Editor's Note: This item originallly was published on ChipFilson.com and appears here with permission.
By Chip Filson
Even though NCUA’s public board meeting on May 25 had a minimal agenda of two items, comments completely scripted, and outcomes pre-determined by design, there is still much to be learned from the live session.
As one NCUA Board member stated, all who are subject to the board’s authority can see if it is carrying out its “fiduciary duties” in a thoughtful manner.
Were the presentations documented with relevant and timely information? Were key issues raised? How knowledgeable were staff and board with the subjects?
While reports of the prepared remarks or occasional comment are helpful, there can be much more from public observation.
The Context for the Meeting
The two agenda items were the quarterly NCUSIF update and a proposed change to the charitable deduction accounts (CDA’s).
Despite political and financial uncertainties, NCUA’s field examiners reported the lowest percentage of code 4 and 5 rated credit unions in decades: just .29% of insured shares.
How did this happen? Are credit union leaders just better managers than their competitors? NCUA a more effective regulator? Or credit unions just lucky at this moment? What one board member cryptically called the “calm before the storm.”
Only NCUA Board Member Rodney Hood provided an analysis for the current state of the system: “Our public financial postings and disclosures and credit union performance highlight the unique character of the cooperative system—a system that was the basis for rejecting the FDIC premium models in years past and still in use today and designing a uniquely cooperative approach. The credit union system is a unique financial system, and our regulatory and Share Insurance Fund framework should reflect this.”
Certainly, the data summarized is great news in the current context. End of story? No. A number of explanations and data points offered were unexamined. Questions would have demonstrated a better grasp of several critical areas of NCUA board oversight.
Issues Left open and Questions Not Asked
CFO Eugene Schied’s NCUSIF update was a literal reading of numbers from 10 slides with no accompanying analysis.
He did point out that the number of NCUSIF-insured CUs had declined by 59 in the quarter. In contrast the board complimented staff on granting a new charter.
However, no board member spoke to the critical question: Is this rate of annual decline of over 200 credit union charters acceptable? For any industry opening one to three new credit unions a year while shutting down 200 that had existed for decades, raises the question if the system sustainable?
Some would respond that this trend is OK because these are mostly smaller mergers and total credit union member numbers keep growing.
From the member-owners’ perspective, however, these are 200 charter failures. Suggesting a chairman’s award for a new charter or two would seem a misfocus compared to the oversight of 200 charter closures. Reducing charter cancellations would seem to be the first priority; getting a new one is a multiyear ordeal.
The CLF and Credit Union Liquidity
All three members mentioned the need for Congress to again restore the CLF’s temporary Covid-era authority. This has been supported by the assertion that over 3,000 credit unions under $250 million now lack CLF access, a status only Congress can fix.
I believe this constant tossing the ball to Congress’ lap for CLF coverage overlooks NCUA’s primary responsibility for the situation:
- For four decades all credit unions were CLF members under existing legislation that is still in place. It was NCUA’s actions that closed this solution.
- There has been no credit union borrowing from the CLF since 2009. That borrowing was via the NCUSIF for U.S. Central and WesCorp.
- Today, smaller natural-person credit unions rely on two primary sources: the corporate system and FHLB. Even when the recent banking liquidity crisis occurred, there was no CLF effort to match the Fed’s Bank Term Funding Program (BTFP), which offered all comers loans up to one year in length.
The CLF has been missing in action for two decades. The NCUA has not collaborated with corporates or credit unions to design a CLF solution that credit unions would seem as vital and relevant. The FHLB system, a cooperative model, has done this well. The CLF’s liquidity design is not a Congressional legislative issue, it is an NCUA leadership and management responsibility.
The NCUSIF’s Performance
The single most critical aspect of NCUSIF performance is the management of its investment portfolio, its primary revenue source.
For the first quarter revenue grew by 49% versus the year earlier. However, the YTD yield was only 1.76% or roughly 3% below the first quarter’s overnight rate. In November 2022, NCUA staff announced it was pausing its ladder strategy until overnight funds reached $4 billion. There was little information how this amount was determined and why.
The critical topic is what has NCUA learned during this ongoing rate cycle that would affect how it approaches future activity? When asked about this, CFO Shied said the fund followed SLY investment policy. After the $4 billion level is reached it would then go back to the 10-year ladder.
A Three-Year Plan
When asked how long it would take the fund to achieve par value in the current rate environment, he replied it would take three years. He listed the required cash flows of $400 million, $700 million and $1 billion in that period. That corresponds to the current weighted average life (WAL) of 3.0 years.
Should the current rate situation become a new normal, then NCUSIF revenue will have recorded below-market returns for over four years since the Fed began raising rates in March 2022.
Every one percentage point of under-market yields costs credit unions $200 million annually on its $22 billion portfolio. The current 3% below market yield result in a $500-600 million annual revenue shortfall that will continue until label rates normalize and the portfolio reprices.
This revenue gap is twice NCUA’s total annual budget. It is a performance shortcoming keeping credit unions from reaping the returns from their fund 1% underwriting. This revenue shortfall is a safety and soundness concern that affects the system’s overall soundness. It is not a design flaw, but a management responsibility.
Two Questions to Ask
Managing IRR risk, and related fund revenue, is the NCUSIF’s top responsibility. It should be guided by two questions:
- How soon will I need the money? There is no way to know this, which means here should be a bias toward more, not less liquidity whatever the interest rate outlook.
- What is the earnings goal for the portfolio? We know from the fund’s loss history long term rate of share growth and budgeting operating expenses, that a yield of 2.5-3.0% would maintain a 1.3% NOL in virtually all scenarios.
Moreover, in years of low losses the Fund should pay a dividend. That was the mutual commitment for credit unions to support the NCUSIF’s perpetual underwriting with a 1% deposit.
The Essential Skill
The essential NCUSIF management skill is IRR monitoring. Compared with a credit union’s ALM challenge of managing two sides of a balance sheet and forecasting net interest income or the economic value of equity, the NCUSIF responsibility is a straight forward. How should the WAL be adjusted given the two questions above and rate outlook?
The Fed’s rise in rates was announced in advance. The speed and amount may have caught many portfolio managers flat footed, but the take away should be to enhance IRR, not revert back to a rote formula that costs credit unions hundreds of millions in lost revenue.
To not openly address this critical aspect of NCUSIF performance and just accept the intent to go back to the old ways of doing things once the $4 billion goal is reached, is an oversight failure.
The CDA Proposal’s Data Omission
The second board item was one-page long. It was a proposal to add more eligible for DCA donations beyond 501 C 3’s. The specific suggestion was 501(c)19, nonprofit groups serving veterans.
The proposal would seem reasonable. The discussion was made in a vacuum. There was no information provided about this 10-year-old incidental power to know the scope of the policy decision. How many credit union have this account? How much do they contribute? What data indicate this ne authority is actually working as intended?
The 5300 quarterly report has some data. At March 2023 there were 278 credit unions holding $1.4 billion in CDA accounts. Seventy-four credit unions had added this account during the past year, and 13 had dropped it. Total balances had increased by $85 million or 6.5%
Where is the Benefit?
When asking for public comment, it is important to data is available and relevant to the issue at hand. How is this authority benefitting members?
One board member stated the rule’s intent was to provide higher returns by allowing investments not authorized for the credit unions to use in their own portfolios. The theory was that the expected higher return would allow credit unions to make donations without impacting their net income. Is that what is happening?
In making policy recommendations there should be a data context, especially when the information is available, so that commenters can know the impact of what is being discussed.
Chip Filson is a co-founder of Callahan & Associates and well known within credit unions as an author, frequent speaker, and consultant. Filson also previously served as president of the Central Liquidity Facility (CLF) and Director of the Office of Programs at NCUA. For more info: www.chipfilson.com.