The National Credit Union Administration (NCUA) recently released its 2024 Supervisory Priorities, highlighting key areas of focus for the agency in the year ahead.
While these areas may seem familiar, as they were all included in the agency’s 2023 priorities, the order has shifted with credit risk and liquidity risk now taking the top two spots.
NCUA’s 2024 Priorities, in order, fall under the following categories:
- Credit Risk
- Liquidity Risk
- Consumer Financial Protection
- Information Security (Cybersecurity)
- Interest Rate Risk (IRR)
- Bank Secrecy Act (BSA) Compliance
- Support for Small Credit Unions and Minority Depository Institutions
In this article, we will focus on the risks most pertinent to accounting and finance functions and discuss how management teams can prepare for heightened supervision of each risk area. While sound oversight and management of all risk areas remains important, understanding the NCUA’s 2024 Priorities can help industry professionals address key areas projected to experience heightened levels of stress and increased regulatory focus.
Credit Risk
Asset and liability composition can be difficult to manage in an environment with consistent loan growth and competitive deposit markets. Asset composition can quickly change if credit unions do not properly assess relative value when making loan and investment decisions. Poorly priced loans can lead to excess growth, which can lead to liquidity pressure and concentration of credit risk. Lending and treasury teams should continue to work together to assess relative value among available investment opportunities with consideration given to strategic priorities for balance sheet composition.
Management teams should take this opportunity to review lending policies and portfolio risk management practices for potential weaknesses. Strong risk management practices center on strong underwriting practices that adequately compensate an institution for the level of risk undertaken, fully analyze a borrower’s ability to repay debt, and properly value and secure collateral pledged. From a macro-portfolio perspective, independent loan reviews and engagements for loan portfolio stress testing are valuable risk management practices that can aid in proactively identifying weaknesses in underwriting and emerging credit concerns among borrowers. Finally, Allowance for Credit Losses (ACL) policies, procedures and methodologies should be reviewed to ensure consistency and relevance given the current economic environment. Institutions that adopted the Current Expected Credit Losses (CECL) methodology in 2024 should consider conducting an independent validation to ensure that outputs are reasonable and well supported.
Liquidity Risk
Liquidity remains a topic of discussion and increased focus given the reduction in on-balance sheet liquidity and competitive deposit environment the industry has experienced over the past 18 months. As such, many ALM First clients have reported increased focus on liquidity risk management during regulatory examinations.
In addition to its 2024 Supervisory Priorities, NCUA released an Advisory letter on Liquidity Risk Management on January 17, 2024. The Advisory letter highlights the key pillars of liquidity risk management, all of which are already reflected in regulation and existing official regulatory guidance. Although no new regulatory requirements have been issued, ALM First considers this letter to be a useful resource for credit unions to reflect upon current liquidity risk management practices and correct any potential weaknesses.
The letter covers the following topics:
- Cash flow forecasting and backtesting
- Asset composition
- Structure of liabilities
- Liquidity risk governance practices
- Funding sources
Although the Advisory letter primarily reiterates existing and generally well-established risk management practices, it warrants highlighting a few key elements for credit unions to consider when assessing existing liquidity risk management practices.
Funding Evaluation
Assessing the relative cost of funding sources remains imperative. Competition in some markets has driven certificate rates above wholesale funding rates. Credit unions should ensure funding sources are diversified and the cost of incremental funding is evaluated prior to enacting a funding strategy.
Short-Term Cash Flow Forecasting
Additionally, the Advisory letter points out the need to manage and forecast cash flows under normal and stressed conditions. ALM models can be leveraged for periodic stress testing of a credit union’s liquidity resilience; however, sources and uses of cash should be monitored more frequently and used to project short-term funding needs.
Backtesting
As with any financial model, backtesting is an important practice that is necessary to fine tune model performance and reliability for decision-making. Many clients have reported difficulties in obtaining actual cash flows from core systems but have been able to achieve sufficient backtesting by leveraging budget variance analyses.
There is no “one size fits all” approach to liquidity risk management and each credit union will need to incorporate the unique aspects of their business model to effectively manage risk.
Interest Rate Risk
After being the top priority for 2023, interest rate risk (IRR) continues to be a focus area for the NCUA in 2024. The 2024 Supervisory Priorities reiterate most of what was stated in last year’s release in that examiners will focus on IRR management practices such as:
- The reasonableness of key assumptions,
- The control of overall IRR exposure,
- Communication of results, and
- Proactive actions to remain within safe and sound policy limits.
Although IRR is not the top priority for 2024, credit unions continue to feel the effect of high interest rates and an inverted yield curve. Deposit migration from non-maturity deposits to certificates has pressured net interest margins and led to greater IRR for rising rate scenarios. Pressure of funding costs will likely persist throughout 2024 and institutions must maintain diligent pricing on both assets and liabilities to achieve the greatest margin stability possible.
In addition to continued focus on higher rates, or “rates higher for longer”, institutions should not lose sight of risks related to falling rates. High-rate assets booked today will likely prepay when rates fall. New assets and funding decisions should ensure that IRR is appropriately considered and controlled for all rate scenarios.
Other Supervisory Priorities
The NCUA’s Supervisory Priorities include non-capital markets and non-credit risk priorities. The agency will also focus on reviewing compliance with consumer financial protection laws and regulations, strengthening cybersecurity measures, BSA compliance and supporting small credit unions and minority depository institutions. These areas are equally important and represent opportunities for management teams to improve risk management practices further.
Preparing For Your Next Exam
2024 is already shaping up to be a challenging year for financial institutions. The NCUA Supervisory Priorities appropriately highlight many risk areas that are top of mind among the industry. For credit unions to continue to effectively serve and meet the needs of their members, risk exposures must be appropriately measured, monitored and controlled. Many of the priorities outlined by the NCUA can be tackled in the normal course of business, through focused allocation of internal resources. However, management teams may desire an external perspective and engage third parties for risk modeling and consulting. Regardless of the approach, enhancing risk management practices to address 2024 Priorities will facilitate smoother regulatory reviews and an overall improved preparedness for the economic uncertainty facing the industry.
Looking for a trusted partner to assist with risk management? Contact ALM First’s team of experienced professionals today to discuss your credit union’s needs.
