Office of Examination and Insurance About E&I and Our Look Forward 06/06/2013 Tim Segerson Office of Examination and Insurance

NFCDCU Baltimore

E&I DOSDRMDDASDCCMNGNCLF The Alphabet Soup of E&I NFCDCU Baltimore All things Risk Related incl. NCUSIF and Stab. Fund Central Liquidity Exam Policy & Program Oversight Guaranteed Note Oversight and Reporting Capital and Credit Market Specialists – Field Support Data Systems, Reporting, and Financial Analysis – ISO Field Support

What E&I Does Recent Enhancements Exam Report Cover – Contact Info. NSPM SCUEP Guidance and Rulemakings – TDR – Waivers – Derivatives – IRR NFCDCU Baltimore Some Things In the Works Supervisory Guidance: – Benefits Plans – NRSROs – Private Student Loans – ERM Exam Improvements – DOR Consistency – Continued Bifurcation

Capacity, Clarity, Consistency NFCDCU Baltimore Capacity – Examiners will evaluate capacity to manage Operational Risk and Balance Sheet Risk. Clarity – NCUA will work to improve guidance for examiners AND credit unions. Consistency – Use of Documents of Resolution (DOR’s) – National Supervision Policy Manual – Exam Procedures

Forces Driving Change 6 Marketplace Technology Information Security Mobile Access Innovation “Leap-Frog" Technologies Competition Overlapping FOMs Non-bank financial institutions Economies of Scale Investment and Loan Products Regulatory Environment CUMAA, 1998 Gramm-Leach- Bliley, 1999 Basel III, 2006 Dodd-Frank, 2010 Accounting Standards Business Combinations Fair Value Accounting NFCDCU Baltimore 2013

The Big Picture Change is Inevitable NFCDCU Baltimore For NCUA Industry evolution/rising stakes dictates nimble, transparent and forward looking strategies – NCUA for 2020 Changing employee demographics Changing CU demographics Changing market place Changing Technology For Credit Unions Market/Technology Will Drive Strategies – Evolve or Suffer the Consequences 3 C’s in Force Sound Operational Controls Balance Sheet Management Self Sufficient Liquidity Management

Changing Balance Sheet NFCDCU Baltimore Increasing Long Term Assets and Non-core Shares 56% of shares 26% of Assets

Can increasing balance sheet exposure become the next crisis in credit unions? NFCDCU Baltimore Avg. Costs before PLLL = 3.89% 3.89% > 3.53% Locking in 30 yrs.? At these rates?

Balance Sheet Exposure of LICUs NFCDCU Baltimore

Operational Risk 11 New Risks Require Enhanced Internal Controls Old Risks require strong controls NFCDCU Baltimore 2013 Fraud losses cost the industry the most of all the failures (sometimes several multiples of reported assets) Internal controls, risk mitigation, and oversight – No substitution for controls – Multiple review levels can mitigate but not replace – Independence Strong effective audit process Internal audits Oversight

Operational Risks – Fraud Hot Spots NFCDCU Baltimore Poor Accounting Controls/Un-reconciled Books – Clean Records and Effectively Monitoring Financial Activity Unrecorded shares – Segregate activity/access control – Monitor bank activity Fictitious and Fraudulent Loans – New loans, Charge off loans, Due Dates, Subsidiary vs Control Account. Un-cleared Overdrafts – Bank Reconcilements, general ledger reviews, access controls/override reports Dormant/inactive share accounts – Timely monitoring and clearing inactive accounts – Control reports False Expenditures – Unsupported expenditures – Budget/financial statement monitoring

Risk Management is Key 10 DO’s 1.Commitment to make tough choices. 2.Forward looking strategy. 3.Well developed and integrated risk management. 4.Balanced appetite for risk (like your life depended on it). 5.Incentives aligned with sustainable risk levels (Taking a long term strategic view). 6.Continuous monitoring and strong comprehensive reporting regime (Good, Bad or Ugly). 7.Strong control environment. 8.Balanced portfolio and portfolio strategy. 9.Equal weight to the downside risks in the decision making process. 10.Optimal capital deployment (Scaled to level of risk and no over-reliance). 13 Good Risk Management fosters vigilance in times of calm and instills discipline in times of crisis. Dr. Michael Ong Examination 2013: What to Expect 10 Don’t’s 1.Lack of commitment to risk management. 2.Disengaged leadership. 3.Concentrated organizational power. 4.Inconsistent or weak process for complexity or risk level. 5.Failure to adhere to policies and procedures. 6.Appetite “creep” (Don’t rationalize – make the touch decision). 7.“Silver Bullets” and “Shiny Objects” (aka shortcuts). 8.Disproportionate yields = unidentified risk (there are no hidden secrets if you have not identified the risk – stop until you can see, measure and control it) 9.A state of denial (The truth of the matter is that you always know the right thing to do. The hard part is doing it. -Norman Schwarzkopf ) 10.Misaligned incentives (poorly designed pay and incentive plans

Three Credit Union Profiles 14 SmallMid-SizedLarge $50 Million $250 Million 4,515 Units % $64.4 B in Assets - 6.1% 1,465 Units %` $163.4 B in Assets % 773 Units % $795.1 B in Assets % NFCDCU Baltimore 2013 LICU = 1,675 & $110.6 B in Assets

Resource Distribution by Asset Cohort 15 Share of Assets vs. Share of Exam Hours NFCDCU Baltimore 2013

What is the point? NFCDCU Baltimore Increasing Large Institutions – Greater sophistication and complexity requires different staffing approaches and exam approaches – Higher impact to the national NCUSIF Limited/Scarce Resources – Stakeholder Value – Consumer/System Protection Modernization Leverage technology to optimize efficiency Modernize Regulatory and Supervisory Framework – Consistency – Flexibility Specialization – Rent v Buy – Diversify Oversight/Program Management

Office Contact Page NFCDCU Baltimore Feel free to contact our office with questions or comments. Primary Staff: Tim Segerson, Deputy Director Office Phone: