ALEXANDRIA, Va. — NCUA shared a Supervisory Letter distributed to all examiners with federal credit unions earlier this month to help ensure examiners and credit unions understand that a 1% return on assets is not required in order to achieve a CAMEL 1 rating.
"NCUA appreciates the delicate balance credit unions must strive to achieve between the short-term and long-term needs of the credit union. In this regard, I encourage credit union officials to be committed to a sincere, conscientious, and well-planned strategy to safely balance the net worth and earnings needs of the credit union with strategies to achieve longer-term objectives," NCUA Chairman JoAnn Johnson wrote in Letter to Federal Credit Unions 06-FCU-04. "I am confident that with an open dialogue examiners will be supportive of such endeavors."
If a credit union has a disagreement with its examiner on the issue of ROA, she encouraged them to contact the supervisory examiner or the regional office. Disagreements with the regional office should be relayed to NCUA's Supervisory Review Committee. "Lower earnings are being observed nationwide," the Supervisory Letter, attached to the Letter to FCUs, acknowledged. "This trend is the result of rising interest rates, a flat yield curve, and some credit unions incurring costs to position themselves strategically. There is no simple metric for determining what a credit union's retained earnings level should be…CAMEL ratings are not automatically determined by matrix ratios. Striving for an arbitrary one percent Return on Average Assets just to achieve a CAMEL 1 rating based on the CAMEL matrix is not an acceptable argument, especially in the current economy, for a well-capitalized credit union. Each credit union's earnings level must be evaluated relative to net worth needs, financial and operational risk exposures, the current economic climate, and the institution's strategic plans."
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NCUA Director of Examination and Insurance Dave Marquis, who signed the letter, concluded, "We must be careful not to inadvertently undermine a credit union's ability to achieve long-term success with an unduly conservative or short-term focused approach to supervision. An overly simplistic focus on one measure of earnings performance could drive unsafe and unsound behavior." In a subsequent interview, he said the agency has seen "spots" of credit unions taking too much risk, but that has been mitigated over the last year or so, particularly with the warnings on fixed rate mortgage loans NCUA has sent out. Overall, though, "We think we have a reasonable balance."
CUNA Chief Economist Bill Hampel said generally that he has not seen extra risk being taken on by credit unions just to bolster ROA.
Marquis also pointed out that when the CAMEL matrix–which included the 1% ROA–was established in 1987, it "canonized" the benchmark. "The concept of the matrix is getting long in the tooth because it doesn't match up with a risk-based program," he said.
Marquis said the future of the matrix is "to be determined." E&I is working to either update or eliminate the matrix and hopes to have the project completed sometime next year, he said. In the meantime, the agency is working on preplanning with its exam staff and educating credit unions.
Additionally, examiners tend to lean on it too much as a "safe zone," according to Marquis, but it really has not been that problematic until the last year to 18 months as ROAs began to slip due to the flattened yield curve. "The squeeze is going to continue for a while, as far as I can see," he forecast.
NAFCU Senior Economist Jeff Taylor said of ROA through the end of 2006, "I'm looking at coming in around the same as last year: .84-.85…I don't really see earnings for the community going up to 1%. Things change." He explained that in the overall scheme a lower ROA is not necessarily a bad thing.
"A lot of credit unions have been able to make up net interest margin with noninterest income or fee income," Taylor said. "At the same time, we don't want credit unions to become too enamored with it."
The Supervisory Letter added, "Lower ROA levels will be viewed positively if they are the result of a sound and well-executed strategy to balance risk exposure or incur costs to position the credit union to achieve longer-term growth and member service objectives. In addition, examiners recognize that the purpose for credit unions retaining earnings is maintaining appropriate, but not excessive, net worth levels relative to the risk profile of the credit union."
However, the letter also said that there is a responsibility that lies with the credit unions to develop and document a sound strategic plan to explain a sinking ROA. "In the absence of documented and sound plans, attempting to justify poor earnings performance after the fact is considered not only a weakness in the Earnings component of CAMEL, but the Management component and relevant risk ratings in the seven areas of risk as well," the conclusion reads.
"I don't know that this has been an ongoing issue for credit unions," NAFCU Senior Counsel and Director of Regulatory Affairs Carrie Hunt said of the instructions to examiners. "NCUA continues to support risk-based for credit unions." She added that NAFCU members have expressed differing experiences with examiners looking at ROA.
Hampel noted that credit unions already have generally high capital levels that could permit them to comfortably lower their ROA as long as the rest of the house is in order. He explained that he has been telling credit unions that they really do not need as high an ROA as they have been achieving, but credit unions have been resisting saying, "Yeah, that all makes sense but our examiners would have a hard time if we did this." Hampel added that this is partially just an expectation on the credit unions' part rather than actual experience.
The economist agreed with Marquis that the matrix is at the crux of the issue. "It's not just the examiner; it's the system…Regardless of what the agency has said in the past, there still is this matrix," he said.
Hampel continued, "It's useful for this kind of common guidance to go out to examiners so they're all hearing the same story."
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