‘S’ Is For ‘Sensitivity’

Reactions vary as the credit union industry prepares for its primary regulator to add ‘S’ to CAMEL.

The NCUA has scheduled a webinar on Thursday, Aug. 18, to discuss its approach to supervising interest rate risk (IRR), including the idea of adding an S to CAMEL.

The move follows a recommendation made last November by the agency’s Office of the Inspector General after the OIG audited the NCUA’s policies for regulating credit union IRR. The NCUA is expected to comply with the recommendation by the end of the year.

CAMEL is an acronym for capital, assets, management, earnings, and liquidity. Many regulatory bodies state and federal already have added to their examination regime the S for sensitivity to interest rate risk.

Whether or not the NCUA should follow suit depends on who’s asked. Some say it’s a good idea; some say it’s redundant since the L already covers IRR in its consideration of market risk; others point to the risk of added regulatory burden.

James Schenck, president and CEO at Pentagon Federal Credit Union ($20.2B, Alexandria, VA), likes the idea and the timing. Since financial institutions have been booking loans at historically low interest rates for nearly a decade now, interest rate sensitivity is one of the top risks facing the industry, Schenck says.

While the NCUA has long had an interest rate sensitivity measure embedded into its liquidity assessments, the PenFed CEO says, he understands why the OIG says the agency should follow the lead of other regulators and add the S.

This standard would provide credibility, accuracy, and clarity as to how interest rate risk is assessed, Schenck says.

On the other end of the asset spectrum, Debora Almirall is not so sure. Adding the S’ will just make us split out the analysis that we’re already doing in ALM. Maybe they should add things like this for the largest of the credit unions, but they really don’t apply to small credit unions. Their balance sheets are less complicated, says the president and CEO of Minnesota Power Employees Credit Union ($92.7M, Duluth, MN).

And right in the middle is John DeLoach, a Tallahassee, FL, attorney whose client list includes dozens of credit unions. I’m neutral on adding S’ for interest rate sensitivity to the CAMEL rating, he says.

DeLoach says that from his boots on the ground perspective, the NCUA already is doing a thorough job examining for IRR and voicing any concerns in exam reports, DORs (documents of resolutions) and LUAs (letters of understanding).

Plus, he says, the examiners with whom I regularly interact have no problem making clear distinctions between liquidity and interest rate risk concerns. I can only guess that a clear delineation may be needed by the NCUA for making such distinctions with the examination as a whole.

Lessons From The Thrift Crisis

A credit union attorney and former Washington state regulatory director, John Bley, also sees the addition of the S’ as necessary because of the current rate environment and because of lessons from the past.

The roots of the 90s thrift crisis was when thrifts went long on the asset side and short on the liability side and then interest rates spiked, he says. Credit unions, whose risk profile is looking more and more like the thrifts of the 90s every day, certainly aren’t immune from such exposures.

Still, Bley says, there needs to be balance. The danger with any new initiative is the manner in which it is implemented, he says. In my opinion, financial regulators have over-reacted to IRR sensitivity issues ever since we started coming out of the Great Recession, Bley says.

Bley and others say that over-reaction has created unnecessary regulatory burden on credit unions that, he says, in fact have a handle on interest rate risk.

He adds, Most credit unions of any size or risk profile should already have systems in place to monitor interest rate sensitivity. They shouldn’t need the government to tell them so.

Almirall at MPECU would agree. Regulators tend to get too conservative, she says. They want us to have a 300bp rate increase in our ALM. If that happened the market would bottom out.

She adds that regulators and indeed, economists and pundits everywhere have been warning that rate increases are just around the corner for the past six years.

We’ve had one rate increase the whole time, the Minnesota credit union executive says. If the NCUA or anyone else has a crystal ball as far as rates are concerned, give me a call!

A Concentrated Focus On Lending, Investment Risk

Sam Taft, director of industry analysis at Callahan Associates, provides this look at the credit union industry interest rate risk environment that awaits adding the S to CAMEL:

As balance sheets grow in both size and complexity, credit unions are facing increased pressure to evaluate their risk exposure. Parts of the portfolio, such as loan and investment concentrations, are being closely monitored for various types of risk.

This is evident as the CAMEL rating system now includes sensitivity to market risk, a large portion of which includes interest rate risk. Strong share and asset growth, coupled with low delinquency, indicate that the credit union industry is well positioned to weather such risk. Additionally, the combination of investment allocations, sales to the secondary market, and deposits ensure interest rate risk is minimal:

  • Fixed-rate long-term mortgages, as a proportion of total first mortgages, is near a 10-year low, which suggests that the industry is actively shifting its strategies to minimize long-term exposure. Additionally, the percentage of fixed-rate, long-term mortgages to total assets has been relatively unchanged over the past five years, and today account for 8.8% of assets.
  • Credit unions are increasingly managing a portion of their interest rate risk through the secondary market. Sales of first mortgages to continue to rise; as of March 2016, credit unions sold 36.9% of first mortgage originations, up from 32.4% two years ago.
  • Share drafts and regular shares account for more than 50% of the total share portfolio, a level not seen in 16 years. High concentrations in these deposit accounts is advantageous for credit unions, as they are stickier in nature and also have lower interest expenses associated with them, when compared to other accounts.
  • The paydown rate on total loans was 34.2% in the first quarter, indicating that the loan portfolio is turning over approximately every three years. Consumer loans the majority of loan originations have shorter durations and thus turn over at a more frequent rate than mortgage products.
  • Investment interest rate risk for the credit union industry has been declining over the past several years as portfolio durations continue to shorten. Investments with maturities of less than one year, including cash, now account for 47.7% of the investment portfolio, up from 41.9% in June 2014. Similarly, the proportion of investments with maturities greater than10 years has declined to a nine-year low, making up 1.2% of investment portfolio.
August 11, 2016

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