02-1682. Evaluation of Credit Union Non-Maturity Deposits; Request for Comments

AGENCY:

National Credit Union Administration (NCUA).

ACTION:

Request for comments.

SUMMARY:

NCUA is soliciting public comment on a study by National Economic Research Associates (n/e/r/a), titled “The Evaluation of Credit Union Non-Maturity Deposits.” NCUA intends to consider whether to use the study to prepare examiner guidance on the appropriate treatment of these instruments in the assessment of interest rate risk.

DATES:

Comments must be received on or before April 24, 2002.

ADDRESSES:

Direct comments to Becky Baker, Secretary of the Board. Mail or hand-deliver comments to: National Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 22314-3428. You may fax comments to [phone], or e-mail comments to [e-mail]. Please send comments by one method only.

FOR FURTHER INFORMATION CONTACT:

Jeremy Taylor, Senior Investment Officer, Office of Investment Services, at the above address or telephone [phone]; or Dan Gordon, Senior Investment Officer, Office of Investment Services, at the above address or telephone [phone].

SUPPLEMENTARY INFORMATION:

A. Background

NCUA commissioned n/e/r/a, an economics-consulting firm, to complete a study of methods to value non-maturity shares. The study has been completed and is available following the text of this Request for Comments on the NCUA website at http://www.ncua.gov/​news/​draftboardactions/​BAM-01-12-13-6.pdf. Alternatively, to get to the study from the NCUA website (www.ncua.gov), select News, then Proposed Rules, then select on the page that follows, Request for Comments “The Evaluation of Credit Union Non-Maturity Deposits.” It can also be obtained in hard copy by requesting it from the Office of Public and Congressional Affairs, 1775 Duke Street, Alexandria, Virginia, 22314-3428, telephone number [phone].

NCUA believes the majority of credit unions would not be affected by the results of the n/e/r/a study, either because their interest rate risk profile is limited, or because they treat shares at par value for interest rate risk measurement purposes. This study will be most relevant to those institutions that assume non-maturity shares materially mitigate the risk of a high level of long-term assets.

Non-maturity shares include share drafts, regular shares and money market share accounts. Non-maturity shares may provide mitigation of interest rate risk to the extent they are a stable, low cost source of funds. Non-maturity shares have uncertain cash flows. This is because they have no contractual maturity and the dividends are set by the credit unions. Therefore, in interest rate risk assessment, credit unions must make assumptions on these cash flows.

NCUA in its asset liability review questionnaire provides guidance to examiners in establishing a scope for their review of a credit union's asset liability management (ALM), including assessment of interest rate risk. However, the questionnaire does not provide a framework for examiner review of non-maturity share assumptions.

The n/e/r/a study contains a comprehensive review of the literature on valuing non-maturity deposits. It provides a conceptual evaluation of alternative methods, with an analysis of the costs and benefits of these methods. The study discusses implementation issues for NCUA and credit unions, and provides recommendations for the most suitable valuation approaches to meet NCUA and credit union needs. The study proposes effective maturities that may reasonably be used for credit union shares where the cash flows are not explicitly documented and modeled by the credit union. The study proposes a method to value these shares, and discusses the appropriate discount rate for these funds. The characteristics of credit union shares, and their differences from bank depository funds, are included in the discussion. Recommendations are also provided where credit unions analyze their cash flows from these shares.

The n/e/r/a study may be useful in evaluating net economic value (NEV) analysis. NEV analysis measures the potential effect of changes in interest rates on net economic value (NEV). NEV means the fair value of assets minus the fair value of liabilities. Valuation techniques used to estimate fair values require assumptions about maturities and interest rates to calculate the present value of cash flows of non-maturity shares. As with gap analysis and review of income simulation models, examiners judge whether these assumptions are reasonable.

B. Areas for Comment

When its analysis of the n/e/r/a study is completed, NCUA will likely use the conclusions to provide guidance for examiner ALM scope determination and evaluation of credit union interest rate risk models and consider what should be the next stage in the evaluation of these issues. NCUA desires to identify reasonable methods for assumptions, valuation techniques and estimated values for non-maturity shares.

NCUA is soliciting comments on the study. Specifically, the agency is interested in comment on the following issues.

(1) Provide specific comments on the study. If there are points with which you disagree or you believe are incorrect, provide both the specific citations in the study and the support for your conclusion.

(2) NCUA is considering establishing a “safe harbor” for non-maturity share assumptions, such as a maturity of 1.0 year for money market shares, 2.5 years for regular shares, and 3.0 years for share drafts. Examiners would judge these, or shorter, terms to be acceptable maturity assumptions for non-maturity shares. Please comment on whether this approach is reasonable.

(3) The characteristics of a non-maturity account, not its labeling, are important determinates of value. For example, two credit unions may have accounts labeled regular shares: the first credit union may rarely change the interest rate; in contrast, the second may reset the rate frequently, similar to a money market share account at the first credit union. What documentation, if any, would be appropriate to use “safe harbor” assumptions?

(4) A credit union might choose to use its own empirical analysis to demonstrate a risk mitigation value larger than a “safe harbor” assumption. NCUA examiners would expect a statistically valid empirical analysis to justify such values. Should NCUA use the validation guidelines addressed in Chapter VIII of the report? If not, please provide alternative guidelines you believe are appropriate and provide evidence to support your recommendation.

(5) Is there background information from sources other than those covered in the n/e/r/a study that NCUA should consider? Please indicate the source of the information and the results. If possible, provide complete copies of the studies or the analysis.

(6) NCUA is contemplating whether to conduct an empirical study of credit union non-maturity share behavior. Please provide specific recommendations on what should be included in such a study.

(7) Are there other considerations in the valuation of shares, beyond those discussed in the n/e/r/a study, which should be taken into account?

By the National Credit Union Administration Board on December 13, 2001.

Becky Baker,

Secretary of the Board.