Interest-rate risk (IRR) is a dominant asset liability management (ALM) topic today, with examiners raising the issue as a top priority. In situations where an examiner deems a credit union’s IRR inadequate, they are dictating specific policy and modeling limits, often in documents of resolution (DORs). This concern, however, appears to be absent in NCUA’s own management of NCUSIF investments, which are limited to U.S. Treasury securities.
Extending The Portfolio’s Duration
In the December financial statement, the insurance fund reported placing $400 million in six different bullet investments with final maturities from 6 to 8.5 years. The average duration was 7.75 years with a weighted yield of 2.66%.
The result of these reinvestments was to extend the portfolio weighted-average maturity from 1,292 days to 1,374 days — approximately 3.8 years duration. This data is taken from the monthly statement released at the January NCUA board meeting so the industry can track the performance of its share insurance fund.
What Would An NCUA Examiner Say?
Today, federal credit union examiners are using a new price risk ratio to evaluate the effectiveness of IRR risk management. Based on the 300-basis-point immediate, parallel shock modeling of the entire NCUSIF portfolio (3.8 year duration) — the method preferred by examiners — the result would be a loss of principal, versus current book value, of $1.27 billion. The price risk ratio is 47% of the NCUSIF’s retained earnings ($2.7 billion), or very near the 50% limit examiners are applying in their policy critiques of credit unions.
Why NCUSIF’s IRR Matters To The Owners
NCUA, like all credit unions, is constantly trying to balance current income from yields on its portfolios versus future risk. And like all credit unions, the risk is that when NCUA might need liquidity, the investment portfolio might be underwater — meaning the market value is less than the book value — and NCUA would only be able to sell securities at a loss when it needed cash.
In the case of the NCUSIF, the liquidity management is an entirely new challenge. During the last financial crisis, the NCUSIF was the largest borrower from the Central Liquidity Facility (CLF), with more than $10 billion for just two institutions. That option no longer exists because NCUA dismantled the cooperative liquidity solution developed by the corporates and the CLF. The TCCUSF liquidity can only be used for the NCUA Guaranteed Note (NGN) funding gaps.
The NCUSIF therefore must manage its liquidity on its own so funds are always available without creating a loss for the credit union owners if cash would be needed for workouts, capital infusions, or even liquidations.
Next Steps For Credit Union Owners
Similar to a credit union, the responsibility for managing the NCUSIF rests with the board, the three Presidential appointees. The owners should ask the board to publicize the NCUSIF’s ALM/IRR policy, including the liquidity planning for events requiring large amounts of cash. These scenarios might include $500 million up to $5 billion disbursements, which would still be less than half the amount NCUSIF borrowed during the last crisis.
Without effective policies, member credit unions will be left filling the potential gaps. That means either the NCUSIF will have to sell securities at a loss and/or NCUA will have to assess a premium to pay for ineffective management of the investment portfolio.
Credit unions should expect the same attention to IRR/ALM management for their collective investment in capital funds that NCUA is requiring of the industry. It’s time for the board to publically address this issue. Doing so would demonstrate the leadership owners should expect. How would examiners react if credit unions were routinely making investments with a 7.75 year duration today?