interest rate risk - acuia.org rhone - interest... · at both risk to earnings and net economic ......
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InterestRateRiskFor Internal AuditorsForInternalAuditors
DeanRohne,CPA,CIA
[email protected]@cliftonlarsonallen.com
2012CliftonLarsonAllenLLP1 111
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SessionObjectives
Reviewrecentregulatoryguidanceoninterestrateriskrisk
Introduceproposedaccountingrequirementonliquidityriskandinterestraterisk
Review specific questions on the recent interest rate Reviewspecificquestionsontherecentinterestrateriskexamquestionnaire
Discussspecifictestinginternalauditorscanperformtoaddressinterestraterisk
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NumberofProblemCreditUnions
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ProblemCreditUnionInsuredShares
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CAMEL4/5byAssets
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NumberofCAMEL3CreditUnions
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CAMEL3byInsuredShares
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CAMEL3byAssetSize
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CAMELCodebyAssetSize
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Definitions
AssetLiabilityManagement(ALM) Managing risks that are present due to mismatches Managingrisksthatarepresentduetomismatchesbetweentheassetsandliabilities.
InterestRateRisk(IRR)( ) Thevulnerabilityofacreditunionsfinancialconditiontoadversemovementsinmarketinterestrates.
LiquidityRisk Theriskthatacreditunionwillnotbeabletomeetits
t d f t h fl d ll t l dcurrentandfuturecashflowandcollateralneeds.
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SessionExpectations
Sessiondesignedtodiscusstestinginternalauditorscould performcouldperform.
Internal auditors should consider the need to utilize Internalauditorsshouldconsidertheneedtoutilizeaspecialistasdeemednecessarybasedonthecomplexityofthecreditunion.p y
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RecentRegulatoryGuidance
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RecentRegulatoryGuidance
NCUALettertoCreditUnions12CU05 Issued May 2012 IssuedMay2012
Requirescertainfederallyinsuredcreditunionstoadoptawrittenpolicyoninterestraterisk(IRR)managementandaprogramtoimplementiteffectively.
Ruleaffects45%ofthecreditunions,but96%ofcreditunion assetsunionassets.
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12CU05
WhydidNCUAamendtheexistingrule? FICUs have recently experienced increased exposure to FICUshaverecentlyexperiencedincreasedexposuretoIRRdueto: Changesinbalancesheetcomposition
IRRfromfirstmortgagesandlongterminvestmentsgrewsubstantiallyduringthemostrecentinterestratecycle.
Increaseduncertaintyinfinancialmarkets
PriorregulationsdidnotspecificallyaddressIRRmanagementandpractices.
With these increases there is a need for strengthening WiththeseincreasesthereisaneedforstrengtheningpoliciesandprogramsrelatedtoIRRmanagement
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12CU05
WhydidNCUAamendtheexistingrule? Concern over IRR exposure ConcernoverIRRexposure
1996 Residentialmortgagebalancesinbanksandcreditunionsaccountedforapproximately15to20percentofthetotalassets
20 0 id i l b l d f 8 % f 2010 residentialmortgagebalancesaccountedfor18.4%ofpeerbanksand30.7%ofcreditunionassets
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SIRRTRatioDefined
SupervisoryInterestRateRiskThreshold(SIRRT) Takesintoaccountlongertermmaturitiesforbothfirstmortgageloansandinvestments
Whil fi t t l b l dit i b l Whilefirstmortgageloanbalancesoncreditunionbalancesheetshavedeclinedtheamountofinvestmentswithlongermaturitieshasincreased.
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SIRRTRatio
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NumberofCUsCoveredby12CU05
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AssetsCoveredby12CU05
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Exposure
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12CU05
Addressesthefollowing: IRR Policy IRRPolicy
IRROversightandManagement
IRRMeasurementandMonitoringg
InternalControls
DecisionMakingBasedonIRRMeasurementSystems
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12CU05
AdditionGuidanceforLargeCreditUnionswithComplex or High Risk Balance SheetsComplexorHighRiskBalanceSheets Definedascreditunionswithassetsover$500million
Thesecreditunionsshouldconsider: Policywhichprovidesfortheuseofoutsidepartiestovalidatethetestsandlimitswiththeriskexposureandcomplexityofthecreditunion
IRRmeasurementsystemstoreportcompliancewithpolicylimitsatbothrisktoearningsandneteconomicvalueofequitybasedonanumberofdefinedinterestratescenarios
Effectofchangestokeyassumptionssuchasslowerorfasterprepayments
Enhanced levels of separation between risk taking and risk
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Enhancedlevelsofseparationbetweenrisktakingandriskassessment.
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12CU05 AppendixB
DesignedtohelpcreditunionsmeetNCUAsexpectationsexpectations
Acknowledgesitisnotpossibleforaonesizefitsall policy for all credit unionsall policyforallcreditunions
Policyrequiresspecializedjudgmentsbasedonthecreditunionsbusinessobjectivesandabilitytoj ywithstandrisk Putsthisresponsibilitywiththeboardofdirectors
ProvidesframeworkoffivefundamentalelementsofaneffectiveIRRmanagementprogram
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12CU05 AppendixB
FiveelementsofaneffectiveIRRmanagementprogramprogram Comprehensive,writtenIRRpolicy
AccountableIRRoversightbyboardofdirectorsandg ymanagement
AppropriateIRRmeasurementandmonitoringsystems
Goodinternalcontrols
InformeddecisionmakingbasedonIRRsystemresults
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12CU05 IRRQuestionnaire
Containsfourpartsthatmightnotallbecompletedbased on complexity of the credit unionbasedoncomplexityofthecreditunion.
PartBaddressescertainratios 174 Test17 4Test
Quickwaytoidentifypotentialcapitalissuesbasedonrepricingofloansandinvestments
E ti t l i l f th f ll i i i i Estimateslossinvalueofthefollowinggivenanincreaseininterestrates Fixedraterealestateloans
V i bl t l t t l Variableraterealestateloans
Investmentsecurities
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12CU05 IRRQuestionnaire
PartBaddressescertainratios(continued) Short Term Liabilities/Total Shares & Borrowings ShortTermLiabilities/TotalShares&Borrowings
Shorttermliabilitiesmustbelessthan50%oftotaldepositsandborrowings
Sh li bili i i l d Shorttermliabilitiesincludes: Shareswithamaturitylessthanoneyear
Borrowingswithamaturitylessthanoneyear
ComplexAssets/TotalAssets Definedasadjustableratemortgages,balloon/hybridmortgages,agency/GSEmortgagebackedsecurities,othermortgagebackedg y/ g g , g gsecurities
Totalmustbelessthan17%oftotalassetsbenotbeconsideredcomplex
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12CU05 IRRQuestionnaire
PartC Consists of a limited scope review to address the following Consistsofalimitedscopereviewtoaddressthefollowing
PoliciesandProcedures BoardOversight IRRManagement IRRMeasurement IRRComponentsp InternalControls UseinDecisionMaking
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire
Includes detailed questions that address the Includesdetailedquestionsthataddressthefollowing: Sources of balance sheet complexitySourcesofbalancesheetcomplexity
Largeproportionofmortgageloansin: Hybridinstruments
N f i t Nonconformingmortgages
Adjustmentratemortgages
InvestmentportfoliocomposedprimarilyofCMSandothert l t d itimortgagerelatedsecurities
Useofnonmaturitysharesinpricingstrategyofthecreditunion Significantamountofcomplexborrowings
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Useofderivativesinmanaginginterestraterisk
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire IRR Policy IRRPolicy
Writtenpolicy Identifywhohasprimaryresponsibilityforimplementing Frequencyofreporting IRRlimits Shorttermandlongtermexposureg p Limitsbasedonshocks Reportingandactiontimeframeswhenoveralimit Annual evaluation Annualevaluation Internalcontrols
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire IRR Oversight and Management IRROversightandManagement
Boardofdirectoroversight Effective?
Assessedadequacyofcontrols
Assessedreliabilityofthemeasurementmethods
Providedadequateinformation
AdequatetrainingonIRRtomeetresponsibilities
Managementresponsibilities Adequatemeasuringsystems
UnderstandandevaluateIRRexposures
Establishedinternalcontrols
Preparecontingencyplans
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Awareofmodelingassumptions
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire IRR Measurement and Monitoring IRRMeasurementandMonitoring
RiskMeasurementSystems Assumptionsmakesenseandcantheybesupported?
Changestoassumptionsdocumented?
AnalysishaveenoughdepthtoadequatelyaddressIRR?
RiskMeasurementMethods Methodsadequatebasedoncomplexityofthecreditunion?
GAPAnalysis DoesmanagementunderstandhowGAPanalysisiscalculatedandhowitisused?
Isthecreditunionwithinpolicylimits
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire IRR Measurement and Monitoring (continued) IRRMeasurementandMonitoring(continued)
IncomeSimulation Measurenetinterestincomeand/ornetincome?
Doesmanagementhaveabilitytodescribehowincomesimulationiscalculatedandusedbythecreditunion?
Isthecreditunionwithinpolicylimits?
A t V l ti AssetValuation DoesthecreditunionuseNCUAsassetvaluationtable?
Doesmanagementhaveabilitytodescribehowassetvaluationiscalculated and used by the credit unioncalculatedandusedbythecreditunion
NetEconomicValue(NEV) UnderstanduseofNEV?
i hi li li i ?
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Withinpolicylimits?
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire Components of IRR Measurement Methods ComponentsofIRRMeasurementMethods
ChartofAccounts AggregationofDataInput AccountAttributes PresentValueDiscountingMethodology PrepaymentAssumptionsp y p RepricingSensitivityAssumptions DecayRatesofNonmaturitySharesAssumptions
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire Internal Controls InternalControls
Auditfunctionindependentofriskassessmentandrisktaking Adequatesegregationofduties ALCOensurecreditunionisoperatingwithinpolicylimits Followuponregulatoryandthirdpartyfindingsbysupervisorycommitteeorinternalaudit
Adequatesystemtoareaswhereerrorsorabusescouldoccur
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire Decision Making Informed by IRR Measurement Systems DecisionMakingInformedbyIRRMeasurementSystems
DoesmanagementusetheresultsofIRRmeasurementsystemstoassistinmakingdecisionsinthefollowingareas:
O ti d i i Operatingdecisions
Changingbalancesheetstructure
Fundingoptions
P i i Pricingstrategy
Businessplans
Doesmanagementproactivelyidentifystepstoaddressnegatived ?trends?
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12CU05 IRRQuestionnaire
PartD ExpandedScopeIRRReviewQuestionnaire Additional guidance for large credit unions with higher risk Additionalguidanceforlargecreditunionswithhigherriskorcomplexbalancesheets Inadditiontotheitemsdescribedabovedoesthecreditunion:
FullyunderstandallpartsofIRR
Periodicallyobtainathirdpartyvalidationincludingthereasonablenessoftheassumptions
i k i d d i f diff MeasurerisktoearningsandNEVunderavarietyofdifferentinterestratescenarios
Disaggregatedatadowntotheaccountlevel?
Adequately test changes to assumptions on IRR measurement results AdequatelytestchangestoassumptionsonIRRmeasurementresults
Enhancedlevelsofseparationbetweenrisktakingandriskassessment?
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ProposedchangestoASC Topic 825ASCTopic825
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FinancialInstruments(Topic825)
DisclosuresaboutLiquidityRiskandInterestRateRiskRisk ProposedaccountingstandingIssuedJune27,2012withcommentsdueSeptember25,2012
Whywasthisissuedasaproposedstandard Stakeholdersfeedbackonaproposedstandardrelatedtoderivatives indicated there are risks inherent within classes ofderivativesindicatedtherearerisksinherentwithinclassesoffinancialinstrumentsandthewayanentitymanagementsthoserisks.
No single amount or measurement is possible to disclose this risk Nosingleamountormeasurementispossibletodisclosethisrisk
Effectivedate Notset,willbedeterminedasFinancialAccountingStandards
( )
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Board(FASB)considersfeedbackontheproposedchanges.
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FinancialInstruments(Topic825)
Disclosuresrequiredaredeterminedbasedonwhether the entity is a financial institutionwhethertheentityisafinancialinstitution. Financialinstitutiondefinedasreportablesegmentswhoseprimarybusinessincludes: Earningincomefrominterestbasedonearningassetsaninterestpaidonborrowedfunds
Providesinsurance
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FinancialInstruments(Topic825)
Disclosureswouldprovideinformationabouttherisks and uncertainties a credit union would have inrisksanduncertaintiesacreditunionwouldhaveinmeetingfinancialobligations. Wouldrequirequantitativeandnarrativedisclosureq qrelatedtoacreditunionsexposuretoIRR.
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FinancialInstruments(Topic825)
Disclosuresforfinancialinstitutions Liquidity Gap Maturity Analysis LiquidityGapMaturityAnalysis
IssuanceofTimeDeposits
AvailableLiquidFundsq
RepricingGapAnalysis
InterestRateSensitivity
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ProposedStandard LiquidityGAPMaturity
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ProposedStandard TimeDepositMaturity
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ProposedStandard YieldPricingAnalysis
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ProposedStandard AvailableLiquidFunds
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ProposedStandard InterestRateSensitivity
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WhatShouldInternalAuditorsDo?
VerifytheCreditUnionhasimplementedtherequirements of 12CU05requirementsof12 CU 05
Determinewhethermanagementisawareofproposed changes and ASC Topic 825proposedchangesandASCTopic825
AssesswhetherIRRshouldbeincludedinthescopeofaninternalauditplanbasedontheinternalauditpdepartmentsriskassessment
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WhatShouldInternalAuditorsDo?
IftestingIRRwithinyourcreditunionconsiderthefollowing:following: Useaspecialistasneeded
Utilizetheexaminerchecklisttoidentifyanyregulatoryy y g yissues Internalcontrolissues Management understanding of IRR present ManagementunderstandingofIRRpresent Boardunderstandingandinvolvement
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Contact UsFollowourblogforcurrent
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DeanRohne,CPA,CIAdean rohne@ cliftonlarsonallen com www.larsonallen.com/blog
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2012CliftonLarsonAllenLLP49