When modeling an adverse economic environment, absent any exposure to the NCUA Guaranteed Notes (NGN), staff projected an NCUSIF premium would be required by the fourth quarter of 2018. These “conclusions” took 65 slides and 17 pages of accompanying notes to justify the work. But the more one looks, the less that is there.
Is The NCUSIF 1% Deposit Model Flawed? Does It Still Work?
Assessing a premium has always been an option in the 1% deposit model. But unlike the NCUSIF's first premium-based model and the FDIC's financial structure today, assessments are intended only as a last resort.
The NCUA defended not returning the surplus corporate credit union bailout money to its rightful owners — credit unions and their members — by saying their models showed a premium sooner or later. Therefore, the logic was to retain the surplus now and save credit unions the problems of writing checks later.
But to retain these projected future premiums, the NCUA had to raise the NOL above 1.3% or it would have to send credit unions these predicted “future assessments.” That’s when the smoke and mirrors start.
In the staff’s model, they identify “three primary drivers” but conveniently omit any numbers that account for most of the funds outflows in good years and bad: the overhead expenses. They project these at a 4.1% rate from the 2016 base of $209 million. After five years, this growth would result in a $255 million annual fixed overhead expense. In staff’s five-year base case projections, this fixed expense would total between 300% and 400% of the forecasted insurance losses.
The NCUA’s model locks in the operating expenses at the current level, its highest ever, and then continues to grow the burden.
This overhead expense impact is shown nowhere. The NCUA’s model locks in the operating expenses at the current level, its highest ever, and then continues to grow the burden. The primary objective of the staff’s presentation is to increase the fund’s asset/revenue base to continue to fund this unhindered budget draw.
In addition to concealing the real numbers driving NCUSIF results, staff made a series of self-serving, misleading statements, such as: “Worthy of note, the equity ratio is expected to decline given the low yield environment and strong insured share growth, even under no economic stress.” For it is the fixed overhead, not growth or insurance losses, that primarily undermines NOL stability in the base case.
This statement suggests staff and presumably the board neither understand how the model works nor the insight from using the prior nine years of actual experience, instead relying on hypothetical futures that are divorced from real outcomes.
How The Model Works: Plain and Simple
Click here to see a spreadsheet that tracks NCUSIF loss rates and expense growth for the past nine years.
By requiring credit unions to maintain 1% of insured risks as the core of the model, plus equity in a range of .2% to .3%, the fund’s assets should provide sufficient investment income to cover most economic scenarios credit unions will confront.
Here is the base data from the actual fund performance for the nine years 2008-2016 and current fund portfolio yields and pre-TCCUSF merger asset size at Sept. 30, 2017:
Insured share growth 9 year: 4.74%, rounded to 5%;
Nine-year rate of loss on insured savings: 1.38 basis points ($1.034 bn divided by $7,506.3 bn)
Total invested fund balance, September 2017: $13.2 billion
Total portfolio yield: 1.5% (last reported November 2017 and before latest FF increase)
NCUA overhead expense charged in 2016: $ 200 million
Insured shares: $1.1 trillion
Beginning NOL at September, 2017: 1.25%
The Current Situation
Given the above historical and current real numbers, what yield is necessary to sustain the 1.25% NOL. If the yield assumed is insufficient, then what additional premium might credit unions have to pay to maintain this NOL?
The formula to find the required yield:
.2 (assumed share growth) + .8 (historical loss rate) + .77(per $100 million of NCUSIF overhead) = B/E yield
.2(5%) + .8(1.38 bps) + 1.52 ($200 million/current fund size of $13.2 bn) = 3.62% yield on $13.2 BN
The required yield of 3.62% (to sustain a 1.25% NOL) minus current actual yield of 1.5% leaves a potential income shortfall of 2.12% or a $279.8 million income in the coming year. This equates to an assessment of 2.5 basis points of insured shares ($1.1 trillion) to maintain a stable 1.25% NOL.
The NCUA Holdback Prevents Credit Unions From Helping Members
The NCUA board decided not to return the full $2.5 billion initial TCCUSF surplus (or 23 basis points per $1.1 trillion of insured shares) to offset a potential premium charge of only 2.5 basis points in 2019.
Board member Rick Metsger commented in a press interview after the September vote that he found “it rather ironic that people within credit unions are now arguing over the size of their returns rather than the premiums they might be assessed.” But this choice of a 2.5bps premium in 2019 versus a 2018 23bps refund was never presented. The board may not have known of this option.
One need not agree with any of the data above to be able to calculate a different outcome. For example, if insured share growth doubles the historical average to 10%, then an additional 1% in yield income would be needed, or about 1 more basis point of premium.
Or if the current $287 million loss reserve, which is $135 million above the historical average, is deemed inadequate, then the NCUA should explain why these extraordinary losses are occurring in a very positive economic environment. Is the problem with credit unions or with the agency’s problem resolution oversight?
It is important to remember the allowance account is set aside to absorb all anticipated losses and is not included in the NOL calculation. The NOL equity is always after all known or estimated losses have been expensed.
See For Yourself. Inform yourself about this issue. Use this spreadsheet as a calculator to project the NCUSIF’s likely premium it if wants to maintain a stable 1.25 NOL.
You Can Now Do the Modeling
Board Chair Mark McWatters said he got his number of 1.3% from BlackRock, the agency’s investments manager, but credit unions didn’t give him their number. Any credit union can now forward the board their “number” using the spread sheet above.
However, any credit union can put their assumptions about share growth, loss rate, fixed expenses, and the rate outlook in to the model. The spread sheet then calculates the “required yield on the investment portfolio to maintain the current NOL. If the yield is below break-even, the model shows the anticipated potential basis points of premium and the potential excess yield.
For example, one would think that the NCUA’s portfolio return would be higher than the average overnight rate, currently at 1.5%, especially as the Fed is indicating up to three more increases in 2018. Today the 10-year treasury is hovering around 2.6%.
The NCUA’s Numbers Hide The Real Facts
The NCUA’s future scenario exercises had one objective: ballooning up the NCUSIF’s size to be able to cover their annually increasing fixed cost overhead transfers under any circumstance. The NCUA's July 20, 2017, briefing is a façade of omniscience with tables, multi-year projections, three economic scenarios, and cash flow waterfall charts
Nowhere in the staff’s July 2017 presentation did NCUA staff show the NCUSIF's operating expenses as a part of its multiple data tables. However, it this fixed overhead expense that primarily accounts for the NCUSIF's results. Over the past nine years, actual expenses have risen at a CAGR of 11.05%, more than twice the rate of insured share growth (4.74%).
If a CEO and board were to use the circumlocutions, the untethered data modeling, and the disregard of member needs and wishes as the NCUA does now, the CAMEL rating for management would deserve a 5.
In recent years 97% of the fund's operating expenses are the result of costs charged using the overhead transfer rate (OTR) process. This transfer rate has increased annually from 52% to 73.1%. From 2008-2016 the resulting charge has grown from $79 million to $203 million.
This increase is equal to the entire increase in NCUA's overall budget in the nine-year period. Rather than increase the FCU’s operating fee, NCUA has allocated all its operating expense growth to the insurance fund.
The NCUA board chose a higher NOL to avoid an NCUSIF assessment versus using administrative fiat to get its hands on credit unions' money. Instead of leadership, the board chose deception to avoid the reaction to a premium.
The insurance fund’s financial model was not intended to fund the NCUA’s budget. That is why there is an operating fee. No model can work if it is used contrary to its designed purpose.
One of the intended guardrails limiting uninhibited NCUA spending was that the board must assess credit unions for increases by either an operating fee rise or NCUSIF premium. The board is circumventing these requirements through manipulation of the OTR and now the NOL.
The board has disabled the critical feedback loops embedded in these assessment processes. The result is that credit unions who pay the bills have no opportunity to apply insight or objections to unchecked board spending.
The FDIC Saves While The NCUA Spends
On Dec. 19, 2017, the FDIC approved its 2018 operating budget. This budget is 48% below that regulator’s 2010 peak in the midst of the financial crisis.
FDIC Chair Martin J. Gruenberg says, “This is the eighth-consecutive reduction in the FDIC’s annual operating budget and staffing. The FDIC remains focused on fulfilling its mission while prudently managing its costs.”
With an 11.1% annual growth of NCUSIF expenses, no one can accuse the NCUA of prudently managing its costs. Indeed, even while cutting its field offices by 40%, that budget inexorably rises.
The Long-Term Impact of Self-Serving Deceptions
This distortion of accepted accounting and administrative practices will have a long-term impact. By conjuring varying hypothetical economic dystopias, rather than being grounded in facts and experience, the traditional historical limits on NCUA conduct are being manipulated and eroded.
The veneer of administrative due process is practiced by asking for comments, but the substance provided is either ignored or rejected. So-called transparency announcements are little more than exercises in PR to support actions already taken. For example, the NCUA’s much-belated October 2017 description of how $5.1 billion in legal recoveries were allocated among the five corporate Asset Managed Estates (AMEs) is not only unintelligible, but also six years after the fact.
The most serious unintended consequence of the cooperative regulator treating members’ common wealth as their own money, is the example this “agency” model communicates to the industry.
Cooperative success depends on leaders putting members’ interest, not managements’ convenience, first. The NCUA is a fiduciary example, for better or for worse. If a CEO and board were to use the circumlocutions, the untethered data modeling, and the disregard of member needs and wishes as the NCUA does now, the CAMEL rating for management would warrant a 5.
This is the third in a series of articles analyzing the NCUA's closing of the Temporary Corporate Credit Union Stabilization Fund (TCCUSF) and retaining the majority of surplus funds for its own use. Read Part 1: The Most Important Audit Ever. Read Part 2: Smoke And Mirrors At The NCUA. Read Part 4: Think What $2.5 Billion Could Do In The Movement's Hands.
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