The NCUA on Thursday released a supervisory letter, providing guidance regarding how examiners will supervise compliance with a November 2012 final rule that substitutes a narrative standard in place of credit rating requirements for investments.
The guidance addresses why ratings have been removed from the regulations in compliance with the Dodd-Frank Act, and provides regulatory expectations for natural person and corporate federal credit unions when they consider creditworthiness factors. Credit unions may still use credit ratings to augment their due diligence, but per the final rule, cannot use ratings as the sole basis to determine an investment’s suitability, the supervisory letter said.
The depth of the due diligence should be a function of the security's credit quality, the complexity of the structure, and the size of the investment. The more complex a security's structure, the more credit-related due diligence an institution should perform, even for investments considered to be of high credit quality, the letter said. “Management must understand the security's structure and how the security may perform in different economic and default environments. Management needs to be particularly diligent when purchasing structured securities,” the letter said. “For example, an FCU should be able to demonstrate an understanding of the effects on cash flows for a structured security assuming varying default levels of the underlying assets.”
Federal credit unions may consider risk factors such as credit spreads, internal or external credit risk assessments, default statistics, inclusion on an index, priorities and enhancements, price, yield and/or volume when evaluating securities, the letter said.
The supervisory letter also includes additional guidance on structured securities analysis and investments grandfathered under the rule.
The guidance is available on the NCUA’s website.