NCUA Regulatory Update on ALM

Transcription

1 Peter Jensen, Regional Capital Markets Specialist NCUA, Region 4, Division of Special Actions NCUA Regulatory Update on ALM University for Credit Unions September 23, 2014

2 Agenda Introduction Interest Rate Risk Liquidity Risk Capital Planning Q & A s and Discussion 2

3 Introduction Peter Jensen is NOT the official media wing of NCUA. This is an environment to ask questions and have professional and respectful discussion. The topics covered in this presentation are NOT the official stance of NCUA. 3

4 Introduction Feel free to contact NCUA s Office of Public and Congressional Affairs with questions or comments about NCUA s official position on ALM related matters. Office of Public and Congressional Affairs National Credit Union Administration (703) Phone (703) Fax pacamail@ncua.gov 4

5 Why should we be concerned about Interest Rate Risk? INTEREST RATE RISK: TRENDS CAUSING CONCERN 5

6 Falling interest rates contributed to declining net interest margins 8.00 Components of Net Interest Margin Percent Loan Yields Investment Yields Cost of Funds Net Interest Margin

7 Prompting lengthening of asset maturities Percent of Assets 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Net Long Term Assets in Credit Union System Fixed Assets MBL Loans Investments 3+ Year Net Fixed Rate 1st Mortgage & Other RE

8 Unrealized losses were widespread and in some cases significant. CUs with Unrealized Losses > 10% of Net Worth percent 10 9 CUs with Unrealized Losses > 10% of NW (Right Axis) 8 30 year Mortgage Rate (Left Axis) # of CUs

9 You ve identified the risk what now? INTEREST RATE RISK: MODELING REVIEW 9

10 Reality of Models ALL MODELS ARE WRONG Reality is too complex to model models are simplifications Models have limits to their usefulness Quality model estimates and outputs rely on quality inputs Model processes are a collection of assumptions and expert judgment 10

11 Model Risk Management Creditable Challenge answers the following questions? Who is responsible for model selection, model usage, model reporting, decision making? Is the model appropriate for what is being estimated? How do we know the models provide useful estimates for decision making? How well does the model perform vs. actual results vs. benchmarks 11

12 Models: Governance, Policy, Controls Governance an effective framework of defined roles, responsibilities, transparent and clear communication and decision making authority Policy the formalization of modeling activities to include model usage, change control, and reporting Controls ensure that the implementation and execution of model governance and policy produce quality information for decision making and that estimates are properly used 12

13 Validation Each component of the model must be subject to validation Inputs: do the data and assumptions fairly reflect the credit union s positions and range of product behaviors? This should be within the scope of examination Processing: is the black box conceptually sound? This is typically not within the scope of examination Reporting: are the estimates useful for decision making and is the decision making process sound? This should be within the scope of examination 13

14 Third Parties Same principles of model risk management apply but modified CU s must still validate the model inputs and their use of model estimates CU s must understand the usefulness and limitations of third party models CU s should have contingency plans for instances when a model is no longer supported by their vendor 14

15 Common Model Check Points Assumptions Discount rate Prepayment speeds Optionality Aggregation Non maturity shares Reasonableness test 15

16 Modelling Do s and Don ts* DO Know what you re measuring Benchmark results Identify major assumptions Isolate variables Know the source of assumptions DON T Obsess over realism Think models predict the future Use one size fits all metric Obsess over precision Expect right/wrong answers *Source: Olson Research 16

17 What tools are available to manage Interest Rate Risk? INTEREST RATE RISK: DERIVATIVES A NEW TOOL FOR CREDIT UNIONS 17

18 Derivative Authority Guiding Principles The final rule provides a framework for derivative activity that: Acknowledges that credit unions are exposed to rising rates Is responsive to threat, but reflects that derivatives aren t a fix all Limits the scope of the rule authority to IRR management Permits only risk reducing transactions 18

19 Derivative Characteristics The final rule establishes derivative characteristics that are appropriate and consistent with our principles: Protect against changes in domestic interest rates Only for risk reduction Plain Vanilla (simple structure) Highly correlated to credit union assets and/or liabilities Can be readily valued and modeled Can be prudently monitored and controlled 19

20 Products Authority Products Product Characteristics Program Characteristics Plain swaps Caps Basis swaps Floors Treasury futures Amortizing notional Forward start (90 days) Not leveraged USD Domestic indicies No structured liabilities Meet GAAP definition Final Authority 20

21 Eligibility Authority Final Authority Eligibility Camel 1,2,3 Management 1,2 Assets more than $250m Field Director approval (Assets) Qualification Standards One standard 21

22 Limit Authority Authority Entry Limit (1 st Year) Standard Limit (After 1 st Year) Fair Value Loss Limit 15% of net worth 25% of net worth Notional Limit Maturity and price sensitivity weighted 65% of net worth Maturity and price sensitivity weighted 100% of net worth Maturity Limit 15 years 15 years 22

23 Other Significant Items Standard FISCU Preemption Counterparty, Collateral and Margining Qualified Experience External Service Providers Regulator Approval Final Rule Derivative Authority Rule only applies to FISCUs that obtain derivatives authority under a parity provision Adopted final CFTC rules for swap clearing Removed explicit years of experience requirement, but looking for skilled staff that understand the product and the necessary controls Removed specific roles to be supported and conducted, but require ALM and liquidity roles to be conducted internally Modified to Interim and Final approvals; shortened review time by 30 days 23

24 Program Supervision Type New Supervision Actions Application Reviews Addition to NSPM for instructions, procedures and reporting Supervision Guidance Letter to Credit Unions to detail overall Exam procedures Call Reporting New Schedules specifically for Derivatives are included in the current call report and instructions 24

25 If we buy and sell money why is liquidity important? LIQUIDITY RISK 25

26 Why is Liquidity a Concern? Crisis revealed weaknesses in contingency funding and liquidity risk management Gained deeper understanding of how liquidity and capital adequacy relate We lost a significant means of contingency liquidity with termination of CLF Agent arrangement Majority of credit unions have not replaced their lost CLF access Balance Sheet has become more prone to liquidity events 26

27 What Else Drives Liquidity Concerns? We came out of the crisis with diminished back up liquidity protection Restoring protection is crucial Flush with cash and pressure on earnings How will cash get deployed? Is it loaned or invested into illiquid or limitedliquidity assets? Level of rates and inherent ALM mismatch makes this potentially riskier 27

28 How should it be measured? Liquidity stress scenarios should incorporate: Increased share outflows, including early withdrawals of CDs Lower borrowing capacity Net worth impact of realized losses on security and loans sales Higher usage of unfunded commitments Extension risk on loans and investments 28

29 NCUA Guiding Principles Liquidity policy is a must have Tiered requirements acknowledges complexity and risk increase with asset size Resources recognizes resource constraints of smaller institutions Public Policy consistent with overarching liquidity and contingency funding views advanced by FFIEC and BIS (Basel) 29

30 Final Rule Liquidity and Contingency Funding 3 tiered Liquidity Management Requirements Letter to CUs 13 CU 10: Guidance on How to Comply with NCUA Regulation Liquidity and Contingency Funding Plans 30

31 General Framework Final Rule Elements Tier 1 (<$50m) : Maintain a basic written policy and list of liquidity sources Tier 2 ($50m to under $250m): Expanded policy requirements to include stress tests and annual review Tier 3 ($250m and up): All of Tier 2 requirements plus pre arranged access to a contingent federal liquidity source (defined as being CLF or Fed DW) Elevated supervisory expectations for Liquidity 31

32 What are the Key Aspects of a Sound Liquidity Plan? Balance Sheet Market Funding Backup Facilities Hold cushion of unencumbered high quality liquid assets (e.g., cash, Treasuries) Establish funding strategy that provides for diversified sources of funding (e.g., corporate credit union or bank LOC, repurchase agreements, FHLBank advances, etc.) Maintain access to a Federal liquidity source for unexpected emergencies (i.e., Fed Discount Window, Central Liquidity Facility)

33 Contingent Federal Liquidity $250 million or more In addition to a written liquidity policy and contingency funding plan, federally insured credit unions in this group must establish access to at least one contingent federal liquidity source: either NCUA s Central Liquidity Facility, the Federal Reserve Discount Window, or both. As of 12/31/13: There are 7801 federally insured credit unions over $250 million They represent approximately 11% of FICUs and hold 79% of all assets 33

34 When are the deadlines? If you are a FICU with total assets: Actions Required by March 31, 2014 Actions Required by December 31, 2014 Under $50 million Have a basic written liquidity policy for managing liquidity in accordance with (a) $50 million and over Establish and document a contingency funding plan in accordance with (b) and (d) $250 million and over Establish and document access to at least one contingent federal liquidity source in accordance with (c) Conduct advance planning and a test of contingent funding sources in accordance with (c)

35 Is capital still King? (An Emphatic) YES!! CAPITAL PLANNING 35

36 Risk Based Capital Rule Final Rule has not been issued Timeline for the Final Rule has not been communicated Can not speak directly to the Final Rule

37 Capital Positioning Capital and net worth must be commensurate with the risk and complexity of the balance sheet Complacency in capital planning is a non option Consider institution, market and event risks Consider a combination of an institution, market and event risks happening during the same time frame

38 Capital Stress Testing Attempt to identify all risks that can impact the capital position The seven areas of risk reviewed by NCUA hold a symbiotic relationship Complete capital stress tests regularly Use the results of capital stress testing to honestly evaluate and challenge policy risk tolerance thresholds

39 Recap Introduction Interest Rate Risk Liquidity Risk Capital Planning 39

40 Q&A S AND DISCUSSION 40

41 References Interest Rate Risk CFR 741, Interest Rate Risk Policy and Program 2. Letter to Credit Unions 12 CU 05, Interest Rate Risk Policy and Program Requirements 3. Letter to Credit Unions 12 CU 11, Interest Rate Risk Policy and Program Requirements Frequently Asked Questions 4. Letter to Credit Unions 10 CU 06, Interagency Advisory on Interest Rate Risk Management 5. Letter to Credit Unions 03 CU 15, Real Estate Concentrations and Interest Rate Risk Management for Credit Unions with Large Positions in Fixed Rate Mortgage Portfolios 6. Letter to Credit Unions 03 CU 11, Non Maturity Shares and Balance Sheet Risk 7. Letter to Credit Unions 99 CU 12, Real Estate Lending and Balance Sheet Risk Management 41

42 References Liquidity Risk 1. Letter to Credit Unions 14 CU 05, Liquidity Requirements Take Effect March Supervisory Letter 14 03, Liquidity and Contingency Funding Plans 3. Letter to Credit Unions 13 CU 10, Guidance on How to Comply with NCUA Regulation Liquidity and Contingency Funding Plans Derivatives CFR 703, Investment and Deposit Activities, Subpart B Derivatives Authority 42

43 Contact Page Feel free to contact RCMS Peter Jensen with questions or comments about this presentation. Peter Jensen Regional Capital Markets Specialist NCUA, Region 4, Division of Special Actions (703) Phone (703) Cell (703) Fax ALM A Discussion 43