Posts

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Bits And Bites For The Board

NCUA’s new rule on interest rate risk emphasizes board-approved policy and oversight by the board.  The board is also responsible for setting strategic direction.  With the speed of change the industry has experienced lately, keeping board members apprised of all that’s happening has become more challenging than ever.

Board meetings typically focus on the day-to-day business of the credit union and review of financial results with very little time spent looking forward or learning about industry issues.  Why not take a bit of each board meeting and purposefully devote some time to strategic issues and education?  While formal board education and planning sessions are crucial, regular discussion on these topics can help keep the board moving in the direction that NCUA requires.

Boards share the ultimate fiduciary responsibility for credit unions and equipping them with the tools they need to make informed decisions is critical.  It’s a little bit like sneaking vegetables into the spaghetti sauce, but small, regular doses of education and strategy can go a long way toward healthy boards and credit unions.

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Have You Reviewed Your Policies Recently?

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Historically, credit unions may have been wary of making material changes to their policies, whether an A/LM policy, Liquidity policy, Investment policy or broader Financial Management policy – for fear of raising regulatory “red flags.”  However, with the adoption of the final rule on interest rate risk (§741.3(b)(5)(i)), and the effective implementation date of September 30, 2012, many credit unions are finding this a great time to revisit their policies.  While reviewing policy, some key questions must be asked:

  • How does the policy help promote safety and soundness, while also reflecting the risk appetite of the credit union’s board and senior management?
  • Have there been situations in recent history where policy limits or guidelines have “tied hands” with respect to making sound business decisions?
  • Conversely, are there limits or guidelines in policy that have aided in the decision-making process, potentially saving the credit union from less than favorable outcomes?
  • How can we effectively construct policy limits and/or guidelines to both satisfy regulatory requirements and aid in the decision-making process of the board and senior management?

With heightened industry awareness surrounding interest rate risk, and increasing regulatory pressure to mitigate the risk being taken by some credit unions today, would it possibly raise more regulatory “red flags” if a credit union did not revisit relevant policies prior to the September 30 implementation date?  A good policy has limits and guidelines intended to promote risk management and safety and soundness.  A great policy has limits and guidelines intended to promote risk management and safety and soundness, but most importantly, provisions that drive dialogue to aid in the decision-making process.  While revisiting policy this year, the above questions will help take your existing policy from “good” to great.

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Setting Board Expectations

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Setting board expectations has always been key.  However, it is increasingly important as many credit unions are seeing their ROA jump—largely due to falling provision ratios.  Over the last two years, the industry average PLL has declined from its peak of just over 1% in 2009 to about 0.50% as of the first quarter in 2011 (see graph A below, Source NCUA, FDIC).  The decrease in PLL has been the single biggest reason that the industry average ROA has increased since its low in 2009 (see graph B).

While this has been great for the industry, the question is, how sustainable is the decline in PLL? In many cases, the decline is not sustainable as credit unions are running a provision that is below “normal” levels or reversing accruals to ALLL that they believe to be excessive (see post Planning for PLL).  This means the current ROA is temporary, as it will decrease once the provision returns to normal levels.

Management teams need to communicate this to their board and set the expectation that their financial position will be different going forward.  This will help prevent misunderstanding between the board and management and ensure that the two groups continue to work together to position their institution to be stronger in the future.

Table A:


Table B:


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Budgeting During Times Of “Unusual Uncertainty”

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Creating a budget is always a challenging and uncertain process.  Developing the annual budget for 2011 may be unusually difficult as there is heightened uncertainty about loan demand, interest rates, investment yields and deposit trends.  Net operating expense concerns include share insurance assessments, threats to non-interest income and provision for loan loss trends—stable, declining, or, for some institutions, still increasing.

Due to this uncertain economic environment, credit unions should consider developing a base budget and then creating multiple scenarios identifying key vulnerabilities that could stress financial performance, such as:

  • What if loan demand continues to be anemic?
  • What if provision for loan loss increases unexpectedly?
  • What if mortgage originations decline materially?
  • What if cost of funds cannot be lowered enough to help offset other adverse scenarios?

Evaluating combinations of negative factors, while depressing, can provide valuable early warning information to management and the credit union’s board.  This process can also help manage key players’ expectations appropriately.

If the base budget is acceptable but there are several plausible scenarios that could create unsatisfactory financial performance, it is good to know this in advance so that decision-makers can begin to think about contingency plans.  This is particularly relevant if the credit union has a level of net worth with very little breathing room.

Identifying the potential problems early on will give your credit union a better chance at making 2011 a financially successful year.  Good luck!