NCUA Update Alaska Credit Union League

May 17, 2013

Mike Dyer, Associate Regional Director, Programs

Topics for Today

NCUA Update 2

• Industry Financial Trends • Reg Modernization & Relief • Exams & Supervision • Changes at NCUA • What’s Ahead in 2013

CU Performance

NCUA Update 3

AK 12/31/2011

AK 12/31/2012

Region V 12/31/2012

Nation 12/31/2012

# of CUs 12 12 664 6,819

Assets $6.8 billion $7.4 billion $132 billion $1.02 trillion

Loans $4.5 billion $4.8 billion $79.6 billion $598 billion

Loans/Shares 74.11% 71.91% 68.16% 68.09%

Net Worth 9.12% 9.24% 9.95% 10.44%

ROAA 0.94% 0.94% 1.01% 0.86%

Del Loans/Loans 1.06% 1.08% 1.01% 1.16%

Charge Offs/Loans 0.71% 0.65% 0.82% 0.73%

NCUA Update 4

Modernization

NCUA Update 4

Streamlining Existing Regs

Targeting New Regs

Minimizing Reg Burdens

Reg Modernization/Relief

• Chairman Matz began Regulatory Modernization Initiative in 2011

• NCUA reviews 1/3 of rules annually

• Consciously strive for least possible regulatory burden imposed; required by law

• Always a public comment period; can really impact final rule outcome

• Credit Unions can have input into process

NCUA Update 6

Some Barriers to Reg Relief • Statutory

– Rules required by Congress • Bank Secrecy Act, SAFE ACT, FCRA, TILA, etc.

– Rules written by other agencies: NCUA must enforce

• CFPB, Federal Reserve, FFIEC etc. • So-called “Alphabet Regs”

• Safety & Soundness

– Core agency mission is to protect consumer deposits

• If relax those rules = more CU failures • Increases share insurance fund costs to YOU

• The above cover majority of NCUA rules!

NCUA Update 7

Recent Reg Relief from Modernization

• Small credit union definition now <$50M assets (IRR, PCA, future rules)

• Streamlined Low Income Designation process

• More flexibility for Troubled Debt Restructurings

• Member Business Loan waiver application process clarified

• Loan modification extension terms clarified

• Streamlined Community Charter application process

• Streamlined Community Development Revolving Loan application process

NCUA Update 8

Reg Relief from Modernization (cont.)

• Allow CUs to hold Treasury Inflation Protected Securities (TIPs)

• Expand rural charter field of membership definition

• Expanded definition of fleet vehicles for Member Business Loans

• Allowed for video teller expansion

• Seven prior Reg-Flex provisions extended to all Federally Insured CUs

• New exam process for CUs <$10M, streamlined • Worked with CFPB to provide definition of “Micro Depository Financial

Institutions”

• Even cancelled three Board meetings in 2012!

NCUA Update 9

Must do Reg Relief Responsibly…

NCUA Update 10

Still $19B+ Shares in CAMEL 4/5 CUs

NCUA Update 11

Topics for Today

NCUA Update 12

Industry Trends Reg Modernization & Relief • Exams & Supervision • Changes at NCUA • What’s Ahead in 2013

Exams & Supervision Changes

NCUA Update 13

• Now on annual exam cycle • All $250M+ state charters insurance exams • Pre-exam notifications improved • Appeals process levels • Ombudsman elevated • Establish “ONES” for $10B+ CUs, Corporates

Reallocating NCUA Resources Past allocations were based on # of CUs, rather than assets and risks

-5

10 15 20 25 30 35 40 45

Less than

$10M

$10 to $50M

$50 to $100M

$100 to $250M

$250 to $500M

$500M to $1B

$1 to $2.5B

$2.5 to $5B

Greater than $5B

Share of FICUs, Assets and Exam Hoursby Asset Size Credit UnionsAssetsExam Hours

5 NCUA Update

OIG & GAO Reports: NCUA Not Firm Enough!

NCUA Update 15

• Capacity – Examiners will evaluate capacity to manage

Operational Risk and Balance Sheet Risk. • Clarity

– NCUA will work to improve guidance for examiners AND credit unions.

• Consistency – Use of Documents of Resolution (DOR’s) – National Supervision Policy Manual

NCUA Update 16

Our Goals: Capacity, Clarity, Consistency

Risk comes from not knowing what you’re

doing.

Warren Buffet

NCUA Update

17

Capacity Managing Risk

Operational Risk

18

Risk of loss resulting from inadequate or failed

processes, people and systems, or from external

events.

NCUA Update

Operational Risk

19

Technology Internal Controls

NCUA Update

Operational Risk

20

New Technology = New Risks

• Online Banking • Remote Deposits • Mobile Banking • Social Media • CUs are NOT too small to be

targeted

NCUA Update

Operational Risks

NCUA Update

21

Technology • Recent events (take your pick)

• Examiner Training • Updated Questionnaires/exam program • Expect enhanced review second half of 2013

– Evolving risk management process – Strong third party due diligence

Operational Risk

22

New Risks Require Enhanced Internal Controls Old Risks require strong controls

NCUA Update

• Fraud losses cost the industry the most of all the failures (sometimes several multiples of reported assets)

• Internal controls, risk mitigation, and oversight – No substitution for controls – Multiple review levels can mitigate but not replace – Independence

• Strong effective audit process • Internal audits • Oversight

Operational Risks – Fraud Hot Spots

NCUA Update 23

• Poor Accounting Controls/Un-reconciled Books – Clean Records and Effectively Monitoring Financial Activity

• Fictitious and Fraudulent Loans – New loans, Charge off loans, Due Dates, Subsidiary vs Control Account.

• Un-cleared Overdrafts – Bank Reconcilements, general ledger reviews, access controls/override reports

• Dormant/inactive share accounts – Timely monitoring and clearing inactive accounts – Control reports

• Unrecorded shares – Segregate activity/access control – Monitor bank activity

• False Expenditures – Unsupported expenditures – Budget/financial statement monitoring

There is a Method to the Madness

NCUA Update 24

• Board Policies • Budget and Plans • Reports/Reporting

Tier 1

• Procedures • Segregation • Control Reports

Tier 2

• Internal Audits • External Audit • Active Oversight

Tier 3

• Controls can vary with the complexity of the organization

• Small institutions have inherent weakness and need strong oversight

• Large institutions have no excuse

• Volunteers have responsibility here – you need to be aware of your surroundings

Operational Risk

NCUA Update 25

Expectations • Robust technology risk management

– Risk assessment and classification – Enhanced controls – security – Mitigation and Escalation procedures – New enhanced review steps second half of 2013

• Internal Controls and Control Environment – Greater transaction testing in weak control environments – Poor controls can affect M rating and CAMEL overall – Closer scrutiny on quality of audit, and SC discharge of responsibilities

Balance Sheet Risk

NCUA Update 26

Interest Rate and Liquidity Long Term Assets, Short Term Funding Earnings at Risk When Rates Rise Contingency Funding Arrangements - Interagency Policy Statement on Funding and Liquidity Risk Management OTS-2010-0005

Letters to Credit Unions (4): - 00-CU-13, 01-CU-08, 03-CU-11, 10-CU-14 All references available at www.ncua.gov

Balance Sheet Risk – “IRR”

NCUA Update

27

20-year Real Estate Loan Trends – Increased concentration means increased Interest Rate Risk Sensitivity and slower increases in yields

-

100

200

300

400

500

600

700

Billi

ons

Car Loans Credit Cards Other Real Estate

RE=34%

RE=54%

20-year Share Trends – Increasing volatility/sensitivity from the funding sources means costs will rise faster.

-

100

200

300

400

500

600

700

800

900

1,000

Billi

ons

Regular Shares Share Drafts Other

Certificates Money Market

Volatile Shares

34%

Volatile Shares now

46%

Balance Sheet Risk

NCUA Update

29

• What is likely to happen when rates rise – Rate will impact share rates faster and deeper than past cycles:

• Either liquidity will drain (if you don’t price competitively)

Or

• Costs to maintain stable funding will rise faster than in the past – Asset yield will increase at a slower rate than in the past for RE/LT

laden balance sheets. • Yield increases will be incremental and may not keep pace with cost of

funds

– Rapid or sustained rate rises can overwhelm tight margins. • Declining margins and cyclically worsening ROAA • Declining liquid assets/liquidity – possibly triggering events in some credit

unions (we’ll talk about that later)

Balance Sheet Risk

NCUA Update

30

Poor IRR Management – Slow Heart Attack

Poor Liquidity Management – Blunt Trauma

• Gradual Decline in ROAA • Tightening Liquidity • Eventual losses • Eventual Depletion of Capital • Insolvency

• Rapid outflows/insufficient inflows • Insufficient contingent liquidity • Sale/liquidation of less liquid

underwater investments • Depletion of capital • Inability to meet current obligations

(bankruptcy)

Balance Sheet Risk

NCUA Update

31

• What you can expect examiners to evaluate – Policies, procedures, decision support and internal controls consistent with

sophistication, and depth/level of potential exposure. • Hint (if you trigger the SIRRT ratio, you need to take IRR seriously)

– Examiners will challenge your preparedness • Strong policies consistent with size, sophistication, exposure level • Make sure you can support your assumptions

– Don’t try to pass a standard set of assumptions as yours. – Whatever the assumptions are they need to tie back to your organization.

• Ensure full disclosure all the way up the line • Break risk taking decision stream from risk management decision stream as much

as possible. • Testing, validation and internal controls around the process • How committed is your organization to controlling risk?

– Challenge yourself – How wide or narrow is your safe operating range? – How critical is your non-maturity deposit assumption?

• Will you survive an error in your assumptions?

Balance Sheet Risk

NCUA Update

32

What you can expect your examiner to look for (cont’d)

• Strong liquidity management and contingent funding policies, procedures, decision support and controls. – Normal funding diversity and options – Shock funding sources – contingency plans

• No more CLF Safety net for most • A liquidity crisis can trigger failure in an institution that may

otherwise survive. (2008 crisis taught us that liquidity can cause sudden death)

Continuous Crisis Management is Bad Management

NCUA Update

33

• When it happens, it will be too late – Assets will not be saleable without incurring large losses

(sudden death/liquidity) – Sufficient imbalances will result in an un-recoverable death

spiral for insufficiently capitalized credit unions – You will painfully watch the decline in your organization

Balance Sheet Risk

34

NCUA Update

• Concentration Risk – Small Market Changes Can Materially Impair Your Operation

– Different Assets/similar behavior – Proportionately Large to Assets/Capital

• Expectations – Policy limits, controls and mitigation/contingency plans – Robust reporting and monitoring – proportionate to risk – Management commitment

- Letter to Credit Unions 10-CU-03

Balance Sheet Risk

35

NCUA Update

New Products and Services Unique Products and Services

- Private Student Loans - Credit Union Funded Employee Benefits - Other Complex Products - Complex Investments - Business Accounts - Unusual products hard to value or price

10 Red Flags for Examiners 1. Lack of commitment to risk management. 2. Disengaged leadership. 3. Concentrated organizational power or control. 4. Inconsistent or weak process for complexity or risk level. 5. Failure to adhere to policies and procedures 6. Appetite “creep” (Don’t rationalize – make the touch decision)

7. “Silver Bullets” and “Shiny Objects” (aka shortcuts)

8. Disproportionate yields = unidentified risk (there are no hidden secrets if you have not identified the risk – stop until you can see, measure and control it)

9. A state of denial (It is not hard to know what is right, the hard part is

doing the right thing.) 10. Misaligned incentives (poorly designed pay and incentive plans)

36 NCUA Update

10 Things Your Examiner Will Like to See

1. Commitment to make tough choices. 2. Forward looking strategy. 3. Well developed and integrated risk management. 4. Balanced appetite for risk (like your life depended on it). 5. Incentives aligned with sustainable risk levels (Taking a long term

strategic view).

6. Continuous monitoring and strong comprehensive reporting regime (Good, Bad or Ugly).

7. Strong control environment. 8. Balanced portfolio and portfolio strategy. 9. Equal weight to the downside risks in the decision making

process. 10. Optimal capital deployment (Scaled to level of risk and no over-reliance).

37 NCUA Update

Enhancing Clarity

38

In 2013, NCUA will issue enhanced guidance on: • Member Business Lending (MBL) Waivers • Alternatives to Credit Ratings • Additional Guidance on Troubled Debt

Restructurings (TDR’s)

NCUA Update

Improving Consistency

39

• Use of Documents of Resolution (DOR’s) • National Supervision Policy Manual vs.

Five Regional Supervision Manuals • CU Online provides District Examiner and

Supervisory Examiner Contact Info • Pre-Examination Letter • Report Cover Letter provides info on

formal and informal appeal options

NCUA Update

Resource Reminders

40

AIRES Questionnaires

NCUA Update

Topics for Today

NCUA Update 41

Industry Trends Reg Modernization & Relief Exams & Supervision • Changes at NCUA • What’s Ahead in 2013

Stay Informed with Monthly NCUA Report

NCUA Update 42

• Sign up at NCUA Express

• Covers all major NCUA action in one place

• Written in “plain writing” style

• Great for volunteers!

WWW.NCUA.GOV

NCUA Update 6

NCUA Update 44

Possible 2013 Action

• Any Congressional Legislation

• Remaining Dodd-Frank Implementation (Joint Agency)

• Simple Interest Rate Swap Derivatives (limited)

• Outstanding 2011/2012 proposals: – Loan Participation Protection rule

– Emergency Liquidity

– CUSO Risk Transparency rule

• Risk Based Net Worth and PCA Reform Proposal

NCUA Update 45

Other 2013 Issues or Events

NCUA Update 46

• 2013 NCUA Examiner Training on DORs, Fraud

• National Supervision & Policy Manual updated to 2.0

• “ONES” Office up and running by 2014

• OIG “Material Loss Review” Reports

• Corporate Stabilization Fund & Share Insurance Fund Range Assessments Announced in July – Stabilization Fund estimated assessment range: 8 to 11

bp – SIF estimated assessment range: 0 to 5 bp

Regional Office Contact Page

NCUA Update 47

Feel free to contact my office with questions or comments. Primary Staff: Mike Dyer Email: mdyer@ncua.gov Office Phone: 602-302-6003