Sunday, December 11, 2016

The NCUA Budget: Easy Money... Part 11

Sorry to jam you with so many posts, but time is running out for the NCUA Board to "ACT" on the NCUSIF to help the CU folks "on the bus"- the Federal Reserve Board meets Tuesday, the NCUA Board meets Thursday.

Let's go back to that NCUSIF investment ladder that we discussed in Part 9 [here's the link] and Part 10 [here's the link]. As we know, the NCUSIF investment ladder has a 10 year time horizon, is invested in treasury bonds, with equal amounts of the $13 billion portfolio (@ $1.3 billion) invested on each yearly "step". We also know that NCUA reinvests the maturing "1 yr step" in 10 year treasury bonds to maintain "the ladder" - that's why the NCUA "investment birthers" bought $800 million in long-term treasuries over the last 90 days!

Yikes! This sounds scary...
Now bear with me 'cause we're going to construct a hypothetical, "retrospective" NCUSIF investment ladder, reflecting the NCUA's current NCUSIF investment strategy - which by the way was only approved in February, 2013...

Looking "backwards"...
Ready? First, remember that NCUA's strategy is to reinvest the maturing one year step in 10 year treasury bonds. Now here's the part you have to think about... if you had been operating this investment strategy for over ten years, then the yield on each of your individual steps would reflect the 10 year treasury rate in prior years. (That didn't make any sense did it!) 

Here's an example. If you bought a 10 year t-bond ten years ago, it would be in your 1 year step now, about to mature - right?  Your 2 year step would reflect the 10 year t-bond rate nine years ago, your 3 year step would reflect the 10 year t-bond eight years ago, etc... the 10 year step would reflect the 10 year t-bond last year.... go slow, don't give up, read it again!

Here are your 10 year t-bond rates over the last 10 years (at 12/1/20xx or the nearest date to 12/1) [here's your link if you'd like to validate]:

12/2006   4.43%
12/2007   3.97%
12/2008   2.72%
12/2009   3.28%
12/2010   2.97%
12/2011   2.11%
12/2012   1.62%
12/2013   2.81%
12/2014   2.22%
12/2015   2.15%

Let's convert them into an NCUSIF investment ladder:

1yr       2yr        3yr       4yr       5yr       6yr       7yr       8yr     9yr       10yr 
4.43%  3.97%  2.72%   3.28%   2.97%   2.11%  1.62%   2.81%  2.22%  2.15%

This example simply shows you what the approximate yields would be in our retrospective NCUSIF ladder. Of course this is not the "real", current NCUSIF ladder, but it does provide the opportunity for you to think about some questions... BTW the current 12/2016 ten year rate is 2.45% [that's why one might complain about NCUA's recent $800 million in purchases at @1.70%!!!]

1) Over the next few years will the maturing steps (say "steps" 1 & 2) be reinvested at rates above or below the rates on the maturing investments? [Hint: the "maturing rates" are 4.43% and 3.97%]
2) Given your answer in #1 will the average yield on the NCUSIF portfolio go up/down over the next few years? [Hint: current portfolio yield is 1.84%]
3) At current market rates how long will the recent $800 million NCUSIF investments "penalize" the earnings of the Fund? [Hint: they were 10 year investments]
4) If your answer to #2 was that the overall portfolio yield will go down over the next few years [Hint: Mr. Fazio forecasts 1.78% in 2017, 1.75% in 2018] and since the NCUA budget is forecast to increase by at least 4% each year [Also Mr. Fazio's forecast] ... how will the NCUA "make up" for the decline in earnings (... and the drop in the NCUSIF "1.30% equity ratio")?


[Going to leave a $100 million offer "on the table"?]


Jim Blaine said...

Been rightfully accused of being in the weeds... sorry... but it's important that CUs understand how their Fund is being (mis)managed... and that it will cost CUs $millions shortly.

Here are your answers to the 4 questions:

1. No one expects 10 yr rates to rise to @4% in next 2 years, so the steps should be reinvested at lower rates

2. Portfolio yield should decline as Mr. Fazio forecasts!

3. Your CU will be penalized for the next 10 years by the $800 million in low rate 10 yr bond NCUA has just purchased.

4. Your credit union will be assessed for the Fund shortfall.

Anonymous said...

Jim -- The devil is always in the details. I appreciate you going into the weeds to explain all of this. It might inspire a few who don't understand how it works to take action now that you have explained it so clearly. You are Warren Buffet"esque" in your ability to make the complex, simple.