Risk Management Challenges for Credit Unions - Wendy Angus, NCUA

Risk Management Challenges for Credit Unions - Wendy Angus, NCUA
What are the key risk management challenges for the nation's credit unions, and how can they best meet them?

Wendy Angus, Director of Risk Management at the National Credit Union Administration (NCUA), discusses:

The biggest risk management issues facing credit unions today;
How credit unions can overcome these challenges;
Advice to institutions looking to improve their approach to risk management.

Prior to joining NCUA in 1996, Angus worked as an examiner with the Office of Thrift Supervision and an auditor in the securitization and asset sale operation at the Resolution Trust Corporation. During her 13 years at NCUA, she has played many roles within the agency. Beginning December 14, 2009, she became the Director of Risk Management in the Office of Examination and Insurance. In this position, she serves as the primary caretaker of the National Credit Union Share Insurance Fund, oversees administrative action nationwide, quarterly call report data collection and analyses, and works with the regional offices to resolve our agency's largest problem case credit unions.

TOM FIELD: What are credit unions' biggest risk management challenges in 2010? Hi, this is Tom Field, Editorial Director with Information Security Media Group. I am talking today with Wendy Angus, the Director of Risk Management at the National Credit Union Administration. Wendy, it is a pleasure to talk to you today.

WENDY ANGUS: You, too, Tom. Thanks for the invitation.

FIELD: Wendy, tell us a little bit about yourself and your role with the NCUA, please.

ANGUS: Sure. Well, before I came to NCUA in 1996, I worked as a savings bank examiner with the Office of Thrift Supervision at the Resolution Trust Corporation for the life of the agency, and since I came to NCUA I worked as an Examiner in the Chicago area, as an Analyst in two different regional offices. I worked in the Office of Examination and Insurance as a Program Officer. I supervised our Economic Development Specialists in the Office of Small Credit Union Initiatives, and most recently I was the Director or Supervision in Region II, which is our Mid-Atlantic area of the country.

Since December, I started as the Director of Risk Management, and in this position I serve as the caretaker of the Insurance Fund. I oversee administrative action nationwide, the quarterly call report data collection and analysis, and I work with the regional offices and our general counsel's office to resolve our agency's largest problem credit unions.

FIELD: Well, excellent. Congratulations on your new role by the way.

ANGUS: Thank you; I am enjoying it.

FIELD: Well, Wendy, I want to get into 2010, but before we do maybe you can talk to me about what were credit unions biggest risk management challenges in the past year, 2009?

ANGUS: Sure. Well many of the biggest challenges for our credit unions in 2009 were basically the result of the current economic environment. Fortunately, the credit union industry as a whole is strong and well capitalized. The aggregate net worth ration for all federally insured credit unions as of September 2009 was a little over 10 percent. I don't have those figures yet for December -- our call reports are coming in fast and furious for the next couple of days.

But on the other hand, the number of credit unions with the net worth that fell below the 7 percent net worth ratio increased from 157 at the end of 2008 to 317 as of September 2009. So that indicates increased stress on individual credit unions.

I would like to focus on what I think are the four biggest risk management challenges that credit unions faced last year and they continue to face this year.

The first is managing the increase in delinquencies, loan losses and bankruptcy filings. With the high unemployment rate of about 10 percent nationwide, it is contributing to the rise in delinquency and loan losses. In some states, such as California, Nevada, Florida and Arizona that have very high unemployment rates, they are also burdened of course with the highest real estate market devaluations. Credit unions in those states in particular are not only combating a high delinquency and foreclosure rates. but they are also experiencing greater losses when they try to sell the foreclosed properties at significantly lower values than the loan balances.

The aggregate delinquency rate for September 2009 for all federally insured credit unions was 1.7 percent. This is an annualized increase of 33 percent from the year-end 2008. The net charge-off rates as of September 2009 were 1.2 percent on average, which is a 44 percent annualized increase from the prior year-end. Of all the delinquency categories, the largest spike we saw was not unexpected, but it was in the first mortgage adjustable rate loans. Credit unions have been pressed to reallocate or hire personnel to beef up their collections divisions, and the loan portfolio management costs, such as the collections, legal fees, etc., as well as the provision for loan and lease loss has put a strain on earnings.

The second challenge is the handling of unprecedented numbers of real estate loan modifications and foreclosures. In September 2009 credit unions reported loan modifications totaling $4.9 billion dollars, which is a 263 percent increase from the year-end 2008. On foreclosed properties held is reported at $1.1 billion, a 55 percent increase from the year-end 2008. Credit unions historically have had very few foreclosures and losses in their real estate portfolios, so this rising trend puts additional pressure on the lending and collections staff and may require more legal expertise than in prior years.

We have also seen a rise in strategic defaults for members who have the ability to pay their mortgages, but are in fact walking away from an upside-down property because they have no incentive to stay in their home.

The third primary challenge this past year was identifying the extent of the risk and the potential losses in their loan portfolios. The need to evaluate their true loss potential in the loan portfolio should be a top priority at every credit union. Comprehensive risk management processes are essential. Even some of our largest credit unions undervalued the information their risk management divisions generated in recent years.

So for example, rather than attempting to be proactive and using forward-looking predictive performance models, many management teams were relying on historic trends to predict loss. In this current environment, history from two to three years ago may not really provide any true value in forecasting potential losses. So now we are seeing more management teams learning to utilize the trends in their own portfolios and develop better predictive risk models using correlations between their own members' behavior and economic trends.

And finally the fourth challenge is managing interest rate risk given the low yields in the investment markets and the increase in concentration of long-term mortgage loan products. Loan portfolios had grown an annualized 2.2 percent or $9.5 billion in the first nine months of 2009. Most of that growth was in fixed rate versus mortgages. Of course this helps out our members, but on the flip side the primary funding sources are higher cost deposit accounts and borrowed funds, and this raises the importance of sound interest rate risk and liquidity risk management practices to offset the potential for a rise in interest rates in the future.

And finally, the rising number of rising real estate loan modifications to lower rates or longer term mortgages places additional stress on credit union earnings. On the flip side of that, it is a tight rope because these modifications may prevent large loan losses currently, today, but we are not sure and we can't really tell what the impact in the long-term will be on earnings; time will tell for sure.

FIELD: Well, Wendy, when you lay those out, especially when you look at those numbers, there is a pretty jarring difference between 2008 and 2009 isn't there?

ANGUS: Definitely, yes.

FIELD: Now when you look at how credit unions have faced up to these challenges that you outlined so well, where would you say that they have done best and worst in tackling these issues?

ANGUS: Well it's easier to cover the best part first. Credit unions have done well supporting their members during these tough economic times. Many credit unions have seen a flight to safety as new and existing members move their funds from uninsured investments to the insured deposits. Total deposits grew by 8.4 percent during the first nine months of 2009. And again, consumers, just as they have in the past, responded very favorably to the lower fees for the services credit unions offer. Credit unions have historically worked closely with the struggling members to help them work out payment solutions, and this has become so much more important in the past couple of years.

I was recently looking at OTS and OCC mortgage matrix report for the third quarter of 2009, and this report talks about performance-related data dealing with the largest mortgage servicing portfolios in the country. Their report shows 6.2 percent of all the mortgage loans in these larger servicing portfolios as being 60 days delinquent. When you look at our federally insured credit unions, the real estate delinquency rate for the same time period was 1.8 percent. So credit unions are doing a great job with working with their members in modifying loans in a timely manner. They also did not grant the volume of sub-prime or Alt A-loan the other financial institutions did and you can see that in the delinquency rates.

Credit unions continue to lend in the first mortgage arena. As I said earlier, the dollar amount of first mortgages granted through the third quarter of 2009 increased by 37 percent over that of third quarter 2008. Credit unions are selling about 55 percent of their first mortgages to the secondary market, and that is probably a good sign, and they are trying to combat the interest rate risks.

Some credit unions have been slow to embrace risk management. They rely heavily on the loyalty of their members, and they fail to truly understand the underlying risks in their loan portfolio. Sometimes risk management departments are also used simultaneously or interchangeably with internal audit departments, and I don't really view those as one and the same. The risk management department really needs to be fully integrated into the credit union strategic plan, and the credit union itself may not have a clear view of its risk tolerance levels or how to incorporate them into successful operating strategies.

FIELD: Now, Wendy, you mentioned up front that a lot of the issues that credit unions tackled in 2009 will be the same this year in 2010. Are there any one or two of those that you think are going to be sort of the biggest issues that the institutions will tackle?

ANGUS: Yes, definitely unemployment is not expected to peak until later this year; if we are lucky it will peak later this year. Therefore we expect delinquency and foreclosures to continue to increase for the better part of 2010. Credit unions will need to continually manage their infrastructures and stay ahead of the curve. They need to maximize their staff and resources. I know a lot of credit unions seem to be focusing on cutting expenses as much as possible. The increase in loan losses will pressure earnings, and I am concerned that credit unions could be enticed by the new programs without proper due diligence.

For example, more credit unions are trying to add members' business lending programs, and even though we have fairly strict regulations covering this particular area, the earnings pressure may entice credit unions to enter the arena without fully evaluating the risk of the program and without having the proper expertise to manage it.

Also the growth in real estate loans at a time when rates are very low elevates interest rate liquidity and credit risk. As I mentioned earlier, the increase in the number of loan modifications to lower rates and longer terms will contribute to their earnings pressure in the long run.

FIELD: So, Wendy, to overcome some of these issues and challenges you have talked about, what are the things that credit unions are going to have to do in 2010 to improve their performance and to mitigate some of these challenges that are just inherent in the marketplace right now?

ANGUS: Well, management teams should thoroughly analyze the risk of any new program before making a decision to offer it. You know, as I tell my children sometimes, just because one financial institution is offering a service doesn't mean that everybody else can do the same thing successfully. Credit unions should also re-analyze their existing programs to ensure the programs are really performing properly. Does management understand the risk involved and whether the programs are covering the costs of operating them?

And many of the economic troubles we see today were the result of a decision focused solely on profit, and if there risk analysis were performed, they may not have been used. While credit unions are generally not profit motivated, they still have to generate positive earnings to offer services and pay adequate dividends to their members. However, the management should not fall into the trap of downplaying or overlooking risks involved in programs just because there appears to be a solid earnings potential.

FIELD: Wendy, what will the NCUA be doing to support credit unions efforts in 2010?

ANGUS: Well, NCUA encourages credit unions to work with their members. However, the credit unions must still have sound policies, procedures and risk management processes in place to safeguard their assets.

We frequently issue letters to credit unions, which provide guidance for emerging issues. In 2009 we issued letter 09CU19 about real estate loan modifications to provide guidance on evaluating and implementing a sound modification program. Soon we will be issuing a letter to credit unions related to evaluating and managing concentration risks.

Our NCUA board members have all conducted webinars and Town Hall meetings to discuss emerging issues and listen to concerns of the credit union industry professionals. Chairman Matz has a Town Hall meeting scheduled actually this Friday, January 22nd, in Dallas; she has another one scheduled February 4th in Orlando. Board member Gigi Hyland recently hosted a webinar on member business lending, and she discussed best practices and concerns examiners had seen in existing programs.

All of the board members have hosted meetings or webinars with our NCUA staff to listen to examiner concerns in particular. We provided guidance to our examination staff to evaluate earnings before the consideration of the insurance stabilization premiums assessed in 2009. You know definitely as in prior years as well, credit union managers can contact their examiner for guidance or feedback on any planned new program, bounce best practices off of them or try to get names of other credit unions that face similar issues and successfully manage their risk. I don't know of any examiner who would be unwilling to provide that information to their credit unions.

FIELD: Wendy, one last question for you. You are sort of in a unique position now that you are new in this role and you are seeing it somewhat with new eyes; what advice would you offer to credit unions that want to improve their risk management efforts this year?

ANGUS: Well, risk management is an integral part of our credit union strategic plan; every credit union should have a written statement about its risk tolerance levels, something like a mission statement, and be able to integrate those tolerance levels into their strategies for everyday operations.

Credit unions should be actively monitoring and evaluating the level of risk in their loan portfolios. For example, we have quite a few of our larger credit unions, particularly those on the West Coast, that have done a great job of analyzing various data points in their loan portfolios. For instance, from the credit score when it was first underwritten to the credit score today, which they also call migration analysis, they update their collateral values on real estate portfolios and even on consumer loans on a regular basis. They get a better idea of the amount of risk in their portfolio. This helps them with determining what kind of risk is tolerable with new credits, what type of staffing needs they have, do they need to actually hire more collectors or work out specialists, and finally, it helps them with managing their foreclosure pipeline.

One control I would recommend is that the credit union have clear limits in their policy as to how much of a specific product the credit union is willing to put on its books; that the limits should be expressed as a percent of net worth at risk rather than as a percentage of assets.

I also recommend managers closely monitor the deposit structures. as much of the money that has been flowing into credit unions in the past year has been in higher yielding money markets and share certificates. You know, as the stock market improves, it is highly likely people will move their funds right back out, which would create specific liquidity requirements for these credit unions.

Then finally I would say above all plans, never enter a new program without thoroughly analyzing the risk and reward relationship. Remember that if something is too good to be true, it often is.

FIELD: Excellent advice, Wendy. I appreciate your time and your insight today.

ANGUS: Thank you. I appreciate your having me.

FIELD: We have been talking with Wendy Angus, the Director of Risk Management with the NCUA.

For Information Security Media Group, I'm Tom Field. Thank you very much.


About the Author

Tom Field

Tom Field

Senior Vice President, Editorial, ISMG

Field is responsible for all of ISMG's 28 global media properties and its team of journalists. He also helped to develop and lead ISMG's award-winning summit series that has brought together security practitioners and industry influencers from around the world, as well as ISMG's series of exclusive executive roundtables.




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