Credit Union Trends and Risks: The NCUA Perspective

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1 Larry Fazio, Director Office of Examination & Insurance Credit Union Trends and Risks: The NCUA Perspective Association of Credit Union Internal Auditors Baltimore, MD June 20, 2014

2 AGENDA 1. High Level Trends Exam Priorities ACUIA 2014 Conference 2

3 12000 Decline in Credit Unions Number of Institutions by Asset Size < $50 $ $1B >$1 B Total ACUIA 2014 Conference 3

4 Three Credit Union Profiles Total Assets $1.01 Trillion Small Mid-Sized Large 4,245 Units % $61.6 B in Assets - 5.6% 1,460 Units % $164.4 B in Assets % 786 Units % $871.9 B in Assets % $50 Million $250 Million ACUIA 2014 Conference 4

5 Net Worth Stable 16.00% 14.00% 12.00% 10.00% 15.11% 10.61% 13.78% 13.47% 13.19% 13.11% 13.19% 12.89% 10.77% 9.89% 10.06% 10.21% 10.44% 10.61% 8.00% 6.00% 4.00% 2.00% 0.00% Mar-14 Aggregate Average (non dollar-weighted) ACUIA 2014 Conference 5

6 40.0% Profitability has Improved, but not for Small Credit Unions Percent Unprofitable by Asset Size 1.20% 35.0% 30.0% 1.05% 1.00% 25.0% 0.73% 0.80% 20.0% 0.58% 0.60% 15.0% 0.41% 0.47% 0.40% 10.0% 5.0% 0.0% 0.15% 37.20% 19.07% 11.10% 6.16% 1.32% 0.46% < $50 $50 - $100 $100 - $250 $250 - $500 $500 - $1B >$1B % Unprofitable ROA (right axis) 0.20% 0.00% ACUIA 2014 Conference 6

7 Earnings Details for Credit Unions by Asset Cohort Industry Profitability Income and Expense (in billions) 8.0% % 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% COF/AA PLL/AA Operating Expenses /AA GI/AA Loan Inc Inv Inc Non-Int Inc Non-Int Exp PLLL Int Exp Net Income < $50 MM $50 - $100 MM $100 - $250 MM $250 - $500 MM $500 MM - $1 B > $1 B Industry % Unprofitable 36.96% 13.04% 9.05% 3.20% 0.92% 0.00% 27.10% Gross Income/AA 4.35% 4.70% 4.96% 4.91% 4.89% 4.76% 4.79% PLLL/AA 0.24% 0.24% 0.25% 0.25% 0.22% 0.28% 0.26% COF/AA 0.36% 0.40% 0.46% 0.48% 0.51% 0.71% 0.59% Op Exp/AA 3.59% 3.65% 3.75% 3.52% 3.40% 2.78% 3.15% ROA 0.16% 0.42% 0.51% 0.65% 0.75% 0.98% 0.78% Net Interest Margin 3.00% 3.05% 3.00% 2.91% 2.90% 2.65% 2.80% ACUIA 2014 Conference 7

8 Problem Credit Unions Decreasing 2,500 CAMEL 3, 4, and 5 Institutions/Shares ,000 1, ,000 1,526 1,648 1,818 1,726 1,563 1,480 1, Mar-14 CAMEL 3 CAMEL 4 CAMEL 5 ACUIA 2014 Conference 8

9 EXAM PRIORITIES ACUIA 2014 Conference 9

10 2014 Exam Priorities Key Risks Interest Rate Risk Cybersecurity Other Operational Risks New Requirements Participation Loans Liquidity CUSO Mortgage Rules ACUIA 2014 Conference 10

11 * * Billions Billions Changing Credit Union Balance Sheets year Real Estate Loan Trends Increased concentration means increased Interest Rate Risk Sensitivity and slower increases in yields RE 1992 = 34% of Loans RE Loans 2013= 53% of Loans 20-year Share Trends Increasing volatility/sensitivity from the funding sources means costs will rise faster. 1, Volatile Shares 1990 = 34% of Shares Volatile Shares 2013 = 45% of Shares Car Loans Credit Cards Other Real Estate Regular Shares Share Drafts Other Money Market Certificates ACUIA 2014 Conference 11

12 Interest Rate Risk ACUIA 2014 Conference 12

13 Interest Rate Risk Extending Asset Durations (investments and loans) Sophisticated balance sheets demand sophisticated and robust analysis. IRR Rule in Place Close monitoring by NCUA Requires written IRR policy and effective risk management programs. Rule does not apply to credit unions under $50 million in assets. Excess risk will be addressed through supervisory action. ACUIA 2014 Conference 13

14 Millions Cyber Security Cyber Risk Affects most Credit Unions All Sizes and All Shapes Nearly half of all FICU members use transactional websites 5, , , , , , ,000 1, , Dec-2009 Dec-2010 Dec-2011 Dec-2012 Dec-2013 Informational Interactive Transactional 4,493 4,465 4,424 4,557 4,515 Number of Members That Use Transactional Website Web Services in FICUs 30,247,099 33,071,055 35,727,978 38,912,728 42,328,858 ACUIA 2014 Conference 14

15 Cyber Security Growing Risk Exposure Size is not so important for criminals anymore Inter-connectedness compounds risk Some key fronts Financial Risk Loss of Assets Account Takeovers $136 cost per capita worldwide - $188 in U.S. (source Ponemon Institute 2013 Study) Reputation/financial Risk loss of personal data function (ID Theft) Target - Profit down 46% sales fell 5.3% since breach. (CBSnews.com) 860+ Million Records Stolen since 2005 (privacy rights.org) ACUIA 2014 Conference 15

16 Some Recent Examples Cyber Security Target Breach - 40 million + records Heartbleed 2 year vulnerability in SSL Internet Explorer vulnerability May 2014 AOL Breach April 2014 Michaels April million card numbers CU Corporate Acct takeover - $100k outgoing before Corporate CU stopped. DDOS Attacks on FICUs in 2013 ACUIA 2014 Conference 16

17 Cybersecurity Program Elements 1) Cyber Risk Management & Oversight Cyber Governance, Cyber Risk Management, Resources, Training & Culture 2) Threat intelligence & Collaboration Intelligence Gathering, Monitoring & Analyzing, Information Sharing 3) Cybersecurity Controls Preventative Controls, Detective Controls, Corrective Controls 4) External Dependency Management Connections, Relationships & Responsibilities 5) Cyber Incident Management & Resilience Incident Detection & Response, Mitigation, Escalation & Reporting, Resilience ACUIA 2014 Conference 17

18 Money Service Businesses Check Casher, PPD Card Sales, Money Transmitter, Travel Company Growing potential risk for FICUs Commercial Banks De-risking CU Commitment to Community Several recent problems nationwide with poor controls and potential illicit finance Enhanced due diligence by FICU when you provide service to a MSB. ACUIA 2014 Conference 18

19 Typical MSB Relationship NCUA Supervised IRS Supervised Source of Funds Credit Union MSB Consumer/Source MSB AML Program ACUIA 2014 Conference 19

20 Corporate MSB Aggregator Insulation from the source raises risk. FICU AML depends on integrity of intermediary AML programs NCUA Supervised IRS Supervised IRS Supervised Source of Funds Check Casher Source Credit Union Corporate MSB/Aggregator $ Transmitter Source PPD Card Seller Source Credit Unions Providing Service to MSBs Must Have Enhanced Due Diligence ACUIA 2014 Conference 20

21 Fraud Hot Spots Poor Accounting Controls/Un-reconciled Books Fictitious and Fraudulent Loans Dormant/inactive accounts Un-cleared Overdrafts Unrecorded shares False Expenditures NACUSAC 2014 Conference & Expo 21

22 Control Framework Tier 1 Governance Tier 2 Management Tier 3 Supervisory Committee Board Policies Budget and Plans Reports/Reporting Procedures Segregation Control Reports Internal Audits External Audit Active Oversight Controls can vary with the complexity of the organization Small institutions often have limited segregation of duties ACUIA 2014 Conference 22

23 New Requirements New Rule Participation Loans see LCU 13-CU-07 Liquidity Funding see LCU 13-CU-10 CUSOs see LCU 13-CU-13 and 14-CU-07 Effective Date September 23, 2013 March 31, 24 June 30, 2014* * Registry when active CFPB Mortgage Rules see LCU 14-CU-01 and Regulatory Alert 14-RA-01 January 10, 2014 ACUIA 2014 Conference 23

24 Participation Loan Rule Effective September 23, 2013 Clarify focus on purchasing side of transaction. Contractual agreement requirements. Key limits: Concentration Limits (greater of 100% of NW or $5mm) Risk retention requirement clarified (10% for FCUs, no less than 5% for others) A limit of 15 percent on participation loans to one borrower. ACUIA 2014 Conference 24

25 Liquidity Rule Effective March 31, 2014 Tiered Requirements: Under $50 Million (4,245 FICUs): Maintain a basic written liquidity policy providing a framework for managing liquidity and a list of contingent liquidity sources that can be employed in emergency situations. $50 Million to $250 Million (1,460 FICUs) : Written liquidity policy plus a contingency funding plan that clearly sets out strategies for emergency liquidity needs. $250 Million + (786 FICUs): In addition to a written liquidity policy and contingency funding plan, required to establish access to NCUA s Central Liquidity Facility, the Federal Reserve s Discount Window. March 31, 2014 Liquidity Source Data Credit Unions > $250 Million in Assets All Federally Insured Credit Unions Count Percent Count Percent Total Federally Insured Credit Unions (FICUs) % % Federal Home Loan Bank Members % % NCUA Central Liquidity Facility (CLF) Members % % Federal Reserve Discount Window Members % % Pre-Pledged Collateral at Discount Window % % Access to CLF or Discount Window % % ACUIA 2014 Conference 25

26 CUSO Rule Effective June 30, 2014 New for all Credit Unions New for all Federally Insured, State-Chartered Credit Unions* Rule Element CUSO Subsidiaries clarifies applicability of the regulations to CUSO subsidiaries. CUSO Registry requires credit unions to ensure that the CUSOs with which they do business agree to provide certain information directly to NCUA and the state supervisory authority, as applicable, on an annual basis. CUSO Accounting requires credit unions to ensure that the CUSOs with which they do business agree to comply with generally accepted accounting principles and obtain a financial statement audit. Less than Adequately Capitalized Federally Insured, State-Chartered Credit Unions added preapproval process for federally insured, statechartered credit unions that are, or would be rendered, less than adequately capitalized by an additional investment in a CUSO. Credit Union Action (Required by June 30, 2014) None Amend written agreement between credit union and CUSO None ACUIA 2014 Conference 26

27 Ability-to-Repay and Qualified Mortgage Rule Effective January 10, 2014 Requires mortgage lenders to consider a consumer s ability to repay a home loan before extending credit to them. Establishes standards for Qualified Mortgages (QMs) safe harbor for lenders to give creditors more certainty about potential legal liability. QMs that are not higher-priced have a safe harbor under the new rule. Otherwise presumed to be in compliance but a borrower can rebut that presumption. The rule applies to new mortgage loans made on or after January 10, 2014 ACUIA 2014 Conference 27

28 Ability to Repay and Qualified Mortgages TIL Requirement All Federally Related Covered Loans Ability to Repay (ATR) TIL QM Non QM 8 ATR Requirements for all Federally Related Covered Mortgages General Specific Criteria Temporary QM GSE Related Balloon both stds are identical Additional Criteria Limited Application Small Portfolio Lender Alternate QM ATR Standards ATR Standard Applies to All Loans QM Flavors are subset of ATR 1. Fully Indexed Payment Consider and verify: 2. mortgage related obligations 3. Income/Assets 4. Employment Status 5. Simultaneous loans 6. Debt, alimony,, child support 7. DTI, residual income 8. Credit History AACUL Conference 28 ACUIA 2014 Conference

29 Questions?? Feel free to contact my office with questions or comments. Office of Examination & Insurance ACUIA 2014 Conference 29