In the preamble to Randy’s recent post The NCUA’s role has become writing a check and giving the bad news, he challenged me about how the insurance fund got its start:
Chip, did you, Bucky, and Ed build this system to simply sell our members to someone else when the going got tough? Was the insurance fund designed to punish credit unions, and reward non-CU problem solvers? Was the point of our investment to hire consultants to broker our problems away? Was the point of insurance not to keep us better off, but whole. Somehow, feeling whole and true to the game is not something I associate with the managers of our fund today. Are they insurance people, or just money managers and political fixers?
When all of this was set up, we saw the need to see it as a system and not an aggregation of independently funded and operating institutions. As to the insurance fund we had to start somewhere. The bottom line is we could not prove with numbers that the 1% plan was a better way, because there were no audited numbers and therefore no accurate loss reserves. Just a cash basis kind of accounting. And 10-15 years of successful state operations. We now have the numbers and almost 30 years of experience. The critical factor is there is so much money that NCUA can use it as a slush fund, not just insurance; and they can claim they are doing their duty just by liquidations—which was not the intent. They seem to be opportuning the system instead of managing or running the fund the way it should work.
In Randy’s blog, he makes the case that he sees the NCUA’s practice of liquidating versus solving credit union problems as just that; mismanagement, a departure from the design, and ratifying their actions by a misinterpretation of the design in the best light, and a clear perversion of the design in the worst light. The $1.62 billion cash outlay to close Melrose and Lompto is just an extreme case of NCUA’s inability to effectively resolve problems, whether they be temporary, such as leadership performance or a CEO transition, or longer term with overvalued assets. NCUA has outsourced its responsibilities to third party, for-profit firms such as Barclays and Black Rock in the case of the corporates. More routinely today, examiners strongly “encourage” credit unions that are having organizational shortcomings to seek a merger rather than working with the credit union to sustain operations.
One study by a CDFI group calculates the age of the average founding date of all active credit union charters today as 1954. Many are older. All have lived through the 70s oil crisis, the recession and double-digit inflation and unemployment of the 1980s, deregulation, multiple banking crises including the shuttering of the S&L industry, the Internet revolution and even the Great Recession. So why would someone quit the charter now having survived a history of economic perils that have caused so many other industries to fail? I believe people give up when they are told repeatedly that the unique capabilities possessed within their credit union charter no longer matter. Members can get the same or better deal elsewhere.
The unique co-op design was not just at the member-owner level. The regulatory system followed the same principles. Whereas the banking industry had three separate institutions responsible for chartering (OCC), liquidity (the Fed) and insurance (FDIC); credit unions created a unified regulatory structure with all three oversight functions under a single board. This approach reflected both the fact that co-ops were a unique financial system outside traditional clearing house and liquidity options. More importantly the structure of the CLF and NCUSIF copied the member-owner design of the credit union model. Consolidated oversight allowed different funds for different needs, good coordination and greater efficiency in sharing information and data. But the cost was the checks and balances of three different institutions in the banking sector.
And credit unions’ combined regulatory capabilities were extremely effective in responding to the economic, political and financial upheavals that occurred. From the 1980s onward.
The structure of the NCUSIF with the 1% deposit and a retained earnings range of 20-30 basis points on top proved to be an ingenious solution. When the NCUSIF was launched in 1971 it had no ability to build retained earnings as did the FDIC and FSLIC both created in the 1930s. The fund’s equity ratio never exceeded .30 basis points of insured shares. The premium-only system did not work. A better way was found by copying the structure and successful experiences of the 16-state chartered private insurance funds.
But the solution was more than design: it also changed the role of the fund from a purely “insurance-pay out the loss and move on model” to a co-op venture capital fund that could be used to stabilize, and recapitalize if necessary to support credit unions affected by internal or external events. Because credit unions had no access to outside capital, the NCUSIF became the capital provider “of last resort”. No institution experiencing a financial downturn will have access to normal capital markets. Title II of the FCU Act created a special section for providing fund assistance (section 208) to provide financial help for credit unions to right themselves when falling short of required capital standards. Capital assistance was an integral part of the NCUSIF design. Credit unions have no other capital options which is why the role of the NCUSIF is so vital.
These early NCUSIF workouts succeeded and saved the NCUSIF and credit unions hundreds of millions of dollars during the 1980s recession and challenges from the transition to deregulation. More importantly, this was the commitment NCUA made to credit unions who were concerned that sending more money all at once to Washington (versus an annual premium) which they feared would just increase the temptation to spend it.
Most importantly the fund’s design worked as intended:
- From 1971-1984 when the NCUSIF could rely only on premiums (1/12th of 1% or 8 basis points) the fund’s annual insurance loss rate was 4.16 basis points or half of the annual premium.
- From 1985 through 2007 the fund’s annual loss rate was only 1.6 basis points. Moreover, the fund required an outside audit according to private company standards so that the loss reserving expense and allowance accounts remained objectively verifiable. In seven years there was not even an insurance loss. In other words, a yield of only 1.6% interest per year on the 1% deposit would be sufficient to cover the annual loss, before adding interest on retained earnings.
- The fund’s normal operating level of 1.2-1.3% of insured shares was 81 times more than the rate of the annual insurance loss. And the 10 basis point retained earnings range in the NOL would have covered a catastrophic loss six times the average with no need for a premium. Today that 10 basis point range is almost $1.2 billion.
- The design worked because of the accountability that was part of the fund’s reporting structure plus the ability and willingness of examiners to assist with problem resolution.
From 2008 through 2018 the loss rate jumped to 1.9 basis points due to NCUA’s practice of liquidating problems versus solving them, which began with the corporate resolution which was moved off the NCUSIF’s balance sheet and onto a separate fund of the TCCUSF. This liquidation pattern carried over into the shutdown of all lenders affected by the taxi medallion disruption. But a second factor was the NCUA’s transferring an increasing percentage of its every growing operating budget to the NCUSIF through the overhead transfer rate. Thus, over 90% of the NCUSIF operating expenses were not from managing the insurance fund, but rather paying for NCUA’s overall operations.
NCUA has changed both the practice and the cooperatively designed approach to use the NCUSIF to liquidate rather than rehabilitate credit union downturns. Instead of using cooperatively provided resources to support turnarounds, NCUA used them to make the problems go away: merge them for someone else to worry about or liquidate. Instead of being a source for system support, it became an off ramp for credit union charters.
About Chip Filson
A nationally recognized leader in the credit union industry, Filson is an astute author, frequent speaker, and consultant for the credit union movement. He has more than 40 years of experience in government, financial institutions, and business. Filson’s breadth of experience makes him an authority on a range of topics, including analysis of credit union trends, credit union public and market-facing opportunities, and strategies for enhancing member value. His contributions to the cooperative movement have been demonstrated with his analysis and advocacy for the corporate credit union system, NCUA’s Corporate Stabilization role, and the need for regulatory reform.
Chip co-founded Callahan & Associates. Filson has held concurrent positions at the National Credit Union Administration (NCUA) as president of the Central Liquidity Facility (CLF) and Director of the Office of Programs, which includes the NCUSIF and the examination process. He holds a magna cum laude undergraduate degree in government from Harvard University. After being awarded a Rhodes Scholarship, he earned a master’s degree in politics, philosophy, and economics from Oxford University in England. He also holds an MBA in management from Northwestern University’s Kellogg School in Chicago.