In the July 21 NCUA Board update on the NCUSIF, CFO Rendell Jones gave every explanation except the correct one for the fund’s second quarter loss of $21.8 million.
Jones said the low rate environment is causing flat NCUSIF earnings. This is not a new event. Earnings on the share insurance fund’s investments have fluctuated between $188 million in 2009 and $218 million last year.
The real reason for the second quarter loss is not slow revenue growth but rather the ongoing increases in operating expenses charged to the fund through the overheard transfer rate (OTR) process.
Expenses Growing 13.5% A Year
From 2008 through 2015 the NCUSIF’s operating expenses (not including any loss provision adjustments) grew from $81.5 million to $198 million. (By contrast, annual inflation rates in the U.S. during those years ranged from 3.8% in 2008 to 0.1% last year, according to the Bureau of Labor Statistics.)
This 13.5% compound annual growth rate in expenses over eight years is due to two factors:
The NCUA increased the transfer rate for its operating expenses charged to the NCUSIF from 52% to 71.8%.
The NCUA also increased its operating expenses every year.
Few if any mature organizations can survive an ever-growing, annual double-digit expense increase.
The net result is that during the past eight years the NCUSIF has picked up more than 100% of the agency’s $112.9 million increase in its operating expenses. All insured credit unions — not just those with federal charters — are paying for the agency’s ever-increasing budget.
“This Math Is Not Heading In The Right Direction”
Board Member Mark McWatters made the above comment in reaction to the quarterly reported loss. However the real issue isn’t the second quarter loss, rather it is the ongoing shift of the NCUSIF’s financial model from an insurance fund to one that underwrites most of NCUA’s ongoing operations.
The consequence is that in the second quarter ending June 30, 2016, 92.8% of the share insurance fund’s incomewas used just to pay the NCUA’s operating expenses. That leaves nearly nothing for the core purpose of loss expense and equity growth.
But the trend is not new. In 2008 only 20.6% of NCUSIF income was used to pay the NCUA’s operating expenses. In 2015, 88.4% of insurance income was used for operating expenses.
Again in 2016 the NCUA increased the OTR further, from 71.8% in 2015 to 73.1% this year.
That is the math that is not going in the right direction. The result is that the fund’s primary purposes — covering potential losses on insured shares or spending to rehabilitate credit unions in difficulty — has been financially compromised to pay the agency’s everyday costs.
While Operating Expenses Eat Up Income - Loss Provisions Are Missaligned
This change in the NCUSIF’s financial model was documented in “A Cash Cow Seven Years in the Making.” Perhaps the title should have read “milking” instead of “making”.
That article also laid bare the agency’s inability or disinclination to align the NCUSIF’s actual cash losses with the loss provision expense. In virtually every year the NCUSIF has been over-reserved and therefore has expensed much higher costs than the actual cash losses paid by the fund.
The latest example is the $36 million increase in loss reserves recorded in the second quarter of 2016. This increase to a total reserve of $178.9 million compares with total losses of only $13.2 million in 2015 and $46 million in 2014.
Increasing reserves to this level equates to 640% of the average losses of the past two years. That “coverage ratio” would seem to be at best an “abundance of caution” or at worst an inability to accurately assess problem situations.
Moreover, all of the macro analysis presented with the NCUSIF update to the board and all of the CAMEL trends are positive except one: the increase from .78% to .85% of insured shares in CAMEL code 4/5 rated credit unions. The distribution of assets in CAMEL codes 1-2 at 92.3% is the highest since 2007.
The Impact On Credit Unions
The ongoing action of taking NCUA’s operating expenses off the top of the insurance fund’s revenue, means that less and less income is available to cover losses and to keep equity growing in line with insured shares. The result will be unplanned-for premiums as the fund’s operating ratio falls closer and closer to the 1.2% floor.
For the past eight years the financial results reported by the NCUSIF have not reflected real world events. The NCUSIF is owned by credit union members who send 1 cent of every share dollar to the fund. The agency’s pattern has been to use the fund in its own self-interest versus its fiduciary responsibility to preserve common resources to rehabilitate or resolve credit unions in difficulty.
With new leadership at the NCUA reassessing many aspects of accepted practice, now is the time to address the conversion of the cooperative fund into a “cash cow” and restore it to its core purpose as the collective capital undergirding the system’s safety and soundness.