The Office of Inspector General recommended adding an S category tothe NCUA'sCAMEL rating system to monitor interest rate risk, according toa Nov. 13 report.

The OIG conducted an audit of the NCUA's IRR policy to determineif its current policy and procedures reduce IRR. The OIG alsostudied what actions the agency has taken or plans to take in orderto identify and address credit unions with IRR concerns.

In the report, the OIG concluded the NCUA's CAMEL rating systemmay not be effectively capturing IRR when assigning a compositerating to a credit union. The report also stated that in the NCUA'sassessment of sensitivity to market risk under the L category ofits CAMEL rating may “understate or obscure instances of high IRRexposure in a credit union.”

The OIG determined the NCUA took steps to identify and addresscredit unions with interest rate risk concerns, but stated theaddition of an S rating would improve the agency's ability toaccurately measure and monitor interest rate risk by separatelyassessing a credit union's sensitivity to market risk.

The OIG recommended the NCUA add an S rating for market risksensitivity and revise the L rating to reflect only liquidityfactors. Under its current structure, the acronym CAMEL is derivedfrom the following components: [C]apital Adequacy, [A]sset Quality,[M]anagement, [E]arnings and [L]iquidity/Asset/LiabilityManagement. The audit was conducted through NCUA staff interviews,and reviews of NCUA guidance, policies, procedures and otherinterest rate risk information. Additionally, the OIG selected acredit union from each of the NCUA's five regions and analyzed thecorresponding examination and supervision reports and relateddocuments.

Regional staff and examiners play essential roles in determiningwhich credit unions have elevated IRR and assessing and addressingIRR concerns, according to the report. Additionally, the NCUA's IRRworking group formed by the agency is refining the process neededto develop examination-based IRR assessment tools, according to thereport. As a result, the OIG said it will revisit this objectivelater, allowing the agency time to develop the process.

Jim Blaine, president/CEO of the Raleigh, N.C.-based, $31billion State Employees' Credit Union, told CU Times IRRis not a new concept for the NCUA or other financial institutions,since it was adopted by banking agencies almost 20 years ago.

“The measurement of interest rate risk has been practiced bycredit unions and the NCUA for decades, so it's not a new idea,” hesaid.

Blaine added increasing the importance of the L component “isexactly the right move.” He explained liquidity is the componentthat “brings organizations down – not capital, not interest raterisk.”

The NCUA agreed with the OIG's recommendations in a lettercontained within the report. NCUA Executive Director Mark Treichelsaid if the board approves the regulatory changes, the regulatorwill target the final implementation of the recommendation by theend of 2018. He added the changes required to meet therecommendations “will be complex.”

The NCUA is moving more toward adopting standards and processesthat are similar to those practiced by other federal regulators,and this move would be in line with that effort, according toBlaine. The FDIC, the Office of the Comptroller of the Currency andthe Board of Governors of the Federal Reserve System began usingthe CAMELS rating system on Jan. 1, 1997, after the system wasrevised in 1996 by the Federal Financial Institutions ExaminationCouncil to add an S. The NCUA adopted the CAMEL rating system inOctober 1987.

However, if the NCUA lines up with other regulators, the endgamecould be problematic for credit unions. Should the NCUA startmirroring other regulators by adapting “a series of banking rulesfor credit unions, then that will impair the credit unions' effortto serve,” Blaine stated.

NAFCU Director of Regulatory Affairs Alicia Nealon told CUTimes the trade group is examining how the addition of S tothe CAMEL rating system will impact its members. “NAFCU has longmaintained that (the) NCUA should address interest rate risk on theexam side, rather than through additional regulation,” shesaid.

Yet the devil is in the details, according to Blaine. One of thefactors that concerns credit unions is the differing perceptionbetween a regulator and the financial institution it oversees. Headded that a strong point of friction between the NCUA and creditunions is the determination of the appropriate level of risk at aninstitution.

“Since there are no specific rules in interest rate risk, thereis not an agreed upon formula or standard template,” he added.“That's where you get all sorts of argument back and forth betweencredit unions and the regulator.”

Bill Hampel, chief policy officer for CUNA, told CUTimes that the trade group was aware the NCUA has beendeveloping new examination tools to assess interest rate risk.

“So long as adding an S to CAMEL simply highlights theincorporation of those tools into the process, without addingadditional exam requirements beyond those tools, doing so would notbe harmful,” Hampel said.

Still, the question of why the recommendations are coming fromthe OIG now – almost 20 years later – lingers.

“It is a little unusual that this originated out of the bluewith the OIG,” Blaine said. “It does look like a political movewithin the organization to give it a basis for argument that theymust proceed and do something.”

The NCUA has lagged behind other regulators that moved forwardwith interest rate risk in 1997. Now that it's been criticized byits auditor, the agency can use the OIG's recommendations to stepcloser in line with other regulators.

However, some warned the agency should exercise caution. Blainecited the corporate credit union collapses in 2008 and 2009 as alooming concern for today's credit unions. Back then, the NCUA'scapital markets division included on-site IRR experts, Blaineexplained, who oversaw institutions that still went “belly up”after being watched daily.

He added, “There's some concern, not only about how interestrate risk is going to be measured by the NCUA, but the degree ofexpertise they have in house to really do that. It's critical forcredit unions how that's measured.”

The OIG report also identified that NCUA Regional Capital MarketSpecialists are pivotal in identifying credit unions with elevatedIRR. These specialists perform annual assessments to helpprioritize a credit union's workload for the upcoming year. Afterreviewing various metrics, the specialists assign a quantitativerisk rating and conduct a review of examination contacts. However,these assessments vary by region, and some take into accountmetrics that are not measured across all regions. These includeballoon or hybrid loans with interest rates that are due toreadjust during assessments of real estate concentrations becausethey carry risks similar to those of fixed rate loans.

In addition to Regional Capital Market Specialists, the reportfound regional Divisions of Supervision also assess and measureIRR. Further, examiners conduct a preliminary risk assessment thatincludes a review of IRR.

“It's probably a positive step forward, but the devil is alwaysin the details on implementation,” Blaine concluded.