Continued from: June 2005 Consulting Services Div. Newsletter

Topics:

1. NCUA Federal Regulators Issue Credit Risk Management Guidance for HELOCs
2. Corporate Governance and Auditing a Hot Topic with NCUA
3. NCUA Chairman Urges Credit Unions to Manage Risk in Today’s Growing Economy (excerpts from NCUA News Release, May 20, 2005)
   

NCUA Federal Regulators Issue Credit Risk Management Guidance for HELOCs

Home equity lines have become increasingly attractive to members as home values continue to rise and interest rates remain low. Their continuing popularity has raised some red flags, however, with some regulatory agencies causing NCUA, among other agencies, to issue guidance on sound risk management practices for home equity lines of credit and loans…

In some cases, credit unions credit risk management practices for home equity lending has not kept pace with the loan product’s growth and continuing eased underwriting standards. Currently, delinquency and loss rates on home equity related products have been low, due in some part to lower tailored repayment requirements and relaxed structures of home equity lending.

• Several aspects of home equity related lending have caused concern among the NCUA regulators. Along with vulnerability to interest rate increases, some the risk factors causing concern include:
  Interest-only features that require no amortization of principal for a protracted period;
• Limited or no documentation of a borrower’s assets, employment and income;
• Higher loan-to-value (LTV) and debt-to-income rations;
• Lower credit risk scores for underwriting home equity loans;
• Greater use of automated valuation models and other collateral evaluation tools for the development of appraisals and evaluations; and
• An increased number of transactions generated through a loan broker or other third party.

To assist credit unions in ensuring they conduct home equity lending in a safe and sound manner with appropriate risk management systems, NCUA has released Letter to Credit Unions 05-CU-07. This Letter outlines the agency’s expectations for sound underwriting standards and effective credit risk management practices as it related to home equity lending.

Corporate Governance and Auditing a Hot Topic with NCUA

Although the Sarbanes-Oxley Act does not specifically apply to federally-chartered credit unions, NCUA Chairman JoAnn Johnson indicates that credit unions should consider certain provisions of the Act that relate to accounting, auditor interdependence, corporate responsibility and enhanced financial disclosures. NCUA has prepared several Letters to Credit Unions outlining NCUA’s selected aspects of the ACT that NCUA feels are important to credit unions…….

The Sarbanes-Oxley Act was enacted as a result of several notorious corporate fiscal accounting fiascos including Enron and MCI. The Sarbanes-Oxley Act was signed into law on 30th July 2002, and introduced highly significant legislative changes to financial practice and corporate governance regulation. It introduced stringent new rules with the stated objective: "to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws". In a sense, it is a credit union’s obligation to ensure that all “investors” in the credit union—each and every member—are provided assurance that their board of directors and management team are complying with their fiduciary responsibility to protect the credit union.

In a recent presentation to the Credit Union Executives Society’s Public Policy Institute, NCUA Board Chairman Johnson stated that as “credit unions grow and diversify their operations, governance will continue to emerge as a significant issue for credit union board of directors and management.” She also noted that “it is vital that boards of directors are fully aware of their responsibilities, and likewise, management should maintain operating policies and practices that are fully in compliance with regulations and the Federal Credit Union Act.” Chairman Johnson further emphasized that the Sarbanes-Oxley Act is not only about practices to comply with the law, but a continuous process to maintain consistent safety and soundness of the member-owned institutions.”

NCUA has prepared a Letter to Credit Unions that outlines selected provisions of the Sarbanes-Oxley Act of 2002 and related sound corporate governance practices for federal credit unions. A copy of Letter to Federal Credit Unions 03-FCU-07 can be found at the following link.
http://www.ncua.gov/letters/2005/FCU/05-FCU-01.pdf

NCUA Chairman Urges Credit Unions to Manage Risk in Today’s Growing Economy (excerpts from NCUA News Release, May 20, 2005)

At Southeast Corporate FCU’s recent Annual Meeting, NCUA Board Chairman Joann Johnson indicated that NCUA has identified four economic fundamentals which they feel are the most important to credit unions at this point in time. In turn, these fundamentals will be discussed with credit union managers during examinations with regards to the potential impacts on the credit union.

Ms. Johnson indicated that the country’s economic condition will require credit unions to more actively monitor the risks ahead. Chairman Johnson noted that NCUA’s capital markets and examination and insurance teams continuously watch and analyze economic developments to ensure that the agency is enabling credit unions to take advantage of presented opportunities but in a safe and prudent fashion. Economic conditions are an important part in determining the environment in which credit unions operate, with this being especially important in light of the current interest rate environment. Since June 2004, the Federal Reserve Open Market Committee has raised the Fed Funds Target 200 basis points to its current level of 3.00 percent.

The four fundamentals that NCUA has identified as being of top importance to credit unions at this time include interest rates, inflation, consumer spending and employment. Of these four, interest rates and inflation can present special concerns to credit unions.

• Increasing interest rates can negatively impact credit union’s interest margins, liquidity and credit quality of their members, potentially creating an earnings squeeze. Rising rates can also negatively impact mortgage demand, changing a composition of credit unions’ loan portfolios. With both short and long term interest rates expected to increase this year, NCUA examiners are paying special attention to the position of credit union balance sheets.
  
  
• Inflation is on the rise. A potential increase in inflation can also lead to more of an increase in interest rates, exacerbating the above impacts.
  
  
• Consumer spending is another indicator NCUA is watching. It represents 70 percent of economic activity and as such is very important; and
  
  
• Employment growth has been improving and will be very important going forward as the economy will need jobs and income growth to support consumer spending. It also has a major impact on confidence and households’ ability to borrow and service their debt.

Chairman Johnson also stated NCUA also provides its examiners “with knowledge on current economic conditions in their regions to enable them to make more informed decisions and discuss with credit union managers the potential impacts of the changing conditions.” She also noted that NCUA constantly “recognizes the implications of economic, as well as other developments, to determine potential impacts on credit unions’ operations, loan and membership growth and decision making ability.” She re-emphasized that NCUA’s role “as a regulator is to help ensure a safe and sound operating environment exists for credit unions to compete and prosper.”

If you have any questions about this Letter to Federal Credit Unions or concerning credit union board of directors and management responsibilities, please contact Southeast Corporate's Consulting Services Division at 1-866-829-7528, extension 371.