During NCUA's November 2016 Board meeting, a 2017 premium range for the Share Insurance Fund (SIF) was announced at 3 to 6 basis points.
The 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 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 assess a premium to restore the ratio to at least that level.
The following analysis supports the opinion that a drop in the equity ratio below 1.2 percent 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. NAFCU will continue to monitor the status of the SIF and keep credit unions updated as to the potential for premium charges in future years.
Download the full analysis and forecast report (December 2016)
*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.
There are 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 are rare (except for during the financial crisis in 2009, for example).
NAFCU's Research Division estimated the impact to the SIF's year-end equity ratio in 2016, 2017 and 2018 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.
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 undergone significant changes in recent years to lengthen the portfolio duration by adopting a laddered investment strategy. The present structure of the portfolio means that it will be much slower to respond to changes in market interest rates than it would otherwise. In the past, the portfolio yield was far more sensitive to changes in the Treasury yield curve than it is today, which allowed for large swings in yield. With this in mind, NAFCU assumed a fairly narrow range of potential investment yield scenarios over the next two years.
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 2016 and 2017 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. We estimate this is a fairly low-probability event as the domestic recovery appears to still be on fairly solid footing and the Great Recession was a unique historical event. With that said, it should be noted that weak business investment and slowing growth abroad pose legitimate threats to the economy. Moreover, with rates still near zero, 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.
NCUA recently altered its budgeting format to incorporate a two-year budget schedule rather than an annual one. As part of this process, NCUA determined both its overall operating budget and the OTR for 2017 and 2018. These figures were used in all three scenarios in NAFCU's analysis.
View NCUA Share Insurance Fund Financial Reports and Statements