Backtesting: A Billion-Dollar Recovery For Credit Unions

Credit unions could use a dividend payment from the over-reserved share insurance fund to improve their balance sheets, make more loans, and help members in need.


Earlier this week, I received the following email (used with permission) from Jay Lewis, vice president of finance at Gateway Metro Federal Credit Union ($179M, St. Louis. MO):

Dear Mr. Filson,

My name is Jay Lewis, and you and I have spoken on occasion about various topics over the years.

Gateway Metro Federal CU recently went through a NCUA exam and one item that came up multiple times was backtesting. Are we backtesting our investments, specifically MBS? Which we have done. Are we back testing our ALM and verifying that the payment speeds are reasonable? Which we do.

It made me start to wonder, and I am sure your company has done this, but has anyone backtested the MBS [mortgage-backed securities] estimates that NCUA made for corporate write downs and then passed on as an expense to the credit unions? Has anyone tracked the investments to see if they needed to be market adjusted as NCUA stated? Or would the data show that NCUA had a knee-jerk reaction and if they would have allowed time to go by and the paydowns on the MBS to occur as normal, what loss if any, would appear? Does it support the PIMCO report and what they saw as losses?

I just want to know if you know whether this had been done.

I replied as follows:

To my knowledge, no one at NCUA has done this. If so, it has not been released to anyone. The data is not in credit union hands that I know of. Now that all five corporates have been conserved and the $60 billion of assets transferred or sold, I suspect the audit trail is murky at best. Note that when the corporates were responsible for managing these investments, they reported monthly on all of the items you asked about — additional losses, changes in OTTI valuations, and, most importantly, earnings from the assets.

Your question is 100% on target and should be raised publicly.

Backtesting And The NCUSIF Reserves

Although current data on Pimco and other corporate valuations is not immediately available, there is one area of reserving that is public, the NCUSIF. What would a backtest show for NCUA’s estimates in this area of responsibility?

In September 2009, NCUA staff presented four stress tests to the Board projecting loss estimates for the credit unions system. These scenarios caused the Board to assess a $727.5 million NCUSIF premium in September 2009. The premium raised the NCUSIF equity to the maximum 1.3% limit, which did not include the significant additions to the loss reserve. This meant a large portion of the funds that credit unions sent did not count as equity and thus are not subject to the 1.3% cap.

The staff’s low estimate of $1.4 billion in natural person losses over two years was due primarily from real estate exposure. When NCUA staff added the losses caused by the estimated $7.0 billion corporate stabilization expense, the projected NCUSIF loss grew from $6.4 billion to a worst-case scenario of $15.5 billion.

 How valid were these estimates and related premium recommendations expensed by credit unions?

Below are the published, audited, actual losses, totaling $605.5 million, from credit union failures charged to the NCUSIF through the past five years. The first six months of 2011 are unaudited; to provide a comparison to the prior full year results, losses are annualized to $14.8 million.

The weighted loss for this five and one-half year period comes to .0153% of insured shares.  This includes the three worst years in NCUSIF history for total incurred losses. Moreover, the vast majority of the loss in 2010 is from the fraud at St. Paul Croatian Federal Credit Union (NCUA estimates that at $187.8 million), making the losses resulting from economic circumstances in 2010 closer to $45.5 million.  

Loss Ratio
Click on graph to view larger size.

Comparing this experience rate with the June 30, 2011, loss reserves of $1.16 billion shows the NCUSIF reserve total is 973% of the projected 2011 loss ($118 million). This number is calculated using the .0153 experience rate times insured shares at midyear. From another viewpoint, the $1.16 billion is 78 times (7,800%) the annualized real losses for the first six months of 2011. 

Loss Reserves
Click on graph to view larger size.

One Billion Dollars Over-Reserved

By any reasonable accounting or real-world test, the NCUSIF is a billion dollars or more over-reserved. Backtesting the September 2009 projections shows they were wildly inaccurate. But NCUA can now correct those judgments.    

NCUA created these excess loss reserves by charging two premiums to credit unions ($730.4 million in 2009 and $930.3 million in 2010). These premiums were expensed taken out of credit unions’ total capital when the funds were sent to NCUA.

This money is deposited in the U.S. Treasury and should be returned to credit unions in the form of a dividend. Credit unions can use this billion-dollar dividend to improve their balance sheets, make more loans, and, most importantly, help members today who still face multiple uncertainties. 

Just as importantly, such an action would help open a new chapter in credit union and NCUA relations. Doing the right thing can engender positive consequences. Who knows, it might even open the door to real dialogue about the $2 billion of credit union funds held by the CLF that is also on deposit at the Treasury. These cooperative funds would help credit union members even more in this fragile period of slow economic recovery. Finally, such actions would significantly reduce the extraordinary regulatory burdens imposed by NCUA on credit unions in the past two years.

So, Jay, this does not answer your specific question about backtesting Pimco and its corporate security value estimates, but your question did open a worthwhile analysis in another area. Hopefully all credit unions can benefit from your query.  




Aug. 25, 2011


  • Chip ... you do a great job in analyzing the problems as well as solutions for the credit union movement. I have always been impressed with your abilities.
    Jim Williams
  • What a great article - very eye-opening. I worked in the Farm Credit system in the '80s during the farm credit crisis and the same type of over-reaction occurred. It's time for the NCUA to correct this.
    Melanie Houser
  • My understanding is that each natual person credit unions carry an asset for their portion of the NCUSIF Fund,based on insured shares - The capital is still on the books of the natural person CU. The issue is that the NCUA is earning little on the NCUSIF fund investments.
    Scott Ewing