A Cash Cow 7 Years In The Making

A review of NCUSIF audits show a rebuff of reality that marks seven years of building budgets while thwarting the fund’s intent to sustain and nurture.

 
 

The National Credit Union Share Insurance Fund restructuring in 1984 was an innovative idea that helped set the credit union industry on a course of modernization that also protected its essential, unique cooperative structure and nature. 

However, 30 years after its redesign, the NCUSIF has become a cash cow for the regulator. A close look at its 2015 audit and seven-year trends shows how a great idea has gone astray.

NCUA board chair Debbie Matz exits at April’s end. This audit completes the record of how the share fund was managed during her tenure. It’s not a pretty picture.

Our analysis shows a pattern of financial misjudgments well beyond just an accounting or expense problem. What this pattern suggests is that the NCUA has little or no ability to accurately determine probable losses, which in turn calls to question the effectiveness of the examination and supervisory program.  

Matz’s tenure also has been marked by the agency’s gross overreach against all logic and precedent to micro-manage capital risk levels, and a regulatory posture that seems to be as much about seizing and exerting authority as protecting the share fund, and more broadly, the credit union movement and all it stands for.

Today, instead of helping credit unions survive rough patches — its original intent — the regulator has used the fund to feather its own bed while crushing small cooperatives with regulatory burden and at times, simply shutting them down despite no realistic threat to the fund that was created to save them.

The Movement’s 1%

The NCUSIF opened in 1971 as a premium-based fund much like its much-larger FDIC and FSLIC counterparts. But those funds had a 50-year head start in building reserves.

The share fund had been around for only a decade when recession and deregulation arrived in the early 1980s, and reserves shriveled to less than 20 basis points, well below the 1.3% or more in the bank and thrift programs.

The only financing option was double premiums costing credit unions as much as 16 basis points from ROA. This expense reduced credit unions’ earnings at the very time they faced critical member needs and the new competitive pressures of deregulation.

In response, the NCUA and credit union leaders together asked Congress to amend the Federal Credit Union Act. This change created the 1% deposit model that had been the financial foundation for more than a dozen state-chartered cooperative insurers going back to the 1960s. One cent of every member share dollar would now be sent to a common pool to be used for troubled institutions. 

This approach meant the cash resources would always be there to help individual credit unions at any time, and to prevent special premiums in economic downturns when that would be most onerous and detract from serving members’ needs.

Better Than Expected

This cooperative design worked better than expected. From 1985 through 2008 only once was a premium assessed and in several years, including 2008, a dividend was paid when the fund’s normal operating ratio exceeded 1.3%.

Meanwhile, Congress had to bail out the FSLIC and FDIC several times and ultimately the FSLIC was merged into the FDIC. The NCUSIF never fell below a 1.23% operating ratio and always acted counter-cyclically. Instead of compounding financial pressures, credit unions could focus on serving members in a crisis because the NCUSIF had the resources in hand.

Repurpose With Redesign

Prior to the 1984 restructure, share insurance was viewed as a “property and casualty” function. If a credit union had a problem and failing capital, the solution was to liquidate or merge and be done with it.

No more. The NCUSIF was now seen as an integral part of the cooperative system’s resources. Whenever a problem occurred requiring external assistance this collective capital could be used to find the best long-term outcome.

Capital assistance could be given, or guarantees to support liquidity needs.  Instead of paying out losses, often at the low point in the cycle of value, credit unions were able to earn their way back to viability.

Co-ops, which rely on members’ goodwill, can take the long view when problems occur. These NCUSIF strategies of “investing” temporary assistance in difficult situations during the 1980s downturn with Central Liquidity Fund loans, section 208 guarantees, and capital injections saved tens of millions in potential losses.

Meanwhile, examiners were tasked with helping credit unions recover, not just look for mergers or liquidation to resolve a problem. The sound management and always available reserves of the share fund also provided the foundation for that approach.

No Boots Or Bootstraps

Credit unions are managed by human beings. Even in stable economic times, problems occur. Most cooperatives operating today have received generations of volunteer oversight and member participation.

NCUSIF assistance helped credit unions pull themselves up by their bootstraps: the same self-help philosophy that is required to start credit union initially.

By inverting the traditional regulatory response of eliminating problem institutions, the fund’s losses were minimal from 1984 through 2007, with the cooperative system navigating multiple economic disruptions with nary a blip.

How things have changed.

With the departure of Debbie Matz, the new NCUA board has an opportunity to make changes. Board members Mark McWatters and Rick Metsger have expressed their desire to hear from the industry. What better way to begin than to hold public hearings on the NCUA’s budget and the transfer of expenses to the NCUSIF? Ideally that would lead to more-responsible decisions for the fund’s real owners, the credit union members.

A Crisis Mindset

The table below shows the seven-year track record (2008-2015) of the NCUSIF during and after the Great Recession.  Some major observations are:

  1. At no time did the agency demonstrate the ability to align the NCUSIF’s actual net cash losses with accounting expenses or the premiums charged credit unions;

  2. The NCUA’s premiums have been pro-cyclical; they undermined credit unions’ ability to help members by adding unnecessary expense on top of credit unions’ market challenges from the housing crisis;

  3. The agency has increasingly diverted the insurance fund’s resources from their core purpose of assistance for problem situations to become the primary funding source for the agency’s ever-growing budget.

As shown in the table below, even when actual data was available to counter widely exaggerated loss forecasts, the regulators just doubled down on their crisis point of view.

In summary, instead of a stronger, more flexible and responsive NCUSIF drawing upon credit unions’ common capital resource for creative solutions, the system’s collective capital has been converted to an operational funding vehicle that will reduce its ability to underwrite the system’s special needs in future crises.

How the Cash Cow Was Birthed

During the past seven years, NCUA has increased the percentage of its operating expenses charged to the NCUSIF from 52% in 2008 to 71.8 % in 2015. This increase has resulted in virtually 100% of the agency’s seven-year spending increase of $114 million being funded by the NCUSIF.

This has created a distortion in the agency’s budgeting and spending trends. Instead of a flat expense trend as presented in operating fund audits, the increases are just taken out of the NCUSIF’s income.

This expense allocation which totaled 88.4% of NCUSIF income in 2015 (up from 20.6% in 2008), has severely limited the fund’s ability to meet its financial loss insurance function. There is little flexibility to provide for emergencies. This entrenched burden drains reserve buildup during normal economic times and creates the need for premiums should any above normal losses occur.

Even though the agency publishes a level operating expense, the reality is that it is distributing its growing costs over the entire credit union system by this taking of NCUSIF income.  

Cash Cow: Diverting Expenses to the NCUSIF

  2008 2015 7-Yr change
% NCUA Exp Transfer 52%  71.8%  
Net NCUA $ Op Exp $74.3 million $75.5 million (+$1.2 million)
NCUSIF $ Op Exp $79.4 million $192.3 million (+$112.9 million)
% NCUSIF OpExp/Inc 20.6% 88.4%  

 

Agency Ignores Numbers, Reality

Here’s additional data from the following table supporting this analysis of a crisis mindset:

  1. The loss provision expense ranged from 431% greater than actual cash losses (2009) to a reversal of more than 566% (lower than actual losses) in 2011. These provision gyrations mean the accounting reports bear little if any relation to what was actually occurring.  
    Compare cash results before any premiums (and after 2009 and 2010) with the audit’s bottom line. Accounting presentations are nowhere close to operating reality. When financial reports are so widely variant from actual results, how can any management team make informed decisions?
    Moreover, how can credit unions funding these audited “results” and other interested readers of these statements have confidence in the judgments of the practitioners?
  2. The NCUA assessed two premiums totaling $1.657 billion in 2009 and 2010.  These premiums were supported by board action memorandums that included wildly inaccurate loss projections. 
    One result is that for three years the fund’s normal operating level exceeded the maximum 1.3%. This overage required the NCUSIF to pay $462 million from these inflated premiums to the Temporary Corporate Credit Union Stabilization Fund — the corporates’ resolution fund — from 2011 through 2013. These cash payments out of the NCUSIF are now tied up until at least 2021 because of the TCCUSF’s structure.
  3. At year end 2009 following the first premium of $727 million to pay for this “non-cash” loss provision expense, the reserve allowance was increased to $759 million. (Line 2 in chart below.) How excessive was this provision? In the following six years (2010-2015) the NCUSIF reported a grand total of $650 million in net cash losses. 
    Absent payouts to the TCCUSF, this 2009 reserve account would still have $109 million remaining today. Even with this over-reserving, the NCUA “doubled down” by assessing in 2010 a second, $930 million premium. (Line 10 in chart below.) This raised the loss reserve at year-end 2010 to the highest level ever of $1.225 billion. None of these funds were ever needed. Instead these accounting provisions were “reversed”, which helps disguise the increased operating costs allocated to the NCUSIF. This process continues today.

SELECTED NCUSIF PERFORMANCE INFORMATION 2008-2015 ($ IN MILLIONS)

    2008 2009 2010 2011 2012 2013 2014 2015
1 Insured Shares at Year-End $659.00 $725.00 $758.00 $795.00 $839.00 $866.00 $903.00 $961.00
2 Loss Reserve Balance at Year-End $278.30 $759.00 $1,225.00 $607.00 $413.00 $221.00 $178.10 $164.90
3 Amount of Reserve for General Losses $232.00 $597.00 $1,052.00 $590.00 $317.00 $208.00 $173.00 $154.90
                   
  Operating Income Statement
4 Investment Income $390.90 $188.80 $217.00 $198.00 $207.00 $198.00 $208.00 $218.50
5 Other Income $4.70 $33.30 $49.50 $5.00 $9.00 $5.00 $6.00 $5.20
6 Total Income $395.60 $222.10 $266.50 $203.00 $216.00 $203.00 $214.00 $223.70
7 Operating Expense -$81.50 -$134.60 -$165.80 -$132.00 -$141.20 -$148.00 -$180.00 -$197.87
8 Net Cash Losses * -$228.00 -$145.00 -$228.00 -$93.00 -$119.00 -$151.00 -$46.00 -$13.20
9 "Cash" Operating Results Before Premium and Reserve Adjustments $86.10 -$57.50 -$127.30 -$22.00 -$44.20 -$96.00 -$12.00 $12.63
                   
10 Cash Premium $0.00 $727.00 $930.00 $0.00 $0.00 $0.00 $0.00 $0.00
11 Operating Results After Premium (Cash) But Before Provision Expense $86.10 $669.50 $802.70 -$22.00 -$44.20 -$96.00 -$12.00 $12.63
                   
12 Provision Expense $290.00 $625.00 $737.00 -$526.00 -$75.00 -$41.00 $3.30 -$0.25
13 Other Non-Cash AME Provision Adjustment     -$2.00 -$7.00 -$3.00 -$8.00 -$45.10 -$35.20
14 Audited Net Income Including All Provision Adjustments $23.80 $189.80 $295.00 $203.00 $64.00 $8.00 $75.90 $61.30
                   
15 Gross Cash Paid Losses * $285.00 $162.00 $278.00 $105.00 $349.00 $225.00 $97.60 $40.00
16 Less: Recoveries * $57.00 $17.00 $50.00 $12.00 $230.00 $74.00 $52.00 $26.80
17 Net Cash Losses * $228.00 $145.00 $226.10 $93.00 $119.00 $151.00 $45.60 $13.20
                   
18 Cash Operating Results - Audited Net Income ** $62.30 -$247.30 -$422.30 -$225.00 -$108.20 -$104.00 -$87.90 -$48.67
                   
  Ratio Analysis 2008 2009 2010 2011 2012 2013 2014 2015
19 Loss Reserve as a % of Following Year Cash Losses 192% 336% 1317% 510% 274% 484.6% 1349.2% N/A
20 Loss Provisison as a % of Current Year Cash Losses 127% 431% 326% -566% -63% -27% 7.2% -1.9%
21 Following Year Cash Losses as a % of Loss Reserve 52.1% 29.8% 7.6% 19.6% 36.6% 20.6% 7.4% N/A
22 Cash Losses as a % of Loss Provisison 78.6% 23.2% 30.7% -17.7% -158.7% -368.3% 1381.8% -5280.0%
                   
23 $ Transferred to TCCUSF: $ Exceeding 1.3%     $0 $279 $88 $95 $0 $0
                   
24 Percent Overhead Transfer Rate to NCUSIF 52.0% 53.8% 57.2% 58.9% 59.1% 59.3% 69.2% 71.8%
25 Opex/Total Income (Exclude Provision & Loan Losses) 20.6% 60.6% 62.2% 65.0% 65.4% 72.9% 84.1% 88.4%
26 $ Overhead Charged $79.40 $90.20 $113.60 $130.00 $137.50 $146.00 $175.60 $192.30
27 Total NCUSIF Operating Expense $81.5 $134.6 $165.8 $132.4 $141.2 $148.3 $180.0 $197.8
  * New Cash Losses is calculated by subtracting Recoveries from Gross Cash Paid Losses
** Results: Positive = Cash > Audit; Negative = Cash < Audit Results

 

NCUA Doubles Down

When the NCUA was challenged to “back-test” the December 2010, $1.2 billion reserve balance against actual results, Larry Fazio, director of examination and insurance, rejected this real-world analysis in the agency’s September 2011 monthly report:

“Ironically, some think the NCUSIF is over-reserved. The NCUA runs these numbers quarterly and makes adjustments to them quarterly both up and down. And of course the process and annual year-end figures are audit tested by independent third parties.”

Barely 60 days after this stand-pat defense, auditors reduced the reserves by $526 million in their 2011 review. In the next two years another $116 million was reversed.

Nebulous And Meaningless

In 2008, the peak year of the market crisis, the NCUA’s overhead transfer rate was 52% of operating fund expenses, or $81.5 million. In 2015, the year of the lowest net cash losses ($13.2 million) the NCUA transferred 71.8% of its expenses, or $192.3 million.  

Common sense suggests that the NCUA’s definition of its insuring role has become so nebulous as to be meaningless. At the height of the crisis 52% of its resources were so-called “insurance-related.” In the year with lowest losses since 2008, over 71% are so labeled.

The following is how the NCUA described this transfer decision in the audited statement in 2008: “The operating fund (OF) charges NCUSIF for these services based upon an annual allocation factor approved by the NCUA board and derived from a study of actual usage.” This same language “derived from a study of actual usage” to explain the OTR in 2015 suggests this so-called study is merely bureaucratic manipulation to attain an already determined outcome.

The NCUA board late last year voted to transfer this allocation decision to staff. This action means the NCUA board has abdicated one of its most critical responsibilities for overseeing the agency budget. The staff, not the board, will determine how much it spends of NCUSIF revenue.

Thus The Cash Cow Premium Inducing Model

This continuous increase in the transfer rate and in the dollars expensed have converted the NCUSIF into a cash cow for NCUA’s daily operations. In doing so NCUA has jeopardized its financial ability to provide cooperative capital resources unless it adds a premium expense to credit unions’ financial burdens in the next crisis.

A table of eight years of selected data from the audits is shown above. The overwhelming conclusion is that the NCUA has no reliable way to estimate its losses and to reserve accordingly.  

A recent example: in the NCUSIF’s 2015 budget, the NCUA forecast $100 million in loss provision expense leading to an NCUSIF estimated bottom line of an $81.9 million loss. This bottom line budget forecast was incorrect by $143 million when the  audited result of a positive $61.3 million was released.

This pattern of financial misjudgments is not just an accounting or expense problem. What it suggests is that the NCUA has little or no ability to accurately determine probable losses, which in turn calls to question the effectiveness of the examination and supervisory program.  

The data above is not just a single year, or a crisis-induced aberration; rather the results are consistently at variance from real-world events that is, net cash losses, every year.

More Than NCUSIF System-Wide Misjudgments

The continuous gap between reality and financial statements goes deeper than the NCUSIF “macro-system results.” In 2014 and 2015 the NCUSIF reported a record amount of provision adjustments that reduced estimated losses from individual credit unions’ asset management estates (AME).

These amounts were $45 million in 2014 and $35 million in 2015. Almost all of these amounts are from upward revaluations of loans held by the AME which were acquired from credit unions in liquidation.

While some might say this is a good result, the reality is that these “revaluations” of $80 million mean that these loans were undervalued when the NCUA took over the credit unions with these assets. This also means that these “micro”case-loss estimates (cash paid less estimated recoveries) overstated the NCUSIF’s losses by $80 million in the years these credit unions were taken over. 

This upward revision in loan values implies that examiners directed write-downs of these loans, requiring higher loss reserves which in turn reduces net worth capital. Might this $80 million in loss reductions have changed the examiners’ assessments of these credit unions’ financial condition? What happened to the careers and the institutions where these forecasts were so far from the mark?

Seven Years Of Financial Incongruence

The eight-year NCUSIF results are also troubling due to the consistent pattern of exaggerating problem situations and loss projections. It shows an inherent conflict between an agency responsible for the industry soundness and the basis for its revenue assessments paid solely by regulated credit unions. 

The incentive is to exaggerate problems or forecast economic difficulties, to validate the regulator’s annual arguments for more resources. The issue should not be about resources, but effectiveness. On both counts the eight years of results show an agency bordering on ineptitude.

The primary role of the NCUA is identifying risks, managing uncertainties, and resolving problems in the members’ interest and at the least cost. The track record instead powerfully demonstrates the need for greater accountability on every aspect of the NCUA’s oversight.

Affirming the NCUSIF’s Proper Role:

New leadership is coming to the NCUA. This gives an opportunity for a renewed understanding about the role and  use of the financial resources of the NCUSIF. As redesigned in 1984 the NCUSIF can be a significant advantage for the cooperative system and for the NCUA’s oversight role.  

However when it becomes a cash cow, it perverts not only the fund’s role, but compromises NCUA’s ultimate responsibility for safety and soundness by diverting funds away from actual insurance loss needs.

The 1984 cooperative restructuring was a grand experiment in government and credit union cooperation. When the 1% deposit change was made, credit unions expressed concern about government managing all the money and with it, the temptation to spend. 

Credit unions’ worst fear for a cooperative approach has happened. A good idea has been hijacked. With the departure of Debbie Matz, the new NCUA board has an opportunity to make changes. Board members Mark McWatters and Rick Metsger have expressed their desire to hear from the industry. What better way to begin than to hold public hearings on the NCUA’s budget and the transfer of expenses to the NCUSIF? Ideally that would lead to more-responsible decisions for the fund’s real owners, the credit union members.

 
 

April 26, 2016


Comments

 
 
 
  • Chip - Thanks for this great article. Real life anecdote - my first credit union job 31 years ago was a credit union under "208 assistance" - that credit union is still serving members today - assistance can and does work. We certainly won't be able to say that about many credits after Matz's leadership the last 7 years.
    Todd