The September 24th NCUA Board meeting demonstrated the need for the Board to start asking some tough questions about numbers being presented to justify Board actions.
The projections presented by staff to justify withdrawing over $2.0 billion in cash from credit unions at a time of great member need fail to pass any reasonable reality test. They only reinforce the truism that all models are wrong; some are useful.
The Need for a Complete Policy Review
By taking over $2.0 billion from the credit union system, especially the $1.0 billion in premiums, the NCUA is acting contrary to the countercyclical purpose of credit unions. At a 7% capital ratio this premium would support over $14 billion in assets, the vast majority of which would be used in loans to members.
A top priority of the Obama Administration is to restore credit markets to normal functioning and where problems exist, to assist in loan modifications. The NCUSIF premium is not only unnecessary; it is contrary to both the Congressional rationale creating credit unions in 1934 and current national policy priorities. The Board urgently needs to undertake a complete policy review.
Instead of taking resources from the credit union system, NCUA should be putting the industry's collective resources back into credit unions. Instead of trying to project losses, the Agency should be helping with resolution. Instead of constraining credit union lending activity, the Agency should be encouraging lending—for that is the surest path for credit unions to earn their way through this crisis.
If the Agency were to take this 180 degree turn in policy, the action might go a long way to re-establishing credit union support for the system. Right now the vast majority of credit unions are asking what has the Agency done for us? A top-to-bottom policy review would be a great start especially if it resulted in the $180 billion of credit union resources now under Agency direction being used to truly benefit the industry, not merely build a bigger bureaucracy.
The Current Reserves in the NCUSIF
The Board's action transfers $2.0 billion to the NCUSIF from credit union balance sheets. About half, $1.1 billion, is to bring the 1% deposit in line with share growth and the new $250,000 insurance limit. Raising the insured shares cap to $250,000 accounts for about $570 million of this 1% topping up.
The second half is the $1.0 billion NCUSIF premium expense. $728 million of this is to add to NCUSIF's retained earnings, which total $2.2 billion as of August 31, 2009. The remaining $337.8 million is apparently to be held as cash for approximately nine months to make a $337 million pay down in June 2010 on the corporate stabilization borrowing.
The NCUSIF's $2.2 billion retained earnings do not include the $524 million allowance for loss reserve. Therefore as of August 2009, NCUA has $2.7 billion in reserves and retained earnings to resolve problem credit unions. The $728 million in premium will be added to this reserve total resulting in over $3.4 billion of credit union funds on top of the 1% deposit held at the NCUSIF.
What is the Agency's Most Critical Role?
To justify these extraordinary numbers NCUA staff has presented summaries predicting increased failures of such an extreme magnitude that one wonders if anyone looked at the real numbers. These hypothetical projections raise the issue of whether the Board has given staff any policy guidance at all. The primary role of the Agency is to prevent failure, not to predict it. There was not one statement anywhere about how these funds would be used for this fundamental purpose. Instead it looks like the practice, if not policy, is for the NCUSIF to try to "buy", that is spend, its way out of problems.
Projections of Loan Loss and the Real Numbers
Some examples of the pretend data presented to the board includes NCUA's 2-year stress test showing "an allocation of $32.5 billion of projected losses (loans) leading to the failure of 90 NPCUs." This, according to the staff report, is from the "baseline analysis." The paper goes on: "the more adverse analysis resulted in an allocation of $56.4 billion in losses (loans)."
The total of all credit union net loan losses for the last five and one half years is $17.4 billion. For the latest 18 months of this current economic downturn, the total is $8.0 billion or about $5.3 billion per 12 months. In other words credit unions are projected to lose, in NCUA’S base case, over 300% more than the actual losses reported during the depths of the crisis.
These losses are used to project credit union failures. These failures are estimated to cost the fund from $1.4 billion to a "maximum exposure to the NCUSIF of $6.4 billion" when layering in the real estate losses scenario with the Corporate Credit Union stress scenario.
To show how remote all of these projections are, one need only to look at the credit unions reporting net worth (not total capital), but net worth, below 7% at June 30, 2009. To bring all 134 credit unions with net worth below 6% back to "adequately-capitalized" would require capital of just $272 million. To raise the net worth of all 166 credit unions between 6 and 7% net worth would require another $230 million. In other words for just $502 million in capital notes in these credit unions, every credit union in the system would be adequately capitalized. The total existing reserve for losses in the NCUSIF is $523 million at August 30, more than enough to make every problem credit union at June 30 meet PCA capital standards. This is before using any of the $2.2 billion in retained earnings.
The resources in the credit union system are more than adequate to manage the current level of capital shortfalls as reported in the call reports. The industry is getting stronger by every measure of industry strength including the coverage ratio and core earnings. Loan turnover is such that the entire portfolio has duration of less than 2 years. This means that credit unions are using current valuations and credit standards on the majority of the loans on the books today. In comparison with the banking industry’s level of delinquencies, charge offs and balance sheet provisions, credit unions are two to three times better off.
A Perverse Incentive to Project More Losses or "Self- filling Prophesy"
The NCUSIF does not need more funding. There is a liquidity line of over $40 billion at the CLF that the NCUSIF can be and has been drawn upon.
The Board is creating a "perverse" incentive for staff to project losses to justify more resources. The five additional staff recommendations, including one to study an increase in the NCUSIF’s normal operating level above 1.30%, are all of this character.
Resources drawn from the industry only undermine credit unions' ability to serve their members. Nowhere in any of the staff justifications was there any accountability or measures for using these resources to actually reduce failures!
Moreover, projecting these extreme loss projections could create self-fulfilling actions. Cashing out problems at the lowest point of value resolves nothing. It merely shifts the burden of failure to the merged credit union or across the whole industry. Anyone can hold a garage sale.
A creative, professionally managed organization is one that is able to work its way through economic downturns—that is what credit unions have done throughout their history. The goal should always be to minimize loss. That is why cooperatives exist for their members. That is why the cooperative system was built over the last 75 years--to use common resources to support individual circumstances, not turn our back on problems.
Under any reasonable operating projections, NCUA does not need more resources; it needs to become more effective at resolving problems. This can be accomplished by using the collective funds owned by credit unions to transition credit unions through the downturn. The $1 billion capital note put into US Central, and now being repaid, could be used to provide all the support needed for troubled credit unions to earn their way back to normal operations.
Earning their way back is the only solution that any troubled firm, bank or credit union, has available. A policy of closing credit unions when they have downturns will inexorably lead to a diminished credit union system—for at some point virtually all firms will have problems.