Monday, February 03, 2014

Irrational (Robusterian*) Regulatory Risk…. IRR !

The NCUA Robusterians at work...
The NCUA seems to be claiming to credit unions and to the entire global financial community that NCUA's very own robusterians have discovered a new financial phenomenon called "interest rate risk" (IRR)! 

Which, in the same sense that Al Gore invented the internet, I guess could be true….

The importance of NCUA's discovery of interest rate risk can not be overemphasized; and, in fact, it has been overemphasized by NCUA Chair Debbie Matz in her latest pronouncements, in the recently released NCUA 2014 Strategic Plan (please try to contain your guffaws!), and in NCUA's  interest rate risk "water-boarding exercises" (we answer to no one!) during credit union exams on both coasts (and numerous points in between!)  

Since NCUA is so adept at IRR and is so obsessively concerned with the certainty of an imminent, rapid, financially destructive surge in market rates, let's take a quick look at how the Agency is protecting itself against that unassailable prediction of IRR hyperinflation….

The NCUA has financial management responsibility for the investment of the $11.5 billion credit union "share insurance fund" (NCUSIF), which supports the protection of CU member deposits. At November, 2013 (Sorry, latest published data available.  NCUA is evidently late in filing its December report!),  the NCUSIF was composed of $8.7 billion in CU deposits (that's the 1% of your members' deposits you send in every year.); $2.7 billion in retained earnings; and $118 million in unrealized investment gains.  The NCUSIF is invested solely in U.S. government securities with maturities running up to 10 years.  
We're "robust" about IRR !

That's good for safety in investments and for liquidity.  On any day of the week NCUA can sell all, or any part of, the NCUSIF portfolio to reposition the portfolio to reflect changes in, or concerns about the future direction of, financial markets.

So, if you were a professional, seasoned investment manager convinced that IRR was the number one threat on the financial planet  due to an imminent, rapid surge in interest rates what would you do? Professional money managers would do at least two things: 1) shorten the term of the existing portfolio by selling securities to reposition for those higher rate investment opportunities and 2) invest new inflows of funds in short term securities to also await the greater earnings available when rates surge.  

Make sense?  Sure it does!  Credit union members make that call every day when choosing which CD they will "purchase" from your CU.  And, if you'll check, your members have, overall, chosen to "shorten up" in this extremely low rate environment.
We're robust !!!
You're not !!!

And, certainly NCUA robusterian investment professionals are smarter than your CU members, right?  Well, NCUA IRR experts in their exam recommendations seem to believe that not only are they IRR-smarter than your members, but they are also IRR-smarter than CU management and elected CU boards! 

So, what did the NCUA IRR robusterians do with the existing $11 billion fund entrusted to them during 2013?  Did NCUA "shorten up" the existing portfolio? NO! NCUA IRR wizards sold no securities to prepare for their self-proclaimed IRR threat and actually lengthened the average portfolio life!  As a result, the unrealized gain on the NCUSIF portfolio declined from $371 million at 12/31/2012 to $118 million at November, 2013.  The NCUA IRR robusterians lost $253 million - a quarter of a billion dollar loss!! - in NCUSIF value by doing absolutely nothing!!! (Against their own, self-important advice to the rest of us in the credit union world!) By the way, that's equivalent to about a 25 basis point assessment on every credit union in the Country "to support the fund"!

Did NCUA invest new inflows in shorter term securities?  NO!  The NCUA IRR robusterians purchased $1.8 billion in securities during the 12 month period at 6 different times (Dec, Feb, May, Aug, Sept, Oct). The aggregate unrealized loss on these NCUA purchases at 12/31/2013 is $104 million.  Every security purchased by our NCUA IRR robusterians in 2013 was for a term > 5 years and is showing an unrealized loss - every single security purchased by NCUA in 2013 is showing an unrealized loss. Yet NCUA pontificators continue "to yell fire in the theater" about the threat of future rising rates!!

And lastly, just for the @*#x!* record…

THE NEV UP 300 BASIS POINT SHOCK  on the NCUA's "professionally" managed,  robusterian NCUSIF PORTFOLIO at 12/31/2013 was a NEGATIVE $431 MILLION!!
If we are to believe NCUA's IRR predictions, if we are to take them at their word, then additional, very substantial losses are "dead ahead" for the NCUSIF. 

Given this level of expertise…. for credit unions to take NCUA's IRR forecasts seriously requires a robust act of faith!!

(Sure wish we had credit unions large enough to have $11 billion portfolios to compare results against these robusterians…)


Anonymous said...

Thanks for all the research and information. As with many parents it looks as if the response from NCUA will be, 'do as I say, not as I do'. That being said, this is credit union money and we have every right to ask them WHY?

Anonymous said...

By the way Jim, SWAG stands for 'Scientific Wild Ass Guess' and NCUA is not 'scientific'. Just saying.

44Rp said...

The recent drop in long term yields may provide NCUA with a chance to luck out here if they decide to sell. Of course gambling with money that doesn't belong to them allows for a nap while behind the wheel, so most likely they are not paying attention right now.

Jim Blaine said...

As to SWAG.... could be "silly"?

Jim Blaine said...

As to "drop in rates", yes an excellent opportunity to realize a significant gain for the NCUSIF ... and again why wouldn't you do so, if you are having your vassals prance around the Country screaming "the sky is falling, the sky is falling" on IRR to credit unions?

Then again, perhaps as to SWAG, it's not "silly", it's actually "stupid"...e-r-r-r, correct that, I meant to say "ROBUST" !

Jim Blaine said...

... and the $125+ million realized gain would go a long way toward paying the NCUSIF's 60% share of NCUA's 2014 $268 million operating budget.

... and as market rates rise dramatically (as they've done this week!) the NCUSIF can reinvest at much higher returns - even robust returns!! - cutting the cost to credit unions for subsidizing the Agency.

Anonymous said...

Silly, Stupid or Robust really does not matter because you should be thankful they are not anticipating rates to go down further and forcing you to go long!

Jim Blaine said...

As to "going long", got a chuckle out of that comment...

Until, one considers that we all could easily receive such an edict, when the prognosticators are in no way held accountable for their robustness! (Bet they picked Denver!)

And, it's clear that if this very low level of interest rates continues much longer, that more CUs will be killed than by any threat of deflation.

Anonymous said...

The Fed finds themselves in a situation that they caused where they can not keep rate low without damaging consequences and they can not raise rates without damaging consequences. It is a kin to being buried in cow manure up to your neck and having a bucket of snot tossed at your face. You just do not know whether to duck or dodge!

Jim Blaine said...

That is absolutely the most horrendous analogy I've ever heard... the "visual" is thoroughly terrible!!!

Anyway, where in the world would one go to get a bucket full.... never mind....

Anonymous said...

Forrest Gump works at NCUA!

"Stupid is as stupid does."