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NCUA NEV Supervisory Test: Heads Up Now

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balance sheet

7 minute read –“Wait…What?  My balance sheet structure really hasn’t changed in the last few months, yet the NCUA NEV Supervisory Test now shows that we went from low/moderate risk to high risk, teetering on extreme.  Why is there such a dramatic shift in results?”  

This is an example of recent conversations with credit union CFOs and CEOs.  We are seeing this on a larger scale as well, our first glance at ALM results for March balance sheets* shows that on average the current NEV ratio (using NCUA deposit values) has declined roughly 1.60%, and the resulting NEV ratio in a shocked +300 is roughly 1.85% lower.   

Meanwhile, all the credit unions in this data set made money in the first quarter, adding to their dollars of net worth.   

Our recommendation to them is dig in right now and start messaging to other key stakeholders why there is such a dramatic difference in results.  

There are several points that should be included when messaging to key stakeholders to provide background, education, and knowledge.  The NEV Supervisory Test is a scoping tool to help examiners determine the scope of their exam.  If the results show extreme risk, it turns from a scoping tool into an action tool.  The NCUA will take action, refer to page 235 of this document to read more.  Your actions and ability to articulate your unique situation can heavily influence their actions.  

As a reminder, the Supervisory Test uses a combination of available information, credit union assumptions, and pre-set values to determine the economic value in the current and +300 bps environments.  More specifically, the Supervisory Test: 

  • For institutions with assets >$500M, uses discounted cashflows based on the credit union’s assumptions for loans and available information on investments to represent the current economic value of your assets.  Given where rates are today, many loan and investment portfolios show a value loss today.

Note: For institutions with assets <$500M, the Supervisory Test may assume current value of loans to be par, or use the credit union’s ALM modeling valuations if available and deemed to be reliable. 

  • Assigns a pre-set value for all your non-maturity deposits.  As a reminder, the pre-set values for NMS is 1% for the current rate environment and an additional 4% value in the +300 bps shock.

Caution:  Rates have increased, yet the NEV Supervisory Test still shows the pre-set value of NMS at 1%.  This means that in today’s higher rate environment, your NEV Supervisory Test takes the hit for asset values declining, but does not get the benefit that was applied to NMS as rates were increasing in previous Supervisory Tests.  Therefore, the starting point for the current NEV ratio is much lower in today’s higher rate environment than previous tests were showing.  This is surprising to many key stakeholders, so it’s a critical point to be messaged to and understood by key stakeholders. 

This also becomes a head scratcher for many when looking at the economic value of deposits in their non-Supervisory Test results.  One CFO summed it up when saying:  

“I don’t understand.  My average rate for my NMS has not changed.  It’s 18 bps, and 5-year borrowing rates are now over 3%, suggesting my deposits have more economic value, and yet the test does not give us any additional benefit for them.  I am confused.” 

It’s understandable that this is confusing.  Yet, the reality is that the NEV Supervisory Test is likely to get increased attention, so you need to be prepared.   

There are many ways to prepare:  

  • Understand the purpose and be able to clearly articulate why the ALM methodologies you use may show differing views as to the magnitude of risk, not to mention the direction.  For example – most often, static balance sheet analyses show no risk in a rising rate environment – as a matter of fact, for many institutions, earnings increase at a pretty decent clip, especially in later years of the analysis.  Read this if you need a review as to why this methodology would show this. 
  • Evaluate the profitability and potential exposure to net worth, keeping in mind that profitability and net worth can be very different than assumed value.  A business model and plan, both strategic and financial, that demonstrate strong earnings across a range of rates and uncertainty can provide valuable insights on potential actions to consider. 
  • Recognize that most actions to improve Supervisory Test results will cost earnings, net worth, or both, especially if long-term rates don’t increase more, or reverse direction and go back down.  Keep in mind that no one, not even the Fed, can accurately predict rates.  Remember, the Fed is trying to influence consumer and business behaviors to tame inflation while also not causing a recession.  Many are already bracing for a recession, which could cause rates to go back down, which can further exacerbate the cost of taking action today to address the Supervisory Test.  
  • Consider expanding your view of the Supervisory Test +400 bps/+500 bps to get an early warning if rates continue to go up.   
  • Collaborate with key stakeholders to reach consensus on the range of rates for which you want to prepare.  Remind them that there is not one right path.  Take the time to understand and discuss the implications of yield curve shifts.  Make sure to discuss timeframe as well.  

The one path

This conversation will help immensely in setting the foundation for decision-making and, ultimately, the financial levers you may want to pull.  To inform your discussions, use the quantification of your longer-term risks to earnings and net worth, with a focus on how much contribution you may need from your new decisions to offset risk and continue to add value to your members and business members.  Remember, they will need you to help them through these rough times. 

  • Run What-Ifs.  No doubt your conversations will result in numerous possibilities, so prioritize.  Run your options through your decision filters to help with prioritization.  Then what-if the highest priorities to understand the potential financial impact.  When you establish your decision filters, make sure to include discussing how to remain relevant to your members and your precious talent.   
  • Remember, most leaders and stakeholders have never faced the combination of external forces that are in play today.  Hunkering down in this environment may not be the best move as the world continues to change at warp speed.   

We realize there are many more considerations and questions than we have provided here.  Please feel free to call us if you would like to have a more in-depth discussion.  

*Results will change as more Balance Sheets come in. 

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Data Reveals Lost Revenue Opportunities

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data

5 minute read – One of our podcasts focuses on the importance of growing top-line revenue.  With so many competing priorities, strategic teams need to seek balance in the initiatives they take on to ensure that revenue growth initiatives receive high priority.

Revenue growth can be generated in many ways, but one source that has the potential to pay off quickly is growing loans by booking more of the opportunities you’re already getting.  Making changes that increase the number of funded applications can make a significant impact on revenue in the short and long term.

Incomplete and Abandoned Applications

Dive into your data to investigate the points in the application where people are quitting.  This can provide great insight into the sources of friction.  Some systems and vendors make it difficult to get this information, but it’s worthwhile to push for the data.

Armed with the quit points, go through the application process yourself with a critical eye and the mindset of someone who is not an expert in financial services.  Something that is even slightly confusing can cause online applicants to jump ship for one of the many other lenders at their fingertips.

Competitors have made applying for a loan incredibly easy, asking as little as possible of their customers.  People may quit if the application goes on too long, asking too many questions.  The mindset for digital applicants is very different from the in-person applicants of the past.  A series of questions that might have felt like a conversation in person can feel tiresome and intrusive when applying digitally.

Declined Applications

Approvals and declines must happen within the organization’s appetite for risk, but the data can point out inconsistencies and missed opportunities.  Look for differences where you would expect to find similarities.  Similar loan types for similar credit scores would typically result in similar approval ratios.  Look by channel (online versus contact center versus phone), underwriter, originator, and branch.

This organization needs to understand why Branch B declines 30% of vehicle applications with credit scores of 600-679, while Branch C only declines 18% (and funds a lot more of them).  They could start by slicing the data by originator and underwriter and using that as a springboard for deeper conversations to understand the differences.

Approved Applications That Don’t Fund

After you’ve gone through the effort to approve a loan, the payback doesn’t come unless the customer says yes.  Your data can tell you how often the effort is wasted.  It can also tell you how long different phases in the process are taking, how the trends vary for different loan types, and whether correlations can be made to branches, originators, channels, underwriters, or credit score.

As you dig in, you may find some of these common points of friction:

  • Too slow to give the customer a decision for processing and funding. It has become SO easy to apply somewhere else if things aren’t moving fast enough
  • Unclear next steps
  • Difficult process, too much documentation or paperwork
  • Left a voicemail, sent an email, or communicated in some other way that this consumer doesn’t prefer
  • Offer isn’t good – rate or amount
  • Product features are lacking

See our blog on using the power of “Why?” for more ideas on identifying potential issues and capturing some of the lost opportunities.

Fixing Hiccups

Taking action on your findings is often technically simple.  Some of the biggest impacts are the result of changing old business rules that have been carried forward and providing clear guidance on steps that are no longer required.  Improving even one or two friction points can pay big dividends into the future.  Plus, the effects are near-term and may produce additional benefits like greater efficiency and improving the customer and employee experience.

As you consider using resources to work through these issues, it helps to quantify the potential for increased revenue.  Once you know your baseline performance, you can do what-ifs on approving or funding more applications.  This institution is looking at direct vehicle loan applications.  By funding 5% more of the approved applications, they could book 9% more in loan balances in this category.

Booking more of the loan applications you already receive is just one way to grow your top-line revenue.  We haven’t even touched on the vast array of other possibilities.  Spend some time thinking about this as a team and utilize your data to help with the analysis.  With so much to do, make sure enough focus is devoted to growing top-line revenue.

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Stay Forward Thinking About IRR Shocks

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3 minute read – With the Federal Reserve using monetary policy and increasing rates to combat inflation, there will be different winners and losers.  Every financial institution has a unique exposure to rising interest rates.  Some financial structures will experience an increase in earnings from higher fed funds and prime rates while others could see earnings squeezed.  

Interest rate risk (IRR) analysis can help provide insights on the financial impact of increased rates.  However, it is important to remember that as the environment changes, if rates increase, the IRR shocks themselves start to go higher, which can mean more pressure for many decision-makers.    

For example, consider a traditional IRR test of a +300 basis point (bp) rate shock.  Over the past two years, short-term market interest rates have been close to 0%.  Since the onset of the pandemic, a +300 bp IRR shock increased short-term rates to roughly 3%.  But if some of the projections come true and short-term rates are 2% by year end, the same IRR shock of +300 bps now takes short-term rates to 5%.  Both tests are for a +300 bp shock in rates, but the pressure of short-term rates at 3% versus 5% can be vastly different.  

Notice the IRR shock results for Case A and B, two financial institutions with very different balance sheet structures.   

If they both had a policy limit of 5% EVE ratio and -40% volatility, both institutions would be within their policy limits if rates stay at current levels.  However, if rates continue to increase, and therefore the shocked environment increases, Case B would be out of policy.  

The Point at Which You Address a Problem… 

…is directly related to the number of viable options you will have to solve it.  This is one of the many truisms that our founder, Cliff Myers, instilled into our culture. 

This forward view helps decision makers get an early glimpse of what may happen and help reduce potential surprises.  While both institutions are currently within their policy limits, the leadership team at Case B should start discussions to evaluate whether they would like to take actions today to reduce their risk in higher rate environments.  If they would like to reduce their risk, the next step would be to evaluate the risk-return trade-offs of different options.  There are always trade-offs to different decisions, and evaluating this earlier can lead to an increase of viable options.

We also recommend exploring different twists in the yield curve when evaluating the potential impact of rate changes.  The current environment, along with some of the expectations of where rates may go, provide a reminder about the importance of testing twists in the yield curve.  Different shifts in short- and long-term rates when evaluating rate increases may reveal more or less sensitivity to the environment.  Seeing the impact of different yield curves should be incorporated in your frequent discussions about interest rate risk.   

For more food for thought, you can listen to c. myers live – An Insightful Conversation About Inflation

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c. myers live – An Insightful Conversation About Inflation

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Top of mind for many decision-makers is the topic of inflation.  While there is a lot of uncertainty around the topic, the key is in the discussion.  In this c. myers live, we dive into discussions your team can be having around inflation and its impact on the financial industry, and why it is important to plan for a range of outcomes.  

To read more about inflation and interest rate risk, check out this blog.

 

Rob Johnson

Rob, one of five c. myers owners, has a reputation for deep, original thinking on asset/liability management and every conceivable modeling methodology, as well as analysis of investments, liquidity, aggregate risk, concentration risk, and other related topics. While Rob is a familiar face to the managements and boards of many of the largest credit unions, he has helped credit unions of all sizes tackle some of their toughest challenges, such as rebuilding capital and navigating safely and soundly with the smallest of margins. He has become quite familiar to many leaders in the regulatory world, both as an educator and a thought leader.

Learn more about Rob

David Loftus

David LoftusSince Dave joined c. myers in 2005, he has become well-known and well-respected by scores of credit unions in every corner of the country. Dave has worked on many complex modeling and consulting projects that c. myers has undertaken – he is always looking for a challenge. He most enjoys facilitating sessions for management teams as they work to make tough financial decisions, while at the same time running “what-ifs,” real-time, to help inform decision-making.

Learn more about David

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Business Intelligence Strategy – Put the Horse Before the Cart

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5 minute read – There are almost as many strategic initiatives focused on business intelligence (BI) and data analytics as there are financial institutions.  The potential breadth and depth of BI is so large that creating clear objectives for BI initiatives is essential.  Yet, perhaps because it is so unwieldy, some organizations have bypassed getting clarity on the BI strategy and jumped into the “how” by focusing first on tools, data sources, and teams.

Putting strategy first in no way minimizes the critical nature of the tools, data sources, teams, etc. It is because it is such a heavy lift, and there are so many options, that the strategic reasons for taking on a BI initiative should be clear up front.  Without articulating what the organization hopes to accomplish and by when, the initiative runs the risk of being driven by inappropriate influences such as which tools are coolest, or which department has the most sway.  This top-down approach ensures that the organizational efforts align with strategy.

Start by asking what strategic outcomes are big and impactful enough to justify moving in this direction.  Think through what is driving the desire for better BI.  It must be grounded in the high-level strategy.

For example, consider two different organizations with two different strategies:

The very reason it’s so important to state the BI strategy is because most organizations want what both of the example organizations are great at, plus more.  And that may be possible, eventually, as BI often progresses in phases.  But prioritizing the key strategic outcomes at the outset provides guidance and a filter when necessary trade-offs must be made as the “how” gets underway.

One helpful exercise is to ask each leader or area to identify the 3 most impactful business opportunities to seize or problems to solve with better BI and have the leadership team discuss.  It’s also appropriate to have conversations around what will be useful beyond the 3, but focus on the most impactful at first.

Cultivating the BI culture and mindset.  First and foremost, don’t be handcuffed by the past.  Most have lived in a static data world where reports are pre-defined and it’s extremely difficult and unreliable at worst, or time-consuming at best, to get the desired BI.  Recognize that shifting away from the static data mindset amounts to asking leaders to think differently.  Begin by asking, What would you want to know in order to transform your part of the business?  Initially, don’t limit the thinking based on what you can get.  Just practice asking questions that push you to think about your business differently, like What do people who click on our prequalified credit card offers have in common? or What else can we see is happening before someone misses a loan payment?  To become an organization that takes optimal advantage of BI to run the business better and move the strategy forward, leaders first need to practice thinking outside of what they are used to getting.

Who will own and drive this important initiative?  It needs a dedicated owner, and that owner must recognize the pan-organizational nature of BI.  It often lands with IT because of the technology tools required, but business intelligence is everybody’s business.  Whether it’s IT, Marketing, or another area driving it, the entire leadership team must be engaged.  Relegating BI to a silo is not a recipe for success.

Don’t forget to circle back. Teams must consistently evaluate whether the BI strategy is yielding the desired “greatness” and success of the high-level strategy.  Regularly reassess and tweak as necessary.  If Organization #1 believes it has successfully fulfilled its BI strategy, they should ask themselves whether they are actually credit analysis, pricing, and collections ninjas, effectively helping people with dented credit get the money they need in a financially healthy way.  If the answer is no, it may be that the culture and mindset shift to fully utilize BI has not happened yet.  It will take leadership demonstrating time and time again how BI can and should be used before a successful shift can be made.

The success of any BI strategy requires a dizzying number of decisions and a complex array of technologies, data, people, and behaviors.  Start by defining the most impactful business opportunities and problems to address and articulate the strategic reasons that are driving your desire for better BI.  Clearly identifying the BI strategy sets the stage for success and guides the multitudes of decisions and activities to follow.