NCUA ALM Exams and 17/4 Analysis

Does your credit union hold mortgage loans? Invest in "complex securities" (i.e., those with embedded options, remaining maturities greater than 3 years, and/or those with unusual coupon formulas)?

If so, prepare for more examiner scrutiny of your asset-liability management (ALM) practices.

If not, then your ALM review should be fairly straightforward. Examiners will focus on four questions:

1) Do you have policies addressing funds management practices?

2) Do you assess and monitor liquidity?

3) Have you borrowed funds since your last exam?

4) Are there any future events (e.g., merger, substantial growth spurt, etc.) that might have a material impact on your balance sheet?

Examiners are given a list of considerations and commentary detailing the "correct" answers and the rationale behind each.

But most credit unions won’t get off so easy. Indeed, roughly 65% of all credit unions have mortgages or complex investments. And these credit unions will be evaluated using the NCUA’s new "17/4 analysis".

The 17/4 analysis is NCUA’s new "resource allocation tool" which uses call report data to crudely approximate IRR exposure: The 17/4 analysis takes all of your fixed-rate real estate loans (firsts and seconds) regardless of their remaining maturity or term to repricing and devalues those assets by 17%. It takes all of your variable-rate real estate and devalues those assets by 4%. Then, for federal credit unions, the effect that rising rates has on complex securities holdings is factored in.

The analysis then measures how these devaluations might change your capital position. If the devaluation does not cause your adjusted book capital to drop below 4% and it does not cause more than a 50% decline in book capital then your ALM review process consists of six key questions:

• Are your policies addressing balance sheet risk management adequate?
• Is there an adequate degree of integration between your balance sheet risk management and planning?
• Are your controls over liquidity risk adequate?
• Is your asset/liability management committee’s (ALCO) oversight of your ALM program adequate?
• Is your ALM person’s ability to generate sound and reasonable IRR measurement results adequate?
• Is your IRR measurement process adequate?

However, if the devaluation causes your adjusted book capital position to decline below 4% OR if the devaluation causes your book capital position to drop by more than 50% then your situation is examined much more closely.

In this case, the next step will be a more rigorous analysis of your credit union’s exposure. Specifically, a market valuation model, driven by NCUA’s Office of Investment Services (OIS) pricing tables will be used. The model and the pricing tables will presumably be similar to the model and pricing tables used by the Office of Thrift Supervision in its efforts to supervise savings and loans and savings banks.

After more detailed modeling using the OIS pricing tables adjusted capital is again examined. The same questions are asked. Does adjusted book capital drop below 4% OR does it decline more than 50%? If not, your ALM review process devolves to the six questions outlined above.

If so, then the bar will be raised considerably. In this case your credit union will be subjected to approximately 7 pages of ALM questions with 11 discussion pages—in all about 120 individual questions which focus on policies, planning, liquidity, your ALCO, ALM program review staff, and a review of your ALM model.

The questionnaire detail and lengthy commentary suggests that examiners may have a lot more to say during their next visit.

To prepare, first run a simple 17/4 analysis (you can use the template on our Web site) and determine where you stand.

Understand that there is no connection between the market valuation implied by 17/4 and the PCA regulation. Specifically you are not required to raise your capital level just because it falls below 7% or 6% using 17/4 analysis (or any other market valuation analysis for that matter.)

Also, be sure to check out the ALM review questionnaire and pricing tables that the NCUA plans to post on its web site after the first of the year.