NCUA Rule Part 741.3(b)(5)

NCUA Rule Part 741.3(b)(5) NAFCU Webcast, Thursday May 24, 2pm EDT 1 of 36

Subjects: 1. Why did NCUA approve an Interest Rate Risk (IRR) Rule? 2. Which credit unions are covered by the Rule? 3. What does the Rule require my credit union to do? 4. How does the Guidance of the Rule help credit Unions to meet the Requirement? 5. What steps will NCUA take to implement the Rule? EFFECTIVE DATE: September 30, 2012 2 of 36

Reasons for the IRR Rule 3 of 36

IRR is a core risk for all credit unions, like those present in lending and investments. For this reason, NCUA applies the Rule to federal and state chartered CUs as a requirement for insurance. The purpose of the rule is to ensure credit unions have a written policy and manage IRR effectively, not to use IRR concerns as cause to revoke insurance. 4 of 36

The purpose of the rule is to elevate the need for written IRR policy and effective IRR management programs for safety and soundness. CUs should utilize policies and programs to inform decision-making. The Appendix to the Rule provides comprehensive guidance for CUs to consider while taking their size, complexity and risk exposure into account. 5 of 36

The guidance of the Rule addresses implementation of IRR policy and program as opposed to specific areas of risk covered by previous Letters to CUs. Purpose of the guidance is to avoid subjective standards. It is not a checklist of mandatory items. Present balance sheet compositions and rate environment pose significant risks to CUs from rising interest rates when these occur in future. 6 of 36

Inflation & Interest Rates1960-2011 7 of 36

Current and Average Yield Curve 8 of 36

RE Loans to Total Assets 9 of 36

Application of the Rule 10 of 36

The IRR rule use a ratio to segregate credit unions with assets $10-50 million. This is called the SIRRT ratio: Total first mortgages held + Total Investments with Maturities > 5 years Total Net Worth Call Report Account Account Number Total first mortgages loans 703 Total investments >5-10 years Total investments > 10 years 799C2 799D Total net worth 997 11 of 36

The trend of aggregate SIRRT exposure also shows the increase in IRR at FICUs since 2005 12 of 36

The SIRRT ratio reduces regulatory burden while effectively covering credit union assets ONLY applies to FICU s $10-50 million in total assets The ratio relates sources of risk directly to the reserve against risk the net worth of the credit union The ratio uses existing call report information and does not require additional reporting 13 of 36

The rule applies to all federally insured credit unions (FICUs) as follows All FICUs with total assets > $50 million on the FICU s last Call Report. Any FICU with total assets $10 million up to $50 million if: Total First Mortgage Loans Held + Total Investments with maturities > 5 years/net Worth (SIRRT ratio) 100%. The Rule does not apply to a FICU with total assets $10 million up to $50 million if the FICU s SIRRT ratio is < 100%. The Rule does not apply to FICUs with total assets < $10 million. 14 of 36

SIRRT ratio at FICUs after separation by SIRRT 15 of 36

Number of FICUs Covered/Not Covered by IRR Rule 16 of 36

FICU Assets Covered/Not Covered by IRR Rule 17 of 36

Rule Requirement 18 of 36

For FICUs to which the Rule applies, the FICU must have: A written interest rate risk policy and an effective interest rate risk management program as part of asset liability management. This is the sole requirement of the Rule. The rule text is available on the agency website at the following address: http://www.ncua.gov/legal/documents/regulations/fir20120126interestrateriskprog.pdf 19 of 36

Assistance on an IRR Policy and Management Program 20 of 36

Policies and programs should be commensurate with FICU size, complexity, and risk exposure. FICUs need to have IRR policies and programs that reflect their own business objectives. IRR programs are effective when they identify, measure, monitor and control IRR. FICUs can then incorporate IRR in their own decision-making process. 21 of 36

I. Direct the CU s actions to manage IRR. II. State reporting frequency. III. Identify responsible parties. IV. Set IRR limits. V. Choose IRR tests. VI. Review IRR changes periodically. VII. Assess impact of new business. VIII.Re-evaluate policy at least annually. 22 of 36

Sound policy should establish who is responsible for IRR and designate appropriate authorities. The board of directors should review and understand the level and nature of a FICU s IRR. The role of management is to be responsible for the daily activities and operations in order to implement the board s policy. Management should allocate sufficient resources, and develop IRR programs with competent staff to evaluate and understand IRR exposures. 23 of 36

Policy establishes what is to be reported. Information should be timely and sufficiently detailed. FICU should set limits based on selected measures appropriate to FICU and the nature of its business e.g. changes in gap, asset valuation, net interest income, net economic value. Policy should specify IRR tests e.g. shocks. The FICU can then review changes in IRR and assess the impact of any new business. Annual review of policy by the board. 24 of 36

IRR policy establishes when: Reporting to the board of IRR exposure is required Review of exceptions to IRR limits will take place The impact of new business is assessed (ongoing). IRR policy is to provide for periodic review of interest rate risk management, limits, and effectiveness, at least annually. Policy may also be re-evaluated whenever conditions affecting the FICU materially change. 25 of 36

An effective IRR program enables a credit union to master the four aspects of IRR management: Identify IRR - What is the risk and where is it coming from? Measure IRR - How much risk and what impact? Monitor IRR Changes in risk, trends and significance? Control IRR - How to manage and mitigate risk? The program incorporates this information and utilizes it in management of the credit union. 26 of 36

Oversight and Management Board and Senior Management IRR Measurement and Monitoring Systems, Methods and Components Internal Controls Decision-Making Additional Guidance for large or complex FICUs 27 of 36

IRR Measurement Systems should: Rely on reasonable and supportable assumptions Document changes in results Identify uncertain cash flows. Methods should be sufficiently rigorous to capture IRR. Components of IRR methods should: Disaggregate data, include all account attributes Make all assumptions explicit. Internal Control audit findings should be addressed and corrected. 28 of 36

Management should utilize the results of the credit union s IRR measurement systems in making operational decisions - such as changing balance sheet structure, funding, pricing strategies, and business planning. A FICU should take steps to mediate excessive exposures and bring these back within the FICU s risk tolerance. Management should use IRR results proactively to adjust assets and liabilities for changes in interest rates. 29 of 36

The rule provides guidelines to assist a FICU in determining the adequacy of its IRR policy and program. Additional guidance for large FICUs with complex or high risk balance sheets: Validation by outside parties Use of both net economic value and income simulation methods Impact analysis of changing assumptions Enhanced levels of separation between risk-taking and risk-assessment functions at the FICU. 30 of 36

Actions & Effective Date 31 of 36

Webinar for federal/state examiners (March) Capital Markets track at the National Conference (April) Letter to Credit Unions (April-May) Notice of the Rule Distribute IRR Questionnaire Webinar for Credit Unions (June) Frequently Asked Questions Call report and examination data support: FPR (1Q12) AIRES (2Q12). 32 of 36

IRR Questionnaire: Tested in regions 2011 Questionnaire no longer utilizes NCUA pricing tables. These continue to be available on the NCUA website. Part A - Minimum scope for FICU s not covered by Part 741 with low risk and complexity Part B - Scope determinant Part C - Oversight level review for FICU s covered by Part 741 that are lower in risk and complexity, or are not covered but are higher risk or complexity Part D - Extended review for FICU s covered by Part 741 with elevated risk or complexity Always examiner judgment to expand if needed. Questionnaire gives guidance on each section of the IRR Rule. Rule will be effective September 30, 2012. 33 of 36

Clarifications of the IRR rule? Expectations for implementation? Conversations with examiners? Any remedies of IRR issues? Questions are also encouraged for NCUA to address in a future webinar 34 of 36

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