CFO Focus: A Heads Up about NCUA’s NEV Supervisory Test

c. myers corporation

6 minutes

Preset rate creates surprising results for many. Here’s how to handle it.

This is reprinted with permission from the original.

“Wait…What? My balance sheet structure really hasn’t changed in the last few months, yet the National Credit Union Administration’s net economic value supervisory test now shows that we went from low/moderate risk to high risk, teetering on extreme. Why is there such a dramatic shift in results?”

This is an example of recent conversations we’ve had with credit union CFOs and CEOs. We are seeing this on a larger scale as well. Our first glance at asset/liability management results for March balance sheets shows that on average the current NEV ratio (using NCUA deposit values) has declined roughly 1.6%, and the resulting NEV ratio in a shocked +300 scenario is roughly 1.85% lower. These results will change as more balance sheets come in.

Meanwhile, all the credit unions in this data set made money in the first quarter, adding to their dollars of net worth.  

Our recommendation to them is dig in right now and start messaging with other key stakeholders about why there is such a dramatic difference in results.

It’s a Scoping Tool

Several points that should be included when messaging key stakeholders to provide background, education and knowledge. The NEV supervisory test is a scoping tool to help examiners determine the scope of the exam they will conduct. If the results show extreme risk, it changes from a scoping tool into an action tool.

When will NCUA take action? Refer to page 235 of this document to read more. What you do and your ability to articulate your unique situation can heavily influence how NCUA responds.

The Foundations of the NEV Supervisory Test

As a reminder, the Test uses a combination of available information, credit union assumptions and pre-set values to determine the economic value in the current and +300 basis points environments. More specifically, the supervisory test uses discounted cash flows based on the assumptions of credit unions with assets greater than $500 million, for loans and available information on investments to represent the current economic value of their assets. Given where rates are today, many loan and investment portfolios show a value loss today. For institutions with assets of less than $500 million, the supervisory test assumes all loans at par.

The test also assigns a pre-set value for all non-maturity deposits. As a reminder, the pre-set values for National Market System is 1% for the current rate environment and an additional 4% value in the +300 bps shock.

Caution: Rates have increased, yet the NEV supervisory test still shows the pre-set value of non-maturity shares at 1%. This means that in today’s higher rate environment, your NEV supervisory test takes the hit for asset values declining but does not get the benefit that was applied to NMS as rates were increasing in previous supervisory tests. Therefore, the starting point for the current NEV ratio is much lower in today’s higher-rate environment than previous tests were showing. This is surprising to many key stakeholders, so it’s a critical point to be messaged to and understood by key stakeholders.

This also becomes a head-scratcher for many when looking at the economic value of deposits in their non-supervisory test results. One CFO summed it up by saying:

“I don’t understand. My average rate for my NMS has not changed. It’s 18 bps, and five-year borrowing rates are now over 3%, suggesting my deposits have more economic value, and yet the test does not give us any additional benefit for them.”

How to Prepare

It’s understandable that this is confusing. Yet, the reality is that the NEV supervisory test is likely to get increased attention, so you need to be prepared.  

There are many ways to prepare:

Understand and be able to clearly articulate why the ALM methodologies you use may show differing views on the magnitude and the direction of risk. For example: Most often, static balance sheet analyses show no risk in a rising rate environment. As a matter of fact, for many institutions, earnings increase at a pretty decent clip, especially in later years of the analysis. Read this if you need to review why this methodology would show this.

Evaluate the profitability and potential exposure to net worth, keeping in mind that profitability and net worth can be very different than the assumed value. A business model and plan, both strategic and financial, that demonstrate strong earnings across a range of rates and uncertainty can provide valuable insights on potential actions to consider.

Recognize that most actions to improve supervisory test results will cost earnings, net worth or both, especially if long-term rates don’t increase more or they reverse direction and go back down. Keep in mind that no one, not even the Fed, can accurately predict rates. Remember, the Fed is trying to influence consumer and business behaviors to tame inflation while also not causing a recession. Many are already bracing for a recession, which could cause rates to go back down and further exacerbate the cost of taking action today to address the supervisory test.

Consider expanding your view of the supervisory test +400 basis points/+500 basis points to get an early warning if rates continue to go up.  

Collaborate with key stakeholders to reach consensus on the range of rates for which you want to prepare. Remind them that there is not one right path. Take the time to understand and discuss the implications of yield curve shifts. Make sure to discuss timeframe as well.

Foundation for Decision-Making

This conversation will help immensely in setting the foundation for decision-making and, ultimately, the financial levers you may want to pull. To inform your discussions, use the quantification of your longer-term risks to earnings and net worth with a focus on how much contribution you may need from your new decisions to offset risk and continue to add value to your members and business members. Remember, they will need you to help them through these rough times.

No doubt your conversations will result in numerous possibilities, so prioritize. Run your options through your decision filters to help with prioritization. Then “what-if” the highest priorities to understand the potential financial impact. When you establish your decision filters, make sure to include discussing how to remain relevant to your members and your precious talent.  

Remember, most leaders and stakeholders have never faced the combination of external forces that are in play today. Hunkering down in this environment may not be the best move as the world continues to change at warp speed.  

C. myers helps financial institution decision-makers uncover opportunities and continuously optimize their business models. Their depth and range of experience in linking strategy, talent, desired financial performance and successful execution enables them to work with their clients as strategic collaborators. They have the experience of working with over 600 financial institutions, including 200+ of those over $1 billion in assets. C. myers helps financial institutions think to differentiate and drive better decisions through strategic planning & business model optimizationstrategic solutions and implementationstrategic leadership developmentreal-time ALM and financial forecastingeducation, and thought leadership.  

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