The NCUA has provided credit unions a glimpse into their playbook for 2018 by recently releasing their Supervisory Priorities for the year. If you think of an NCUA exam like the classic Windows game Minesweeper, the Supervisory Priorities are akin to the NCUA “flagging” where a few of the bombs are located. It doesn’t guarantee that you will make it to the end of the exam without blowing-up, but considering NCUA guidance on landmine location will likely increase your chances.
Here are some of the topics of focus that most affect lending, and some thoughts on how you can prepare for the forewarned scrutiny:
Automobile sales have widely expanded since the recession ended, and 2017 was the 3rd year in a row where over 17 million cars were sold. Although the outlook for 2018 signals a slow-down in the industry, it remains that the growth of auto sales has corresponded with a growth in credit union balance sheets. Knowing this to be true, the NCUA has declared, again, that it will focus on the following aspects of auto loans:
• High Loan-to-Values (LTVs)
• Extended loan maturities (term lengths over 7 years)
• Subprime loans
• Indirect loans
From an examiner’s perspective, these aspects are hot-buttons because they each represents a source of growth in auto lending. Lenders (not just credit unions) have been more likely to offer products with longer term lengths and higher LTVs to grow their portfolio since the recovery started. In the current environment, extended term lengths exacerbate high LTV loans, and increase the magnitude of loss on defaults because, in many cases, collateral deterioration is outpacing loan amortization. However, the presence of extended terms and high LTVs don’t necessarily correspond to an increased level of default risk. If longer term lengths are part of your auto lending strategy, build your case using FICO rescoring and migration to show that credit risk hasn’t necessarily increased with collateral risk.
In your subprime paper, it is incumbent upon the credit union to construct the auto portfolio where these loans are priced in a way that offsets increased credit risk. The loss rates in deep-FICO tiers may be greater than your prime members, but if priced correctly, higher net yield on such loans may provide justification.
Regarding indirect loans, it is always best practice to evaluate your dealers and assess their performance. This gives you something to show the regulators, and gives you a story to tell about how you plan to move forward with indirect lending.
Consistent with 2017, the NCUA will focus on institutional governance of commercial lending. The bulletin for 2018 includes reference to the Examiner’s Guide, and specifically mentioned focus on the credit union’s risk management processes. First, I recommend that someone at your credit union has read and understands the examiner’s guide. It is invaluable to have someone involved in the exam that speaks “Examiner”.
Taking a wider view, the NCUA is signaling that they are going to be interested in credit union underwriting and due diligence documentation – making sure practice matches policy and procedure. Also, the NCUA will likely be interested in ongoing risk management of Commercial loans after origination. This aims at what the credit union is doing to monitor and review collections, performance, profitability and concentration of their commercial portfolio. Risk management doesn’t stop upon origination – what you are doing to revisit credit quality ratings, monitor collateral, and analyze earnings-quality of the underlying business should be documented and available to the NCUA.
Interest Rate & Liquidity Risk
Another point of focus is the revised interest rate risk supervisory tool and examination procedures the NCUA will use to assess interest rate risk. The 2018 bulletin mentions that not all credit unions were evaluated with this tool in 2017, so be ready for it if you fall into that category. This is where having a map of where the landmines are located will help you, as the NCUA actually makes the workbook for the interest rate risk supervisory tool available here.
If I were at a credit union, it would be worthwhile to download the tool and at a minimum understand what inputs they will require, and probably go as far as populating as much of it as you can to produce sort of a “dry run” for what to expect from the NCUA. Proactively getting a feel for the results allows you to plan a response or action as the results warrant.
The keys to limiting the headache that accompanies an NCUA exam are (1) understanding what the NCUA will likely focus on (2) being a proactive participant in the exam process and (3) being an expert in your own data. This year, your exam will require having both a regulatory and analytical understanding of your auto portfolio, commercial lending, and capital risk.
By doing this, you will increase your odds of accomplishing something that I rarely have had the patience to do in Minesweeper – navigate all of the bombs without blowing-up.