Transcript Loss Reviews – Lessons Learned

Melinda Love, Director
NCUA, Office of Examination and Insurance
I. Causes of Failures
II. Measure, Monitor, Control
III. Progressive Enforcement
IV. On the Horizon
V. Questions
2
I. Causes of Failures
3

Determine the types of problems causing
losses to the NCUSIF;

Learn how to better identify and address
problems BEFORE they result in a loss;

Assess strengths and weaknesses of various
risk management policies and programs; and

Translate the review into recommendations
to improve our systems and training.

Background
 OIG Threshold
▪ Losses > $25 million and 10% of credit union
assets
 E&I Threshold
▪ Losses between $2 million and $25 million
 Region Threshold
▪ Losses < $2 million
Year
FCU
#
Reserves
FISCU
Charges
#
Reserves
TOTAL FICU
Charges
#
Charges
2006 13 $
5,752,667 $
6,322,347
3
$
586,999 $
2007 7
6,735,820 $
5,500,505
5
$
40,299,319 $
2008 12 $ 27,839,552 $ 29,982,857
6
$ 219,441,223 $ 211,865,206 18 $ 247,280,775
2009 17 $ 95,055,707 $ 88,994,459
11 $
65,174,352 $
65,325,190
28 $ 160,230,059
$ 154,319,649
2010 21 $ 209,543,030 $ 209,314,444
7
44,805,537 $
13,958,602
28 $ 254,348,567
$ 223,273,046
Total 70 $ 344,926,776 $ 340,114,612
32 $ 370,307,430 $ 330,822,346 102 $ 715,234,206
$ 670,936,958
%
AVG
69%
$
48%
51%
$4,858,780
31%
$
52%
537,965 16 $
Reserves
39,135,383
6,339,666 $
6,860,312
12 $ 47,035,139 $
44,635,888
$ 241,848,063
49%
$10,338,198
$6,577,813
Year
FCU
#
2006
13
2007
7
2008
12
2009
2010
Total
FISCU
Average Assets
$
Average Assets
#
Average Assets
3
$
867,763
16
$
1,661,367
5
$
79,898,158
12
$
34,310,146
$ 12,862,764
6
$ 138,281,260
18
$
54,668,929
17
$ 49,457,502
11
$
184,911,630
28
$
102,671,624
21
$ 24,937,128
7
$
63,200,259
28
$
34,502,911
70
$ 22,214,570
32
$ 115,881,606
102 $
51,600,307
$
1,844,506
#
TOTAL FICU
1,747,281
Statistics
Number
Total Assets
Total Losses
Average Assets
Average Losses
P&A
Liquidation
Assisted
Merger
FCU
$
$
$
$
18
801,132,243
319,120,326
44,507,347
17,728,907
9
8
1
FISCU
9
$ 2,556,131,669
$
310,905,756
$ 284,014,630
$ 35,545,084
7
0
2
Total
27
$ 3,357,263,912
$ 630,026,082
$ 124,343,108
$ 23,334,299
16
8
3
8
Credit Union
Assets
Smallest Assets
$972,266
Largest Assets $1,623,575,224
Loss
% Loss to Assets
$3,690,194
$40,856,071
Average Loss to Asset Size = 18.77%
379.55%
2.52%
#1 Reason for Credit Union Failures
Ineffective Risk Management
Two primary categories for failures
 Inappropriate or no internal controls -
fraud
 Ineffective or unwilling management
13 Fraud Related Failures
Total Assets in
Fraud Failures
$ 330,263,481
Total Losses in
Fraud Failures
$ 252,641,813
Average Loss to
Assets
76.5%
CU
Weak SC
Limited
Staff
Records /
OOB
Audit or
Verification
Manipulated
Records
Trusted
Staff
A
X
X
X
X
X
X
B
X
X
X
X
X
X
C
X
X
X
X
X
X
D
X
X
X
X
X
E
X
X
X
X
X
X
F
X
X
X
X
X
G
X
X
X
H
X
X
X
I
X
J
X
X
K
X
X
L
X
X
M
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X

Handle concerns with an inactive
Supervisory Committee and lack of
internal controls promptly

Don’t excuse away “red flags”

Review AIRES share and loan downloads
and review standard queries toward
detecting fraud



Accrued Interest Greater Than Payment
Paid Ahead Loans
Delinquency Progression
 Zero Delinquency
 Inverted Delinquency

Volume of Loans Granted
 Refinancing
 New Loans For Delinquent Loan Payments
▪ Trace Payments on Delinquent Loans

Loans to One Member

Loans to the Same Address

Loans Compared to Shares

Loan Balances Over Time
2002
Loan
Amount
2005
Share
Amount
Loan
Amount
2008
Share
Amount
Loan
Amount
2009
Share
Amount
2011
Loan
Amount
Share
Amount
Loan
Amount
556,148
155
2,572,030
255
3,645,450
565
13,905,560
179,510
16,605,102
550,239
7,902
2,171,757
26
3,354,295
178,555
4,619,400
16,820
6,008,798
495,750
2,226
1,836,611
2,932,680
3,880
2,981,461
3,740
3,425,603
440,129
37,177
1,726,961
2,858,743
277
3,422,594
431,093
234
1,307,078
2,307,867
504
2,691,630
420,239
26
1,278,233
419,675
2,927
1,271,192
1,135
1,901,741
402,685
118
1,267,921
12,363
1,793,694
401,714
581
1,256,822
394,100
20
1,164,105
4,511,772
51,367
15,852,711
568
829
79
1,740
1,408
901
19,301
2,764,615
2,267,263
1,983,047
1,713,450
275
502
2,281
317
37,825
2,991
2,057,704
1,585
2,648,185
2,014,562
655
2,340,461
1,933,015
151
2,291,878
1,896,613
24
2,220,272
1,686,248
80
1,828,588
82
2,101,973
24,042,481
227,271
36,403,514
203,348
43,756,495
Share
Amount
27,035
3,695
3,914
279
662
1,108
1,758
510
3,615
3,036
45,613

Return on Assets double peer results

No delinquency, despite explosive loan
growth

Large cash balance in relation to assets

Cost of Funds double actual dividend rates

Very high percentage of new loans granted
Management
Add
Program
•Limited strategy
•Limited planning
•Limited
infrastructure
•Poor policies
•Poor procedures
•No brakes
New
Program
Management
Excessive
Growth
Poor due
diligence over 3rd
party vendors
•No net worth limits
•No risk
management
processes
New
Program
Management
Concentration
Excessive
Growth
•Borrowed funds
•Non-member deposits
Liquidity
New Program
Management
Concentration
Excessive
Growth
•Increasing losses
•PLL expense
•High Cost of Funds
New Program
High Expenses
/ Losses
Excessive
Growth
Management
Liquidity
Concentration

Review new and rapidly growing programs - CATCH
IT EARLY!!

Require credit unions to establish appropriate risk
management processes and risk limits prior to
implementing new programs.

Remind credit unions to perform due diligence on
the 3rd party vendors before & ongoing.

Require credit unions to establish interim
benchmarks to review and if necessary retool their
programs.
USE ALL THE TOOLS
II. Measure, Monitor, Control
29
2011/2012 Outlook - Complex But Workable
Jobs Market
Real Estate Values
Unemployment key indicator for credit union delinquency
Heavy real estate concentration makes credit unions vulnerable to dips
Examination & Monitoring
Off-site Monitoring
Examination Scope
 Allocation of resources
 Focus of Examination
 Analysis of 5300 Data
 Economic changes
CAMEL
Examination Report
On-site Examination
 Administrative Record
Follow-up
 Management Results
 Risk management
30
Labor Market Contraction
Striking geography of state unemployment rates…
National: 9.0%
Region I Rates:
 NV: 12.5% (2nd highest
in the nation)
 RI: 10.9% (4th)
 MI: 10.2% (7th)


VT: 5.3% (48th)
NH: 4.9% (49th)
31
Housing Price Collapse
Regional distribution of losses…
U.S.: -15.2%
RI Declines:
• NV: -50.8% (largest
in the nation)
• MI: -21.1% (9th)
• RI: -15.0% (14th)
• NH: -13.0 (17th)
• ME: -5.3% (37th)
• NY: -5.3%: (38th)
32
Mortgage Delinquency
Geography of mortgage delinquency and foreclosure (all
institutions).
U.S.: 8.1%
R I Rates:
• NV: 16.0% (2nd
highest in the
nation)
• NY: 9.1% (5th)
• RI: 8.4% (9th)
• ME: 8.3% (12th)
• NH: 5.2% (34th)
• VT: 5.1% (35th)
33
Mortgage Delinquency
Geography of mortgage delinquency and foreclosure (credit
unions).
U.S.: 2.3%
R I States:
• NV: 6.85% (3rd highest in the
nation)
• MI: 2.19% (14th)
• MA: 1.96% (16th)
• NY: 1.57% (25th)
• VT: 1.09% (40th)
• NH: 0.91% (48th)
34
Indirect Lending
• Increasing delinquency and loan losses
• Cut-throat pricing in some locations
Real Estate Loan
Modifications
• 20 to 22% recidivism rates , shadow foreclosure market
• Extend & pretend mindset of some
Participations
• Mostly MBL participations viewed as investments
• Increasing delinquency and losses
Member Business
Loans
• Highest growth area of balance sheets
• Increasing delinquency and losses
Interest Rate Risk
• Increasing proportion of loan portfolio in fixed rate firsts
• Historically low mortgage rates during growth period
35
Internal
Controls
Vendor program controls
Portfolio segmentation
Who owns what
Collection programs
FICO migration
Asset disposal
Measure &
Monitor
Vendor
Volume of new
Delinquency & losses
First pmt defaults
Financial condition
Pricing data
Loan Officers
Volume by dealer
Delinquency & losses
Collectors
Volume of actions
Recoveries
Repo orders
Re-aging of accounts
ALLL
Treatment
AB 06-1, Dec 2006
Portfolio Segmentation
Grading system
Losses by grade
ALLL funding by grade
Dealers
Financial condition
Environmental factor
FICO Migration
Re-grading paper
Calculate new loss
levels
36
Internal
Controls
Policy articulates
Limits for portfolio
segments & approvals
Waterfall approach to
offers
Performance Tracking
Recidivism rates
Early actions
FICO migration
LTV changes
Measure &
Monitor
Portfolio segments
Waterfall segments
Volume of new
Delinquency & losses
First pmt defaults
Loan Officers
Volume by segment
Delinquency & losses
Collectors
Volume of actions
Recoveries
Foreclosures
CLTV over time
FICO change over time
TDRs
ALLL
Treatment
AB 06-1, Dec 2006
Portfolio segmentation
Losses by segment
ALLL funding by
segment
Waterfall segmentation
Losses by segment
ALLL funding by
segment
FICO & CLTV migration
Correlate changes in
both
ALLL funding for
higher risk combos
38
Internal
Controls
Slow growth rate
Policy
Segment limits
Approval limits
Experience
Underwriting analysis
Internal review
Third party review
Servicing program
Periodic analysis
C&D requirements
Risk rating system
Asset disposal
Measure &
Monitor
Portfolio segments
Volume of new
Delinquency & losses
Financial condition
CRE values
Risk ratings
Loan Officers
Volume by segment
Delinquency & losses
Collectors
Volume of actions
Recoveries
C&D
Draws
Inspections
ALLL
Treatment
AB 06-1, Dec 2006
Old FAS 114
Impaired?
NPV, FV, or MV
Portfolio segmentation
Grading system
Losses by grade
ALLL funding by grade
Concentrations/large loans
Financial condition
Environmental factor
CRE value changes
Re-grading paper
Calculate new loss
levels
39
Internal
Controls
Vendor program controls
Understand
counterparties’ agendas
Policy limits
Underwrite the loan
Who owns what
Follow the contract
Collection programs
Measure &
Monitor
Vendor
Volume of new
Delinquency & losses
Financial condition
Official Approving
Volume
Delinquency & losses
Vendor Collectors
Actions per contract
Recoveries
Re-aging of accounts
ALLL
Treatment
AB 06-1, Dec 2006
Portfolio segmentation
Grading system
Losses by grade
ALLL funding by grade
Vendors
Financial condition
Environmental factor
Changes over time
Re-grading paper
Asset disposal
40
INTEREST-RATE-RISK EXPOSURE:
CREDIT UNIONS VS. PEER BANKS AND THRIFTS
Residential Real-Estate Loans as a Percentage of Assets, 1996-2010
December Figures; Federally Insured Credit Unions (FICUs) Only;
Peer Banks/Thrifts Hold Under $45 Billion in Assets
40.0%
Minor Tick = 1 Percentage Point
FICU exposure to
interest-rate
shocks has risen
– absolutely and
relative to banks.
35.0%
Recession
Federally Insured Credit Unions
Peer Banks and Thrifts
34.7%
32.4%
30.7%
33.8%
30.0%
25.0%
25.3%
24.8%
23.7%
26.6% 26.3%
15.0%
22.1%
21.6%
23.3% 23.0%
20.0%
28.4%
23.6%
22.9%
24.1%
18.8%
32.0%
30.6%
26.4% 26.6%
22.6%
22.5%
23.3%
22.4%
21.7%
22.5%
21.4%
20.0%
DATA SOURCES
Federal Deposit Insurance Corporation (Call Reports)
National Credit Union Administration (Call Reports)
National Bureau of Economic Research
10.0%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Internal
Controls
Modeling policies
Model assumptions
Quality
Actually used
Modeling accuracy
Action based on results
Exit strategy
Measure &
Monitor
Capital
Treatment
Assets
Net economic value
Fixed rates volume
Sufficient capital to
Prepayment speeds
maintain positive NEV
Variable rate
Income matching
sensitivity
Cover non income
Investment optionality
producing assets
Liabilities
Rate sensitive
deposits
NMS actions
General market conditions
Rate changes
Sensitivity to change
Net economic value
42


Funding the ALLL is a subject of recurrent
interest to CUs and examiners alike.
Provisioning is especially relevant in the
current environment as credit unions are
challenged to maintain positive spread.
43
1.40%
1.31%
1.30%
1.20%
Board adopts IRPS No. 02-3,
GAAP-compliant ALLL
1.10%
1.09%
1.00%
0.90%
0.85%
0.78%
0.80%
0.73%
0.73%
0.72%
0.67%
0.70%
0.60%
2002
2003
2004
2005
2006
2007
2008
2009
44

Pool segmentation is too broad and more segmentation
should be done to improve provisioning accuracy, (e.g., new
auto vs. used auto, direct vs. indirect, credit scores, type of collateral, credit risk
grade, etc.)

CUs tend to apply an historical C/O percentage to the O/S
pool balance and stop the methodology there without
considering relevant, current Q&E factors.

Credit unions need to consider how the current environment compares to the period
over which the historical loss percentage was calculated and adjust their provisioning
outcome accordingly.
45

CU systems do not flag TDR
 Provisioning for TDR modifications falls within the scope of FAS 114 rather
than FAS 5 with methodology, funding, and documentation implications.


If a loan is evaluated for impairment under FAS 114 and found not to be
impaired, CUs tend to end their analysis there with the result of
underfunding their ALLL. Such loans should be reevaluated in a FAS 5
pool and provisioned accordingly.
When applying the three impairment measures under FAS 114:

if a credit union is depending on an income stream for repayment, they
should use the PV of expected future cash flows;
 if the CU is depending on sale of the collateral, they should use the fair value
of the collateral less cost to sell.
46


Not prudent to wait until the last dollar becomes
uncollectible before charging-off an outstanding loan
balance.
When an asset, or portion thereof, is considered
uncollectible, and of such little value that its continuance on
the books is not warranted, it should be charged-off.
 This does not mean that the asset has absolutely no recovery or
salvage value; rather, it is not practical or desirable to defer writing off
an essentially worthless asset (or portion thereof), even though partial
recovery may occur in the future
47
III. Progressive Enforcement
48
Letter of
Understanding
Removal
Prohibition
Civil
Money
Penalties
Cease
&
Desist
PCA
Preliminary
Warning
Letter
Document of
Resolution
Conservatorship
L
I
Q
U
I
D
A
T
I
O
N
IV. On The Horizon
50
TDR Policy
BSA Testing
Interest Rate
Risk Rule
• Addressing confusion and bank/CU differences
• FFIEC Chiefs comments on private company standards
• Shared branching and SAR completion
• Corporate rule 2 may impose additional reporting
• Formal policy and action
Investments Rule
• Concentration limits
CUSO Rule
• Reporting and access
Risk Based
Net Worth Rule
MBL Rule
• Deal better with concentrations
• Tighten up areas where significant losses have occurred
51
V. Questions
52
National Credit Union Administration
June 17, 2011
53