Good, bad, or downright ugly, examinations are a fact of life for the nation’s credit unions. Credit unions have a resource for general compliance with existing guidelines, but regulators often expand their feedback to include industry best practices ─ guidance that may be an elusive, moving target.
“The complexity of the balance sheet is changing and so is the industry,” says Larry Fazio, National Credit Union Administration’s director of the office of examination and insurance during a speech at Credit Union National Association’s 2012 Governmental Affairs Conference.
NCUA is an insurance company as well as a regulator so “we can’t get to a place where every recommendation is based on regulations,” Fazio says. “They’d be too extensive.”
This creates a frustrating challenge for credit unions to stay ahead of issues that may not always fit cleanly or stand out in the existing guidelines, including the NCUA’s main risk categories.
Sifting through those big picture risk concerns to understand how they might apply to your credit union is no easy task. But if institutions can understand how regulators think, they may secure a subtle advantage in preparing for the next examination.
If a strategy or product isn’t broke, then don’t fix it, but don’t rely too heavily on it either. One top NCUA issue for 2012 is risk concentration that is significant enough to threaten the organization or its operations. Regulators are especially keyed in to real estate loan levels as a percentage of total loans, but they are wary of any area of the portfolio that the credit union may rely too heavily upon.
Another perceived concentration issue is an overexposure to rate, with credit unions borrowing short to lend long.
“Money markets and other options which are more rate-dependent than share certificates have taken over the share balance,” Fazio says.
J. Owen Cole Jr., a second GAC panelist and NCUA’s director for division of capital markets, says the current interest rate environment is “quite extreme, volatile, and quite potentially concerning.” He advises credit unions taking on risk to make sure their risk is diversified.
When it comes to liquidity, credit unions should also develop and document multiple strategies, not just one failsafe relationship. Even at institutions with a stable corporate credit union or Federal Home Loan Bank (FHLB) relationship, regulators will be looking for additional emergency sources for contingency funds beyond their primary business contacts, Fazio says.
Other concerns include strategic issues like due diligence and credit risk, particularly in regards to large increases in loans more than 12 months delinquent.
In terms of due diligence, “the level of sophistication required depends upon the dollar amount” says Matthew Biliouris, the office’s director of supervision, speaking to attendees. Just as consumers rely heavily on sites like the Better Business Bureau, regulators expect credit unions to take advantage of the multiple sources available for background checks, business model cash flows, financial and operations control review, and accounting considerations.
Operational red flags can include an overreliance on third-party vendors that don’t match the credit union’s business model (particularly ones paid by volume) or relationships that limit the nimbleness of the credit union to adapt to changes, creating potential strategic risk.
“We look at contracts and want to see that the credit union is looking out for itself and taking care of any regulatory changes,” Biliouris says. Shed or rework any manipulative or one-sided contracts now, and you’ll save yourself money and headaches come examination time.“These issues don’t exist in a vacuum.”
A new program that yields credit risk can bring reputation risk or other types of issues that feed off each other and have serious impact on the credit union’s brand over time.
Document Potential Issues And Improvements
A thin defense is better than none at all, and documentation of each step made to mitigate risk can prove helpful in deflecting blows during examination time. Creating and actively referring to risk oversight and risk appetite management policies will help credit unions narrow down their top risks and demonstrate how they are addressing those issues in an ongoing, sustainable way.
Examiners may consider these activities as red flags that a credit union is reaching too far for yield.
Extending asset maturities and going longer on the yield curve
Moving down in your credit worthiness scale
Investing in structured products and complex securities