally settled on the dubious strategy of selling bonds at losses as well as borrowing funds from the FHLB that we did not need.  These were done to bring the results of these static stress tests in line with the NCUA’s modeled projections.  We calculated these actions caused us unnecessary losses of over $10 million before we stopped counting.  These came from both the realized losses, the added expense of unneeded borrowings, and the lost revenue on assets sold.

In the aftermath of that debacle, the credit unions senior management and two board members travelled to Alexandria, Virginia to meet a top NCUA regulator to explain our frustration at the loss.  After waiting for hours for our scheduled appointment, he heard us out.  We never heard back; however, the Regional Director soon departed.  Perhaps our message had at least been partially received.

The Problem with Static Tests

Fast forward to today.  We find ourselves in the “extreme risk” rating at the end of the first quarter due to the rapid rise in rates.  The glaring problem with static stress tests is that non-maturity deposits (which make up a large part of most natural person credit unions’ share liabilities) are limited to a one year average life. 

Several third-party studies document our share’s average life to be in excess of ten years.  Despite this, the asset side of the balance sheet is written down while the long-standing member relationships, on which most credit unions’ balance sheets are built, doesn’t get much credit at all.  For example, if a two-year average life on savings and checking accounts were used, the results of the static test wouldn’t even put us in the high interest rate risk category. 

Closing Thoughts

While we have authorization to utilize derivatives (something we didn’t have back in 2014), this could help lower the costs of compliance if we are forced to take action. However, I’m adamant against doing illogical things just to pass a static stress test this time around.

I’ve wondered how it’s OK for the NCUSIF to hold similarly long-term bonds in their portfolios without any concern during periods of volatility like this. We have the strength of our core share relationships and capital positions to withstand periods of rising rates.  NCUA just keeps reporting growing unrealized  losses transferring their IRR risk to credit unions to make up any operating shortfalls.

I also believe that NCUA should really be much more worried about very low interest rate environments.   These periods of very narrow yield curve pickups are actually much worse for financial intermediaries to navigate than periods like the one we’re now in. Overall the industry’s net margin should generally benefit from rising rates, shouldn’t it?

Two Observations

1. One expert’s view of  the situation today:  As you know, but people often forget, there is no ‘unrealized loss’ if a bond or loan is held to maturity.  There is an interest rate risk component that needs to be managed.  But if I am holding some 4% mortgages 10 years from now, and the overnight rate is 4%, then I am not upside-down.  I just have some of my assets earning the minimum rate of return. 

This is why I prefer net income simulation over IRR shock.  We don’t live in a static world, it’s a dynamic one.

2. During the November 2021 Board meeting the following interaction took place on the agency’s management of the NCUSIF portfolio and stress tests:

Board Member Hood: Thank you, Myra.  And again, I do have another question and this is for the record.  Do we all have an interest rate risk shock test to the fund (NCUSIF)  like we do for our credit unions under our supervision rule?  And also, do we do a cash flow forecast on a regular basis as well?

Eugene Schied: This is Eugene Schied, and I’ll take that question Mr. Hood.  Yes, we shock the – we do perform a shock test and perform cash flow analysis for the share insurance fund.  These are both reviewed by the investment committee on at least a quarterly basis.  The investment committee looks at the monthly cash flow projections for the upcoming 12 months as part of this regular analysis.  That concludes my answer, sir.

Board Member Hood: Great.  Thank you, Eugene.  I would just say that as I consider our investment strategy, we should note that examining portfolios and managing investments in the portfolio are two separate and distinct skillsets.  The NCUA today has over $20 billion, with a capital B, in investments under management; so I think we should have an even greater focus on this during our upcoming Share Insurance Fund updates.

 

 

 

 

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What Are Credit Unions to do When NCUA Messes Up?

Many NCUA management actions have limited direct impact on credit unions.  But when mistakes are made in a critical system component, the NCUSIF,  they can cost credit unions dearly.

The NCUSIF’s sole source of revenue is the earnings on its $20.5 billion investment portfolio of government securities.

The objectives of the NCUSIF’s current investment policy are clear:

The investment objectives of the NCUSIF are:

  1. To meet liquidity needs resulting from the operations of the Fund; and
  2. To invest, on a daily basis, any excess cash in authorized Treasury investments seeking to maximize yield.

The Investment Committee has fallen increasingly short of these objectives for at least the past 15 months. Results  have been contrary to these clearly stated goals.

The Numbers: $10 billion in New Investments in Two Years

At December 2019, the NCUSIF’s portfolio size was $16.02 billion of which $5 billion matured in two years or less.   At February 2022, the portfolio had increased to $20.5 billion.

Since  interest rates declined to historic lows in March 2020 at the start of the national economic shutdown, the NCUSIF has invested more than $10 billion ( 50% of its current portfolio) following a robotic 7-year ladder.

Today these $10 billion investments are worth less than par.  They cannot be sold without incurring market losses constraining the NCUSIF’s liquidity options as stated in objective 1.

At February 2022, the portfolio reports a total unrealized market loss of $343 million, a decline in value of over $ 800 million since December 2020.   The current unrealized loss will increase as rates  rise.  These declines since December 2020, easy to  see from the monthly market value disclosure. They also indicate that the portfolio’s yield is increasingly  falling behind market rates.

A $45 Million Dollar Mistake and Still Growing

The most recent investment of $650 million on February 15, 2022 for seven years at a fixed yield of 2.01% continues this mismanagement in the face of unanimous market indicators and Fed statements pointing to rising rates.

Today the seven year T-Note is near 3% yield.   Not only is this investment from just 60 days earlier worth less than par, the loss of income over the seven-year term is currently over $45 million. That is 1% (or higher yield pickup) times $650 million times seven years.

Credit unions and their members will pay the cost for these and other misjudgments that have resulted in at least half of the NCUSIF’s portfolio below market.  With a 3.5 year effective price duration, the portfolio will continue to decline in value by 3.5% for every 1% increase in the yield curve going forward.

The NCUSIF Investment Committee

The Board’s Policy delegates the implementation of the its two policy objectives to four of the agency’s most senior staff including:

Director of Office of Examination and Insurance, Chair

Chief Financial Officer

Director, Division of Capital and Credit Markets

Chief Economist

One would have hoped given the first quarter’s “Rout in the Bond Market” (WSJ headline), the continued inflation projections, the Federal Reserve’s frequent announcements of policy change, that someone would have called a timeout on this robotic investing ladder. The declines in market value are in plain sight; but more critical are  increasing constraints on future income possibilities, objective 2.

What Can Credit Unions Do?

The reason for monthly NCUSIF financial disclosures is so the fund’s owners who rely on NCUA management, can see the results and raise concerns with the board.

Credit union’s first responsibility is to speak up.  Directly communicate your views of this performance failure.  For your members will pay the cost of these misjudgments ($45 million and higher) potentially for years.

The reported results fall way short of policy.  What will the board do?   The committee seems unable to follow market trends, its own NEV data or internal IRR analysis (if any), or even to be aware of different portfolio options.

In public board meetings, staff is dismissive of change calling alternatives “market timing” when in fact the real issue is simply “investment management.” This is a responsibility every credit union is expected to perform in all phases of the interest rate cycle.

Assuming the board is incapable of monitoring and implementing its stated policy, then Congress is the next recourse.

The Damage to NCUA and the System’s Reputation

 

When NCUA and senior employees are oblivious to market trends, the situation raises questions about competency in many other areas of operational assessments and regulatory approvals.

Supervision requires judgments.  Policies nor rules can prescribe detailed actions. Ratio calculations can be written down but determining the correct numbers entails seasoned analysis.

The economy is in an inflationary period which some say has not been experienced for 40 years.  The Federal reserve’s balance sheet and its increase in money supply has never been larger.   Short term overnight rates are priced in forward markets as high as 3% in a year’s time.

There will be significant adjustments as credit unions transition their balance sheets to the new environment and as member’s see rising rate options.

There will be lots of hyperbolic forecasts and many forebodings in forthcoming months. After all, “preaching negativity makes you an expert” as one colleague used to say.

But credit union’s track record in the most extreme crises has been one of patient, experienced adjustments even when markets seemed to have lost all logic.

As NCUA’s enters this new cycle of interest rates, will its ability to make reasoned adjustments match credit union’s own track record?  This initial response in the comparatively simple management of a treasury portfolio, with just two clear policy goals, is not encouraging.

Can the agency learn from its own misjudgments?

 

 

 

 

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Why Chairman Harper Will Merge the NCUSIF into the FDIC Before His Term Ends

Let’s be frank.  Chairman Harper has yet to be confirmed by the Senate to his new term.  Therefore he is keeping his most important initiative under wraps until he officially has the job

But he has made no secret of his “Commander’s” ambition when he proclaimed at the March board meeting, “NCUA will guide the credit union system through the economic uncertainty caused by inflation, rising gas bills, and continued supply chain woes.”

After the Senate approves his appointment, he will reveal his “guide” plan: merging the NCUSIF into the FDIC.  There are two ways this can be accomplished, which I explain at the end.

It is important to understand why Harper sees this as his top priority.  Even more critical is recognizing how much support this merger proposition will have from credit unions and all other system stakeholders.

Harper’s Idealization of the FDIC

Since his appointment to the NCUA board Harper has continued to tout the FDIC as the gold standard for regulators.  He has repeatedly spoken of their consumer exam prowess (see GAC remarks), the FDIC’s financial flexibility, its support of MDI institutions and even their subsidized employee cafeteria.

In brief, he has concluded that NCUA cannot compare with the FDIC’s competencies, so his solution is to join with them.

But there is more than Harper’s FDIC-envy motivating the plan.  His core belief is that scale matters and that larger size means greater competence.  With the FDIC’s scale and NCUA’s mission driven purpose, the success of credit unions is virtually guaranteed.

NCUSIF’s “Tall Tree” Problem

The “tall tree” phenomena refers to risk underwriting when an organization represents a disproportionate amount of exposure.

The other board members sympathize with Harper’s view that  “bigger-is-better.”  They know that Navy FCU’s assets are over eight times as large as the NCUSIF.  If Navy’s NEV fell near zero in an examiner  shock test, the NCUSIF would face a bigger problem than all the corporates combined in 2009.

Adding the FDIC’s $123 billion and the $5.0 billion NCUSIF equity, the agency need no longer worry about “tall trees”  whenever examiners’ IRR modeling shows a PCA solvency shortfall.

Harper has other reasons for the merger in addition to his scale ambitions.

  • FDIC’s insurance fund has a superior financial model. Its premiums are risk based, open ended and there is no cap on fund size;
  • FDIC has no 1% deposit, so there is no controversy about “double counting” the fund’s assets:
  • FDIC has no accounting issues about true-ups, proper reserving and no independent private audit:
  • FDIC examiners are better at consumer compliance, technical analysis and asset liquidation management;
  • FDIC is a superior, more recognized brand than the NCUSIF;
  • The five person FDIC board has a vacancy that Harper will request be reserved for the NCUA Chair going forward (similar to OCC membership).

Credit Unions will support the merger because:

  • Transferring NCUA’s insurance activities will reduce its annual budget by at over $200 million, or 62%, the current OTR rate, for insurance related expenses;
  • Credit unions’ 1% deposit will be returned so they can once again earn a market yield;
  • FDIC’s premium expense is currently only 3 to 5 basis points per year which could be paid out of the yield on the 1% returned deposit if rates reach 3-5%;
  • Buying banks will be much easier for credit unions with only one insurer’s approval required;
  • FDIC’s logo will show members that credit unions are really on a level playing field with banks;
  • All credit unions already comply with FDIC’s capital requirements thanks to RBC/CCULR;
  • Credit union mergers show their belief that scale is the most important attribute to achieve cooperative purpose;
  • FDIC’s solvency has in fact been guaranteed by the US government, whereas the only proof for NCUSIF’s backing is a sentence in NCUA’s press releases.

Members will support the move because:

  • They were told the NCUSIF coverage was the same as the FDIC;
  • The FDIC is a better known brand;
  • The 1 cent of each share dollar members now send to fund the NCUSIF will be returned to the credit union;
  • Members have been told that credit unions offer “better banking”-this confirms that belief;
  • It doesn’t make any difference–insurance has never been the reason they joined the credit union in the first place. For the first 60 years of financial cooperatives there was no share insurance.

Why the FDIC will support the plan:

  • The $4.9 billion in NCUSIF equity to be added via the merger is more than 2 X the risk being transferred in the total assets of all CAMEL code 4 and 5 credit unions;
  • Eliminates an embarrassing financial comparison for the FDIC ‘s 90-year-old premium based model and its habitual inability to achieve its normal operating level;
  • The FDIC’s monopoly of deposit insurance will expand its power and influence especially within the cooperative system.

State regulators and NASCUS will support the merger as it will strengthen the dual chartering system:

  • It ends debates with NCUA about whether their rules apply to state charters or just FCU’s. Going forward, SCU’s will have just their one state regulator;
  • NASCUS will no longer have to argue about the Overhead Transfer Rate which caused state-chartered credit unions to pay a disproportionate share of NCUA’s operating expenses;
  • It eliminates the need to expand the NCUA board to include a state regulator;
  • The FDIC’s largess for examiner training is superior to NCUA’s;
  • It will activate state charters’ interest in cooperative insurance options. Credit unions in WI, FL, IA, MI and WA will seek to restore a choice of insurer.

CUNA/NAFCU will support the merger:

  • It certifies the level playing field for credit unions-a long term goal;
  • There are expanded opportunities for Lobbying for their DC staffs.

Congressional Democrats will support the merger:

  • All three NCUA board members were appointed by President Trump but democrats now are the majority on the FDIC board.  The party believesTrump holdovers should not control an agency in a democratic administration.

Congressional Republicans will support the plan:

  • It simplifies government and eliminates a federal agency overlap (NCUSIF) for the same activity;
  • Credit unions don’t pay taxes but this will require them to help pay for the federal government’s future FDIC bailouts during the next banking crisis;
  • It will relieve representatives of having to chose between their banking and coop constituencies as both will be under a common regulatory system.

Two Paths for Implementing Harper’s Merger Plan

 

One approach is to propose congressional legislation.  As Chair, Harper has already communicated to Congress his requests to change the NCUSIF’s financial model and modify CLF’s membership requirements.

While the legislative path is always uncertain, this effort could have bipartisan appeal as it is unlikely to have any opposition from credit unions or the banking industry.

Should this approach not prove feasible, then Harper will follow the same process used to implement the NCUA’s CCULR capital rule.  The banking industry required congressional legislation to add this option to the FDIC’s capital requirements.   NCUA was not mentioned in this CCULR enabling legislation.

However, Harper went back to the original PCA requirement from 1998 that said credit union safety and soundness requirements must be comparable to banks’.  NCUA said that bank regulators were authorized to offer CCULR, ergo credit union regulators have the same authority.  All three board members agreed with this legal reasoning.

Using this precedent, NCUA can mandate FDIC insurance  for credit unions by a rule based solely on the PCA requirement of “comparability.“ For there could be no greater comparability than a common insurer for both credit unions and banks.  The implementation could be done quickly,.  Credit unions were given just 9 days to comply with CCULR once it was passed.by the board.

In conclusion

Readers.  It is April 1.

I am not saying that NCUA should merge the NCUSIF with the FDIC.

It would likely be a shock for market-shy cooperatives to be in the same league as the profit-driven banks.

I’m just saying that it could happen.

And that it almost certainly will happen.

Because Harper has shown he gets what he wants. Moreover, credit unions could really end up screwing the banks using their newly won FDIC emblems while  holding onto their tax exemption.

After all, different charters are just legal fictions anyway. All financial institutions do the same things.

FDIC’s scale will facilitate even faster credit union growth from more bank buyouts and ever larger mergers.

And members will have peace of mind knowing that all along the NCUSIF was no different from the FDIC.

 

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Inflation, Interest Rates and Managing the NCUSIF’s $21 Billion Portfolio

Last week the Federal Reserve began its long-publicized tightening of monetary policy.  The Board raised the overnight fed funds target rate to .25-.50% .  Six more raises are planned which would take this rate at year end to around 2%.

The consensus of economists is the Fed’s  plan may be a day late and dollar short.  From MSNBC columnist Kelly Evans right after the announcement:

The Fed published a crucial update in its projections yesterday that showed members now expect the short-term Fed funds rate to hit 2.8% by the end of next year–up from only 1.6% in their December projections. In just three months’ time, in other words, as inflation has shot way higher than anyone at the Fed expected, the committee is signaling the need for almost ten rate hikes by late next year, roughly twice as many as they previously thought necessary. 

In his March 21st speech to National Association of Business Economists (NABE) Fed Chairman Jerome Powell unveiled an even more hawkish view.  Increases could be in .50% increments if needed to counter inflation.

Interest rate rises have substantial consequences for the management of the NCUSIF.   All planned revenue for the NCUSIF is from earnings on its investment portfolio of Treasury securities.  The portfolio will be almost $22 billion by 2022 yearend as credit unions keep sending in 1% of the increase in their share deposits.

Robotic Investing

As the public concern about inflation grew in 2021, the NCUSIF’s investment committee  continued using a “ladder” approach.  The resulting multiple investments  had average durations of 5-6 years and average yields of less than 1%.   This was done at an historically low point in the interest rate cycle.

Despite Board questioning, the staff defended their decisions by saying they don’t try to “time the market.”  Whereas the record shows that the staff has substantially modified the portfolio’s average duration over the past seven years from 1,815 days in 2015 to as low as 901 days in 2018.

One consequence of the Board’s questions  is  NCUA has now published its NCUSIF investment policy.   It can be found here with a last modified date of February 23, 2022. The substance appears unchanged from the previous February 2013 policy.

While NCUA did not formally request input, it is in the industry’s self-interest, even duty, to look at this document to suggest how the management of this $22 billion portfolio could be improved at this point in the  market.

The NCUSIF’s Financial status as of January 2022

 

The most recent NCUSIF financials are at January 31, 2022.    They show the $20.4 billion portfolio is $265 million underwater (market value less than book); the  yield is 1.20% with an   average weighted duration of 1,244 days or 3.5 years.

January’s total income was  $21 million and expenses $17.4 million (up 20% from January 2021). Monthly net income is  $3.6 million with no loss reserve expense or recoveries.

The portfolio is divided into identical  $2.8 billion dollar maturity “buckets” spread over seven years through 2028.  Just $431 million is held overnight.

One year ago, January 2021, the portfolio was $17.8 billion, with a 1.29% yield, weighted average maturity of 1,184 days or 3.3 years.  The portfolio reported a gain in market value of $459 million.

In January 2020, two months before the COVID national economic shutdown and plunge in rates, the NCUSIF reported an average yield of 1.88% and a weighted average life of 2.9 years.  Interest revenue was $25.5  million and operating expense of $16.9 million resulting in a bottom line of $9.5 million, or three times the January 2022  outcome.

The fund’s portfolio maturity extensions during COVID’s low rate  stimulus environment have put the NCUSIF into a financial hole.  Revenue is much less on a portfolio that is 25%  larger  ($ 5 billion) than two years ago; the portfolio has lost $724 million in market value due to its below market return and maturity extensions at the bottom of the interest rate cycle.

These circumstances  suggest an urgent need for a review of NCUSIF portfolio management and reporting. The current policy implementation is not a positive outcome for NCUA or credit unions.

 Changes to Enhance Transparency and Performance

There is investment expertise aplenty in credit unions.   Some areas for commenting on the newly published policy might include:

  1. How can investment return goals be better integrated with projected income and budgeted expense so that target for investment yield can be set objectively? For example a 2% portfolio yield and today’s fund size would cover all budgeted expenses and still leave over $200 million to grow equity or cover any new reserve expense.
  2. How should the objective of paying a dividend to credit unions be incorporated in the fund’s policy objectives?
  3. How can the fund’s investment decisions be more transparent especially the assumptions used when making decisions and changes to portfolio’s duration?
  4. What additional information should be in the monthly reports posted and provided to the board to evaluate investment performance? For example shock tests?
  5. What financial models does the fund use when making decisions? Can these be made public so that credit unions can comment on the projections and assumptions used?

There are  many potential insights to this critical NCUA board policy that could lead to more effective oversight and performance.  The critical success factor is sending these suggestions to NCUA  to be evaluated for updating the policy.

Auspicious Timing

While there has been no formal request for comments, one approach would be to send suggestions to the investment committee’s new Chair which is the Director of E & I. Kelly Lay was just appointed to this position.  This gives her an excellent opportunity to bring credit union experience to the investment process.  Her email is klay@NCUA.gov.

The timing is also critical because rates will be rising, how fast and how far is anyone’s guess.  Both domestic inflation and international events will create ongoing uncertainty.  But the direction is certainly set.

To continue the robotic ladder when it is known rates will in all likelihood continue to rise, is folly.  It brings no credit to the committee’s work and the board’s oversight.

Yesterday’s treasury coupon yields for 25 weeks was .95% and for one year, 1.31%.    These are higher rates than any of the investment decisions made in 2021.  A portfolio return increase of only 1% would double the fund’s annual revenue.

To decide when to extend out the yield curve should be based on analysis of  what breakeven yield is needed to cover costs and equity growth and any loss reserves.   Whether that is 2% or some other number, the goal should be to optimize yield taking into context the operating needs and sending excess earning back to credit unions.

Circumstances have given credit unions and NCUA a valuable moment to improve the management of this important, ever-growing industry asset.   Will credit unions and NCUA take this opportunity?

 

 

 

 

 

 

 

 

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A Fee that Credit Unions Should Review for Appropriateness

Increasing attention is being given to all financial institution’s overdraft/courtesy-pay/nsf fee structures.   An excellent summary of many of the issues is in this article from CUSO magazine.

After the reassessments of these fees, there is another one that credit unions may want to proactively review.

The Unclaimed Property/Inactive Account Fee

A member recently told the story about learning of this fee the hard way.   She had been a loyal credit union member for over two decades and had left a small balance of $500 in case a family member needed to borrow.

The regular savings account paid interest of .05%, offered only online statements and had no activity for over two years.  When checking her 2021 yearend balance online she discovered that the amount had fallen by 20%.

The explanation: a $3 per month inactive account fee was being assessed.  She knew nothing about the fee or how long it had been in place.  In essence she felt the credit union had effectively free use of her money and was charging her on top of that!

When contacted, the credit union explained the fee and offered to refund the money for the last two years, which was as far back as their system would go.

Credit Union’s Responsibility for Inactive Accounts

When Ed, Bucky and I went to NCUA in 1981, I can remember credit unions approaching the agency about charging inactive account fees, which in essence was the step prior to forwarding these accounts to the states as unclaimed property.

In Illinois the Department of Financial Institutions was responsible for administering the unclaimed property act and ensuring funds were properly reported, returned to the state after five years of inactivity so the owners’ names could be publicly listed to  reclaim their funds.

My colleagues believed charging a fee during this inactive period was counter to both the spirit of the act and for a cooperative financial institution.

Credit unions claimed  the accounts were costing them money: maintaining the account, mailing monthly or quarterly statements and plus interest.  Even as they tried to reactivate them, they wanted to be reimbursed for the operational “costs” of the accounts.

For others, the not so hidden motive was to fee the account to $0, especially smaller balances,  close out the member, and not worry about reporting it as unclaimed property.

Others asserted that the fee was in fact an incentive for members to reactivate their accounts.

Inactive accounts come in all flavors:  parents opening accounts for their children, now long gone; accounts left when members move out of the area; the account opened for an indirect loan member, etc.

The common characteristics are there is no member-initiated account activity, the relationship is static, and there is high probability the owner is unaware of any fees being charged.   Therefore it is an easy fee to assess as it is mostly invisible to the account holder.

Other Credit Union Examples

One CEO I talked with said they charge $3 a month on about 500 accounts generating $1,500 in revenue.   At any point in time about 40% of the accounts will be sent to the state.

Another CEO said the credit union charges $10 per quarter.   In both cases the fee had not been evaluated for decades.

Both recognized that in an era of virtual accounts, minimal interest on savings and near zero marginal operating costs, the credit union should focus on contacting members, not seeing the issue as a revenue item.

I would urge credit unions to look at their current inactive account policy and fees.   It may not be as consequential as overdrafts, but if a class action attorney situation arrives, just looking up the years of records, charges and potential refunds, would seem to suggest any income is not worth the potential cost.

Also don’t forget abandoned safety deposit boxes must also be reported as unclaimed after the statutory period of inactivity.

NCUA’s Unclaimed Policy

Just as a footnote, NCUA also acquires unclaimed insured share accounts when liquidating credit unions.

It is interesting to note that the agency’s policy is contrary to the legal practice required of credit unions.

As stated on the website, if NCUA cannot locate the party after 18 months, it converts them to “uninsured” and retains the balances for use by the insurance fund.

Invariably, some items may remain unclaimed. Some checks are never cashed; or the credit union’s address information was incomplete. There are also cases when we don’t have a recent address and are unable to get a forwarding address from the post office.

Share accounts claimed within the 18-month insurance period are paid at their full-insured amount. At the expiration of the 18-month insurance period, shares that are not claimed are considered uninsured and written down to share in the loss to the National Credit Union Share Insurance Fund. Even if shares are uninsured when they are claimed, there may still be a distribution.

On rare occasions, the liquidation of a credit union may result in surplus funds. If a surplus remains, a distribution to the shareholders is required. This may occur several years after the credit union is liquidated and it is sometimes difficult to locate these members.

This is another example where NCUA exempts itself from the rules credit unions are required to follow to protect member’s assets.

 

 

 

 

 

 

 

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Where’s The Rest of Credit Union Members’ $1.2 Billion?

In early January following NCUA’s posting of the September 30, 2021 AME financials for the five corporates, I published an analysis of the forecasted amount to be paid to credit unions.

That analysis showed NCUA projected total distributions of $3.185 billion to shareholders of four of the five estates.  The $569 million in additional payouts NCUA announced on February 28 brings actual payments to $2.010 billion.

Even with  these latest payments, there is still $1.2 billion due to credit union members based on NCUA’s financial projections.

The portion that NCUA announced as dividends on February 28 will go to the former Southwest Corporate shareholders.  They already received their entire capital contribution and are projected to be paid a $330 million liquidating dividend.   After this initial “dividend,” they will be due $120 million more.

Questions Abound

 

The NGN program ended in June 2021.   Why has it taking so long to return the remaining $1.2 billion balance to credit unions?   Will NCUA post a list of the remaining legacy assets and their current market  value with its December 2021 AME financial statements?

The five spread sheets of every legacy asset updated through September 2017 for each estate are already completed.  Shouldn’t NCUA now update these and publish the current market value for every remaining asset?

Is it fair to conclude that 12 years after the 2010 liquidation of the five corporates, only one was actually insolvent?   The other four were deemed insolvent because they were victims of exaggerated and inaccurate loss provisions projected decades into the future?

At this time NCUA forecasts total cash recoveries over $5.7 billion. Of this amount $2.6 billion was the TCCUSF surplus merged into the NCUSIF on October 1, 2017.

Is it correct to say this cash surplus occurred only after the agency subtracted $3.6 billion in liquidation expenses as reported in section B 1 Liquidation Expense in the AME financials?  Are these expenses approximately the same amount as the net legal recoveries?

The so-called legacy assets seized in 2010 have never changed.  Is it reasonable to suggest that this regulatory modeling miss-estimate of $6 to $8 billion was how NCUA determined the corporates to be insolvent?  Moreover, the vast majority of the projected credit defaults had not occurred when the corporates were seized.

If these erroneous projections of at least the $5.7 billion cash surpluses are reasonable, does this suggest why a look back at the entire event should be undertaken?  How can such misleading estimates be avoided in the future?

The Critical Work Still to be Done

 

NCUA’s errors in models and their assumptions resulted in irreversible damage for the credit union system and the individuals involved.   It continues still today in the diminished role of the corporate network.

While many might say let bygones be gone, the processes and powers that created this regulatory debacle have not been assessed or even changed.

The real work of the Corporate Resolution Plan remains to be completed.   Paying out the recoveries from events that should have never taken place should not be the end.  Rather it should compel a thorough look at what caused these errors and miscalculations in the first place.

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A Potentially Pivotal NCUA Board Meeting

Last Thursday’s NCUA monthly board agenda seemed light.  It started at 11:30 and lasted less than an hour.  But the ultimate outcomes could be consequential.

The main topic required no action: the report on the NCUSIF 2021 yearend audit by KPMG. And an extension of PCA covid waiver.

However I believe seeds were planted that could have a significant impact on credit unions and the NCUA’s management of the NCUSIF for credit unions. Here’s why.

The NCUSIF Dialogue: Planting seeds for Change

Chairman Harper opened the NCUSIF review with these words:

For nearly 40 years now, the NCUA has earned an unmodified opinion for the audits of its funds. This sustained achievement underscores the NCUA’s commitment to transparency, accountability, sound financial management, and the careful stewardship of the resources entrusted to the agency.

NCUSIF is the only federally managed insurance fund to require an outside independent CPA audit.  GAO audits the FDIC and the FSLIC– when it existed.

An important difference is the establishment of a loss allowance account following GAAP accounting standards.  The process took three years (1982-1984) for NCUSIF’s reserving process to be independently  validated by the auditors with a clean opinion.

Harper then stated: As a regulator, we need to hold ourselves to the same standard that we expect of the credit unions we oversee.

The Chairman’s commitments to “transparency” and following “the same standard we expect of credit unions” could be critical if followed through with actions on topics raised by his fellow board members.

Hauptman on Investment Policy

After noting the NCUSIF’s sound performance, he made the following comment:

The National Credit Union Share Insurance Fund is a mutual asset — both reported and controlled by the NCUA and an asset reported by the credit unions. Credit unions are required to supply the majority of the fund’s equity through a 1-percent contribution of their insured shares. Just like any credit union board, the NCUA Board has the responsibility to regularly review its investment strategy . And for the sake of transparency and clarity, to do so at an open Board meeting.

He asked questions about the fund’s current investment approach and how to respond to “critics” of recent decisions.   The NCUSIF investment policy last updated in 2013,  is  now being posted with the audit. Hauptman committed to “working with my fellow Board Members on reviewing and updating the investment policy soon.” 

I believe credit unions should also comment on the policy, especially the fund’s duration management.  In the last seven years the NCUSIF portfolio’s weighted average  life (duration) at yearend was reported as follows:

2021 – 1,306 days

2020 – 1,204  days

2019 —   971   days

2018 —   901   days

2017 —   951   days

2016 —  1,864  days

2015 —  1,815 days

Under one policy, these numbers show a 100% change from the lowest 2.5 year duration, to 5.1 years.  Staff maintains this was just maintaining a consistent ladder, not timing the market.

In 2021 the investments robotically followed a seven-year ladder that extended the duration when the interest rate cycle was at an historically low point.

Effective investment management is critical to the fund’s operational design, but also, as Hauptman noted, for credit union confidence in NCUA’s oversight of their 1% asset.  If the policy is updated for more effective monitoring and performance, this could be an important improvement. The sooner the better.

Hood on Accounting Options and Understating the NCUSIF’s NOL

In Hood’s remarks he addressed the fund’s NOL (normal operating level ratio) “true-up” at yearend and its impact on the equity ratio.  He pointed out a “timing difference” in that the 1% share deposit is from June 30, but the insured shares and retained earnings in the ratio are from December 31 numbers.

If the ratio used the same balance sheet dates, the NOL “pro-forma” would be 1.29% not the reported 1.26% at December 2021.

Each basis point (.0001%) is $166 million.  This “timing difference” understates the actual financial position of the NCUSIF by $500 million at yearend.

In the dialogue that followed,  the CFO said this understatement averaged 2 basis points over the last ten years, and has been as high as 6.

Hood then quoted from a memo by Cotton and Company:  the memo produced by the outside accounting firm states that the timeliness and accuracy of data is required in the Federal Credit Union Act so this provision in the law “may provide some latitude from a strict interpretation that the equity ratio must be calculated based on the financial statements amounts, particularly given the knowledge of the timing effect on the calculation of the equity ratio…. Accordingly, it may be permissible to use the pro-forma calculation of the contributed capital amount, when calculating the actual equity ratio.”

When Hood remarked that he would like to see the full Cotton memo published, the CFO replied, “Okay.”

Two Commitments for Greater Transparency

Improved investment transparency and management and better presentation of the NCUSIF’s financials would greatly benefit credit unions.   Moreover, the NOL “true up” is just one of several changes that would make the financial reporting more useful.

In 2010 NCUA changed the accounting standard for the NCUSIF from private GAAP to federal GAAP practice.   There are numerous presentation differences that make the federal approach more difficult to understand because that format was intended for entities that rely on federal appropriations.

Each of the other three funds managed by NCUA report their financial performance and audits using private GAAP.  Given Chairman Harper’s intent  that NCUA follow the “same standard that we expect of the credit unions we oversee,” changing the NCUSIF to the practice followed in its first 30 years would certainly be appropriate.

Sounds of Silence or What was Not Said

The context around the NCUSIF’s financials was all positive with the overall CAMEL ratings showing improvement.

After Harper’s opening recognition of the NCUSIF’s and credit union soundness, he ended with his obligatory theme of future fears:  Nevertheless. . .

  • If the elevated growth of insured shares continues, we can expect a further erosion of the Share Insurance Fund’s equity ratio;
  • the emergence of inflation—something many Americans have never experienced at this rate before—means that the interest rate environment is uncertain.
  • Additionally . . . in my view, the system has not experienced the full extent of the pandemic’s financial and economic disruptions just yet.

Yet despite these uncertainties none of the board members, including the chair, made any mention of assessing a premium which the board had authority to do as long as it did not raise the NOL above 1.3%.   Given Chairman Harper’s previous statements about the fund’s adequacy, this is an interesting silence.

Moreover, the board’s acknowledgement of the yearend NOL at 1.26% (or 1.29%) shows their recognition that the NOL is a range with a low end of 1.2% and a high end cap, currently 1.33%.  The NOL is not a single magic number, but rather an outcome with a “buffer” above 1.2%  that varies depending on current assessments.

This silence after so much talk in early in 2021 about a possible premium, is hopefully a recognition of the flexibility and resilience of the fund’s design.   When combined with enhanced board reporting of NCUSIF investments and a reexamination of accounting presentation, credit unions could be a much better position to understand their fund going forward.

The Board’s public commitments to transparency of the fund’s modeling, the Cotton accounting memo and its presentation options, and the investment policy enhancements would be vital steps to bring the NCUSIF into full cooperative sunlight.

 

 

 

 

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Managing the NCUSIF-Is It too Late to Act?

What should credit unions do when the regulator who makes the rules, does not follow its own rules?

Yesterday the consumer price increase for calendar 2021 was reported as 7%, the highest in 40 years.  This was not a surprise.   Concern about increasing inflation and the Fed’s response had been growing since the summer of 2021.

Interest rate risk is not a new topic. NCUA first proposed adding an S for sensitivity  to the CAMEL rating in 2016.  In October 2021, the board approved a rule adding this “S”  with Chairman Harper saying:

The NCUA’s adoption of the CAMELS system is good public policy and long overdue.  Separating the liquidity and market sensitivity components will allow the NCUA to better monitor these risks within the credit union system, better communicate specific concerns to individual credit unions, and better allocate resources.

The agency’s description of interest rate risk was straight forward:

The sensitivity to market risk reflects the exposure of a credit union’s current and prospective earnings level and economic capital position arising from changes in market prices and the general level of interest rates. Effective risk management programs include comprehensive interest rate risk policies, appropriate and identifiable risk limits, clearly defined risk mitigation strategies, and a suitable governance framework.

Ignoring its Own Rules

However Just six days prior to this, those responsible for managing the NCUSIF’s portfolio invested $1.0 billion (5% of the portfolio) at an average weighted life of 5.95 years and yield of 1.19%.

These investments actually extended the portfolio’s overall maturity from the month before.

This was a continuation of the robotic process  the NCUSIF investment committee had followed since market rates had fallen to near zero in 2020.

In December 2020 question were raised about these investment decisions: What Is NCUSIF’s IRR Investment Policy? Is this a Gap in NCUA Board Oversight?  The article pointed out NCUSIF’s most recent investments included a 7-year fixed rate yielding only .45%.  Would any reasonable person make this investment at this point in the cycle of historically low rates?

In August 2021, the NCUSIF continued its market tone-deaf investing by placing $1.2 billion at an average weighted yield of .943% and life of 5.7 years.   The analysis pointed out that these decisions were hurting credit unions.  One immediate decision that month cost credit unions $4.2 million in foregone revenue over the next 7 years before it matures.

At the same time, credit unions in contrast, reported keeping 53% of their record level of investments in overnight funds.

Who Makes These Decisions?

The NCUSIF has an investment committee of four people including the Chief Financial Officer, the Director of E &I, the chief economist and the head of the Capital and Credit Markets division.

NCUA preaches interest rate management,  but does not practice it.  One doesn’t have to run a stress test to see the devastating results  of these recent decisions. The  NCUSIF’s monthly data documents the decline in portfolio value as rates began  rising over the past 12 months.

In September 2020, the $17 billion NCUSIF reported a market gain of $586 million. In October 2021, the latest report available, this had fallen  by 97%, to just $16.2 million on a portfolio $20.3 billion.  Large portions of the most recent investments are now worth less than their purchase price.  These low yields will hurt the NCUSIF’s performance for years to come.

Who Is Responsible for this Performance Failure?

The NCUA board receives a monthly report on the NCUSIF and a quarterly in-person update.

In questions about investments as recently as December’s meeting, staff’s response is they are just following Board policy.   In the September’s 2021 board meeting the CFO agreed to make public this investment policy.  It didn’t happen.  Several meetings later, he explained the policy was under review and would not be released until that was completed-at some indefinite time in the future.

The Board unanimously approved the new interest rate sensitivity rule in October 2021, which was first published in March.   It receives the monthly report showing the robotic investment activity and steadily falling portfolio values.  The board’s  words and deeds are far apart when it comes to IRR.

The Costs to Credit Unions and NCUA

When the agency’s highest professionals show an inability to manage the agency’s largest asset, the $20 billion NCUSIF, in accordance with its own rules on interest rate sensitivity, fundamental questions are raised.

Are senior staff competent for this task?  Are these investments what the Board really intends with policy?   Is no one in the agency,  staff or board, able to see the damage this causes to the fund’s revenue and its financial soundness?

Good judgement comes from experience.  And experience?  That comes from bad judgement. How many more bad judgements does the board need?

More than the NCUSIF’s future is at stake, as important as that is.   This year-long example of failure to respond to the changing economic conditions in managing the funds, begs the question: Is the agency capable of overseeing this issue in credit unions?   The IRR monitoring of the NCUSIF is simple.  In most credit unions the issues are much more complex.

Both the NCUA board and senior staff are letting credit unions down.  Sooner or later the bill for this failure will come due.   A simple portfolio yield of just 2% on $21 billion is sufficient to cover the normal financial expenses in the fund.  When these investment decisions lock in rates of 1% or less for 5 or 6 years, a premium may be required to pay for the damage caused by poor management.

If this failure is the outcome for the simple management of the NCUSIF’s IRR, the bigger issue is whether the agency has the grasp to properly monitor the industry through the coming rise in the interest rate cycle.

The first test will be what the leadership does about their responsibility for the NCUSIF.  Will the board and senior staff continue to kick the can down the road, blind to the consequences of inaction, or make a difference now?