Given today's volatile rate environment and the potential for greater interest-rate risk associated with growth in real-estate loans, it's likely your credit union's asset/liability management (ALM) planning processes will be a focus of your examiners. While on the surface, such a focus may seem stressful and burdensome, it's actually beneficial, as good ALM practices are critical to successful business decisions.
At First Carolina Corporate Credit Union, we often help credit unions develop or enhance their ALM programs-and when they are preparing for exams, we recommend they review the critical elements of the ALM process, such as:
Asset/Liability Policy. First, it's important to review your policies prior to an exam to make sure they are up to date. Address any changes to your process or risk limits, and any new regulatory guidelines. The key to an effective ALM policy is to document your credit union's understanding of balance-sheet risk and its impact on financial performance, and to define acceptable risk limits, responsibilities, reporting requirements and internal controls to manage the risk.
* ALCO Committee Meetings & Minutes. Credit unions with more complex balance sheets should have an asset/liability committee (ALCO), comprised of members of the board and management. Typically, the ALCO meets monthly to evaluate investment activities, financial performance and risk exposures. Your examiners will request to see the ALCO minutes, which should include review and documentation of the items listed below. While credit unions with straightforward balance sheets may not need a formal ALCO, they nonetheless should review these items at each board meeting and record them in the board minutes.
* Current-period report of interest-rate risk, liquidity and capital adequacy. How do these compare with policy limits? What corrective actions were taken on any policy violations or risks that were approaching risk levels?
* Integration of ALCO with the strategic planning process. How effective is the communication between the ALCO and management-level staff responsible for managing risk exposure and business activities? What is the process for policy development and changes, financial product development and implementation of the business strategies?
* Review and evaluation of risk-measurement methodology and key assumptions. What are the processes for ongoing risk measurement and evaluation? Is the measurement methodology commensurate with the risks of the credit union? Are key modeling assumptions reviewed by ALCO?
* Review and discussion of the economic outlook. Does management report on current market trends at the ALCO meeting? Is this information integrated with ALM decisions?
* Review of financial performance including actual to plan. Are financial activities and results evaluated at each ALCO meeting for the previous month?
* ALCO recommendations to the board. Does management regularly examine issues that affect your credit union's financial actions? Are these issues reflected in recommendations for policy changes, the pros and cons of new financial products or strategies, and risk exposure?
* Education. Because the ALCO is responsible for the oversight of your credit union's ALM program, the examiners expect the committee to have the proper training to understand and assess interest-rate and liquidity risk. Each ALCO member should regularly receive some type of asset/liability training. Management of smaller credit unions without an ALCO and boards of all credit unions should have a basic understanding of asset/liability management.
* Interest-Rate-Risk Modeling. Financial institution regulators suggest that interest-rate risk should be measured at least semiannually, and industry practice is at least quarterly. The exam objective is to determine if the interest-rate-risk model adequately measures the complexity of your balance sheet. Credit unions with less-complex balance sheets may use basic gap models, while credit unions with greater complexity in their balance sheets should model earnings at risk using simulation models and capital at risk using economic-valuation models.
What You Should Include
Whether you use in-house models or models provided by outside service providers, the process should be documented and include the following:
* Measurement methodology.
* Types of rate scenarios used in modeling.
* Assumptions regarding prepayments, decay rates, valuation methods, etc.
* Balance-sheet aggregation.
* Internal controls to verify accuracy of results.
It's important to ensure that someone on staff is adequately trained on the model, understands how assumptions impact the results and can determine if the results are accurate. Depending on the size and complexity of your credit union's balance sheet, examiners may request model validation from an outside, third party to test the reasonableness of the model results.
* Prior Period Exam Comments. Review comments from any prior-period exam to ensure agreed-upon changes were implemented or that you have a plan for implementation.
An ALM exam may seem overwhelming, but with good documentation of an effective ALM program, you should be able to expect a successful experience.
Lisa Boylen, CPA, is an ALM Analyst at First Carolina Corporate Credit Union. She can be reached at (336) 217-4906.
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