Revised Interest Rate Risk SupervisionEffective January 1, 2017

Key Changes to NCUA’s interest rate risk supervision:

1. Development of Interest Rate Risk Review Procedures Workbook

2. Updated IRR tolerance thresholds in the NEV Supervisory Test

3. Creation of an estimated net economic value tool (ENT) for CUs with total

assets of $50 million or less

4. Revision of the IRR chapter in the Examiner’s Guide

1. Development of Interest Rate Risk Review Procedures Workbook

• Series of MS Excel worksheets designed for the examiner to walk through the IRR analysis.

• Calculations of the NEV Supervisory Test drive the overall analysis.

• Market Risk tab serves as the primary quantitative assessment.

• Scope of review is dependent on size of institution and risk• Under $50m: No IRR Workbook Steps• $50m - $500m: Baseline Level I/II (15 – 25 Steps)• Over $500m: Full review (35 Steps)

Workbook Tabs

1. Market Risk2. Earnings at Risk3. Stress Testing4. Measurement Systems5. Risk Management6. Overall IRR Rating7. NEV Supervisory Test8. Category Matrix

2. Updated IRR tolerance thresholds in the NEV Supervisory Test

• Mirrors CU IRR model and results.

• Uses -1% and -4% change adjustments to base and +300bp for non-maturing deposits.

• Tolerance thresholds are based on calculated:

1) Shocked Net Worth Ratio (Equity/Assets for +300bp)

2) CU NEV IRR Sensitivity (% change in equity between base and +300)

NEV Supervisory Test is a capital-at-risk measurement, used to evaluate a credit union’s balance sheet in a interest rate shock scenario

3. Creation of an estimated net economic value tool (ENT) for CUs with total assets of $50 million or less

***ENT will be used when an IRR analysis is unavailable or insufficient***

• Replaces CU IRR analysis in NEV Supervisory Test

• Based on Call Report and sensitivity of observed CU’s IRR analysis.

• Highly limited in its functionality due to Call Report aggregation and generalized assumptions.

• Examiners would prefer to not use ENT due to its limitations.

• Can not be a mix ENT and CU IRR.

Tab A: Market Risk

• Utilizes NEV Supervisory test as the quantification measure.

• Purpose is to gauge the inherent degree of market risk and sources of the of risk within the balance sheet

• Reliability of the NEV Supervisory test is dependent on reliability of model inputs.

Anticipated areas of examiner focus:

1. Determine if the portfolio and IRR values are reasonable and supported. (Review of assumptions)

2. Identify the account components that may materially impact the NEV results.

3. Focus on loans and investments.

Tab A: Market RiskReasonable and Supported Results

Overall

• Initial “eye test”: Do both the CU IRR model and NEV Supervisory test produce anticipated results?

Assumptions

• Assesses how pricing and value are determined

• Outside sources are preferred over internal assumptions; Bloomberg pricing tables, Fannie Mae, CoreLogic.

• Values should account for impact of embedded options; callable investments, loan prepayments, etc.

• Assumptions should be assessed and updated more than once a year.

AssumptionsCash Flows - Need to adjust based on embedded options and expedited cash flows

Duration (not required) - Asset sensitivity should match duration; i.e. longer theduration, greater the sensitivity

Prepayment Speed - Cant remain static through scenarios• Must adjust from base to shock• Should adjust based on remaining balances.

Discount Rate Assumptions• Each account should be tied to a similar product discount rate/source.

Account Aggregation and Data Completeness• Ensure reasonableness and not over simplified.• Ensure all accounts/data is captured in the model.

Tab A: Market Risk

Verification of Supervisory Test Results

• Compares the NEV Supervisory Test to CU IRR results.

• Significant variances should be explainable.

• Most Variances should be attributed to non-maturing deposits.

Tab A: Market Risk

Tolerance thresholds are based on calculated:1) Shocked Net Worth Ratio (Equity/Assets

for +300bp)2) CU NEV IRR Sensitivity (% change in

equity between base and +300)

Unitus ResultsShock NEV NEV Change

CU Results 15.59% 14.30% -13.86%NEV Sup Test 11.60% 9.55% -22.74%Difference -3.98% -4.75% -8.87%

Base NEV

Tab B: Earnings at Risk

Examination of the earnings projections for a variety of scenarios. Intention is to show earnings weaknesses and to identify key drivers.

• Projected base net-interest income and net-interest expense should closely match actual.

• Multiple scenarios are expected to be run• Parallel Shock • Steepening and flattening• Sensitivity scenarios; change in prepayment, NMD behavior, spread widening

• Results will be compared to policy limits and ALCO response. (Are we using the information or just going through the motions)

• Review of asset and liability generated income for reasonableness• Repricing strategies• Growth assumptions

Tab C: Stress TestingAdditional balance sheet scenarios should be run to test other non-parallel impacts.

• Examiner review process will be similar to shock test.

• Types of scenarios:• Rate – Non-parallel rate changes• Sensitivity – Prepay, decay, etc. changes • Limit – break it

Tab D: Measurement SystemsExamination of the process and procedures for using, updating, and validating the model

• Capabilities (i.e. rigor and sophistication) of the models• Controls surrounding the modeling process• Reasonableness and documentation of material assumptions• Usefulness of system outputs and reports• Adequacy of periodic variance analysis

Tab E: Risk ManagementReview of our management oversight and policy

• Review of Board and ALCO minutes to show transparency of IRR results, good or bad• Review of policy for:

• Compliance• Identification of Limits and triggers• Proactive action steps

Tab F: Overall Rating

• Rating from Market Risk creates a rating floor• Tabs B – E can not improve our rating; can only lower our rating

Summary

• Support assumptions with outside sources

• Ensure assumptions are not stale

• Review reports for usefulness

• Transparency with Board and ALCO