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Comments on NCUA Concentration Limits Supervisory Letter

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We have received many calls on the NCUA Concentration Limits Supervisory Letter.  Credit unions are asking us what limits will satisfy NCUA or if there are any standard limits.

The answer is:  there is no standard answer.  This was stated by NCUA in conversation along with NCUA’s statement, there is no magic formula, during a webinar hosted by NAFCU on June 2, 2010.

Before establishing concentration limits for policy, we think there are several key questions that need to be considered.  Following are just a few:

  • What types of concentration limits are appropriate for our credit union?
  • Should we focus on classes or concentrations within classes?  If concentrations within classes, how much should we drill down?
  • How will the newly established limits impact our strategic plans, business decisions, earnings and competitive stance?  Test drive potential scenarios and business decisions your credit union may want to make to see the potential downside of proposed limits.  Keep in mind that the supervisory letter is not limiting the discussion to assets.
  • What is our rationale for determining concentration limits?  If we are experiencing unacceptable losses with our current concentrations, will we set concentration limits lower than our current levels?
  • How will we respond if we reach a designated limit?  Will we shut down our program?  Will we sell existing holdings to make room for new business?
  • Will these new limits prevent our credit union from taking too much risk, or will they result in unintended consequences of taking more risk?  For example, if you reach your limit on typical products, will you begin adding products where there is limited expertise in order to increase earnings?
  • Do absolute levels of concentration cause too much risk?  Or, is it the rate of growth in a particular concentration?  Or, is it the rate of growth in concentration during an economic boom?
  • How will we aggregate multiple limits to ensure we are not missing the big picture?

Because this decision will directly impact strategy, business decisions, day-to-day operations as well as competitive stance, we encourage decision makers to think through what is best for their credit union rather than take the easier route of using generic limits.

Keep in mind that that in the supervisory letter, NCUA states, “A material red flag is a credit union that simply raises the established limit when it is reached without advanced analysis supporting the rationale for the change in policy.”

If you would like help thinking through what would be best for your credit union, please contact us.

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Are Your Members Sending You A Signal?

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According to NCUA’s first quarter data, shares grew an average of almost 11% (annualized) while loan growth declined 4.76% (annualized)─over a 15% differential.  Funds not loaned out are sitting in investments (generally not earning very much) and are putting a squeeze on the margin.  With loan demand down, many of our clients are requesting what-if scenarios on purchasing longer-term investments with these “excess funds” to pick up a little extra yield.

While running what-if scenarios on the asset side of the balance sheet is a good idea, don’t forget the other half of the equation.  Another common theme we are seeing is an increase in non-maturity shares and a decrease in CDs.  This certainly takes some pressure off the cost of funds today, but it could be costly to mistake a potentially short-term member adjustment to current market conditions for a long-term trend.

At many places today, the rate differential between a money market and a CD is not that big—so it seems that members are willing to give up a few basis points.  But for what? Are your members sending you a signal that they are positioning themselves to move to the stock market as soon as “things turn around?”  Or back to CDs when rates tick up some?  We recommend that you test out these potential scenarios, and more, to help you get a better handle on how things could possibly play out in the future.

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Conservatorship of U.S. Central and WesCorp

Reading NCUA Letter 09-CU-06 was difficult.  However, since our founding in 1991, we have encouraged our clients to always consider Event Risk Conditions.  Most would agree that we are in such conditions!  Since the publication of NCUA Letter 09-CU-02 in January, we have encouraged our clients to consider the likelihood of additional assessments.  Following 09-CU-06, we continue that encouragement.

In light of 09-CU-06, here are some questions NPCUs should consider asking about Corporate Stabilization:

  • What would the cost to NPCUs be if additional corporates are put into conservatorship?
  • What would be the cost if a greater number of NPCUs fail over the next couple of years?
  • What would be the cost of recapitalizing the corporate system?

We hope a couple of these questions can be answered during NCUA’s Webcast Monday, March 23.  While these are ominous questions, facing them head-on will help NPCUs to be much better prepared.

The following are questions we feel NPCUs should be asking related to their long-term strategic and financial objectives:

  • What are our longer-term liquidity options should existing options become limited? (Note: the FHLBs are experiencing financial difficulties)
  • Are our strategic initiatives still applicable, or do they need to be altered or postponed given the most recent assessment?  …If member capital needs to be written off?  …If there are additional assessments in 2009/2010?
  • Would we be willing to contribute financially to a corporate recapitalization effort? If so, how much?
  • How much additional member deposit growth could we absorb while continuing to maintain sufficient net worth?
  • What if we have unexpected losses from our own business model?  How would we react?

A few words of caution.  It is understandable to want to find ways to improve upon a dismal earnings forecast for 2009.  However, while understandable, it may add unacceptable risks to your financial structure.  We strongly urge all NPCUs not to make decisions based on only the short term.  For example, the 10-year Treasury Bill and 30-year mortgages are now at, or near, record lows; increasing yield with longer-term investments or by making more mortgage loans and holding them in portfolio can add interest rate risk.

We encourage NPCUs to test the financial consequences, in advance, of all proposed changes to their financial structure, especially increases in long-term fixed assets.  Additionally, reducing operating expenses judiciously is one thing, but slashing them outright can threaten core drivers of profitability once markets stabilize.  A core purpose of net worth, after all, is to sustain a credit union through Event Risk Conditions and other rough times.