Impact of Four Stress Test Scenarios on the NCUSIF

While the headlines coming out of the September 24 NCUA Board meeting focused on the 15 basis point assessment to be paid by federally-insured credit unions, what might be more important is the summary of findings about the maximum loss exposure to the National Credit Union Share Insurance Fund (NCUSIF) under four different stress test scenarios (see Board Action Item 1b).

The four scenarios were: impact of distressed real estate market on natural person credit union’s (NPCU) real estate loan portfolio; complete write down of NPCU capital investments in corporate credit unions (CCU); layering distressed real estate with complete write down of capital invested in corporate credit unions; and Treasury’s Supervisory Capital Assessment Program.

While NCUA staff believes that the NCUSIF has sufficient resources to handle a severe financial crisis, they acknowledge that the risk to the NCUSIF is increasing. The stress test results show that there is likely to be a material increase in the number of credit unions with inadequate capital and subjected to prompt corrective action.

Additionally, “increases in the number of troubled credit unions will result in stress to NCUA in resolving problem cases as resources will be strained both in terms of Agency manpower to properly supervise the credit unions and a probable reduction in the number of institutions willing and able to absorb the related assets and liabilities.”

Here is a summary of the findings from the four different scenarios.

1. Evaluating potential failures and losses due to the distressed real estate market, which includes applying an immediate shock on reserves given a variety of default and loss rates in NPCU real estate portfolios. The analysis revealed rising levels of defaults on all real estate related loans and rising levels of losses associated with the defaults. Additionally, the consensus forecast predicts further increases in the level of defaults. NCUA’s 2-year stress scenario resulted in the allocation of $32.5 billion in projected losses amongst NPCUs resulting in the potential failure of 90 NPCUs and a worst case projected loss exposure to the NCUSIF of $1.4 billion.

2. Measuring the risk presented by CCUs consisted of a complete write-off of current NPCU capital investments in CCUs, as well as the impact of an immediate assessment to NPCUs of an estimated Stabilization Fund liability of $7 billion. The analysis resulted in the allocation of $9.3 billion in losses amongst NPCUs and resulted in a projection of 25 NPCU failures presenting a maximum exposure to the NCUSIF of $80 million.

3. Evaluating the impact from both the real estate stresses and the CCU system, which allowed for analysis of the risk layering. As with the 2008 analysis, the layering of both the real estate and CCU risk on individual NPCUs resulted in a pronounced increase in both the number of failures and the level of potential losses to the NCUSIF. Combining the 2-year real estate stress scenario with the CCU stress scenario resulted in a projection of 227 NPCU failures and a maximum exposure to the NCUSIF of $6.4 billion.

4. Performing stress testing based upon the Treasury’s Supervisory Capital Assessment Program. This analysis provided a 2-year stress scenario under both an assumed path for the economy (baseline) and a deeper more protracted downturn (more adverse) that included non-real estate loans. This testing provided a measure of a NPCU’s capital buffer. The baseline analysis produced an allocation of $32.6 billion in losses resulting in 38 failures with a maximum exposure to the NCUSIF of $577 million. The more adverse scenario resulted in an allocation of $56.4 billion in losses resulting in 519 NPCU failures at a maximum exposure of $15.5 billion to the NCUSIF.

I believe that assuming the worst case scenario facing credit unions and the NCUSIF is a write down of capital investments in CCUs is overly optimistic. The most likely outcome is represented by either 2-year real estate stress test or combined real estate stress test and corporate credit union write down.

My thinking on this issue is supported by the evidence that there were 315 problem credit unions on August 31, 2009, with shares representing 4.55 percent of total insured shares.