From CAMEL to CAMELS

No. You won’t have multiple camel ratings, but there will be an S at the end of the NCUA’s new CAMELS rating system, which went into effect on April 1, 2022. CAMELS is an acronym for:

Capital Adequacy
Asset Quality
Management
Earnings
Liquidity
Sensitivity to Market Risk

What’s New?

Most credit unions should be intimately familiar with the first 5 letters of the rating system. The addition of the “S” reflects the Sensitivity to Market Risk of a credit union’s current and prospective earnings and economic capital arising from changes in market prices and interest rates.

The addition of the “S” is primarily in response to the imminent interest rate hikes the Fed plans in 2022. This piles onto the current guidance, which already includes the requirement that examiners assess the amount and direction of exposure to Interest Rate Risk.

What Does it Mean?

I would think of this as the NCUA doubling down on its commitment to review a credit union’s interest rate risk and interest rate risk monitoring policies. Previously a component of each individual grade on the CAMEL scale, the NCUA has deemed it significant enough to be rated on its own.

Why?

With rapidly changing rates in 2022 expected to continue throughout the year and into 2023, interest rate risk is one of the key threats to creating concentration risk.

When interest rates go up, all else equal, credit unions that have a large proportion of fixed rate, long-term assets will be impacted more negatively than others. Given the increase in credit union mortgage portfolios over the past several years, the potential affect of increasing rates is exacerbated.

How can credit unions Prepare?

Monitoring and managing sensitivity to market risk is something that you should already be doing. However, you should review your documentation and procedures, along with your concentration limits. What does your policy say that you’ll do if you breach a particular limit? If you have breached that limit, are you taking appropriate action?

There are times when you engage in exercises to satisfy regulatory requirements, and times when you practice them because it’s important. If you haven’t already, I would agree with examiners that evaluating how changes in interest rates impact your credit union. Here are a few ways you’ll be impacted:

Specific Interest Rate Risks

Net Interest Income(NII) is impacted if the income you’re earning on your assets goes up less than the additional costs you’re incurring on your liabilities.

Net Economic Value (NEV) is impacted if the value of your assets decreases by less than the value of your liabilities. Impacts to NII and NEV are generally correlated, with the change in NEV being more significant.

Other Market Risks

While changes in the market value of assets and liabilities is the most obvious risk of rising rates, interest rate increases have a number of other unfortunate impacts. When rates go up…

• Companies borrow more and economic growth slows. This generally means slower wage growth and increases in unemployment rates.
• Variable rate payers experience payment shock as the payments on their loans reprice.
• Purchasing power from new home or vehicle buyers is reduced, putting downward pressure on demand and prices.

While the economy seems to have avoided any long-term adverse impacts from COVID-19, increasing interest rates has it feeling as if we’re stepping out of the frying pan into the fire.

Threats come at you from a variety of angles. Balance sheet diversification is key in keeping your concentrations of risk at bay, and data analysis is a valuable tool in your Asset/Liability Management toolkit.