Below
is an edited version of Chip Filson's, President of Callahan
& Associates, oral comments to the NCUA Board on November
1st. Please note that since that date, the impact of the NCUSIF’s
financial model is more acute. Chip Discusses the consequences
of the administrative charges at $100 million or more. However,
he looks at one other impact.
The Fund
consists of the 1% deposit, which grows as credit union insured
shares grow, and the .3% equity which can increase only from
retained earnings. That .3% is approximately $1.2 billion
today. Assume share growth for this year is 15%. That means
that $180 million needs to be added to retained earnings just
to keep the “normal operating ratio” of the fund
at 1.3%--or it starts to decline.
The total
income of the Fund this year will be in the $240 million range
Total income for the first 8 months was $178 on a portfolio
that was earning 5.6% as of August 31, 2001. Over half of
the Fund’s investments at that date were under 1 year
and $1.4 billion were less than 3 months. So although it looks
like the Fund could earn about $240 million this year, next
year the revenue could be half that amount. All of these calculations
are before taking out a projected $100 million in Administrative
costs from NCUA and assuming no insurance losses.
What we
face is the prospect of a premium to keep the Fund at a “normal
operating level” in the best of times for credit unions!
The following
is the write up of the remarks at the meeting:
“Promises
Not Lived Up To”
I.
Changing the NCUSIF’s Financial Model
In 1984
the Fund’s revenue structure was converted from annual
premiums to earnings on a deposit base of 1% of insured savings
plus .3% retained earnings or equity. The simplicity of this
change was that the Fund’s assets grew at the same rate
as the insured risk.
We modeled
this approach extensively using different assumptions about
loss rates and interest environments. The income for the Fund
became the interest earnings on the Fund’s assets provided
by the members’ 1% deposit balances. These earnings served
four uses. They covered:
- Administrative
costs to manage the fund;
- Insurance
losses from failing credit unions;
- An
addition to equity to keep the .3% capital at the level
to maintain a normal operating level of 1.3% of insured
risk;
- Dividends
to the Fund’s shareholder owners.
Premiums
were not necessary except in extreme circumstances, if ever.
Moreover, premiums were restricted to only one assessment
in any one year.
The fundamental
assumption is that the investment earnings would be sufficient
to meet and maintain all of the Fund’s obligations.
II.
What’s Happened?
Through
increases in Agency expenditures and increases in the overhead
transfer rate (OTR), the administrative costs alone now threaten
to eat up all of the Fund’s earnings. For example, at
current projected budget levels and a 67% transfer rate, the
administrative expenses alone could reach $100 million next
year. If interest rates continue to fall, say to 2-2.25%,
then it is not inconceivable that all the earnings would be
for administration. Nothing would be available for:
- Insurance
losses;
- Growing
the .3% retained earnings; or
- Dividends
to the Fund’s owners.
The financial
model for the Fund has been turned upside down. Administrative
expenses, not insurance losses, are eating up all of the Fund’s
revenues.
III.
Why is it urgent that this issue be addressed?
1. Promises
were made to NCUSIF insured credit unions about how their
money would be used. They are documented in the Agency’s
1984 Annual Report. Those promises have not been lived up
to. Confidence in the fund’s stability is very closely
tied to confidence in the Fund’s administration –
not the amount of $.
2. No
one can predict how deep an economic downturn we will have,
how long the war will last or how low interest rates might
go and for how long. Any of these factors or a combination
could easily cause the fund to fall short of its ability to
maintain a normal operating level.
3. We
are in a “new era” – in 2 respects:
a. We
are in an emergency wartime condition. Everyone needs to
tighten his or her belt – business as usual will not
suffice. We must find new ways to do business faster, cheaper,
better.
b. Safety
and soundness threats are not the same as in the past. Credit
unions are failing, not for traditional problems such as
bad loans or poor investment decisions, but rather through
the loss of relevance, i.e. the inability to deliver true
economic value to members. For example at mid-year:
2,518
credit unions had negative share growth
1,716
had growth less than their cost of funds…
These
4,234 credit unions are experiencing disinvestment by members
at a time of the highest industry share growth in the last
decade.
These
are the issues that are central to the soundness of the credit
union system.
Conclusions:
It is
more urgent than ever to change the NCUA’s approach to
using the Fund’s revenue – or risk jeopardizing
the very purpose for which the fund was capitalized, promoting
confidence in the credit union system.