by J. Mark McWatters, Chairman
Last month, the NCUA Board took an important first step in closing the Temporary Corporate Credit Union Stabilization Fund through a significant proposal we issued for public comment.
The Stabilization Fund has been vital to the success of the Corporate System Resolution Program. The Stabilization Fund provided short-term and long-term funding to resolve a portfolio of residential mortgage-backed securities, commercial mortgage-backed securities, other asset-backed securities and corporate bonds from the five failed corporate credit unions. A re-securitization program was also created, and the agency issued a series of NCUA Guaranteed Notes that were sold to investors to provide long-term funding for the legacy assets of the corporates. In short, the Stabilization Fund contained the costs of the failed corporates within the credit union system, at no cost to taxpayers.
While the Stabilization Fund served a much-needed purpose, its utility is at an end and it is time to consider terminating it. Unlike in 2009, the current exposure to the Share Insurance Fund by the legacy assets and the NGNs is lower than the $13.3 billion in assets the Share Insurance Fund holds (as of April 30). Due primarily to nearly $4 billion in net legal recoveries, the Stabilization Fund has a positive net position of approximately $1.9 billion as of May.
NCUA wants to be able to return funds that were collected to help pay for the Corporate System Resolution Program to credit unions now that the agency’s $6 billion in borrowings from the U.S. Treasury have been repaid. However, in our effort to close the Stabilization Fund, we must not and cannot endanger the Share Insurance Fund.
Why We Need to Raise the Normal Operating Level
As we move toward closing the Stabilization Fund on Oct. 1—well ahead of its scheduled June 2021 termination—we must consider the resource needs of the Share Insurance Fund, which will be responsible for the remaining obligations of the Corporate System Resolution Program when the Stabilization Fund is closed. That is why a necessary component of this proposal also calls for raising the normal operating level of the Share Insurance Fund from the current 1.30 percent of total insured shares to 1.39 percent.
Why is it necessary for us to consider raising the normal operating level of the Share Insurance Fund, which hasn’t been changed since 2007? I want to address this question in detail and focus on the concerns we are trying to manage, as well as the legal constraints we are operating under and must take into account.
Under the Federal Credit Union Act, to close the Stabilization Fund, it is necessary to transfer its remaining assets and obligations to the Share Insurance Fund. Closing the Stabilization Fund and distributing all assets, property and funds to the Share Insurance Fund will actually increase the equity ratio in the Share Insurance Fund above the current normal operating level of 1.30 percent of total insured shares.
The Federal Credit Union Act requires the agency to return to insured credit unions equity in the Share Insurance Fund above the normal operating level. Yet, we would be negligent in our duty if we proceed to return amounts over what is needed to maintain the current operating level of 1.30 percent without also considering the broader and long-term impact on credit unions and the Share Insurance Fund.
Careful analysis shows that the assumption of some of the assets and liabilities of the Stabilization Fund will introduce additional volatility risk to the Share Insurance Fund’s equity ratio above what could be safely managed if the normal operating level remains at its current level. It is critical that the Share Insurance Fund maintain a sufficient amount of equity to cover potential changes in the value of the claims on the asset management estates of the failed corporates.
In addition, trends and factors separate from the management of the Stabilization Fund’s assets and liabilities are straining the equity ratio of the Share Insurance Fund. The equity ratio has been declining over the last several years. We anticipate it will continue to do so, even without economic stress, due to continued strong growth in insured credit unions’ shares and low yields on the Share Insurance Fund’s investments, which are limited by law.
If the Stabilization Fund is not closed in 2017, the Share Insurance Fund equity ratio is projected to be at 1.23 percent by year-end, and there could be no distribution to insured credit unions. Continued pressure on the equity ratio through share growth and other factors would mean that premiums would have to be charged to insured credit unions, as required by the Federal Credit Union Act, should the equity ratio drop below 1.20 percent.
The table below shows the impact of the various factors on the equity ratio under baseline, adverse, and severely adverse scenarios.
The NCUA Board believes the remaining obligations of the Corporate System Resolution Program can be prudently borne by the Share Insurance Fund without inordinate risk. But this table demonstrates that additional equity will be needed to maintain the heath of the Share Insurance Fund.
Raising the normal operating level will allow the NCUA to transfer the remaining assets and liabilities of the Stabilization Fund to the Share Insurance Fund and to do so in a manner that meets the requirements of the Federal Credit Union Act.
Increasing the normal operating level to 1.39 percent will allow the NCUA to mitigate and manage the stresses at work on the Share Insurance Fund, including the obligations of the Stabilization Fund, and maintain an equity ratio well above 1.20 percent, barring an unforeseen dramatic downturn in the economy, of course. Ensuring the Share Insurance Fund’s equity ratio remains well above 1.20 percent is fully consistent with the minimum equity level established by Congress.
Moreover, raising the normal operating level will allow us to avoid charging a Share Insurance Fund premium to federally insured credit unions this year or in the near future.
The Proposed 1.39 Percent Normal Operating Level Is Based on Key Factors
The Board has the authority under the Federal Credit Union Act to set the normal operating level of the Share Insurance Fund between 1.20 percent and 1.50 percent. So, how did the agency determine the proposed 1.39 percent normal operating level is appropriate at this time?
The NCUA modeled the Share Insurance Fund’s exposure to account for the impact of a moderate recession, as characterized by the Federal Reserve Board’s Adverse economic scenario developed for its 2017 annual stress test supervisory protocol. For the legacy asset exposure, the NCUA engaged BlackRock to model the impact on the projected cash flows of the failed corporate unions’ legacy assets by also incorporating the Federal Reserve Board’s Adverse economic stress scenario.
The analyses showed that in a moderate recession, without the equity ratio falling below 1.20 percent, the Share Insurance Fund’s equity ratio needs to be high enough to withstand:
- A 13-basis point decline in the equity ratio due to the effects on the three primary drivers of the Share Insurance Fund’s performance: insured share growth, interest income on the fund’s investment portfolio and insurance losses;
- A 4-basis point decline in the value of the Share Insurance Fund’s claim on the corporate credit union asset management estates; and
- A 2-basis point decline in the equity ratio expected to occur before the remaining NGNs begin to mature in 2020 and remaining exposure to the legacy assets can be reduced.
Projected Equity Ratio Under Various Economic Stresses
|Scenario||First Quarter 2017 Ratio*||2017||2018||2019||2020||2021||2022|
|Severely Adverse Scenario||1.26%||1.24%||1.18%||1.13%||1.11%||1.09%||1.06%|
*Current equity ratio is based on the preliminary and audited financial information for the first quarter of 2017. For additional information on the Share Insurance Fund’s performance, go to page 12.
Because of these analyses, the proposed 1.39 percent normal operating level consists of:
- A 1.33 percent base-line normal operating level, plus
- A 0.04 percent reserve to reflect contingent liabilities of the NGN program, plus
- A 0.02 percent reserve to reflect the projected downward trend in the equity ratio through 2019, with the goal of avoiding a future premium assessment.
Setting the normal operating level at 1.39 percent will allow the agency to distribute between $600 million and $800 million to federally insured credit unions next year, money that can be put to work building local communities, creating new businesses and improving the lives of members across the country.
Lastly, increasing the normal operating level as we have proposed does not mean it has to remain at that level. The agency will continue to assess the normal operating level periodically and will adjust as needed, consistent with the Federal Credit Union Act. Any change to the normal operating level of more than one basis point will be made only after a formal announcement and after stakeholders have had an opportunity to comment on the change. NCUA will also issue a report that will include data and analysis in support for any future changes in the normal operating level.
Credit Union Officials Are Urged to Comment
Comments on the current proposal to close the Stabilization Fund and raise the normal operating level of the Share Insurance Fund are due Sept. 5. I urge credit union officials to review it in detail and share your specific views before the deadline.
We have identified three broad questions on which we would like comments on:
- Should we close the Stabilization Fund in 2017, at some future date, or wait until it is currently scheduled to close in 2021?
- Should we set the normal operating level based on the Share Insurance Fund’s ability to withstand a moderate recession or on its ability to withstand a severe recession?
- Should we base our approach for setting the normal operating level on preventing the equity ratio from declining below 1.20 percent or some other higher minimum level?
While these are important questions, solid analysis on all aspects of the proposal is encouraged.
In order for the agency to review the comments and adopt a final rule in time to close the Stabilization Fund in October, a short comment period is necessary. To aid those who want to comment, we have provided a webpage with resources addressing the proposal.
Additionally, we held a webinar on the proposal on Aug. 9. An archived version is available at http://bit.ly/2vMvr6m (opens new window).
The Board also issued a separate proposal (opens new window) to amend its rules on the calculation of a federally insured credit union’s proportionate share of an equity distribution from the Share Insurance Fund, and to add a temporary provision that governs equity distributions resulting from the Corporate System Resolution Program. The proposal would prohibit a federally insured credit union that terminates its federal share insurance coverage during a particular calendar year from receiving an equity distribution for that year to provide greater fairness to credit unions that remain federally insured.
Comments on this proposal are also due Sept. 5.
Prudent administration of the Share Insurance Fund and the protection it provides for member deposits is paramount and fundamental to maintaining a safe and sound national credit union system. The NCUA Board has a duty to manage the Share Insurance Fund responsibly for the benefit of all insured credit union members and the credit union community. And we want to avoid charging insurance premiums if at all possible.
It is also important to maintain public confidence in federal share insurance. The proposed plan to close the Stabilization Fund in 2017 will ensure the Share Insurance Fund has the appropriate level of resiliency to meet these objectives.
I believe these proposals have the potential to create a viable path forward that will allow the credit union system to put the resolution of the failed corporate credit unions to rest. It is imperative that we accomplish this significant objective in a transparent and fully accountable manner that is beneficial to credit unions and the agency, given the legal, accounting, and economic constraints and realities. I welcome your comments.