The approach of Autumn brings with it several associated seasons: a new school year, a new football season, and, for credit unions, budget season. It is also a time when the NCUA Share Insurance Fund (NCUSIF or SIF) is most heavily scrutinized. While NAFCU is constantly monitoring the fund and the NCUA’s administration of it, most credit unions are addressing more important challenges. But budget season inevitably prompts the question of whether a SIF premium is on tap for the coming year. Fortunately, the answer to that question is most likely not. Whether a premium may be needed beyond this year will depend critically on how interest rates evolve.
The SIF is a $20 billion fund whose operations are fairly simple. The key measure of health for the SIF is the equity ratio, which is analogous to a credit union’s net worth ratio and is simply defined as total equity—which consists of retained earnings and insured credit unions’ one-percent capitalization deposits—divided by total insured shares.1 The equity ratio operates in a window formed by two thresholds: a 1.2 percent statutory floor, below which the NCUA must establish a restoration plan, and the normal operating level (NOL) established by the NCUA, above which level the agency must issue distributions. The NOL historically was set at 1.3 percent but currently sits at 1.33 percent.
There are four primary drivers of the equity ratio: share growth, investment yield, fund losses due to credit union failures, and operating expenses. While loss expenses can have a big impact in times of distress, those events are rare. Typically, the biggest drivers are share growth and investment yield. Higher share growth tends to reduce the equity ratio. Although credit unions contribute to fund equity in amounts proportional to share growth, those contributions are only one percent of insured shares, while the equity ratio is generally 20–30 basis points higher. That gap accounts for the diluting effect of share growth.
This means that in most years, whether the equity ratio increases, or declines, depends on whether the SIF’s investment portfolio is able to earn a return that compensates for that year’s growth in insured shares. By making a few simplifying assumptions, we can establish a nearly linear relationship between the two, which we call the “hurdle rate” as shown in Chart 1. For any given level of share growth, investment yield above the hurdle rate (i.e., in the top left area of the chart) would generally provide enough income to increase the equity ratio absent any major loss events. Prior to the Great Recession, the SIF was generally able to clear the hurdle rate, and during this period fund distributions out of surplus equity were common. However, the post-Great Recession era has been markedly different. In the first few years of the 2010s, the fund operated very close to the hurdle rate, but that was only because share growth was weak by historical standards. As share growth strengthened in the latter half of the decade, investment yield consistently fell short of the hurdle rate, precipitating a steady decline in the equity ratio (see Chart 2). COVID exacerbated this trend by driving up share growth to historically high levels.
Relief may be on the way. Higher interest rates are already having an impact on the fund’s investment yield. Furthermore, the agency announced that it would resume investing in Treasury securities out to 10-year durations, up from a maximum of seven years previously.2 That means that substantially all of the upcoming investments purchased by the SIF will be at longer maturities until the portfolio is balanced. However, even if rates remain higher than they were prior to COVID, it will still take time for the SIF yield to improve. NAFCU estimates that with share growth near the historical average (roughly six percent), the fund’s yield will only improve by 30 basis points per year over the medium term. That means that, holding rates constant, the SIF would not earn a yield equal to the hurdle rate until 2025, assuming normal share growth.3
So, to the question of the day on whether a premium is likely for 2023? The answer is: “not very,” barring an unforeseen loss event. But NAFCU forecasts the equity ratio to resume a slow decline over the next few years before hopefully stabilizing in 2025. The last couple of years have taught us to be humble about forecasting the future. Who would have imagined in early 2020 that a potential outcome of COVID would be higher interest rates? NAFCU will continue to counsel caution from the NCUA, so that premiums are not assessed prematurely, and those funds can do what they ought to be doing: serving the needs of your members.
- Note that unrealized gains and losses on SIF investments are not included in the equity ratio calculation.
- See discussion during NCUA Board Meeting, May 26, 2022. Note that the agency had a similar strategy of investing in Treasuries with maturities up to 10 years as recently as 2017. That year the agency changed its investment policy to shorten maturities to no more than seven years. Later that same year, the agency announced that it would be conserving several large credit unions with concentrations in taxi medallion loans.
- Note that the recent stability of the equity ratio is partly the result of the WesCorp asset management estate (AME), which has consistently outperformed forecasts. This has allowed that estate to repay a larger amount of its obligations to the SIF than anticipated. NAFCU does not include AME performance in its forecast.