What is the ideal ROA ratio for a credit union?
NCUA is telling its examiners there isn't one. But several state regulators said that while they're encouraged by the agency's recognition that ROA targets are not fixed, but they also want to make sure federal examiners are practicing what the NCUA board is preaching.
While a 1% ROA has long been considered the rule of thumb, in a new Supervisory Letter to examiners (06-01) the agency stressed that "lower earnings are being observed nationwide. This trend is a result of rising interest rates, a flat yield curve and some credit unions positioning themselves strategically."
Several analysts who spoke with The Credit Union Journal said a fairer assessment of extant financial conditions may not exist in the reality-based world of CU economics. And coming on the stark realization that the once sacrosanct 1% Return on Average Assets (ROA) is as much history as the steel teller cage, NCUA has put its examiners on notice that reduced earnings may not indicate a reason to "inadvertently undermine a credit union's ability to achieve a long term success with an unduly conservative or short-term focused approach to supervision."
Reality Vs. Theory
In other words, the matrix may be real, but it's also theoretical. The CAMEL Matrix established by NCUA in 1987 seemed to etch in stone the 1% ROA target as the ideal by tying it to the Earnings component in order to get a CAMEL 1 rating. Indeed, the agency's letter uses the word "canonized" in fact, to describe just how saintly the achievement of that benchmark has become. The NCUA acknowledges how "tenacious" the 1% ROA "rule of thumb" has become despite the CAMEL ratings system having undergone several revisions. And the federal regulator has previously cited that a "Fixation on a profitability target established in a vacuum (e.g. striving for a 1% ROA for the sake of meeting this rule of thumb) often leads to poor decision-making with negative long tern consequences for the institution." (Supervisory Letter 05-01 Evaluating Capital Adequacy.)
The Letter states that there is "no simple metric" for determining what a CU's ROA level should be and that CAMEL ratings are not automatically determined by Matrix ratios. A CU's earnings level should be based on its particular needs and current financial conditions must be taken into account. Those conditions include the quality of its earnings, risk profile, operational conditions and strategic plan.
That position should come as relief to many and a surprise to some who have been on the bad side of a federal examiner seemingly stuck somewhere between the Matrix and the real world. "This (NCUA) letter mirrors real life," said Jerrie Lattimore, Credit Union Administrator for North Carolina. "The policy may be a good one, but let's see how the implementation works. We've seen some disconnect in the past between policy and action, between what board members may say and the actions of field examiners. But it appears that the NCUA is trying to bridge that gap and I see that as a very good thing."
Lattimore's colleague in Kansas, John Smith, the Administrator of the Department of Credit Unions, called it a "realistic letter. It's pretty clear, and I'm thinking of issuing a letter to our state credit unions here that examiners always have the option of diverting from the Matrix in recognition of other factors faced by the credit union."
In fact, in his prior role as CU Administrator in the state of Missouri, Smith issued Bulletin 2003-CU-02 in April, acknowledging the Department's performance of Risk-Based Examinations for several years that stated, "Examiners must look behind the financial information to determine the significance of the key ratios, trends, projections and interrelationships with the seven risk areas. Examiners have the discretion to increase or decrease any CAMEL rating if in their professional judgment it is justified."
NCUA is also saying it will no longer countenance examiners who like to see piles of retained earnings at the expense of reduced or restricted services to members. CUs need not "engage in reactive or extraordinary measures simply because earnings levels decline as a result of broader economic conditions when net worth levels meet or exceed their needs." Some of those measures include imposing higher fees, selling less profitable business lines or making risky loans and investments.
Reality Vs. Theory
With the new letter, NCUA is inviting comment, saying it wants a "sincere debate" and a healthy dialogue about earnings and how they properly fit within a CU's plan for fiscal well-being.
NCUA Director of Examination and Insurance Dave Marquis acknowledged that the letter was carefully worded to promote that very message. "We went to the risk-based program several years ago, and CAMEL is still out there, so examiners needed a standard in order to properly apply CAMEL ratings. We've determined that the Matrix is quantifiable, but it also needs an overlay of qualitative factors. We needed some reeducation. I'm talking to field staff this week and that's my message," he said.
