Compliance Blog

Posted by Anthony Demangone

Last week, NCUA issued Letter to Credit Union 09-CU-23. Access the letter here.  Access the enclosure to the letter here.   

What is it about?  Earlier in November, NCUA issued guidance to its examiners to help them judge or evaluate credit union earnings.  The letter to credit unions simply shares the "examiner guidance" with all federally-insured credit unions.  The enclosure is the actual guidance that the examiners have received.

Why was it issued?  I can't say for sure, but here's my guess.  In the current economic environment, many credit unions have lower earnings, or no earnings at all.  NCUA wanted to remind examiners not to make knee-jerk reactions to earnings after looking at ratios.  Here's a snippet of the enclosure that captures the spirit of the guidance.

The fact that a credit union’s net income level is relatively high or low is not by itself evidence there is a problem. Rather, it is merely a trigger for a thorough review of the credit union’s earnings structure to determine the underlying factors driving the performance. Letter to Federal Credit Unions 06-FCU-04 (August 2006), Evaluation of Earnings, provides examples of red flags which should trigger a more in-depth review of a credit union’s earnings performance.

Lower ROA levels may be indicative of a sound and well-executed strategy to balance risk exposure. The credit union may have incurred costs that position the credit union to achieve longer-term growth and member service objectives consistent with their strategic plan. While there can be sound reasons for lower earnings, there also are unsound reasons. A credit union may have made strategic decisions that will adversely affect earnings and net worth over the long-term. This could include an unsound level of fixed assets that the earnings structure cannot support. It also could include a fundamental shift in the balance sheet resulting in depressed net interest margin insufficient to cover the cost of core operations.

NCUA also notes that costs related to the corporate stabilization effort are also dragging down earnings.  Examiners must look at everything before reaching a conclusion.  In fact, NCUA said they should consider the following::

1. Adequacy of net worth given the risk profile of the credit union;
2. Quality and sources of the earnings structure;
3. Fit with the overall strategies of the credit union;
4. Future direction of earnings performance and adequacy of budget process;
5. Adequacy of the Allowance for Loan and Lease Losses; and
6. Ability of the credit union to realize an adequate level of earnings in a safe and sound manner.

Conclusion.   NCUA did us a favor by publishing this.  If an examiner hammers you for low earnings and points to nothing more than the lower earnings or the ratios that result, this guidance should be mentioned.  Examiners were told to dig beneath the ratios to truly understand what was happening.  And more than once, NCUA urged examiners to maintain healthy lines of communication.   With that communication, credit unions should be able to explain exactly what is affecting earnings and whether they are adequate, given the entire picture.