Regulatory
Strength of Credit Union Beyond ROA
During the second half of 2006, the NCUA issued guidance in the form of two letters (06-FCU-04 and supervisory letter 06-01) indicating that an arbitrary return on assets (ROA) of 1 percent, long viewed as the benchmark for strength of earnings, is no longer the primary measure to be evaluated. The NCUA has advised the examiners to make a much closer evaluation of other items such as how well a credit union is measuring and monitoring risk, the strength of board oversight, and overall risk policies within the credit union. Earnings need to be evaluated based on the individual credit union’s unique needs, as well as overall economic trends. The concern also surfaced that placing emphasis on a short-term measure such as ROA could be contradictory to a longer-term safety and performance view. Additionally, with the current trends within credit unions including an overall slowing of asset growth within the industry, lower levels of earnings are required to maintain capital levels. In fact, mathematically, a credit union with 11 percent net worth and 5 percent asset growth only requires a return on assets of 55 basis points to maintain its net-worth ratio. Add to the formula that credit unions nationally are experiencing all-time high net-worth levels, and the push for continued high ROA does not seem as relevant. With an ever increasing array of products and services available to their members, how a credit union manages risk seems more relevant to the long-term strength of the credit union.
NCUA Hot Topics
The NCUA has again indicated the areas it is most concerned about heading into 2007. These areas include management competence, credit risk, and reputation risk. Within the area of management competence, the NCUA will be looking at areas such as corporate governance, risk management systems, overall internal controls, and methods of completing due diligence for new products and services. Within credit risk, the two largest issues are indirect lending and mortgage lending. Finally, within reputation risk, the NCUA will be evaluating compliance programs, disaster recovery planning, and member data safeguards. In addition to strengthening overall business operations, buttoning down these areas will help you prepare for upcoming exams.
ALLL Guidance On December 13, 2006, the NCUA joined the Federal Reserve Board, Office of Comptroller of the Currency, FDIC, and Office of Thrift Supervision in issuing a new policy statement on the allowance for loan and lease losses (ALLL) that updated guidance to institutions to assure consistency with Generally Accepted Accounting Principles (GAAP). The joint agencies also released a supplemental Frequently Asked Question (FAQ) guide to assist in complying with GAAP. While the new guidance does not significantly change existing methodology (credit unions received NCUA’s IRPS 2002), it reiterates several issues found in various sources in the past. The policy spells out the board of directors and management’s responsibility in the ALLL process and calls for a more detailed analysis of the allowance. The policy strongly implies that a simple unadjusted historical loss ratio applied to current loan balances (as described in Statement of Financial Accounting Standards No. 5) is probably not adequate in itself. Management should also consider qualitative or environmental factors that are likely to cause estimated credit losses associated with the credit union’s existing portfolio to differ from historical loss experience. The policy lists numerous examples of potential items to be considered. The policy also permits using varying historical periods (i.e., 48 months for one type of loan versus 24 months for another type). Most prevalent in the policy is the requirement to keep the underlying support for how the allowance was determined. All adjustments to the historical factors should be documented.
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