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Jul 27 2016

Upcoming Interest Rate Risk Management Changes By Ncua

Article

Written by webmaster

3 min read

In June the NCUA board reviewed the recommendation by NCUA’s Office of Examination and Insurance to consider releasing a proposal in the coming months to incorporate an “S” to the credit union CAMEL Ratings. The Examination and Insurance staff believe the changing size and complexity of the credit union system warrants its adoption. At this time, it appears the agency will draft and issue a proposal for public notice and comment which could take several years to implement.

In the meantime, it has been publicized at several conferences I have attended recently that the agency is retooling and attempting to standardize the current IRR supervisory procedures. This will include an updated examiner’s guide, streamlined procedures, predefined premiums for non-maturity deposits (NMDs) to be used by the examiners, and updated risk rating categories. This is expected to be fully rolled out by the end of 2016 and may be seen in the field as soon as examiners have received training, which is scheduled to start sometime in July.

I have talked with several capital market specialists from NCUA over the past couple of years and expressed my frustrations regarding the lack of consistency in how regulators treat the measurement, management, and monitoring of interest rate risk from one credit union to the next and from one state to the next. The biggest variable and issue that arises in the estimation of IRR frequently resides in the valuation of non-maturity deposits. If NMDs are not recognized as holding any value, then IRR analysis may indicate high levels of IRR and if managed to this scenario, the credit union will sacrifice earnings. If NMDs are treated with longer average lives and lower rate sensitivities, these deposits provide substantial mitigation and allow the credit union to take on longer-term assets, which often results in examiner criticism. As I expressed how tiresome the continual debate and valuation of NMDs in the NEV calculation has become, they expressed the same frustration and weariness on this topic.

The presentations by the NCUA representatives outlined the upcoming changes and emphasized the purpose and benefits to credit unions as follows:

Uniform application, as well as measurable, consistent, and transparent supervisory practices
Clear expectations
Rating accuracy
Risk-focused discussions
Negligible burden

The benefits to NCUA were listed as:

Measures relative risk from a baseline or benchmark
Easily identifies outliers and institutions that need additional review
Enhances surveillance and monitoring
Increases consistency
Improves resource allocation
Improves communication

At this point I would like to emphasize that this change does not replace the credit union’s responsibility to independently measure, manage, and monitor their IRR, nor is it intended to replace strong, supportable, empirically derived assumptions. The changes are being implemented by NCUA to help the regulatory process and therefore should not be blindly adopted by the credit union. I recommend modeling and discussing this analysis as an alternative scenario and evaluating it based on its merits and limitations.

The NEV supervisory test calculation will use book, base, and up 300 bp valuations for assets straight out of the credit union’s model. The examiner will assess the model’s asset valuation for reasonableness, which is consistent with their current practices. The examiner will use the current asset valuations and apply the following premiums for NMDs—1% in the base case. After applying base case premium, a premium of 4% will be applied in the up 300 from the base case, resulting in a total premium of 4.96% from the book value. Using these premiums, the NEV sensitivity and the post shock NEV value will be recalculated and the results will fall into 4 risk ratings (see the chart below). The definitions have also been adjusted to reflect the new treatment of NMDs with low-risk category defined as post shock NEV above 7% and valuation change < 40%; moderate category is post shock NEV between 4% and 7% with valuation change from 40%-65%; and the high category at post shock NEV between 2%-4% and valuation change between 65%-85%.

The L component of the CAMEL rating will be assessed a risk level that will not be lower than the determined risk level. The examiner will have some discretion to adjust risk rating up based on credit union management and understanding of IRR. As it stands now, NCUA indicates very few credit unions currently fall in the extreme range.

Understanding the changes will be important to assisting in the regulatory process and will hopefully reduce the confusion and inconsistent application by examiners in the area of interest rate risk.

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Jan 14 2021

Five Top Credit Union Topics For 2021

As we move into 2021, the following topics might be worth discussing and considering with your management team.

Earnings

During the first half of 2020, net interest margins came under substantial pressure as market interest rates were shocked dramatically downward. Net interest margins are expected to remain under downward pressure throughout 2021 as investment portfolios continue to reprice lower and share growth continues.

One of the easiest and quickest responses to declining interest income is to address the cost of funds. Many credit unions still have room to decrease their cost of funds, as shown in the September 2020 ending period graph below.

Source: NCUA

Delinquency

Based on the September 2020 call report data, loan delinquencies and net charge-offs remained low and were below September 2019 delinquencies. Loan forbearance and other assistance programs in place through the entirety of 2020 may have helped delinquencies. Also, certain sectors of the economy are not as impacted as others. The unemployment rate is expected to continue drifting lower in 2021. However, as the assistance programs are lifted, delinquencies and charge-offs are expected to increase as unemployment remains substantially above the years leading up to the pandemic.

Source: MHSI Online Peer Analysis Module through September 2020

Credit Union Philosophy

Serving the underserved has always been a hallmark of credit unions, and now more than ever, there is an opportunity to do this for many credit union members. As these times have been challenging, credit unions can continue to evaluate and prioritize how to best serve members in the coming year, especially those under financial stress. Exploring how to provide service to those that are underbanked might be an opportunity. One option may include evaluating risk-based lending policies and programs, especially given the robust liquidity on most credit union balance sheets. New and alternative avenues to bolster income should continue to be explored.

Digital and Technology

As the pandemic shifts and prolongs, credit unions should evaluate if their electronic delivery channels meet members and potential members’ needs. Moving to or improving digital delivery channels should be accelerated and prioritized. Digital delivery should include evaluating loan origination and servicing channels to maximize new loan volumes. Online and remote financial services will continue to grow and may be the preferred way members access and manage their financial activities.

Balance Sheet Growth

Before the pandemic, many experts anticipated credit union loan growth to taper off but remain positive. After the first quarter of 2021, loan production became unpredictable, however, by the end of the third quarter, annualized loan growth was 6.34%. Real estate lending, driven by the abruptly lower interest rate environment, helped with the growth. Experts anticipate loan growth to be around 6.0% to 6.5% over the next 12 months as the economy recovers.

The first few months of 2021 may see strong share growth as the second round of government assistance and stimulus takes hold, and households remain reluctant to spend until signs of COVID easing and warmer weather occur. Share growth last year increased at an annualized rate of over 18% and is expected to be approximately 8.0% to 10.0% in the coming year. If double-digit growth continues, earnings sufficient enough to sustain capital will be critical. If economic conditions improve and overall consumer activity increases, loan growth and increasing long-term interest rates could counter some of the anticipated income pressures. Fortunately, the credit union industry is very well capitalized and able to ride out the adverse conditions and absorb some more growth, even if earnings are reduced.

Nov 04 2020

The Bottom of the Frog Market

Several years back, I went to Mexico for a vacation. While there, I found a ceramic hand-painted frog-shaped planter that I wanted. My husband loves the hunt, and his quest began. Every time we saw a frog-planter, he would start negotiating with the vendor to get the lowest possible price. We searched for several days and would stop in different towns and check the markets while enjoying our vacation and exploring. When we found a frog, he would inquire about the price and negotiate for further discounts. After a few days and no success at getting the cost of the frog below a certain point, my husband declared, “we have hit the bottom of the frog market.”

…

The Bottom of the Frog MarketRead More »

Sep 30 2020

Economic Uncertainties and Interest Rate Certainties – Asset Allocation Assessments and Considerations

Future GDP Projections

In September, the Federal Reserve Chairman spoke publicly on several occasions and reiterated that the central bank is committed to helping the economy “for as long as it takes.” He noted continued improvements in the economy, but also acknowledged a highly uncertain path ahead. The September FOMC (Federal Open Market Committee) projections are now projecting a full-year GDP decline of 3.7%. This is substantially better than their previous expectation of a 6.5% decline. However, they lowered their 2021 outlook from 5.0% to 4.0% and their 2022 outlook from 3.5% to 3.0%. Their 2023 outlook is at 2.50%.

Interest Rates and Economic Uncertainties

The FOMC also indicated that they would allow inflation to run above 2.0% on a sustained basis before any federal funds rate increases. As such, most individual members of the Committee indicated that the federal funds rate could remain close to zero through 2023. Some economists and analysts even think that we may not see an increase in the federal funds rate until 2024 or 2025. They believe that it will take up to five years for the global economy to fully recover to pre-pandemic levels.

The risks to the FOMC economic growth projections are high. Even the Chairman of the FOMC acknowledged the economic uncertainty of the path ahead. Following the sharp rebound in many economic data measures and drop in the unemployment rate, some recent measures have disappointed compared to expectations and some are indicating a recovery that is stalling. At the current time of this article, the nature of further fiscal stimulus continues to be negotiated in congress and some are not expecting a resolution until after the presidential election. Of course this only adds to the current economic uncertainty.

What is highly certain over the short to medium term timeframe is that interest rates will not likely be increasing more than just relatively minor fluctuations in the medium to long end of the U.S. Treasury yield curve. It is more likely that potential risks on the horizon could drive medium and longer-term U.S. Treasury yields even lower.

Reassessing Balance Sheet Strategy

Given the above outlook, it would certainly seem that some credit union balance sheet strategies of recent years should be reevaluated for the foreseeable future. Reassessing asset allocation strategies is possibly more relevant at the current time than at any time in the past several years. For example, the credit union may want to ask itself how much should we be redeploying assets into two to three year investment CDs given current interest rates on those maturities. If the answer is less than previous years, then what are the alternatives we can explore.

Priorities Going Forward

In exploring alternatives, the first priority for credit unions is of course serving members. Assessments and considerations could include expanding the types of loans offered, reevaluating risk based lending allocations, increasing real estate concentrations, debt consolidation programs, and loan payment support alternatives to name just a few. Secondary to the first priority are considerations such as allocations to loan participations and alternative investments. For example, should the credit union assess CUSO or similar investment possibilities. What are all of the possibilities for these type of investments that may be available to the credit union? After all, an alternative of earning five basis points at the corporate credit union with too much of assets is not likely to accomplish any priorities or goals for the credit union.

The present time and foreseeable future is a great time for credit unions to really show how they can serve and support members during these challenging times. Being there for your members is for sure the highest purpose for the credit union and always assessing ways to provide service and assistance to them will always be the credit union’s first priority. In addition and secondarily, now more than any time in recent years it may make sense to really take a deep dive into the above asset allocation assessments, considerations, and possibilities. Ideally, the best answers going forward would combine the first priority with the second to optimize balance sheet performance while best serving members.