On Feb. 15, the NCUA board announced the results for the 2017 National Credit Union Share Insurance Fund. Surprisingly, the fund recorded a loss of $229 million.
A critical role of owners of a firm or citizens in a democracy is the willingness to ask tough questions. Especially when bad news is a surprise.
Some credit unions are asking why they should care about how the NCUA manages the NCUSIF? Because it’s members’ money.
Similar to all other assets, each credit union is accountable for the safety of this deposit. However, the state of the NCUSIF also communicates the credit union system’s financial reputation to Congress and the public at large.
At stake is not only member resources but also the public perception of the industry. So, when the NCUA board announced the worst monthly financial performance in the history of the share fund, credit unions should take notice.
The following summary and data will help credit unions ask tough questions that should accompany surprising bad results, whether reported by a credit union or a government agency.
The Bad News
At the February meeting, the NCUA board revealed a monthly provision expense increase of $657 million and an $815 million reserve for specific credit union losses as part of a 300% one-month allowance account increase to $925 million. These charges created the first-ever yearly loss for the NCUSIF of $229 million. These results come at a time of almost unprecedented national prosperity in the economy and for financial institutions.
The November NCUSIF financial report to the board indicated none of these last-minute problems. In fact, just prior to its merger with the Temporary Corporate Credit Union Stability Fund on Oct. 1, the NCUSIF recorded a $74 million provision expense. This brought the total allowance account to $286 million, of which only $21 million was for specific credit union problems.
In other words, everything looked normal 11 months into the year.
Even with this worst ever monthly and yearly financial results, the NCUA met its 1.46% equity target precisely as projected in July 2017. Even better, the agency announced that the projected dividend of more than $700 million from the $2.6 billion merged assets of the TCCUSF would go forward as predicted.
How Did These Two Results Occur?
In the face of this newly discovered financial disaster, the NCUA booked another $500 million to $600 million of income from the assets of the five asset managed estates (AMEs), the accounts created for the liquidated corporate credit unions. This brought total recoveries to more than $3.1 billion from the surplus of the five corporate credit unions liquidated during the financial crisis.
If the NCUA had directly added this last-minute income to reserves, creating a year-end equity level of at least 1.52%, it would then be required to dividend another $600 million on top of the $700 million previously forecast for a total of more than $1.3 billion.
Also read: The NCUA Makes The Wrong Kind Of History
How can the NCUA hold onto these last-minute funds? The answer, expense it away. Thus, the one-month, unprecedented loss expense of $657 million wiping out the new income. This number was exactly the right amount to record an equity level at the previously projected 1.46%.
Since 2009, the NCUA’s allowance account has shown no link to the actual losses recorded. No one has challenged this lack of factual relevance in the past. The regulators assert they are acting prudently. Who can question their judgment?
When managing the common wealth created by the cooperative model and the source of all NCUA funds, uncommon leadership is necessary to avoid the conflation of self-interest and fiduciary responsibility. The obvious question is, has the NCUA’s self-interest overridden its responsibility to members for stewardship of credit union funds?
A context for asking this question is the NCUA’s dismissal of Congress’ express legislative language concerning TCCUSF resources: these provisions (of the TCCUSF Act) are restricted to resolving problems in the corporate credit union system, and not used for other purposes, such as for dealing with natural person credit unions.
Is the NCUA’s logic for this most recent income retention the same as for the merger? If this is the case, from which AMEs do these funds come, and what is the current status of each AME account?
Why Is The $500-$600 Million A Last-Minute Surprise?
On Oct. 21, 2017, the NCUA posted for the first time a full record of the allocation of $5.2 billion in legal recoveries from the big banks that sold the toxic securities that brought down much of the corporate credit union system. KPMG finished its final TCCUSF audit on Nov. 14, and as late as Nov. 30, the merged NCUSIF had still not recognized any additional surplus.
In the KPMG NCUSIF year-end audit there is $480 million described as the final paydown on the NCUSIF’s $1.0 billion note in the failed U.S. Central Corporate Credit Union. This total is the major component of the $674 million reported in the audit’s Statement of Changes in Financial Position under the line item Financing Sources Transferred in Without Reimbursement.
In plain language, this is cash from AME assets. And no one foresaw this half-billion dollar income until December?
What did the board do with these last-minute funds? It expensed the newly found riches away and highlighted the $735 million dividend.
What Is The Right Level For The Allowance Account?
The question then arises, is this dramatic, one-month 300% increase the proper level for the allowance account?
According to NCUA audits, the actual loss history for the fund is 1.2269 basis points of insured shares over the past 10 years. This loss record would suggest an allowance level of $134 million as appropriate based on actual experience. For example, the net cash losses in 2017 were only $18.9 million. The allowance at the end of November, before December’s extraordinary loss expense, was $286 million, or more than double this 10-year experience record.
The traditional conservator goal is to restore a credit union to financial self-sufficiency with a combination of new assets, streamlined operations, and capital injections, if necessary, thereby restoring the earnings power of the cooperative.
The NCUA says taxi medallion lenders now pose an $818 million threat to the share insurance fund. It is possible to analyze this judgment by looking at year-end taxi medallion lenders and trends.
This spreadsheet (click here) shows credit unions holding taxi medallions. The total net worth plus allowance account delinquency coverage ratio appears in the final column. The names are drawn from press accounts identifying credit unions originating or participating in taxi medallion loans. Names of the individual credit unions have been eliminated as some might object to being characterized as having any meaningful exposure to taxi medallion loss. Reputation matters to credit unions.
As shown, individual credit union coverage ratios of all delinquencies range from a low of 121% to more than 3,000%, with an average of 781% for this group. It is difficult to see any potential losses from this data.
Below these credit unions are the two credit unions in conservatorship, which means the NCUA is running them and responsible for the accuracy of their financial reports.
LOMTO Federal Credit Union has an allowance account totaling 169% of delinquent loans offset by a negative net worth of $37.5 million. Melrose Credit Union’s $237 million allowance less $187 million in negative net worth leaves $50 million to cover losses in $474 million of delinquencies. Assuming both delinquent portfolios are largely secured by taxi medallions, then there is significant recovery opportunity with the proper case oversight.
The key in both cases is the effectiveness of the workout strategy and managers in charge. The NCUA’s resolution efforts are often contradictory. The agency often prefers to liquidate as many individual problem assets as possible and then try to find a low-cost merger option for the remaining assets and liabilities.
However, the traditional conservator goal is to restore a credit union to financial self-sufficiency with a combination of new assets, streamlined operations, and capital injections, if necessary, thereby restoring the earnings power of the cooperative.
This strategy takes patience, creativity, and empowered leadership while the cycle of collateral devaluation runs its course and reaches a new normal.
This approach not only minimizes loss to the NCUSIF but also shows the recovery capability that cooperatives can accomplish with proper leadership. Unlike private firms, there is no outside venture capital waiting to scoop up failing firms and then nurse the franchise to its full capacity.
No matter what the approach to workouts, it’s difficult to see anything close to a $818 million loss even if the agency wants to hold a fire sale.
Asking Tough Questions: The Role Of Boards And CEOs
From the financial facts provided, any credit union executive should be able to develop questions they believe need to be answered, including:
- Is the worst year ever in NCUSIF’s history justified?
- Are the last-minute parallel offsets of income and expense in December just coincidence?
- Is the NCUA’s resolution capability so limited that an $800 million expenditure of credit union funds is necessary to restore two credit unions to self-sufficiency?
While reviewing the above data and the NCUSIF’s year-end audit, leaders might also want to read the footnote on page 44 regarding another contingent reserve. The NCUA asserted that the fund needs to hold onto four basis points $440 million of member funds because of the contingent liability from the NGN notes guarantee transferred upon the merger.
The note reads in part: Changing the assumptions for reasonably possible variations in certain macroeconomic circumstances such as a decline in housing prices from its most recent peak in the external model would have resulted in no expected losses associated with the re-securitization transactions under any scenario as of Dec. 31, 2017.
That has been the same conclusion for the past five years. Why is the NCUA continuing to hold these funds? What does that indicate about its approach to other contingency funding?
Will there ever be a more important time to ask tough questions?