interest rate risk - acuia.org rhone - interest... · at both risk to earnings and net economic ......

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InterestRateRiskFor Internal AuditorsForInternalAuditors

DeanRohne,CPA,CIA

[email protected]@cliftonlarsonallen.com

2012CliftonLarsonAllenLLP1 111

SessionObjectives

Reviewrecentregulatoryguidanceoninterestrateriskrisk

Introduceproposedaccountingrequirementonliquidityriskandinterestraterisk

Review specific questions on the recent interest rate Reviewspecificquestionsontherecentinterestrateriskexamquestionnaire

Discussspecifictestinginternalauditorscanperformtoaddressinterestraterisk

2012CliftonLarsonAllenLLP2

NumberofProblemCreditUnions


ProblemCreditUnionInsuredShares


CAMEL4/5byAssets


NumberofCAMEL3CreditUnions


CAMEL3byInsuredShares


CAMEL3byAssetSize


CAMELCodebyAssetSize


Definitions

AssetLiabilityManagement(ALM) Managing risks that are present due to mismatches Managingrisksthatarepresentduetomismatchesbetweentheassetsandliabilities.

InterestRateRisk(IRR)( ) Thevulnerabilityofacreditunionsfinancialconditiontoadversemovementsinmarketinterestrates.

LiquidityRisk Theriskthatacreditunionwillnotbeabletomeetits

t d f t h fl d ll t l dcurrentandfuturecashflowandcollateralneeds.


SessionExpectations

Sessiondesignedtodiscusstestinginternalauditorscould performcouldperform.

Internal auditors should consider the need to utilize Internalauditorsshouldconsidertheneedtoutilizeaspecialistasdeemednecessarybasedonthecomplexityofthecreditunion.p y


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RecentRegulatoryGuidance


RecentRegulatoryGuidance

NCUALettertoCreditUnions12CU05 Issued May 2012 IssuedMay2012

Requirescertainfederallyinsuredcreditunionstoadoptawrittenpolicyoninterestraterisk(IRR)managementandaprogramtoimplementiteffectively.

Ruleaffects45%ofthecreditunions,but96%ofcreditunion assetsunionassets.


12CU05

WhydidNCUAamendtheexistingrule? FICUs have recently experienced increased exposure to FICUshaverecentlyexperiencedincreasedexposuretoIRRdueto: Changesinbalancesheetcomposition

IRRfromfirstmortgagesandlongterminvestmentsgrewsubstantiallyduringthemostrecentinterestratecycle.

Increaseduncertaintyinfinancialmarkets

PriorregulationsdidnotspecificallyaddressIRRmanagementandpractices.

With these increases there is a need for strengthening WiththeseincreasesthereisaneedforstrengtheningpoliciesandprogramsrelatedtoIRRmanagement


12CU05

WhydidNCUAamendtheexistingrule? Concern over IRR exposure ConcernoverIRRexposure

1996 Residentialmortgagebalancesinbanksandcreditunionsaccountedforapproximately15to20percentofthetotalassets

20 0 id i l b l d f 8 % f 2010 residentialmortgagebalancesaccountedfor18.4%ofpeerbanksand30.7%ofcreditunionassets


SIRRTRatioDefined

SupervisoryInterestRateRiskThreshold(SIRRT) Takesintoaccountlongertermmaturitiesforbothfirstmortgageloansandinvestments

Whil fi t t l b l dit i b l Whilefirstmortgageloanbalancesoncreditunionbalancesheetshavedeclinedtheamountofinvestmentswithlongermaturitieshasincreased.


SIRRTRatio


NumberofCUsCoveredby12CU05


AssetsCoveredby12CU05


Exposure


12CU05

Addressesthefollowing: IRR Policy IRRPolicy

IRROversightandManagement

IRRMeasurementandMonitoringg

InternalControls

DecisionMakingBasedonIRRMeasurementSystems


12CU05

AdditionGuidanceforLargeCreditUnionswithComplex or High Risk Balance SheetsComplexorHighRiskBalanceSheets Definedascreditunionswithassetsover$500million

Thesecreditunionsshouldconsider: Policywhichprovidesfortheuseofoutsidepartiestovalidatethetestsandlimitswiththeriskexposureandcomplexityofthecreditunion

IRRmeasurementsystemstoreportcompliancewithpolicylimitsatbothrisktoearningsandneteconomicvalueofequitybasedonanumberofdefinedinterestratescenarios

Effectofchangestokeyassumptionssuchasslowerorfasterprepayments

Enhanced levels of separation between risk taking and risk


Enhancedlevelsofseparationbetweenrisktakingandriskassessment.

12CU05 AppendixB

DesignedtohelpcreditunionsmeetNCUAsexpectationsexpectations

Acknowledgesitisnotpossibleforaonesizefitsall policy for all credit unionsall policyforallcreditunions

Policyrequiresspecializedjudgmentsbasedonthecreditunionsbusinessobjectivesandabilitytoj ywithstandrisk Putsthisresponsibilitywiththeboardofdirectors

ProvidesframeworkoffivefundamentalelementsofaneffectiveIRRmanagementprogram


12CU05 AppendixB

FiveelementsofaneffectiveIRRmanagementprogramprogram Comprehensive,writtenIRRpolicy

AccountableIRRoversightbyboardofdirectorsandg ymanagement

AppropriateIRRmeasurementandmonitoringsystems

Goodinternalcontrols

InformeddecisionmakingbasedonIRRsystemresults


12CU05 IRRQuestionnaire

Containsfourpartsthatmightnotallbecompletedbased on complexity of the credit unionbasedoncomplexityofthecreditunion.

PartBaddressescertainratios 174 Test17 4Test

Quickwaytoidentifypotentialcapitalissuesbasedonrepricingofloansandinvestments

E ti t l i l f th f ll i i i i Estimateslossinvalueofthefollowinggivenanincreaseininterestrates Fixedraterealestateloans

V i bl t l t t l Variableraterealestateloans

Investmentsecurities



PartBaddressescertainratios(continued) Short Term Liabilities/Total Shares & Borrowings ShortTermLiabilities/TotalShares&Borrowings

Shorttermliabilitiesmustbelessthan50%oftotaldepositsandborrowings

Sh li bili i i l d Shorttermliabilitiesincludes: Shareswithamaturitylessthanoneyear

Borrowingswithamaturitylessthanoneyear

ComplexAssets/TotalAssets Definedasadjustableratemortgages,balloon/hybridmortgages,agency/GSEmortgagebackedsecurities,othermortgagebackedg y/ g g , g gsecurities

Totalmustbelessthan17%oftotalassetsbenotbeconsideredcomplex


p


PartC Consists of a limited scope review to address the following Consistsofalimitedscopereviewtoaddressthefollowing

PoliciesandProcedures BoardOversight IRRManagement IRRMeasurement IRRComponentsp InternalControls UseinDecisionMaking



PartD ExpandedScopeIRRReviewQuestionnaire

Includes detailed questions that address the Includesdetailedquestionsthataddressthefollowing: Sources of balance sheet complexitySourcesofbalancesheetcomplexity

Largeproportionofmortgageloansin: Hybridinstruments

N f i t Nonconformingmortgages

Adjustmentratemortgages

InvestmentportfoliocomposedprimarilyofCMSandothert l t d itimortgagerelatedsecurities

Useofnonmaturitysharesinpricingstrategyofthecreditunion Significantamountofcomplexborrowings


Useofderivativesinmanaginginterestraterisk


PartD ExpandedScopeIRRReviewQuestionnaire IRR Policy IRRPolicy

Writtenpolicy Identifywhohasprimaryresponsibilityforimplementing Frequencyofreporting IRRlimits Shorttermandlongtermexposureg p Limitsbasedonshocks Reportingandactiontimeframeswhenoveralimit Annual evaluation Annualevaluation Internalcontrols



PartD ExpandedScopeIRRReviewQuestionnaire IRR Oversight and Management IRROversightandManagement

Boardofdirectoroversight Effective?

Assessedadequacyofcontrols

Assessedreliabilityofthemeasurementmethods

Providedadequateinformation

AdequatetrainingonIRRtomeetresponsibilities

Managementresponsibilities Adequatemeasuringsystems

UnderstandandevaluateIRRexposures

Establishedinternalcontrols

Preparecontingencyplans


Awareofmodelingassumptions


PartD ExpandedScopeIRRReviewQuestionnaire IRR Measurement and Monitoring IRRMeasurementandMonitoring

RiskMeasurementSystems Assumptionsmakesenseandcantheybesupported?

Changestoassumptionsdocumented?

AnalysishaveenoughdepthtoadequatelyaddressIRR?

RiskMeasurementMethods Methodsadequatebasedoncomplexityofthecreditunion?

GAPAnalysis DoesmanagementunderstandhowGAPanalysisiscalculatedandhowitisused?

Isthecreditunionwithinpolicylimits



PartD ExpandedScopeIRRReviewQuestionnaire IRR Measurement and Monitoring (continued) IRRMeasurementandMonitoring(continued)

IncomeSimulation Measurenetinterestincomeand/ornetincome?

Doesmanagementhaveabilitytodescribehowincomesimulationiscalculatedandusedbythecreditunion?

Isthecreditunionwithinpolicylimits?

A t V l ti AssetValuation DoesthecreditunionuseNCUAsassetvaluationtable?

Doesmanagementhaveabilitytodescribehowassetvaluationiscalculated and used by the credit unioncalculatedandusedbythecreditunion

NetEconomicValue(NEV) UnderstanduseofNEV?

i hi li li i ?


Withinpolicylimits?


PartD ExpandedScopeIRRReviewQuestionnaire Components of IRR Measurement Methods ComponentsofIRRMeasurementMethods

ChartofAccounts AggregationofDataInput AccountAttributes PresentValueDiscountingMethodology PrepaymentAssumptionsp y p RepricingSensitivityAssumptions DecayRatesofNonmaturitySharesAssumptions



PartD ExpandedScopeIRRReviewQuestionnaire Internal Controls InternalControls

Auditfunctionindependentofriskassessmentandrisktaking Adequatesegregationofduties ALCOensurecreditunionisoperatingwithinpolicylimits Followuponregulatoryandthirdpartyfindingsbysupervisorycommitteeorinternalaudit

Adequatesystemtoareaswhereerrorsorabusescouldoccur



PartD ExpandedScopeIRRReviewQuestionnaire Decision Making Informed by IRR Measurement Systems DecisionMakingInformedbyIRRMeasurementSystems

DoesmanagementusetheresultsofIRRmeasurementsystemstoassistinmakingdecisionsinthefollowingareas:

O ti d i i Operatingdecisions

Changingbalancesheetstructure

Fundingoptions

P i i Pricingstrategy

Businessplans

Doesmanagementproactivelyidentifystepstoaddressnegatived ?trends?



PartD ExpandedScopeIRRReviewQuestionnaire Additional guidance for large credit unions with higher risk Additionalguidanceforlargecreditunionswithhigherriskorcomplexbalancesheets Inadditiontotheitemsdescribedabovedoesthecreditunion:

FullyunderstandallpartsofIRR

Periodicallyobtainathirdpartyvalidationincludingthereasonablenessoftheassumptions

i k i d d i f diff MeasurerisktoearningsandNEVunderavarietyofdifferentinterestratescenarios

Disaggregatedatadowntotheaccountlevel?

Adequately test changes to assumptions on IRR measurement results AdequatelytestchangestoassumptionsonIRRmeasurementresults

Enhancedlevelsofseparationbetweenrisktakingandriskassessment?


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ProposedchangestoASC Topic 825ASCTopic825


FinancialInstruments(Topic825)

DisclosuresaboutLiquidityRiskandInterestRateRiskRisk ProposedaccountingstandingIssuedJune27,2012withcommentsdueSeptember25,2012

Whywasthisissuedasaproposedstandard Stakeholdersfeedbackonaproposedstandardrelatedtoderivatives indicated there are risks inherent within classes ofderivativesindicatedtherearerisksinherentwithinclassesoffinancialinstrumentsandthewayanentitymanagementsthoserisks.

No single amount or measurement is possible to disclose this risk Nosingleamountormeasurementispossibletodisclosethisrisk

Effectivedate Notset,willbedeterminedasFinancialAccountingStandards

( )


Board(FASB)considersfeedbackontheproposedchanges.


Disclosuresrequiredaredeterminedbasedonwhether the entity is a financial institutionwhethertheentityisafinancialinstitution. Financialinstitutiondefinedasreportablesegmentswhoseprimarybusinessincludes: Earningincomefrominterestbasedonearningassetsaninterestpaidonborrowedfunds

Providesinsurance



Disclosureswouldprovideinformationabouttherisks and uncertainties a credit union would have inrisksanduncertaintiesacreditunionwouldhaveinmeetingfinancialobligations. Wouldrequirequantitativeandnarrativedisclosureq qrelatedtoacreditunionsexposuretoIRR.



Disclosuresforfinancialinstitutions Liquidity Gap Maturity Analysis LiquidityGapMaturityAnalysis

IssuanceofTimeDeposits

AvailableLiquidFundsq

RepricingGapAnalysis

InterestRateSensitivity


ProposedStandard LiquidityGAPMaturity


ProposedStandard TimeDepositMaturity


ProposedStandard YieldPricingAnalysis


ProposedStandard AvailableLiquidFunds


ProposedStandard InterestRateSensitivity


WhatShouldInternalAuditorsDo?

VerifytheCreditUnionhasimplementedtherequirements of 12CU05requirementsof12 CU 05

Determinewhethermanagementisawareofproposed changes and ASC Topic 825proposedchangesandASCTopic825

AssesswhetherIRRshouldbeincludedinthescopeofaninternalauditplanbasedontheinternalauditpdepartmentsriskassessment


WhatShouldInternalAuditorsDo?

IftestingIRRwithinyourcreditunionconsiderthefollowing:following: Useaspecialistasneeded

Utilizetheexaminerchecklisttoidentifyanyregulatoryy y g yissues Internalcontrolissues Management understanding of IRR present ManagementunderstandingofIRRpresent Boardunderstandingandinvolvement


Contact UsFollowourblogforcurrent

discussionsoncreditunions.

www larsonallen com/blog

DeanRohne,CPA,CIAdean rohne@ cliftonlarsonallen com www.larsonallen.com/blog

www.twitter.com/cliftonlarsonallen

[email protected]

8006574477

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interest rate risk - acuia.org rhone - interest... · at both risk to earnings and net economic ......

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