Revised Interest Rate Risk Supervision Effective 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 Risk 2. Earnings at Risk 3. Stress Testing 4. Measurement Systems 5. Risk Management 6. Overall IRR Rating 7. NEV Supervisory Test 8. Category Matrix
2. Updated IRR tolerance thresholds in the NEV Supervisory Test NEV Supervisory Test is a capital-at-risk measurement, used to evaluate a credit union s balance sheet in a interest rate shock scenario 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)
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.
Reasonable and Supported Results Overall Tab A: Market Risk 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.
Assumptions Tab A: Market Risk Cash Flows - Need to adjust based on embedded options and expedited cash flows Duration (not required) - Asset sensitivity should match duration; i.e. longer the duration, 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. Unitus Results Base NEV Shock 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% Most Variances should be attributed to 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)
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 Testing Additional 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 Systems Examination 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 Management Review 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