Dear Boards of Directors and Chief Executive Officers:
This letter outlines the NCUA’s supervisory priorities and other updates to the agency’s examination program for 2023. Our focus will be on the areas posing the highest risk to credit union members, the credit union industry, and the National Credit Union Share Insurance Fund (Share Insurance Fund).
The NCUA will conduct examination and supervision activities both onsite and offsite, as appropriate. Examiners will continue to conduct some examination activity offsite when the activity can be completed efficiently and effectively at credit unions that can accommodate offsite work.
The agency’s exam flexibility initiative will continue in 2023, which establishes an extended exam cycle for certain credit unions.1 The NCUA will also continue our Small Credit Union Exam Program in most federal credit unions with assets under $50 million. For all other credit unions, NCUA examiners will use the agency’s risk-focused examination procedures.
Below are the NCUA’s primary areas of supervisory focus in 2023.
Supervisory Priorities for 2023
Interest Rate Risk
Interest rates rose significantly across the yield curve during 2022, elevating interest rate risk (IRR) and the related exposure to earnings and capital. This sharp rise in rates has amplified market risk because a credit union’s assets and liabilities do not reprice equally, potentially impacting net economic values and credit unions’ projected earnings.
In September 2022, the NCUA issued Letter to Credit Unions 22-CU-09, Updates to Interest Rate Risk Supervisory Framework, and Supervisory Letter 22-01, Updates to Interest Rate Risk Supervisory Framework, updating the NCUA supervisory framework for IRR.
With the April 2022 addition of the Sensitivity to Market Risk, or “S,” component to the CAMELS rating system, the agency has formalized the focus on IRR as a specific rating category separate from liquidity risk.
High levels of IRR can increase your credit union’s liquidity risks, contribute to asset quality deterioration and capital erosion, and put pressure on earnings.
Well-managed credit unions are prudent and proactive in managing IRR and the related risks to capital, asset quality, earnings, and liquidity. As such, examiners will review your credit union’s IRR program for the following key risk management and control activities:
- Key assumptions and related data sets are reasonable and well documented.
- The credit union’s overall level of IRR exposure is properly measured and controlled.
- Results are communicated to decision-makers and the board of directors.
- Proactive action is taken to remain within safe and sound policy limits.
Higher interest rates have caused a slowdown in prepayments for some loans and investment holdings, which has resulted in reduced cashflows. Large increases in share balances from 20202022 may result in an increased level of share sensitivity and share roll off as market rates continue to rise.
In evaluating the “L” component of the CAMELS rating to determine the adequacy of your credit union’s liquidity risk management framework, examiners will consider the current and prospective sources of liquidity compared to funding needs. Examiners will review your credit union’s liquidity policies, procedures, and risk limits. Examiners will also evaluate the adequacy of your credit union’s liquidity risk management framework relative to the size, complexity, and risk profile of your credit union.
Examiners will assess liquidity management by evaluating:
- The potential effects of changing interest rates on the market value of assets and borrowing capacity.
- Scenario analysis for liquidity risk modeling, including possible member share migrations (for example, shifts from core deposits into more rate-sensitive accounts).
- Scenario analysis for changes in cash flow projections for an appropriate range of relevant factors (for example, changing prepayment speeds).
- The appropriateness of contingency funding plans to address any plausible unexpected liquidity shortfalls.
Resources and guidance on liquidity risk can be found in the NCUA’s Examiner’s Guide.
Credit risk is a supervisory priority for 2023 as high inflation and rising interest rates are putting financial pressure on credit union members. High inflation and the increasing likelihood of an increase in unemployment rates could negatively impact borrowers’ ability to repay outstanding debt. Rising interest rates could also result in higher loan payments for borrowers.
NCUA examiners will review the soundness of existing lending programs, any adjustments your credit union made to loan underwriting standards and portfolio monitoring practices, and loan workout strategies for borrowers facing financial hardships. NCUA examiners will carefully consider all factors in evaluating your credit union’s efforts to provide relief for borrowers, including whether the efforts were reasonable and conducted with proper controls and management oversight.
For more information and additional resources, see the following:
- Press release, Agencies Issue Interagency Policy Statement on Allowances for Credit Losses and Interagency Guidance on Credit Risk Review Systems
- NCUA Letter to Credit Unions 20-CU-13, Working with Borrowers Affected by the COVID-19 Pandemic
- NCUA Letter to Credit Unions 14-CU-08, Home Equity Lines of Credit Nearing Their End-of-Draw Period
- NCUA Letter to Credit Unions 10-CU-07, Commercial Real Estate Loan Workouts
- NCUA Letter to Credit Unions 10-CU-03, Concentration Risk
- NCUA Letter to Credit Unions 07-CU-06, Working with Residential Mortgage Borrowers
- NCUA Letter to Credit Unions 03-CU-01, Loan Charge-off Guidance
Fraud Prevention and Detection
Fraud risks remain elevated. As such, the NCUA will continue our efforts to review internal controls and separation of duties. In 2023, the agency will also implement a management questionnaire designed to enhance the identification of fraud red flags, material supervisory concerns, or other potential new risks to which your credit union may be exposed.
This questionnaire will help protect credit unions and reduce potential losses to the Share Insurance Fund. The questionnaire will be sent to credit unions in the pre-examination planning stage for all full-scope exams along with the Items Needed List, including on joint exams with State Supervisory Authorities (SSAs). Credit unions only need to complete one questionnaire per examination. If an SSA uses a similar questionnaire, the federal and state examiners will coordinate to decide which questionnaire the credit union will complete to reduce duplication.
Credit unions will typically receive the questionnaire through MERIT’s survey function, and the credit union CEO or another senior executive will complete, sign, and then return the questionnaire through MERIT’s survey function. Examiners will review the credit union’s responses in the pre-examination planning process to refine the scope of the examination, as appropriate.
For more fraud prevention resources, visit the NCUA’s Fraud Prevention Resources page.
Information Security (Cybersecurity)
Cybersecurity risks remain a significant, persistent, and ever-evolving threat to the financial system. Credit union technology-related operating environments are increasing in complexity. Your credit union can protect itself with a cybersecurity program that evolves and adapts to the changing threat environment.
The NCUA will continue to have cybersecurity as an examination priority. Examiners will evaluate whether credit unions have established adequate information security programs to protect members and the credit union. To strengthen the examination process for cybersecurity, the NCUA developed and tested updated Information Security Examination procedures tailored to institutions of varying size and complexity. Examiners will use these new procedures in 2023.
Additionally, credit unions are encouraged to remain very vigilant and continue to adapt their ability to respond to evolving cybersecurity threats. Your credit union may conduct voluntary, cybersecurity self-assessments using the Automated Cybersecurity Evaluation Toolbox. The toolbox works in coordination with and will prepare you for an Information Security Examination.
For more cybersecurity information and resources, including the new examination procedures, visit the NCUA’s Cybersecurity Resources webpage.
Consumer Financial Protection
The NCUA will continue to review compliance with applicable consumer financial protection laws and regulations for federal credit unions that the NCUA has under its consumer financial protection supervision authority. Examiners will continue to review your credit union’s compliance with Flood Disaster Protection Act requirements, including disclosure requirements, as we continue to evolve our understanding of the impact of climate-related financial risk on credit unions, credit union members, and the Share Insurance Fund.
Examiners will also consider trends in violations identified through examinations and member complaints, emerging issues, and any recent changes to regulatory requirements to establish priorities. Accordingly, in 2023 examiners will focus on areas related to:
- Overdraft programs.
- Fair lending, including review of residential real estate appraisals for any bias.
- The Truth in Lending Act.
- The Fair Credit Reporting Act.
In 2022, examiners requested information about a credit union’s policies and procedures governing its overdraft programs. In 2023, examiners will expand the review of credit unions’ overdraft programs, including website advertising, balance calculation methods, and settlement processes. The NCUA will also evaluate any adjustments credit unions have made to their overdraft programs to address consumer compliance risk and potential consumer harm from unanticipated overdraft fees.
Regarding fair lending, examiners will review policies and practices for steering or loan pricing discrimination risk factors.2 In addition, examiners will assess a credit union’s policies and practices related to residential real estate appraisals and conduct a tailored file review to evaluate the consistency, fairness, and accuracy of the appraisals a credit union obtains.
Examiners will additionally evaluate compliance with Truth in Lending Act requirements and disclosures related to auto lending for certain credit unions that have experienced high auto loan growth over the past year. Examiners will also review credit reporting protections under the Fair Credit Reporting Act related to furnishing, adverse action notices, risk-based pricing, and consumer rights disclosures.
Current Expected Credit Loss Implementation
Credit unions are required to implement the Financial Accounting Standards Board’s Accounting Standards Update No. 2016-13, Topic 326, Financial Instruments – Credit Losses, commonly referred to as Current Expected Credit Loss (CECL) for financial reporting years starting after December 15, 2022. Most credit unions adopted CECL on January 1, 2023.
Under the NCUA’s CECL Transition Rule, federally insured credit unions with assets of less than $10 million are generally not required to implement CECL. For credit unions below this threshold, the rule requires “any reasonable reserve methodology (incurred loss), provided it adequately covers known and probable loan losses.”3 Federally insured, state-chartered credit unions should refer to state law on Generally Accepted Accounting Principles (GAAP) requirements and CECL standard applicability, as those requirements may be more restrictive.
Examiners will evaluate the adequacy of your credit union’s Allowance for Credit Losses (ACL) on loans and leases by reviewing:
- ACL policies and procedures.
- Documentation of an ACL reserving methodology, including logic for model selection and related input data, modeling assumptions, and qualitative adjustments.
- Adherence to GAAP (if applicable).
If your credit union’s ACL is independently reviewed by the Supervisory Committee or an internal or external auditor, examiners will also consider the results of that review as part of their evaluation.
As applicable, examiners may also review your credit union’s adjustment to undivided earnings (retained earnings) in relation to the CECL Transition Rule.
A variety of CECL resources are available for credit unions, including:
- FASB’s Accounting Standards Update 2016-13, Topic 326, Financial Instruments – Credit Losses
- FASB Staff Q&A, Topic 326, No. 1: Whether the Weighted-Average Remaining Maturity Method Is an Acceptable Method to Estimate Expected Credit Losses
- FASB Staff Q&A, Topic 326, No. 2: Developing an Estimate of Expected Credit Losses on Financial Assets
- NCUA Letter to Credit Unions 17-CU-05, Frequently Asked Questions on the New Accounting Standard on Financial Instruments Credit Losses
- NCUA Letter to Credit Union 22-CU-10, Simplified CECL Tool for Credit Unions
The credit union system continues to experience an ongoing trend of consolidation. The NCUA has found that inadequate succession planning is often a reason for credit union consolidations, especially in smaller credit unions. Succession planning can be critical to the continued operation of credit unions, especially those with senior leaders who may be retiring soon. A credit union’s failure to plan for the transition of its management and board officials could come with high costs. Conversely, good succession planning confers a variety of benefits, including ensuring organizational viability over the long term.
During 2023, examiners will request information about a credit union’s approach to succession planning for senior leaders, including any written succession plan the credit union has established. This information will help the NCUA further understand succession planning activities and needs in the credit union system.
Examiners will not evaluate this information or any formal or informal succession plans developed by credit unions beyond what would normally be considered in assigning the Management component of the CAMELS rating.4 Also, examiners will not issue an Examiner’s Finding or Document of Resolution if the credit union has not conducted succession planning, or the planning is not adequate, unless the credit union is in violation of its own policy for conducting succession planning or administering any such plan(s).
Support for Small Credit Unions and Minority Depository Institutions
In 2023, the NCUA will continue its Small Credit Union and Minority Depository Institutions (MDIs) support program, which the agency implemented in 2022 to support and preserve these credit unions. Credit unions with less than $100 million in assets and MDIs are uniquely positioned to improve the financial well-being of underserved communities by offering their members access to safe, fair, and affordable credit and other financial services and products. The NCUA’s program focuses assistance on identifying available resources, providing training and guidance, and supporting credit union management in their efforts to address operational matters. We expect the additional benefits of the program to include:
- Greater awareness of the unique needs of small credit unions and MDIs and their role in serving underserved communities.
- Expanded opportunities for these credit unions to receive support through NCUA grants, training, and other initiatives.
- Furthering partnerships with organizations and industry mentors that can support small credit unions and MDIs.
Additionally, the agency has developed MDI-specific exam procedures to guide examiners during their supervision of MDIs. Preserving small credit unions and MDIs is fundamental to the NCUA’s mission.
Credit union feedback helps the NCUA evaluate the effectiveness of our examination processes and improves communication with credit unions. In September 2021, the NCUA initiated a post-examination survey pilot to gather feedback on examinations. In addition to pilot survey responses, the NCUA has conducted focus groups comprised of senior credit union staff and NCUA examination staff to gather input. In 2023, the NCUA will update the post-examination survey to continue obtaining feedback from credit unions on their NCUA examinations. As a reminder, federal credit unions may record their exam exit meetings provided they comply with applicable laws and regulations for recording and provide a copy of the recording to the NCUA. These recordings can be useful to both credit unions and the NCUA. NCUA examiners will agree to the recording of the exam exit meetings, and the NCUA will monitor how often exam exit meetings are recorded.
The NCUA will continue our ongoing enhancements to how the agency supervises and supports your credit union and its members as the agency adopts innovations and incorporates efficiencies in our exam program. The NCUA’s primary mission of protecting the system of cooperative credit and its member-owners through effective chartering, supervision, regulation, and insurance can only be achieved by adapting to technological and economic changes.
Should you have any questions about the NCUA’s supervisory priorities for 2023, please contact your NCUA examiner or regional office.
Todd M. Harper