Interest Rate Risk Policy and Program, 5155-5167 [2012-2091]
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5155
Rules and Regulations
Federal Register
Vol. 77, No. 22
Thursday, February 2, 2012
This section of the FEDERAL REGISTER
contains regulatory documents having general
applicability and legal effect, most of which
are keyed to and codified in the Code of
Federal Regulations, which is published under
50 titles pursuant to 44 U.S.C. 1510.
The Code of Federal Regulations is sold by
the Superintendent of Documents. Prices of
new books are listed in the first FEDERAL
REGISTER issue of each week.
NATIONAL CREDIT UNION
ADMINISTRATION
12 CFR Part 741
RIN 3133–AD66
Interest Rate Risk Policy and Program
National Credit Union
Administration (NCUA).
AGENCY:
ACTION:
Final rule.
NCUA is issuing a final rule
requiring Federally insured credit
unions to develop and adopt a written
policy on interest rate risk management
and a program to effectively implement
that policy, as part of their asset liability
management responsibilities. The
interest rate risk policy and
implementation program will be among
the factors NCUA will consider in
determining a credit union’s
insurability. To assist credit unions, the
final rule includes an appendix setting
forth guidance on developing an interest
rate risk policy and an effective
implementation program based on
generally recognized best practices for
safely and soundly managing interest
rate risk.
SUMMARY:
This rule is effective on
September 30, 2012.
DATES:
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FOR FURTHER INFORMATION CONTACT:
Jeremy Taylor, Senior Capital Markets
Specialist, Office of Examination and
Insurance, National Credit Union
Administration, 1775 Duke Street,
Alexandria, Virginia 22314, or
telephone: (703) 518–6620.
SUPPLEMENTARY INFORMATION:
I. Background
II. Subject-by-Subject Discussion of
Comments on Proposed Rule
III. Regulatory Procedures
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I. Background 1
A. What Is Interest Rate Risk? The
term ‘‘interest rate risk’’ (‘‘IRR’’) refers to
the vulnerability of a credit union’s
financial condition to adverse
movements in market interest rates.
Although some IRR is a normal part of
financial intermediation,2 it still may
negatively affect a credit union’s
earnings, net worth, and its net
economic value, which is the difference
between the market value of assets and
the market value of liabilities. Changes
in interest rates influence a credit
union’s earnings by altering interestsensitive income and expenses (e.g.,
loan income and share dividends).
Changes in interest rates also affect the
economic value of a credit union’s
assets and liabilities because the present
value of future cash flows and, in some
cases, the cash flows themselves may
change when interest rates change. IRR
takes several forms: Repricing risk, yield
curve risk, spread risk, basis risk, and
options risk. For definitions of these
risks, see section IX. of Appendix B
following the final rule text below.
B. Why is NCUA Amending the
Existing Rule? In the past, NCUA issued
guidance on asset/liability management
and IRR management in Letters to Credit
Unions.3 NCUA believes Federallyinsured credit unions (‘‘FICUs’’), relying
on this guidance, generally have
managed their IRR adequately.
However, FICUs have recently
1 President Obama signed the Plain Writing Act
of 2010 (Pub. L. 111–274) into law on October 13,
2010, to ‘‘improve the effectiveness and
accountability of Federal agencies to the public by
promoting clear Government communication that
the public can understand and use.’’ This preamble
is written to meet the plain writing objectives.
2 The process of channeling funds from savers to
investors.
3 Letters to Credit Unions: 99–CU–12, Real Estate
Lending and Balance Sheet Risk Management, Aug.
1999; 00–CU–10, Asset Liability Management
Examination Procedures, Nov. 2000; 00–CU–13,
Liquidity and Balance Sheet Risk Management, Dec.
2000; 01–CU–08, Liability Management—Highly
Rate-Sensitive and Volatile Funding Sources, July
2001; 01–CU–19, Managing Share Inflows in
Uncertain Times, Oct. 2001; 03–CU–11, NonMaturity Shares and Balance Sheet Risk, July 2003;
03–CU–15, Real Estate Concentrations and Interest
Rate Risk Management for Credit Unions with Large
Positions in Fixed-Rate Mortgage Portfolios, Sept.
2003; 06–CU–16, Interagency Guidance on
Nontraditional Mortgage Product Risk, Oct. 2006;
10–CU–06, Interagency Advisory on Interest Rate
Risk Management, Jan. 6, 2010. NCUA plans to
issue a Letter to Credit Unions addressing the
‘‘Interagency Advisory on Interest Rate Risk
Management, Frequently Asked Questions’’ that
was issued on January 12, 2012.
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experienced increasing exposure to IRR
due to changes in balance sheet
composition and increased uncertainty
in the financial markets. This increase
has heightened the importance for
FICUs to have strong policies and
programs explicitly addressing the
credit union’s management of controls
for IRR.
Therefore, it is both timely and
appropriate to require certain credit
unions to have a formal policy
addressing IRR management and a
corresponding program to effectively
implement that policy. Further, it is
incumbent upon NCUA, as steward of
the National Credit Union Share
Insurance Fund (‘‘the Fund’’), to
consider a credit union’s IRR
management policy and implementation
program as a factor in determining
whether the Fund should insure its
member deposits.
C. What Were the Requirements of the
Proposed Rule? The existing regulation
on insurability of accounts prescribes
certain criteria NCUA must consider in
‘‘determining the insurability of a credit
union * * * and in continuing the
insurability of its accounts.’’ 12 CFR
741.3. Among the ‘‘factors * * * to be
considered in determining whether the
credit union’s financial condition and
policies are both safe and sound,’’ are
the existence of written lending and
investment policies. Id. § 741.3(b)(2)–
(3). IRR management policies and
practices are absent from the existing
factors.
In response to credit unions’
increasing exposure to IRR, NCUA
issued a proposed rule in March 2011
amending section 741.3(b) to require, as
an additional factor in determining
whether a ‘‘credit union’s financial
condition and policies are both safe and
sound,’’ the existence of a written policy
on IRR management and a program to
effectively implement that policy
(together ‘‘an IRR policy and program’’).
76 FR 16570 (Mar. 24, 2011). The
proposed rule set an effective date for
compliance at three months after the
publication of the final rule in the
Federal Register.
As proposed, the rule would apply to
two categories of FICUs, (a) those having
more than $50 million in assets; and (b)
those having assets between $10 million
and $50 million whose ratio of first
mortgage loans, plus investments with
maturities greater than five years (the
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numerator), equals or exceeds 100% of
its net worth (the denominator). This
ratio is known as the ‘‘Supervisory
Interest Rate Risk Threshold Ratio’’
(‘‘SIRRT ratio’’) and is explained in
section II.D. of this preamble.
Conversely, the rule would not apply to
FICUs with assets of less than $10
million, or to those with assets between
$10 million and $50 million whose
combined first mortgage loans, plus
investments with maturities greater than
five years, are less than 100% of its net
worth.
To help credit unions understand and
meet NCUA’s expectations for
compliance with amended section
741.3(b), the proposed rule included an
appendix (‘‘Appendix B’’) setting forth
comprehensive guidance on developing
both a written policy on IRR
management and a program to
effectively implement that policy.4
Appendix B acknowledges that it is not
possible to establish a ‘‘one-size-fits-all’’
template of IRR management standards
and metrics that would be appropriate
for all FICUs. Rather, it recognizes that
IRR management requires specialized
judgments based on each credit union’s
business objectives and ability to
withstand risk.
Appendix B leaves to each affected
credit union’s board of directors the
obligation and responsibility to make
those judgments. Yet, it also provides
them a framework of five fundamental
elements of an effective IRR
management program: A
comprehensive, written IRR policy;
accountable IRR oversight by board of
directors and management; appropriate
IRR measurement and monitoring
systems; good internal controls; and
informed decision-making based on IRR
measurement system results. It also
provides guidelines for determining the
adequacy of IRR policy and
effectiveness of implementation
program. The appendix also includes
guidance for large credit unions with
complex or high-risk balance sheets.
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II. Subject-by-Subject Discussion of
Comments on Proposed Rule
The proposed rule was issued with a
60-day comment period that expired on
May 23, 2011. 76 FR 16570. NCUA
received 48 comment letters in
response—29 from Federally-insured
credit unions, 13 from credit union
industry trade associations, one from an
4 NCUA plans to introduce a new IRR
questionnaire that corresponds to Appendix B of
the final rule to replace the IRR questionnaire
presently used by examiners. The present
questionnaire is located on NCUA’s Web site at:
https://www.ncua.gov/Resources/CUs/ALM/Pages/
ALMReview.aspx.
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association of state credit union
supervisory authorities, and 5 from
industry consultants. Five commenters
affirmatively supported the proposed
rule; 29 commenters either opposed the
rule or did not state a definitive
position; and 14 commenters addressed
particular aspects of the rule or made
suggestions for improving it. The
comments on the proposed rule are
addressed as follows:
A. Authority to Impose Insurability
Criteria. A trade association compared
the existing insurability factors
requiring a lending policy and an
investment policy with the proposed
requirement for an IRR management
policy and implementation program.
This commenter distinguished between
lending and investment authorities and
limitations that are ‘‘specifically
detailed in the Federal Credit Union
Act’’ and the authority to require IRR
management, which it contends ‘‘is a
regulatory directive and is not
addressed in the Act.’’ The suggestion
that there is authority in the Act to
require the existing lending and
investment policies but not to require an
IRR management policy and
implementation program is incorrect.5
The basis for both the existing and
proposed factors for insurability is
safety and soundness. As section
741.3(b) itself confirms, the ‘‘financial
policies and conditions’’ it prescribes
are ‘‘factors * * * to be considered in
determining whether the credit union’s
financial condition and policies are both
safe and sound.’’
B. Regulatory Burden and
Duplication. A number of commenters
said that requiring an IRR management
policy and implementation program as
insurability criteria imposes an
excessive regulatory burden on credit
unions, especially in the wake of the
regulatory mandates imposed as a result
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, 12 U.S.C.
5301 et seq. Emphasizing this point,
some commenters protested that other
financial regulators have not introduced
IRR management rules.
A number of commenters also noted
that mechanisms to manage credit
unions’ IRR already exist that are
sufficient to monitor and assess shifts in
IRR and to indicate when corrective
action is warranted. For example, they
5 The Act itself does contain authority for adding
the IRR policy and implementation program as an
insurability criterion. Title II of the Act requires
NCUA, when granting insurance to a Federal or
state credit union, to consider the applicant’s
‘‘history, financial condition and management
policies,’’ 12 U.S.C. 1781(c)(1)(A), and to deny
insurance if it finds that the applicant’s ‘‘financial
condition and policies are unsafe or unsound.’’ Id.
§ 1781(c)(2).
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cite interagency advisories, NCUA
Letters to Credit Unions, and credit
union examinations themselves. See
footnote 3 above. NCUA does not
dispute the utility of these existing
mechanisms, but does not agree that
they are sufficient in an environment of
increased risk exposure and interest rate
volatility. As detailed in sections C. and
D. below in this preamble, IRR exposure
at credit unions is on the rise to the
point that it is higher than at peer
commercial banks.
It is unclear that the numerous Letters
to Credit Unions NCUA has periodically
issued, providing supervisory advice
and guidance on IRR management, has
led to improvements in IRR
management that are sufficient to meet
the growing risk exposure and
increasing interest rate volatility.
Appendix B to the final rule is intended
to complement the existing guidance by
providing a framework for each credit
union to develop its own definitive IRR
policy and program. Accordingly, the
final rule adopts as timely and prudent
the proposed requirements for an IRR
management policy and implementation
program as additional criteria for
insurability.
C. Need for Interest Rate Risk Policy
and Program. A number of commenters
asserted that NCUA has not
demonstrated a need to require an IRR
management policy and implementation
program beyond the conclusion that IRR
exposure has increased. One commenter
contended that the past performance of
credit unions in managing net interest
margins following periods of rising rates
suggests that an IRR management policy
and implementation program is
unnecessary. Recent relevant data
demonstrates otherwise.
NCUA compared IRR exposure since
1996 of credit unions versus commercial
banks based on growth in real estate
loans as a percentage of total assets. At
year-end 2010, residential mortgages
accounted for 30.7% of credit union
assets compared to only 18.4% at peer
commercial banks. In 1996, residential
mortgages as a percent of total assets for
both credit unions and banks were in
the 15–20% range.6 While peer
institutions have retreated from booking
mortgage loans, credit unions have
increased residential mortgage holdings
and taken on more interest rate risk in
the process.
Other NCUA data show the percent of
credit unions with exposure to
mortgages, and the median level of
6 See ‘‘Interest Rate Risk Proposal Gets Ahead of
the Curve,’’ The NCUA Report (Apr. 2011, No. 4).
This article concluded that the IRR exposure of
Federally insured credit unions has risen steeply
since 1996 relative to peer commercial banks.
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due to their record levels of long-term
assets by raising deposit rates more
slowly. NCUA notes that in January
2012 the Federal Reserve indicated that
it expected economic conditions to
warrant keeping the Federal funds rate
at exceptionally low levels at least
through late 2014.
NCUA acknowledges the aggregate
upward trend over the long term in
credit unions’ sales of first mortgage real
estate loans that they originated. Most
recently, the percentage of first mortgage
real estate loans sold fell to 44.8% of
loans granted year to date in the 3rd
quarter of 2011, but this was from a high
for the full year of 51.9% in 2010.
NCUA notes that the present 44.8%
level remains significantly greater than
the most recent low point of 26.3% of
loans sold for the year in 2007. The
increase is concentrated in the largest
credit unions, however. For example,
the percentage of first mortgage real
estate loans sold in the $10 million to
$50 million asset cohort was 16.0% of
first mortgage real estate loans granted
at credit unions year to date in the 3rd
quarter of 2011, and 14.5% of first
mortgage real estate loans granted for
the year in December 2007.
NCUA also acknowledges that credit
unions use deposit interest rates to
mitigate the impact of increases in
short-term rates on their net interest
margin. Understanding IRR requires
taking into account the historical levels
of interest rates. Short-term rates
presently are 500 basis points below
2006–2007 levels, and any return even
to average long-term rates is likely to
stress credit unions’ ability to manage
such a change in the level of interest
rates. Reluctance to increase deposit
interest rates sufficiently in an effort to
enhance earnings and mitigate interest
rate risk could trigger unexpected
deposit outflows and thereby increase a
credit union’s liquidity risk.
All these indicators of IRR exposure
point to heightened risk for credit
unions. While acknowledging that
credit unions act in various ways to
manage IRR, the consistent rise in IRR
at credit unions relative to other peer
institutions deserves regulatory
attention and is warranted as a
prerequisite for insurability.
D. Supervisory Interest Rate Risk
Threshold (SIRRT). For credit unions in
the asset cohort of $10 million to $50
million, the proposed and final rules
rely on the SIRRT ratio as a reliable
indicator of IRR concentration:
A credit union in that asset cohort must
develop and adopt an IRR policy and
program only if its SIRRT ratio equals or
exceeds 100% of its net worth, i.e., a
ratio of 1:1. The rule does not require a
credit union with assets under $10
million to develop and adopt an IRR
policy and program, regardless of its
SIRRT.
NCUA has tracked the SIRRT ratio
among the population of FICUs as an
aggregate percentage of their net worth
from 2005 (when Call Reports started to
break out investment maturities at 5
years) to September 2011. Table 2 below
depicts this aggregate ratio:
7 See ‘‘Size Matters: Another Perspective on IRR,’’
The NCUA Report (June 2011, No. 6).
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by asset size cohort at year-end 2010, as
depicted in Table 1:
Each of these measures indicates that
the risk from changing interest rates to
credit unions with long-term fixed cash
flows increases with asset size and the
escalation occurs most significantly in
the $10 million to $50 million asset
cohort.
Credit unions can use sales of real
estate loans originated to reduce IRR
exposure on their balance sheets. In that
regard, a trade association commented
that credit unions’ sales of first mortgage
originations during the current interest
rate cycle have increased from 25–30%
of first mortgage loans granted to over
50%. The trade association argued that
credit unions manage their net interest
margin in this and other ways. The
commenter noted that following a 300
basis point increase in the Fed funds
rate in 1994 and a 425 basis point
increase in 2004–2006, credit union net
interest margins fell only by 1 basis
point in 1995, by 15 basis points in
2005, and by 11 basis points in 2006.
Credit unions can manage net interest
margins, for example, by means of share
deposit pricing. On this point, the
commenter also suggested the Federal
Reserve is not expected to raise interest
rates quickly. The commenter also
asserted that liquidity at credit unions
might allow them to offset IRR exposure
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credit union IRR exposure to net worth
by asset size cohort at year-end 2010, as
depicted in Table 1:
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As previously discussed, the
percentage of residential real estate
loans declined from a high point of
almost 35% of assets in 2008 to 30.7%
of assets in 2010. See footnote 6 above.
However, this does not take into
account the movement of FICU assets
into long-term investments since 2008,
as the growth in consumer demand for
mortgage loans slowed during this
recessionary period. When these
elements are included, as Table 2
shows, the SIRRT ratio increased from
256.2% of net worth in 2008 to a high
of 271.1% in March 2011. The ratio
declined to 264.8% in September 2011.
Nonetheless, since 2005, the ratio has
increased from 199.1%. In sum, credit
union assets that present the highest IRR
exposure have increased relative to
credit union net worth and have
reached a significantly higher level. The
IRR exposure levels depicted by the data
also indicate that credit unions’ net
interest margin performance, as
previously discussed, does not
eliminate the need for an IRR policy and
IRR management program.
Several commenters questioned the
components of the SIRRT numerator.
Some advocated limiting the maturity of
first mortgages to match the 5-year
maturity limit of investments. Others
supported excluding adjustable rate
mortgages from the numerator. One
commenter argued that the numerator
should distinguish between fixed-rate
and variable-rate loans.
NCUA does not believe the
components of the numerator of the
SIRRT ratio should be changed.
Adjustable rate mortgages carry
modeling risk because these loans are
complex. Specifically, they have
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periodic and lifetime caps with varying
reset dates and margins that must be
incorporated to reflect risk. These
complex mortgages should therefore be
included in the SIRRT ratio.
A number of commenters addressed
the asset size thresholds for subjecting
credit unions to the IRR policy and
program. Of these, several favored
raising the asset ‘‘floor’’ to $20 million
and $50 million, respectively, thus
excluding credit unions below the
‘‘floor.’’ One commenter criticized use
of asset thresholds altogether, asserting
that IRR may be present in credit unions
regardless of asset size. One commenter
agreed that small credit unions should
be excluded by adhering to the $10
million asset ‘‘floor’’ originally
proposed.
The comments on the SIRRT ratio
overlook the fundamental reasons for
reliance on the ratio. Net worth is the
reserve of funds available to absorb the
risks of a credit union, and it is
therefore the best measure against
which to gauge the credit union’s risk
exposure. A credit union where the
SIRRT ratio is at or over 1:1 is exposed
to IRR at a heightened level. This
requires additional attention by credit
unions in the $10 million to $50 million
asset cohort to their IRR policy and
management program in order to
manage this risk. At year-end 2010 in
the $10 million to $50 million asset
cohort, median first mortgages to net
worth (56.4%) exceeded the median for
all credit unions (35.0%). Additional
NCUA data also shows at year-end 2010
that for credit unions in the $10 million
to $50 million asset cohort with a SIRRT
ratio at or above 1:1, median first
mortgages to net worth was 179.9% of
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net worth, and median long-term
residential mortgages repricing at or
longer than five years to net worth was
148.1% of net worth. By comparison,
credit unions in the $10 million to $50
million asset cohort with a SIRRT ratio
below 1:1 have a 2.7% ratio of median
first mortgages to net worth and a 28.5%
ratio of median long-term residential
mortgages to net worth. NCUA therefore
concludes that the SIRRT ratio
effectively partitions risk.
NCUA devised the SIRRT ratio’s
‘‘floor’’ and ‘‘ceiling’’ thresholds to
minimize regulatory burden and at the
same time ensure adequate regulatory
coverage of total credit union assets.
Applying the thresholds to the $10
million to $50 million asset cohort
achieves both of these objectives.
Moreover, the data indicates that a
credit union’s IRR exposure as its assets
grow is likely to occur at the $10 million
to $50 million asset range At year-end
2010, among the total population of
FICUs, 3,184 credit unions had a SIRRT
ratio equal to or exceeding 100% of
their net worth, whereas 4,155 credit
unions had a SIRRT ratio less than
100% of their net worth, thus
minimizing regulatory burden. At the
same time, applying the SIRRT ratio to
the $10 million to $50 million asset
cohort would have imposed the IRR
policy and program requirement on
95.5% of credit union assets, or $873.6
billion out of a total of $914.4 billion in
credit union assets.
NCUA reviewed data as of September
30, 2011 for purposes of the final rule.
The SIRRT ratio is depicted in Table 3
for credit unions by asset cohort and it
demonstrates the segregation of risk. As
shown in Table 2 previously, the
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aggregate SIRRT ratio for all credit
unions was 264.8%.
have been covered by the rule based on
September 30, 2011 data.
Accordingly, the proposed $10
million ‘‘floor’’ and the proposed $50
million ‘‘ceiling’’ thresholds as applied
to the SIRRT ratio continue to provide
effective segregation of risk while
reasonably minimizing regulatory
burden.
E. Application of the Rule. Many
commenters expressed concern about
how the proposed rule would be
applied in practice. Several observed
that it would impose a ‘‘one-size-fitsall’’ set of IRR policies, or be used as a
checklist by examiners, or viewed by
examiners as a mandate, or inhibit the
flexibility of credit unions, thereby
allowing examiners to micro-manage
them. A number of commenters were
concerned that examiners would apply
the rule subjectively, leading to ‘‘generic
standards.’’ Others predicted that
examiners would rely on peer data and
simplified assumptions. Finally, several
noted the absence from the rule of an
express definition of what constitutes an
‘‘effective program.’’
It is not the intent of the rule for
examiners to subjectively impose
unduly standardized supervisory
oversight. Examiners will be expected to
apply the standards within a consistent
framework based on their knowledge of
each credit union’s operations and
available resources. While the rule itself
does not define what is an ‘‘effective
program,’’ the guidance in Appendix B
does. It provides that ‘‘an effective IRR
management program identifies,
measures, monitors, and controls IRR
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depicted in Table 5, which shows that
95.9% of all credit union assets would
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54.8% of all credit unions would not
have been covered by the rule.
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it shows that 1,316 credit unions in the
$10 to $50 Million asset cohort would
not have been covered by the rule, and
The distribution of credit union assets
not covered and covered by the rule is
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The distribution of the number of
credit unions not covered and covered
by the rule is depicted in Table 4 and
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Federal Register / Vol. 77, No. 22 / Thursday, February 2, 2012 / Rules and Regulations
and is central to safe and sound credit
union operations.’’ Further, as the
preamble to the proposed rule also
recognized: ‘‘it is impossible to establish
specific, regulatory requirements for IRR
that would be appropriate for all FICUs.
IRR management involves judgment by
a FICU based on its own individual
mission, structure, and circumstances.
Any rule must take into account the
diversity of FICUs and avoid a one-sizefits-all approach. Accordingly, FICUs
should devise a policy and risk
management program appropriate to
their own situation.’’ 76 FR 16571. The
NCUA Board reaffirms the notion that
IRR management must be
individualized, while subject to
regulatory oversight and prudent
insurability standards.
NCUA acknowledges that using
simplifying assumptions to apply the
rule involves a certain degree of
subjectivity, but believes this is a
necessary part of the supervision
process. Any assumption used to
aggregate data or categorize financial
instruments can be a simplifying
assumption. However, NCUA does not
take issue with using such assumptions
or generic standards so long as these are
consistent with the best practices
described in the January 2010 FFIEC
Advisory on Interest Rate Risk
Management and take into account the
size, complexity and risk exposure of
the credit union. NCUA recognizes the
use of peer data may be appropriate.
Simplifying assumptions are part of the
practice of IRR management and are an
issue only when they cause either credit
union management or an examiner to
underestimate complexity. For example,
a credit union may use simplifying
assumptions in the process of modeling
IRR, and these can be acceptable so long
as they do not cause interest rate risk to
be misstated.
To address consistency of application
NCUA plans to issue guidance and
training for examiners, including a
questionnaire that is tailored
specifically to this rule. See footnote 4
above. The commentary in the
questionnaire emphasizes that the
guidance items are not mandatory.
Credit unions are encouraged to review
and discuss these guidance items with
their examiners.
F. Guidance on IRR Policy and
Program. A number of commenters
made observations about the role of the
specific guidance in Appendix B to the
rule. Of these, one commenter asked
whether Appendix B supersedes
existing guidance on IRR management.
One recommended publishing
Appendix B on the NCUA Web site
when it is adopted. Another
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recommended updating the Examiners
Guide to include the guidance in
Appendix B.
NCUA does not intend Appendix B to
supplant existing advice on specific
aspects of IRR management. Existing
NCUA Letters to Credit Unions address
specific aspects of IRR such as real
estate lending, liquidity, rate-sensitive
funding sources, and non-maturity
shares. These Letters to Credit Unions
are consistent with the practices set
forth in Appendix B and credit unions
should continue to heed the advice they
give. See footnote 3 above. The guidance
in Appendix B is also complementary to
the 2010 Interagency Advisory on
Interest Rate Risk Management and the
2012 Interagency Advisory on Interest
Rate Risk Management, Frequently
Asked Questions. NCUA will continue
to issue Letters to Credit Unions relating
to IRR management as necessary and
will update the Examiners Guide
accordingly.
A number of commenters addressed
technical aspects of IRR measurement
methods. Of these, some said Appendix
B implied a preference for the valuation
of non-maturity shares at par. One said
that credit unions should be free to
choose their own method. One noted
the selection of curves for discounting is
debatable. One said a credit union
offering rate is the most defensible
reinvestment rate. One said that IRR
measures using changes in rates might
not fully reflect the level of IRR. One
said that 300 basis point shocks should
not be an industry standard for the rule.
One said that parallel shock analysis is
not realistic. One recommended
semiannual IRR testing in an IRR
management program.
NCUA responds to these and similar
technical comments by reiterating that it
does not seek to endorse certain IRR
measures, measurement techniques, or
assumptions over others. For example,
NCUA does not prescribe valuing nonmaturity shares at par but it
acknowledges that such measures and
the use of historical rate scenarios may
provide useful information. Similarly,
NCUA does not require discounting on
yield curves or endorse any particular
discount rate. NCUA does recommend
the use of pro forma risk measurement
and the discipline of utilizing relevant
stress tests to better understand IRR and
to be aware of the scenarios that would
have the most detrimental impact on
earnings, net worth, or net economic
value. Base values of balance sheet
instruments are as integral to stating risk
exposure as stressed results. Testing
should be as frequent as needed for a
credit union to be fully aware of its IRR
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exposure and semi-annual IRR testing
may not be sufficient to manage IRR.
Several more commenters made
observations on the separation of credit
union responsibilities with respect to
IRR. Of these, two commented on the
separation of risk taking and risk
management. One of these
recommended that NCUA provide
examples to suggest appropriate
separation of duties, and another one
said that separation would be
burdensome.
NCUA does not believe this section of
Appendix B on policy, board oversight
and credit union structure needs to be
amended. The proposed rule suggested
that credit unions should separate risktaking and risk measurement functions
‘‘if possible’’, particularly in the case of
large, complex or high-risk credit
unions. In the case of large, complex or
high-risk credit unions, the final rule
already provides an example of
separating the investment function from
the IRR measurement function, e.g.
having the IRR measurement function
report to an audit or supervisory
committee. However, it is not the
function of this rule to prescribe specific
organizational structures.
G. Alternatives to the Proposed Rule.
A number of commenters suggested that
NCUA should focus on the 800 credit
unions that lack an IRR policy instead
of the estimated 75% of credit unions
that have such policies in place. NCUA
does not agree. The data introduced
earlier indicates that IRR overall is at an
unprecedented level; it is not limited to
a small subset of credit unions.
Attempting to balance flexibility with
regulatory concerns, one commenter
suggested that an effective IRR program
would be one that takes assets and
liabilities into account, requires
management reports to the board, and
performs tests as directed by regulators.
NCUA agrees that any rulemaking that
addresses IRR should be crafted to not
limit credit union flexibility, while still
considering regulatory concerns. For
this reason, the guidance in Appendix B
is flexible. At the same time, shifting
interest rates pose a core risk that could
jeopardize the liquidity and solvency of
credit unions. The steady increase in
this exposure to interest rate changes
warrants a high level of attention by
management and oversight by NCUA
and state supervisory authorities. The
Board therefore believes that an IRR
policy and an effective IRR management
program must be implemented by
regulation and should not be left solely
to the supervisory process.
H. Effective Date and Implementation
of Final Rule. The proposed rule
prescribed a period of three months
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between publication of the final rule
and its effective date for credit unions
to comply with the rule’s new
requirements. A number of commenters
urged making the acclimation period
longer than three months and some
recommended a phase-in period of as
long as one year. In view of these
comments, NCUA has reassessed the
steps and the time it will take both
affected credit unions and itself to
acclimate to the final rule.
Balancing its concern for a timely
response to interest rate risk issues
against its objective to ensure careful
implementation of the final rule, the
Board has decided to modify the
effective date of the final rule to
September 30, 2012.
III. Regulatory Procedures
A. Regulatory Flexibility Act. The
Regulatory Flexibility Act requires
NCUA to prepare an analysis to describe
any significant economic impact a rule
may have on a substantial number of
small entities (primarily those credit
unions with less than ten million
dollars in assets). By its terms, the final
rule’s requirement to develop a written
IRR management policy and a program
to effectively implement the policy do
not apply to credit unions with less than
$10 million in assets. Accordingly, this
final rule will not have a significant
economic impact on a substantial
number of small credit unions and a
Regulatory Flexibility Analysis is not
warranted.
B. Paperwork Reduction Act. This
final rule requires certain credit unions
to develop, as prerequisites for
insurability of its member deposits, a
written IRR management policy (‘‘an
IRR policy’’) and a program to
effectively implement the policy. The
Paperwork Reduction Act of 1995
(‘‘PRA’’) applies to rulemakings in
which an agency by rule creates a new
paperwork burden on regulated entities
or modifies an existing burden. 44
U.S.C. 3507(d). For purposes of the
PRA, a paperwork burden may take the
form of either a reporting or a
recordkeeping requirement, both
referred to as information collections.
NCUA has determined that the
requirement to develop an IRR policy
creates a new information collection
requirement. As required, NCUA has
applied to the Office of Management
and Budget (‘‘OMB’’) for approval of the
information collection requirement
described below.
The final rule requires two categories
of credit unions to develop an IRR
policy and program: those having more
than $50 million in assets; and those
having assets between $10 million and
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$50 million whose combined first
mortgage loans, plus investments with
maturities greater than five years, equal
or exceed 100% of net worth. As of
September 30, 2011, 3,246 FICUs (45%
of all FICUs) fell in either of these two
categories. NCUA estimates, however,
that 2,446 of the affected FICUs (or
approximately 75% of them) already
have an IRR policy in place; they will
need only to review the existing IRR
policy, and make appropriate
adjustments where necessary, to comply
with the final rule. The other 800
affected FICUs (approximately 25% of
them) will need to newly develop an
IRR policy. Periodic review of an
existing IRR policy should require
minimal or no additional burden.
The final rule is accompanied by an
Appendix setting forth comprehensive
guidance on developing both an IRR
policy and program. The guidance
specifies eight policy items that must be
addressed. See section II of Appendix B
following rule text below. The length of
an IRR management policy covering
these eight policy elements will vary
according to the credit union’s business
strategies. A credit union offering basic
share accounts and short-term loans but
no mortgage loans, and that makes
relatively simple investments, should be
able to develop a basic IRR policy in one
to two hours that establishes, for
example, maturity limits for loans, the
minimum amount of short-term funds,
and the range of permissible
investments. In contrast, credit unions
with more complex balance sheets,
especially those containing mortgage
loans and complex investments, may
warrant a more comprehensive IRR
management policy that requires
additional time to produce.
NCUA estimates that addressing the
eight policy items will each entail an
equal time burden of two hours. The
maximum time for all segments of an
IRR policy is therefore estimated at 16
hours. In turn, the aggregate information
collection burden for affected credit
unions to comply with the rule is
estimated 12,800 hours (800 credit
unions × 16 hours).
The proposed rule noted that
organizations and individuals wishing
to comment on this information
collection requirement should direct
their comments to the Office of
Information and Regulatory Affairs,
OMB, Attn: Shagufta Ahmed, Room
10226, New Executive Office Building,
Washington, DC 20503, with a copy to
Mary Rupp, Secretary of the Board,
National Credit Union Administration,
1775 Duke Street, Alexandria, Virginia
22314–3428.
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The sole commenter in response to
the proposed rule contended that the
estimate of 16 hours to complete an IRR
policy understates the time it takes to
collect the information, establish limits
and review the data. That commenter
offered no alternative estimate.
NCUA considers public comments on
the collection of information in:
• Evaluating whether the collection of
information is necessary for the proper
performance of the functions of the
NCUA, including whether the
information will have a practical use;
• Evaluating the accuracy of the
NCUA’s estimate of the burden of the
collection of information, including the
validity of the methodology and
assumptions used;
• Enhancing the quality, usefulness,
and clarity of the information to be
collected; and
• Minimizing the burden of collection
of information on those who are to
respond, including through the use of
appropriate automated, electronic,
mechanical, or other technological
collection techniques or other forms of
information technology; e.g., permitting
electronic submission of responses.
OMB assigned No. 3133–0184 to this
rulemaking.
C. Executive Order 13132. Executive
Order 13132 encourages independent
regulatory agencies to consider the
impact of their actions on state and local
interests. In adherence to fundamental
federalism principles, NCUA, an
independent regulatory agency as
defined in 44 U.S.C. 3502(5), voluntarily
complies with the Executive Order. This
rule will not have substantial direct
effects on the states, on the relationship
between the national government and
the states, or on the distribution of
power and responsibilities among the
various levels of government. Therefore,
this rule does not constitute a policy
that has federalism implications for
purposes of the executive order.
D. The Treasury and General
Government Appropriations Act, 1999—
Assessment of Federal Regulations and
Policies on Families. The NCUA has
determined that this rule will not affect
family well-being within the meaning of
the Treasury and General Government
Appropriations Act, Pub. L. 105–277,
112 Stat. 2681 (1998).
E. Small Business Regulatory
Enforcement Fairness Act. The Small
Business Regulatory Enforcement
Fairness Act of 1996 (Pub. L. 104–121)
(SBREFA) provides generally for
congressional review of agency rules. A
reporting requirement is triggered in
instances where NCUA issues a final
rule as defined by section 551 of the
APA. 5 U.S.C. 551. The Office of
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Management and Budget has
determined that this rule is not a major
rule for purposes of SBREFA. As
required by SBREFA, NCUA will file the
appropriate reports with Congress and
the General Accounting Office so this
rule may be reviewed.
List of Subjects in 12 CFR Part 741
Credit unions, Requirements for
insurance.
By the National Credit Union
Administration Board on January 26, 2012.
Mary F. Rupp,
Secretary of the Board.
For the reasons set forth above, NCUA
amends 12 CFR part 741 as follows:
PART 741—REQUIREMENTS FOR
INSURANCE
1. The authority citation for part 741
continues to read:
■
Authority: 12 U.S.C. 1757, 1766(a), 1781–
1790 and 1790d; 31 U.S.C. 3717.
2. In § 741.3, add paragraph (b)(5) to
read as follows:
■
§ 741.3
Criteria
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*
*
*
*
*
(b) * * *
(5)(i) The existence of a written
interest rate risk policy (IRR policy’’)
and an effective interest rate risk
management program (‘‘effective IRR
program’’) as part of asset liability
management in all Federally- insured
credit unions (‘‘FICU’’) as follows. All
measurements are based on the most
recent Call Report filing of the FICU.
(A) A FICU with assets of more than
$50 million must adopt a written IRR
policy and implement an effective IRR
program;
(B) A FICU with assets of $10 million
or more but not greater than $50 million
must adopt a written IRR policy and
implement an effective IRR program if
the total of first mortgage loans it holds
combined with total investments with
maturities greater than five years, as
reported by the FICU on its most recent
Call Report, is equal to or greater than
100% of its net worth (i.e., a 1:1 ratio);
(C) A FICU with assets $10 million or
more but not greater than $50 million
are not required to comply with this
paragraph if the total of first mortgage
loans it holds, combined with total
investments with maturities greater than
five years, is less than 100% of its net
worth (i.e., a 1:1 ratio); and
(D) A FICU with less than $10 million
in assets is not required to comply with
this paragraph regardless of the amount
of first mortgage loans and total
investments with maturities greater than
five years it holds.
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(ii) For purposes of paragraph (b)(5)(i)
of this section—
(A) A FICU is considered to hold a
first mortgage loan for its own portfolio
when it has not demonstrated the intent
and ability to sell the loan to an
independent third party within 120
days of origination;
(B) Investments are defined in § 703.2
of this chapter. Investments with
maturities greater than five years are
defined as those reported by the FICU
on the Call Report; and
(C) Appendix B to this Part 741
provides guidance on how to develop an
IRR policy and an effective IRR
program. The guidance describes
widely-accepted best practices in the
management of interest rate risk for the
benefit of all FICUs.
*
*
*
*
*
■ 3. Part 741 is amended by adding
Appendix B to read as follows:
Appendix B to Part 741—Guidance for
an Interest Rate Risk Policy and an
Effective Program
Table of Contents
I. Introduction
A. Complexity
B. IRR Exposure
II. IRR Policy
III. IRR Oversight and Management
A. Board of Directors Oversight
B. Management Responsibilities
IV. IRR Measurement and Monitoring
A. Risk Measurement Systems
B. Risk Measurement Methods
C. Components of IRR Measurement
Methods
V. Internal Controls
VI. Decision-Making Informed by IRR
Measurement Systems
VII. Guidelines for Adequacy of IRR Policy
and Effectiveness of Program
VIII. Additional Guidance for Large Credit
Unions With Complex or High Risk
Balance Sheets
IX. Definitions
I. Introduction
This appendix provides guidance to FICUs
in developing an interest rate risk (IRR)
policy and program that addresses aspects of
asset liability management in a single
framework. An effective IRR management
program identifies, measures, monitors, and
controls IRR and is central to safe and sound
credit union operations. Given the
differences among credit unions, each credit
union should use the guidance in this
appendix to formulate a policy that embodies
its own practices, metrics and benchmarks
appropriate to its operations.
These practices should be established in
light of the nature of the credit union’s
operations and business, as well as its
complexity, risk exposure, and size. As these
elements increase, NCUA believes the IRR
practices should be implemented with
increasing degrees of rigor and diligence to
maintain safe and sound operations in the
area of IRR management. In particular, rigor
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and diligence are required to manage
complexity and risk exposure. Complexity
relates to the intricacy of financial
instrument structure, and to the composition
of assets and liabilities on the balance sheet.
In the case of financial instruments, the
structure can have numerous characteristics
that act simultaneously to affect the behavior
of the instrument. In the case of the balance
sheet, which contains multiple instruments,
assets and liabilities can act in ways that are
compounding or can be offsetting because
their impact on the IRR level may act in the
same or opposite directions. High degrees of
risk exposure require a credit union to be
diligently aware of the potential earnings and
net worth exposures under various interest
rate and business environments because the
margin for error is low.
A. Complexity
In influencing the behavior of instruments
and balance sheet composition, complexity is
a function of the predictability of the cash
flows. As cash flows become less predictable,
the uncertainty of both instrument and
balance sheet behavior increases. For
example, a residential mortgage is subject to
prepayments that will change at the option
of the borrower. Mortgage borrowers may pay
off their mortgage loans due to geographical
relocation, or may increase the amount of
their monthly payment above the minimum
contractual schedule due to other changes in
the borrower’s circumstances. This cash flow
unpredictability is also found in investments,
such as collateralized mortgage obligations,
because these contain mortgage loans.
Additionally, cash flow unpredictability
affects liabilities. For example, nonmaturity
share balances vary at the discretion of the
depositor making deposits and withdrawals,
and this may be influenced by a credit
union’s pricing of its share accounts.
B. IRR Exposure
Exposure to IRR is the vulnerability of a
credit union’s financial condition to adverse
movements in market interest rates. Although
some IRR exposure is a normal part of
financial intermediation, a high degree of this
exposure may negatively affect a credit
union’s earnings and net economic value.
Changes in interest rates influence a credit
union’s earnings by altering interest-sensitive
income and expenses (e.g. loan income and
share dividends). Changes in interest rates
also affect the economic value of a credit
union’s assets and liabilities, because the
present value of future cash flows and, in
some cases, the cash flows themselves may
change when interest rates change.
Consequently, the management of a credit
union’s pricing strategy is critical to the
control of IRR exposure.
All FICUs required to have an IRR policy
and program should incorporate the
following five elements into their IRR
program:
1. Board-approved IRR policy.
2. Oversight by the board of directors and
implementation by management.
3. Risk measurement systems assessing the
IRR sensitivity of earnings and/or asset and
liability values.
4. Internal controls to monitor adherence to
IRR limits.
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5. Decision making that is informed and
guided by IRR measures.
II. IRR Policy
The board of directors is responsible for
ensuring the adequacy of an IRR policy and
its limits. The policy should be consistent
with the credit union’s business strategies
and should reflect the board’s risk tolerance,
taking into account the credit union’s
financial condition and risk measurement
systems and methods commensurate with the
balance sheet structure. The policy should
state actions and authorities required for
exceptions to policy, limits, and
authorizations.
Credit unions have the option of either
creating a separate IRR policy or
incorporating it into investment, ALM, funds
management, liquidity or other policies.
Regardless of form, credit unions must
clearly document their IRR policy in writing.
The scope of the policy will vary
depending on the complexity of the credit
union’s balance sheet. For example, a credit
union that offers short-term loans, invests in
non-complex or short-term bullet
investments (i.e. a debt security that returns
100 percent of principal on the maturity
date), and offers basic share products may
not need to create an elaborate policy. The
policy for these credit unions may limit the
loan portfolio maturity, require a minimum
amount of short-term funds, and restrict the
types of permissible investments (e.g.
Treasuries, bullet investments). More
complex balance sheets, especially those
containing mortgage loans and complex
investments, may warrant a comprehensive
IRR policy due to the uncertainty of cash
flows.
The policy should establish
responsibilities and procedures for
identifying, measuring, monitoring,
controlling, and reporting IRR, and establish
risk limits. A written policy should:
• Identify committees, persons or other
parties responsible for review of the credit
union’s IRR exposure;
• Direct appropriate actions to ensure
management takes steps to manage IRR so
that IRR exposures are identified, measured,
monitored, and controlled;
• State the frequency with which
management will report on measurement
results to the board to ensure routine review
of information that is timely (e.g. current and
at least quarterly) and in sufficient detail to
assess the credit union’s IRR profile;
• Set risk limits for IRR exposures based
on selected measures (e.g. limits for changes
in repricing or duration gaps, income
simulation, asset valuation, or net economic
value);
• Choose tests, such as interest rate shocks,
that the credit union will perform using the
selected measures;
• Provide for periodic review of material
changes in IRR exposures and compliance
with board approved policy and risk limits;
• Provide for assessment of the IRR impact
of any new business activities prior to
implementation (e.g. evaluate the IRR profile
of introducing a new product or service); and
• Provide for at least an annual evaluation
of policy to determine whether it is still
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commensurate with the size, complexity, and
risk profile of the credit union.
IRR policy limits should maintain risk
exposures within prudent levels. Examples of
limits are as follows:
GAP: less than ±I 10 percent change in any
given period, or cumulatively over 12
months.
Income Simulation: net interest income
after shock change less than 20 percent over
any 12-month period.
Asset Valuation: after shock change in
book value of net worth less than 50 percent,
or after shock net worth of 4 percent or
greater.
Net Economic Value: after shock change in
net economic value less than 25 percent, or
after shock net economic value of 6 percent
or greater.
NCUA emphasizes these are only for
illustrative purposes, and management
should establish its own limits that are
reasonably supported. Where appropriate,
management may also set IRR limits for
individual portfolios, activities, and lines of
business.
III. IRR Oversight and Management
A. Board of Directors Oversight
The board of directors is responsible for
oversight of their credit union and for
approving policy, major strategies, and
prudent limits regarding IRR. To meet this
responsibility, understanding the level and
nature of IRR taken by the credit union is
essential. Accordingly, the board should
ensure management executes an effective IRR
program.
Additionally, the board should annually
assess if the IRR program sufficiently
identifies, measures, monitors, and controls
the IRR exposure of the credit union. Where
necessary, the board may consider obtaining
professional advice and training to enhance
its understanding of IRR oversight.
B. Management Responsibilities
Management is responsible for the daily
management of activities and operations. In
order to implement the board’s IRR policy,
management should:
• Develop and maintain adequate IRR
measurement systems;
• Evaluate and understand IRR risk
exposures;
• Establish an appropriate system of
internal controls (e.g. separation between the
risk taker and IRR measurement staff);
• Allocate sufficient resources for an
effective IRR program. For example, a
complex credit union with an elevated IRR
risk profile will likely necessitate a greater
allocation of resources to identify and focus
on IRR exposures;
• Develop and support competent staff
with technical expertise commensurate with
the IRR program;
• Identify the procedures and assumptions
involved in implementing the IRR
measurement systems; and
• Establish clear lines of authority and
responsibility for managing IRR; and
• Provide a sufficient set of reports to
ensure compliance with board approved
policies.
Where delegation of management authority
by the board occurs, this may be to
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designated committees such as an asset
liability committee or other equivalent. In
credit unions with limited staff, these
responsibilities may reside with the board or
management. Significant changes in
assumptions, measurement methods, tests
performed, or other aspects involved in the
IRR process should be documented and
brought to the attention of those responsible.
IV. IRR Measurement and Monitoring
A. Risk Measurement Systems
Generally, credit unions should have IRR
measurement systems that capture and
measure all material and identified sources of
IRR. An IRR measurement system quantifies
the risk contained in the credit union’s
balance sheet and integrates the important
sources of IRR faced by a credit union in
order to facilitate management of its risk
exposures. The selection and assessment of
appropriate IRR measurement systems is the
responsibility of credit union boards and
management.
Management should:
• Rely on assumptions that are reasonable
and supportable;
• Document any changes to assumptions
based on observed information;
• Monitor positions with uncertain
maturities, rates and cash flows, such as
nonmaturity shares, fixed rate mortgages
where prepayments may vary, adjustable rate
mortgages, and instruments with embedded
options, such as calls; and
• Require any interest rate risk calculation
techniques, measures and tests to be
sufficiently rigorous to capture risk.
B. Risk Measurement Methods
The following discussion is intended only
as a general guide and should not be used by
credit unions as an endorsement of a
particular method. An IRR measurement
system may rely on a variety of different
methods. Common examples of methods
available to credit unions are GAP analysis,
income simulation, asset valuation, and net
economic value. Any measurement
method(s) used by a credit union to analyze
IRR exposure should correspond with the
complexity of the credit union’s balance
sheet so as to identify any material sources
of IRR.
GAP Analysis
GAP analysis is a simple IRR measurement
method that reports the mismatch between
rate sensitive assets and rate sensitive
liabilities over a given time period. GAP can
only suffice for simple balance sheets that
primarily consist of short-term bullet type
investments and non mortgage-related assets.
GAP analysis can be static, behavioral, or
based on duration.
Income Simulation
Income simulation is an IRR measurement
method used to estimate earnings exposure to
changes in interest rates. An income
simulation analysis projects interest cash
flows of all assets, liabilities, and off-balance
sheet instruments in a credit union’s
portfolio to estimate future net interest
income over a chosen timeframe. Generally,
income simulations focus on short-term time
horizons (e.g. one to three years). Forecasting
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income is assumption sensitive and more
uncertain the longer the forecast period.
Simulations typically include evaluations
under a base-case scenario, and
instantaneous parallel rate shocks, and may
include alternate interest-rate scenarios. The
alternate rate scenarios may involve ramped
changes in rates, twisting of the yield curve,
and/or stressed rate environments devised by
the user or provided by the vendor.
NCUA Asset Valuation Tables
For credit unions lacking advanced IRR
methods that seek simple valuation
measures, the NCUA Asset Valuation Tables
are available and prepared quarterly by the
NCUA. These are available on the NCUA
Web site through www.ncua.gov.
These measures provide an indication of a
credit union’s potential interest rate risk,
based on the risk associated with the asset
categories of greatest concern—(e.g.,
mortgage loans and investment securities).
The tables provide a simple measure of the
potential devaluation of a credit union’s
mortgage loans and investment securities that
occur during ± 300 basis point parallel rate
shocks, and report the resulting impact on
net worth.
Net Economic Value (NEV)
NEV measures the effect of interest rates on
the market value of net worth by calculating
the present value of assets minus the present
value of liabilities. This calculation measures
the long-term IRR in a credit union’s balance
sheet at a fixed point in time. By capturing
the impact of interest rate changes on the
value of all future cash flows, NEV provides
a comprehensive measurement of IRR.
Generally, NEV computations demonstrate
the economic value of net worth under
current interest rates and shocked interest
rate scenarios.
One NEV method is to discount cash flows
by a single interest rate path. Credit unions
with a significant exposure to assets or
liabilities with embedded options should
consider alternative measurement methods
such as discounting along a yield curve (e.g.
the U.S. Treasury curve, LIBOR curve) or
using multiple interest rate paths. Credit
unions should apply and document
appropriate methods, based on available data
(e.g. utilizing observed market values), when
valuing individual or groups of assets and
liabilities.
C. Components of IRR Measurement Methods
In the initial setup of IRR measurement,
critical decisions are made regarding
numerous variables in the method. These
variables include but are not limited to the
following.
Chart of Accounts
Credit unions using an IRR measurement
method should define a sufficient number of
accounts to capture key IRR characteristics
inherent within their product lines. For
example, credit unions with significant
holdings of adjustable-rate mortgages should
differentiate balances by periodic and
lifetime caps and floors, the reset frequency,
and the rate index used for rate resets.
Similarly, credit unions with significant
holdings of fixed-rate mortgages should
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differentiate at least by original term, e.g., 30
or 15-year, and coupon level to reflect
differences in prepayment behaviors.
Aggregation of Data Input
As the credit union’s complexity, risk
exposure, and size increases, the degree of
detail should be based on data that is
increasingly disaggregated. Because
imprecision in the measurement process can
materially misstate risk levels, management
should evaluate the potential loss of
precision from any aggregation and
simplification used in its measurement of
IRR.
Account Attributes
Account attributes define a product,
including: P\principal type, rate type, rate
index, repricing interval, new volume
maturity distribution, accounting accrual
basis, prepayment driver, and discount rate.
Assumptions
IRR measurement methods rely on
assumptions made by management in order
to identify IRR. The simplest example is of
future interest rate scenarios. The
management of IRR will require other
assumptions such as: Projected balance sheet
volumes; prepayment rates for loans and
investment securities; repricing sensitivity,
and decay rates of nonmaturity shares.
Examples of these assumptions follow.
Example 1. Credit unions should consider
evaluating the balance sheet under flat (i.e.
static) and/or planned growth scenarios to
capture IRR exposures. Under a flat scenario,
runoff amounts are reinvested in their
respective asset or liability account.
Conducting planned growth scenarios allows
management to assess the IRR impact of the
projected change in volume and/or
composition of the balance sheet.
Example 2. Loans and mortgage related
securities contain prepayment options that
enable the borrower to prepay the obligation
prior to maturity. This prepayment option
makes it difficult to project the value and
earnings stream from these assets because the
future outstanding principal balance at any
given time is unknown. A number of factors
affect prepayments, including the refinancing
incentive, seasonality (the particular time of
year), seasoning (the age of the loan), member
mobility, curtailments (additional principal
payments), and burnout (borrowers who
don’t respond to changes in the level of rates,
and pay as scheduled). Prepayment speeds
may be estimated or derived from numerous
national or vendor data sources.
Example 3. In the process of IRR
measurement, the credit union must estimate
how each account will reprice in response to
market rate fluctuations. For example, when
rates rise 300 basis points, the credit union
may raise its asset or liability rates in a like
amount or not, and may choose to lag the
timing of its pricing change.
Example 4. Nonmaturity shares include
those accounts with no defined maturity
such as share drafts, regular shares, and
money market accounts. Measuring the IRR
associated with these accounts is difficult
because the risk measurement calculations
require the user to define the principal cash
flows and maturity. Credit unions may
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assume that there is no value when
measuring the associated IRR and carry these
values at book value or par. Many credit
unions adopt this approach because it keeps
the measurement method simple.
Alternatively, a credit union may attribute
value to these shares (i.e. premium) on the
basis that these shares tend to be lower cost
funds that are core balances by virtue of
being relatively insensitive to interest rates.
This method generally results in nonmaturity
shares priced/valued in a way that will
produce an increased net economic value.
Therefore, the underlying assumptions of the
shares require scrutiny.
Credit unions that forecast share behavior
and incorporate those assumptions into their
risk identification and measurement process
should perform sensitivity analysis.
V. Internal Controls
Internal controls are an essential part of a
safe and sound IRR program. If possible,
separation of those responsible for the risk
taking and risk measuring functions should
occur at the credit union.
Staff responsible for maintaining controls
should periodically assess the overall IRR
program as well as compliance with policy.
Internal audit staff would normally assume
this role; however, if there is no internal
auditor, management, or a supervisory
committee that is independent of the IRR
process, may perform this role. Where
appropriate, management may also
supplement the internal audit with outside
expertise to assess the IRR program. This
review should include policy compliance,
timeliness, and accuracy of reports given to
management and the board.
Audit findings should be reported to the
board or supervisory committee with
recommended corrective actions and
timeframes. The individuals responsible for
maintaining internal controls should
periodically examine adherence to the policy
related to the IRR program.
VI. Decision-Making Informed by IRR
Measurement Systems
Management should utilize the results of
the credit union’s IRR measurement systems
in making operational decisions such as
changing balance sheet structure, funding,
pricing strategies, and business planning.
This is particularly the case when measures
show a high level of IRR or when
measurement results approach boardapproved limits.
NCUA recognizes each credit union has its
own individual risk profile and tolerance
levels. However, when measures of fair value
indicate net worth is low, declining, or even
negative, or income simulations indicate
reduced earnings, management should be
prepared to identify steps, if necessary, to
bring risk within acceptable levels. In any
case, management should understand and
use their IRR measurement results, whether
generated internally or externally, in the
normal course of business. Management
should also use the results proactively as a
tool to adjust asset liability management for
changes in interest rate environments.
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IRR policy and the effectiveness of their
program to manage IRR.
BILLING CODE 7535–01–P
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VII. Guidelines for Adequacy of IRR Policy
and Effectiveness of Program
The following guidelines will assist credit
unions in determining the adequacy of their
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BILLING CODE 7535–01–C
NCUA acknowledges both the range of IRR
exposures at credit unions, and the diverse
means that they may use to accomplish an
effective program to manage this risk. NCUA
therefore does not stipulate specific
quantitative standards or limits for the
management of IRR applicable to all credit
unions, and does not rely solely on the
results of quantitative approaches to evaluate
the effectiveness of IRR programs.
Assumptions, measures and methods used by
a credit union in light of its size, complexity
and risk exposure determine the specific
appropriate standard. However, NCUA
strongly affirms the need for adequate
practices for a program to effectively manage
IRR. For example, policy limits on IRR
exposure are not adequate if they allow a
credit union to operate with an exposure that
is unsafe or unsound, which means that the
credit union may suffer material losses under
plausible adverse circumstances as a result of
this exposure. Credit unions that do not have
a written IRR policy or that do not have an
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15:14 Feb 01, 2012
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effective IRR program are out of compliance
with § 741.3 of NCUA’s regulations.
VIII. Additional Guidance for Large Credit
Unions With Complex or High Risk Balance
Sheets
FICUs with assets of $500 million or
greater must obtain an annual audit of their
financial statements performed in accordance
with generally accepted accounting
standards. 12 CFR 715.5, 715.6, 741.202. For
purposes of data collection, NCUA also uses
$500 million and above as its largest credit
union asset range. In order to gather
information and to monitor IRR exposure at
larger credit unions as it relates to the share
insurance fund, NCUA will use this as the
criterion for definition of large credit unions
for purposes of this section of the guidance.
Given the increased exposure to the share
insurance fund, NCUA encourages the
responsible officials at large credit unions
that are complex or high risk to fully
understand all aspects of interest rate risk,
including but not limited to the credit
union’s IRR assessment and potential
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Fmt 4700
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directional changes in IRR exposures. For
example, the credit union should consider
the following:
• A policy which provides for the use of
outside parties to validate the tests and limits
commensurate with the risk exposure and
complexity of the credit union;
• IRR measurement systems that report
compliance with policy limits as shown both
by risks to earnings and net economic value
of equity under a variety of defined and
reasonable interest rate scenarios;
• The effect of changes in assumptions on
IRR exposure results (e.g. the impact of
slower or faster prepayments on earnings and
economic value); and,
• Enhanced levels of separation between
risk taking and risk assessment (e.g.
assignment of resources to separate the
investments function from IRR measurement,
and IRR monitoring and oversight).
IX. Definitions
Basis risk: The risk to earnings and/or
value due to a financial institution’s holdings
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ER02FE12.013
5166
Federal Register / Vol. 77, No. 22 / Thursday, February 2, 2012 / Rules and Regulations
of multiple instruments, based on different
indices that are imperfectly correlated.
Interest rate risk: The risk that changes in
market rates will adversely affect a credit
union’s net economic value and/or earnings.
Interest rate risk generally arises from a
mismatch between the timing of cash flows
from fixed rate instruments, and interest rate
resets of variable rate instruments, on either
side of the balance sheet. Thus, as interest
rates change, earnings or net economic value
may decline.
Option risk: The risk to earnings and/or
value due to the effect on financial
instruments of options associated with these
instruments. Options are embedded when
they are contractual within, or directly
associated with, the instrument. An example
of a contractual embedded option is a call
option on an agency bond. An example of a
behavioral embedded option is the right of a
residential mortgage holder to vary
prepayments on the mortgage through time,
either by making additional premium
payments, or by paying off the mortgage prior
to maturity.
Repricing risk: The repricing of assets or
liabilities following market changes can
occur in different amounts and/or at different
times. This risk can cause returns to vary.
Spread risk: The risk to earnings and/or
value resulting from variations through time
of the spread between assets or liabilities to
an underlying index such as the Treasury
curve.
Yield curve risk: The risk to earnings and/
or value due to changes in the level or slope
of underlying yield curves. Financial
instruments can be sensitive to different
points on the curve. This can cause returns
to vary as yield curves change.
[FR Doc. 2012–2091 Filed 2–1–12; 8:45 am]
BILLING CODE 7535–01–P
DEPARTMENT OF TRANSPORTATION
Federal Aviation Administration
14 CFR Part 39
[Docket No. FAA–2011–0691; Directorate
Identifier 2011–NE–26–AD; Amendment 39–
16909; AD 71–13–01R1]
RIN 2120–AA64
Federal Aviation
Administration (FAA), DOT.
ACTION: Final rule; rescission.
We are rescinding an
airworthiness directive (AD) for
Lycoming Engines model TIO–540–A
series reciprocating engines. The
existing AD, AD 71–13–01, was
prompted by a report of a failed fuel
injector tube assembly. Since we issued
AD 71–13–01, we became aware that
Lycoming Engines no longer supports
Service Bulletin (SB) No. 335A, which
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Jkt 226001
This AD is effective March 8,
2012.
For service information
identified in this AD, contact Lycoming,
652 Oliver Street, Williamsport, PA
17701; phone: (570) 323–6181; fax: (570)
327–7101; Web site:
www.lycoming.com. You may review
copies of the referenced service
information at the FAA, Engine &
Propeller Directorate, 12 New England
Executive Park, Burlington, MA. For
information on the availability of this
material at the FAA, call (781) 238–
7125.
ADDRESSES:
Examining the AD Docket
You may examine the AD docket on
the Internet at https://
www.regulations.gov; or in person at the
Docket Management Facility between
9 a.m. and 5 p.m., Monday through
Friday, except Federal holidays. The AD
docket contains this AD, the regulatory
evaluation, any comments received, and
other information. The address for the
Docket Office (phone: (800) 647–5527)
is Document Management Facility, U.S.
Department of Transportation, Docket
Operations, M–30, West Building
Ground Floor, Room W12–140, 1200
New Jersey Avenue SE., Washington,
DC 20590.
FOR FURTHER INFORMATION CONTACT:
Norm Perenson, Aerospace Engineer,
New York Aircraft Certification Office,
FAA, Engine & Propeller Directorate,
1600 Stewart Avenue, Suite 410,
Westbury, NY 11590; phone: (516) 228–
7337; fax: (516) 794–5531; email:
Norman.perenson@faa.gov.
Discussion
AGENCY:
VerDate Mar<15>2010
DATES:
SUPPLEMENTARY INFORMATION:
Airworthiness Directives; Lycoming
Engines Reciprocating Engines
SUMMARY:
was incorporated by reference in AD
71–13–01. The intent of the
requirements of that SB is now in
Lycoming Engines Mandatory SB No.
342F, which we have incorporated by
reference into AD 2008–14–07. The
FAA determined, therefore, that this
requirement is duplicated by another
AD.
We issued a notice of proposed
rulemaking (NPRM) to amend 14 CFR
part 39 to rescind an AD that would
apply to the specified products. That
NPRM published in the Federal
Register on July 19, 2011 (76 FR 42609).
That NPRM proposed to rescind AD 71–
13–01 (Amendment number is 39–1231;
36 FR 11512–03, June 15, 1971) for
Lycoming Engines model TIO–540–A
series reciprocating engines. That AD
requires a one-time visual inspection of
external fuel injector lines on Lycoming
Engines model TIO–540–A series
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Fmt 4700
Sfmt 4700
5167
reciprocating engines for fuel stains,
cracks, dents, and bend radii under 5⁄8
inch and, if necessary, removal from
service and replacement with
serviceable parts. That AD also requires
installing, if necessary, fuel injector line
support clamps in accordance with
Lycoming Engines SB No. 335 or later
version of that SB.
Since we issued AD 71–13–01
(Amendment number is 39–1231; 36 FR
11512–03, June 15, 1971), Lycoming
Engines has informed us that it no
longer supports SB No. 335A. They also
pointed out that Lycoming Engines
Mandatory SB No. 342F, dated June 4,
2010, or the Instructions for Continued
Airworthiness section of the Engine
Overhaul Manual is the service
information that owners, operators, and
certificated repair facilities must use for
initial and repetitive visual inspections
of external fuel lines on all affected
Lycoming Engines reciprocating
engines.
We incorporated by reference
Lycoming Engines Mandatory SB No.
342E, dated May 18, 2004, into AD
2008–14–07 (73 FR 39574, July 10,
2008). We will supersede AD 2008–14–
07 to incorporate by reference Lycoming
Engines Mandatory SB No. 342F, dated
June 4, 2010.
Comments
We gave the public the opportunity to
participate in developing this AD. We
received no comments on the NPRM (76
FR 42609, July 19, 2011).
Conclusion
We reviewed the relevant data and
determined that air safety and the
public interest require rescinding the
AD as proposed.
Authority for This Rulemaking
Title 49 of the United States Code
specifies the FAA’s authority to issue
rules on aviation safety. Subtitle I,
section 106, describes the authority of
the FAA Administrator. Subtitle VII:
Aviation Programs, describes in more
detail the scope of the Agency’s
authority.
We are issuing this rulemaking under
the authority described in Subtitle VII,
Part A, Subpart III, Section 44701:
‘‘General requirements.’’ Under that
section, Congress charges the FAA with
promoting safe flight of civil aircraft in
air commerce by prescribing regulations
for practices, methods, and procedures
the Administrator finds necessary for
safety in air commerce. This regulation
is within the scope of that authority
because it addresses an unsafe condition
that is likely to exist or develop on
E:\FR\FM\02FER1.SGM
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Agencies
[Federal Register Volume 77, Number 22 (Thursday, February 2, 2012)]
[Rules and Regulations]
[Pages 5155-5167]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-2091]
========================================================================
Rules and Regulations
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains regulatory documents
having general applicability and legal effect, most of which are keyed
to and codified in the Code of Federal Regulations, which is published
under 50 titles pursuant to 44 U.S.C. 1510.
The Code of Federal Regulations is sold by the Superintendent of Documents.
Prices of new books are listed in the first FEDERAL REGISTER issue of each
week.
========================================================================
Federal Register / Vol. 77, No. 22 / Thursday, February 2, 2012 /
Rules and Regulations
[[Page 5155]]
NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Part 741
RIN 3133-AD66
Interest Rate Risk Policy and Program
AGENCY: National Credit Union Administration (NCUA).
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: NCUA is issuing a final rule requiring Federally insured
credit unions to develop and adopt a written policy on interest rate
risk management and a program to effectively implement that policy, as
part of their asset liability management responsibilities. The interest
rate risk policy and implementation program will be among the factors
NCUA will consider in determining a credit union's insurability. To
assist credit unions, the final rule includes an appendix setting forth
guidance on developing an interest rate risk policy and an effective
implementation program based on generally recognized best practices for
safely and soundly managing interest rate risk.
DATES: This rule is effective on September 30, 2012.
FOR FURTHER INFORMATION CONTACT: Jeremy Taylor, Senior Capital Markets
Specialist, Office of Examination and Insurance, National Credit Union
Administration, 1775 Duke Street, Alexandria, Virginia 22314, or
telephone: (703) 518-6620.
SUPPLEMENTARY INFORMATION:
I. Background
II. Subject-by-Subject Discussion of Comments on Proposed Rule
III. Regulatory Procedures
I. Background \1\
---------------------------------------------------------------------------
\1\ President Obama signed the Plain Writing Act of 2010 (Pub.
L. 111-274) into law on October 13, 2010, to ``improve the
effectiveness and accountability of Federal agencies to the public
by promoting clear Government communication that the public can
understand and use.'' This preamble is written to meet the plain
writing objectives.
---------------------------------------------------------------------------
A. What Is Interest Rate Risk? The term ``interest rate risk''
(``IRR'') refers to the vulnerability of a credit union's financial
condition to adverse movements in market interest rates. Although some
IRR is a normal part of financial intermediation,\2\ it still may
negatively affect a credit union's earnings, net worth, and its net
economic value, which is the difference between the market value of
assets and the market value of liabilities. Changes in interest rates
influence a credit union's earnings by altering interest-sensitive
income and expenses (e.g., loan income and share dividends). Changes in
interest rates also affect the economic value of a credit union's
assets and liabilities because the present value of future cash flows
and, in some cases, the cash flows themselves may change when interest
rates change. IRR takes several forms: Repricing risk, yield curve
risk, spread risk, basis risk, and options risk. For definitions of
these risks, see section IX. of Appendix B following the final rule
text below.
---------------------------------------------------------------------------
\2\ The process of channeling funds from savers to investors.
---------------------------------------------------------------------------
B. Why is NCUA Amending the Existing Rule? In the past, NCUA issued
guidance on asset/liability management and IRR management in Letters to
Credit Unions.\3\ NCUA believes Federally-insured credit unions
(``FICUs''), relying on this guidance, generally have managed their IRR
adequately. However, FICUs have recently experienced increasing
exposure to IRR due to changes in balance sheet composition and
increased uncertainty in the financial markets. This increase has
heightened the importance for FICUs to have strong policies and
programs explicitly addressing the credit union's management of
controls for IRR.
---------------------------------------------------------------------------
\3\ Letters to Credit Unions: 99-CU-12, Real Estate Lending and
Balance Sheet Risk Management, Aug. 1999; 00-CU-10, Asset Liability
Management Examination Procedures, Nov. 2000; 00-CU-13, Liquidity
and Balance Sheet Risk Management, Dec. 2000; 01-CU-08, Liability
Management--Highly Rate-Sensitive and Volatile Funding Sources, July
2001; 01-CU-19, Managing Share Inflows in Uncertain Times, Oct.
2001; 03-CU-11, Non-Maturity Shares and Balance Sheet Risk, July
2003; 03-CU-15, Real Estate Concentrations and Interest Rate Risk
Management for Credit Unions with Large Positions in Fixed-Rate
Mortgage Portfolios, Sept. 2003; 06-CU-16, Interagency Guidance on
Nontraditional Mortgage Product Risk, Oct. 2006; 10-CU-06,
Interagency Advisory on Interest Rate Risk Management, Jan. 6, 2010.
NCUA plans to issue a Letter to Credit Unions addressing the
``Interagency Advisory on Interest Rate Risk Management, Frequently
Asked Questions'' that was issued on January 12, 2012.
---------------------------------------------------------------------------
Therefore, it is both timely and appropriate to require certain
credit unions to have a formal policy addressing IRR management and a
corresponding program to effectively implement that policy. Further, it
is incumbent upon NCUA, as steward of the National Credit Union Share
Insurance Fund (``the Fund''), to consider a credit union's IRR
management policy and implementation program as a factor in determining
whether the Fund should insure its member deposits.
C. What Were the Requirements of the Proposed Rule? The existing
regulation on insurability of accounts prescribes certain criteria NCUA
must consider in ``determining the insurability of a credit union * * *
and in continuing the insurability of its accounts.'' 12 CFR 741.3.
Among the ``factors * * * to be considered in determining whether the
credit union's financial condition and policies are both safe and
sound,'' are the existence of written lending and investment policies.
Id. Sec. 741.3(b)(2)-(3). IRR management policies and practices are
absent from the existing factors.
In response to credit unions' increasing exposure to IRR, NCUA
issued a proposed rule in March 2011 amending section 741.3(b) to
require, as an additional factor in determining whether a ``credit
union's financial condition and policies are both safe and sound,'' the
existence of a written policy on IRR management and a program to
effectively implement that policy (together ``an IRR policy and
program''). 76 FR 16570 (Mar. 24, 2011). The proposed rule set an
effective date for compliance at three months after the publication of
the final rule in the Federal Register.
As proposed, the rule would apply to two categories of FICUs, (a)
those having more than $50 million in assets; and (b) those having
assets between $10 million and $50 million whose ratio of first
mortgage loans, plus investments with maturities greater than five
years (the
[[Page 5156]]
numerator), equals or exceeds 100% of its net worth (the denominator).
This ratio is known as the ``Supervisory Interest Rate Risk Threshold
Ratio'' (``SIRRT ratio'') and is explained in section II.D. of this
preamble. Conversely, the rule would not apply to FICUs with assets of
less than $10 million, or to those with assets between $10 million and
$50 million whose combined first mortgage loans, plus investments with
maturities greater than five years, are less than 100% of its net
worth.
To help credit unions understand and meet NCUA's expectations for
compliance with amended section 741.3(b), the proposed rule included an
appendix (``Appendix B'') setting forth comprehensive guidance on
developing both a written policy on IRR management and a program to
effectively implement that policy.\4\ Appendix B acknowledges that it
is not possible to establish a ``one-size-fits-all'' template of IRR
management standards and metrics that would be appropriate for all
FICUs. Rather, it recognizes that IRR management requires specialized
judgments based on each credit union's business objectives and ability
to withstand risk.
---------------------------------------------------------------------------
\4\ NCUA plans to introduce a new IRR questionnaire that
corresponds to Appendix B of the final rule to replace the IRR
questionnaire presently used by examiners. The present questionnaire
is located on NCUA's Web site at: https://www.ncua.gov/Resources/CUs/ALM/Pages/ALMReview.aspx.
---------------------------------------------------------------------------
Appendix B leaves to each affected credit union's board of
directors the obligation and responsibility to make those judgments.
Yet, it also provides them a framework of five fundamental elements of
an effective IRR management program: A comprehensive, written IRR
policy; accountable IRR oversight by board of directors and management;
appropriate IRR measurement and monitoring systems; good internal
controls; and informed decision-making based on IRR measurement system
results. It also provides guidelines for determining the adequacy of
IRR policy and effectiveness of implementation program. The appendix
also includes guidance for large credit unions with complex or high-
risk balance sheets.
II. Subject-by-Subject Discussion of Comments on Proposed Rule
The proposed rule was issued with a 60-day comment period that
expired on May 23, 2011. 76 FR 16570. NCUA received 48 comment letters
in response--29 from Federally-insured credit unions, 13 from credit
union industry trade associations, one from an association of state
credit union supervisory authorities, and 5 from industry consultants.
Five commenters affirmatively supported the proposed rule; 29
commenters either opposed the rule or did not state a definitive
position; and 14 commenters addressed particular aspects of the rule or
made suggestions for improving it. The comments on the proposed rule
are addressed as follows:
A. Authority to Impose Insurability Criteria. A trade association
compared the existing insurability factors requiring a lending policy
and an investment policy with the proposed requirement for an IRR
management policy and implementation program. This commenter
distinguished between lending and investment authorities and
limitations that are ``specifically detailed in the Federal Credit
Union Act'' and the authority to require IRR management, which it
contends ``is a regulatory directive and is not addressed in the Act.''
The suggestion that there is authority in the Act to require the
existing lending and investment policies but not to require an IRR
management policy and implementation program is incorrect.\5\ The basis
for both the existing and proposed factors for insurability is safety
and soundness. As section 741.3(b) itself confirms, the ``financial
policies and conditions'' it prescribes are ``factors * * * to be
considered in determining whether the credit union's financial
condition and policies are both safe and sound.''
---------------------------------------------------------------------------
\5\ The Act itself does contain authority for adding the IRR
policy and implementation program as an insurability criterion.
Title II of the Act requires NCUA, when granting insurance to a
Federal or state credit union, to consider the applicant's
``history, financial condition and management policies,'' 12 U.S.C.
1781(c)(1)(A), and to deny insurance if it finds that the
applicant's ``financial condition and policies are unsafe or
unsound.'' Id. Sec. 1781(c)(2).
---------------------------------------------------------------------------
B. Regulatory Burden and Duplication. A number of commenters said
that requiring an IRR management policy and implementation program as
insurability criteria imposes an excessive regulatory burden on credit
unions, especially in the wake of the regulatory mandates imposed as a
result of the Dodd-Frank Wall Street Reform and Consumer Protection
Act, 12 U.S.C. 5301 et seq. Emphasizing this point, some commenters
protested that other financial regulators have not introduced IRR
management rules.
A number of commenters also noted that mechanisms to manage credit
unions' IRR already exist that are sufficient to monitor and assess
shifts in IRR and to indicate when corrective action is warranted. For
example, they cite interagency advisories, NCUA Letters to Credit
Unions, and credit union examinations themselves. See footnote 3 above.
NCUA does not dispute the utility of these existing mechanisms, but
does not agree that they are sufficient in an environment of increased
risk exposure and interest rate volatility. As detailed in sections C.
and D. below in this preamble, IRR exposure at credit unions is on the
rise to the point that it is higher than at peer commercial banks.
It is unclear that the numerous Letters to Credit Unions NCUA has
periodically issued, providing supervisory advice and guidance on IRR
management, has led to improvements in IRR management that are
sufficient to meet the growing risk exposure and increasing interest
rate volatility. Appendix B to the final rule is intended to complement
the existing guidance by providing a framework for each credit union to
develop its own definitive IRR policy and program. Accordingly, the
final rule adopts as timely and prudent the proposed requirements for
an IRR management policy and implementation program as additional
criteria for insurability.
C. Need for Interest Rate Risk Policy and Program. A number of
commenters asserted that NCUA has not demonstrated a need to require an
IRR management policy and implementation program beyond the conclusion
that IRR exposure has increased. One commenter contended that the past
performance of credit unions in managing net interest margins following
periods of rising rates suggests that an IRR management policy and
implementation program is unnecessary. Recent relevant data
demonstrates otherwise.
NCUA compared IRR exposure since 1996 of credit unions versus
commercial banks based on growth in real estate loans as a percentage
of total assets. At year-end 2010, residential mortgages accounted for
30.7% of credit union assets compared to only 18.4% at peer commercial
banks. In 1996, residential mortgages as a percent of total assets for
both credit unions and banks were in the 15-20% range.\6\ While peer
institutions have retreated from booking mortgage loans, credit unions
have increased residential mortgage holdings and taken on more interest
rate risk in the process.
---------------------------------------------------------------------------
\6\ See ``Interest Rate Risk Proposal Gets Ahead of the Curve,''
The NCUA Report (Apr. 2011, No. 4). This article concluded that the
IRR exposure of Federally insured credit unions has risen steeply
since 1996 relative to peer commercial banks.
---------------------------------------------------------------------------
Other NCUA data show the percent of credit unions with exposure to
mortgages, and the median level of
[[Page 5157]]
credit union IRR exposure to net worth by asset size cohort at year-end
2010, as depicted in Table 1:
---------------------------------------------------------------------------
\7\ See ``Size Matters: Another Perspective on IRR,'' The NCUA
Report (June 2011, No. 6).
[GRAPHIC] [TIFF OMITTED] TR02FE12.006
Each of these measures indicates that the risk from changing
interest rates to credit unions with long-term fixed cash flows
increases with asset size and the escalation occurs most significantly
in the $10 million to $50 million asset cohort.
Credit unions can use sales of real estate loans originated to
reduce IRR exposure on their balance sheets. In that regard, a trade
association commented that credit unions' sales of first mortgage
originations during the current interest rate cycle have increased from
25-30% of first mortgage loans granted to over 50%. The trade
association argued that credit unions manage their net interest margin
in this and other ways. The commenter noted that following a 300 basis
point increase in the Fed funds rate in 1994 and a 425 basis point
increase in 2004-2006, credit union net interest margins fell only by 1
basis point in 1995, by 15 basis points in 2005, and by 11 basis points
in 2006.
Credit unions can manage net interest margins, for example, by
means of share deposit pricing. On this point, the commenter also
suggested the Federal Reserve is not expected to raise interest rates
quickly. The commenter also asserted that liquidity at credit unions
might allow them to offset IRR exposure due to their record levels of
long-term assets by raising deposit rates more slowly. NCUA notes that
in January 2012 the Federal Reserve indicated that it expected economic
conditions to warrant keeping the Federal funds rate at exceptionally
low levels at least through late 2014.
NCUA acknowledges the aggregate upward trend over the long term in
credit unions' sales of first mortgage real estate loans that they
originated. Most recently, the percentage of first mortgage real estate
loans sold fell to 44.8% of loans granted year to date in the 3rd
quarter of 2011, but this was from a high for the full year of 51.9% in
2010. NCUA notes that the present 44.8% level remains significantly
greater than the most recent low point of 26.3% of loans sold for the
year in 2007. The increase is concentrated in the largest credit
unions, however. For example, the percentage of first mortgage real
estate loans sold in the $10 million to $50 million asset cohort was
16.0% of first mortgage real estate loans granted at credit unions year
to date in the 3rd quarter of 2011, and 14.5% of first mortgage real
estate loans granted for the year in December 2007.
NCUA also acknowledges that credit unions use deposit interest
rates to mitigate the impact of increases in short-term rates on their
net interest margin. Understanding IRR requires taking into account the
historical levels of interest rates. Short-term rates presently are 500
basis points below 2006-2007 levels, and any return even to average
long-term rates is likely to stress credit unions' ability to manage
such a change in the level of interest rates. Reluctance to increase
deposit interest rates sufficiently in an effort to enhance earnings
and mitigate interest rate risk could trigger unexpected deposit
outflows and thereby increase a credit union's liquidity risk.
All these indicators of IRR exposure point to heightened risk for
credit unions. While acknowledging that credit unions act in various
ways to manage IRR, the consistent rise in IRR at credit unions
relative to other peer institutions deserves regulatory attention and
is warranted as a prerequisite for insurability.
D. Supervisory Interest Rate Risk Threshold (SIRRT). For credit
unions in the asset cohort of $10 million to $50 million, the proposed
and final rules rely on the SIRRT ratio as a reliable indicator of IRR
concentration:
[GRAPHIC] [TIFF OMITTED] TR02FE12.007
A credit union in that asset cohort must develop and adopt an IRR
policy and program only if its SIRRT ratio equals or exceeds 100% of
its net worth, i.e., a ratio of 1:1. The rule does not require a credit
union with assets under $10 million to develop and adopt an IRR policy
and program, regardless of its SIRRT.
NCUA has tracked the SIRRT ratio among the population of FICUs as
an aggregate percentage of their net worth from 2005 (when Call Reports
started to break out investment maturities at 5 years) to September
2011. Table 2 below depicts this aggregate ratio:
[[Page 5158]]
[GRAPHIC] [TIFF OMITTED] TR02FE12.008
As previously discussed, the percentage of residential real estate
loans declined from a high point of almost 35% of assets in 2008 to
30.7% of assets in 2010. See footnote 6 above. However, this does not
take into account the movement of FICU assets into long-term
investments since 2008, as the growth in consumer demand for mortgage
loans slowed during this recessionary period. When these elements are
included, as Table 2 shows, the SIRRT ratio increased from 256.2% of
net worth in 2008 to a high of 271.1% in March 2011. The ratio declined
to 264.8% in September 2011. Nonetheless, since 2005, the ratio has
increased from 199.1%. In sum, credit union assets that present the
highest IRR exposure have increased relative to credit union net worth
and have reached a significantly higher level. The IRR exposure levels
depicted by the data also indicate that credit unions' net interest
margin performance, as previously discussed, does not eliminate the
need for an IRR policy and IRR management program.
Several commenters questioned the components of the SIRRT
numerator. Some advocated limiting the maturity of first mortgages to
match the 5-year maturity limit of investments. Others supported
excluding adjustable rate mortgages from the numerator. One commenter
argued that the numerator should distinguish between fixed-rate and
variable-rate loans.
NCUA does not believe the components of the numerator of the SIRRT
ratio should be changed. Adjustable rate mortgages carry modeling risk
because these loans are complex. Specifically, they have periodic and
lifetime caps with varying reset dates and margins that must be
incorporated to reflect risk. These complex mortgages should therefore
be included in the SIRRT ratio.
A number of commenters addressed the asset size thresholds for
subjecting credit unions to the IRR policy and program. Of these,
several favored raising the asset ``floor'' to $20 million and $50
million, respectively, thus excluding credit unions below the
``floor.'' One commenter criticized use of asset thresholds altogether,
asserting that IRR may be present in credit unions regardless of asset
size. One commenter agreed that small credit unions should be excluded
by adhering to the $10 million asset ``floor'' originally proposed.
The comments on the SIRRT ratio overlook the fundamental reasons
for reliance on the ratio. Net worth is the reserve of funds available
to absorb the risks of a credit union, and it is therefore the best
measure against which to gauge the credit union's risk exposure. A
credit union where the SIRRT ratio is at or over 1:1 is exposed to IRR
at a heightened level. This requires additional attention by credit
unions in the $10 million to $50 million asset cohort to their IRR
policy and management program in order to manage this risk. At year-end
2010 in the $10 million to $50 million asset cohort, median first
mortgages to net worth (56.4%) exceeded the median for all credit
unions (35.0%). Additional NCUA data also shows at year-end 2010 that
for credit unions in the $10 million to $50 million asset cohort with a
SIRRT ratio at or above 1:1, median first mortgages to net worth was
179.9% of net worth, and median long-term residential mortgages
repricing at or longer than five years to net worth was 148.1% of net
worth. By comparison, credit unions in the $10 million to $50 million
asset cohort with a SIRRT ratio below 1:1 have a 2.7% ratio of median
first mortgages to net worth and a 28.5% ratio of median long-term
residential mortgages to net worth. NCUA therefore concludes that the
SIRRT ratio effectively partitions risk.
NCUA devised the SIRRT ratio's ``floor'' and ``ceiling'' thresholds
to minimize regulatory burden and at the same time ensure adequate
regulatory coverage of total credit union assets. Applying the
thresholds to the $10 million to $50 million asset cohort achieves both
of these objectives. Moreover, the data indicates that a credit union's
IRR exposure as its assets grow is likely to occur at the $10 million
to $50 million asset range At year-end 2010, among the total population
of FICUs, 3,184 credit unions had a SIRRT ratio equal to or exceeding
100% of their net worth, whereas 4,155 credit unions had a SIRRT ratio
less than 100% of their net worth, thus minimizing regulatory burden.
At the same time, applying the SIRRT ratio to the $10 million to $50
million asset cohort would have imposed the IRR policy and program
requirement on 95.5% of credit union assets, or $873.6 billion out of a
total of $914.4 billion in credit union assets.
NCUA reviewed data as of September 30, 2011 for purposes of the
final rule. The SIRRT ratio is depicted in Table 3 for credit unions by
asset cohort and it demonstrates the segregation of risk. As shown in
Table 2 previously, the
[[Page 5159]]
aggregate SIRRT ratio for all credit unions was 264.8%.
[GRAPHIC] [TIFF OMITTED] TR02FE12.009
The distribution of the number of credit unions not covered and
covered by the rule is depicted in Table 4 and it shows that 1,316
credit unions in the $10 to $50 Million asset cohort would not have
been covered by the rule, and 54.8% of all credit unions would not have
been covered by the rule.
[GRAPHIC] [TIFF OMITTED] TR02FE12.010
The distribution of credit union assets not covered and covered by
the rule is depicted in Table 5, which shows that 95.9% of all credit
union assets would have been covered by the rule based on September 30,
2011 data.
[GRAPHIC] [TIFF OMITTED] TR02FE12.011
Accordingly, the proposed $10 million ``floor'' and the proposed
$50 million ``ceiling'' thresholds as applied to the SIRRT ratio
continue to provide effective segregation of risk while reasonably
minimizing regulatory burden.
E. Application of the Rule. Many commenters expressed concern about
how the proposed rule would be applied in practice. Several observed
that it would impose a ``one-size-fits-all'' set of IRR policies, or be
used as a checklist by examiners, or viewed by examiners as a mandate,
or inhibit the flexibility of credit unions, thereby allowing examiners
to micro-manage them. A number of commenters were concerned that
examiners would apply the rule subjectively, leading to ``generic
standards.'' Others predicted that examiners would rely on peer data
and simplified assumptions. Finally, several noted the absence from the
rule of an express definition of what constitutes an ``effective
program.''
It is not the intent of the rule for examiners to subjectively
impose unduly standardized supervisory oversight. Examiners will be
expected to apply the standards within a consistent framework based on
their knowledge of each credit union's operations and available
resources. While the rule itself does not define what is an ``effective
program,'' the guidance in Appendix B does. It provides that ``an
effective IRR management program identifies, measures, monitors, and
controls IRR
[[Page 5160]]
and is central to safe and sound credit union operations.'' Further, as
the preamble to the proposed rule also recognized: ``it is impossible
to establish specific, regulatory requirements for IRR that would be
appropriate for all FICUs. IRR management involves judgment by a FICU
based on its own individual mission, structure, and circumstances. Any
rule must take into account the diversity of FICUs and avoid a one-
size-fits-all approach. Accordingly, FICUs should devise a policy and
risk management program appropriate to their own situation.'' 76 FR
16571. The NCUA Board reaffirms the notion that IRR management must be
individualized, while subject to regulatory oversight and prudent
insurability standards.
NCUA acknowledges that using simplifying assumptions to apply the
rule involves a certain degree of subjectivity, but believes this is a
necessary part of the supervision process. Any assumption used to
aggregate data or categorize financial instruments can be a simplifying
assumption. However, NCUA does not take issue with using such
assumptions or generic standards so long as these are consistent with
the best practices described in the January 2010 FFIEC Advisory on
Interest Rate Risk Management and take into account the size,
complexity and risk exposure of the credit union. NCUA recognizes the
use of peer data may be appropriate. Simplifying assumptions are part
of the practice of IRR management and are an issue only when they cause
either credit union management or an examiner to underestimate
complexity. For example, a credit union may use simplifying assumptions
in the process of modeling IRR, and these can be acceptable so long as
they do not cause interest rate risk to be misstated.
To address consistency of application NCUA plans to issue guidance
and training for examiners, including a questionnaire that is tailored
specifically to this rule. See footnote 4 above. The commentary in the
questionnaire emphasizes that the guidance items are not mandatory.
Credit unions are encouraged to review and discuss these guidance items
with their examiners.
F. Guidance on IRR Policy and Program. A number of commenters made
observations about the role of the specific guidance in Appendix B to
the rule. Of these, one commenter asked whether Appendix B supersedes
existing guidance on IRR management. One recommended publishing
Appendix B on the NCUA Web site when it is adopted. Another recommended
updating the Examiners Guide to include the guidance in Appendix B.
NCUA does not intend Appendix B to supplant existing advice on
specific aspects of IRR management. Existing NCUA Letters to Credit
Unions address specific aspects of IRR such as real estate lending,
liquidity, rate-sensitive funding sources, and non-maturity shares.
These Letters to Credit Unions are consistent with the practices set
forth in Appendix B and credit unions should continue to heed the
advice they give. See footnote 3 above. The guidance in Appendix B is
also complementary to the 2010 Interagency Advisory on Interest Rate
Risk Management and the 2012 Interagency Advisory on Interest Rate Risk
Management, Frequently Asked Questions. NCUA will continue to issue
Letters to Credit Unions relating to IRR management as necessary and
will update the Examiners Guide accordingly.
A number of commenters addressed technical aspects of IRR
measurement methods. Of these, some said Appendix B implied a
preference for the valuation of non-maturity shares at par. One said
that credit unions should be free to choose their own method. One noted
the selection of curves for discounting is debatable. One said a credit
union offering rate is the most defensible reinvestment rate. One said
that IRR measures using changes in rates might not fully reflect the
level of IRR. One said that 300 basis point shocks should not be an
industry standard for the rule. One said that parallel shock analysis
is not realistic. One recommended semiannual IRR testing in an IRR
management program.
NCUA responds to these and similar technical comments by
reiterating that it does not seek to endorse certain IRR measures,
measurement techniques, or assumptions over others. For example, NCUA
does not prescribe valuing non-maturity shares at par but it
acknowledges that such measures and the use of historical rate
scenarios may provide useful information. Similarly, NCUA does not
require discounting on yield curves or endorse any particular discount
rate. NCUA does recommend the use of pro forma risk measurement and the
discipline of utilizing relevant stress tests to better understand IRR
and to be aware of the scenarios that would have the most detrimental
impact on earnings, net worth, or net economic value. Base values of
balance sheet instruments are as integral to stating risk exposure as
stressed results. Testing should be as frequent as needed for a credit
union to be fully aware of its IRR exposure and semi-annual IRR testing
may not be sufficient to manage IRR.
Several more commenters made observations on the separation of
credit union responsibilities with respect to IRR. Of these, two
commented on the separation of risk taking and risk management. One of
these recommended that NCUA provide examples to suggest appropriate
separation of duties, and another one said that separation would be
burdensome.
NCUA does not believe this section of Appendix B on policy, board
oversight and credit union structure needs to be amended. The proposed
rule suggested that credit unions should separate risk-taking and risk
measurement functions ``if possible'', particularly in the case of
large, complex or high-risk credit unions. In the case of large,
complex or high-risk credit unions, the final rule already provides an
example of separating the investment function from the IRR measurement
function, e.g. having the IRR measurement function report to an audit
or supervisory committee. However, it is not the function of this rule
to prescribe specific organizational structures.
G. Alternatives to the Proposed Rule. A number of commenters
suggested that NCUA should focus on the 800 credit unions that lack an
IRR policy instead of the estimated 75% of credit unions that have such
policies in place. NCUA does not agree. The data introduced earlier
indicates that IRR overall is at an unprecedented level; it is not
limited to a small subset of credit unions.
Attempting to balance flexibility with regulatory concerns, one
commenter suggested that an effective IRR program would be one that
takes assets and liabilities into account, requires management reports
to the board, and performs tests as directed by regulators. NCUA agrees
that any rulemaking that addresses IRR should be crafted to not limit
credit union flexibility, while still considering regulatory concerns.
For this reason, the guidance in Appendix B is flexible. At the same
time, shifting interest rates pose a core risk that could jeopardize
the liquidity and solvency of credit unions. The steady increase in
this exposure to interest rate changes warrants a high level of
attention by management and oversight by NCUA and state supervisory
authorities. The Board therefore believes that an IRR policy and an
effective IRR management program must be implemented by regulation and
should not be left solely to the supervisory process.
H. Effective Date and Implementation of Final Rule. The proposed
rule prescribed a period of three months
[[Page 5161]]
between publication of the final rule and its effective date for credit
unions to comply with the rule's new requirements. A number of
commenters urged making the acclimation period longer than three months
and some recommended a phase-in period of as long as one year. In view
of these comments, NCUA has reassessed the steps and the time it will
take both affected credit unions and itself to acclimate to the final
rule.
Balancing its concern for a timely response to interest rate risk
issues against its objective to ensure careful implementation of the
final rule, the Board has decided to modify the effective date of the
final rule to September 30, 2012.
III. Regulatory Procedures
A. Regulatory Flexibility Act. The Regulatory Flexibility Act
requires NCUA to prepare an analysis to describe any significant
economic impact a rule may have on a substantial number of small
entities (primarily those credit unions with less than ten million
dollars in assets). By its terms, the final rule's requirement to
develop a written IRR management policy and a program to effectively
implement the policy do not apply to credit unions with less than $10
million in assets. Accordingly, this final rule will not have a
significant economic impact on a substantial number of small credit
unions and a Regulatory Flexibility Analysis is not warranted.
B. Paperwork Reduction Act. This final rule requires certain credit
unions to develop, as prerequisites for insurability of its member
deposits, a written IRR management policy (``an IRR policy'') and a
program to effectively implement the policy. The Paperwork Reduction
Act of 1995 (``PRA'') applies to rulemakings in which an agency by rule
creates a new paperwork burden on regulated entities or modifies an
existing burden. 44 U.S.C. 3507(d). For purposes of the PRA, a
paperwork burden may take the form of either a reporting or a
recordkeeping requirement, both referred to as information collections.
NCUA has determined that the requirement to develop an IRR policy
creates a new information collection requirement. As required, NCUA has
applied to the Office of Management and Budget (``OMB'') for approval
of the information collection requirement described below.
The final rule requires two categories of credit unions to develop
an IRR policy and program: those having more than $50 million in
assets; and those having assets between $10 million and $50 million
whose combined first mortgage loans, plus investments with maturities
greater than five years, equal or exceed 100% of net worth. As of
September 30, 2011, 3,246 FICUs (45% of all FICUs) fell in either of
these two categories. NCUA estimates, however, that 2,446 of the
affected FICUs (or approximately 75% of them) already have an IRR
policy in place; they will need only to review the existing IRR policy,
and make appropriate adjustments where necessary, to comply with the
final rule. The other 800 affected FICUs (approximately 25% of them)
will need to newly develop an IRR policy. Periodic review of an
existing IRR policy should require minimal or no additional burden.
The final rule is accompanied by an Appendix setting forth
comprehensive guidance on developing both an IRR policy and program.
The guidance specifies eight policy items that must be addressed. See
section II of Appendix B following rule text below. The length of an
IRR management policy covering these eight policy elements will vary
according to the credit union's business strategies. A credit union
offering basic share accounts and short-term loans but no mortgage
loans, and that makes relatively simple investments, should be able to
develop a basic IRR policy in one to two hours that establishes, for
example, maturity limits for loans, the minimum amount of short-term
funds, and the range of permissible investments. In contrast, credit
unions with more complex balance sheets, especially those containing
mortgage loans and complex investments, may warrant a more
comprehensive IRR management policy that requires additional time to
produce.
NCUA estimates that addressing the eight policy items will each
entail an equal time burden of two hours. The maximum time for all
segments of an IRR policy is therefore estimated at 16 hours. In turn,
the aggregate information collection burden for affected credit unions
to comply with the rule is estimated 12,800 hours (800 credit unions x
16 hours).
The proposed rule noted that organizations and individuals wishing
to comment on this information collection requirement should direct
their comments to the Office of Information and Regulatory Affairs,
OMB, Attn: Shagufta Ahmed, Room 10226, New Executive Office Building,
Washington, DC 20503, with a copy to Mary Rupp, Secretary of the Board,
National Credit Union Administration, 1775 Duke Street, Alexandria,
Virginia 22314-3428.
The sole commenter in response to the proposed rule contended that
the estimate of 16 hours to complete an IRR policy understates the time
it takes to collect the information, establish limits and review the
data. That commenter offered no alternative estimate.
NCUA considers public comments on the collection of information in:
Evaluating whether the collection of information is
necessary for the proper performance of the functions of the NCUA,
including whether the information will have a practical use;
Evaluating the accuracy of the NCUA's estimate of the
burden of the collection of information, including the validity of the
methodology and assumptions used;
Enhancing the quality, usefulness, and clarity of the
information to be collected; and
Minimizing the burden of collection of information on
those who are to respond, including through the use of appropriate
automated, electronic, mechanical, or other technological collection
techniques or other forms of information technology; e.g., permitting
electronic submission of responses.
OMB assigned No. 3133-0184 to this rulemaking.
C. Executive Order 13132. Executive Order 13132 encourages
independent regulatory agencies to consider the impact of their actions
on state and local interests. In adherence to fundamental federalism
principles, NCUA, an independent regulatory agency as defined in 44
U.S.C. 3502(5), voluntarily complies with the Executive Order. This
rule will not have substantial direct effects on the states, on the
relationship between the national government and the states, or on the
distribution of power and responsibilities among the various levels of
government. Therefore, this rule does not constitute a policy that has
federalism implications for purposes of the executive order.
D. The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families. The NCUA
has determined that this rule will not affect family well-being within
the meaning of the Treasury and General Government Appropriations Act,
Pub. L. 105-277, 112 Stat. 2681 (1998).
E. Small Business Regulatory Enforcement Fairness Act. The Small
Business Regulatory Enforcement Fairness Act of 1996 (Pub. L. 104-121)
(SBREFA) provides generally for congressional review of agency rules. A
reporting requirement is triggered in instances where NCUA issues a
final rule as defined by section 551 of the APA. 5 U.S.C. 551. The
Office of
[[Page 5162]]
Management and Budget has determined that this rule is not a major rule
for purposes of SBREFA. As required by SBREFA, NCUA will file the
appropriate reports with Congress and the General Accounting Office so
this rule may be reviewed.
List of Subjects in 12 CFR Part 741
Credit unions, Requirements for insurance.
By the National Credit Union Administration Board on January 26,
2012.
Mary F. Rupp,
Secretary of the Board.
For the reasons set forth above, NCUA amends 12 CFR part 741 as
follows:
PART 741--REQUIREMENTS FOR INSURANCE
0
1. The authority citation for part 741 continues to read:
Authority: 12 U.S.C. 1757, 1766(a), 1781-1790 and 1790d; 31
U.S.C. 3717.
0
2. In Sec. 741.3, add paragraph (b)(5) to read as follows:
Sec. 741.3 Criteria
* * * * *
(b) * * *
(5)(i) The existence of a written interest rate risk policy (IRR
policy'') and an effective interest rate risk management program
(``effective IRR program'') as part of asset liability management in
all Federally- insured credit unions (``FICU'') as follows. All
measurements are based on the most recent Call Report filing of the
FICU.
(A) A FICU with assets of more than $50 million must adopt a
written IRR policy and implement an effective IRR program;
(B) A FICU with assets of $10 million or more but not greater than
$50 million must adopt a written IRR policy and implement an effective
IRR program if the total of first mortgage loans it holds combined with
total investments with maturities greater than five years, as reported
by the FICU on its most recent Call Report, is equal to or greater than
100% of its net worth (i.e., a 1:1 ratio);
(C) A FICU with assets $10 million or more but not greater than $50
million are not required to comply with this paragraph if the total of
first mortgage loans it holds, combined with total investments with
maturities greater than five years, is less than 100% of its net worth
(i.e., a 1:1 ratio); and
(D) A FICU with less than $10 million in assets is not required to
comply with this paragraph regardless of the amount of first mortgage
loans and total investments with maturities greater than five years it
holds.
(ii) For purposes of paragraph (b)(5)(i) of this section--
(A) A FICU is considered to hold a first mortgage loan for its own
portfolio when it has not demonstrated the intent and ability to sell
the loan to an independent third party within 120 days of origination;
(B) Investments are defined in Sec. 703.2 of this chapter.
Investments with maturities greater than five years are defined as
those reported by the FICU on the Call Report; and
(C) Appendix B to this Part 741 provides guidance on how to develop
an IRR policy and an effective IRR program. The guidance describes
widely-accepted best practices in the management of interest rate risk
for the benefit of all FICUs.
* * * * *
0
3. Part 741 is amended by adding Appendix B to read as follows:
Appendix B to Part 741--Guidance for an Interest Rate Risk Policy and
an Effective Program
Table of Contents
I. Introduction
A. Complexity
B. IRR Exposure
II. IRR Policy
III. IRR Oversight and Management
A. Board of Directors Oversight
B. Management Responsibilities
IV. IRR Measurement and Monitoring
A. Risk Measurement Systems
B. Risk Measurement Methods
C. Components of IRR Measurement Methods
V. Internal Controls
VI. Decision-Making Informed by IRR Measurement Systems
VII. Guidelines for Adequacy of IRR Policy and Effectiveness of
Program
VIII. Additional Guidance for Large Credit Unions With Complex or
High Risk Balance Sheets
IX. Definitions
I. Introduction
This appendix provides guidance to FICUs in developing an
interest rate risk (IRR) policy and program that addresses aspects
of asset liability management in a single framework. An effective
IRR management program identifies, measures, monitors, and controls
IRR and is central to safe and sound credit union operations. Given
the differences among credit unions, each credit union should use
the guidance in this appendix to formulate a policy that embodies
its own practices, metrics and benchmarks appropriate to its
operations.
These practices should be established in light of the nature of
the credit union's operations and business, as well as its
complexity, risk exposure, and size. As these elements increase,
NCUA believes the IRR practices should be implemented with
increasing degrees of rigor and diligence to maintain safe and sound
operations in the area of IRR management. In particular, rigor and
diligence are required to manage complexity and risk exposure.
Complexity relates to the intricacy of financial instrument
structure, and to the composition of assets and liabilities on the
balance sheet. In the case of financial instruments, the structure
can have numerous characteristics that act simultaneously to affect
the behavior of the instrument. In the case of the balance sheet,
which contains multiple instruments, assets and liabilities can act
in ways that are compounding or can be offsetting because their
impact on the IRR level may act in the same or opposite directions.
High degrees of risk exposure require a credit union to be
diligently aware of the potential earnings and net worth exposures
under various interest rate and business environments because the
margin for error is low.
A. Complexity
In influencing the behavior of instruments and balance sheet
composition, complexity is a function of the predictability of the
cash flows. As cash flows become less predictable, the uncertainty
of both instrument and balance sheet behavior increases. For
example, a residential mortgage is subject to prepayments that will
change at the option of the borrower. Mortgage borrowers may pay off
their mortgage loans due to geographical relocation, or may increase
the amount of their monthly payment above the minimum contractual
schedule due to other changes in the borrower's circumstances. This
cash flow unpredictability is also found in investments, such as
collateralized mortgage obligations, because these contain mortgage
loans. Additionally, cash flow unpredictability affects liabilities.
For example, nonmaturity share balances vary at the discretion of
the depositor making deposits and withdrawals, and this may be
influenced by a credit union's pricing of its share accounts.
B. IRR Exposure
Exposure to IRR is the vulnerability of a credit union's
financial condition to adverse movements in market interest rates.
Although some IRR exposure is a normal part of financial
intermediation, a high degree of this exposure may negatively affect
a credit union's earnings and net economic value. Changes in
interest rates influence a credit union's earnings by altering
interest-sensitive income and expenses (e.g. loan income and share
dividends). Changes in interest rates also affect the economic value
of a credit union's assets and liabilities, because the present
value of future cash flows and, in some cases, the cash flows
themselves may change when interest rates change. Consequently, the
management of a credit union's pricing strategy is critical to the
control of IRR exposure.
All FICUs required to have an IRR policy and program should
incorporate the following five elements into their IRR program:
1. Board-approved IRR policy.
2. Oversight by the board of directors and implementation by
management.
3. Risk measurement systems assessing the IRR sensitivity of
earnings and/or asset and liability values.
4. Internal controls to monitor adherence to IRR limits.
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5. Decision making that is informed and guided by IRR measures.
II. IRR Policy
The board of directors is responsible for ensuring the adequacy
of an IRR policy and its limits. The policy should be consistent
with the credit union's business strategies and should reflect the
board's risk tolerance, taking into account the credit union's
financial condition and risk measurement systems and methods
commensurate with the balance sheet structure. The policy should
state actions and authorities required for exceptions to policy,
limits, and authorizations.
Credit unions have the option of either creating a separate IRR
policy or incorporating it into investment, ALM, funds management,
liquidity or other policies. Regardless of form, credit unions must
clearly document their IRR policy in writing.
The scope of the policy will vary depending on the complexity of
the credit union's balance sheet. For example, a credit union that
offers short-term loans, invests in non-complex or short-term bullet
investments (i.e. a debt security that returns 100 percent of
principal on the maturity date), and offers basic share products may
not need to create an elaborate policy. The policy for these credit
unions may limit the loan portfolio maturity, require a minimum
amount of short-term funds, and restrict the types of permissible
investments (e.g. Treasuries, bullet investments). More complex
balance sheets, especially those containing mortgage loans and
complex investments, may warrant a comprehensive IRR policy due to
the uncertainty of cash flows.
The policy should establish responsibilities and procedures for
identifying, measuring, monitoring, controlling, and reporting IRR,
and establish risk limits. A written policy should:
Identify committees, persons or other parties
responsible for review of the credit union's IRR exposure;
Direct appropriate actions to ensure management takes
steps to manage IRR so that IRR exposures are identified, measured,
monitored, and controlled;
State the frequency with which management will report
on measurement results to the board to ensure routine review of
information that is timely (e.g. current and at least quarterly) and
in sufficient detail to assess the credit union's IRR profile;
Set risk limits for IRR exposures based on selected
measures (e.g. limits for changes in repricing or duration gaps,
income simulation, asset valuation, or net economic value);
Choose tests, such as interest rate shocks, that the
credit union will perform using the selected measures;
Provide for periodic review of material changes in IRR
exposures and compliance with board approved policy and risk limits;
Provide for assessment of the IRR impact of any new
business activities prior to implementation (e.g. evaluate the IRR
profile of introducing a new product or service); and
Provide for at least an annual evaluation of policy to
determine whether it is still commensurate with the size,
complexity, and risk profile of the credit union.
IRR policy limits should maintain risk exposures within prudent
levels. Examples of limits are as follows:
GAP: less than I 10 percent change in any given
period, or cumulatively over 12 months.
Income Simulation: net interest income after shock change less
than 20 percent over any 12-month period.
Asset Valuation: after shock change in book value of net worth
less than 50 percent, or after shock net worth of 4 percent or
greater.
Net Economic Value: after shock change in net economic value
less than 25 percent, or after shock net economic value of 6 percent
or greater.
NCUA emphasizes these are only for illustrative purposes, and
management should establish its own limits that are reasonably
supported. Where appropriate, management may also set IRR limits for
individual portfolios, activities, and lines of business.
III. IRR Oversight and Management
A. Board of Directors Oversight
The board of directors is responsible for oversight of their
credit union and for approving policy, major strategies, and prudent
limits regarding IRR. To meet this responsibility, understanding the
level and nature of IRR taken by the credit union is essential.
Accordingly, the board should ensure management executes an
effective IRR program.
Additionally, the board should annually assess if the IRR
program sufficiently identifies, measures, monitors, and controls
the IRR exposure of the credit union. Where necessary, the board may
consider obtaining professional advice and training to enhance its
understanding of IRR oversight.
B. Management Responsibilities
Management is responsible for the daily management of activities
and operations. In order to implement the board's IRR policy,
management should:
Develop and maintain adequate IRR measurement systems;
Evaluate and understand IRR risk exposures;
Establish an appropriate system of internal controls
(e.g. separation between the risk taker and IRR measurement staff);
Allocate sufficient resources for an effective IRR
program. For example, a complex credit union with an elevated IRR
risk profile will likely necessitate a greater allocation of
resources to identify and focus on IRR exposures;
Develop and support competent staff with technical
expertise commensurate with the IRR program;
Identify the procedures and assumptions involved in
implementing the IRR measurement systems; and
Establish clear lines of authority and responsibility
for managing IRR; and
Provide a sufficient set of reports to ensure
compliance with board approved policies.
Where delegation of management authority by the board occurs,
this may be to designated committees such as an asset liability
committee or other equivalent. In credit unions with limited staff,
these responsibilities may reside with the board or management.
Significant changes in assumptions, measurement methods, tests
performed, or other aspects involved in the IRR process should be
documented and brought to the attention of those responsible.
IV. IRR Measurement and Monitoring
A. Risk Measurement Systems
Generally, credit unions should have IRR measurement systems
that capture and measure all material and identified sources of IRR.
An IRR measurement system quantifies the risk contained in the
credit union's balance sheet and integrates the important sources of
IRR faced by a credit union in order to facilitate management of its
risk exposures. The selection and assessment of appropriate IRR
measurement systems is the responsibility of credit union boards and
management.
Management should:
Rely on assumptions that are reasonable and
supportable;
Document any changes to assumptions based on observed
information;
Monitor positions with uncertain maturities, rates and
cash flows, such as nonmaturity shares, fixed rate mortgages where
prepayments may vary, adjustable rate mortgages, and instruments
with embedded options, such as calls; and
Require any interest rate risk calculation techniques,
measures and tests to be sufficiently rigorous to capture risk.
B. Risk Measurement Methods
The following discussion is intended only as a general guide and
should not be used by credit unions as an endorsement of a
particular method. An IRR measurement system may rely on a variety
of different methods. Common examples of methods available to credit
unions are GAP analysis, income simulation, asset valuation, and net
economic value. Any measurement method(s) used by a credit union to
analyze IRR exposure should correspond with the complexity of the
credit union's balance sheet so as to identify any material sources
of IRR.
GAP Analysis
GAP analysis is a simple IRR measurement method that reports the
mismatch between rate sensitive assets and rate sensitive
liabilities over a given time period. GAP can only suffice for
simple balance sheets that primarily consist of short-term bullet
type investments and non mortgage-related assets. GAP analysis can
be static, behavioral, or based on duration.
Income Simulation
Income simulation is an IRR measurement method used to estimate
earnings exposure to changes in interest rates. An income simulation
analysis projects interest cash flows of all assets, liabilities,
and off-balance sheet instruments in a credit union's portfolio to
estimate future net interest income over a chosen timeframe.
Generally, income simulations focus on short-term time horizons
(e.g. one to three years). Forecasting
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income is assumption sensitive and more uncertain the longer the
forecast period. Simulations typically include evaluations under a
base-case scenario, and instantaneous parallel rate shocks, and may
include alternate interest-rate scenarios. The alternate rate
scenarios may involve ramped changes in rates, twisting of the yield
curve, and/or stressed rate environments devised by the user or
provided by the vendor.
NCUA Asset Valuation Tables
For credit unions lacking advanced IRR methods that seek simple
valuation measures, the NCUA Asset Valuation Tables are available
and prepared quarterly by the NCUA. These are available on the NCUA
Web site through www.ncua.gov.
These measures provide an indication of a credit union's
potential interest rate risk, based on the risk associated with the
asset categories of greatest concern--(e.g., mortgage loans and
investment securities).
The tables provide a simple measure of the potential devaluation
of a credit union's mortgage loans and investment securities that
occur during 300 basis point parallel rate shocks, and
report the resulting impact on net worth.
Net Economic Value (NEV)
NEV measures the effect of interest rates on the market value of
net worth by calculating the present value of assets minus the
present value of liabilities. This calculation measures the long-
term IRR in a credit union's balance sheet at a fixed point in time.
By capturing the impact of interest rate changes on the value of all
future cash flows, NEV provides a comprehensive measurement of IRR.
Generally, NEV computations demonstrate the economic value of net
worth under current interest rates and shocked interest rate
scenarios.
One NEV method is to discount cash flows by a single interest
rate path. Credit unions with a significant exposure to assets or
liabilities with embedded options should consider alternative
measurement methods such as discounting along a yield curve (e.g.
the U.S. Treasury curve, LIBOR curve) or using multiple interest
rate paths. Credit unions should apply and document appropriate
methods, based on available data (e.g. utilizing observed market
values), when valuing individual or groups of assets and
liabilities.
C. Components of IRR Measurement Methods
In the initial setup of IRR measurement, critical decisions are
made regarding numerous variables in the method. These variables
include but are not limited to the following.
Chart of Accounts
Credit unions using an IRR measurement method should define a
sufficient number of accounts to capture key IRR characteristics
inherent within their product lines. For example, credit unions with
significant holdings of adjustable-rate mortgages should
differentiate balances by periodic and lifetime caps and floors, the
reset frequency, and the rate index used for rate resets. Similarly,
credit unions with significant holdings of fixed-rate mortgages
should differentiate at least by original term, e.g., 30 or 15-year,
and coupon level to reflect differences in prepayment behaviors.
Aggregation of Data Input
As the credit union's complexity, risk exposure, and size
increases, the degree of detail should be based on data that is
increasingly disaggregated. Because imprecision in the measurement
process can materially misstate risk levels, management should
evaluate the potential loss of precision from any aggregation and
simplification used in its measurement of IRR.
Account Attributes
Account attributes define a product, including: P\principal
type, rate type, rate index, repricing interval, new volume maturity
distribution, accounting accrual basis, prepayment driver, and
discount rate.
Assumptions
IRR measurement methods rely on assumptions made by management
in order to identify IRR. The simplest example is of future interest
rate scenarios. The management of IRR will require other assumptions
such as: Projected balance sheet volumes; prepayment rates for loans
and investment securities; repricing sensitivity, and decay rates of
nonmaturity shares. Examples of these assumptions follow.
Example 1. Credit unions should consider evaluating the balance
sheet under flat (i.e. static) and/or planned growth scenarios to
capture IRR exposures. Under a flat scenario, runoff amounts are
reinvested in their respective asset or liability account.
Conducting planned growth scenarios allows management to assess the
IRR impact of the projected change in volume and/or composition of
the balance sheet.
Example 2. Loans and mortgage related securities contain
prepayment options that enable the borrower to prepay the obligation
prior to maturity. This prepayment option makes it difficult to
project the value and earnings stream from these assets because the
future outstanding principal balance at any given time is unknown. A
number of factors affect prepayments, including the refinancing
incentive, seasonality (the particular time of year), seasoning (the
age of the loan), member mobility, curtailments (additional
principal payments), and burnout (borrowers who don't respond to
changes in the level of rates, and pay as scheduled). Prepayment
speeds may be estimated or derived from numerous national or vendor
data sources.
Example 3. In the process of IRR measurement, the credit union
must estimate how each account will reprice in response to market
rate fluctuations. For example, when rates rise 300 basis points,
the credit union may raise its asset or li