Surviving the Examination During Challenging Times

Follow these five steps toward a productive exam.

December 12, 2011
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Balance-sheet pressures caused by reduced loan demand, shrinking margins, and the continued drain of corporate stabilization assessments have many experts predicting almost half of the nation’s credit unions will operate at a loss this year. Add to that the fact that the credit union industry is one of the most highly regulated in the U.S.

So how do you survive your examination? And how can you make it a constructive process?

Proper preparation can be the “transactional lubrication” your credit union needs to reduce the regulatory friction of an exam. Here are five steps your credit union can follow to reduce examination anxiety and make the experience productive:

1. Understand the examination’s scope and logic (yes, there is some).

Half of life’s successes can be attributed to simply understanding the rules. Fortunately, we not only know the rules for credit union examinations, we have the playbook in the form of NCUA’s Examiner’s Guide.

Examiners are focusing on:
  • Real estate lending
  • Business lending
  • Indirect lending
  • Participation loans
  • Investments
  • Loan modifications

In the first chapter, NCUA makes the focus of its examiner corps quite clear: “Examiners allot time to reviewing areas containing the most risk for an individual credit union. Activities posing the highest risk receive the most scrutiny.” Risk has always been the “No. 1 enemy.”

We have access not only to the regulator’s exam manual, but also to the AIRES (Auto-mated Integrated Regulatory Examination Software) questionnaires, which examiners use to evaluate credit union operations.

Together, they reveal that the exam will include a review of the past exam findings, 5300 Call Report data, supervisory committee audit, ALM (asset/liability management) assessment, ALLL (allowance for loan and lease losses) process, payment processing, regulatory compliance, and other risk-based red flags that catch the examiner’s eye.

Examiner scrutiny includes, of course, the traditional balance sheet review of general credit union performance data and key ratios such as income, net worth, return on assets, and delinquency and charge-offs—and Bank Secrecy Act compliance, data security, and due diligence oversight of third-party vendors.

One other potential resource is now in the works. NCUA is developing a “National Supervision Policy Manual” to replace regional policies. This should make examinations more uniform across the country and address a long-time complaint of credit unions about inconsistent exam standards.

The agency expects to implement the manual in the first half of 2012, and CUNA has requested that it be publicly accessible on the agency’s website.

2. Maintain an accurate understanding of your credit union’s current position.

Your credit union’s risk appetite is probably the biggest area of disagreement with the examiner. From granting a loan to making investment decisions, risk is an inevitable part of credit union operations, but you must manage it properly.

Risk assessments are an essential management and regulatory tool. Be prepared to show your examiner how your credit union has mastered what I call the “three R’s”: risk, recognition, and reaction.

Examiners currently are focusing on: real estate lending, business lending, indirect lending, participation loans, investments, and loan modifications. These areas represent the greatest risk right now.

In fact, the NCUA Board currently is reviewing every one of these areas to determine what additional regulations might be needed to address future risks. A new regulation undoubtedly will be in place in 2012 requiring credit unions above a certain asset size to have a formal interest-rate risk program, and the agency will soon consider a similar regulation to address concentration risk.

Next: Involve all areas

A Few More Pointers

Ken Schroeder
December 20, 2011 9:28 am
Great Article, David. Here's a couple of suggested add-ons: Business Continuity--(of course I'd add that, since that is what I do) Verify that your program is active and viable. That means a lot more than putting a new date on your plan and getting the boss to sign it. While emphasis has faded a bit since the years following the storm seasons of Katrina, Wilma, Ike, the need for a viable program is in no way diminished. Consider just this past year, flooding all along the Mississippi and its feeder rivers, tornados everywhere, fires in Texas. A solid, well exercised plan will help get a credit union back into operation quicker and provide better service to the membership. Review should be a continual, on-going process within the organization. Any examiner worth his or her salt will see through a paper-only plan. Vendor Management: Every credit union depends on critical vendors to operate, whether it be IT outsourcing, core processing, even inside & outside maintenance. Stop the flow of goods and services and see how long you can keep your doors open. A Vendor Management program doesn't mean buying a new (and usually very expensive) piece of software, putting some data in it and calling it a day. It means every business owner within the credit union knows and understands the critical single points of failure that a vendor relationship presents. Those business owners must have a monitoring process in place to sniff out when a vendor can no longer deliver and have a backup plan in place to mitigate that failure (see my business continuity comments above). Again, any examiner who is effective will look for an internal process that verifies that the dependency on these crtical vendors is adequately managed. Warmest regards for the Holidays!

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