Risk Management and Value Valuation and Asset Pricing

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					                               Interest Rate Risk (IRR) Review Questionnaire

Charter:                                              12345
CU Name:                                              ABC FCU
Examiner:                                             J. Smith
Effective Date:                                       10/31/2000

The Interest Rate Risk Questionnaire (IRRQ) is designed to be flexible, yet comprehensive. When there is little
evidence of interest rate risk (IRR), the scope will be narrowed and focused on a general review of the credit
union's ALM program. When there is greater likelihood of IRR, you will extend the scope to investigate and review
the ALM program in depth.

The following questions will guide you through the process.
                                                INITIAL ASSESSMENT
                                                        Y/N                               COMMENTS
Does the credit union have any loans secured by
real estate, or any complex investments?

                                         If “No” complete only Part A

                                  If “Yes," skip Part A, and go to Part B

                                                           PART A
                                                         Y/N                              COMMENTS
1. Does the credit union have policies
addressing ALM practices?
2. Do the officials monitor the credit union's
exposure to interest rate risk on a periodic basis?

3. Are there any future events forecasted by the
credit union that may have a material impact on
the balance sheet structure (e.g., new loan,
share, or investment strategies, merger,
aggressive growth strategy)?

                                          STOP--Part A is concluded.




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                                Interest Rate Risk (IRR) Review Questionnaire


                                                           PART B
12345
ABC FCU
J. Smith
10/31/00

                                                 Y/N                                       COMMENTS
1. After conducting an asset valuation using
the 17/4 method for mortgages and the
shocked valuation for securities, what is the
shocked net worth ratio (refer to the Asset
Valuation worksheet for calculation)?

2. Does the shocked net worth ratio fall
below 4.0 percent?
3. Does the shocked net worth decline more
than 50% from the book value net worth?



If the answers to both questions 2 & 3 are “No," complete Part C and skip Part D.
If the answer to either question 2 or 3 is “Yes," calculate the adjusted net capital ratio
using the OIS Pricing Tables.
                                                 Y/N                                       COMMENTS
4. After conducting an asset valuation
using the OIS Pricing Tables method for
mortgages and the shocked valuation for
securities, what is the shocked net worth
ratio (refer to the Asset Valuation worksheet
for calculation)?
5. Does the shocked net worth ratio fall
below 4.0 percent?
6. Does the shocked net worth decline
more than 50% from the market value net
worth?

If the answers to both questions 5 & 6 are “No," complete Part C and skip Part D
If the answer to either question 5 or 6 is “Yes," skip Part C, and complete Part D




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                              Interest Rate Risk (IRR) Review Questionnaire


                                                             PART C
12345
ABC FCU
J. Smith
10/31/00

For each question, the corresponding section of Part D is provided as a reference. At your option,
you may refer to Part D to gain a more comprehensive understanding of a particular area of
review. For example, you may review Step 1 of Part D to better understand the expected scope
and depth of ALM policies.

ALM Policies Review – Step 1                        Rating                                COMMENTS
1. Are the credit union’s policies addressing
interest rate risk management Adequate or
Inadequate?
ALM Planning Review – Step 2                       Rating                                 COMMENTS
2. Is there an Adequate or Inadequate
degree of integration between interest rate risk
management and planning?

Respond to questions 4, 5, or 6 if the credit union has an ALCO (or similar committee) or measures interest rate
risk (IRR) using a model (even if outsourced). Smaller credit unions (e.g., < $10 million in assets) and credit
unions with minimal holdings of real estate loans and complex investments may not need an ALCO or model to
effectively manage their risk. You must determine if the absence of these functions materially impairs the credit
union's ability to manage its IRR exposure. If you determine their absence will be material, address your
concerns in the appropriate section below (e.g., question 4, 5 or 6).


ALCO Review – Step 3                               Rating                                 COMMENTS
3. Is the ALCO’s oversight of the credit
union’s ALM program Adequate or
Inadequate?
ALM Program Staff Review – Step 4                  Rating                                 COMMENTS
4. Is the ALM person’s ability to generate
sound and reasonable IRR measurement
results Adequate or Inadequate?
IRR Measurement Review – Step 5                    Rating                                 COMMENTS
5. Is the credit union’s IRR measurement
process Adequate or Inadequate?
                                                   Rating                                 COMMENTS
Conclusion
6. Is the quality of interest rate risk
management Adequate, or Inadequate?
                                         STOP -- Part C is concluded




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                                  Interest Rate Risk (IRR) Review Questionnaire


                                                               PART D
12345
ABC FCU
J. Smith
10/31/00


Complete each of the Steps below. Each Step consists of two Sections. Section I summarizes whether the
particular area of review is acceptable. Section II asks questions to support the rating assignment (e.g., Weak or
Adequate) in Section I. Accordingly, both Section I and Section II must be completed for each Step, unless the
question does not apply to the credit union (e.g., the credit union has not established an ALCO).


                                              STEP 1 – ALM POLICIES REVIEW
Section I                                                   Rating                            COMMENTS
Are the credit union’s policies addressing interest
rate risk management Adequate or Inadequate?

Section II                                                                                    COMMENTS
1. Are the credit union's policies written?
2. If so, when were the policies last reviewed and
approved by the board?
3. Are the policies clear, specific and tailored to the
credit union?
4. Who has the primary responsibility for
implementing the ALM policy?
5. If an ALCO exists, what are its primary
responsibilities?
6. Does the policy address internal controls governing
the ALM process?
7. Does the policy establish IRR measures and limits
expressed in terms of GAP, earnings (i.e., NI, NII),
capital (i.e., mortgage shock, investment shock,
change in NEV) or a combination of these?
8. Does the policy establish IRR limits based on a
stressed interest rate environment (e.g., shock test)?
If so, what is the basis for the stressed interest rate
environment?
9. What are the IRR limits? Do they represent
reasonable controls?
10. Do the limits address short-term and long-term
IRR exposure?
11. How often is IRR measured?
12. Have the policy limits been exceeded since the
previous examination? If so, was performance
brought back within limits in a reasonable time?
13 How often are interest rate risk reports required to
be provided to officials?
14. Does the policy require timely reporting and action
time frames when a limit is exceeded?




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                                   Interest Rate Risk (IRR) Review Questionnaire


                                              STEP 2 – ALM PLANNING REVIEW
Section I                                                      Rating                           COMMENTS
Is there an Adequate or Inadequate degree of
integration between interest rate risk
management and planning?
Section II
PLANNING-General                                                                                COMMENTS
1. What changes in the share/liability portfolio
structure are expected that have potentially high IRR
implications (e.g., non-member shares, high rate
money market accounts, minimal early withdrawal
penalties on CDs)?
2. What changes in the loan portfolio structure are
expected that have potentially high IRR implications
(e.g., long maturities [>5 years], prepayment risk, non-
conforming real estate loans)?


3. What changes in the investment portfolio structure
are expected that have potentially high IRR
implications (e.g., lengthening maturities, inverse
floaters, dual-index floaters, callable securities)?
4. What future events are forecast by management
that may have a material impact on the balance
sheet’s structure (e.g., merger, aggressive growth
plans, sponsor layoff or restructure)?
PLANNING - Detailed                                                                             COMMENTS
1. Has the credit union demonstrated it incorporates
ALM into its strategic plan?
     a) Do the ALCO members participate in strategic
     plan development?
     b) Does the strategic plan identify and measure
     potential interest rate risks?
     c) Are projections or ‘what if’ scenarios run to
     analyze the future IRR implications of new
     products or changes in the investment portfolio
     structure?
     d) Are projections or ‘what if’ scenarios run to
     analyze the future IRR implications of potential
     events?
     e) What were the results of the analysis?
2. Does the credit union conduct periodic
assessments to compare actual performance with
prior plans?




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                                  Interest Rate Risk (IRR) Review Questionnaire


                                                   STEP 3 – ALCO REVIEW
Section I                                                     Rating                           Comments
Is the ALCO’s oversight of the credit union’s ALM
program Adequate or Inadequate?
Section II
ALCO Minutes
1. Are minutes prepared?
2. Do the minutes reflect the ALCO is meeting as
often as required by the policy?
3. What types of decisions and discussions are
documented in the minutes?
     a. At each meeting, is there evidence the ALCO
     evaluates the credit union’s IRR exposure, and
     compares the results to the ALM policy limits?

     b. Is there evidence that contingency plans were
     developed when risk thresholds were approached
     or exceeded?
     c. Does the ALCO determine whether the
     current risk measurement system adequately
     evaluates the credit union’s IRR and liquidity risk
     exposures?
ALCO Review
1. Who are the current ALCO members and what
staff or board positions do they hold?
2. Does the composition of the ALCO include
persons who are knowledgeable about interest rate
risk?
3. What training was provided to ALCO members
since the prior examination?
4. What control does the ALCO maintain over the
interest risk measurement system?
     a.     Does it participate in developing model
     assumptions?
     b.     Does it evaluate alternatives to the current
     risk measurement system?
5. Does the ALCO receive adequate information to
reasonably assess the quantitative exposure to IRR
and liquidity risks?
6. Can the ALCO explain the results of the output
reports and how it uses them?
7. What changes in the ALM process would the
ALCO recommend to improve the risk management
function?




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                                 Interest Rate Risk (IRR) Review Questionnaire


                                   STEP 4 – ALM PROGRAM STAFF REVIEW

The following questions apply to credit unions with in-house risk measurement models and those that outsource
the responsibility to a vendor. In either case, the risk measurement results are dependent upon assumptions.
Failure to understand how the results are derived, or how they may be influenced, can lead to misinterpretation of
the output or inaccurate data input.

Section I                                                   Rating                           Comments

Is the ALM person’s ability to generate sound
and reasonable IRR measurement results
Adequate or Inadequate?
Section II
1. What are the experience and background of the
person(s) charged with determining the model
assumptions and interpreting the output (i.e., ALM
program person)?
2. What is the ALM program person's level of
understanding of the credit union’s risk measurement
model?
3. If model defaults are used, has the ALM program
person determined if the defaults are appropriate for
the credit union's balance sheet?
4. What periodic training on contemporary ALM
concepts does the ALM program person attend?
5. What periodic training on the model does the ALM
program person attend?
6. Are the ALM program person’s duties limited to
conducting risk measurement analysis, or is the
person also assigned decision-making responsibilities
that could affect risk performance (e.g., making
investment or share dividend decisions)?

7. Who is the back-up ALM program person and
what training has been provided on the model being
used?
Risk Measurement Review
1. Who evaluated the reasonableness of the risk
measurement system inputs and assumptions? Was
it someone other than the ALM program person?

2. Is the reviewer knowledgeable about ALM and the
credit union's risk measurement system?
3. What steps were taken to determine the input and
assumptions were reasonable?
4. What recommendations, if any, were made?
5. Have the recommendations been implemented? If
not, why?
6. What internal controls have been established to
ensure the risk measurement input accurately reflects
the credit union’s financial data?
7. What steps does the credit union take to ensure
results can be compared between periods?
     a.    Are assumptions documented?
     b.    Are users of the results (e.g., ALCO and
     board) made aware of changes in key
     assumptions?




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                                   Interest Rate Risk (IRR) Review Questionnaire


                                        STEP 5 – IRR MEASUREMENT REVIEW

Note: Reviewing a model’s capabilities and the assumptions driving a model requires a
comprehensive understanding of the risk measurement system. This process can be complex.
Complete the following questions after discussing the risk measurement process with the ALM
Program Person. If you find that the degree of model and/or user sophistication exceeds your ability
to determine whether the model system reasonably measures interest rate risk, you should consult
with your supervisor to seek additional assistance (e.g., request assistance by the Regional Capital
Market Specialist).


Section I                                                      Rating                               Comments
Is the degree of measurement precision and
accuracy Adequate or Inadequate (based on how
the model is being used, not simply the model’s
capabilities)?
Based on the credit union’s IRR measurement
tool, is IRR exposure Low, Moderate, or High?

Section II
GENERAL
1. What measurement methodology is used (e.g.,
GAP, earnings simulation, NEV)?
2. Based on the complexity of the balance sheet, is
the measurement method appropriate for measuring
short- and long-term risks?
3. What model does the credit union use to measure
IRR?
INPUT                                               The following questions apply to GAP, earnings-based (NI/NII simulation) and
                                                           economic value models (NEV/asset valuation), unless specified otherwise.
1. What is the rate shock scenario used to measure
interest rate risk?
2. Does the credit union sufficiently stratify assets by
type and characteristic?
3. For amortizing accounts (e.g., real estate and
commercial loans, and mortgage-related investments
[CMOs and mortgage pass-throughs]), how does the
credit union account for estimated prepayments?

     a. If the credit union accounts for prepayments
     on amortizing accounts, is the prepayment data
     current?
     b. Are the prepayment estimates reasonable
     and supported by documentation?
     c. Do prepayment assumptions change during
     different interest rate cycles?
4. Do callable investment cash flows correlate with
the call date in falling rate shocks scenarios?
5. Do certificate cash flows account for early
withdrawals by members in rising rate scenarios?
6. Do borrowing cash flows account for calls by the
lender in rising rate scenarios?
7 How does the credit union treat nonmaturity share
account cash flows (e.g., what maturity is assigned)?




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                                  Interest Rate Risk (IRR) Review Questionnaire

GAP ANALYSIS
(This section need not be completed if the credit union performs earnings simulation, asset valuation or NEV analysis)

1. Does the credit union calculate GAP on a
cumulative or periodic basis?
2. What is the current one-year GAP ratio?
3. Is the GAP ratio in compliance with the policy
limits?
EARNINGS SIMULATION
1. Does the credit union accurately capture the
repricing intervals of accounts? Specifically;
     a. Are periodic and lifetime caps and floors
     reflected in variable rate accounts?
     b. Are rate sensitivity assumptions for
     nonmaturity share accounts reasonable and
     supportable?
     c. Does the credit union account for lagging
     indices (e.g., COFI)?
2. Is the balance sheet shocked ‘as is’, or are future
growth assumptions incorporated into the results?

3. Over what time horizon is the shocked earnings
computed?
4. What are the results of the earnings simulation
analysis?
5. Are the earnings simulation results in compliance
with the policy limits?
ASSET VALUATION
1. What assets does the credit union include in the
asset valuation?
2. How are real estate loans valued?
3. How are investments valued (e.g., through
Bloomberg or CMS BondEdge, other)?
4. How do the results from the credit union’s asset
valuation compare to the estimates from the asset
valuation calculated in Part B?
5. What are the current results of the most recent
asset valuation conducted by the credit union?


6. Are the asset valuation results in compliance with
the policy limits?
NEV
1. What serves as the basis for valuing accounts
(e.g., discounted cash flows or third party information
providers)?
2. If values are based on discounted cash flow
analysis, how does the credit union determine the
discount rates?
3. How does the credit union value nonmaturity
shares?
4. What are the current results of the most recent
NEV analysis conducted by the credit union?
5. Are the NEV results in compliance with the policy
limits?




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                               Interest Rate Risk (IRR) Review Questionnaire


                                                      CONCLUSION
Section I                                                Rating
6. Is the quality of interest rate risk management
Adequate, or Inadequate?




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