Surviving the Examination During Challenging Times

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.

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