Interest Rate Risk Supervision and Adding ‘S’ to CAMEL

NCUA Webinar August 18, 2016

2pm EDT

NCUA

E&I/ DCCM

Why the Supervision Update is Necessary

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1. Respond to NCUAB supervisory priorities (expectations)

2. Address new requirements: a. IRR Rule (§741 eff. September 2012)

b. Derivatives Rule (§703 eff. April 2014)

3. Enhance examiner guidance

4. Reduce inconsistency

5. Identify outlier risk

6. Continuous Quality Improvement

Key Changes to IRR Supervision (Part I)

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1. Examiner guidance

2. IRR scope and review procedures

3. IRR risk-tolerance thresholds (NEV)

IRR Supervision Scope (March 2016 Data)

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Total Assets of $500m or greater

Total Assets between $50m and $500m

Is “Supervisory Test” High or

Extreme?

No Yes

35 Steps25 Steps15 Steps

Total Assets under $50m

Estimated NEV Tool “ENT”

IRR Workbook not required

1,779 CUs$283b

3,681 CUs$55b

493 CUs$903b

1st E

xa

m C

ycle

Post 1st

Exam Cycle

Key Changes to IRR Supervision (Cont’d)

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3. IRR risk-tolerance thresholds (NEV) a) Traditional +/- 300 basis point supervisory test

b) Thresholds for post-shock NEV ratio and sensitivity

c) Levels for low, moderate, high and extreme IRR

d) Utilizes CU data (internally generated NEV reports)

e) Non-maturity share benefit (value) capped for Base and Shock scenarios

Why a NEV Supervisory Test

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1. Captures longer-term risk of embedded options

2. Capital-at-risk measure

3. Total-balance-sheet metric

4. Widely utilized in risk management

5. Superior to Call Report metrics (NLTA, SIRRT, 17/4)

6. Data exists in majority of larger institutions

7. NCUA can readily capture, archive and study

8. Better IRR review utility for small credit unions

Why the Standardization of Non-Maturity Shares

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1. Uncertainty a. Out of sample forecast risk b. Impact from crisis/recession (surge deposits) c. Technology

2. NMS observations in the CU industry

a. Wide dispersion of valuation assumptions b. No market consensus on values c. NMS comprise > 70% of liabilities on average

3. Standardization approach a. 1% benefit for Base case scenarios b. 4% benefit for shocked scenario (currently +300bps)

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NEV Supervisory Test – Risk Thresholds

Risk Level

Low

Moderate

High

Extreme

2% up to 4% 65% to 85%

Below 2% Above 85%

Post-shock NEV NEV Sensitivity (%)

Above 7% Below 40%

4% up to 7% 40% to 65%

Note: NCUA has made use of a NEV metric in the current Examiner’s Guide since 2000 in Chapter 13

Key IRR Review Areas

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• NEV Supervisory Test

• Analysis of Balance Sheet Valuations Market Risk

• Review of Scenarios

• Review of results/assumptions Earnings at Risk

• Review of Scenarios

• Results Stress Testing

• Platform assessments

• Data controls Measurement Systems

• Oversight

• Policies/Reporting/Controls/Staff Risk Management

Benefits for Credit Unions

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1. Shifting the focus towards IRR outliers

2. Uniform, measurable, consistent and transparent IRR measure

3. Increased clarity of supervisory expectations

4. Increased accuracy of IRR rating

5. Greater consistency by examiners

6. Risk-focused discussions (majoring in majors)

7. Reduced examination burden for most

Benefits for Supervision

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1. Ability to more uniformly and consistently measure risk across all CUs (baseline and benchmark)

2. Enhanced risk analysis and surveillance of IRR

3. Improved resource allocation

4. Increased clarity and transparency

How will we transition to an “S” Rating?

12

“L”

Liquidity

ALM IRR

S L M E C A

Today: CAMEL Letter No. 07-CU-12

Future: CAMELS Letter No. xx-CU-xx

New IRR supervisory rating will be incorporated into existing scheme (part of “L” rating) for now

Any future CAMELS rating methodology would be issued for public notice and comment and separates liquidity from market risk sensitivity

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Next Steps

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1. Finalize the Examiner Guidance

2. Communicate to Credit Union Industry via “Letter to Credit Unions” which will include the revised Examiner Guide, Procedures Workbook and Frequently Asked Questions

3. Complete the Agency-wide Examiner training on the revised IRR Guidance

4. Implement the revised IRR Supervision

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Q&A