The Share Insurance Fund's (SIF's) equity ratio is a general measure of the health of the fund and is calculated as the sum of federally-insured credit unions' (FICUs') capital contribution of one percent of their insured shares and the fund's retained earnings, divided by total insured shares. The normal operating level for the equity ratio has historically been set by the agency at 1.3 percent. If the SIF finishes the year with an equity ratio above that level, the excess funds are returned to FICUs. If the ratio falls below 1.2 percent, the Board is required to charge a premium to restore the ratio to at least that level.
NAFCU's analysis supports the opinion that a drop in the equity ratio below 1.2 percent (and accompanying premium assessment) is extremely unlikely in 2017 and would only be a possibility in 2018 in the event of a severe recession. Nevertheless, the downward trend of the equity ratio in recent years suggests that this likelihood will grow in future years.
During NCUA's July 2017 Board meeting, a proposal was announced whereby the NCUA's Temporary Corporate Credit Union Stabilization Fund (TCCUSF) would be closed and its assets and liabilities merged with the SIF. NCUA estimates that doing so would increase the equity ratio of the SIF back to the normal operating level (NOL) – currently set at 1.3 percent – and also result in a dividend for federally-insured credit unions (FICUs). Furthermore, it would mean that a premium charge for the SIF would be avoided in 2017.
However, there are several downsides to the proposal which credit unions should consider. Most significantly, NCUA proposes to increase the NOL by 9 basis points to 1.39 percent, which could reduce the estimated return to credit unions of the $4.8 billion worth of corporate stabilization assessments paid in prior years by up to 60 percent.
A breakdown of the refund to credit unions of their corporate stabilization assessments is below (all based on NCUA projections, assuming closure of the TCCUSF in 2017):
NCUA gathered comments on this proposal in September 2017. NAFCU member resources regarding this proposal include:
- Comment letter template and talking points
- Regulatory Alert proposed rule summary
- SIF rebate calculator based on different scenarios in the proposal
Current Status of the SIF
*The Emergency Economic Stabilization Act of 2008 increased the amount of insurance coverage on all accounts up to $250k. Estimates do not assume full funding of the one percent capitalization deposit at year end.
Save for an extraordinary event such as the merger of the Corporate Stabilization Fund, there are typically four primary factors which drive changes in the equity ratio: insured share growth, investment yield, insurance loss expenses and operating expenses. Generally speaking, these factors change only slowly over time, so large changes in the equity ratio from one year to the next are rare.
NAFCU's Research Division estimated the impact to the SIF's year-end equity ratio in 2017, 2018 and 2019 based on three scenarios: a base case, an optimistic case and a pessimistic case. The three scenarios entail parameters for the various drivers of the equity ratio which are judged to be consistent with economic and industry conditions under these scenarios.
Insured Share Growth
Share growth is a major determinant of changes in the equity ratio. Forecasting share growth is difficult, and as such, NAFCU's analysis allows for a wide range of possible outcomes (chart below). A key determinant of share growth is the performance of financial markets. When returns are low and/or volatility is high, particular in the stock market, households often seek a safe haven for their financial assets.
Lower share growth has helped to shield the SIF in this low interest rate environment. Going forward, NAFCU's base case assumes a return to the historical norm (6 percent for non-recession years). That level of share growth combined with the current portfolio yield will not sustain the equity ratio, and further declines similar to what we have seen in the last two years can be expected.
Note: The Emergency Economic Stabilization Act of 2008 increased the amount of insurance coverage on all accounts up to $250k. In the absence of this legislation, share growth that year would have been 8.5 percent.
Of the four factors investigated in our analysis, the two most important are share growth and investment yield. The two can be considered in tandem: in order to achieve a stable equity ratio, higher rates of share growth would generally need to be accompanied by higher investment yields.
Investments currently constitute roughly 95 percent of total SIF assets. While the portfolio is limited to U.S. Treasury Notes up to 10 years in maturity, plus a small amount in an overnight account, the portfolio has nevertheless experienced significant changes in recent years. From 2007 through 2016, the weighted average maturity of the portfolio tripled from 1.7 years to 5.2 years. In early 2017, NCUA sold a significant portion of long-term investments and used the proceeds to purchase shorter-term securities. As a result, the weighted average life dropped to 3.5 years. The decline in length of maturity reduced the investment yield from 1.8 percent in 2016 to just 1.5 percent so far in 2017. It also increases the sensitivity of the portfolio to changes in market rates.
Insurance Loss Expenses
In most years, the combination of investment yield and share growth explains the majority of any changes in the equity ratio. However, during and immediately after the financial crisis it was insurance loss expense which most affected the bottom line (chart below). NCUA's reserving methodology relies on an econometric model which takes into account industry conditions such as capital levels, delinquencies and CAMEL codes, along with broader trends in the housing market and economy.
In our scenario analysis, the primary question to consider in determining the parameters for insurance loss expense in 2017 - 2019 is the prognosis for the wider economy, including the probability of a recession. In the pessimistic scenario, conditions are nearly as severe as they were in 2007 and 2008 at the onset of the financial crisis. This would appear to be a low-probability event as the Great Recession was a unique historical event, although economic growth has been slow in recent years. Moreover, with rates still low by historical standards, the Federal Reserve would have fewer tools at its disposal to deal with another recession.
Operating expenses for the SIF are determined by the overall spending by the agency as well as the overhead transfer rate (OTR). In recent years, the operating expenses for the SIF have risen dramatically (chart below). This reflects both the rise in agency expenses – which have grown by an annual average of roughly 7 percent from 2007 through 2017 (budgeted) – as well as by a rise in the OTR from 54 percent in 2009 to 73 percent in 2016/17.