It was George E.P. Box, the eminent statistician, who said, “Essentially, all models are wrong but some are useful.”

Currently, the five largest U.S. credit unions are hoping the models being used by NCUA to stress test their institutions' financial stability against three possible economic scenarios are less wrong and more useful than they fear them to be.

Credit unions with more than $10 billion in assets faced a Nov. 21 deadline to submit their financial information to the NCUA to be stress tested by BlackRock, an international asset management firm that worked with the regulator on the corporate credit union bailout. The stress tests will determine whether the financial institutions have adequate capital to withstand economic shocks.

In February, each of the five credit unions will be required to provide a capital plan that will work in conjunction with stress testing results and, as necessary, incorporate any changes the stress testing revealed into the plan.

The credit unions undergoing the testing are $62.5 billion Navy Federal Credit Union, Vienna, Va.; $29.1 billion State Employees' Credit Union, Raleigh, N.C.; $18.6 billion Pentagon Federal Credit Union, Alexandria, Va.; $12.7 billion Boeing Employees Credit Union, Tukwila, Wash.; and the $10.4 billion SchoolsFirst Federal Credit Union, Santa Ana, Calif.

Although stress testing is not a requirement for credit unions under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the NCUA in Sept. 2013 announced its intention to draft a rule requiring annual stress testing for its credit unions. Stress testing would be part of a “coordinated approach,” NCUA Chairman Debbie Matz said in a press release issued at the time, to the supervision of a changing industry with asset growth concentrated in large credit unions.

The NCUA received 22 comment letters, not only from the credit unions to be tested, but also other credit unions, trade associations and even one state department of financial institutions with credit union oversight responsibilities.

The letters raised issue with everything from need for the development of new models to the amount the NCUA was spending on the project to whether or not the results of the test should remain confidential, similar to CAMEL ratings, or be open and transparent, which is what the Federal Reserve had mandated for bank stress-test results.

“The comments NCUA received on the proposed rule supported the concept of stress testing, and concerns raised focused on implementation,” NCUA Public Affairs Specialist John Fairbanks said. “The final rule addressed most of those concerns.”

The most common theme among concerns was what the tests would yield and how that information would be used. The wealth of data required, not to mention the cost of compliance, were enough to give the five credit unions pause.

“We are submitting a ton of data for a 10-year period, and this whole process has been a significant undertaking in terms of time, money and effort,” Katherine Elser, CFO and SVP of finance and administration for BECU, said. “Since July, we've dedicated a couple of people full-time and another couple part-time, and we are working furiously.”

In July, BECU held its kickoff meeting with regulators to discuss the process and expectations. The sheer magnitude of the project created a time crunch that caused a high amount of stress for staff, according to Michael Quamma, BECU's vice president of treasury. It also raised concerns about the accuracy and outcomes of the process.

“This is a process with a lot of moving parts – our strategy, the economy and the idiosyncratic nature of our geographic footprint,” Quamma said. “Our concern is that NCUA owns the assumptions [from the testing] and that we don't have control.”

BECU hired consulting firm KPMG to run its own stress test scenarios as part of the planning and preparation for data submission, Elser said.

Navy Federal's attitude toward stress testing is similar to that of BECU, but in the case of the world's largest credit union, it's business as usual, according to Vince Pennisi, the credit union's chief investment and risk officer.

“When the Federal Reserve came out with stress testing requirements four or five years ago and set the asset threshold at $50 billion, we recognized that, being a financial institution over the threshold, it would be smart to do stress testing ourselves,” Pennisi said. “We've been doing it each and every year since stress testing requirement for banks came out.”

Navy Federal has invested significant resources in building risk management capabilities and has had sophisticated models in place for a decade or more, Pennisi said. The models, designed to respond to overall economic changes such as a rising unemployment rate, allow financial scenarios to be developed that would apply to any large financial institution.

“Originally, we did some minor tweaking to accommodate the credit union model,” Pennisi said. “There are some differences in components of capital between banks and credit unions, but once we established this a decade ago, we didn't have to make changes.”

The credit union runs a formal stress test annually using its model to measure institutional performance against current risk, Pennisi said. Tests are also run monthly and, when called for, on an ad hoc basis.

“We had suggested in our comment letter [to the NCUA] to validate the models already in existence rather than go through the extra expense of hiring an outside vendor,” Pennisi said. “We felt validating made more sense. We've had to do substantial work to provide that data to Blackrock.”

The NCUA's history with modeling has not gone well for credit unions, said Callahan and Associates Chairman Chip Filson.

“It's not modeling errors, it's misunderstanding what models can and can't do. It's a fallacy to think you can program a balance sheet like you can a software program,” Filson said. “NCUA's use of modeling has been particularly destructive to the credit union system.”

Like BECU, SECU also contracted with KPMG to study the credit union's deposit accounts, which the consulting firm said were long-lived and a stable, reliable source of funding for the credit union. The credit union worked with Promontory Financial Group, a Washington, D.C.-based consulting firm, to establish a new capital plan commensurate with the NCUA's new capital guidelines.

Independent studies by consulting firm CliftonLarsonAllen indicated that SECU's liquidity coverage ratio was 20 times that of the minimum banking industry standard. In a separate study, the same firm noted that SECU's allowance for loan and lease loss was seven times the amount required to cover the credit union's actual annual loan losses.

“Expert consulting from industry experts is not new for us,” Mike Lord, SECU's CFO, said. “We've been doing it for years. We don't know where all the risk might be so it's good to have a set of independent eyes.”

The most recent round of consulting, which also included a mortgage portfolio evaluation by Moody's Corp., has cost SECU more than $1 million, according to Jim Blaine, SECU's president/CEO. However, it was necessary given the credit union's past experiences with the regulator, he noted.

“We hire outside consultants because the way we manage capital and our balance sheet has been under constant criticism by NCUA for 30 years,” Blaine said. “We've grown dramatically and handled it, but we have been under constant criticism and attack by NCUA.”

One of the issues of greatest concern to SECU is the lack of transparency when it comes to sharing stress test results. Unlike banks, whose test results are required to be made public by their regulator, the NCUA has mandated that credit union stress test results, like CAMEL ratings, may not be made public, Blaine said.

Instant Insights /

Stress Test Scramble Underway for Billion Dollar CUs

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