Credit unions facing an unpredictable economy and rising interest rates will turn to the National Credit Union Administration’s supervisory priorities for guidance on where to focus their time and resources, especially as the Current Expected Credit Loss (CECL) accounting standard takes effect. The National Credit Union Administration (NCUA) emphasized interest rate, liquidity, and credit risk as the main areas for concern in its 2023 letter. So how can credit unions prepare to mitigate these risks, and what do they need to know about meeting examiner expectations for CECL?
The 2023 NCUA supervisory priorities: Takeaways for credit unions implementing CECL
NCUA expectations for credit unions post-CECL adoption
The NCUA's focus on risk, especially credit risk, has implications for credit unions instituting CECL this quarter.
You might also like this webinar: "CECL implementation FAQs: Progress as 2023 approaches"
Three main areas of risk from the NCUA letter
The NCUA supervisory priorities emphasized the following regarding increased risk:
- Interest rate risk (IRR): Examiners will focus on key interest rate risk management and control activities, including reasonable and well-documented assumptions and data sets. Credit unions should measure and control their overall IRR exposure and proactively act to stay within safe and sound policy limits. Results should be appropriately communicated to decision-makers and the board of directors.
- Liquidity risk: Examiners will be focused on the credit union’s liquidity risk management framework relative to the credit union’s risk profile. The assessment will focus on liquidity sources compared to funding needs and how changing rates and market values impact assets used for collateral. Scenario analysis will also be a focus, including member share migration, cash-flow projections, and appropriateness of any contingency funding.
- Credit risk: High inflation and rising rates continue to increase credit risk, putting pressure on members’ pocketbooks and increasing the odds that borrowers will be unable to repay outstanding debt. The NCUA will review the soundness of lending programs, including underwriting, monitoring practices, and loan workout
Credit risk and CECL
The NCUA’s approach to CECL implementation
Closely related to credit risk is the implementation of the CECL methodology. The NCUA supervisory priorities state that examiners will review policies and procedures, documentation of methodology, adherence with GAAP, and results of any independent review of the ACL. If your credit union has adopted current excepted credit losses (CECL), expect a review of the initial adjustment to undivided earnings.
Most credit unions began the institutional use of CECL accounting practices in Q1 2023, as the first required regulatory reporting will start with the March 31, 2023 call report. But not all credit unions were ready to address CECL in their 2022 capital plans. The NCUA supervisory priorities provided guidance on adopting and incorporating the standard into credit unions’ forward-looking capital planning and stress testing.
Considering the complexities of transitioning to CECL for reserving loss for both financial statements and forecasting, the NCUA has not dictated any “specific approach for forward-looking forecasting, and inclusion, of CECL-based loss estimates for capital planning and supervisory stress testing purposes.” Its only requirement is that credit unions account for the “day one adjustment” to their allowance for credit losses (ACL) and net worth in forward-looking plans and stress tests. This means measuring the credit losses for newly recognized financial assets at origination and recording allowance for credit losses to present the net amount expected to be collected on the balance sheet. Covered credit unions should evaluate and incorporate the ACL/net worth impact of CECL adoption in their 2023 self-run stress testing activities beginning in the year of adoption, which would be Q1 2023.
According to their latest guidance, the NCUA encourages covered credit unions to apply a “best efforts” approach to incorporating CECL into their existing capital assessment and planning practices. Unless an approach is entirely misguided, the NCUA will not take exception to it. To defend their choices, credit unions should be sure to document and support their reasoning behind each decision made in their capital plan. For context, the NCUA reported that no credit unions chose to include the impact of CECL in their 2022 scenario forecasts, capital assessments, and plans. Some credit unions discussed the expected effects of CECL adoption in 2023 in a separate section of their plans. Presenting the pre- and post-CECL adoption impact on net worth and stress test net worth ratios allowed credit unions to visualize how CECL may affect their policies and regulatory net worth standards after CECL adoption.
Risk management teams should carefully review their ACL policies and procedures—or ensure they understand their model’s mechanics if it is outsourced to a third party. Any adjustments to the model should be documented, and all decisions should be supported in writing, making explicit connections between the decision and the institution’s characteristics and risk profile.
Stay up to date on CECL best practices.
Although not required before implementation, a best practice for adopting CECL is periodically having all CECL models validated by an independent party.
Other supervisory priorities
The NCUA has many non-credit risk priorities. Other areas examiners will focus on include fraud prevention and detection, information security and cybersecurity, consumer financial protection programs, and succession planning for senior leaders. While these risk areas are equally important and represent opportunities for management teams to improve risk management practices, CECL and the upcoming first reporting date are at the top of many credit unions’ priority lists. If your credit union bit off more than it could chew with developing and implementing its own CECL models, an experienced vendor can help with a CECL solution for credit unions that can be tailored to fit your needs.