CU Risks Today: What is NCUA Looking at?

1. Melinda Love, Director NCUA, Office of Examination and Insurance CU Risks Today:What is NCUA Looking at?

2. I.Causes of Failures II. Measure, Monitor, Control III. Progressive Enforcement IV. On the Horizon V.Questions Contents

3. Contents I.Causes of Failures

4. Loss Reviews – Purpose • Determine the types of problems causing losses to the NCUSIF; • Learn how to better identify and address problems BEFORE they result in a loss; • Assess strengths and weaknesses of various risk management policies and programs; and • Translate the review into recommendations to improve our systems and training.

5. Loss Reviews – Thresholds • Background • OIG Threshold • Losses > $25 million and 10% of credit union assets • E&I Threshold • Losses between $2 million and $25 million • Region Threshold • Losses < $2 million

6. Aggregate Reserve and Loss Statistics

7. Average Assets of Failed CUs and Loss Statistics

8. Loss Review Statistics17 Postmortems & 10 MLRsMay 2004- April 2010

9. Loss Review Statistics Average Loss to Asset Size = 18.77%

10. Why They Failed #1 Reason for Credit Union Failures Ineffective Risk Management

11. Why They Failed Two primary categories for failures • Inappropriate or no internal controls - fraud • Ineffective or unwilling management

12. Why They Failed

13. Fraud Failure Statistics 13 Fraud Related Failures

14. Fraud Losses – Common Traits

15. Fraud LossesWhat is NCUA doing differently? • Handle concerns with an inactive Supervisory Committee and lack of internal controls promptly • Don’t excuse away “red flags” • Review AIRES share and loan downloads and review standard queries toward detecting fraud

16. Queries You May Want to Run • Accrued Interest Greater Than Payment • Paid Ahead Loans • Delinquency Progression • Zero Delinquency • Inverted Delinquency • Volume of Loans Granted • Refinancing • New Loans For Delinquent Loan Payments • Trace Payments on Delinquent Loans

17. Loan Concentrations • Loans to One Member • Loans to the Same Address • Loans Compared to Shares • Loan Balances Over Time

18. Loan Concentrations

19. Are Your RatiosToo Good to Be True? • Return on Assets double peer results • No delinquency, despite explosive loan growth • Large cash balance in relation to assets • Cost of Funds double actual dividend rates • Very high percentage of new loans granted

20. Ineffective Risk Management

21. Poor Strategic Planning • Limited strategy • Limited planning • Limited infrastructure

22. Poor Strategic Planning • Poor policies • Poor procedures • No brakes Poor due diligence over 3rd party vendors

23. Poor Strategic Planning • No net worth limits • No risk managementprocesses

24. Poor Strategic Planning • Borrowed funds • Non-member deposits

25. Poor Strategic Planning • Increasing losses • PLL expense • High Cost of Funds

26. Concentration Risk

27. What Will Examiners Do? • Review new and rapidly growing programs - CATCH IT EARLY!! • Require credit unions to establish appropriate risk management processes and risk limits prior to implementing new programs. • Remind credit unions to perform due diligence on the 3rd party vendors before & ongoing. • Require credit unions to establish interim benchmarks to review and if necessary retool their programs.

28. What Can We Do? USE ALL THE TOOLS

29. Contents II.Measure, Monitor, Control

30. Examination & Monitoring Off-site Monitoring Examination Scope Examination Report On-site Examination Examination Process 2011/2012 Outlook - Complex But Workable Jobs Market Unemployment key indicator for credit union delinquency Real Estate Values Heavy real estate concentration makes credit unions vulnerable to dips • Allocation of resources • Focus of Examination • Analysis of 5300 Data • Economic changes CAMEL • Management Results • Risk management • Administrative Record • Follow-up

31. Labor Market Contraction • Striking geography of state unemployment rates… National: 9.0% Region I Rates: • NV: 12.5% (2nd highest in the nation) • RI: 10.9% (4th) • MI: 10.2% (7th) • VT: 5.3% (48th) • NH: 4.9% (49th)

32. Housing Price Collapse • Regional distribution of losses… • U.S.: -15.2% RI Declines: • NV: -50.8% (largest in the nation) • MI: -21.1% (9th) • RI: -15.0% (14th) • NH: -13.0 (17th) • ME: -5.3% (37th) • NY: -5.3%: (38th)

33. Mortgage Delinquency • Geography of mortgage delinquency and foreclosure (all institutions). • U.S.: 8.1% R I Rates: • NV: 16.0% (2nd highest in the nation) • NY: 9.1% (5th) • RI: 8.4% (9th) • ME: 8.3% (12th) • NH: 5.2% (34th) • VT: 5.1% (35th)

34. Mortgage Delinquency • Geography of mortgage delinquency and foreclosure (credit unions). • U.S.: 2.3% • R I States: • NV: 6.85% (3rd highest in the nation) • MI: 2.19% (14th) • MA: 1.96% (16th) • NY: 1.57% (25th) • VT: 1.09% (40th) • NH: 0.91% (48th)

35. NCUA Heightened Concern Areas • Increasing delinquency and loan losses • Cut-throat pricing in some locations Indirect Lending • 20 to 22% recidivism rates , shadow foreclosure market • Extend & pretend mindset of some Real Estate Loan Modifications • Mostly MBL participations viewed as investments • Increasing delinquency and losses Participations Member Business Loans • Highest growth area of balance sheets • Increasing delinquency and losses Interest Rate Risk • Increasing proportion of loan portfolio in fixed rate firsts • Historically low mortgage rates during growth period

36. Indirect Lending Measure & Monitor ALLL Treatment Internal Controls • Vendor • Volume of new • Delinquency & losses • First pmt defaults • Financial condition • Pricing data • Loan Officers • Volume by dealer • Delinquency & losses • Collectors • Volume of actions • Recoveries • Repo orders • Re-aging of accounts • AB 06-1, Dec 2006 • Portfolio Segmentation • Grading system • Losses by grade • ALLL funding by grade • Dealers • Financial condition • Environmental factor • FICO Migration • Re-grading paper • Calculate new loss levels • Vendor program controls • Portfolio segmentation • Who owns what • Collection programs • FICO migration • Asset disposal

37. Housing Market

38. Real Estate Loan Modifications Measure & Monitor ALLL Treatment Internal Controls • Policy articulates • Limits for portfolio segments & approvals • Waterfall approach to offers • Performance Tracking • Recidivism rates • Early actions • FICO migration • LTV changes • Portfolio segments • Waterfall segments • Volume of new • Delinquency & losses • First pmt defaults • Loan Officers • Volume by segment • Delinquency & losses • Collectors • Volume of actions • Recoveries • Foreclosures • CLTV over time • FICO change over time • TDRs • AB 06-1, Dec 2006 • Portfolio segmentation • Losses by segment • ALLL funding by segment • Waterfall segmentation • Losses by segment • ALLL funding by segment • FICO & CLTV migration • Correlate changes in both • ALLL funding for higher risk combos

39. Member Business Loans Measure & Monitor ALLL Treatment Internal Controls • Portfolio segments • Volume of new • Delinquency & losses • Financial condition • CRE values • Risk ratings • Loan Officers • Volume by segment • Delinquency & losses • Collectors • Volume of actions • Recoveries • C&D • Draws • Inspections • Slow growth rate • Policy • Segment limits • Approval limits • Experience • Underwriting analysis • Internal review • Third party review • Servicing program • Periodic analysis • C&D requirements • Risk rating system • Asset disposal • AB 06-1, Dec 2006 • Old FAS 114 • Impaired? • NPV, FV, or MV • Portfolio segmentation • Grading system • Losses by grade • ALLL funding by grade • Concentrations/large loans • Financial condition • Environmental factor • CRE value changes • Re-grading paper • Calculate new loss levels

40. Participations - Purchaser Measure & Monitor ALLL Treatment Internal Controls • Vendor program controls • Understand counterparties’ agendas • Policy limits • Underwrite the loan • Who owns what • Follow the contract • Collection programs • Asset disposal • AB 06-1, Dec 2006 • Portfolio segmentation • Grading system • Losses by grade • ALLL funding by grade • Vendors • Financial condition • Environmental factor • Changes over time • Re-grading paper • Vendor • Volume of new • Delinquency & losses • Financial condition • Official Approving • Volume • Delinquency & losses • Vendor Collectors • Actions per contract • Recoveries • Re-aging of accounts

41. Interest Rate Risk Exposure FICU exposure to interest-rate shocks has risen – absolutely and relative to banks.

42. Interest Rate Risk Measure & Monitor Capital Treatment Internal Controls • Assets • Fixed rates volume • Prepayment speeds • Variable rate sensitivity • Investment optionality • Liabilities • Rate sensitive deposits • NMS actions • General market conditions • Rate changes • Sensitivity to change • Net economic value • Net economic value • Sufficient capital to maintain positive NEV • Income matching • Cover non income producing assets • Modeling policies • Model assumptions • Quality • Actually used • Modeling accuracy • Action based on results • Exit strategy

43. ALLL Trending, Provisioning, C/Os • Funding the ALLL is a subject of recurrent interest to CUs and examiners alike. • Provisioning is especially relevant in the current environment as credit unions are challenged to maintain positive spread.

45. Provisioning Challenges • Pool segmentation is too broad and more segmentation should be done to improve provisioning accuracy, (e.g., new auto vs. used auto, direct vs. indirect, credit scores, type of collateral, credit risk grade, etc.) • CUs tend to apply an historical C/O percentage to the O/S pool balance and stop the methodology there without considering relevant, current Q&E factors. • Credit unions need to consider how the current environment compares to the period over which the historical loss percentage was calculated and adjust their provisioning outcome accordingly.

46. Provisioning Challenges • CU systems do not flag TDR • Provisioning for TDR modifications falls within the scope of FAS 114 rather than FAS 5 with methodology, funding, and documentation implications. • If a loan is evaluated for impairment under FAS 114 and found not to be impaired, CUs tend to end their analysis there with the result of underfunding their ALLL. Such loans should be reevaluated in a FAS 5 pool and provisioned accordingly. • When applying the three impairment measures under FAS 114: • if a credit union is depending on an income stream for repayment, they should use the PV of expected future cash flows; • if the CU is depending on sale of the collateral, they should use the fair value of the collateral less cost to sell.

47. Charge-Off Policies • Not prudent to wait until the last dollar becomes uncollectible before charging-off an outstanding loan balance. • When an asset, or portion thereof, is considered uncollectible, and of such little value that its continuance on the books is not warranted, it should be charged-off. • This does not mean that the asset has absolutely no recovery or salvage value; rather, it is not practical or desirable to defer writing off an essentially worthless asset (or portion thereof), even though partial recovery may occur in the future

48. Contents III.Progressive Enforcement

49. Administrative Record Steps Civil Money Penalties Letter of Understanding LIQUIDATION Removal Prohibition Cease & Desist PCA Document of Resolution Preliminary Warning Letter Conservatorship

50. Contents IV.On The Horizon